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THE MAINSTAY FUNDS
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STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1998
AS SUPPLEMENTED JULY 27, 1998 AND JANUARY 13, 1999
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The MainStay Funds (the "Trust") is an open-end management investment
company (or mutual fund) currently consisting of twenty-two series, the
following fifteen of which are discussed herein: California Tax Free Fund,
Capital Appreciation Fund, Convertible Fund, Equity Index Fund, Government Fund,
High Yield Corporate Bond Fund, International Bond Fund, International Equity
Fund, Money Market Fund, New York Tax Free Fund, Strategic Income Fund,
Strategic Value Fund, Tax Free Bond Fund, Total Return Fund and Value Fund
(individually or collectively referred to as a "Fund" or the "Funds"). MainStay
Management, Inc. (the "Manager") serves as the manager for the Funds and has
entered into Sub-Advisory agreements with MacKay-Shields Financial Corporation
("MacKay-Shields") the Sub-Adviser for fourteen of the Funds and Monitor Capital
Advisors, Inc. ("Monitor"), Sub-Adviser for the Equity Index Fund.
MacKay-Shields and Monitor are sometimes jointly referred to as the
"Sub-Advisers."
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the Prospectus of the Trust dated May 1, 1998, 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).
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
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addition, you can make inquiries through your registered representative.
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TABLE OF CONTENTS
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STATEMENT OF
ADDITIONAL
INFORMATION
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND..........................................................6
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS....................................................9
Repurchase Agreements...................................................................................9
Lending of Portfolio Securities........................................................................11
Bank Obligations.......................................................................................12
U.S. Government Securities.............................................................................13
Debt Securities........................................................................................13
Convertible Securities.................................................................................14
Arbitrage..............................................................................................15
Foreign Securities.....................................................................................16
Foreign Currency Transactions..........................................................................17
Foreign Index-Linked Instruments.......................................................................21
Brady Bonds............................................................................................21
Municipal Securities...................................................................................22
Industrial Development and Pollution Control Bonds.....................................................27
Variable Rate Demand Notes ("VRDNs")...................................................................28
Floating and Variable Rate Securities..................................................................29
Zero Coupon Bonds......................................................................................29
Standby Commitments -- Obligations with Puts Attached..................................................30
When-Issued Securities.................................................................................31
Mortgage-Related and Other Asset-Backed Securities.....................................................32
Short Sales Against the Box............................................................................42
Options on Securities..................................................................................42
Options on Foreign Currencies..........................................................................49
Securities Index Options...............................................................................52
Futures Transactions...................................................................................53
Swap Agreements........................................................................................64
Loan Participation Interests...........................................................................67
Risks Associated with Debt Securities..................................................................69
Risks of Investing in High Yield Securities ("Junk Bonds").............................................69
HIGH YIELD CORPORATE BOND FUND, STRATEGIC
VALUE FUND AND STRATEGIC INCOME FUND
SPECIAL CONSIDERATIONS.....................................................................................70
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EQUITY INDEX FUND
SPECIAL CONSIDERATIONS.....................................................................................71
TOTAL RETURN FUND
SPECIAL CONSIDERATIONS.....................................................................................72
CALIFORNIA TAX FREE FUND AND NEW YORK TAX FREE FUND
SPECIAL CONSIDERATIONS.................................................................................72
Risk Factors Affecting California Municipal Securities.................................................73
Risk Factors Affecting New York Municipal Securities...................................................85
Special Considerations Affecting Puerto Rico..........................................................102
THE EQUITY INDEX FUND GUARANTEE................................................................................108
FUNDAMENTAL INVESTMENT RESTRICTIONS............................................................................110
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS........................................................................112
TRUSTEES AND OFFICERS..........................................................................................117
THE MANAGER, THE SUB-ADVISERS AND THE DISTRIBUTOR..............................................................125
Management Agreement..................................................................................125
Sub-Advisory Agreements...............................................................................126
Distribution Agreement................................................................................129
Other Services........................................................................................136
Expenses Borne by the Trust...........................................................................138
PORTFOLIO TRANSACTIONS AND BROKERAGE...........................................................................139
NET ASSET VALUE................................................................................................144
SHAREHOLDER INVESTMENT ACCOUNT.................................................................................147
SHAREHOLDER SERVICING AGENT....................................................................................148
PURCHASES, REDEMPTION AND REPURCHASE...........................................................................148
Purchase at NAV.......................................................................................148
Distributions in Kind.................................................................................148
Suspension of Redemptions.............................................................................149
CDSC Waivers..........................................................................................149
TAX-DEFERRED RETIREMENT PLANS..................................................................................150
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Cash or Deferred Profit Sharing Plans Under Section 401(k)
for Corporations and Self-Employed Individuals...................................................150
Individual Retirement Account ("IRA").................................................................150
403(b)(7) Tax Sheltered Account.......................................................................153
General Information...................................................................................153
CALCULATION OF PERFORMANCE QUOTATIONS..........................................................................154
TAX STATUS.....................................................................................................163
Taxation of the Funds.................................................................................163
Character of Distributions to Shareholders -- General.................................................166
Character of Distributions to Shareholders -- The Tax-Free Funds......................................168
Discount..............................................................................................169
Users of Bond-Financed Facilities.....................................................................170
Taxation of Options, Futures and Similar Instruments..................................................170
Passive Foreign Investment Companies..................................................................172
Foreign Currency Gains and Losses.....................................................................173
Commodity Investments.................................................................................174
Dispositions of Fund Shares...........................................................................174
Tax Reporting Requirements............................................................................175
Foreign Taxes.........................................................................................176
State and Local Taxes - General.......................................................................177
Explanation of Fund Distributions.....................................................................178
Additional Information Regarding the Equity Index Fund................................................178
Additional Information Regarding the California Tax Free
Fund and New York Tax Free Fund..................................................................179
Annual Statements.....................................................................................180
General Information...................................................................................181
ORGANIZATION AND CAPITALIZATION................................................................................181
General...............................................................................................181
Voting Rights.........................................................................................182
Shareholder and Trustee Liability.....................................................................182
OTHER INFORMATION..............................................................................................183
Independent Accountants...............................................................................183
Legal Counsel.........................................................................................183
Share Ownership of the Funds..........................................................................183
Code of Ethics........................................................................................187
Year 2000.............................................................................................187
FINANCIAL STATEMENTS...........................................................................................188
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND
Each Fund has a separate investment objective or objectives which it
pursues through separate investment policies, as described in the Prospectus.
The following discussion elaborates on the presentation of the Money Market
Fund's investment policies contained in the Prospectus.
The Fund may invest its assets in U.S. dollar-denominated securities of
U.S. or foreign issuers and in securities of foreign branches of U.S. banks,
such as negotiable certificates of deposit (Eurodollars. Since the portfolio of
the Fund may contain such securities, an investment therein involves investment
risks that are different in some respects from an investment in a fund which
invests only in debt obligations of U.S. domestic issuers. Such risks may
include future political and economic developments, the possible imposition of
foreign withholding taxes on interest income payable on the securities held in
the portfolio, possible seizure or nationalization of foreign deposits, the
possible establishment of exchange controls or the adoption of other foreign
governmental restrictions which might adversely affect the payment of the
principal of and interest on securities in the portfolio.
All of the assets of the Fund generally will be invested in obligations
which mature in 397 days or less and substantially all of these investments will
be held to maturity; however, securities collateralizing repurchase agreements
may have maturities in excess of 397 days. The Fund will, to the extent
feasible, make portfolio investments primarily in anticipation of or in response
to changing economic and money market conditions and trends. The dollar-weighted
average maturity of the Fund's portfolio may not exceed 90 days. Consistent with
the provisions of a rule of the Securities and Exchange Commission ("SEC"), the
Fund invests only in U.S. dollar-denominated money market instruments that
present minimal credit risk and, with respect to 95% of its total assets,
measured at the time of investment, that are of the highest quality. The
Sub-Adviser shall determine whether a security presents minimal credit risk
under procedures adopted by the Fund's Board of Trustees. A money market
instrument will be considered to be of the highest quality (1) if rated in the
highest rating category (i.e., Aaa or Prime-1 by Moody's, AAA or A-1 by S&P's)
by (I) any two nationally recognized statistical rating organizations ("NRSROs")
or, (ii) if rated by only one NRSRO, by that NRSRO; (2) if issued by an issuer
that has received a short-term rating from an NRSRO with
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respect to a class debt obligations that is comparable priority and security,
and that are rated in the highest rating category by (I) any two NRSRO's or,
(ii) if rated by only one NRSRO, by that NRSRO;(3) an unrated security that is
of comparable quality to a security in the highest rating category as determined
by the Sub-Adviser;(4)(I) with respect to a security that is subject to any
features that entitle the holder, under certain circumstances, to receive the
approximate amortized cost of the underlying security or securities plus accrued
interest "Demand Feature" or obligations of a person other than the issuer of
the security, under certain circumstances, to undertake to pay the principal
amount of the underlying security plus interest "Guarantees", the Guarantee has
received a rating from an NRSRO or the Guarantee is issued by a guarantor that
has received a rating from an NRSRO with respect to a class of debt obligations
that is comparable in priority and security to the Guarantee, with certain
exceptions, and (ii) the issuer of the Demand Feature or Guarantee, or another
institution, has undertaken promptly to notify the holder of the security in the
event that the Demand Feature or Guarantee is substituted with another Demand
Feature or Guarantee,(5) if it is a security issued by a money market fund
registered with the SEC under the 1940 Act; or (6) if it is a Government
Security. With respect to 5% of its total assets, measured at the time of
investment, the Fund may also invest in money market instruments that are in the
second-highest rating category for short-term debt obligations (i.e., rated Aa
or Prime-2 by Moody's or AA or A-2 by S&P).
The Fund may not invest more than 5% of its total assets, measured at
the time of investment, in securities of any one issuer that are of the highest
quality, except that the Fund may exceed this 5% limitation with respect to 25%
of its total assets for up to three business days after the purchase of
securities of any one issuer and except that this limitation shall not apply to
U.S. government securities or securities subject to certain Guarantees. The Fund
may not invest more than the greater of 1% of its total assets or one million
dollars, measured at the time of investment, in securities of any one issuer
that are in the second-highest rating category. Immediately after the
acquisition of any Demand Feature or Guarantee, the Fund, with respect to
seventy five percent of its total assets, shall not have invested more than ten
percent of its assets in securities issued by or subject to Demand Features or
Guarantees from the institution that issued the Demand Feature or Guarantee,
with certain exceptions. In addition, immediately after the acquisition of any
Demand Feature or Guarantee (or a security
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after giving effect to the Demand Feature or Guarantee) that is a not within the
highest rating category by NRSROs, the Fund shall not have invested more than
five percent of its total assets in securities issued by or subject to Demand
Features or Guarantees from the institution that issued the Demand Feature or
Guarantee. In the event that an instrument acquired by the Fund is downgraded or
otherwise ceases to be of the quality that is eligible for the Fund, the
Sub-Adviser, under procedures approved by the Board of Trustees shall promptly
reassess whether such security presents minimal credit risk and shall recommend
to the Valuation Committee of the Board (the "Valuation Committee") that the
Fund take such action as it determines is in the best interest of the Fund and
its shareholders. The Valuation Committee, after consideration of the
recommendation of the Sub-Adviser and such other information as it deems
appropriate, shall cause the Fund to take such action as it deems appropriate,
and shall report promptly to the Board the action it has taken and the reasons
for such action.
Pursuant to the rule, the Fund uses the amortized cost method of
valuing its investments, which facilitates the maintenance of the Fund's per
share net asset value at $1.00. The amortized cost method, which is normally
used to value all of the Fund's portfolio securities, involves initially valuing
a security at its cost and thereafter amortizing to maturity any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument.
The Trustees have also established procedures designed to stabilize, to
the extent reasonably possible, the Fund's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include review of the
Fund's portfolio by the Trustees, at such intervals as they deem appropriate, to
determine whether the Fund's net asset value calculated by using available
market quotations or market equivalents (the determination of value by reference
to interest rate levels, quotations of comparable securities and other factors)
deviates from $1.00 per share based on amortized cost.
The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Trustees. If such deviation
exceeds 1/2 of 1%, the Trustees will promptly consider what action, if any, will
be initiated. In the event the Trustees determine that a deviation exists which
may result in material dilution or other unfair
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results to investors or existing shareholders, they will take such corrective
action as they regard to be necessary and appropriate, including the sale of
portfolio instruments prior to maturity to realize capital gains or losses or to
shorten average portfolio maturity; withholding part or all of dividends or
payment of distributions from capital or capital gains; redemptions of shares in
kind; or establishing a net asset value per share by using available market
quotations or equivalents. In addition, in order to stabilize the net asset
value per share at $1.00, the Trustees have the authority (1) to reduce or
increase the number of shares outstanding on a pro rata basis, and (2) to offset
each shareholder's pro rata portion of the deviation between the net asset value
per share and $1.00 from the shareholder's accrued dividend account or from
future dividends.
The Fund may hold cash for the purpose of stabilizing its net asset
value per share. Holdings of cash, on which no return is earned, would tend to
lower the yield on the Fund's shares.
The Fund may also, consistent with the provisions of the rule, invest
in securities with a face maturity of more than 397 days, provided that the
security is a variable or floating rate security that meets the guidelines of
Rule 2a-7 with respect to maturity.
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS
The Funds may engage in the following investment practices or invest in
the following instruments to the extent permitted in the Prospectus.
REPURCHASE AGREEMENTS
The Funds 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. The Equity Index Fund will enter into repurchase
agreements only with domestic banks with total assets in excess of one billion
dollars or primary government securities dealers reporting to the Federal
Reserve Bank of New York, and with respect to securities of the type in which
the Fund may invest. In addition, the International Bond and International
Equity Funds may enter into domestic or foreign repurchase agreements
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with certain sellers deemed to be creditworthy pursuant to guidelines adopted 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
(usually not more than a week in the case of the Equity Index Fund, California
Tax Free Fund and New York Tax Free Fund) 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 a Fund as a dividend to shareholders. Subject
to applicable limitations, the Tax Free Bond Fund will enter into repurchase
agreements as a means of earning income on its cash reserves when, in the
judgment of the Sub-Adviser, shareholders would benefit more from receiving
taxable income thereon than from earning no income or tax-free income at a lower
rate on such reserves.
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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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-Advisers seek 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 Strategic Income Fund, Strategic Value Fund, California Tax Free
Fund and New York Tax Free Fund may enter into reverse repurchase agreements. A
Fund will maintain a segregated account consisting of liquid assets to cover its
obligations under reverse repurchase agreements. Each of the California Tax Free
Fund and New York Tax Free Fund will limit its investments in reverse repurchase
agreements and other borrowing to no more than 10% of its total assets. Each of
the Strategic Income Fund and Strategic Value Fund will limit its investments in
reverse repurchase agreements to no more than 5% of its total assets.
LENDING OF PORTFOLIO SECURITIES
Each Fund, except the Tax Free Bond Fund and the Money Market Fund, may
seek to increase its income by lending portfolio securities. Under guidelines
adopted by the Funds' 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
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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 certain of the Funds, has entered into an agency agreement with
Merrill Lynch Portfolio Services, Inc. which acts as the Funds' 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 Funds'
Sub-Advisers.
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 a 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 lending Fund. In addition, pursuant to
guidelines adopted by the Board, each Fund is prohibited from lending more than
5% of its total 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 Funds 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
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and loan associations, such obligations are federally insured. The Equity Index
Fund will not be subject to the above restriction to the extent it invests in
bank obligations of United States banks (including foreign branches) which have
more than $1 billion in total assets at the time of investment and are members
of the Federal Reserve System or are examined by the Comptroller of the Currency
or whose deposits are insured by the Federal Deposit Insurance Corporation. The
Equity Index Fund also may invest in certificates of deposit of savings and loan
associations (federally or state chartered and federally insured) having total
assets in excess of $1 billion.
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-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." The Equity Index Fund will
invest in such securities only when it is satisfied that the credit risk with
respect to the issuer is minimal.
DEBT SECURITIES
Debt securities may have fixed, variable or floating (including inverse
floating) rates of interest. To the extent that a Fund invests in debt
securities, it will be subject to certain risks. The value of the debt
securities held by a Fund, and thus the NAV of the shares of a Fund, generally
will
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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 a Fund's investments, changes in
relative values of the currencies in which a Fund's investments are denominated
relative to the U.S. dollar, and the extent to which a 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 a Fund, and a
decline in interest rates will increase the value of fixed income securities
held by a Fund.
CONVERTIBLE SECURITIES
The Capital Appreciation Fund, Convertible Fund, High Yield Corporate
Bond Fund, International Bond Fund, International Equity Fund, Strategic Income
Fund, Strategic Value Fund, Total Return Fund and Value 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 Funds' portfolios 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 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
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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 a
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
Each Fund, except the California Tax Free Fund, Equity Index Fund,
International Bond Fund, International Equity Fund, New York Tax Free Fund and
Tax Free Bond Fund, may sell in one market a security which it owns and
simultaneously purchase the same security in another market, or 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 Funds do 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
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their prices to the Fund at the time of the transaction, thus eliminating any
risk to the assets of a Fund.
FOREIGN SECURITIES
Except for the California Tax Free Fund, Government Fund, New York Tax
Free Fund and Tax Free Bond Fund, each 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. Under current SEC rules relating to the use of the amortized cost
method of portfolio securities valuation, the Money Market Fund is restricted to
purchasing U.S. dollar-denominated securities, but it is not otherwise precluded
from purchasing securities of foreign issuers.
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
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litigation relating to a portfolio investment, the Funds may encounter
substantial difficulties in obtaining and enforcing judgments against non-U.S.
resident individuals and companies. 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 Funds invest 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 Funds' assets.
However, each Fund, except the California Tax Free Fund, the Equity Index Fund,
the Government Fund, the Money Market Fund, the New York Tax Free Fund and the
Tax Free Bond 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. Each of
these Funds 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, a 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 Funds 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
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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 a Fund will be served by entering into such
a contract. Generally, the Sub-Adviser believes that the best interest of a Fund
will be served if a Fund is permitted to enter into forward contracts under
specified circumstances. First, when a 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, a 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 a 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 a 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
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contract is entered into and the date it matures. With respect to positions that
constitute "transaction" or "position" hedges (including "proxy" hedges), a 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, a 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, 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, a 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 a 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 a 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.
A Fund's dealing in forward contracts will be limited to the
transactions described above. Of course, a 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. A Fund generally
will not enter into a forward contract with a term of greater than one year.
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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, a 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 a 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 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 a
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
Funds 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 a
Fund's exposure to currency exchange rate activity and could result in losses to
the Fund if currencies do not perform as investment managers anticipate. A 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 a 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
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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.
A Fund's foreign currency transactions may be limited by the
requirements of Subchapter M of the Code for qualification as a regulated
investment company.
FOREIGN INDEX-LINKED INSTRUMENTS
As part of its investment program, and to maintain greater flexibility,
the International Bond Fund, International Equity Fund and Strategic Income Fund
may, subject to compliance with each Fund's limitations applicable to its
investment in debt securities, invest in instruments issued by the U.S. or a
foreign government or by private issuers that return principal and/or pay
interest to investors in amounts which are linked to the level of a particular
foreign index ("foreign index-linked instruments"). Foreign index-linked
instruments have the investment characteristics of particular securities,
securities indexes, futures contracts or currencies. Such instruments may take a
variety of forms, such as debt instruments with interest or principal payments
determined by reference to the value of a currency or commodity at a future
point in time.
A foreign index may be based upon the exchange rate of a particular
currency or currencies or the differential between two currencies, or the level
of interest rates in a particular country or countries, or the differential in
interest rates between particular countries. In the case of foreign index-linked
instruments linking the interest component to a foreign index, the amount of
interest payable will adjust periodically in response to changes in the level of
the foreign index during the term of the foreign index-linked instrument.
BRADY BONDS
Each of the Convertible Fund, High Yield Corporate Bond Fund,
International Bond Fund, Strategic Income Fund, Strategic Value Fund and Total
Return 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.
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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 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
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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 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.
Tax Anticipation Notes are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues,
to be payable from these specific future taxes. They are usually general
obligations of the issuer, secured by the taxing power for the payment of
principal and interest.
Revenue Anticipation Notes are issued in expectation of receipt of
other kinds of revenue, such as federal revenues. They, also, are usually
general obligations of the issuer.
Bond Anticipation Notes are normally issued to provide interim
financial assistance until long-term financing can be arranged. The long-term
bonds then provide funds for the repayment of the notes.
Construction Loan Notes are sold to provide construction financing for
specific projects. After successful completion and acceptance, many projects
receive permanent financing through the FHA under the FNMA or GNMA.
Project Notes are instruments sold by the Department of Housing and
Urban Development ("HUD") but issued by a state or local housing agency to
provide financing for a variety of programs. They are backed by the full faith
and credit of the U.S. government, and generally carry a term of one year or
less.
Short-Term Discount Notes (tax-exempt commercial paper) are short-term
(365 days or less) promissory notes issued by municipalities to supplement their
cash flow.
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
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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 Funds. 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.
The Tax Free Bond Fund may invest more than 25% of its total assets in
Municipal Bonds the issuers of which are located in the same state and may
invest more than 25% of its total assets in Municipal Bonds the security of
which is derived from any one of
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the following categories: hospitals and health facilities; turnpikes and toll
roads; ports and airports; colleges and universities; public housing
authorities; general obligations of states and localities; lease rental
obligations of states and local authorities; state and local housing finance
authorities; municipal utilities systems; bonds that are secured or backed by
the Treasury or other U.S. government guaranteed securities; or industrial
development and pollution control bonds. There could be economic, business or
political developments which might affect all Municipal Bonds of a similar type.
However, the Fund believes that the most important consideration affecting risk
is the quality of Municipal Bonds.
The Tax Free Bond Fund may engage in short-term trading (selling
securities held for brief periods of time, usually less than three months) if
the Sub-Adviser believes that such transactions, net of costs including taxes,
if any, would improve the overall return on its portfolio. The needs of
different classes of lenders and borrowers and their changing preferences and
circumstances have in the past caused market dislocations unrelated to
fundamental creditworthiness and trends in interest rates which have presented
market trading opportunities. There can be no assurance that such dislocations
will occur in the future or that the Fund will be able to take advantage of
them.
There are, in addition, a variety of hybrid and special types of
municipal obligations, such as municipal lease obligations, as well as numerous
differences in the security of Municipal Bonds both within and between the two
principal classifications described above. Municipal lease obligations are
municipal securities that may be supported by a lease or an installment purchase
contract issued by state and local government authorities to acquire funds to
obtain the use of a wide variety of equipment and facilities such as fire and
sanitation vehicles, computer equipment and other capital assets. These
obligations, which may be secured or unsecured, are not general obligations and
have evolved to make it possible for state and local governments to obtain the
use of property and equipment without meeting constitutional and statutory
requirements for the issuance of debt. Thus, municipal lease obligations have
special risks not normally associated with Municipal Bonds. These obligations
frequently contain "non-appropriation" clauses that provide that the
governmental issuer of the obligation has no obligation to make future payments
under the lease or contract unless money is appropriated for such purposes by
the legislative body on a yearly or other periodic
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basis. In addition to the "nonappropriation" risk, many municipal lease
obligations have not yet developed the depth of marketability associated with
Municipal Bonds; moreover, although the obligations may be secured by the leased
equipment, the disposition of the equipment in the event of foreclosure might
prove difficult. For the purpose of each Fund's investment restrictions, the
identification of the "issuer" of Municipal Bonds which are not General
Obligation Bonds is made by the Sub-Adviser on the basis of the characteristics
of the Municipal Bonds as described above, the most significant of which is the
source of funds for the payment of principal of and interest on such Bonds.
In order to limit certain of these risks, the California Tax Free Fund,
New York Tax Free Fund and Tax Free Bond Fund will not invest more than 10% (15%
in the case of the Strategic Income Fund) of its total assets in municipal lease
obligations that are illiquid (along with all other illiquid securities). The
liquidity of municipal lease obligations purchased by the Funds will be
determined pursuant to guidelines approved by the Board of Trustees. Factors
considered in making such determinations may include: the frequency of trades
and quotes for the obligation; the number of dealers willing to purchase or sell
the security and the number of other potential buyers; the willingness of
dealers to undertake to make a market in the security; the nature of marketplace
trades; the obligation's rating; and, if the security is unrated, the factors
generally considered by a rating agency.
There may be other types of municipal securities that become available
which are similar to the foregoing described municipal securities in which each
Fund may invest.
INCOME LEVEL AND CREDIT RISK Municipal obligations are 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 municipalities to levy taxes. There is
also the possibility that as a result of litigation or other conditions, the
power or ability of any one or more issuers to pay, when due, principal or
interest on its or their municipal obligations may be materially affected.
Although the Funds' quality standards are designed to minimize the credit
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risk of investing in Municipal Bonds, that risk cannot be entirely eliminated.
TAX CONSIDERATIONS With respect to the California Tax Free Fund, New
York Tax Free Fund and Tax Free Bond Fund, income derived by a Fund from taxable
investments, including but not limited to securities lending transactions,
repurchase transactions, options and futures transactions, and investments in
commercial paper, bankers' acceptances and certificates of deposit will be
taxable for federal, state and local income tax purposes when distributed to
shareholders. Income derived by a Fund from interest on direct obligations of
the U.S. government will be taxable for federal income tax purposes when
distributed to shareholders but, provided that the Fund meets the requirements
of state law and properly designates distributions to shareholders, such
distributions may be excludable from income for state personal income tax
purposes. A portion of original issue discount relating to stripped Municipal
Bonds and their coupons may also be treated as taxable income under certain
circumstances.
The Tax Reform Act of 1986 ("TRA") limited the types and volume of
Municipal Bonds qualifying for the federal income tax exemption for interest,
and the Code treats tax-exempt interest on certain Municipal Bonds as a tax
preference item included in the alternative minimum tax base for corporate and
noncorporate shareholders. In addition, all tax-exempt interest may result in or
increase a corporation's liability under the corporate alternative minimum tax,
because a portion of the difference between corporate "adjusted current
earnings" and alternative minimum taxable income is treated as a tax preference
item. Further, an issuer's failure to comply with the detailed and numerous
requirements imposed by the Code after bonds have been issued may cause the
retroactive revocation of the tax-exempt status of certain Municipal Bonds after
their issuance. The Funds intend to monitor developments in the municipal bond
market to determine whether any defensive action should be taken.
INDUSTRIAL DEVELOPMENT AND POLLUTION CONTROL BONDS
Industrial Development Bonds which pay tax-exempt interest are, in most
cases, revenue bonds and are issued by, or on behalf of, public authorities to
raise money to finance various privately operated facilities for business,
manufacturing, housing, sports, and pollution control. These bonds are also used
to finance public facilities such as airports, mass transit
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systems, ports, and parking. The payment of the principal and interest on such
bonds is solely dependent on the ability of the facility's user to meet its
financial obligations and the pledge, if any, of the real and personal property
so financed as security for such payments. These bonds 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.
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. Industrial Development Bonds issued after
the effective date of the TRA, as well as certain other bonds, are now
classified as "private activity bonds." Some, but not all, private activity
bonds issued after that date qualify to pay tax-exempt interest.
VARIABLE RATE DEMAND NOTES ("VRDNS")
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund may invest in tax-exempt obligations which contain a floating or variable
interest rate adjustment formula and an unconditional right of demand to receive
payment of the unpaid principal balance plus accrued interest upon a short
notice period prior to specified dates, generally at 30, 60, 90, 180 or 365-day
intervals. The interest rates are adjustable at various intervals to the
prevailing market rate for similar investments, such adjustment formula being
calculated to maintain the market value of the VRDN at approximately the par
value of the VRDN on the adjustment date. The adjustments are typically based
upon the prime rate of a bank or some other appropriate interest rate adjustment
index.
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund may also invest in VRDNs in the form of participation interests
("Participating VRDNs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank ("Institution").
Participating VRDNs provide a Fund with a specified undivided interest (up to
100%) of the underlying obligation and the right to demand payment of the unpaid
principal balance plus accrued interest on the Participating VRDNs from the
Institution upon a specified number of days' notice, not to exceed seven days.
In addition, the Participating VRDN is backed up by an irrevocable letter of
credit or guaranty of the Institution. A Fund has an undivided
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interest in the underlying obligation and thus participates on the same basis as
the Institution in such obligation, except that the Institution typically
retains fees out of the interest paid or the obligation for servicing the
obligation, providing the letter of credit and issuing the repurchase
commitment.
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 Funds with a certain degree of protection against rises in
interest rates, the Funds 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
Funds' limitations on investments in such securities.
ZERO COUPON BONDS
The Funds, except the Equity Index 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
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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 Fund receives no payment on the investment in that year. Zero coupon
bonds tend to be more volatile than conventional debt securities.
STANDBY COMMITMENTS -- OBLIGATIONS WITH PUTS ATTACHED
The California Tax Free Fund, New York Tax Free Fund, Strategic Income
Fund and Tax Free Bond Fund may purchase municipal securities together with the
right to resell the securities to the seller at an agreed-upon price or yield
within a specified period prior to the maturity date of the securities. Although
it is not a put option in the usual sense, such a right to resell is commonly
known as a "put" and is also referred to as a "standby commitment." Each Fund
may pay for a standby commitment either separately, in cash, or in the form of a
higher price for the securities which are acquired subject to the standby
commitment, thus increasing the cost of securities and reducing the yield
otherwise available from the same security. The Sub-Adviser understands that the
Internal Revenue Service (the "IRS") has issued a revenue ruling to the effect
that, under specified circumstances, a registered investment company will be the
owner of tax-exempt municipal obligations acquired subject to a put option. The
IRS has also issued private letter rulings to certain taxpayers (which do not
serve as precedent for other taxpayers) to the effect that tax-exempt interest
received by a regulated investment company with respect to such obligations will
be tax-exempt in the hands of the company and may be distributed to its
shareholders as exempt-interest dividends. The IRS has subsequently announced
that it will not ordinarily issue advance ruling letters as to the identity of
the true owner of property in cases involving the sale of securities or
participation interests therein if the purchaser has the right to cause the
security, or the participation interest therein, to be purchased by either the
seller or a third party. Each of the California Tax Free Fund, New York Tax Free
Fund and Tax Free Bond Fund intends to take the position that it is the owner of
any municipal obligations acquired subject to a standby commitment and that
tax-exempt interest earned with respect to such municipal obligations will be
tax-exempt in its hands; however, no assurance can be given that this position
would
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prevail if challenged. In addition, there is no assurance that standby
commitments will be available to a Fund, nor has the California Tax Free Fund,
New York Tax Free Fund or Tax Free Bond Fund assumed that such commitments would
continue to be available under all market conditions.
A standby commitment may not be used to affect a Fund's valuation of
the municipal security underlying the commitment. Any consideration paid by a
Fund for the standby commitment, whether paid in cash or by paying a premium for
the underlying security, which increases the cost of the security and reduces
the yield otherwise available from the same security, will be accounted for by
the Fund as unrealized depreciation until the standby commitment is exercised or
has expired.
WHEN-ISSUED SECURITIES
The Funds 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, that Fund would earn no income; however, it is the Trust's intention
that each 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 Trust 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 a 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 a Fund's net asset value or income will be exposed to additional
risk by the purchase of securities on a when-issued basis. Each Fund will
establish a segregated account in which it will maintain liquid assets at least
equal in value
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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
Each 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 Funds, to
the extent permitted in the Prospectus, may also invest in debt securities which
are secured with collateral consisting of 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.
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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 a 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 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 as 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.
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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 Funds reserve 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 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 Funds' 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 Funds 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 Funds' quality
standards.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES The mortgage-related
securities in which the Funds may invest may be: (I) privately issued securities
which are collateralized by pools
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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.
The California Tax Free Fund, New York Tax Free Fund and Equity Index
Fund, however, may not invest in non-government mortgage pass-through
securities. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable. No Fund will purchase mortgage-related securities or any other
assets which in the Sub-Advisers' opinion are illiquid if, as a result, more
than 10% (15% in the case of the International Equity, International Bond,
Strategic Income and Strategic Value Funds) 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 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.
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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.
The eligible Funds will not invest in any privately issued CMOs that do
not meet the requirements of Rule 3a-7 under the 1940 Act if, as a result of
such investment, more than 5% of a Fund's net assets would be invested in any
one CMO, more than 10% of the Fund's net assets would be invested in CMOs and
other investment company securities in the aggregate, or the Fund would hold
more than 3% of any outstanding issue of CMOs.
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 repaid is likely to be such that each class of
bonds will be retired in advance of its scheduled maturity date.
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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
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related underlying mortgage assets, in the same manner as an 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 a
Fund's limitations on investment in illiquid securities.
Under certain circumstances, a Fund's investment in residual interests
in "real estate mortgage investment conduits" ("REMICs") may cause shareholders
of that 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 a
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
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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
market, the depth and liquidity of which will vary from time to time. 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 rule in determining whether to invest in
residual interests.
GOVERNMENT FUND The Government Fund may invest in securities
collateralized by mortgages or pools of mortgages the issuer of which has
qualified to be treated as a "REMIC". 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
market, the depth and liquidity of which will vary from issue to issue and from
time to time. 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 Government Fund will consider this rule 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
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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 a Fund's limitations on investment in illiquid securities.
RISKS ASSOCIATED WITH MORTGAGE-BACKED SECURITIES The value of some
mortgage-backed securities in which the Funds may invest may be particularly
sensitive to changes in prevailing interest rates, and, like the other
investments of the Funds, the ability of a Fund to successfully utilize these
instruments may depend in part upon the ability of an Sub-Adviser to forecast
interest rates and other economic factors correctly. If a 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 Funds
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
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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 a Fund invested in such securities and wishing
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 a 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 CARSSM ("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 CARSSM 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 institution
unaffiliated with the trustee or originator of the trust. An investor's return
on CARSSM 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
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factors. As a result, certificate holders may experience delays in payments or
losses if the letter of credit is exhausted.
The Sub-Advisers expect that other asset-backed securities (unrelated
to mortgage loans) will be offered to investors in the future. Consistent with
its investment objectives and policies, a Fund also may invest in other types of
asset-backed securities.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which a 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, a Fund owns or has the right to obtain securities equivalent in kind
and amount. Each of the Funds will only enter into short sales against the box.
A 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, a Fund could experience losses or delays in
recovering gains on short sales. The Funds will only enter into short sales
against the box with brokers the Sub-Advisers believe are creditworthy. Short
sales against the box will be limited to no more than 25% of a Fund's total
assets.
OPTIONS ON SECURITIES
WRITING CALL OPTIONS Any Fund, except the Money Market Fund and the Tax
Free Bond Fund, may sell ("write") covered call options on the portfolio
securities of such Fund in an attempt to enhance investment performance. The
California Tax Free Fund and New York Tax Free Fund may purchase and sell both
put and call options on debt securities in standardized contracts traded on
national securities exchanges, boards of trade, or similar entities, or quoted
on NASDAQ, and agreements, sometimes called "cash puts," which may accompany the
purchase of a new issue of bonds from a dealer. A call option sold by a Fund is
a
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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.
A 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. A 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.
A 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.
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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 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.
Each 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 a 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 Funds may, to the extent determined
appropriate by the Sub-Advisers, engage without limitation in the writing of
options on U.S. government securities. Subject to the limitation that all
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call and put option writing transactions be covered, and limitations imposed on
regulated investment companies under federal tax law, the International Bond
Fund and International Equity Fund may, to the extent determined appropriate by
the Sub-Adviser, engage without limitation in the writing of options on their
portfolio securities.
WRITING PUT OPTIONS Each Fund, except the Money Market Fund and the Tax
Free Bond Fund, may also write covered put options. Put options written by a
Fund are agreements by a 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 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 Funds receive 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 Funds 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 Funds also may effect a closing purchase transaction, in the case
of a put option, to permit the Funds to maintain their 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.
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If a 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 Funds may also write straddles (combinations of
covered puts and calls on the same underlying security). The extent to which the
Funds 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 each Fund qualify
as such. Subject to the limitation that all call and put option writing
transactions be covered, the Funds may, to the extent determined appropriate by
the Sub-Advisers, engage without limitation in the writing of options on U.S.
government securities.
PURCHASING OPTIONS Each Fund, except Money Market Fund and the Tax Free
Bond 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 Funds will engage in such transactions only with
firms the Sub-Advisers deem to be of sufficient creditworthiness so as to
minimize these risks.
The Funds may purchase put options on securities to protect their
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. A 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 a 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
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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 Funds may also purchase call options on securities the Funds intend
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 securities remained below the sum of the premium and the
exercise price during the option period. In order to terminate an option
position, the Funds 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. Each Fund, except the Equity Index Fund, Money Market
Fund and Tax Free Bond Fund may 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 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 equivalent of a short sale against
the box. To implement this trading strategy, the Fund will simultaneously
execute with the same broker a purchase of shares of the common stock and an "in
the money" over-the-counter put option to sell the common stock to the broker
and generally 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.
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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 may require
that the Fund write a call option, which would enable the broker to profit in
the event the price of the stock rises above the exercise price of the call
option (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.
A Fund's purpose in selling covered options is to realize greater
income than would be realized on portfolio securities transactions alone. A 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 a 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 Capital Appreciation Fund, Convertible
Fund, Government Fund, High Yield Corporate Bond Fund, Money Market Fund, Total
Return Fund and Value Fund will not purchase a put or call option if, as a
result, the amount of premiums paid for all put and call options then
outstanding would exceed 10% of the value of the Fund's total assets.
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.
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The ability of a 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
Each Fund, except the California Tax Free Fund, the Equity Index Fund,
the Government Fund, the Money Market Fund, the New York Tax Free Fund and the
Tax Free Bond Fund, may, to the extent that it invests in foreign securities,
purchase and write options on foreign currencies. A Fund may use foreign
currency options contracts for various reasons, including: to manage its
exposure to changes in currency exchange rates; as an efficient means of
adjusting its overall exposure to certain currencies; or in an effort to enhance
its return.
A Fund may 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. A Fund may also 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. 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,
a Fund may purchase put options on the foreign currency. If the value of the
currency does decline, that Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the 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, a Fund may
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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 a 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, a 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.
If a 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 diminution 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, a 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 a 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 writing options on foreign
currencies, a 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 a Fund is "covered" if
that 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
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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 a 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 a Fund in liquid assets in a segregated account with
its custodian.
Options on foreign currencies to be written or purchased by a Fund will
be traded on U.S. and foreign exchanges or over-the-counter. 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 the
exercise of the option. 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 a 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 a Fund's position, a Fund may forfeit the entire amount of the
premium plus related transaction costs.
A 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 a Fund seeks to
close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, a 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 a 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.
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SECURITIES INDEX OPTIONS
The Funds may purchase call and put options on securities indexes (only
call options on the S&P 500 Composite Price Index in the case of the Equity
Index Fund) for the purpose of hedging against the risk of unfavorable price
movements which may adversely affect the value of a Fund's securities. The
Equity Index Fund may purchase call options on the S&P 500 Index to protect
against increases in the prices of securities underlying the Index that the
Equity Index Fund intends to purchase pending its ability to invest in such
securities in an orderly manner.
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. Options on other types of securities indexes, which do not currently
exist, including indexes on debt securities, may be introduced and traded on
exchanges in the future. If such options are introduced, the Funds will not
purchase them until they have appropriately amended or supplemented the
Prospectus or Statement of Additional Information, or both.
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
securities held or to be acquired by a Fund will not exactly
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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 a 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 a 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 a 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.
A Fund may sell securities index options prior to expiration in order
to close out its positions in securities index options which it has purchased. A
Fund may also allow options to expire unexercised.
FUTURES TRANSACTIONS
The California Tax Free Fund, Convertible Fund, Government Fund, High
Yield Corporate Bond Fund, International Bond Fund, International Equity Fund,
New York Tax Free Fund, Strategic Income Fund, Strategic Value Fund, Tax Free
Bond Fund and Total Return 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 a Fund's portfolio and for other appropriate
risk management purposes. For example, a Fund may purchase futures contracts as
a substitute for the purchase of longer-term debt securities to lengthen the
average duration of a Fund's portfolio of fixed-income securities. The
Government Fund may enter into futures contracts and purchase and write options
on futures, which are not U.S. government securities, in order to attempt to
hedge against changes in interest rates and to seek current income. 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 Capital Appreciation Fund, Convertible
Fund, Equity Index Fund, International Equity Fund, Strategic Income Fund,
Strategic Value Fund, Total Return Fund
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and Value Fund may purchase and sell stock index futures to hedge the equity
portion of those Funds' securities portfolios 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). These Funds, and the
International Bond Fund, may also purchase and sell other futures when deemed
appropriate, in order to hedge the equity or non-equity portions of their
portfolios. In addition, each Fund, except the California Tax Free Fund, Equity
Index Fund, Government Fund, Money Market Fund, New York Tax Free Fund and Tax
Free Bond Fund may, to the extent it invests in foreign securities, enter into
contracts for the future delivery of foreign currencies to hedge against changes
in currency exchange rates. Each of the Funds may also purchase and write put
and call options on futures contracts of the type into which such Fund is
authorized to enter 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 Funds 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 a Fund to risks that are materially greater than the
risks associated with trading on U.S. exchanges. The International Bond Fund and
International Equity Fund are not limited to the above-listed 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 a 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,
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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 a 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. Each Fund expects to earn interest
income on its initial margin deposits. A futures contract held by a Fund is
valued daily at the official settlement price of the exchange on 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 a 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, each Fund will mark-to-market its open futures positions.
A 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 a 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.
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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--a 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-Advisers to reflect the fair value of the
contract, in which case the positions will be valued by or under the direction
of the Trustees.
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. A 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, a 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. A 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.
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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.
Because the only futures contracts currently available to hedge the Tax
Free Bond Fund's portfolio of municipal obligations are futures on various U.S.
government securities and futures on a municipal securities index, perfect
correlation between that Fund's futures positions and portfolio positions may be
difficult to achieve.
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 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 a Fund's
securities portfolio with regard to market (systematic) risk, as distinguished
from stock-specific risk. The Funds may enter into stock index futures to the
extent that they have equity securities in their portfolios. Similarly, the
Funds may enter into futures on debt securities indexes (including the municipal
bond index) to the extent they have debt securities in their portfolios. By
establishing an appropriate "short" position in securities index futures, a 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, a 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
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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. A 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 Funds do 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 a 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 a Fund, as purchaser, to take
delivery of an amount of currency at a specified future time at a specified
price. A 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 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 a 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 a Fund's
securities. The degree of correlation may be distorted by the
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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 Funds 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 Funds will purchase or write only options on futures contracts
that are traded on a U.S. or foreign exchange or board of trade. The Funds 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 (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
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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 a 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
a 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 a 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.
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 a 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
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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 a 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.
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, a 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 Funds 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 Funds 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,
a 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
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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, a 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 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, a 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, a 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
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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 a 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 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 a 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
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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 Funds 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 a Fund would have to
exercise options it has purchased in order to realize any profit and would be
less able to limit its 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 International Bond Fund, International Equity Fund, Strategic Value
Fund and Strategic Income Fund may enter into interest rate, index and currency
exchange rate swap agreements for purposes of attempting to obtain a particular
desired return
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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 movements
exceeding given minimum or maximum levels. A 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"). A 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. A 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 a 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, a Fund bears the
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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 a 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 Funds by the Code may limit the Funds' 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 a 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 1940 Act, commodity pool, corporation,
partnership, proprietorship, organization, trust or other entity, employee
benefit plan, governmental entity, broker-dealer, 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
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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
A 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, a 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, a Fund may
purchase an assignment of all or a portion of a lender's interest in a corporate
loan, in which case, a 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. A
Fund also may purchase a Participation Interest in a portion of the rights of a
lender in a corporate loan. In such a case, a Fund will be entitled to receive
payments of principal, interest and fees, if any, but generally will not be
entitled to enforce its rights directly against the agent bank or the borrower;
rather a Fund must rely on the lending institution for that purpose. A 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. A 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
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of the corporate loan agreement. Furthermore, unless under the terms of a
participation agreement a Fund has direct recourse against the borrower (which
is unlikely), a 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 held by the agent bank for the benefit of a 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, a 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 a Fund acts as co-lender in connection with a participation
interest or when a Fund acquires a participation interest the terms of which
provide that a Fund will be in privity of contract with the corporate borrower,
a Fund will have direct recourse against the borrower in the event the borrower
fails to pay scheduled principal and interest. In all other cases, a Fund will
look to the agent bank to enforce appropriate credit remedies against the
borrower. In acquiring participation interests a Fund will conduct analysis and
evaluation of the financial condition of each such co-lender and participant to
ensure that the participation interest meets a Fund's qualitative standards.
There is a risk that there may not be a readily available market for loan
participation interests and, in some
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cases, this could result in a Fund disposing of such securities at a substantial
discount from face value or holding such security until maturity. When a 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 Funds consider loan participation interests not subject to puts
to be illiquid.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that a Fund invests in debt securities, it will be
subject to certain risks. The value of the debt securities held by a 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 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.
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 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
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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. A 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 on account of such interest
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.
HIGH YIELD CORPORATE BOND FUND, STRATEGIC
VALUE FUND AND STRATEGIC INCOME FUND
SPECIAL CONSIDERATIONS
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 Funds do 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, each 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 each Fund will vary as the
aggregate value of the Funds' portfolio securities increases or decreases.
Moreover, the value
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of the debt securities that each 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 Funds but will be reflected in the net asset value of the
Funds' shares.
EQUITY INDEX FUND
SPECIAL CONSIDERATIONS
The Equity Index Fund is managed using mathematical algorithms to
determine which stocks are to be purchased or sold to replicate the S&P 500
Index to the extent feasible. From time to time, adjustments may be made in the
Fund's portfolio because of changes in the composition of the Index, but such
changes should be infrequent. No attempt is made to manage the portfolio in the
traditional sense using economic, financial and market analysis.
The Sub-Adviser believes that the indexing approach described above is
an effective method of simulating percentage changes in the S&P 500 Index.
"Standard & Poor's", "S&P 500", "S&P", "S&P 500", "Standard & Poor's
500" and "500" are trademarks of Standard & Poor's Corporation and have been
licensed for use by Monitor Capital Advisors, Inc. S&P does not sponsor,
endorse, sell or promote the Fund or represent the advisability of investing in
the Fund.
The Fund is not sponsored, endorsed, sold or promoted by S&P. S&P makes
no representation or warranty, express or implied, to the owners of the Fund or
any member of the public regarding the advisability of investing in securities
generally or in the Fund particularly or the ability of the S&P 500 Index to
track general stock market performance. S&P's only relationship to Monitor is
the licensing of certain trademarks and trade names of S&P and of the S&P 500
Index which is determined, composed and calculated by S&P without regard to
Monitor or the Fund. S&P has no obligation to take the needs of Monitor or the
owners of the Fund into consideration in determining, composing or calculating
the S&P 500 Index. S&P is not responsible for and has not participated in the
determination
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of the prices and amount of the Fund or the timing of the issuance or sale of
the Fund or in the determination or calculation of the equation by which the
Fund is to be converted into cash. S&P has no obligation or liability in
connection with the administration, marketing or trading of the Fund.
S&P does not guarantee the accuracy and/or the completeness of the S&P
500 Index or any data included therein and S&P shall have no liability for any
errors, omissions, or interruptions therein. S&P makes no warranty, express or
implied, as to results to be obtained by Monitor, owners of the Fund, or any
other person or entity from the use of the S&P 500 Index or any data included
therein. S&P makes no express or implied warranties, and expressly disclaims all
warranties of merchantability or fitness for a particular purpose or use with
respect to the S&P 500 Index or any data included therein. Without limiting any
of the foregoing, in no event shall S&P have any liability for any special,
punitive, indirect, or consequential damages (including lost profits), even if
notified of the possibility of such damages.
TOTAL RETURN FUND
SPECIAL CONSIDERATIONS
Although the Total Return Fund does not intend to seek short-term
profits, securities in its portfolio will be sold whenever the Sub-Adviser
believes it is appropriate to do so without regard to the length of time the
particular security may have been held, subject to certain tax requirements for
qualification as a regulated investment company under the Code. A high turnover
rate involves greater expenses to the Fund and may increase the possibility of
shareholders realizing taxable capital gains. The Fund engages in portfolio
trading if it believes a transaction, net of costs (including custodian
charges), will help in achieving its investment objective.
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CALIFORNIA TAX FREE FUND AND NEW YORK TAX FREE FUND
SPECIAL CONSIDERATIONS
RISK FACTORS AFFECTING CALIFORNIA MUNICIPAL SECURITIES
The following information as to certain California State ("State") risk
factors is given to investors in view of the policy of the MainStay California
Tax Free Fund of concentrating its investments in California municipal issuers.
Such information constitutes only a brief discussion, does not purport to be a
complete description and is based on information from sources believed by the
Trust to be reliable, including official statements relating to securities
offerings of California and municipal issuers, and periodic publications by
national ratings organizations. Such information, however, has not been
independently verified by the Trust.
Certain California constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives, as discussed
below, could adversely affect the market values and marketability of, or result
in default of, existing obligations of the State. Obligations of the State or
local governments may also be affected by budgetary pressures affecting the
State and economic conditions in the State. The following information
constitutes only a brief summary and is not intended as a complete description.
Certain of the California municipal securities in which the Fund may
invest may be obligations of issuers which rely in whole or in part on
California State revenues for payment of these obligations. Property tax
revenues and a portion of the State's General Fund surplus are distributed to
counties, cities and their various taxing entities and the State assumes certain
obligations theretofore paid out of local funds. Whether and to what extent a
portion of the State's General Fund will be distributed in the future to
counties, cities and their various entities, is unclear.
Certain of the California municipal securities may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, Proposition 13 added Article XIIIA to the
California Constitution. The effect of Article XIIIA is to limit ad valorem
taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues.
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Legislation enacted by the California legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that notwithstanding
any other law, local agencies may not levy any ad valorem property tax except to
pay debt service on indebtedness approved by the voters prior to July 1, 1978,
and that each county will levy the maximum tax permitted by Article XIIIA of
$4.00 per $100 assessed valuation. The apportionment of property taxes in fiscal
years after 1978-79 was revised pursuant to Statutes of 1979, Chapter 282, which
provides relief funds from State moneys beginning in fiscal year 1979-80 and is
designed to provide a permanent system for sharing State taxes and budget funds
with local agencies. Under Chapter 282, cities and counties receive more of the
remaining property tax revenues collected under Proposition 13 instead of direct
State aid. School districts receive a correspondingly reduced amount of property
taxes, but receive compensation directly from the State and are given additional
relief.
On November 4, 1986, California voters approved an initiative statute
known as "Proposition 62." This statute (i) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity; (ii)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction; (iii) restricts the use
of revenues from a special tax to the purposes or for the service for which the
special tax was imposed; (iv) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by Article
XIIIA of the California Constitution; (v) prohibits the imposition of
transaction taxes and sales taxes on the sale of real property by local
governments; (vi) requires that any tax imposed by a local government on or
after August 1, 1985 be ratified by a majority of the electorate within two
years of the adoption of the initiative or be terminated by November 15, 1988;
(vii) requires that, in the event a local government fails to comply with the
provisions of this measure, a reduction in the amount of tax revenue allocated
to such local government occur in an amount equal to the revenues received by
such entity attributable to the tax levied in violation of the initiative; and
(viii) permits these provisions to be amended exclusively by the voters of the
State of California. In September 1988, the California Court of Appeals held
that it was unconstitutional to require that local tax measures be submitted to
the electorate, as described in (vi) above.
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In September 1995, the California Supreme Court upheld the
constitutionality of Proposition 62, creating uncertainty as to the legality of
certain local taxes enacted by non-charter cities in California without voter
approval.
In November 1996, California voters approved Proposition 218. The
initiative applied the provisions of Proposition 62 to all entities, including
charter cities. It requires that all taxes for general purposes obtain a simple
majority popular vote and that taxes for special purposes obtain a two-thirds
majority vote. Prior to the effectiveness of Proposition 218, charter cities
could levy certain taxes such as transient occupancy taxes and utility user's
taxes without a popular vote. Proposition 218 will also limit the authority of
local governments to impose property-related assessments, fees and charges,
requiring that such assessments be limited to the special benefit conferred and
prohibiting their use for general governmental services. Proposition 218 also
allows voters to use their initiative power to reduce or repeal
previously-authorized taxes, assessments, fees and charges.
The State is subject to an annual appropriations limit imposed by
Article XIIIB of the State Constitution (the "Appropriations Limit"). The
Appropriations Limit does not restrict appropriations to pay debt service on the
bonds or other voter-authorized bonds. Article XIIIB prohibits the State from
spending "appropriations subject to limitation" in excess of the Appropriations
Limit. "Appropriations subject to limitation," with respect to the State, are
authorizations to spend "proceeds of taxes," which consist of tax revenues, and
certain other funds, including proceeds from regulatory licenses, user charges
or other fees to the extent that such proceeds exceed "the cost reasonably borne
by that entity in providing the regulation, product or service," but "proceeds
of taxes" exclude most State subventions to local governments, tax refunds and
some benefit payments such as unemployment insurance. No limit is imposed on
appropriations of funds which are not "proceeds of taxes," such as reasonable
user charges or fees and certain other non-tax funds.
Not included in the Appropriations Limit are appropriations for the
debt service costs of bonds existing or authorized by January 1, 1979, or
subsequently authorized by the voters, appropriations required to comply with
mandates of courts or the federal government and, pursuant to Proposition 111,
appropriations for qualified capital outlay projects and appropriations of
revenues derived from any increase in gasoline taxes and motor vehicle weight
fees above January 1, 1990 levels, and appropriation of certain special taxes
imposed by initiative
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(e.g., increased cigarette and tobacco taxes enacted by Proposition 99 in 1988).
The Appropriations Limit may also be exceeded in cases of emergency.
The State's Appropriations Limit in each year is based on the limit for
the prior year, adjusted annually for changes in State per capita personal
income and changes in population, and adjusted, when applicable, for any
transfer of financial responsibility of providing services to or from another
unit of government. The measurement of change in population is a blended average
of statewide overall population growth, and change in attendance at local school
and community college ("K-14") districts. As amended by Proposition 111, the
Appropriations Limit is tested over consecutive two-year periods. Any excess of
the aggregate "proceeds of taxes" received over such a two-year period above the
combined Appropriations Limits for those two years is divided equally between
transfers to K-14 districts and refunds to taxpayers.
The legislature enacted legislation to implement Article XIIIB which
defines certain terms used in Article XIIIB and sets forth the methods for
determining the Appropriations Limit. California Government Code Section 7912
requires an estimate of the Appropriations Limit to be included in the
Governor's Budget, and thereafter to be subject to the budget process and
established in the Budget Act.
On November 9, 1988, the State's voters approved Proposition 98, a
combined initiative constitutional amendment and statute called the "Classroom
Instructional Improvement and Accountability Act." Proposition 98 changed State
funding of public education below the university level and the operation of the
State Appropriations Limit, primarily by guaranteeing K-14 schools a minimum
share of General Fund revenues. Under Proposition 98 (as modified by Proposition
111, enacted on June 5, 1990), K-14 schools are guaranteed the greater of (a) in
general, a fixed percent of General Fund revenues ("Test 1"), (b) the amount
appropriated to K-14 schools in the prior year, adjusted for changes in the cost
of living (measured as in Article XIIIB by reference to State per capita
personal income) and enrollment ("Test 2"), or (c) a third test, which would
replace Test 2 in any year when the percentage growth in per capita General Fund
revenues from the prior year plus one half of one percent is less than the
percentage growth in State per capita personal income ("Test 3"). Under Test 3,
schools would receive the amount appropriated in the prior year adjusted for
changes in enrollment and per capita General Fund revenues, plus an additional
small adjustment factor. If Test 3 is used in any year, the difference between
Test 3 and Test 2 would become a
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"credit" to schools which would be the basis of payments in future years when
per capita General Fund revenue growth exceeds per capita personal income
growth. Legislation adopted prior to the end of the 1988-89 fiscal year,
implementing Proposition 98, determined the K-14 schools' funding guarantee
under Test 1 to be 40.3 percent of the General Fund tax revenues, based on
1986-87 appropriations. The percentage has been adjusted to approximately 35
percent to account for a subsequent redirection of local property taxes, since
such redirection directly affects the share of General Fund revenues to schools.
Proposition 98 permits the legislature by two-thirds vote of both
houses, with the Governor's concurrence, to suspend the K-14 schools' minimum
funding formula for a one-year period. Proposition 98 also contains provisions
transferring certain State tax revenues in excess of the Article XIIIB limit to
K-14 schools.
During the recent recession, General Fund revenues for several years
were less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The legislature responded to these developments by designating "extra"
Proposition 98 payments in one year as a "loan" from future years' Proposition
98 entitlements, and also intended that the "extra" payments would not be
included in the Proposition 98 "base" for calculating future years'
entitlements. In 1992, a lawsuit was filed, called California Teachers'
Association v. Gould, which challenged the validity of these off-budget loans.
As part of the negotiations leading to the 1995-96 Budget Act, an oral agreement
was reached to settle this case. The formal settlement required adoption of
legislation satisfactory to the parties to implement its terms, which has
occurred. The court gave final approval of the settlement in late July, 1996.
The settlement provides, among other things, that both the State and
K-14 schools share in the repayment of prior years' emergency loans to schools.
Of the total $1.76 billion in loans, the State will repay $935 million by
forgiveness of the amount owed, while schools will repay $825 million. The
State's share of the repayment will be reflected as an appropriation above the
current Proposition 98 base calculation. The schools' share of the repayment
will count as appropriations that count toward satisfying the Proposition 98
guarantee, or from "below" the current base. Repayments are spread over the
eight-year period of 1994-95 through 2001-02 to mitigate any adverse fiscal
impact. The Director of Finance has certified that a settlement has occurred,
allowing approximately $351 million in appropriations
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from the 1995-96 fiscal year to be disbursed to schools in August 1996.
Substantially increased General Fund revenues, above initial budget
projections, in the fiscal year 1994-95 and thereafter have resulted or will
result in retroactive increases in Proposition 98 appropriations from subsequent
fiscal years' budgets. Because of the State's increasing revenues, per-pupil
funding at the K-12 level has increased by about 22% from the level in place
from 1991-92 through 1993-94, and is estimated at about $5,150 per ADA in
1997-98. A significant amount of the "extra" Proposition 98 monies in the last
few years have been allocated to special programs, most particularly an
initiative to allow each classroom from grades K-3 to have no more than 20
pupils by the end of the 1997-98 school year. There are also new initiatives for
reading skills and to upgrade technology in high schools.
Certain California municipal securities in the Fund may be obligations
which are secured in whole or in part by a mortgage or deed of trust on real
property. Upon the default of a mortgage or deed of trust with respect to
California real property, the creditor's nonjudicial foreclosure rights under
the power of sale contained in the mortgage or deed of trust are subject to the
constraints imposed by California law upon transfers of title to real property
by private power of sale. During the three-month period beginning with the
filing of a formal notice of default, the debtor is entitled to reinstate the
home mortgage by making any overdue payments. Under standard loan servicing
procedures, the filing of the formal notice of default does not occur unless at
least three full monthly payments have become due and remain unpaid. The power
of sale is exercised by posting and publishing a notice of sale for at least 20
days after expiration of the three-month reinstatement period. Therefore, the
effective minimum period for foreclosing on a mortgage could be in excess of
seven months after the initial default. Such time delays in collections could
disrupt the flow of revenues available to an issuer for the payment of debt
service on the outstanding obligations if such defaults occur with respect to a
substantial number of home mortgages or deeds of trust securing an issuer's
obligations.
Certain California municipal securities in the Fund may be obligations
which finance the acquisition of single family home mortgages for low- and
moderate-income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to the California
statutory limitations described above applicable to obligations secured by real
property. Under California anti-deficiency legislation,
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there is no personal recourse against a mortgagor of a single family residence
purchased with the loan secured by the mortgage.
Under California law, mortgage loans secured by single family
owner-occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years of the term of the mortgage loan, and cannot in any
event exceed six months' advance interest on the amount prepaid in excess of 20
percent of the original principal amount of the mortgage loan. This limitation
could affect the flow of revenues available to an issuer for debt service on the
outstanding debt obligations which financed such home mortgages.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on
the Richter Scale struck Los Angeles. Significant property damage to private and
public facilities occurred in a four-county area including northern Los Angeles
County, Ventura County, and parts of Orange and San Bernardino Counties. The
possibility exists that another such earthquake could create a major dislocation
of the State economy.
Congress passed and the President signed (on August 22, 1996) the
Personal Responsibility and Work Opportunity Act of 1996 making a fundamental
reform of the current welfare system. Among many provisions, the Law includes:
(I) conversion of Aid to Families with Dependent Children from an entitlement
program to a block grant titled Temporary Assistance for Needy Families (TANF),
with lifetime time limits on TANF recipients, work requirements and other
changes; (ii) provisions denying certain federal welfare and public benefits to
legal noncitizens, allowing states to elect to deny additional benefits
(including TANF) to legal noncitizens, and generally denying almost all benefits
to illegal immigrants; and (iii) changes in the Food Stamp program, including
reducing maximum benefits and imposing work requirements.
As part of the 1997-98 Budget Act legislative package, the Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent Children
(AFDC) and Greater Avenues to Independence (GAIN) programs effective January 1,
1998. Consistent with the federal law, CalWORKs contains new time limits on
receipt of welfare aid, both lifetime as well as for any current period of aid.
The centerpiece of CalWORKs is the linkage of eligibility to work participation
requirements. Administration of the new Welfare-
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to-Work programs will be largely at the county level, and counties are given
financial incentives for success in this program.
Although the long-term impact of the new federal Law and CalWORKs
cannot be determined until there has been more experience, the State does not
presently anticipate that these new programs will have an adverse financial
impact on the General Fund. Overall TANF grants from the federal government are
expected to equal or exceed the amounts the State would have received under the
old AFDC program.
Pressures on the State's budget in the late 1980's and early 1990's
were caused by a combination of external economic conditions (including a
recession which began in 1990) and growth of the largest General Fund Programs -
K-14 education, health, welfare and corrections - at rates faster than the
revenue base. During this period, expenditures exceeded revenues in four out of
six years up to 1992-93, and the State accumulated and sustained a budget
deficit approaching $2.8 billion at its peak at June 30, 1993. Between the
1991-92 and 1994-95 Fiscal Years, each budget required multibillion dollar
actions to bring projected revenues and expenditures into balance, including
significant cuts in health and welfare program expenditures; transfers of
program responsibilities and funding from the State to local governments;
transfer of about $3.6 billion in annual local property tax revenues from other
local governments to local school districts, thereby reducing State funding for
schools under Proposition 98; and revenue increases (particularly in the 1991-92
Fiscal Year budget), most of which were for a short duration.
Despite these budget actions, the effects of the recession led to
large, unanticipated budget deficits. By the 1993-94 Fiscal Year, the
accumulated deficit was so large that it was impractical to budget to retire it
in one year, so a two-year program was implemented, using the issuance of
revenue anticipation warrants to carry a portion of the deficit over the end of
the fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, again using cross-fiscal year
revenue anticipation warrants to partly finance the deficit into the 1995-96
fiscal year.
Another consequence of the accumulated budget deficits, together with
other factors such as disbursement of funds to local school districts "borrowed"
from future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the Legislature and the Governor failed to
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adopt a budget for the 1992-93 Fiscal Year by July 1, 1992, which would have
allowed the State to carry out its normal annual cash flow borrowing to
replenish its cash reserves, the State Controller issued registered warrants to
pay a variety of obligations representing prior years' or continuing
appropriations, and mandates from court orders. Available funds were used to
make constitutionally-mandated payments, such as debt service on bonds and
warrants. Between July 1 and September 4, 1992, when the budget was adopted, the
State Controller issued a total of approximately $3.8 billion of registered
warrants.
For several fiscal years during the recession, the State was forced to
rely on external debt markets to meet its cash needs, as a succession of notes
and revenue anticipation warrants were issued in the period from June 1992 to
July 1994, often needed to pay previously maturing notes or warrants. These
borrowings were used also in part to spread out the repayment of the accumulated
budget deficit over the end of a fiscal year, as noted earlier. The last and
largest of these borrowings was $4.0 billion of revenue anticipation warrants
which were issued in July, 1994 and matured on April 25, 1996.
The State's financial condition improved markedly during the 1995-96
and 1996-97 fiscal years, with a combination of better than expected revenues,
slowdown in growth of social welfare programs, and continued spending restraint
based on the actions taken in earlier years. The State's cash position also
improved, and no external deficit borrowing has occurred over the end of these
two fiscal years.
The economy grew strongly during these fiscal years, and as a result,
the General Fund took in substantially greater tax revenues (around $2.2 billion
in 1995-96 and $1.6 billion in 1996-97) than were initially planned when the
budgets were enacted. These additional funds were largely directed to school
spending as mandated by Proposition 98, and to make up shortfalls from reduced
federal health and welfare aid. The accumulated budget deficit from the
recession years was finally eliminated. In the Governor's 1998-99 Budget
Proposal, released January 9, 1998, the Department of Finance reported that the
State's budget reserve (the SFEU) totaled $461 million as of June 30, 1997.
On January 9, 1997, the Governor released his proposed budget for the
1997-98 Fiscal Year (the "Proposed Budget"). The Proposed Budget estimated
General Fund revenues and transfers of about $50.7 billion, and proposed
expenditures of $50.3 billion. In May 1997, the Department of Finance increased
its revenue estimate for the upcoming fiscal year by $1.3 billion, in response
to the continued strong growth in the State's economy.
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In May, 1997, action was taken by the California Supreme Court in an
ongoing lawsuit, PERS v. Wilson, which made final a judgment against the State
requiring an immediate payment from the General Fund to the Public Employees
Retirement Fund ("PERF") to make up certain deferrals in annual retirement fund
contributions which had been legislated in earlier years for budget savings, and
which the courts found to be unconstitutional. On July 30, 1997, following a
direction from the Governor, the Controller transferred $1.228 billion from the
General Fund to the PERF in satisfaction of the judgment, representing the
principal amount of the improperly deferred payments from 1995-96 and 1996-97.
In late 1997, the plaintiffs filed a claim with the State Board of
Control for payment of interest under the Court rulings in an amount of $308
million. The Department of Finance has recommended approval of this claim. If
approved by the Board of Control, the claim would become part of a claims bill
to be paid in the 1998-99 Fiscal Year.
Once the pension payment of $1.228 billion eliminated essentially all
the "increased" revenue in the budget, final agreement was reached within a few
weeks on a welfare reform package and the remainder of the budget. The
Legislature passed the Budget Bill on August 11, 1997, along with numerous
related bills to implement its provisions. On August 18, 1997, the Governor
signed the Budget Act, but vetoed approximately $314 million of specific
spending items, primarily in health and welfare and education areas from both
the General Fund and Special Funds. Most of this spending (approximately $200
million) was restored in later legislation passed before the end of the
Legislative Session.
The Budget Act anticipated General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and expenditures
of $52.8 billion (an 8.0 percent increase from the 1996-97 levels). The Budget
Act also included Special Fund expenditures of $14.4 billion (as against
estimated Special Fund revenues of $14.0 billion), and $2.1 billion of
expenditures from various Bond Funds. Following enactment of the Budget Act, the
State implemented its normal annual cash flow borrowing program, issuing $3.0
billion of notes which mature on June 30, 1998.
The following were major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contained a large increase
in funding for K-14 education under Proposition 98, reflecting strong revenues
which exceeded initial budgeted
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amounts. Part of the nearly $1.75 billion in increased spending was allocated to
prior fiscal years. Funds were provided to fully pay for the
cost-of-living-increase component of Proposition 98, and to extend the class
size reduction and reading initiatives.
2. The Budget Act reflected the $1.228 billion pension case judgment
payment, and brought funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts.
3. Funding from the General Fund for the University of California and
California State University was increased by about 6 percent ($121 million and
$107 million, respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels, adjusted for caseload changes.
5. Health and welfare costs were contained, continuing generally the
grant levels from prior years, as part of the initial implementation of the new
CalWORKs program.
6. Unlike prior years, this Budget Act did not depend on uncertain
federal budget actions. About $300 million in federal funds, already included in
the federal FY 1997 and 1998 budgets, was included in the Budget Act, to offset
incarceration costs for illegal aliens.
7. The Budget Act contained no tax increases, and no tax reductions.
The Renters Tax Credit was suspended for another year, saving approximately $500
million.
At the end of the Legislative Session on September 13, 1997, the
Legislature passed and the Governor later signed several bills encompassing a
coordinated package of fiscal reforms, mostly to take effect after the 1997-98
Fiscal Year. Included in the package are a variety of phased-in tax cuts,
conformity with certain provisions of the federal tax reform law passed earlier
in the year, and reform of funding for county trial courts, with the State to
assume greater financial responsibility. The Department of Finance estimates
that the major impact of these fiscal reforms will occur in Fiscal Year 1998-99
and subsequent years.
On January 9, 1998, the Governor released his Budget Proposal for the
1998-99 Fiscal Year (the "Governor's Budget"). The Governor's Budget projects
total General Fund revenues and transfers of $55.4 billion, a $2.5 billion
increase (4.7 percent)
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over revised 1997-98 revenues. This revenue increase takes into account reduced
revenues of approximately $600 million from the 1997 tax cut package, but also
assumes approximately $500 million additional revenues primarily associated with
capital gains realizations. The Governor's Budget notes, however, that capital
gains activity and the resultant revenues derived from it are very hard to
predict.
Total General Fund expenditures for 1998-99 are recommended at $55.4
billion an increase of $2.4 billion (4.5 percent) above the revised 1997-98
level. The Governor's Budget includes funds to pay the interest claim relating
to the court decision on pension fund payments, PERS v. Wilson. The Governor's
Budget projects that the State will carry out its normal intra-year cash flow
external borrowing in 1998-99, in an estimated amount of $3.0 billion. The
Governor's Budget projects that the budget reserve, the SFEU, will be $296
million at June 30, 1999, slightly lower than the projected level at June 30,
1998 PERS liability.
The Governor's Budget projects Special Fund revenues of $14.7 billion,
and Special Fund expenditures of $15.2 billion, in the 1998-99 Fiscal Year. A
total of $3.2 billion of bond fund expenditures are also proposed.
On December 6, 1994, Orange County, California (the "County"), together
with its pooled investment funds (the "Funds") filed for protection under
Chapter 9 of the federal Bankruptcy Code, after reports that the Funds had
suffered significant market losses in their investments, causing a liquidity
crisis for the Funds and the County. More than 200 other public entities, most
of which, but not all, are located in the County, were also depositors in the
Funds. The bankruptcy filing stemmed from approximately $1.7 billion in losses
suffered by the County's investment pool due to investments in high risk
"derivative" securities. On June 12, 1996, it emerged from bankruptcy after the
successful sale of $880 million in municipal bonds allowed the County to pay off
the last of its creditors. On January 7, 1997, the County returned to the
municipal bond market with a $136 million bond issue maturing in 13 years at an
insured yield of 7.23%.
The State is a party to numerous legal proceedings, many of which
normally recur in governmental operations. In addition, the State is involved in
certain other legal proceedings which, if decided against the State, may require
the State to make significant future expenditures or may impair future revenue
sources.
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Due to the State's continuing budget problems, the State's general
obligation bonds were downgraded in July 1994 from A1" to "Aa" by Moody's, from
"A+" to "A" by S&P. The ratings companies expressed uncertainty in the State's
ability to balance its budget by 1996. However, on July 30, 1996, citing the
State's improving economy and budget situation, S&P upgraded the State's general
obligation bonds from "A" to "A+." There can be no assurance that such ratings
will continue for any given period of time or that they will not in the future
be further revised or withdrawn.
RISK FACTORS AFFECTING NEW YORK MUNICIPAL SECURITIES
The following information as to certain New York State ("State") and
New York City ("City") risk factors is given to investors in view of the policy
of the MainStay New York Tax Free Fund of concentrating its investments in New
York municipal issuers. Such information constitutes only a brief discussion,
does not purport to be a complete description and is based on information from
sources believed by the Trust to be reliable, including official statements
relating to securities offerings of New York and municipal issuers, and periodic
publications by national ratings organizations. Such information, however, has
not been independently verified by the Trust.
There are a number of methods by which the State may incur debt. The
State may issue general obligations bonds. Under the State Constitution, the
State may not, with limited exceptions for emergencies, undertake long-term
general obligation borrowing (i.e., borrowing for more than one year) unless the
borrowing is authorized in a specific amount for a single work or purpose by the
legislature and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State.
The State may undertake short-term borrowings without voter approval
(I) in anticipation of the receipt of taxes and revenues, by issuing tax and
revenue anticipation notes; and (ii) in anticipation of the receipt of proceeds
from the sale of duly authorized but unissued general obligation bonds, by
issuing bond anticipation notes. The State may also, pursuant to specific
constitutional authorization, directly guarantee certain obligations of the
State's authorities ("Authorities"). Payments of debt service on State general
obligation and State-guaranteed bonds and notes are legally enforceable
obligations of the State.
The State also employs additional long-term financing mechanisms,
lease-purchase and contractual-obligation financings, which involve obligations
of public authorities or municipalities
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that are State-supported but not general obligations of the State. The fiscal
stability of the State is related in part to the fiscal stability of its public
authorities.
Public authority operating expenses and debt service costs are
generally paid by revenues generated by the projects financed or operated, such
as tolls charged for the use of highways, bridges or tunnels, rentals charged
for housing units, and charges for occupancy at medical care facilities. In
addition, State legislation authorizes several financing techniques for public
authorities. Also, there are statutory arrangements providing for State local
assistance payments otherwise payable to localities to be made under certain
circumstances to public authorities. Although the State has no obligation to
provide additional assistance to localities whose local assistance payments have
been paid to public authorities under these arrangements, if local assistance
payments are diverted, the affected localities could seek additional State
assistance. Some authorities also receive moneys from State appropriations to
pay for the operating costs of certain of their programs. The Metropolitan
Transit Authority (the "MTA") receives the bulk of this money in order to
provide transit and commuter services.
In 1990, as part of a State fiscal reform program, legislation was
enacted creating the "New York Local Government Assistance Corporation"
("LGAC"), a public benefit corporation empowered to issue long-term obligations
to fund certain payments to local governments traditionally funded through the
State's annual seasonal borrowing. Over a period of years, the issuance of those
long-term obligations, which are to be amortized over no more than 30 years, was
expected to eliminate the need for continued short-term seasonal borrowing. The
legislation also dedicated revenues equal to one-quarter of the four cent State
sales and use tax to pay debt service on these bonds. In addition, the
legislation imposed a cap on the annual seasonal borrowing of the State at $4.7
billion, less net proceeds of bonds issued by LGAC and bonds issued to provide
for capitalized interest, except in cases where the Governor and the legislative
leaders have certified both the need for additional borrowing and a schedule for
reducing it to the cap. If borrowing above the cap is thus permitted in any
fiscal year, it is required by law to be reduced to the cap by the fourth fiscal
year after the limit was first exceeded.
On January 6, 1992, Moody's lowered from "A" to "Baa1" its rating of
those State bonds that are backed by annual legislative appropriations. On
February 11, 1997, Moody's downgraded its rating of the State's general
obligation bonds from "A" to "A2." On January 13, 1992, S&P lowered its rating
of the State's
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general obligation bonds from "A" to "A-." As of July 1998, S&P rated general
obligation bonds as an "A".
The Governor presented his 1998-99 Executive Budget to the Legislature
on January 20, 1998. The Executive Budget contains financial projections for the
State's 1997-98 through 2000-01 fiscal years, detailed estimates of receipts and
a proposed Capital Program and Financing Plan for the 1997-98 through 2002-03
fiscal years. It is expected that the Governor will prepare amendments to his
Executive Budget as permitted under law and that these amendments will be
reflected in a revised Financial Plan to be released on or before February 19,
1998. There can be no assurance that the Legislature will enact into law the
Executive Budget as proposed by the Governor, or that the State's adopted budget
projections will not differ materially and adversely from the projections set
forth in this Update.
The 1998-99 Financial Plan is projected to be balanced on a cash basis
in the General Fund. Total General Fund receipts, including transfers from other
funds, are projected to be $36.22 billion, an increase of $1.02 billion over
projected receipts in the current fiscal year. Total General Fund disbursements,
including transfers to other funds, are projected to be $36.18 billion, an
increase of $1.02 billion over the projected expenditures (including
prepayments), for the current fiscal year. As compared to the 1997-98 State
Financial Plan, the Executive Budget proposes year-to-year growth in General
Fund spending of 2.89 percent. State Funds spending (i.e., General Fund plus
other dedicated funds, with the exception of federal aid) is projected to grow
by 8.5 percent. Spending from All Governmental Funds (excluding transfers) is
proposed to increase by 7.6 percent from the prior fiscal year.
Current law and programmatic requirements are primarily responsible for
the year-to-date growth in General Fund spending. These include a current law
increase in school aid ($607 million), cost and enrollment growth in handicapped
education ($91 million) and Medicaid ($212 million), and employee contract
increases and inflation adjustments for State agency operations. The Executive
Budget also includes increases of $84 million for corrections programs to cover
new capacity demands and $152 million for mental health programs to finance
current law increases and the expansion of community beds. Other spending growth
reflects a requested increase of $108 million for the Judiciary and $117 million
for long-term transfers due to the financing of CEFAP from resources available
in 1997-98, $37 million in welfare assistance savings, $36 million from lower
spending in General State charges, and $68 million in lower
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transfers primarily due to the elimination of the Lottery transfer made in
1997-98.
The 1998-99 Financial Plan projects that the State will end 1998-99
with a closing balance in the General Fund of $500 million, which reflects $400
million in the TSRF and $100 million in the CRF, following an anticipated
deposit of $35 million in the latter fund during the year. Detailed explanations
of the 1998-99 Financial Plan follow a discussion of the economic outlook.
Moderate growth is projected to continue in 1998 and 1999 for
employment, wages and personal income, although the growth rates will lessen
gradually during the course of the two years. Personal income is estimated to
grow by 5.4 percent in 1997, fueled in part by a continued large increase in
financial sector bonus payments, and is projected to grow 4.7 percent in 1998
and 4.4 percent in 1999. Increases in bonus payments at year-end 1998 are
projected to be modest, a substantial change from the rate of increase of the
last few years. Overall employment growth is expected to continue at a modest
rate, reflecting the slowing growth in the national economy, continued spending
restraint in government, and restructuring in the health care, social service,
and banking sectors.
The 1998-99 Financial Plan projects General Fund receipts (including
transfers from other funds) of $36.22 billion, an increase of $1.02 billion over
the estimated 1997-98 level. Recurring growth in the State General Fund tax base
is projected to be approximately six percent during 1998-99, after adjusting for
tax law and administrative changes. This growth rate is lower than the rates for
1996-97 or currently estimated for 1997-98, but roughly equivalent to the rate
for 1995-96.
The forecast of General Fund receipts in 1998-99 incorporates several
Executive Budget tax proposals that, if enacted, would further reduce receipts
otherwise available to the General Fund by approximately $700 million during
1998-99. The Executive Budget proposes accelerating school tax relief for senior
citizens under STAR, which is projected to reduce General Fund receipts by $537
million in 1998-99. The proposed reduction supplements STAR tax reductions
already scheduled in law, which are projected at $187 million in 1998-99. The
Budget also proposes several new tax-cut initiatives and other funding changes
that include reducing the fee to register passenger motor vehicles and
earmarking a larger portion of such fees to dedicated funds and other purposes;
extending the number of weeks in which certain clothing purchases are exempt
from sales taxes; more fully conforming State law to reflect recent Federal
changes
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in estate taxes; continuing lower pari-mutuel tax rates; and accelerating
scheduled property tax relief for farmers from 1999 to 1998. In addition to the
specific tax and fee reductions discussed above, the Executive Budget also
proposes establishing a reserve of $100 million to permit the acceleration into
1998-99 of other tax reductions that are otherwise scheduled in law for
implementation in future fiscal years.
General Fund receipts in 1998-99 will also be affected by the loss of
certain one-time receipts recorded in 1997-98, the largest of which include
approximately $200 million in retroactive federal reimbursements for prior-year
social service spending recorded as a transfer from other funds and about $55
million in retroactive assessments on Office of Mental Retardation and
Developmental Disabilities facilities that were received in 1997-98 as
miscellaneous receipts. Estimates for 1998-99 also reflect the loss of one-time
receipts from a tax amnesty program.
Personal income tax collections in the General Fund are projected to
increase by $1.32 billion over 1997-98, from $18.50 billion to $19.82 billion.
The increase reflects growth in constant law liability of over six percent in
1998, down from an estimated 12 percent growth in 1997. Growth in personal
income tax liability in 1997 benefitted from a temporary surge in capital-gains
income in response to 1997 reductions in the federal tax rate on such income. In
addition to the General Fund receipts, approximately $724 million in personal
income tax collections will be deposited in special revenue funds to finance the
School Tax Assistance Program (STAR).
User tax collections and fee receipts are projected to reach $7.2
billion in 1988-99, an increase of $144 million over the current year. The
largest source of receipts in this category is the sales and use tax, which
accounts for nearly 80 percent of projected receipts. Sales tax receipts are the
most responsive to economic trends such as nominal growth in income, prices,
employment, and consumer confidence. The strong growth in income experienced
this year produced continuing growth in the base of the sales and use tax of 5.2
percent in 1997-98. The sales tax growth rate projected for the coming year is
expected to be marginally higher.
The 1998-99 forecast for user taxes and fees also reflects the impact
of scheduled tax reductions that will lower receipts by $38 million, as well as
the impact of two Executive Budget proposals that are projected to lower
receipts by an additional $79 million. The first proposal would divert $30
million in motor vehicle registration fees from the General Fund to the
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Dedicated Highway and Bridge Trust Fund; the second would reduce fees for motor
vehicle registrations, which would further lower receipts by $49 million. The
underlying growth of receipts in this category is projected at 4 percent, after
adjusting for these scheduled and recommended changes.
In comparison to the current fiscal year, business tax receipts are
projected to decline slightly in 1998-99, falling from $4.98 billion. The
decline in this category is largely attributable to scheduled tax reductions. In
total, collections for corporation and utility taxes and the petroleum business
tax are projected to fall by $107 million from 1997-98. The decline in receipts
in these categories is partially offset by growth in the corporation franchise,
insurance and bank taxes, which are projected to grow by $88 million over the
current fiscal year.
Receipts from other taxes, which include taxes on estate and gifts,
real property gains, and pari-mutuel wagering, are projected to total $1.01
billion in 1998-99, a decline of $78 million from the current year. The main
reason for the decline is an expected fall in the number and value of large
estate tax payments from the extraordinary level achieved in 1997-98. The
decline also reflects the first full-year impact of the repeal of the gains tax.
Miscellaneous receipts, which include license revenues, fee and fine
income, investment income and abandoned property proceeds, as well as the yield
of the largest share of the State's medical provider assessments, are projected
to fall from $1.57 billion in the current year to $1.4 billion in 1998-99, a
decline of $170 million. The decline is largely a result of the loss of over $90
million in one-time transactions and $56 million in statutory reductions in
medical provider assessments.
Transfers to the General Fund from other funds consist primarily of tax
revenues in excess of debt service requirements. Proceeds from the one-cent
sales tax in excess of those used to support debt service payments to the Local
Government Assistance Corporation (LGAC) account for 85 percent of the 1998-99
receipts in this category. LGAC transfers to the General Fund are projected to
increase by $72 million to $1.55 billion in 1998-99, consistent with estimates
for sales and use receipts. Other transfers periodically include non-recurring
transactions, which result in significant annual increases and decreases for
this category. All other transfers are projected to decrease by $250 million to
$270 million in 1998-99 and thereafter.
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The 1998-99 Financial Plan projects General Fund disbursements of
$36.18 billion, an increase of $1.02 billion over projected spending for the
current year.
Disbursements from the category of Grants to Local Governments
constitute approximately 67.9 percent of all General Fund spending, and include
payments to local governments, non-profit providers and individuals.
Disbursements in this category are projected to increase by $931 million to
$24.55 billion in 1998-99, or 3.9 percent above 1997-98. The largest increases
are for school aid and Medicaid.
School aid is projected at $9.47 billion in 1998-99, an increase of
$607 million on a State fiscal year basis. This increase funds both the balance
of aid payable for the 1997-98 school year and a proposed 1998-99 school year
increase of $518 million. Medicaid costs are estimated to increase $212 million
to $5.68 billion, about the same spending level as in 1994-95. After adjusting
1997-98 spending for the one-time acceleration of a 53rd weekly Medicaid payment
scheduled for 1998-99, Medicaid spending is projected to increase by $348
million or 6.5 percent. The adjustment eliminates this extraordinary payment in
1997-98 for purposes of comparison with 1998-99. Spending in local assistance
programs for higher education, handicapped education, mental hygiene, local
public health and revenue sharing are also proposed to increase.
Support for State operations, which pays for the costs of operating the
Executive, Legislative, and Judicial branches of government, is projected to
increase by $524 million to $6.73 billion, or 8.4 percent higher than 1997-98.
This projected increase is primarily due to costs associated with an additional
27th payroll and current collective bargaining agreements, the loss of Federal
disproportionate share receipts that offset General Fund spending in mental
hygiene programs, and a $108 million requested increase in the Judiciary's
budget. Adjusting for the extra payroll, State operations spending increases by
a projected 6.1 percent. The State workforce is roughly 191,000 at present and
is projected to remain stable over the year.
Total spending in General State charges is projected to decline
slightly from 1997-98 to $2.23 billion. This annual decline reflects projected
decreases in one-time costs for pension and Court of Claims payments, offset by
projected increases for health insurance contributions, social security costs,
and the loss of reimbursements due to a reduction in the fringe benefit rate
charged to positions financed by non-General funds.
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Transfers in support of debt service are projected to grow at 5.8
percent in 1998-99, from $2.03 billion to $2.15 billion. Transfers in support of
capital projects for 1998-99 are estimated to total $190 million, a decrease of
$453 million from 1997-98, reflecting the absence of one-time transfers for the
Hudson River Park and CEFAP in 1997-98.
All other transfers reflect remaining transfers from the General Fund
to other funds. These transfers decline by $68 million to $323 million in
1998-99, reflecting non-recurring transfers in 1997-98 to the State University
Tuition Stabilization Fund ($29 million) and to the Lottery fund to support
school aid as a result of lower-than-projected 1997-98 Lottery receipts ($70
million), offset by a $34 million increase in the State subsidy to the Roswell
Park Cancer Institute.
The Division of the Budget estimates that the 1998-99 Financial Plan
includes approximately $62 million in non-recurring resources, comprising less
than two-tenths of one percent of General Fund disbursements. The non-recurring
resources projected for use in 1998-99 consist of $27 million in retroactive
federal welfare reimbursements for family assistance recipients with HIV/AIDS,
$25 million in receipts from the Housing Finance Agency that were originally
anticipated in 1997-98, and $10 million in other measures, including $5 million
in asset sales.
For 1998-99, the Financial Plan projects disbursements of $30.16
billion from Special Revenue Funds (SRFs), an increase of $2.32 billion or 8.3
percent over 1997-98. Disbursements in State SRFs are projected at $8.29
billion, an increase of $1.09 billion or 15.2 percent from 1997-98.
Disbursements from federal funds, which account for approximately three-quarters
of all SRF spending, are estimated at $21.87 billion in 1998-99, an increase of
$1.22 billion or 5.9 percent from 1997-98.
The implementation of the first phase of the STAR program accounts for
$724 million of the 1.09 billion increase in proposed State SRF spending in
1998-99. Other projected State SRF spending increases include: $149 million in
additional operating assistance for mass transit systems; $82 million to expand
the Child Health Plus program, which provides health insurance for uninsured
children under 19 years of age; and $138 million for various State agency
activities. Spending from the State Lottery Fund is projected to increase
slightly over 1997-98, while disbursements from the Indigent Care Fund are
projected to remain flat.
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The $1.22 billion year-to-year growth in federal SRF spending is
primarily due to increases in Medicaid ($433 million), Children and Family
Assistance Programs ($297 million), education programs ($172 million), the
expanded Child Health Plus program ($144 million), and the welfare program ($50
million).
Disbursements from Capital Projects funds in 1998-99 are estimated at
$4.82 billion, or $1.07 billion higher than 1997-98. The proposed spending plan
includes: $2.51 billion in disbursements for transportation purposes, including
the State and local highway and bridge program; $815 million for environmental
activities; $379 million for correctional services; $228 million for SUNY and
CUNY; $290 million for mental hygiene projects; and $375 million for CEFAP.
The projected 1998-99 General Fund cash flow will not depend on either
short-term spring borrowing or the issuance of LGAC bonds. The new-money bond
issuance portion of the LGAC program was completed in 1995-96, and provisions
prohibiting the State from returning to a reliance upon cash flow manipulation
to balance its budget will remain in bond covenants until the LGAC bonds are
retired.
The 1998-99 cash flow projects substantial closing balances in each
quarter of the fiscal year, with excesses in receipts over disbursements in
every quarter of the fiscal year and no monthly balance (prior to March) lower
than $1.5 billion. The closing fund balance is projected at $500 million.
The Executive Budget projects budget gaps of approximately $1.75
billion in 1999-00 growing to $3.75 billion in 2000-01.
General Fund receipts are projected at $36.14 billion and $35.75
billion for 1999-00 and 2000-01, respectively. The receipt projections were
prepared on the basis of an economic forecast of a steadily growing national
economy, in an environment of low inflation and slow employment growth. The
forecast for the State's economic performance likewise is for slow but steady
economic growth. Personal income is expected to rise between 4.25 and 4.5
percent over this period, with average total employment growth of slightly less
than one percent a year. Private sector employment is expected to rise slightly
more rapidly.
Statutory changes affecting General Fund receipts are dominated by the
dedication of a portion of the income tax to fund school tax reductions under
STAR. Personal income receipts dedicated to STAR are estimated at $1.39 billion
in 1999-00 and at $2.04 billion in 2000-01. The General Fund tax relief
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provided by the estate and gift tax reduction program, sales tax reductions and
other 1997 enactments further reduce taxes and fees by roughly $1 billion by the
last year of the forecast period. Other 1998-99 budget proposals that lower
General Fund taxes and fees will annualize to approximately $110 million in
1999-00 and $100 million in 2000-01.
The receipt projections reflect constant law income tax liability
growth of approximately 5.3 percent annually and sales tax growth averaging
slightly less than 5 percent over the period. Constant law business tax
liability is projected to rise slowly over the two years.
Miscellaneous receipt projections reflect $250 million in each of the
outyears as the potential State benefit from a broader national settlement
involving tobacco taxes and health liability.
Disbursements from the General Fund are projected at $37.84 billion in
1999-00 and $39.45 billion in 2000-01, after assuming implementation of spending
proposals contained in the Executive Budget, the value of which is annualized
and assumed to continue. The projections include additional school aid increases
of roughly 7 percent annually to finance present law and implement proposals
enacted under the STAR/School Aid program. Additional funding to implement
welfare reform is also included, as well as funding for mental health community
reinvestment, prison expansion, and other previous multi-year spending
commitments. Growth in General Fund Medicaid spending is projected at just over
6 percent annually. Other spending growth is projected to follow recent trends.
Consistent with past practice, funding is not included for any costs associated
with new collective bargaining agreements after the expiration of the current
round of contracts at the end of the 1998-99 fiscal year.
Savings actions totaling $600 million in 1999-00 and growing to $800
million in 2000-01 are assumed in these spending projections. It is expected
that the 1999-00 Financial Plan will include continued actions by State agencies
to deliver services more efficiently, continued savings from workforce
management efforts, aggressive efforts to maximize federal and other non-General
Fund spending offsets, and other efforts to control State spending.
The Governor is required by law to propose a balanced budget each year.
In order to address any potential remaining budget gap, the Governor is expected
to make additional proposals to bring receipts in line with disbursements. The
State has closed projected budget gaps of $5.0 billion, $3.9 billion and $2.3
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billion in its 1995-96, 1996-97 and 1997-98 fiscal years, respectively.
The Division of the Budget believes that the economic assumptions and
projections of receipts and disbursements accompanying the 1998-99 Executive
Budget are reasonable. However, the economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. Those factors can be very complex, can vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State but
by entities, such as the federal government, that are outside the State's
control. Because of the uncertainty and unpredictability of changes in these
factors, their impact cannot be fully included in the assumptions underlying the
State's projections. For example, there can be no assurance that the Legislature
will enact the Governor's proposals or that the State's actions will be
sufficient to preserve budgetary balance or to align recurring receipts and
disbursements in either 1998-99 or in future fiscal years.
Uncertainties with regard to the economy present the largest potential
risk to future budget balance in New York State. This risk includes either a
financial market or broader economic "correction" during the period, a risk
heightened by the relatively lengthy expansions currently underway. The
securities industry is more important to the New York economy than the national
economy, and a significant deterioration in stock market performance could
ultimately produce adverse changes in wage and employment levels. In addition, a
normal "forecast error" of one percentage point in the expected growth rate
could cumulatively raise or lower receipts by over $1 billion by the last year
of the 1998 through 2001 projection period. On the other hand, the national or
State economy may continue to perform better than projected, which could produce
beneficial short-term results in State receipts.
On August 11, 1997 President Clinton exercised his line item veto
powers to cancel a provision in the Federal Balanced Budget Act of 1997 that
would have deemed New York State's health care provider taxes to be approved by
the federal government. New York and several other states have used hospital
rate assessments and other provider tax mechanisms to finance various Medicaid
and health insurance programs since the early 1980s. The State's process of
taxation and redistribution of health care dollars was sanctioned by federal
legislation in 1987 and 1991. However, the federal Health Care Financing
Administration (HCFA) regulations governing the use of provider taxes require
the State to seek waivers from HCFA that would grant explicit approval of the
provider taxing system now in place. The State filed the
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majority of these waivers with HCFA in 1995 but has yet to receive final
approval.
The Balanced Budget Act of 1997 provision passed by Congress was
intended to rectify the uncertainty created by continued inaction on the State's
waiver requests. A federal disallowance of the State's provider tax system could
jeopardize up to $2.6 billion in Medicaid reimbursement received through
December 31, 1998. The President's veto message valued any potential
disallowance at $200 million.
On October 9, 1997 the President offered a corrective amendment to the
HCFA regulations governing such taxes. The Governor has stated that this
proposal does not appear to address all of the State's concerns, and
negotiations are ongoing between the State and HCFA. In addition, the City of
New York and other affected parties in the health care industry have filed a
lawsuit challenging the constitutionality of the President's line item veto.
On July 31, 1997, the New York State Tax Appeals Tribunal delivered a
decision involving the computation of itemized deductions and personal income
taxes of certain high income taxpayers. By law, the State cannot appeal the
Tribunal's decision. The decision will lower income tax liability attributable
to such taxpayers for the 1997 and earlier open tax years, as well as on a
prospective basis. The impact of this decision on receipts estimates for the
current and future fiscal years will be reflected in the Financial Plan and
Financial Plan Update that will accompany the 1998-99 Executive Budget.
Section 22-c of the State Finance Law, as amended by Chapter 389 of the
Laws of 1997, now requires the Governor to submit the five-year Capital Program
and Financing Plan with the Executive Budget. That Plan also is required to be
updated by the later of July 30 or 90 days after enactment of the State budget.
The Update to the five-year Capital Program and Financing Plan was
released on November 18, 1997. The Update reflected voter disapproval of the
School Facility Health and Safety Bond Act, additional issuances for 1997-98 of
approximately $225 million for CEFAP, $42 million for the Albany County Airport,
and $228 million in Certificates of Participation (COPs) to finance welfare
information systems.
The proposed 1997-98 through 2002-03 Capital Program and Financing Plan
was released with the 1998-99 Executive Budget on January 20, 1998. As a part of
that Plan, changes were proposed to the State's 1997-98 borrowing plan,
including: the delay in
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the issuance of COPs to finance welfare information systems until 1998-99 to
permit a thorough assessment of needs; and the elimination of issuances for the
CEFAP to reflect the proposed conversion of that bond-financed program to
pay-as-you-go financing.
As a result of these changes, the State's 1997-98 borrowing plan now
reflects: $501 million in general obligation bonds (including $140 million for
purposes of redeeming outstanding BANs) and $140 million in general obligation
commercial paper; the issuance of $83 million in COPs for equipment purchases;
and approximately $1.8 billion in borrowings by public authorities pursuant to
lease-purchase and contractual-obligation financings for capital programs of the
State, including costs of issuance, reserve funds, and other costs, net of
anticipated refundings and other adjustments for 1997-98 capital projects. The
projection of State borrowings for the 1997-98 fiscal year is subject to change
as market conditions, interest rates and other factors vary through the end of
the fiscal year.
On August 22, 1996, the President signed into law the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996. This federal
legislation fundamentally changed the programmatic and fiscal responsibilities
for administration of welfare programs at the federal, state and local levels.
The new law abolishes the federal Aid to Families with Dependent Children
program (AFDC), and creates a new Temporary Assistance to Needy Families program
(TANF) funded with a fixed federal block grant to states. The new law also
imposes (with certain exceptions) a five-year durational limit on TANF
recipients, requires that virtually all recipients be engaged in work or
community service activities within two years of receiving benefits, and limits
assistance provided to certain immigrants and other classes of individuals.
States are required to meet work activity participation targets for their TANF
caseload; these requirements are phased in over time. States that fail to meet
these federally mandated job participation rates, or that fail to conform with
certain other federal standards, face potential sanctions in the form of a
reduced federal block grant.
The State Financial Plan is based upon forecasts of national and State
economic activity developed through both internal analysis and review of State
and national economic forecasts prepared by commercial forecasting services and
other public and private forecasters. Economic forecasts have frequently failed
to predict accurately the timing and magnitude of changes in the national and
the State economies. Many uncertainties exist in forecasts of both the national
and State economies, including consumer attitudes toward spending, the extent of
corporate and
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governmental restructuring, federal fiscal and monetary policies, the level of
interest rates, and the condition of the world economy, which could have an
adverse effect on the State. There can be no assurance that the State economy
will not experience results in the current fiscal year that are worse than
predicted, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
Projections of total State receipts in the State Financial Plan are
based on the State tax structure in effect during the fiscal year and on
assumptions relating to basic economic factors and their historical
relationships to State tax receipts. In preparing projections of State receipts,
economic forecasts relating to personal income, wages, consumption, profits and
employment have been particularly important. The projection of receipts from
most tax or revenue sources is generally made by estimating the change in yield
of such tax or revenue source caused by economic and other factors, rather than
by estimating the total yield of such tax or revenue source from its estimated
tax base. The forecasting methodology, however, ensures that State fiscal year
estimates for taxes that are based on a computation of annual liability, such as
the business and personal income taxes, are consistent with estimates of total
liability under such taxes.
Projections of total State disbursements are based on assumptions
relating to economic and demographic factors, levels of disbursements for
various services provided by local governments (where the cost is partially
reimbursed by the State), and the results of various administrative and
statutory mechanisms in controlling disbursements for State operations. Factors
that may affect the level of disbursements in the fiscal year include
uncertainties relating to the economy of the nation and the State, the policies
of the federal government, and changes in the demand for and use of State
services.
The Division of the Budget believes that its projections of receipts
and disbursements relating to the current State Financial Plan, and the
assumptions on which they are based, are reasonable. Actual results, however,
could differ materially and adversely from any projections. In the past, the
State has taken management actions and made use of internal sources to address
potential State Financial Plan shortfalls, and DOB believes it could take
similar actions should variances occur in its projections for the current fiscal
year.
In recent years, State actions affecting the level of receipts and
disbursements, the relative strength of the State and regional economy, actions
of the federal government and other
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factors, have created structural budget gaps for the State. These gaps resulted
from a significant disparity between recurring revenues and the costs of
maintaining or increasing the level of support for State programs. To address a
potential imbalance in any given fiscal year, the State would be required to
take actions to increase receipts and/or reduce disbursements as it enacts the
budget for that year, and under the State Constitution, the Governor is required
to propose a balanced budget each year. There can be no assurance, however, that
the legislature will enact the Governor's proposals or that the State's actions
will be sufficient to preserve budgetary balance in a given fiscal year or to
align recurring receipts and disbursements in future fiscal years.
Constitutional challenges to State laws have limited the amount of
taxes which political subdivisions can impose on real property. In 1979, the
State's highest court declared unconstitutional a State law allowing localities
and school districts to impose a special increase in real estate property taxes
in order to raise funds for pensions and other uses. Additional court actions
have been brought against the State, certain agencies and municipalities
relating to financing, the amount of real estate tax, the use of tax revenues
and other matters.
An additional risk to the 1998-99 State Financial Plan arises from the
potential impact of certain litigation now pending against the State, which
could produce adverse effects on the State's projections of receipts and
disbursements.
Certain litigation pending against the State, its subdivisions and
their officers and employees could have a substantial and long-term adverse
effect on State finances. The State is a party to numerous legal proceedings,
many of which normally recur in governmental operations. Because of the
prospective nature of these proceedings, no estimate of the potential loss can
be made.
The State is a defendant in numerous legal proceedings pertaining to
matters incidental to the performance of routine governmental operations. Such
litigation includes, but is not limited to, claims asserted against the State
arising from alleged torts, alleged breaches of contracts, condemnation
proceedings and other alleged violations of State and Federal laws.
Included in the State's outstanding litigation are a number of cases
challenging the legality or the adequacy of a variety of significant social
welfare programs primarily involving the
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State's Medicaid and mental health programs. Adverse judgments in these matters
generally could result in injunctive relief coupled with prospective changes in
patient care which could require substantial increased financing of the
litigated programs in the future. Because of the prospective nature of these
matters, no provision for this potential exposure has been made in the
accompanying general purpose financial statements.
Actions commenced by several Indian nations claim that significant
amounts of land were unconstitutionally taken from the Indians in violation of
various treaties and agreements during the eighteenth and nineteenth centuries.
The claimants seek recovery of approximately six million acres of land as well
as compensatory and punitive damages.
In addition, the State is party to other claims and litigation which
its legal counsel has advised are not probable of adverse court decisions.
Although the amounts of potential losses, if any, are not presently
determinable, it is the State's opinion that its ultimate liability in these
cases is not expected to have a material adverse effect on the State's financial
position.
The fiscal health of the State may also be affected by the fiscal
health of New York City ("the City"), which continues to require significant
financial assistance from the State. The City depends on State aid both to
enable the City to balance its budget and to meet its cash requirements. The
State could also be affected by the ability of the City to market its securities
successfully in the public credit markets. As of July 1998, Moody's rated New
York City general obligation bonds "A3" and S&P rated the same bonds "A-."
Both the State and City face potential economic problems which could
seriously affect the ability of both the State and City to meet their financial
obligations. The economic problems of New York City adversely affect the State
in numerous ways. In addition, for decades the State economy has grown more
slowly than that of the nation as a whole, resulting in a decline in the
position of New York as one of the country's wealthier states. The causes of
this decline are varied and complex and some causes reflect international and
national trends beyond the State's and City's control.
Certain localities outside New York City have experienced financial
problems and have requested and received additional State assistance during the
last several State fiscal years. The potential impact on the State of any future
requests by localities for additional assistance is not included in the
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projections of the State's receipts and disbursements for the State's 1998-1999
fiscal year.
Fiscal difficulties experienced by the City of Yonkers resulted in the
re-establishment of the Financial Control Board for the City of Yonkers by the
State in 1984. That Board is charged with oversight of the fiscal affairs of
Yonkers. Future actions taken by the State to assist Yonkers could result in
increased State expenditures for extraordinary local assistance.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The Supervisory Board's powers were increased in 1995, when
Troy MAC was created to help Troy avoid default on certain obligations. The
legislation creating Troy MAC prohibits the City of Troy from seeking federal
bankruptcy protection while Troy MAC bonds are outstanding.
Seventeen municipalities received extraordinary assistance during the
1996 legislative session through $50 million in special appropriations targeted
for distressed cities, and that was largely continued in 1997.
Municipalities and school districts have engaged in substantial
short-term and long-term borrowings. State law requires the Comptroller to
review and make recommendations concerning the budgets of those local government
units other than New York City authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding. Eighteen
localities had outstanding indebtedness for deficit financing at the close of
their fiscal year ending in 1995.
From time to time, federal expenditure reductions could reduce, or in
some cases eliminate, federal funding of some local programs and accordingly
might impose substantial increased expenditure requirements on affected
localities. If the State, the City or any of the public authorities were to
suffer serious financial difficulties jeopardizing their respective access to
the public credit markets, the marketability of notes and bonds issued by
localities within the State could be adversely affected. Localities also face
anticipated and potential problems resulting from certain pending litigation,
judicial decisions and long-range economic trends. Long-range potential problems
of declining urban population, increasing expenditures and other economic trends
could adversely affect localities and require increasing State assistance in the
future.
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SPECIAL CONSIDERATIONS AFFECTING PUERTO RICO
The following highlights some of the more significant financial trends
and problems affecting the Commonwealth of Puerto Rico (the Commonwealth or
Puerto Rico) and is based on information drawn from official statements and
prospectuses relating to the securities offerings of Puerto Rico and its
agencies and instrumentalities. Such information, however, has not been
independently verified by the Trust.
The economy of Puerto Rico is closely integrated with that of the
United States. Since 1983, Puerto Rico has experienced a wide ranging economic
expansion with growth in almost every sector of its economy and record levels of
employment.
Puerto Rico's more than decade-long economic expansion continued
throughout the five-year period from fiscal 1993 through fiscal 1997. Almost
every sector of the economy participated and record levels of employment were
achieved. Factors behind this expansion included government-sponsored economic
development programs, periodic declines in the exchange value of the United
States dollar, increases in the level of federal transfers, and the relatively
low cost of borrowing.
Gross product in fiscal 1993 was $25.1 billion ($24.5 billion in 1992
prices) and gross product in fiscal 1997 was $32.0 billion ($27.6 billion in
1992 prices). This represents an increase in gross product of 27.5% from fiscal
1993 to 1997 (12.6% in 1992 prices). Since fiscal 1985, personal income, both
aggregate and per capita, has increased consistently each fiscal year. In fiscal
1996, aggregate personal income was $29.4 billion ($27.8 billion in 1992 prices)
and personal income per capita was $7,882 ($7,459 in 1992 prices).
Puerto Rico's economy continued to expand throughout the period from
fiscal 1990 through fiscal 1997. While trends in the Puerto Rico economy
generally follow those of the United States, Puerto Rico did not experience a
recession in 1991 as the United States did. This was primarily because of low
oil prices, low interest rates, and Puerto Rico's strong manufacturing base,
which has a large component of non-cyclical industries. Other factors
contributing to Puerto Rico's decade-long expansion include
commonwealth-sponsored economic development programs, the relatively stable
prices of oil imports, low exchange rates for the U.S. dollar, the level of
federal transfers, and the relatively low cost of borrowing funds during the
period. These factors will continue to affect Puerto Rico's economic growth
rate.
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According to the Labor Department's Household Employment Survey, during
the first five months of fiscal 1998, total employment increased 1.9% over
fiscal 1997. Total employment averaged 1,137,200 during the first five months of
fiscal 1998, compared to 1,115,600 in the same period of fiscal 1997. The
seasonally adjusted unemployment rate for November 1997 was 14.0%.
The Planning Board's gross product forecast for fiscal 1998, made in
February 1997, projected an increase of 2.6% over fiscal 1997.
Puerto Rico has a diversified economy with the manufacturing and
service sectors comprising the principal sectors. Manufacturing is the largest
sector in terms of gross domestic product. According to the Planning Board's
preliminary figures, in fiscal 1996 manufacturing generated $18.9 billion, or
41.4% of gross domestic product and accounted for 15.3% of total employment; as
compared with fiscal 1995, when it generated $17.9 billion, or 41.9%, of gross
domestic product and accounted for 16.4% of total employment. Manufacturing in
Puerto Rico is now more diversified than during the earlier phases of its
industrial development. In the last two decades, industrial development has
tended to be more capital intensive and more dependent on skilled labor. This
gradual shift in emphasis is best exemplified by the heavy investment in the
pharmaceutical, scientific instruments, computer, microprocessor, medical
product and electrical product industries over the last decade. One of the
factors assisting the development of the manufacturing sector has been the tax
incentives offered by the federal and Puerto Rico governments. Recently enacted
federal legislation amending Internal Revenue Code Section 936, however, phases
out the federal tax incentives during a ten-year period.
The service sector, which includes hotel and related services and
which, during fiscal 1997, accounted for approximately 48.8% of total
employment, accounted for $17.1 billion, or 37.6%, of Puerto Rico's gross
domestic product in fiscal 1996, as compared with $16.2 billion, or 38.1%, of
gross domestic product in fiscal 1995. The services sector, particularly
wholesale and retail trade and finance, insurance and real estate, has
experienced significant growth partly in response to the expansion of the
manufacturing sector.
Growth in construction and tourism has also contributed to increased
economic activity in fiscal 1997. The growth in the construction industry has
been evidenced by a nominal increase of 14.7% in construction investment for
fiscal 1997 over fiscal 1996. Tourism has grown in each fiscal year since fiscal
1985.
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More than 4.3 million visitors spent over $2.0 billion in Puerto Rico in fiscal
1997. San Juan has become the largest home port for cruise ships in the
Caribbean and the second largest home port for cruise ships in the world.
Twenty-four U.S. and international airlines offer scheduled service to and from
San Juan, and a major U.S. airline uses San Juan as a hub for its
intra-Caribbean operations. This reflects the importance of Puerto Rico as a
tourist destination and as a transportation hub in the Caribbean.
For many years, United States companies operating in Puerto Rico
enjoyed a special tax credit that was available under Section 936 of the
Internal Revenue Code. Originally, the credit provided an effective 100% federal
income tax exemption for most operating income, as well as qualifying investment
income from Puerto Rico sources. Amendments to Section 936 made in 1993 (the
"1993 Amendments") instituted two alternative methods for calculating the tax
credit and limited the amount of the credit that a qualifying company can claim.
These limitations are based on a percentage of qualifying income (the
"percentage of income limitation") and on qualifying expenditures for wages,
other wage related benefits and other qualifying costs and expenses (the
"economic activity limitation", also known as the "wage credit limitation").
As a result of amendments incorporated in the Small Business Job
Protection Act of 1996, enacted by the United States Congress and signed into
law by President Clinton on August 20, 1996 (the "1996 Amendments"), the tax
credit is now being phased out over a ten-year period for existing 936 credit
claimants and is no longer available for corporations that establish operations
in Puerto Rico after October 13, 1995 (including existing Section 936
Corporations, if they establish new product lines in Puerto Rico). The 1996
Amendments also moved the credit based on the economic activity limitation to
Section 30A of the Code and phased it out over 10 years.
In addition, the 1996 Amendment eliminated the credit previously
available for income derived from certain qualified investments in Puerto Rico.
During 1997, the Governor proposed to Congress the enactment of a new
permanent federal incentive program similar to what is now provided under
Section 30A. Such program would provide U.S. companies a tax credit based on
qualifying wages paid and other wage related expenses, such as fringe benefits,
as well as depreciation expenses for certain tangible assets and research and
development expenses. Under the Governor's proposal, the credit granted to
qualifying companies would continue in effect
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until Puerto Rico shows, among other things, substantial economic improvements
in terms of certain economic parameters. The fiscal 1998 federal budget
submitted by President Clinton to Congress in February 1997, included a proposal
to modify Section 30A to extend the availability of the Section 30A credit
indefinitely, make it available to companies establishing operations in Puerto
Rico after October 13, 1995, and eliminate the income cap. However, President
Clinton's proposal was not included in the fiscal 1998 federal budget. While the
Government of Puerto Rico intends to continue lobbying for this proposal, it is
not impossible at this time to predict whether the Section 30A credit will be
modified, nor to determine the long term effect on the Puerto Rico economy of
the enactment of the 1996 Amendments. The Commonwealth of Puerto Rico does not
believe there will be short-term or medium-term material adverse effects on
Puerto Rico's economy as a result of the enactment of the 1996 Amendments. The
Commonwealth of Puerto Rico further believes that the phase-out period allows
sufficient time to implement additional incentive programs to safeguard Puerto
Rico's competitive position.
The Industrial Incentives Program, through the 1987 Industrial
Incentives Act, grants corporations engaged in certain qualified activities a
fixed 90% exemption from Commonwealth income and property taxes and a 60%
exemption from municipal license taxes. Under the 1987 Act, as amended,
applications for grants of tax exemption could be filed until December 31, 1996.
On September 12, 1996 the Governor of Puerto Rico signed into law Act No. 212
which postponed the deadline for filing applications until December 31, 1997.
On December 2, 1997 the Governor of Puerto Rico signed into law Act No.
135 (the "1998 Tax Incentives Law"), a new industrial incentives law aimed at
attracting and retaining foreign investment in Puerto Rico.
The benefits provided by the 1998 Tax Incentives Law are available to
new companies as well as companies currently conducting tax exempt operations in
Puerto Rico which choose to renegotiate their existing tax exemption grant. The
activities eligible for tax exemption include manufacturing, certain designated
services performed for markets outside Puerto Rico, the production of energy
from local renewable sources for consumption in Puerto Rico and laboratories for
scientific and industrial research. For companies qualifying thereunder, the
1998 Tax Incentive Law would impose income tax rates ranging from 2% to 75%. In
addition, it would grant 90% exemption from property taxes, 100% exemption from
municipal license taxes during the first eighteen months of operation and
between 80% and 60% thereafter, and 100% exemption from municipal excise taxes.
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The 1998 Tax Incentive Law also provides various special deductions designed to
stimulate employment and productivity, research and development and capital
investment in Puerto Rico.
Under the 1998 Tax Incentives Law, companies can repatriate or
distribute their profits free of tollgate taxes. In addition, passive income
derived from the investment of eligible funds in Puerto Rico financial
institutions, obligations of the Government of Puerto Rico and other designated
investments continue to be fully exempt from income and municipal license taxes.
Individual shareholders of an exempted business are allowed a credit against
their Puerto Rico income taxes equal to 30% of their proportionate share in the
exempted business' income tax liability. Gain from the sale or exchange of
shares of an exempted business by its shareholders during the exemption period
is subject to a 4% income tax rate.
The Constitution authorizes the contracting of debts as determined by
the Legislature. Nevertheless, the Constitution provides that direct obligations
of the Commonwealth evidenced by bonds or notes and backed by the full faith,
credit and taxing power of the Commonwealth, shall not be issued if the amount
of the principal of, and interest on, such bonds and notes and on all such bonds
and notes issued thereafter which is payable in any fiscal year, together with
any amount paid by the Commonwealth in the preceding fiscal year on account of
bonds or notes guaranteed by the Commonwealth, exceed 15% of the average annual
revenues raised under the provisions of Commonwealth legislation and conveyed
into the Treasury (hereinafter "internal revenues") in two fiscal years
preceding the then current fiscal year. Section 2, Article VI of the
Constitution does not limit the amount of debt that the Commonwealth may
guarantee so long as the 15% limitation is not exceeded. Internal revenues
consist principally of income taxes and excise taxes. Certain revenues, such as
federal excise taxes on offshore shipments of alcoholic beverages, tobacco
products and customs duties, which are collected by the United States Government
and returned to the Commonwealth, and motor vehicle fuel taxes and license fees,
which are allocated to the Puerto Rico Highway and Transportation Authority, a
blended component unit, are not included as revenues for the purpose of
calculating the debt limit, although they may be available for the payment of
debt service. The Commonwealth has never defaulted on the payment of principal
or interest on any of its general long-term debt obligations. At June 30, 1997,
the Commonwealth was in compliance with the debt limitation requirement.
On February 26, 1997, legislation was introduced in the U.S. House of
Representatives proposing a mechanism to settle
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permanently the political relationship between Puerto Rico and the United
States, either through full self government (e.g., statehood or independence,
including, as an alternative, free association via a bilateral treaty) or
continued commonwealth. Under the legislation, failure to settle on full self
government after completion of the referendum process provided therein would
result in retention of commonwealth status. Any change in the current status of
Puerto Rico could have an adverse impact on such matters as the basic
characteristics of future Puerto Rico debt obligations, the markets for these
obligations, and the types, levels and quality of revenue sources pledged for
the payment of existing and future debt obligations.
With respect to pending and threatened litigation, excluding the
litigation mentioned in the following paragraph, the Commonwealth has reported
liabilities of approximately $106 million for awarded and anticipated
unfavorable judgments. This amount was included as other long-term liabilities
in the general long-term debt account group and represents the amount estimated
as a probable liability or a liability with a fixed or expected due date which
will require future available financial resources for its payment. Management
believes that the ultimate liability in excess of amounts provided, if any,
would not be significant.
The Commonwealth and various component units are defendants in a
lawsuit alleging violations of civil rights. Preliminary hearings and discovery
proceedings are in progress. The amounts claimed exceed $50 billion; however,
the ultimate liability cannot be presently determined. It is the opinion of
management that the claim is excessive and exaggerated. No provision for any
liability that may result upon adjudication of this lawsuit has been recognized
in the financial statements by the Commonwealth.
On January 22, 1996, the US District Court in Puerto Rico consolidated
all cases against the Commonwealth related to the complaints filed in 1979 by
the inmates of the correctional facilities in Puerto Rico. The Court ruled a
permanent order requiring the Commonwealth to comply with the requirement of the
minimum fixed living space per inmate. In the opinion of management, based on
advice of their legal counsel, this order will limit the imposition of further
fines and the fines already paid together with the accrued liability the general
long-term debt account group, (which amount to approximately $200 million at
June 30, 1997) shall be sufficient to carry out the Court's requirements.
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THE EQUITY INDEX FUND GUARANTEE
NYLIFE Inc. ("NYLIFE") and the Equity Index Fund have entered into a
Guaranty Agreement (the "Guarantee") for the benefit of shareholders. The
Guarantee has been issued for the benefit of all shareholders and has been
issued at no cost to the Equity Index Fund or its shareholders. The Guarantee
Date (as defined in the Prospectus) with respect to a particular Equity Index
Fund share will be 10 years after the purchase date of such share. If, on a
particular Guarantee Date, payments must be made under the terms of the
Guarantee, the terms of the Guarantee will obligate NYLIFE unconditionally and
irrevocably to pay to the Equity Index Fund's transfer and dividend disbursing
agent for the benefit of shareholders with that Guarantee Date an amount equal
to the difference between the Guaranteed Amount and net asset value per each
Guaranteed Share (as defined in the Prospectus) outstanding. The Equity Index
Fund's transfer and dividend disbursing agent will forward the difference
between the Guaranteed Amount and the net asset value directly to each
individual shareholder.
A Guaranteed Share is a unit that will at all times be equal to the net
asset value of one share initially purchased by the investor plus the net asset
value of all dividends and distributions attributable to such share (which
includes cumulative dividends and distributions paid with respect to any
additional shares of the Fund received as dividends and distributions) paid
during the period from the date of purchase to the Guarantee Date. A Guaranteed
Share (the unit to which the Guaranteed Amount will apply) is not the same as a
share of the Fund. Shareholders who redeem shares, or who elect to receive
dividends and distributions in cash, will own fewer units to which the
Guaranteed Amount applies (i.e., they will own fewer Guaranteed Shares) and
therefore will lose a portion of the benefit of the Guarantee with respect to
any such redemption or dividends or distributions received in cash.
NYLIFE will pay any amounts owing under the Guarantee to the Fund's
transfer and dividend disbursing agent on the third business day following a
Guarantee Date. A pro rata portion of any amounts so paid will then be forwarded
to each shareholder holding, as of the close of business on such date,
Guaranteed Shares with that Guarantee Date. If the Guarantee Date should fall on
a weekend or on a holiday, the Guarantee Date shall be the first business day
following the Guarantee Date. The Guarantee is intended to assure each owner of
Guaranteed Shares
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on a Guarantee Date that he or she will be able to recover, as of the Guarantee
Date, at a minimum, the Guaranteed Amount (with no adjustment for inflation or
the time value of money). The Guarantee will benefit any holder of such
Guaranteed Shares on the relevant Guarantee Date, who need not be the original
purchaser, and who, for example, may own such shares by gift or inheritance.
Although the Equity Index Fund does not intend to pay dividends and
distributions in cash to shareholders (unless a shareholder elects to receive
payments in cash), such dividends and distributions which are reinvested will be
taxable to shareholders. See "Tax Status." The Guaranteed Amount does not
reflect any adjustment for the payment of taxes by a shareholder on dividends
and distributions received from the Equity Index Fund.
The obligations, if any, of NYLIFE under the Guarantee shall be
discharged when all required payments are made in full to the transfer and
dividend disbursing agent for the benefit of the shareholders or if the Equity
Index Fund's net asset value on a Guarantee Date is such that no amounts are
payable to shareholders under the terms of the Guarantee. Payment obligations
under the Guarantee will be solely the obligations of NYLIFE. Neither the Equity
Index Fund, New York Life Insurance Company, Monitor, NYLIFE Distributors, any
of their affiliates nor any other party is undertaking any obligation to the
Equity Index Fund or its shareholders with respect to the Guarantee.
Although the Guarantee has been arranged for by the Equity Index Fund
and is created under contract between the Equity Index Fund and NYLIFE, the
Equity Index Fund has no interest in, and specifically disclaims any interest
in, the proceeds payable under the Guarantee, which are payable solely to the
shareholders with a particular Guarantee Date. The designation of such
shareholders as the sole beneficiaries of the Guarantee may not be changed by
either the Equity Index Fund or such shareholders. The Guarantee is neither
transferable nor assignable by the Equity Index Fund or the shareholders it
benefits, nor may the Equity Index Fund or its shareholders cancel or waive
rights under the Guarantee. The Guarantee cannot be surrendered by either the
Fund or its shareholders for cash, except in the event that payment is made
pursuant to its terms. Neither the Equity Index Fund nor its shareholders may
use the Guarantee as a pledge for a loan, nor may the Equity Index Fund or its
shareholders
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obtain any loan from NYLIFE with respect to amounts that may be payable pursuant
to the Guarantee.
The foregoing is only a summary, and not a complete statement of the
principal terms of the Guarantee. Reference is made to the Guarantee, a specimen
copy of which has been filed as an exhibit to the Registration Statement. This
summary is subject thereto and qualified in its entirety by such reference.
FUNDAMENTAL INVESTMENT RESTRICTIONS
The following restrictions may not be changed with respect to any Fund
without the approval of the majority of the outstanding voting securities of
that Fund (as defined in the 1940 Act). Investment restrictions that appear
below or elsewhere in this Statement of Additional Information that involve a
maximum percentage of securities or assets shall not be considered to be
violated unless an excess 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, a Fund.
The Trust may not, on behalf of any Fund:
1. With respect to 75% of each Fund's total assets invest more
than 5% of the value of the total assets of a 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 a Fund. This restriction does not apply to the
California Tax Free Fund, Equity Index Fund, International Bond Fund and New
York Tax Free 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 these Funds maintain 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 total assets (10% in
the case of the California Tax Free Fund and New York Tax Free Fund).
3. Purchase securities (or with respect to the California Tax
Free Fund, New York Tax Free Fund, and Tax Free Bond Fund
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purchase (I) Pollution Control and Industrial Development Bonds or (ii)
securities the interest from which is not exempt from regular federal income
tax) if such purchase would cause 25% or more in the aggregate of the market
value of the total assets of a 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 in respect to investments in U.S.
government securities or, with respect to each Fund except Strategic Value Fund,
investments in repurchase agreements with respect thereto (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 (a)
the above limitation does not apply to the Equity Index Fund to the extent that
the Standard & Poor's 500 Composite Stock Price Index is so concentrated; (b) up
to 40% of the High Yield Corporate Bond Fund's, Strategic Income Fund's and
Strategic Value Fund's total assets, taken at market value, may be invested in
each of the electric utility and telephone industries, but each Fund 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); (c) 25% or more of the market value of the total
assets of the Money Market Fund will be invested in the securities of banks and
bank holding companies, including certificates of deposit and bankers'
acceptances; and (d) at such time that the 1940 Act is amended to permit a
registered investment company to elect to be "periodically industry
concentrated" (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 total assets in a particular industry) the Funds elect to be so
classified and the foregoing limitation shall no longer apply with respect to
the Funds. With respect to the California Tax Free Fund and New York Tax Free
Fund, private activity bonds ultimately payable by companies within the same
industry are treated as if they were issued by issuers in the same industry for
purposes of this restriction.
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) or, in the case of the California Tax Free Fund and New York Tax
Free Fund, real
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estate investment trust securities; commodities and commodity contracts. The
Trust reserves the freedom of action to hold and to sell real estate acquired
for any 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 currencies (securities,
with respect to the Strategic Value Fund) 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.
5. Make loans to other persons, except loans of portfolio
securities (in the case of the California Tax Free Fund and New York Tax Free
Fund, in an amount not to exceed 10% of the value of each Fund's total assets in
accordance with applicable guidelines approved by the Board of Trustees and 30%
in the case of the Equity Index Fund). The purchase of debt obligations (and
bankers' acceptances and commercial paper in the case of the Equity Index Fund)
and the entry into repurchase agreements in accordance with such Fund's
investment objectives and policies are not deemed to be loans for this purpose.
6. Act as an underwriter of securities issued by others, except
to the extent that a Fund may be considered an underwriter within the meaning of
the 1933 Act, as amended, in the disposition of portfolio securities.
7. Issue senior securities, except to the extent permitted under
the Investment Company Act of 1940.
The following fundamental investment restriction is applicable to the
Tax Free Bond Fund only. The Tax Free Bond Fund must:
1. Invest at least 80% of the Fund's net assets in securities the
interest on which is exempt from regular federal income tax, except that the
Fund may temporarily invest more than 20% of its net assets in securities the
interest income on which may be subject to regular federal income tax.
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 Funds, except the
California Tax
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Free Fund, New York Tax Free Fund, International Bond Fund, International Equity
Fund, Equity Index Fund, Strategic Income Fund and Strategic Value 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.
In accordance with such policies and restrictions, a Fund may not:
(a) purchase from or sell portfolio securities of a Fund to
any of the officers or Trustees of the Trust, its investment advisers,
its principal underwriter or the officers, or directors of its
Sub-Advisers or principal underwriter;
(b) invest more than 10% of the net assets of a Fund (taken at
market value at the time of the investment) in "illiquid securities,"
illiquid securities being defined to include securities subject to
legal or contractual restrictions on resale (other than restricted
securities eligible for resale pursuant to Rule 144A or Section 4(1)
under the Securities Act of 1933 determined to be liquid pursuant to
guidelines adopted by the Board), repurchase agreements maturing in
more than seven days, certain options traded over the counter that a
Fund has written, securities for which market quotations are not
available, or other securities which legally or in the opinion of the
Sub-Adviser are deemed illiquid;
(c) 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;
(d) invest in other companies for the purpose of exercising
control or management;
(e) purchase securities on margin except in connection with
arbitrage transactions or make short sales, unless by virtue of its
ownership of other securities, it has the right to obtain securities
equivalent in kind and amount to the securities sold, except that the
Trust may obtain such short-term credits as may be necessary for the
clearance of
B-113
<PAGE> 114
purchases and sales of securities and in connection with transactions
involving forward foreign currency exchange contracts;
(f) purchase or sell any put or call options or any
combination thereof, except that the Trust may purchase and sell or
write (I) options on any futures contracts into which it may enter,
(ii) put and call options on currencies, securities indexes and covered
put and call options on securities, and (iii) may also engage in
closing purchase transactions with respect to any put and call option
position it has entered into; and except that the Government Fund may
not write any covered put options on U.S. government securities if, as
a result, more than 50% of its total assets (taken at current value)
would be subject to put options written by such Fund; or
(g) purchase, with respect to the Government Fund, any call
option, long futures contract or long option on a futures contract if,
at the date of purchase, realized net losses from such transactions
during the fiscal year to date exceed 5% of such Fund's average net
assets during such period.
The following are non-fundamental restrictions of the California Tax
Free Fund, Equity Index Fund and New York Tax Free Fund:
(a) A 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 or reorganization.
(b) The Funds may not invest more than 10% of the net assets
of a Fund (taken at market value at the time of the investment) in
"illiquid securities," illiquid securities being defined to include
securities subject to legal or contractual restrictions on resale
(other than restricted securities eligible for resale pursuant to Rule
144A or Section 4(1) under the Securities Act of 1933 determined to be
liquid pursuant to guidelines adopted by the Board).
(c) A Fund may not invest in other companies for the purpose
of exercising control or management.
B-114
<PAGE> 115
(d) A Fund may not purchase securities on margin, except in
connection with arbitrage transactions, or make short sales, unless it
owns the securities sold short or it has the right to obtain securities
equivalent in kind and amount to the securities sold, except that the
Trust may obtain such short-term credits as may be necessary for the
clearance of purchases and sales of securities. (This restriction has
no application to transactions in futures, options and foreign currency
exchange contracts).
The following investment restrictions are non-fundamental, operating
policies of the International Bond Fund, International Equity Fund, Strategic
Income Fund and Strategic Value Fund, and may be amended by the Board of
Trustees without shareholder approval:
(a) As an operating policy, a 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, a 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. This restriction is not applicable to the Strategic Income
Fund.
(c) As an operating policy, a 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 or Section 4(2)
commercial paper 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. A Fund may
not invest more than 15% of its net assets in repurchase agreements
providing for settlement in more than seven days, or in other
instruments which for regulatory purposes or in the Sub-Adviser's
opinion may be deemed to be illiquid, such as a certain portion of
options traded in the
B-115
<PAGE> 116
over-the-counter market, and securities being used to cover options a
Fund has written.
(d) As an operating policy, a 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.
In addition, though not a fundamental policy, the California Tax Free
and New York Tax Free Funds will not sell securities short, except that each
Fund reserves the right to sell securities short "against the box."
In addition, though not a fundamental policy, the Equity Index Fund may
not engage in arbitrage transactions, nor may it purchase warrants (excluding
those acquired by the Equity Index Fund in units or attached to securities), nor
will the Equity Index Fund sell securities short or buy on margin, except that
the Fund reserves the right to sell securities short "against the box."
The Trustees have the ultimate responsibility for determining whether
specific securities are liquid or illiquid. The Trustees have delegated the
function of making day-to-day determinations of liquidity to the Sub-Advisers,
pursuant to guidelines approved by the Trustees.
Each Sub-Adviser takes into account a number of factors in determining
whether a Rule 144A security being considered for purchase by a Fund is liquid,
including at least the following:
(I) the frequency and size of trades and quotes for the Rule 144A
security relative to the size of the Fund's holding;
(ii) the number of dealers willing to purchase or sell the 144A
security and the number of other potential purchasers;
(iii) dealer undertakings to make a market in the 144A security;
and
B-116
<PAGE> 117
(iv) the nature of the 144A security and the nature of the market
for the 144A security (i.e., the time needed to dispose of the security, the
method of soliciting offers, and the mechanics of transfer).
To make the determination that an issue of 4(2) commercial paper is liquid, a
Sub-Adviser must conclude that the following conditions have been met:
(a) the 4(2) commercial paper is not traded flat or
in default as to principal or interest;
(b) the 4(2) commercial paper is rated:
(I) in one of the two highest rating categories by at least two
nationally recognized statistical rating organizations ("NRSROs");or
(ii) if only one NRSRO rates the security, the 4(2) commercial
paper is rated in one of the two highest rating categories by that NRSRO; or
(iii) if the security is unrated, the Sub-Adviser has determined
that the security is of equivalent quality based on factors commonly used by
rating agencies; and
(c) there is a viable trading market for the specific security,
taking into account all relevant factors (e.g., whether the security is the
subject of a commercial paper program that is administered by an issuing and
paying agent bank and for which there exists a dealer willing to make a market
in the security, the size of trades relative to the size of the Fund's holding
or whether the 4(2) commercial paper is administered by a direct issuer pursuant
to a direct placement program).
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
B-117
<PAGE> 118
persons" of the Trust for purposes of the 1940 Act are indicated by an asterisk.
B-118
<PAGE> 119
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Richard M. Kernan, Jr. * Chairman and Trustee Director of MainStay VP Series Fund, Inc.
51 Madison Avenue from January 1987 to present; Chairman of
New York, NY 10010 the Board and Chief Executive Officer of
Age: 57 MainStay VP Series Fund, Inc. from August
1989 to present; Executive Vice President and
Chief Investment Officer of New York Life
Insurance Company from March 1995 to
present; Executive Vice President prior
thereto; Member of the Board of Directors of
New York Life Insurance Company from
November 1996 to present and Chairman of
the Investment Committee from January 1997
to present; and Director, Greystone Realty
Corp. January 1997 to present.
Stephen C. Roussin* President, Chief Executive Director and Chairperson, MainStay
51 Madison Avenue Officer and Trustee Institutional Funds, Inc., 1997 to present;
New York, NY 10010 Senior Vice President, New York Life
Age: 34 Insurance Company, 1997 to present; Senior
Vice President, Smith Barney, 1994 to 1997;
and Division Sales Manager, Prudential
Securities, 1989 to 1994.
Harry G. Hohn* Trustee Retired Chairman and Chief Executive
51 Madison Avenue Officer, New York Life Insurance Company;
New York, NY 10010 Chairman of the Board and Chief Executive
Age: 66 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 1997;
Director, Insurance Marketplace Standards
Association, 1996 to 1997; 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.
Edward J. Hogan Trustee Rear Admiral U.S. Navy (Retired);
Box 2321 Independent Management Consultant, 1992 to
Sun Valley, ID 83353 1997.
Age: 65
</TABLE>
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<PAGE> 120
<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 University,
Kissinger New York, NY, 1991 to present; Trustee,
Henderson Road Rockefeller University, 1995 to present;
South Kent, CT 06785 Trustee, Animal Medical Center, 1993 to
Age: 64 present; and Trustee, The Masters School,
1994 to present; Member, Board of
Overseers, Rockefeller Institute of
Government, Albany, NY, 1983-1992 (Board
dissolved).
Terry L. Lierman Trustee President, Capitol Associates, Inc., 1984 to
426 C Street, N.E. present; President, Employee Health
Washington, D.C. 20002 Programs, 1990 to present; Vice Chairman,
Age: 50 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; Commissioner, State of Maryland,
Higher Education Commission, 1995 to
present; Vice Chairman, National
Organization on Fetal Alcohol Syndrome,
1993 to present; Chief Executive Officer,
Medical Crisis Systems, 1997 to present; and
Board Member, Hollings Cancer Center,
Medical University of South Carolina, 1993 to
present.
John B. McGuckian Trustee Chairman of the Board, Ulster Television plc,
Ardverna 1990 to present; Director, Ulster Television
Cloughmills plc, 1970 to present; Chairman of the Board,
Northern Ireland Tedcastle Holding Ltd. (energy), 1995 to
BT4 49NL present; Director, Cooneen Textiles Ltd.
Age: 58 (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 1997;
and Chairman of Senate and Senior Pro-
Chancellor, Queen's University, 1986 to
present.
</TABLE>
B-120
<PAGE> 121
<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 218 Director, PaineWebber Group, 1980 to
Vero Beach, FL 32963 1993; President, PaineWebber Group,
Age: 65 1988 to 1990; Chairman of the Board,
Paine Webber Properties, 1985 to 1989;
Director, Harbour Group, 1986 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, Sugen,
Inc., 1992 to present; Chairman of the Board,
Omniquip International, Inc., 1996 to present;
Director, Carey Diversified, L.L.C., January
1,1998 to present.
Donald K. Ross* Trustee Retired Chairman and Chief Executive
953 Cherokee Lane Officer, New York Life Insurance Company;
Franklin Lakes, NJ 07417 Director, New York Life Insurance Company,
Age: 72 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.
Richard S. Trutanic Trustee Managing Director, The Somerset Group
1155 Connecticut Ave. N.W., (financial advisory firm), 1990 to present;
Suite 400 Chief Executive Officer and President,
Washington, DC 20036 Americap L.L.C. (Financial Advisory Firm),
Age: 45 1997 to present; Senior Vice President,
Washington National Investment Corporation
(financial advisory firm), 1985 to 1990;
Director, Allin Communications Corporation,
1996 to 1997; and Director and Member of
Executive Committee, Southern Net, Inc.,
1986 to 1990.
</TABLE>
B-121
<PAGE> 122
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Walter W. Ubl* Trustee Senior Vice President, New York Life
85 East End Avenue Insurance Company, 1995 to 1997; Vice
Apt. 2N President, 1984 to 1995; Vice President in
New York, NY 10028 charge of Mutual Funds Department, 1989 to
Age: 56 1997 ; Director and Vice President, NYLIFE
Distributors Inc., 1993 to 1997; and Director
and Senior Vice President NYLIFE Securities
Inc., 1996 to 1997.
- --------------------------------------------------------------------------------------------------------------------------
OFFICERS (OTHER THAN TRUSTEES)
- --------------------------------------------------------------------------------------------------------------------------
Jefferson C. Boyce Senior Vice President Chairman, Monitor Capital Advisors, Inc.,
51 Madison Avenue 1997 to present; Senior Vice President,
New York, NY 10010 MainStay Institutional Funds Inc., 1995 to
Age: 40 present; Senior Vice President, New York Life
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 Chief Vice President, New York Life Insurance
51 Madison Avenue Financial Officer Company, 1988 to present; Director, Vice
New York, NY 10010 President and Chief Financial Officer, NYLIFE
Age: 54 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.
</TABLE>
B-122
<PAGE> 123
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Richard Zuccaro Tax Vice President Vice President, New York Life Insurance
51 Madison Avenue Company, 1995 to present; Vice President --
New York, NY 10010 Tax, New York Life Insurance Company, 1986
Age: 48 to 1995; Tax Vice President, NYLIFE Securities
Inc., 1987 to present; Tax Vice President,
NAFCO, Inc., 1990 to present; Tax Vice
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.
</TABLE>
B-123
<PAGE> 124
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
A. Thomas Smith III Secretary Vice President and Associate General Counsel,
51 Madison Avenue New York Life Insurance Company, 1997 to
New York, NY 10010 present; Associate General Counsel, New York
Age: 41 Life Insurance Company, 1996 to 1997;
Assistant General Counsel, New York Life
Insurance Company, 1994 to 1996; Secretary,
Eclipse Financial Asset Trust, 1994 to present;
Secretary, MainStay Institutional Funds Inc.,
MainStay VP Series Fund, Inc., New York Life
Fund Inc., 1994 to 1997; Assistant Secretary,
Eagle Strategies Corp. (registered investment
adviser), 1997 to present; Secretary, Eagle
Strategies Corp. (registered investment adviser),
1996 to present; and Assistant General Counsel,
Dreyfus Corporation, 1991 to 1993.
*Messrs. Ross, Roussin, Hohn, Kernan and Ubl are deemed to be "interested persons" of the Trust under the 1940 Act.
</TABLE>
As indicated in the above table, certain Trustees and officers also
hold positions with MacKay-Shields, Monitor, New York Life Insurance Company,
NYLIFE Securities Inc. and/or NYLIFE Distributors Inc.
Effective August 1, 1998, the Independent Trustees of the Trust receive
from the Trust an annual retainer of $45,000 and a fee of $2,000 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, 1997, the Trustees received the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same investment advisers as the Trust or
an investment adviser that is an affiliated person of one of the Trust's
investment advisers:
B-124
<PAGE> 125
<TABLE>
<CAPTION>
Total Compensation
Aggregate From Registrant
Name of Compensation and Fund Complex
Trustee from the Trust Paid to Trustees
- ------- -------------- ------------------
<S> <C> <C>
Edward J. Hogan $48,000 $48,000
Nancy M. Kissinger $46,000 $46,000
Terry L. Lierman $48,000 $48,000
Donald E. Nickelson $52,000 $52,000
Richard S. Trutanic $46,000 $46,000
John B. McGuckian* $12,000 $12,000
</TABLE>
* Mr. McGuckian was elected to his position as Trustee of the Trust on
July 28, 1997.
As of April 1, 1998, the Trustees and officers of the Trust as a group
owned less than 1% of the outstanding shares of any class of beneficial interest
of each of the Funds.
THE MANAGER, THE SUB-ADVISERS AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Funds, MainStay
Management, Inc. (the "Manager"), subject to the supervision of the Trustees of
the Trust and in conformity with the stated policies of the Funds, administers
the Funds' business affairs and has investment advisory responsibilities.
The Trustees, including the Independent Trustees, approved the
Management Agreement at an in-person meeting held July 28, 1997. On October 24,
1997, the shareholders of each of the Funds other than the Strategic Value Fund
approved the Management Agreement. The Management Agreement for the Strategic
Value Fund was approved by the Fund's sole shareholder on October 21, 1997. The
Management 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 each of the Funds (as defined in the
1940 Act and in a rule under the 1940 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 Management Agreement for each Fund was
last approved by the Trustees, including a majority of the Trustees who are not
"interested
B-125
<PAGE> 126
persons" of the Trust or the Manager (as that term is defined in the 1940 Act),
at a meeting held on April 27, 1998.
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 a Fund for any error or judgment by the Manager or for any loss sustained by
a 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 each
of the Funds, and except as indicated in the Prospectus under the heading
"Manager, Sub-Advisers 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;
(b) the fees to be paid to the Sub-Advisers pursuant to the
Sub-Advisory Agreements; and
(c) all expenses incurred by the Manager in connection with
administering the ordinary course of the Funds' business, other than those
assumed by the Trust.
SUB-ADVISORY AGREEMENTS
Pursuant to Sub-Advisory Agreements between the Manager and
MacKay-Shields and between the Manager and Monitor on behalf of each Fund (each
a "Sub-Adviser" and collectively the "Sub-Advisers"), MacKay-Shields and
Monitor, subject to the supervision of the Trustees of the Trust and the Manager
and in conformity with the stated policies of each of the Funds and the Trust,
manage the Funds' portfolios, including the purchase, retention, disposition and
loan of securities.
The Trustees, including the Independent Trustees, approved the
Sub-Advisory Agreements at an in-person meeting held July 28, 1997.
B-126
<PAGE> 127
On October 24, 1997, the shareholders of each of the Funds other than the
Strategic Value Fund approved the Sub-Advisory Agreements with MacKay-Shields
and Monitor. The Sub-Advisory Agreement with respect to the Strategic Value Fund
was approved by that Fund's sole shareholder on October 21, 1998. The
Sub-Advisory Agreements will remain in effect for two years following their
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 each of the Funds (as defined
in the 1940 Act and in a rule under the 1940 Act) and, in either case, by a
majority of the Trustees who are not "interested persons" of the Trust, the
Manager, MacKay-Shields or Monitor (as the term is defined in the 1940 Act). The
Sub-Advisory Agreements for each Fund were last approved by the Trustees,
including a majority of the Trustees who are not "interested persons" of the
Trust, the Manager, MacKay-Shields or Monitor (as defined in the 1940 Act), at a
meeting held on April 27, 1998.
The Sub-Advisers have authorized any of their 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 they render, the Sub-Advisers bear the salaries
and expenses of all of their personnel.
The Sub-Advisory Agreements provide that MacKay-Shields and Monitor
shall not be liable for any error of judgment by MacKay-Shields or Monitor or
for any loss suffered by any of the Funds except in the case of MacKay-Shields'
or Monitor's willful misfeasance, bad faith, gross negligence or reckless
disregard of duty. The Agreements also provide that they shall terminate
automatically if assigned and that they may be terminated without penalty by
either party upon no more than 60 days' nor less than 30 days' written notice.
For the period from October 27, 1997 through December 31, 1997, the
amount of the Management fee paid and waived and/or reimbursed by each Fund; the
amount of the Sub-Advisory fee paid by the Manager from the Management fee; and
the amount of the Sub-Advisory fee waived and/or reimbursed were as follows:
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<PAGE> 128
<TABLE>
<CAPTION>
Management Sub-Advisory
Management Fee Waived Sub-Advisory Fee Waived
Fund Fee Paid* and/or Reimbursed Fee Paid* and/or Reimbursed
- ---- ---------- ----------------- ------------ -----------------
<S> <C> <C> <C> <C>
California Tax Free Fund..... $ 22,562 $ -- $ 11,281 $ --
Capital Appreciation Fund.... 1,996,154 -- 998,077 --
Convertible Fund............. 1,210,730 -- 605,365 --
Equity Index Fund+........... 149,354 223,441 74,559 --
Government Fund.............. 712,902 -- 356,451 --
High Yield Corporate Bond
Fund..................... 3,590,202 -- 1,795,101 --
International Bond Fund..... 24,178 18,134 15,111 12,089
International Equity Fund... 145,829 -- 87,497 --
Money Market Fund............ 165,694 205,316 82,847 102,658
New York Tax Free Fund....... 11,863 5,413 5,932 2,707
Strategic Income Fund++...... -- 74,218 -- 37,109
Strategic Value Fund++....... 23,276 -- 11,638 --
Tax Free Bond Fund........... 533,914 -- 266,957 --
Total Return Fund............ 1,431,434 -- 715,717 --
Value Fund................... 1,479,934 -- 739,967 --
</TABLE>
* After expense reimbursement or waiver.
+ The Equity Index Fund's expense limitation was terminated April 1,
1998.
++ The Strategic Income Fund commenced operations on February 28, 1997.
Effective February 28, 1998, the Fund's expense cap was terminated.
The Strategic Value Fund commenced operations on October 21, 1997.
In previous years, prior to a change in management structure, the Funds
paid an advisory fee directly to MacKay-Shields or Monitor. For the period from
January 1, 1997 through October 26, 1997 and the fiscal years ended December 31,
1996 and 1995, the amount of the advisory fee paid and waived and/or reimbursed,
by each Fund to MacKay-Shields or Monitor was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------
Advisory Fee Advisory Fee Advisory Fee
Advisory Waived and/or Advisory Waived and/or Advisory Waived and/or
Fee Paid* Reimbursed Fee Paid* Reimbursed Fee Paid* Reimbursed
--------- ------------- --------- ------------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
California Tax Free Fund..... $ 44,678 $ 2,589 $ 45,307 $ 11,228 $ 29,964 $ 16,845
Capital Appreciation Fund.... 3,934,494 -- 3,429,258 -- 2,155,386 --
Convertible Fund............. 2,710,393 -- 2,444,000 -- 1,027,604 --
Equity Index Fund............ 256,066 -- 163,785 -- 81,072 --
Government Fund.............. 1,760,807 -- 2,643,801 -- 3,056,716 --
High Yield Corporate Bond
Fund..................... 6,921,965 5,816,110 -- 3,930,939 --
International Bond Fund...... 65,696 52,556 68,489 54,933 52,534 42,028
International Equity Fund.... 384,003 -- 342,100 -- 166,703 --
Money Market Fund............ 407,638 396,862 397,071 473,155 391,304 282,975
New York Tax Free Fund....... 25,025 13,579 29,457 19,911 31,482 14,241
Strategic Income Fund+....... 61,282 40,291 N/A N/A N/A N/A
Strategic Value Fund+........ N/A N/A N/A N/A N/A N/A
Tax Free Bond Fund........... 1,217,473 -- 1,579,820 -- 1,610,982
Total Return Fund............ 3,025,045 -- 3,087,111 -- 2,396,247
</TABLE>
B-128
<PAGE> 129
<TABLE>
<S> <C> <C> <C> <C>
Value Fund................... 2,976,469 -- 2,682,642 1,932,406
</TABLE>
- -------------------------
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
* After expense reimbursement or waiver.
In previous years, prior to a change in management structure, the
Funds paid an administrative fee directly to NYLIFE Distributors Inc. as
administrator. For the period from January 1, 1997 through October 26, 1997 and
the fiscal years ended December 31, 1996 and 1995 the amount of the
administration fee paid and waived and/or reimbursed by each Fund was as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- ------
Fee Waived Fee Waived Fee Waived
and/or and/or and/or
Fee Paid* Reimbursed Fee Paid* Reimbursed Fee Paid* Reimbursed
--------- ----------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
California Tax Free Fund..... $ 44,678 $ 2,589 $ 45,307 $ 11,228 $ 29,964 $ 16,845
Capital Appreciation Fund.... 3,934,494 -- 3,429,258 -- 2,155,386 --
Convertible Fund............. 2,710,393 -- 2,444,000 -- 1,027,604 --
Equity Index Fund............ 605,767 418,496 365,118 290,022 324,287
Government Fund.............. 1,760,807 -- 2,643,801 -- 3,056,716
High Yield Corporate Bond
Fund..................... 6,921,965 -- 5,816,110 -- 3,930,939
International Bond Fund..... 39,417 26,278 41,100 27,467 31,522 21,013
International Equity Fund... 256,002 -- 228,066 -- 111,135 --
Money Market Fund............ 407,638 396,862 397,071 473,155 391,304 282,975
New York Tax Free Fund....... 25,025 13,579 29,457 19,911 31,481 14,242
Strategic Income Fund+........ 61,282 40,291 N/A N/A N/A N/A
Strategic Value Fund+......... N/A N/A N/A N/A N/A N/A
Tax Free Bond Fund........... 1,217,473 -- 1,579,820 -- 1,610,982 --
Total Return Fund............ 3,025,045 -- 3,087,111 -- 2,396,247 --
Value Fund................... 2,976,469 -- 2,682,642 -- 1,932,406 --
</TABLE>
- -----------------------
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
* After expense reimbursement or waiver.
DISTRIBUTION AGREEMENT
NYLIFE Distributors acts as the Principal Underwriter and Distributor
of the Funds' shares pursuant to the Distribution Agreement with the Trust dated
January 1, 1994. NYLIFE Securities Inc., an affiliated company, sells shares of
the Funds 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 connection with their distribution of Trust shares. In
addition, the Distributor will
B-129
<PAGE> 130
pay for a variety of account maintenance and personal services to shareholders
after the sale.
The Distribution Agreement for the Funds 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 October 25, 1993.
The Distribution Agreement for the International Bond Fund and the International
Equity Fund was approved by the Trustees, including a majority of the
Independent Trustees at a meeting held on July 25, 1994. The Distribution
Agreement for the Strategic Income Fund was approved by the Trustees, including
a majority of the Independent Trustees at a meeting held on January 27, 1997.
The Distribution Agreement for the Strategic Value Fund was approved by the
Trustees, including a majority of the Independent Trustees, at a meeting held on
July 28, 1997. The Distribution Agreements were reapproved by the Trustees,
including a majority of the Independent Trustees, at a meeting held on April 27,
1998.
As disclosed in the Prospectus, each of the Funds (except the Money
Market Fund and the Equity Index Fund, which does not offer Class B shares) has
adopted separate plans of distribution pursuant to Rule 12b-1 under the 1940 Act
for each class of shares of each Fund (the "Class A Plans", the "Class B Plans"
and, collectively, the "Plans"). Under the Class A Plans, Class A shares of each
Fund pay the Distributor a monthly fee at the annual rate of 0.25% of the
average daily net assets of each Fund's Class A shares for distribution or
service activities, as designated by the Distributor. The Class A Plans for each
of the Funds other than the California Tax Free Fund, New York Tax Free Fund,
Equity Index Fund and Strategic Income Fund were approved by the sole initial
shareholder of the Class A of shares of each Fund on December 31, 1994. The
Class A Plans were approved by the shareholders of the California Tax Free Fund,
New York Tax Free Fund and the Equity Index Fund at a Special Meeting of
Shareholders held on December 28, 1994 and the Class A Plan was approved by the
sole initial shareholder of the Strategic Income Fund on February 3, 1997 and by
the sole initial shareholder of the Strategic Value Fund on October 21, 1997.
Regarding the California Tax Free Fund, the New York Tax Free Fund and the
Equity Index Fund, the Trustees of the Trust, including a majority of the
Independent Trustees, by vote cast in person at a meeting called for the purpose
of voting on such Plans, initially approved the Plan now designated as the Class
A Plans on July 25, 1994. Regarding the Strategic Income
B-130
<PAGE> 131
Fund, the Trustees of the Trust, including a majority of 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 January 27, 1997.
As noted above, the Class B shares of each Fund (except the Money
Market Fund and the Equity Index Fund, which does not offer Class B shares) also
have adopted Rule 12b-1 distribution plans. Originally, Rule 12b-1 plans of
distribution were adopted by each of the Funds (except the California Tax Free
Fund, New York Tax Free Fund and Money Market Fund) for the then sole existing
class of shares of the Funds. More specifically, Rule 12b-1 distribution plans
were approved on October 21, 1997 by the sole initial Class B shareholder of the
Strategic Value Fund, on February 3, 1997 by the sole initial shareholder of the
Strategic Income Fund, on September 8, 1994 by the sole initial shareholder of
each of the International Bond Fund and International Equity Fund, on April 25,
1988 by the shareholders of the Total Return Fund, on May 29, 1987 by the sole
initial shareholder of the Tax Free Bond Fund and on April 27, 1987 by the
shareholders of the Capital Appreciation Fund, Convertible Fund, Government
Fund, High Yield Corporate Bond Fund and Value Fund. The Trustees of the Trust,
including a majority of the Independent Trustees, by vote cast in person at
meetings called for the purpose of voting on such Plans, initially approved the
Plans of the Total Return Fund on October 26, 1987, initially approved the Plans
of the Tax Free Bond Fund on April 27, 1987, and initially approved the Plans of
the Capital Appreciation Fund, Convertible Fund, Government Fund, High Yield
Corporate Bond Fund and Value Fund on April 28, 1986. In addition, on October
31, 1988, the Trustees of the Trust, including a majority of the Independent
Trustees, amended the Tax Free Bond Fund's Plan to permanently reduce the amount
of the distribution fee to be imposed subsequent to that date. On October 26,
1992, the Trustees of the Trust, including a majority of the Independent
Trustees, amended each of the plans of distribution to provide that a portion of
total amount of the distribution fee as a service fee, to pay for a variety of
account maintenance and personal services to shareholders after the sale. On
October 25, 1993, the Trustees of the Trust, including a majority of the
Independent Trustees, amended each of the plans of distribution to reflect that
NYLIFE Distributors would serve as principal underwriter of the Funds' shares,
effective January 1, 1994. Prior to the implementation of the multi-class
distribution system the distribution plans in effect for the Funds were amended
and redesignated and, now, are applicable only to the Class B shares of each
Fund. On October 30, 1995, the Trustees of the Trust, including a majority of
the
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<PAGE> 132
Independent Trustees, amended the Class A Plans and the Class B Plans to clarify
that the Plans contemplate payment for expenses that may generally be
characterized as administrative.
Regarding the California Tax Free Fund and New York Tax Free Fund, the
Class B Plans were approved by the sole initial shareholder of the Class B
shares of each Fund on December 31, 1994. The Trustees of the Trust, including a
majority of the Independent Trustees, by vote cast in person at meetings called
for the purpose of voting on such Plans, initially approved such Plans now
designated as the Class B Plans on October 24, 1994.
Regarding the International Bond Fund and International Equity Fund,
the Trustees of the Trust, including a majority of the Independent Trustees, by
vote cast in person at meetings called for the purpose of voting on such Plans,
initially approved the distribution plans now designated as the Class B Plans on
July 25, 1994, and the Class A Plans on October 24, 1994. The Trustees of the
Trust, including a majority of the Independent Trustees, by vote cast in person
at a meeting called for the purpose of voting on such Plan, initially approved
the Class B Plan of the Strategic Income Fund on January 27, 1997. The Trustees
of the Trust, including a majority of the Independent Trustees, by vote cast in
person at a meeting called for the purpose of voting on such Plan, initially
approved the Class B Plan of the Strategic Value Fund on July 28, 1997.
On October 24, 1997, Class B shareholders for each of the Funds, other
than the Equity Index Fund, Money Market Fund, Strategic Income Fund and
Strategic Value Fund, approved a revision to the Class B Plans of each Fund to
revise the method of calculation of the distribution fee. The Trustees,
including a majority of the Independent Trustees, approved the revision at an
in-person meeting held July 28, 1997. The Class B shareholders approved the
revision at a meeting held October 24, 1997.
Under the current Class B plans, each Fund's Class B shares pay a
monthly distribution fee to the Distributor at the annual rate of 0.75% (0.25%
in the case of the California Tax Free Fund, New York Tax Free Fund and the Tax
Free Bond Fund) of the average daily net assets attributable to the Fund's Class
B shares. Pursuant to the Class B Plan, the Class B shares also pay a service
fee to the Distributor at the annual rate of 0.25% of the average daily net
assets of the Funds' Class B shares.
B-132
<PAGE> 133
Once approved by a vote of a majority of the outstanding voting
securities of a class of shares of a Fund, each 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 a 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 Independent Trustees, 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 a 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).
For the fiscal year ended December 31, 1997, the Funds paid
distribution and service fees pursuant to the Class A and Class B Plans as
follows:
B-133
<PAGE> 134
<TABLE>
<CAPTION>
Amount of Fee Amount of Fee
Pursuant to Pursuant to
Class A Plan Class B Plan
------------- -------------
<S> <C> <C>
California Tax Free Fund+........ $ 43,324 $ 29,795
Capital Appreciation Fund+...... 436,614 12,479,365
Convertible Fund+................ 160,596 7,496,884
Equity Index Fund................ 826,562 N/A
Government Fund+................. 41,839 5,572,110
High Yield Corporate Bond Fund+.. 447,670 25,344,441
International Bond Fund+......... 29,391 188,387
International Equity Fund+....... 44,218 567,206
Money Market Fund................ N/A N/A
New York Tax Free Fund+.......... 35,389 23,696
Strategic Income Fund++.......... 58,867 226,126
Strategic Value Fund++........... 5,136 10,314
Tax Free Bond Fund+.............. 32,364 2,207,368
Total Return Fund+............... 229,294 8,376,017
Value Fund+...................... 241,617 9,356,170
</TABLE>
- -----------------------
+ The Class B Plan was amended effective October 27, 1997. Figures
reflect calculation of fee pursuant to previous method for the
period from January 1, 1997 through October 26, 1997 and
calculation of fee pursuant to the current method for the period
from October 27, 1997 through December 31, 1997.
++ The Strategic Income Fund commenced operations on February 28,
1997. The Strategic Value Fund commenced operations on October
21, 1997.
For the fiscal year ended December 31, 1997, 1996 and 1995, NYLIFE
Distributors retained the following amounts in sales charges for sales of Class
A shares of the Funds:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
California Tax Free Fund..... $ 6,958 $ 35,009 $ 57,181
Capital Appreciation Fund+... 201,562 1,430,417 718,806
Convertible Fund+............ 39,646 903,782 529,361
Equity Index Fund............ 329,059 1,968,993 308,486
Government Fund+............. 5,803 96,545 95,975
High Yield Corporate Bond
Fund+.................... 308,282 1,413,313 782,534
International Bond Fund+..... 5,235 54,586 10,984
International Equity Fund+... 121,009 91,571 63,684
Money Market Fund+........... N/A N/A N/A
New York Tax Free Fund....... 2,297 22,774 35,722
Strategic Income Fund++...... 14,008 N/A N/A
Strategic Value Fund++....... 344 N/A N/A
Tax Free Bond Fund+.......... 5,710 51,345 62,656
Total Return Fund+........... 50,232 334,470 233,202
Value Fund+.................. 112,844 574,807 413,692
</TABLE>
- -----------------------
+ The Fund began offering Class A shares on January 3, 1995.
++ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
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<PAGE> 135
For the fiscal years ended December 31, 1997 and 1996, contingent
deferred sales charges were paid by investors on the redemption of Class B
shares of each Fund, as follows:
<TABLE>
<CAPTION>
Year Ended
Year Ended December 31,
December 31, 1997 1996
----------------- ---------------
<S> <C> <C>
California Tax Free Fund......... $ 3,586 $ 2,008
Capital Appreciation Fund........ 1,485,899 966,555
Convertible Fund................. 1,466,588 852,359
Equity Index Fund................ N/A N/A
Government Fund.................. 788,647 952,234
High Yield Corporate Bond Fund... 2,684,352 1,482,294
International Bond Fund.......... 31,152 27,332
International Equity Fund........ 88,010 48,979
Money Market Fund+............... 779,844 640,623
New York Tax Free Fund........... 2,531 2,810
Strategic Income Fund++.......... 11,479 N/A
Strategic Value Fund++........... -- N/A
Tax Free Bond Fund............... 492,542 605,386
Total Return Fund................ 871,336 745,382
Value Fund....................... 996,052 712,915
</TABLE>
- -----------------------
+ The amount shown represents proceeds from contingent deferred sales
charges which were assessed on redemptions of shares which had
previously been exchanged from other Funds into the Money Market Fund.
++ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
For the fiscal year ended December 31, 1997, it is estimated that the
following amounts were spent on compensation to dealers with respect to the
Class A shares of each Fund: California Tax Free Fund spent $36,835; Capital
Appreciation Fund spent $1,231,407; Convertible Fund spent $246,918; Equity
Index Fund spent $3,332,052; Government Fund spent $33,248; High Yield
Corporate Bond Fund spent $2,144,790; International Bond Fund spent $34,080;
International Equity Fund spent $75,027; New York Tax Free Bond Fund spent
$16,433; Strategic Income Fund spent $169,199; Strategic Value Fund spent
$141,685 Tax Free Bond Fund spent $32,283; Total Return Fund spent $307,772;
and Value Fund spent $665,119.
B-135
<PAGE> 136
For the fiscal year ended December 31, 1997, it is estimated that the
following amounts were spent for distribution-related activities with respect to
the Class B shares of each Fund:
<TABLE>
<CAPTION>
Printing And Approximate
Mailing Total Amount
Sales Prospectuses to Spent by NYLIFE
Material other than Compensation to Compensation Sales Distributors
and Current Distribution to Sales Distribution With Respect to
Advertising Shareholders Personnel Personnel Other Costs Each Fund
----------- ------------ --------- --------- ----- ----- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
California Tax Free $451 $5,941 $12,935 $4,638 $7,356 $84,185 $115,506
Fund
Capital Appreciation 87,010 1,547,023 3,159,974 625,088 1,888,695 13,803,858 21,111,648
Fund
Convertible Fund 22,979 727,746 537,699 88,566 279,208 4,640,527 6,296,725
Govt. Fund 8,234 547,016 323,510 72,554 178,934 1,867,222 2,997,470
High Yield Corp. Fund 130,347 2,796,481 4,100,335 771,492 2,419,468 41,119,642 51,337,765
International Bond 1,446 17,869 52,794 8,395 29,550 249,823 359,877
Fund
International Equity 5,115 53,876 185,125 32,625 106,364 756,109 1,139,214
Fund
New York Tax Free 1,345 4,517 6,991 2,553 6,197 64,232 85,835
Fund
Tax Free Fund 3,774 407,263 269,467 53,290 172,880 1,277,394 2,184,068
Total Return Fund 39,072 1,007,008 1,307,798 262,631 777,495 5,737,640 9,131,644
Value Fund 56,482 1,149,205 1,983,639 394,408 1,177,580 9,955,251 14,716,565
Strategic Income
Fund* 5,873 33,872 209,498 38,134 119,979 1,062,130 1,469,486
Strategic Value Fund* (535) 6,051 (60,004) 12,737 (18,061) 286,835 227,023
===================================================================================================================================
Total 361,593 8,303,868 12,089,761 2,367,111 7,145,645 80,904,848 111,172,826
===================================================================================================================================
</TABLE>
- -----------------------
* The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 22, 1997.
OTHER SERVICES
Pursuant to an Accounting Agreement with the Trust, dated October 24,
1997, the Manager performs certain bookkeeping and pricing services for the
Funds. Each Fund will bear an allocable portion of the cost of providing these
services to the Trust.
B-136
<PAGE> 137
For the period from October 27, 1997 through December 31, 1997, the
amount of recordkeeping fees paid to the Manager by each Fund was as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
1997
------------
<S> <C>
California Tax Free Fund..... N/A
Capital Appreciation Fund.... 41,466
Convertible Fund............. 21,595
Equity Index Fund............ N/A
Government Fund.............. 16,639
High Yield Corporate Bond
Fund..................... 68,994
International Bond Fund...... 2,608
International Equity Fund.... 5,460
Money Market Fund............ 12,407
New York Tax Free Fund....... N/A
Strategic Income Fund........ 4,701
Strategic Value Fund......... 2,323
Tax Free Bond Fund........... 13,665
Total Return Fund............ 28,016
Value Fund................... 31,142
</TABLE>
For the period January 1, 1997 through October 26, 1997 and the fiscal
years ended December 31, 1996 and 1995, the amount of recordkeeping fee paid to
NYLIFE Distributors, the previous Accounting Agent, by each Fund was as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1997 December 31, 1996 December 31, 1995
<S> <C> <C> <C>
California Tax Free Fund................ $ N/A $ N/A $ N/A
Capital Appreciation Fund............... 164,868 145,721 95,042
Convertible Fund........................ 108,332 81,568 57,184
Equity Index Fund....................... N/A N/A N/A
Government Fund......................... 80,879 114,622 128,798
High Yield Corporate Bond Fund.......... 270,515 233,333 164,329
International Bond Fund................. 11,358 12,511 12,000
International Equity Fund............... 24,683 22,075 12,668
Money Market Fund....................... 54,915 62,593 53,064
New York Tax Free Fund.................. N/A N/A N/A
Strategic Income Fund+.................. 13,624 N/A N/A
Strategic Value Fund+................... N/A N/A N/A
Tax Free Bond Fund...................... 60,703 80,430 79,801
Total Return Fund....................... 119,962 126,154 103,032
Value Fund.............................. 125,541 16,985 85,935
</TABLE>
- ----------------
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operation on October 21, 1997.
B-137
<PAGE> 138
In addition, each Fund may reimburse NYLIFE Securities, NYLIFE
Distributors and MainStay Shareholder Services for the cost of certain
correspondence to shareholders and the establishment of 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 each Fund, is responsible under its
Management Agreement for the payment of expenses related to each 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 Sub-Advisers,
(iii) certain fees and expenses of the Trust's Custodians and Transfer
Agent,(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 a Fund, in connection with its securities
transactions, (vi) the fees of any trade association of which a Fund or the
Trust is a member, (vii) the cost of share certificates representing shares of a
Fund, (viii) reimbursement of a portion of the organization expenses of a Fund
and the fees and expenses involved in registering and maintaining registration
of the Trust and of its shares with the SEC and registering the Trust as a
broker or dealer and qualifying its shares under state securities laws,
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 a Fund's business,
(xi) any expenses assumed by the Fund pursuant to its plan of distribution,(xii)
all taxes and business fees payable by a Fund to federal, state or other
governmental agencies, and (xiii) costs associated with the pricing of the
Funds' shares. 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.
Certain of the Funds have entered into a committed line of credit with
The Bank of New York as agent, and various other lenders from whom a Fund may
borrow up to 5% of its net assets in order to honor redemptions. The credit
facility is expected
B-138
<PAGE> 139
to be utilized in periods when the Funds experience unusually large redemption
requests.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected
by brokers, and the Funds pay 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.
Regarding the California Tax Free Fund and New York Tax Free Fund,
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 a 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 Sub-Advisers attempt to achieve this result by selecting
broker-dealers to execute portfolio transactions on behalf of each Fund and
their 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
B-139
<PAGE> 140
commissions. Consistent with the foregoing primary considerations, the Conduct
Rules of the NASD and such other policies as the Trustees may determine, the
Sub-Advisers may consider sales of shares of the Funds as a factor in the
selection of broker-dealers to execute the Funds' 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 on an exchange, 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 each Sub-Advisory Agreement and as permitted by Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act"), a Sub-Adviser may cause a
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 a 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 Trust 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.
Although commissions paid on every transaction will, in the judgment of
the Sub-Advisers, be reasonable in relation to the
B-140
<PAGE> 141
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 Trust and the
Sub-Advisers' 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-Advisers 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 Trust, a commission higher than one charged elsewhere will not
be paid to such a firm solely because it provided Research to an Sub-Adviser.
Research provided by brokers is used for the benefit of all of the Sub-Advisers'
clients and not solely or necessarily for the benefit of the Trust. The
Sub-Advisers' investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort are sometimes used by the
Sub-Advisers as a consideration in the selection of brokers to execute portfolio
transactions.
In certain instances there may be securities which are suitable for a
Fund's portfolio as well as for that of another Fund or one or more of the other
clients of the Sub-Advisers. Investment decisions for a Fund and for the
Sub-Advisers' 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 particular
transaction as far as a Fund is concerned. The
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Trust believes that over time its ability to participate in volume transactions
will produce better executions for the Funds.
The Sub-Advisory fee that the Manager pays on behalf of each Fund to
the Sub-Advisers will not be reduced as a consequence of the Sub-Advisers'
receipt of brokerage and research services. To the extent a 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-Advisers in serving both the Funds and other clients and, conversely,
such services obtained by the placement of brokerage business of other clients
would be useful to the Sub-Advisers in carrying out their obligations to the
Funds.
For the fiscal years ended December 31, 1997, 1996 and 1995 each of
the following Funds paid brokerage commissions as follows:
<TABLE>
<CAPTION>
Total Brokerage Total Brokerage Commissions
Commissions Paid Paid to Affiliated Persons
---------------- ---------------------------
Year ended Year ended Year ended Year ended Year ended Year ended
Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Capital Appreciation Fund...... 1,349,716 $ 882,877 $ 681,250 $ -- $ --- $ ---
Convertible Fund............... 1,728,411 1,952,991 674,139 -- --- ---
Equity Index Fund.............. 24,704 63,111 7,018 -- --- ---
Government Fund................ 1,719 20,809 71,818 -- --- ---
High Yield Corporate Bond
Fund......................... 1,297,005 1,187,150 1,207,587 -- --- 1,970(0%)(1)
International Equity Fund...... 239,373 215,696 135,267 -- --- ---
Strategic Income Fund+......... 11,739 N/A N/A -- N/A N/A
Strategic Value Fund+.......... 21,314 N/A N/A -- N/A N/A
Total Return Fund.............. 609,009 399,858 436,507 -- --- ---
Value Fund..................... 2,347,711 1,354,707 1,055,169 -- --- 5,074(0%)(1)
</TABLE>
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<TABLE>
<CAPTION>
Total Brokerage
Commissions Paid
Total Amount of Transactions to Brokers that
Where Commissions Paid Provided Research
-------------------------------------------------------------- ------------------------
Year Ended Year Ended Year Ended Year ended
December 31, 1997 December 31, 1996 December 31, 1995 December 31, 1997
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Capital Appreciation Fund...... 987,618,526 $ 571,478,397(0.0%)(2) $ 391,017,677(0.0%)(2) 1,349,716
Convertible Fund............... 1,608,359,897 1,296,465,108(0.0%)(2) 395,570,645(0.0%)(2) 1,728,411
Equity Index Fund.............. 21,540,769 64,348,135(0.0%)(2) 5,863,505(0.0%)(2) 24,704
Government Fund................ 12,111,250 275,083,720(0.0%)(2) 712,117,650(0.0%)(2) 1,719
High Yield Corporate Bond
Fund......................... 1,451,737,826 2,471,387,854(0.0%)(2) 1,414,045,455(0.0%)(2) 1,297,005
International Equity Fund...... 60,462,344 49,098,906(0.0%)(2) 33,559,758(0.0%)(2) 239,373
Strategic Income Fund+......... 41,537,454 N/A N/A 11,739
Strategic Value Fund+.......... 12,723,841 N/A N/A 21,314
Total Return Fund ............. 459,057,404 271,187,968(0.0%)(2) 604,631,476(0.0%)(2) 609,009
Value Fund .................... 1,523,756,743 848,170,710(0.0%)(2) 544,224,812(0.0%)(2) 2,347,711
</TABLE>
- -------------------------
(1) Percent of total commissions paid.
(2) Percent of total transactions involving the payment of commissions
effected through affiliated persons.
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
The California Tax Free Fund, International Bond Fund, Money Market
Fund, New York Tax Free Fund and Tax Free Bond Fund paid no brokerage
commissions during the fiscal years ended December 31, 1997, 1996 and 1995.
Capital Appreciation Fund held commercial paper of American Express
Credit Corp. valued at $30,000,000 and commercial paper of Prudential Funding
Corp. valued at $62,926,000; Equity Index Fund held common stock in Merrill
Lynch & Co., Inc. valued at $1,358,753, common stock of Schwab (Charles) Corp.
valued at $624,156, common stock of American Express Co. valued at $2,333,620
and common stock of Morgan Stanley, Dean Witter, Discover & Co. valued at
$1,970,814; International Equity Fund held commercial paper of Merrill Lynch &
Co. Inc. valued at $3,599,399 and common stock of HSBC Holdings PLC valued
$258,829; Convertible Fund held commercial paper of American Express Credit
Corp. Valued at $1,700,000, and common stock and preferred stock of Merrill
Lynch & Co., Inc. valued at $10,913,400 and $1,228,200, respectively; Total
Return Fund held commercial paper of American Express Credit Corp. valued at
$43,450,000, and bonds of Lehman Brothers Holdings Inc., 7.375%, due 5/15/07,
valued at $984,537; Value Fund held commercial paper of American Express Credit
Corp. valued at $29,820,000 and commercial paper of Prudential Funding Corp.
valued at $20,694,000; Government Fund held commercial paper of American
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Express Credit Corp. valued at $32,000,000 and commercial paper of Prudential
Funding Corp. Valued at $6,000,000; High Yield Corporate Bond Fund held
commercial paper of American Express Credit Corp. valued at $137,292,000 and
commercial paper of Prudential Funding Corp. valued at $25,000,000; Money Market
Fund held commercial paper of American Express Credit Corp. valued at $3,173,000
and commercial paper of Goldman Sachs Group L.P. valued at $14,483,450;
Strategic Income Fund held commercial paper of American Express Credit Corp.
valued at $3,000,000, bonds of Lehman Large Loan, Series 1997-LL1 Class A,
6.79%, due 6/12/04, valued at $203,666 and bonds of Merrill Lynch Mortgage
Investors, Inc., Series 1995-C2 Class A1, 7.1817%, due 6/15/21, valued at
$238,560; and Strategic Value Fund held commercial paper of American Express
Credit Corp. valued at $1,187,000 and commercial paper of Prudential Funding
Corp. valued at $1,115,000.
Investors may, subject to the approval of the Trust, the Manager and
the Sub-Adviser, purchase shares of a Fund with liquid securities that are
eligible for purchase by that 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.
NET ASSET VALUE
The net asset value per share of each Fund (other than the Money Market
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. The net asset value per share of
the Money Market Fund is also determined at noon on such days.
Portfolio securities of the Money Market Fund are valued at their
amortized cost, which does not take into account unrealized securities gains or
losses. While this method provides certainty in valuation, it may result in
periods during which value, as determined by amortized cost, is higher or lower
than the price the Money Market Fund would receive if it sold the instrument.
During periods of declining interest rates, the quoted yield on shares of the
Money Market Fund may tend to be higher than a like computation made by a fund
with identical investments utilizing a method of valuation based upon market
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prices and estimates of market prices for all of its portfolio instruments.
Thus, if the use of amortized cost by the Money Market Fund resulted in a lower
aggregate portfolio value on a particular day, a prospective investor in the
Money Market Fund would be able to obtain a somewhat higher yield if he or she
purchased shares of the Money Market Fund on that day, than would result from
investment in a fund utilizing solely market values, and existing investors in
the Money Market Fund would receive less investment income. The converse would
apply in a period of rising interest rates.
Portfolio securities of each other 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
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
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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 Funds 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 Funds 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 Trust recognizes
dividend income and other distributions on the ex-dividend date, except that
certain dividends from foreign securities are recognized as soon as the Trust 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 Funds' net asset values
are 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 occur between
the time their prices are determined and the close
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of the New York Stock Exchange will not be reflected in the Funds' calculation
of net asset values unless the Sub-Adviser deems that the particular event would
materially affect net asset value, in which case an adjustment will be made.
Because the Guarantee regarding the Equity Index Fund is payable to
shareholders directly (and not payable to the Equity Index Fund), and because it
represents only a contingent liability rather than an agreement to pay a
definite amount on the Guarantee Date, the Trustees believe that the Guarantee
should have no impact in determining the Equity Index Fund's net asset value.
The proceeds received by each 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 such Fund and constitute the underlying assets of that Fund. The underlying
assets of each Fund will be segregated on the books of account, and will be
charged with the liabilities in respect to such Fund and with a share of the
general liabilities of the Trust. Expenses with respect to any two or more Funds
will be allocated in proportion to the net asset values of the respective Funds
except where allocations of direct expenses can otherwise be fairly made.
To the extent that any newly organized fund or class of shares
receives, on or before December 31, any seed capital, the net asset value of
such fund(s) or class(es) will be calculated as of December 31.
SHAREHOLDER INVESTMENT ACCOUNT
A Shareholder Investment Account is established for each investor in
the Funds, under which a record of the shares of each 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 a Fund (other than the
Money Market 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.
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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, REDEMPTION AND REPURCHASE
PURCHASE AT NAV
A Fund's Class A shares may be purchased at NAV, without payment of any
sales charge, by employees (and immediate family members) of GAMCO.
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 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.
DISTRIBUTIONS IN KIND
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The Trust has agreed to redeem shares of each 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 applicable 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.
SUSPENSION OF REDEMPTIONS
The Trust may suspend the right of redemption of shares of any 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.
CDSC WAIVERS
The Prospectus identifies certain categories of Class B share
redemptions on which the contingent deferred sales charge ("CDSC") will be
waived. See "Tell Me the Details - Alternative Sales Arrangements - Deferred
Sales Charge Class B Shares." In addition to those categories, the CDSC will be
waived in connection with the following redemptions of Class B shares by
accounts established before January 1, 1998: (i) withdrawals from IRS qualified
and nonqualified retirement plans, individual retirement accounts, tax sheltered
accounts, and deferred compensation plans, where such withdrawals are permitted
under the terms of the plan or account (e.g., attainment of age 59 1/2,
separation from service, death, disability, loans, hardships, withdrawals of
excess contributions pursuant to applicable IRS rules, withdrawals based on life
expectancy under applicable IRS rules); (ii) preretirement transfers or
rollovers within a retirement plan where the proceeds of the redemption are
invested in proprietary products offered or
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distributed by New York Life or its affiliates; (iii) living revocable trusts on
the death of the beneficiary; (iv) redemptions made within one year following
the death or disability or a shareholder; (v) redemptions by directors,
Trustees, officers and employees (and immediate family members) of the Trust and
of New York Life and its affiliates where no commissions have been paid; (vi)
redemptions by employees of any dealer which has a soliciting dealer agreement
with the Distributor, and by any trust, pension, profit-sharing or benefit plan
for the benefit of such persons where no commissions have been paid; (vii)
redemptions by tax-exempt employee benefit plans resulting from the adoption or
promulgation of any law or regulation; (viii) redemptions by any state, country
or city, or any instrumentality, department, authority or agency thereof and by
trust companies and bank trust departments; and (ix) transfers to (a) other
funding vehicles sponsored or distributed by New York Life or an affiliated
company, or (b) guaranteed investment contracts, regardless of the sponsor,
within a retirement plan.
TAX-DEFERRED RETIREMENT PLANS
CASH OR DEFERRED PROFIT SHARING PLANS UNDER SECTION 401(k) FOR CORPORATIONS AND
SELF-EMPLOYED INDIVIDUALS
Shares of a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond 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.
All Funds, except the California Tax Free Fund, New York Tax Free Fund and Tax
Free Bond 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.
INDIVIDUAL RETIREMENT ACCOUNT ("IRA")
Shares of a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond 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
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additional types of IRAs will be available -- the "Roth" IRA and the "Education"
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 (i) $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 a IRA contribution by a married couple is $4,000.
An individual who has not attained age 70-1/2 may make a 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 (and reaching $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
individual's 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.
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
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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 penalty tax. For
distributions made after 1997, the penalty tax does not apply to withdrawals up
to a total of $10,000 for qualified 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 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
for this purpose. Unlike the traditional IRA, Roth IRAs are not subject to
minimum distribution requirements during the account owner's lifetime. However,
the amount in a Roth IRA is subject to required distribution rules after the
death of the account owner.
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 year old. The
maximum contribution is phased out for taxpayers with adjusted gross income
between $95,000 and $110,000 ($150,000 - $160,000 if married filing
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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 part of a
distribution is taxable, a penalty 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 a penalty tax upon
distribution.
All income and capital gains deriving from IRA investments in the Fund
are reinvested and compounded 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 tax-deferred compounded earnings on IRA investments
can lead to substantial retirement and/or education savings.
403(b)(7) TAX SHELTERED ACCOUNT
Shares of a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond Fund, may also be purchased as the underlying
investment for tax sheltered custodial accounts (403(b) plans) 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 a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond 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 Funds' Custodian and
Transfer Agent designate New York Life 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
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plan provides that dividends and distributions will be reinvested automatically.
For further details with respect to any plan, including fees charged by New York
Life 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, quotations of the Money Market Fund's "yield" and
"effective yield" may be included in advertisements or communications to
shareholders. These performance figures are calculated in the following manner:
A. Yield -- the net annualized yield based on a specified
seven-calendar day period calculated at simple interest rates. Yield is
calculated by determining the net change, exclusive of capital changes,
in the value of a hypothetical preexisting account having a balance of
one share at the beginning of the period, subtracting a hypothetical
charge reflecting deductions from shareholder accounts, and dividing
the difference by the value of the account at the beginning of the base
period to obtain the base period return. The yield is annualized by
multiplying the base period return by 365/7. The yield figure is stated
to the nearest hundredth of one percent. The yield of the Class A and
Class B shares of the Money Market Fund for the seven-day period ended
December 31, 1997 was 5.07% and 5.07%, respectively.
B. Effective Yield -- the net annualized yield for a specified
seven-calendar day period assuming a reinvestment of dividends
(compounding). Effective yield is calculated by the same method as
yield except the yield figure is compounded by adding one, raising the
sum to a power equal to 365 divided by 7, and subtracting one from the
result, according to the following formula: Effective Yield = [(Base
Period Return + 1) 365/7] - 1. The effective yield of the Class A and
Class B shares of the Money Market Fund for the seven-day period ended
December 31, 1997 was 5.20% and 5.20%, respectively.
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<PAGE> 155
The yield and effective yield of the Money Market Fund reflect
the reduction of certain fees otherwise payable and voluntary expense
limitations. Had there been no reduction of fees or expense
limitations, the yield and effective yield of the Money Market Fund
would have been 4.77% and 4.88%, respectively, for Class A shares and
4.77% and 4.88%, respectively, for Class B shares for the seven-day
period ended December 31, 1997.
As described above, yield and effective yield are based on historical
earnings and are not intended to indicate future performance. The "effective
yield" will be slightly higher than the "yield" because of the compounding
effect of the assumed reinvestment of dividends. Yield and effective yield will
vary based on changes in market conditions and the level of expenses.
From time to time a Fund, other than the Money Market 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 each 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 and reflects fee waivers and reimbursements in effect for each 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. The
performance information shown below for the period ended December 31, 1996
provides performance figures for both Class A and Class B shares of the Funds,
except in the case of the Equity Index Fund which offers only one class of
shares, Class A shares.
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
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<PAGE> 156
investment will be affected less by this charge the longer you retain your
investment in the Fund.
Quotations of each Fund's average annual total return will be
calculated according to the following SEC formula:
n
P(1+T) = 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)
Each 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 a
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 average annual total returns of the Class A shares of the following
Funds for the one-year and, as applicable, five-year and ten-year periods ended
December 31, 1997 and the period from inception to December 31, 1997 were as
follows:*
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<PAGE> 157
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97 12/31/97 12/31/97 Return(a) Date
- ---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund............... 3.04% 5.64% N/A 6.11% 10/1/91
Capital Appreciation Fund (b).......... 17.27% 16.33% 18.28% 14.88% 5/1/86
Convertible Fund (b)................... 5.24% 12.38% 12.65% 9.99% 5/1/86
Equity Index Fund...................... 28.30% 18.45% N/A 17.83% 12/20/90
Government Fund (b).................... 4.21% 4.93% 6.69% 6.54% 5/1/86
High Yield Corporate
Bond Fund (b)........................ 7.16% 13.11% 11.79% 10.49% 5/1/86
International Bond Fund (b)............ -2.75% N/A N/A 8.69% 9/13/94
International Equity Fund (b).......... -1.23% N/A N/A 3.35% 9/13/94
New York Tax Free Fund................. 3.52% 5.74% N/A 6.36% 10/1/91
Strategic Income Fund.................. N/A N/A N/A 1.83% 2/28/97
Strategic Value Fund................... N/A N/A N/A -1.61% 10/22/97
Tax Free Bond Fund (b)................. 4.11% 5.18% 6.58% 6.19% 5/1/86
Total Return Fund (b).................. 11.74% 11.91% 12.48% 12.50% 12/29/87
Value Fund (b)......................... 15.18% 15.40% 16.43% 12.68% 5/1/86
</TABLE>
- -------------
* Assumes the deduction of the maximum applicable initial sales charge.
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class B shares for the period from inception through December
31, 1994. Performance data for the two classes after this date vary
based on differences in their expense structures.
The average annual total returns of the Class B shares of the following
Funds for the one-year and, as applicable, five-year and ten-year periods
ended December 31, 1997, and the period from inception to December 31, 1997
were as follows*:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97* 12/31/97* 12/31/97* Return(a) Date
- ---- --------- --------- --------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund (b)........... 2.63% 6.14% N/A 6.75% 10/1/91
Capital Appreciation Fund.............. 18.45% 17.08% 18.77% 15.29% 5/1/86
Convertible Fund....................... 5.67% 13.00% 13.08% 10.35% 5/1/86
Government Fund........................ 3.54% 5.19% 6.99% 6.79% 5/1/86
High Yield Corporate
Bond Fund............................ 6.55% 13.53% 12.11% 10.76% 5/1/86
International Bond Fund................ -3.85% N/A N/A 9.08% 9/13/94
International Equity Fund.............. -1.22% N/A N/A 3.85% 9/13/94
New York Tax Free Fund (b)............. 3.14% 6.26% N/A 7.03% 10/1/91
Strategic Income Fund.................. N/A N/A N/A 1.02% 2/28/97
Strategic Value Fund................... N/A N/A N/A -0.96% 10/22/97
Tax Free Bond Fund..................... 3.80% 5.70% 7.01% 6.56% 5/1/86
Total Return Fund...................... 12.65% 12.60% 12.93% 12.97% 12/29/87
Value Fund............................. 16.29% 16.11% 16.89% 13.07% 5/1/86
</TABLE>
- -------------
* Assumes a complete redemption at the end of each year and the deduction
of the maximum applicable contingent deferred sales charge.
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class A shares for the period from inception through
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<PAGE> 158
December 31, 1994. Performance data for the two classes after this date
vary based on differences in their expense structures.
The average annual total returns of the Class A shares of the following
Funds without deducting the applicable initial sales charge is as follows:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97 12/31/97 12/31/97 Return(a) Date
- ---- -------- ---------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
California Tax Free Fund............... 7.90% 6.62% N/A 6.89% 10/1/91
Capital Appreciation Fund (b).......... 24.10% 17.65% 18.95% 15.44% 5/1/86
Convertible Fund(b).................... 11.36% 13.66% 13.29% 10.52% 5/1/86
Equity Index Fund...................... 32.26% 19.17% N/A 18.35% 12/20/90
Government Fund(b)..................... 9.12% 5.90% 7.18% 6.96% 5/1/86
High Yield Corporate
Bond Fund (b)........................ 12.20% 14.15% 12.30% 10.92% 5/1/86
International Bond Fund (b)............ 1.83% N/A N/A 10.22% 9/13/94
International Equity Fund (b).......... 4.52% N/A N/A 5.14% 9/13/94
New York Tax Free Fund................. 8.39% 6.72% N/A 7.15% 10/1/91
Strategic Income Fund.................. N/A N/A N/A 6.62% 2/28/97
Strategic Value Fund................... N/A N/A N/A 4.11% 10/22/97
Tax Free Bond Fund (b)................. 9.02% 6.15% 7.08% 6.61% 5/1/86
Total Return Fund (b).................. 18.24% 13.18% 13.10% 13.14% 12/29/87
Value Fund (b)......................... 21.88% 16.72% 17.09% 13.23% 5/1/86
</TABLE>
- -------------
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class B shares for the period from inception through December
31, 1994. Performance data for the two classes after this date vary
based on differences in their expense structures.
The average annual total returns of the Class B shares of the following
Funds without deducting the applicable contingent deferred sales charge is as
follows:
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<PAGE> 159
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97 12/31/97 12/31/97 Return(a) Date
- ---- -------- ---------- --------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund (b)........... 7.63% 6.45% N/A 6.75% 10/1/91
Capital Appreciation Fund.............. 23.45% 17.29% 18.77% 15.29% 5/1/86
Convertible Fund....................... 10.67% 13.24% 13.08% 10.35% 5/1/86
Government Fund........................ 8.54% 5.51% 6.99% 6.79% 5/1/86
High Yield Corporate
Bond Fund............................ 11.55% 13.77% 12.11% 10.76% 5/1/86
International Bond Fund ............... 1.15% N/A N/A 9.57% 9/13/94
International Equity Fund ............. 3.78% N/A N/A 4.40% 9/13/94
New York Tax Free Fund (b)............. 8.14% 6.57% N/A 7.03% 10/1/91
Strategic Income Fund.................. N/A N/A N/A 6.02% 2/28/97
Strategic Value Fund................... N/A N/A N/A 4.04% 10/22/97
Tax Free Bond Fund .................... 8.80% 6.02% 7.01% 6.56% 5/1/86
Total Return Fund ..................... 17.65% 12.85% 12.93% 12.97% 12/29/87
Value Fund............................. 21.29% 16.33% 16.89% 13.07% 5/1/86
</TABLE>
- -------------
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class A shares for the period from inception through December
31, 1994. Performance data for the two classes after this date vary
based on differences in their expense structures.
The performance data 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 each Fund, except the Money Market 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 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:
6
Yield = 2[(a-b +1) -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
B-159
<PAGE> 160
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.
For the 30-day period ended December 31, 1997, the yield of each of the
following Funds was:
<TABLE>
<CAPTION>
30-Day
Period Ended
December 31,
1997
--------------
Fund Class A Class B
---- ------- -------
<S> <C> <C>
California Tax Free Fund.............. 4.74% 4.71%
----- ------
Government Fund....................... 4.84% 4.34%
----- ------
High Yield Corporate Bond Fund........ 6.77% 6.33%
----- ------
International Bond Fund............... 4.57% 4.02%
----- ------
New York Tax Free Fund................ 4.72% 4.69%
----- ------
Tax Free Bond Fund.................... 4.81% 4.79%
----- ------
Strategic Income Fund................. 5.93% 5.30%
----- ------
</TABLE>
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund may publish its tax equivalent yield in advertisements and communications
to shareholders. The tax equivalent yield is calculated by determining the rate
of return that would have to be achieved on a fully taxable investment to
produce the after-tax equivalent of the Fund's yield, assuming certain tax
brackets for a Fund shareholder.
The table below illustrates the taxable yield equivalent to a tax-free
yield of 5.50%.*+
B-160
<PAGE> 161
<TABLE>
<CAPTION>
To Equal a 5.50% Tax
If Free Return, a Taxable
Your Federal Investment Would Have to
Marginal Tax Earn Without Fee Reduction
Rate is: or Expense Limit
------------ --------------------------
<S> <C>
15.00% 6.47%
28.00% 7.64%
31.00% 7.97%
36.00% 8.59%
39.60% 9.11%
</TABLE>
- --------------------
* This table reflects application of the regular Federal income tax only;
other taxes may be applicable with respect to a particular shareholder.
Such taxes could change the information shown. Tax rates are subject to
change. Investors in the California and New York Tax Free Funds should
in particular note that the chart does not reflect any state and local
taxes that may be deductible in computing Federal income tax liability.
+ This table is for illustrative purposes only; investors should consult
their tax advisers with respect to the tax implications of an
investment in a Fund that invests primarily in securities, the interest
on which is exempt from regular Federal income tax.
A 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 each 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 a Fund's performance including (i) realized and
unrealized capital gains and losses, which are reflected in calculations of a
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
B-161
<PAGE> 162
for yield calculations. In addition, the current dividend rate does not take
into account the imposition 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 a Fund will
fluctuate over time, and any presentation of a Fund's yield, current dividend
rate, total return or tax-equivalent yield 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, total return or tax-equivalent yield
may be in any future period.
In addition, advertising for a 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 a 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 a
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 a Fund may
discuss the investment philosophy, personnel and assets under management of the
Fund's Manager and Sub-Adviser, and other pertinent facts relating to the
management of the Fund by the adviser.
From time to time any of the Funds 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 a Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i) unmanaged
indexes, such as the Standard &
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<PAGE> 163
Poor's 500 Composite Stock Price Index, the Salomon Brothers 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 Funds. Advertisements for a Fund may also include general information
about the performance of unmanaged indexes with investment parameters similar to
the Fund's. 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 Funds may include general
information about the services and products offered by the 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 FUNDS
The following summarizes certain federal income tax considerations
generally affecting the Funds and their stockholders. No attempt is made to
present a detailed explanation of the tax treatment of the Funds or their
stockholders, and the discussion here is not intended as a substitute for
careful tax planning. The discussion is based upon present provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the regulations
promulgated thereunder, and
B-163
<PAGE> 164
judicial and administrative ruling authorities, all of which are subject to
change, which change may be retroactive. Prospective investors should consult
their own tax advisors with regard to the federal tax consequences of the
purchase ownership, and disposition of Fund shares, as well as the tax
consequences arising under the laws of any state, foreign country, or other
taxing jurisdiction.
Each Fund intends to be treated as a regulated investment company
("RIC") under Subchapter M of the Code. To qualify as a regulated investment
company, each Fund must, among other things: (i) derive in each taxable year at
least 90% of its gross income from dividends, interest, payments with respect to
certain securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income derived with respect to its
business of investing in such stock, securities, or currencies ("Qualifying
Income Test"); (ii) diversify its holdings so that, at the end of each quarter
of the taxable year, (a) at least 50% of the market value of the Fund's assets
is represented by cash, cash items, 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, and (b) not more than 25% of
the value of its total assets is invested in the securities on any one issuer
(other than U.S. Government securities or the securities of other regulated
investment companies), or of two or more issuers which the Fund controls (as
that term is defined in the relevant provisions of the Code) and which are
determined to be engaged in the same or similar trades or businesses or related
trades or businesses; and (iii) distribute at least 90% of the sum of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of any net long-term capital
losses) and its net tax-exempt interest each taxable year. The Treasury
Department is authorized to promulgate regulations under which foreign currency
gains would constitute qualifying income for purposes of the Qualifying Income
Test only if such gains are directly related to investing in securities (or
options and futures with respect to securities). To date, no such regulations
have been issued.
Certain requirements relating to the qualification of a Fund as
regulated investment company may limit the extent to which a Fund will be able
to engage in certain investment practices,
B-164
<PAGE> 165
including transactions in futures contracts and other types of derivative
securities transactions. In addition, if a Fund were unable to dispose of
portfolio securities due to settlement problems relating to foreign investments
or due to the holding of illiquid securities, the Fund's ability to qualify as a
regulated investment company might be affected.
A Fund qualifying as a regulated investment company generally will not
be subject to U.S. federal income tax on its investment company taxable income
and net capital gains (any net long-term capital gains in excess of the net
short-term capital losses), if any, that it distributes to shareholders. Each
Fund intends to distribute to its shareholders, at least annually, substantially
all of its investment company taxable income and any net capital gains.
Generally, regulated investment companies, like the Fund, must
distribute amounts on a timely basis in accordance with a calendar year
distribution requirement in order to avoid a nondeductible 4% excise tax.
Generally, to avoid the tax, a regulated investment company must distribute
during each calendar year, (I) at least 98% of its ordinary income (not taking
into account any capital gains or losses) for the calendar year, (ii) at least
98% of its capital gains in excess of its capital losses (adjusted for certain
ordinary losses) for the 12-month period ending on October 31 of the calendar
year, and (iii) all ordinary income and capital gains for previous years that
were not distributed during such years. To avoid application of the excise tax,
each Fund intends to make its distributions in accordance with the calendar year
distribution requirement. A distribution is treated as paid on December 31 of
the calendar year if it is declared by a Fund in October, November or December
of that year to shareholders of record on a date in such a month and paid by the
Fund during January of the following calendar year. Such distributions are
taxable to shareholders in the calendar year in which the distributions are
declared, rather than the calendar year in which the distributions are received.
Provided that a Fund qualifies as a regulated investment company, under
the Code, it generally will not be subject to any excise or income taxes in
Massachusetts. A 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
B-165
<PAGE> 166
consider whether distributions of a Fund's earnings will be subject to tax in
their hands.
Each Fund, other than the Equity Index Fund (which offers only one
class of shares) and the Strategic Income Fund and Strategic Value Fund, has
received a ruling from the IRS to the effect that differing distributions
between the classes of its shares will not result in a Fund's dividends and
other distributions being regarded as "preferential dividends" under the Code.
Generally, a preferential dividend is a dividend which a Fund cannot treat as
having been distributed for purposes of (I) determining whether the Fund
qualifies as a regulated investment company for federal tax purposes, and (ii)
determining the Fund's tax liability.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- GENERAL
Assuming a 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 sources (such as
interest) other 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 generally eliminated unless such
shares are deemed to have been held for more than 45 days. The 45-day holding
period must occur during the 90-day period beginning 45 days before the date on
which the shares become ex-dividend. In the case of dividends on certain
preferred stock, the holding period requirement is 90 days during a 180-day
period. 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 and the applicable holding period
requirements are not met, 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 net capital gain, whether received in cash or
reinvested in Fund shares, will generally be taxable to
B-166
<PAGE> 167
shareholders as either "20% Rate Gain" or "28% Rate Gain," depending upon the
Fund's holding period for the assets sold. "20% Rate Gains" arise from sales of
assets held by a Fund for more than 18 months and are subject to a maximum tax
rate of 20%; "28% Rate Gains" arise from sales of assets held by a Fund for more
than one year but no more than 18 months and are subject to a maximum tax rate
of 28%. Net capital gains from assets held for one year or less will be taxed as
ordinary income. Distributions will be subject to these capital gains rates
regardless of how long a shareholder has held Fund shares.
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 a Fund
within 30 days before or after a purchase of shares of the same 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 a Fund for reinvestment, requiring federal income taxes
to be paid thereon by that Fund, the Fund intends to elect to treat such capital
gains as having been distributed to shareholders. As a result, such capital
gains will be taxable to 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 the relevant Fund shares by the
difference between their pro-rata share of such gains and their tax credit.
Except for distributions by the Money Market Fund, distributions by a
Fund result in a reduction in the net asset value of a Fund's shares. Should a
distribution reduce the net asset value below a shareholder's cost basis, such
distribution nevertheless would generally 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
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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 a Fund's net investment income or net
capital gain may be characterized as a return of capital to shareholders or, 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.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- THE TAX-FREE FUNDS
The Code permits the character of tax-exempt interest distributed by a
regulated investment company to "flow through" as tax-exempt interest to its
shareholders, provided that 50% or more of the value of its assets at the end of
each quarter of its taxable year is invested in state, municipal or other
obligations the interest on which is exempt under Section 103(a) of the Code.
Each of the California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund (collectively, the "Tax Free Funds") intend to satisfy the 50% requirement
to permit their distributions of tax-exempt interest to be treated as such for
regular Federal income tax purposes in the hands of their shareholders.
Exempt-interest dividends must be taken into account by individual shareholders
in determining whether their total incomes are large enough to result in
taxation of up to 85% of their social security benefits and certain railroad
retirement benefits. None of the income distributions of the Tax Free Funds will
be eligible for the deduction for dividends received by corporations.
Although a significant portion of the distributions by the Tax Free
Funds generally is expected to be exempt from federal taxes, each of these Funds
may under certain circumstances invest in obligations the interest from which is
fully taxable, or, although exempt from the regular federal income tax, is
subject to the alternative minimum tax. Similarly, gains from the sale or
exchange of obligations the interest on which is exempt from regular Federal
income tax will constitute taxable income to those Funds. In addition, a sale of
shares in such Fund (including a redemption of such shares and an exchange of
shares between two mutual funds) will be a taxable event, and may result in a
taxable gain or loss to a shareholder. Accordingly, it is possible that
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a significant portion of the distributions of these Funds will constitute
taxable rather than tax-exempt income in the hands of a shareholder.
Furthermore, investors should be aware that tax laws may change, and issuers may
fail to follow applicable laws, causing a tax-exempt item to become taxable.
Exempt-interest dividends from the Tax Free Funds; ordinary dividends
from the Tax Free Funds, if any; capital gains distributions from the Tax Free
Funds and any capital gains or losses realized from the sale or exchange of
shares may be subject to state and local taxes. However, the portion of a
distribution of the Funds' tax-exempt income that is attributable to state and
municipal securities issued within the shareholder's own state may not be
subject, at least in some states, to state or local taxes.
Distributions derived from interest on certain private activity bonds
which is exempt from regular federal income tax are treated as a tax preference
item and may subject individual or corporate shareholders to liability (or
increased liability) for the alternative minimum tax. In addition, because a
portion of the difference between adjusted current earnings, as defined in the
Code, and alternative minimum taxable income is an addition to the alternative
minimum tax base, all distributions derived from interest which is exempt from
regular federal income tax are included in adjusted current earnings and may
subject corporate shareholders to or increase their liability for the
alternative minimum tax.
DISCOUNT
Certain of the bonds purchased by the Funds, 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 (or the price at which it was deemed issued for federal income tax
purposes) and its stated redemption price at maturity. Original issue discount
is treated for federal income tax purposes as income earned by a Fund over the
term 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 a 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 a Fund at a discount
which exceeds the original issue discount on such
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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 a
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 a 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.
USERS OF BOND-FINANCED FACILITIES
Section 147(a) of the Code prohibits exemption from taxation of
interest on certain governmental obligations to persons who are "substantial
users" (or persons related thereto) of facilities financed thereby. No
investigation as to the users of the facilities financed by bonds in the
portfolios of the Tax Free Funds has been made by these Funds. Persons who may
be "substantial users" (or "related persons" of substantial users) of facilities
financed by private activity bonds should consult their tax advisers before
purchasing shares of a Fund since the acquisition of shares of the Tax Free Bond
Fund, California Tax Free Fund or New York Tax Free Fund may result in adverse
tax consequences to them.
TAXATION OF OPTIONS, FUTURES AND SIMILAR INSTRUMENTS
Many of the options, futures contracts and forward contracts entered
into by a 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. 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.
Distribution of Fund gains from hedging transactions will be taxable to
shareholders. Generally, hedging transactions and
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certain other transactions in options, futures and forward contracts undertaken
by a Fund may result in "straddles" for federal income tax purposes. The
straddle rules may affect the character of gains (or losses) realized by a Fund.
In addition, losses realized by a 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, certain
transactions (including options, futures contracts, notional principal
contracts, short sales and short sales against the box) 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 a Fund are not entirely clear. The hedging transactions in
which a Fund engages may increase the amount of short-term capital gain realized
by a Fund which is taxed as ordinary income when distributed to shareholders.
A Fund may make one or more of the elections available under the Code
which are applicable to straddles. If a 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 may
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 a Fund's status as a
regulated investment company may limit the extent to which a Fund will be able
to engage in transactions in options, futures contracts or forward contracts.
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Regarding the Tax Free Bond Fund, the California Tax Free Fund and New
York Tax Free Fund, gains from certain transactions, including, for example,
transactions in options, futures, and other instruments, and from obligations
the interest on which is not exempt from Federal income tax, will be taxable
income to those Funds.
The International Bond Fund, International Equity Fund, Strategic Value
Fund and Strategic Income Fund may engage in swap transactions. The tax
treatment of swap agreements is not entirely clear in certain respects.
Accordingly, while the Funds intend to account for such transactions in a manner
they deem to be appropriate, the IRS might challenge such treatment. If such a
challenge were successful, status of a Fund as a regulated investment company
might be affected. The Funds intend to monitor developments in this area.
PASSIVE FOREIGN INVESTMENT COMPANIES
Certain of the Funds 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 a 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.
A Fund may be eligible to elect alternative tax treatment with respect
to PFIC shares. Under an election that currently is available in some
circumstances, a 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
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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. Alternatively, a Fund may elect to mark to
market its PFIC shares at the end of each taxable year, with the result that
unrealized gains are treated as though they were realized and reported as
ordinary income. Any mark-to-market losses and any loss from an actual
disposition of PFIC Shares would be deductible as ordinary losses to the extent
of any net mark-to-market gains included in income in prior years.
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 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 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 a Fund accrues income or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time a 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 a 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, a 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.
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COMMODITY INVESTMENTS
A regulated investment company is required under the Code to derive at
least 90% of its gross income from certain qualifying sources. 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 a 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 a Fund were capital
assets in the hands of the shareholder, and generally will be taxable to
stockholders as "20% Rate Gain" if the shares had been held for more than 18
months or as "28% Rate Gain" if the shares had been held for more than one year
but no more than 18 months. A loss realized by a shareholder on the redemption,
sale or exchange of shares of a 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 a 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 a 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 either 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 a
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 pursuant
to a right acquired upon the initial purchase of shares. 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. The portion of the sales charge affected by this rule
will be treated as a sales charge paid for the new shares and will be reflected
in their basis.
If reverse stock splits are done, a share may have a split holding
period reflecting the fact that part of the share represents a reinvested
dividend or distribution.
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 a Fund distribution in his or her own state and locality (or foreign
country).
Under the federal income tax law, a 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 (other than shares of the Money Market Fund), 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 a Fund with their taxpayer identification number and with
required certifications regarding their status under the
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federal income tax law or if the IRS or a broker notifies a Fund that the number
furnished by the shareholder is incorrect. In addition, both the Fund and the
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 a Fund from sources outside the
United States may be subject to foreign taxes which were paid or withheld at the
source. The payment of such taxes will reduce the amount of dividends and
distributions paid to the Funds' stockholders. Since the percentage of each
Fund's total assets (with the exception of the International Bond Fund and
International Equity Fund) which will be invested in foreign stocks and
securities will not be more than 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 a Fund will be
subject depends on the specific countries in which each Fund's assets will be
invested and the extent of the assets invested in each such country and,
therefore, cannot be determined in advance.
The International Bond Fund and the International Equity 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 a 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 share-
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holders 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. 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 a Fund
and any special tax considerations associated with foreign investments of a Fund
should be examined by shareholders with regard to their own tax situations.
Shareholders of the Tax Free Bond Fund, the California Tax Free Fund
and New York Tax Free Fund may be subject to state and local taxes on
distributions from the Fund, including distributions which are exempt from
federal income taxes. Some states exempt from the state personal income tax
distributions from a Fund derived from interest on obligations issued by the
U.S. government or by such state or its municipalities or political
subdivisions. Each investor should consult his or her own tax adviser to
determine the tax status of distributions from the Funds in his or her own state
and locality.
Opinions relating to the validity of municipal securities and the
exemption of interest thereon from federal income tax are rendered by bond
counsel to the issuers. The Tax Free Bond Fund, California Tax Free Fund and New
York Tax Free Fund, the Sub-Adviser and its affiliates, and the Funds' counsel
make no review of proceedings relating to the issuance of state or municipal
securities or the bases of such opinions.
Due to the lack of adequate supply of certain types of tax-exempt
obligations, and other reasons, various instruments are being marketed which are
not "pure" state and local obligations, but which are thought to generate
interest excludable from taxable
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income under Code section 103. While a Fund may invest in such instruments, it
does not guarantee the tax-exempt status of the income earned thereon or from
any other investment. Thus, for example, were a Fund to invest in an instrument
thought to give rise to tax-exempt interest but such interest ultimately were
determined to be taxable, the Fund might have invested more than 20% of its
assets in taxable instruments. In addition, it is possible in such circumstances
that a Fund will not have met the 50% investment threshold, described above,
necessary for it to pay exempt-interest dividends.
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, each Fund will issue to
each shareholder a statement of the federal income tax status of all
distributions, including, in the case of the Tax Free Bond Fund, the California
Tax Free Fund and New York Tax Free Fund, a statement of the percentage of the
prior calendar year's distributions which the Fund has designated as tax-exempt,
the percentage of such tax-exempt distributions treated as a tax-preference item
for purposes of the alternative minimum tax, and in, the case of the Tax Free
Bond Fund, the source on a state-by-state basis of all distributions.
ADDITIONAL INFORMATION REGARDING THE EQUITY INDEX FUND
If Shareholders receive distributions of amounts paid pursuant to the
Guarantee, such distributions from the Fund may not be eligible for the
dividends-received deduction available to corporations.
In addition, although not considered likely, it is possible that
shareholders could be regarded for tax purposes as receiving a constructive
distribution(s) (which could be taxable) from the Fund to the extent that the
Guarantee is deemed to have value.
It is anticipated that capital gain or loss from the disposition of
shares will be eligible for treatment as long-term or short-term capital gain or
loss depending upon the shareholder's actual holding period for the shares.
Investors should be aware that, under IRS regulations, as a result of the
Guarantee, a shareholder's holding period for Fund shares might be deemed not to
commence until the Guarantee is paid or expires. In that event, the capital gain
or loss on the disposition of Fund shares would be short-term capital gain or
loss until such time as
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the shares have been held continuously by the shareholder for the requisite
long-term holding period (currently more than one year for Federal income tax
purposes) after the expiration or payment of the Guarantee. The holding period
for shares received from reinvestment of dividends and distributions will
commence no earlier than the reinvestment date but could be delayed as described
previously in this paragraph as a result of the Guarantee.
ADDITIONAL INFORMATION REGARDING THE CALIFORNIA TAX FREE FUND AND NEW YORK TAX
FREE FUND
Under California law, a mutual fund which qualifies as a regulated
investment company must have at least 50% of its total assets in obligations
exempt from California personal income tax at the end of each quarter of its
taxable year in order to be eligible to pay dividends which will be exempt from
California personal income tax. Generally, shareholders who are California
residents will not incur California personal income tax on the amount of
exempt-interest dividends received by them from the California Tax Free Fund and
derived from California state and local issues, whether taken in cash or
reinvested in additional shares. However, other taxes, such as the franchise tax
may apply. Shareholders will normally be subject to California personal income
tax on dividends paid from interest income derived from taxable securities and
from securities issued by states other than California and its subsidiaries and
on distributions of capital gains.
Deductions for interest on indebtedness incurred or continued by a
shareholder to purchase or carry shares of the Fund may be disallowed in whole
or in part for California personal income tax purposes.
Exempt-interest dividends paid by the New York Tax Free Fund from
interest on qualifying New York bonds generally are exempt from New York State
and New York City personal income taxes, but not corporate franchise taxes.
Dividends and distributions of the Fund derived from taxable income and capital
gains are not exempt from New York State and New York City taxes. Deductions for
interest on indebtedness incurred or continued by a shareholder to purchase or
carry shares of the Fund may be disallowed in whole or in part for New York
State or New York City personal income tax purposes.
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Dividends from the California Tax Free Fund or New York Tax Free Fund
(including exempt-interest dividends), capital gains distributions from a Fund,
and any capital gains or losses realized from the sale or exchange of shares may
be subject to state and local taxes (as well as Federal taxes). However, the
portion of a distribution of a Fund's tax-exempt income that is attributable to
state and municipal securities issued within the shareholder's own state
generally will not be subject to state or local taxes. Individuals are often
exempt from state and local personal income taxes on distributions of tax-exempt
interest income derived from obligations of issuers located in the state in
which they reside when these distributions are received directly from these
issuers, but are usually subject to such taxes on income derived from
obligations of issuers located in other jurisdictions. Shareholders are urged to
consult their tax advisers with specific reference to their own federal, state
and local tax situations.
ANNUAL STATEMENTS
Each shareholder of the California Tax Free Fund will be sent after the
close of the calendar year an annual statement as to the federal income tax and
California state personal income tax status of his or her dividends and
distributions from the Fund for the prior calendar year. Any dividends
attributable to interest on municipal obligations that are not California
municipal securities will be taxable as ordinary dividends for California state
personal income tax purposes even if such dividends are excluded from gross
income for federal income tax purposes. These statements will also designate the
amount of exempt-interest dividends that is a specific preference item for
purposes of the federal individual and corporate alternative minimum taxes. Each
shareholder also will receive, if appropriate, various written notices after the
close of the Fund's prior taxable year as to the federal income tax status of
his or her dividends and distributions which were received from the Fund during
the Fund's prior taxable year. Shareholders should consult their tax advisers as
to any other state and local taxes that may apply to these dividends and
distributions. The dollar amount of dividends excluded or exempt from federal
income taxation or California state personal income taxation, if any, will vary
for each shareholder depending upon the size and duration of each shareholder's
investment in the Fund.
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Each shareholder of the New York Tax Free Fund will be sent after the
close of the calendar year an annual statement as to the federal income tax and
New York State and New York City personal income tax status of his or her
dividends and distributions from the Fund for the prior calendar year. These
statements will also designate the amount of exempt-interest dividends that is a
specified preference item for purposes of the federal individual and corporate
alternative minimum taxes. Each shareholder also will receive, if appropriate,
various written notices after the close of the Fund's prior taxable year as to
the federal income tax status of his or her dividends and distributions which
were received from the Fund during the Fund's prior taxable year. Shareholders
should consult their tax advisers as to any other state and local taxes that may
apply to these dividends and distributions. The dollar amounts of dividends
excluded or exempt from federal income taxation or New York State and City
personal income taxation and the dollar amount subject to federal income
taxation or New York State and City personal income taxation, if any, will vary
for each shareholder depending upon the size and duration of each shareholder's
investment in the Fund.
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 a 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.
ORGANIZATION AND CAPITALIZATION
GENERAL
The Funds are separate series of an open-end investment company, The
MainStay Funds ("Trust"), established under the laws of The Commonwealth of
Massachusetts by a Declaration of Trust dated January 9, 1986, as amended. The
Tax Free Bond Fund was originally formed as the MacKay-Shields MainStay Tax Free
Bond Fund pursuant to a Declaration of Trust on January 9, 1986 and became a
series of the Trust pursuant to a reorganization which
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occurred on May 29, 1987. The Total Return Fund commenced operations on December
29, 1987. The Equity Index Fund commenced operations on December 20, 1990. The
California Tax Free Fund and New York Tax Free Fund commenced operations on
October 1, 1991. The International Bond Fund and International Equity Fund
commenced operations on September 13, 1994. The Strategic Income Fund and
Strategic Value Fund commenced operations on February 28 and October 22, 1997,
respectively. The organizational expenses of each 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 each Fund or class on matters affecting an individual
Fund or a particular class of shares issued by a 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
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 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.
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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.
OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York, 10036, has been selected as independent accountants of the Trust. The
Funds' Annual Reports, which are incorporated by reference in this SAI, have
been so incorporated in reliance on the reports of Price Waterhouse, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.
LEGAL COUNSEL
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006,
passes upon certain legal matters in connection with the shares offered by the
Trust, and also acts as counsel to the Trust.
SHARE OWNERSHIP OF THE FUNDS
The following table sets forth information concerning beneficial and
record ownership, as of April 1, 1998, of the Funds' shares by each person who
beneficially or of record owns more than five percent of the voting securities
of any Fund:
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<TABLE>
<CAPTION>
Shares Percentage
Name and Address Beneficially Outstanding
Name of Fund of Shareholder Owned (1) Shares Owned
- ------------ -------------- --------- ------------
<S> <C> <C> <C>
California NYLIFE Distributors Inc.(2) 14.43% 271,121
Tax Free Fund 300 Interpace Parkway
Class A Parsippany, NJ 07054
California Otto V. & Yvonne Louise-Ericksen 9.22% 173,217
Tax Free Fund Tschudi Revoc. Living Trust
Class A 1805 St. Andrews Dr.
Moraga, CA 94668
California William J. & Elinor Potikian 10.36% 83,366
Tax Free Fund Family Revocable Trust
Class B 4475 N. College
Fresno, CA 93704
Capital New York Life Trust Company 24.26% 1,541,608
Appreciation Client Accounts
Class A 51 Madison Avenue, Rm 117A
New York, NY 10010-1603
Convertible New York Life Trust Company 10.45% 468,409
Fund Client Accounts
Class A 51 Madison Avenue, Rm 117A
New York, NY 10010-1603
New York Tax NYLIFE Distributors Inc.(2) 35.07% 499,488
Free Fund 300 Interpace Parkway
Class A Parsippany, NJ 07054
New York Tax Felice Brand 9.33% 53,769
Free Fund 158 Wright Avenue
Class B Deer Park, NY 11729-2224
New York Tax Henry Sheimann Irrevocable Trust 5.59% 32,224
Free Fund 11-31 Jackson Avenue
Class B Scardsdale, NY 10583
New York Tax Smith Barney Inc. 5.45% 77,602
Free Fund 388 Greenwich St.
Class A New York, NY 10013
International NYLIFE Distributors Inc.(2) 55.90% 770,905
Bond Fund 300 Interpace Parkway
Class A Parsippany, NJ 07054
</TABLE>
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<TABLE>
<CAPTION>
Shares Percentage
Name and Address Beneficially Outstanding
Name of Fund of Shareholder Owned (1) Shares Owned
- ------------ -------------- --------- ------------
<S> <C> <C> <C>
International Defined Benefit Pension Trust of FMCNA 5.45% 74,305
Bond Fund C/O the Free Methodist Foundation
Class A 8050 Spring Arbor Road
Spring Arbor, MI 49283
International Merrill Lynch Pierce 5.73% 76,991
Bond Fund Fenner & Smith
Class A 4800 Deer Lake Dr. East
Jacksonville, FL 32246
International NYLIFE Distributors Inc.(2) 36.68% 625,090
Equity Fund 260 Cherry Hill Road
Class A Parsippany, NJ 07054
International New York Life Trust Company 5.95% 101,533
Equity Fund Clients Accounts
Class A 51 Madison Avenue, Room 117A
New York, NY 10010
Strategic Income NYLIFE Distributors Inc.(2) 10.36% 549,397
Fund 300 Interpace Parkway
Class B Parsippany, NJ 07054
Strategic Income New York Life Insurance 33.92% 653,946
Fund Company General Account
Class A 51 Madison Avenue
New York, NY 10010
Value Fund New York Life Trust Company 22.23% 1,420,946
Class A Client Accounts
51 Madison Avenue, Rm 117A
New York, NY 10010-1603
Government New York Life Trust Company 18.12% 363,748
Fund Client Accounts
Class A 51 Madison Avenue, Rm 117A
New York, NY 10010-1603
Tax Free
Bond Fund Schmitt Family Trust 15.26% 202,393
Class A P.O. box 1566
Savannah, GA 31402
</TABLE>
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<PAGE> 186
<TABLE>
<CAPTION>
Shares Percentage
Name and Address Beneficially Outstanding
Name of Fund of Shareholder Owned (1) Shares Owned
- ------------ -------------- --------- ------------
<S> <C> <C> <C>
Value Fund Delaware Charter Guarantee 5.37% 343,465
Class A & Trust Co., Trustee
FBO Savings Incentive Plan for
Employees of LSB Industries Inc.
Holding Account 401K Plan
P.O. Box 8708
Wilimgton, DE 19899
Money Market New York Life Trust Company 6.89% 6,623,580
Fund Client Accounts
Class A 51 Madison Avenue, Room 117A
New York, NY 10010
Total Return New York Life Trust Company 49.57% 2,668,627
Fund Client Accounts
Class A 51 Madison Avenue, Room 117A
New York, NY 10010
Strategic Income Rodney A. Vanderaa 5.43% 104,752
Fund Joy Vanderaa
Class A 19140 Ada St.
Lansing, IL 60438
Strategic Income James C. Calano 5.76% 111,076
Fund 200 Boulder View Lane
Class A Boulder, CO 80304
Strategic Income Terry L. Vanderaa 5.07% 97,656
Fund Linda A. Vanderaa
Class A ATC Vancom
P.O. Box 7320
Oakbrook Terrace, IL 60181
Strategic Income Rodney A. Vanderaa 5.19% 100,040
Fund Wendy M. Vanderaa
Class A 18448 Holland Road
Lansing, IL 60436
Strategic Value New York Life Insurance 59.65% 914,161
Fund Company
Class A 51 Madison Avenue
New York, NY 10010
</TABLE>
- -------------
(1) This information, not being within the knowledge of the Trust, has been
furnished by each of the above persons. Beneficial ownership is as
defined under Section 13(d) of the Securities Exchange Act of 1934.
Fractional Shares have been omitted.
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<PAGE> 187
(2) Mr. George Daoust, in connection with his position with NYLIFE
Distributors, has the power to vote all of the shares shown in the
above table owned by NYLIFE Distributors. Mr. Daoust disclaims
beneficial ownership of such shares.
NYLIFE Distributors Inc. is a corporation organized under the laws of
Delaware. NYLIFE Distributors Inc. is a wholly owned subsidiary of NYLIFE Inc.,
and an indirect wholly owned subsidiary of New York Life Insurance Company.
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 Sub-Adviser unless such power is the result of
their position with the Trust or Investment Sub-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.
YEAR 2000
The services provided to the Funds by the Manger, the Sub-Advisers and
the Funds' other service providers are dependent on those service providers'
computer systems. Many computer software and hardware systems in use today
cannot distinguish between the year 2000 and the year 1900 because of the way
dates are encoded and calculated (the "Year 2000 Issue"). The failure to make
this distinction would have a negative implication on handling securities
trades, pricing and account services. The Manager, the Sub-Advisers and the
Funds' other service providers are taking steps that each believes are
reasonably designed to address the Year 2000 Issue with respect to the computer
systems that they use. The Funds have no reason to believe these steps will not
be sufficient to avoid any material adverse impact on the Funds, although there
can be no assurances. The costs or consequences of incomplete or untimely
resolution of the Year 2000 Issue are unknown to the Manager, the Sub-Advisers
and the Funds' other service providers at this time but could have a material
adverse impact on the operations of the Funds and the Manager, the Sub-Advisers
and the Funds' other service providers. In addition, companies in which the
Funds invest may experience Year 2000 Issue
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<PAGE> 188
difficulties which could adversely impact their business and adversely affect
the value of the securities issued by them.
FINANCIAL STATEMENTS
The financial statements of the Capital Appreciation Fund, California
Tax Free Fund, New York Tax Free Fund, Value Fund, Convertible Fund, Total
Return Fund, High Yield Corporate Bond Fund, Government Fund (formerly the
Government Plus Fund), Tax Free Bond Fund (formerly the MacKay-Shields MainStay
Tax Free Bond Fund), International Bond Fund, International Equity Fund, Equity
Index Fund, Money Market Fund, Strategic Income Fund and Strategic Value Fund,
including the Portfolio of Investments as of December 31, 1997, the Statement of
Assets and Liabilities as of December 31, 1997, the Statement of Operations for
the year ended December 31, 1997, the Statement of Changes in Net Assets for the
years ended December 31, 1997 and 1996, the Notes to the Financial Statements
and the Reports of Independent Accountants, all of which are included in the
1997 Annual Reports to the Shareholders are hereby incorporated by reference
into this Statement of Additional Information.
An audited financial statement for NYLIFE Inc. as of December 31, 1997,
is included in this Statement of Additional Information.
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<PAGE> 189
THE MAINSTAY FUNDS
MAINSTAY BLUE CHIP GROWTH FUND
MAINSTAY RESEARCH VALUE FUND
MAINSTAY SMALL CAP VALUE FUND
MAINSTAY GROWTH OPPORTUNITIES FUND
MAINSTAY SMALL CAP GROWTH FUND
MAINSTAY EQUITY INCOME FUND
MAINSTAY GLOBAL HIGH YIELD FUND
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
JUNE 1, 1998
AS SUPPLEMENTED JANUARY 13, 1999
- --------------------------------------------------------------------------------
The MainStay Funds (the "Trust") is an open-end management investment
company (or mutual fund) currently consisting of twenty-two series, the
following seven of which are discussed herein: Blue Chip Growth Fund, Research
Value Fund, Small Cap Value Fund, Growth Opportunities Fund, Small Cap Growth
Fund, Equity Income Fund and Global High Yield Fund (individually or
collectively referred to as a "Fund" or the "Funds"). MainStay Management, Inc.
(the "Manager") serves as the manager for the Funds and has entered into
Sub-Advisory Agreements with Gabelli Asset Management Company ("GAMCO") with
respect to the Blue Chip Growth Fund; John A. Levin & Co., Inc. ("John A. Levin
& Co.") with respect to the Research Value Fund; Dalton, Greiner, Hartman, Maher
& Co. ("Dalton, Greiner") with respect to the Small Cap Value Fund; Madison
Square Advisors, Inc. ("Madison Square Advisors") with respect to the Growth
Opportunities Fund; and MacKay-Shields Financial Corporation ("MacKay-Shields")
with respect to the Small Cap Growth Fund, Equity Income Fund and Global High
Yield Fund. GAMCO, John A. Levin & Co., Dalton, Greiner, Madison Square Advisors
and MacKay-Shields are sometimes jointly referred to as the "Sub-Advisers."
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the Prospectus of the Funds dated June 1, 1998, 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).
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
<PAGE> 190
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.
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<TABLE>
<CAPTION>
TABLE OF CONTENTS
PAGE IN
STATEMENT OF
ADDITIONAL
INFORMATION
-----------
<S> <C>
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS................................6
Repurchase Agreements................................................................6
Lending of Portfolio Securities......................................................7
Bank Obligations.....................................................................8
U.S. Government Securities...........................................................9
Debt Securities......................................................................9
Convertible Securities..............................................................10
Arbitrage...........................................................................11
Foreign Securities..................................................................11
Foreign Currency Transactions.......................................................13
Foreign Index-Linked Instruments....................................................17
Brady Bonds.........................................................................17
Floating and Variable Rate Securities...............................................18
Zero Coupon Bonds...................................................................19
When-Issued Securities..............................................................19
Mortgage-Related and Other Asset-Backed Securities..................................20
Short Sales Against the Box.........................................................29
Options on Securities...............................................................30
Options on Foreign Currencies.......................................................36
Securities Index Options............................................................38
Futures Transactions................................................................40
Swap Agreements.....................................................................50
Loan Participation Interests........................................................52
Risks Associated with Debt Securities...............................................54
Risks of Investing in High Yield Securities ("Junk Bonds")
............................................................................55
FUNDAMENTAL INVESTMENT RESTRICTIONS.........................................................55
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS.....................................................57
TRUSTEES AND OFFICERS.......................................................................59
THE MANAGER, THE SUB-ADVISERS AND THE DISTRIBUTOR...........................................68
Management Agreement................................................................68
Sub-Advisory Agreements.............................................................69
Distribution Agreement..............................................................70
Other Services......................................................................72
</TABLE>
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<TABLE>
<S> <C>
Expenses Borne by the Trust........................................................ 72
PORTFOLIO TRANSACTIONS AND BROKERAGE....................................................... 73
NET ASSET VALUE............................................................................ 76
SHAREHOLDER INVESTMENT ACCOUNT............................................................. 79
SHAREHOLDER SERVICING AGENT................................................................ 79
PURCHASES, REDEMPTION AND REPURCHASE....................................................... 80
Purchases at NAV................................................................... 80
Letter of Intent ("LOI")........................................................... 80
Distributions in Kind.............................................................. 80
Suspension of Redemptions.......................................................... 80
TAX-DEFERRED RETIREMENT PLANS.............................................................. 81
Cash or Deferred Profit Sharing Plans Under Section 401(k)
for Corporations and Self-Employed Individuals.............................. 81
Individual Retirement Account ("IRA").............................................. 81
403(b)(7) Tax Sheltered Account.................................................... 84
General Information................................................................ 84
CALCULATION OF PERFORMANCE QUOTATIONS...................................................... 84
TAX STATUS................................................................................. 88
Taxation of the Funds.............................................................. 88
Character of Distributions to Shareholders -- General
........................................................................... 91
Discount........................................................................... 93
Taxation of Options, Futures and Similar Instruments
........................................................................... 93
Passive Foreign Investment Companies................................................95
Foreign Currency Gains and Losses.................................................. 96
Commodity Investments.............................................................. 97
Dispositions of Fund Shares........................................................ 97
Tax Reporting Requirements......................................................... 98
Foreign Taxes...................................................................... 99
State and Local Taxes - General................................................... 100
Explanation of Fund Distributions................................................. 100
General Information............................................................... 100
ORGANIZATION AND CAPITALIZATION........................................................... 101
General........................................................................... 101
Voting Rights..................................................................... 101
Shareholder and Trustee Liability................................................. 101
</TABLE>
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<TABLE>
<S> <C>
OTHER INFORMATION......................................................................... 102
Independent Accountants........................................................... 102
Legal Counsel..................................................................... 102
Code of Ethics.................................................................... 102
FINANCIAL STATEMENTS...................................................................... 103
</TABLE>
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INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS
The Funds may engage in the following investment practices or invest in
the following instruments to the extent permitted in the Prospectus.
REPURCHASE AGREEMENTS
The Funds 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. In addition, the Global High Yield Fund may enter
into domestic or foreign repurchase agreements with certain sellers deemed to be
creditworthy pursuant to guidelines adopted 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 a 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
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<PAGE> 195
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 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-Advisers seek 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 Funds may enter into reverse repurchase agreements. A Fund will
maintain a segregated account consisting of liquid assets to cover its
obligations under reverse repurchase agreements. Each of the Funds will limit
its investments in reverse repurchase agreements to no more than 5% of its total
assets.
LENDING OF PORTFOLIO SECURITIES
Each Fund may seek to increase its income by lending portfolio
securities. Under guidelines adopted by the Funds' 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
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<PAGE> 196
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 certain of the
Funds, has entered into an agency agreement with Merrill Lynch Portfolio
Services, Inc. which acts as the Funds' 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 Funds' Sub-Advisers.
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 a 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 lending Fund. In addition, pursuant to
guidelines adopted by the Board, each Fund is prohibited from lending more than
5% of its total 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 Funds 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
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<PAGE> 197
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-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 a Fund invests in debt
securities, it will be subject to certain risks. The value of the debt
securities held by a Fund, and thus the NAV of the shares of a 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 a Fund's investments,
changes in relative values of the currencies in which a Fund's investments are
denominated relative to the U.S. dollar, and the extent to which a 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 a Fund,
and a decline
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<PAGE> 198
in interest rates will increase the value of fixed income securities held by a
Fund.
CONVERTIBLE SECURITIES
The Funds 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 Funds' portfolios 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 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
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<PAGE> 199
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 a
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
Each Fund may sell in one market a security which it owns and
simultaneously purchase the same security in another market, or 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 Funds do 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 a Fund.
FOREIGN SECURITIES
The Funds may invest 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
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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 Funds may encounter
substantial difficulties in obtaining and enforcing judgments against non-U.S.
resident individuals and companies.
Investment in emerging market countries presents risks in greater degree
than, and in addition to, those presented by investment in foreign issuers in
general. Developing countries have economic structures that are less mature.
Furthermore, developing countries have less stable political systems and may
have high inflation, rapidly changing interest and currency exchange rates, and
their securities markets are substantially less developed. The economies of
developing countries generally are heavily dependent upon international trade,
and, accordingly, have been and may continue to be adversely affected by trade
barriers, exchange controls, managed adjustments in relative currency values and
other protectionist measures in the countries with which they trade. These
economies also have been and may continue to be adversely affected by economic
conditions in the countries with which they trade.
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FOREIGN CURRENCY TRANSACTIONS
Many of the foreign securities in which the Funds invest 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 Funds' assets.
However, each 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. Each of
these Funds 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, a 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 Funds 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 a Fund will be served by
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entering into such a contract. Generally, the Sub-Adviser believes that the best
interest of a Fund will be served if a Fund is permitted to enter into forward
contracts under specified circumstances. First, when a 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, a 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 a 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 a 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), a 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).
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Finally, a 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, 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, a 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 a 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 a 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.
A Fund's dealing in forward contracts will be limited to the
transactions described above. Of course, a 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. A 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, a 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"
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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 a 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 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 a
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
Funds 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 a
Fund's exposure to currency exchange rate activity and could result in losses to
the Fund if currencies do not perform as investment managers anticipate. A 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 a 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.
A Fund's foreign currency transactions may be limited by the
requirements of Subchapter M of the Code for qualification as a regulated
investment company.
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FOREIGN INDEX-LINKED INSTRUMENTS
As part of its investment program, and to maintain greater flexibility,
the Global High Yield Bond Fund may, subject to compliance with each Fund's
limitations applicable to its investment in debt securities, invest in
instruments issued by the U.S. or a foreign government or by private issuers
that return principal and/or pay interest to investors in amounts which are
linked to the level of a particular foreign index ("foreign index-linked
instruments"). Foreign index-linked instruments have the investment
characteristics of particular securities, securities indexes, futures contracts
or currencies. Such instruments may take a variety of forms, such as debt
instruments with interest or principal payments determined by reference to the
value of a currency or commodity at a future point in time.
A foreign index may be based upon the exchange rate of a particular
currency or currencies or the differential between two currencies, or the level
of interest rates in a particular country or countries, or the differential in
interest rates between particular countries. In the case of foreign index-linked
instruments linking the interest component to a foreign index, the amount of
interest payable will adjust periodically in response to changes in the level of
the foreign index during the term of the foreign index-linked instrument.
BRADY BONDS
The Global High Yield 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 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
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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.
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 Funds with a certain degree of protection against rises in
interest rates, the Funds 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
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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 Funds' limitations on investments in such securities.
ZERO COUPON BONDS
The Funds 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 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 Funds 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, that Fund would earn no income; however, it is the Trust's intention
that each 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 Trust intends to purchase such securities with the
purpose of actually acquiring them unless a sale appears desirable for
investment reasons.
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At the time the Trust makes the commitment on behalf of a 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 a Fund's net asset value or income will be exposed to additional
risk by the purchase of securities on a when-issued basis. Each 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 Funds 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 Funds, to
the extent permitted in the Prospectus, may also invest in debt securities which
are secured with collateral consisting of 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
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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 a 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 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 as 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
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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 Funds reserve 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 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 Funds' investment quality standards. There can be no
assurance that the private insurers or guarantors can meet their obligations
under the insurance
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policies or guarantee arrangements. The Funds 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 Funds' quality standards.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES The mortgage-related
securities in which the Funds 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 privately issued mortgage-related securities is
becoming increasingly liquid, securities issued by certain private organizations
may not be readily marketable. No Fund will purchase mortgage-related securities
or any other assets which in the Sub-Advisers' 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 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
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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.
The eligible Funds will not invest in any privately issued CMOs that do
not meet the requirements of Rule 3a-7 under the 1940 Act if, as a result of
such investment, more than 5% of a Fund's net assets would be invested in any
one CMO, more than 10% of the Fund's net assets would be invested in CMOs and
other investment company securities in the aggregate, or the Fund would hold
more than 3% of any outstanding issue of CMOs.
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
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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 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
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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 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 a
Fund's limitations on investment in illiquid securities.
Under certain circumstances, a Fund's investment in residual interests
in "real estate mortgage investment conduits" ("REMICs") may cause shareholders
of that 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 a
Fund.
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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 market, the depth and liquidity of which
will vary from time to time. 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
rule 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.
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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 a Fund's limitations on investment in illiquid securities.
RISKS ASSOCIATED WITH MORTGAGE-BACKED SECURITIES The value of some
mortgage-backed securities in which the Funds may invest may be particularly
sensitive to changes in prevailing interest rates, and, like the other
investments of the Funds, the ability of a Fund to successfully utilize these
instruments may depend in part upon the ability of an Sub-Adviser to forecast
interest rates and other economic factors correctly. If a 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 Funds
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 a Fund invested in such securities and wishing
to sell them may find it difficult to find a buyer, which may in turn decrease
the price at which they may be sold.
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Credit risk reflects the chance that a 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 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-Advisers expect that other asset-backed securities (unrelated to
mortgage loans) will be offered to investors in the future. Consistent with its
investment objectives and policies, a Fund also may invest in other types of
asset-backed securities.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which a 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, a Fund owns or has the right to obtain securities equivalent in kind
and amount. Each of the Funds will only enter into short sales against the box.
A 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
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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, a Fund could experience losses or delays in recovering
gains on short sales. The Funds will only enter into short sales against the box
with brokers the Sub-Advisers believe are creditworthy. Short sales against the
box will be limited to no more than 25% of a Fund's total assets.
OPTIONS ON SECURITIES
WRITING CALL OPTIONS Any Fund may sell ("write") covered call options on
the portfolio securities of such Fund in an attempt to enhance investment
performance. A call option sold by a 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.
A 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. A 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
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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.
A 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 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
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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.
Each 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 a 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 Funds may, to the extent determined
appropriate by the Sub-Advisers, engage without limitation in the writing of
options on U.S. government securities. Subject to the limitation that all call
and put option writing transactions be covered, and limitations imposed on
regulated investment companies under federal tax law, the Global High Yield Fund
may, to the extent determined appropriate by the Sub-Adviser, engage without
limitation in the writing of options on their portfolio securities.
WRITING PUT OPTIONS Each Fund may also write covered put options. Put
options written by a Fund are agreements by a 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 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 Funds receive 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
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time when it may be required to fulfill its obligation as a
writer of the option.
The Funds 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 Funds also may effect a closing purchase transaction, in the case
of a put option, to permit the Funds to maintain their 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 a 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 Funds may also write straddles (combinations of covered
puts and calls on the same underlying security). The extent to which the Funds
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 each Fund qualify
as such. Subject to the limitation that all call and put option writing
transactions be covered, the Funds may, to the extent determined appropriate by
the Sub-Advisers, engage without limitation in the writing of options on U.S.
government securities.
PURCHASING OPTIONS Each 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 Funds will engage in such
transactions only with firms the Sub-Advisers deem to be of sufficient
creditworthiness so as to minimize these risks.
The Funds may purchase put options on securities to protect their
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
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another. A 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 a 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 Funds may also purchase call options on securities the Funds intend
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 securities remained below the sum of the premium and the
exercise price during the option period. In order to terminate an option
position, the Funds 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 Each Fund may 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 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 equivalent of a short sale against
the box. To implement this trading strategy, the Fund will simultaneously
execute with the same broker a purchase of shares of the common stock and an "in
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the money" over-the-counter put option to sell the common stock to the broker
and generally 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 may require
that the Fund write a call option, which would enable the broker to profit in
the event the price of the stock rises above the exercise price of the call
option (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.
A Fund's purpose in selling covered options is to realize greater income
than would be realized on portfolio securities transactions alone. A 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 a 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 a Fund to successfully utilize options may depend
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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
Each Fund may, to the extent that it invests in foreign securities,
purchase and write options on foreign currencies. A Fund may use foreign
currency options contracts for various reasons, including: to manage its
exposure to changes in currency exchange rates; as an efficient means of
adjusting its overall exposure to certain currencies; or in an effort to enhance
its return.
A Fund may 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. A Fund may also 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. 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,
a Fund may purchase put options on the foreign currency. If the value of the
currency does decline, that Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the 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, a 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
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securities the Fund intends to acquire. As in the case of other types of options
transactions, however, the benefit a 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, a 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.
If a 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 diminution 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, a 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 a 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 writing options on foreign
currencies, a 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 a Fund is "covered" if that
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 a 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
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amount of the difference is maintained by a Fund in liquid assets in a
segregated account with its custodian.
Options on foreign currencies to be written or purchased by a Fund will
be traded on U.S. and foreign exchanges or over-the-counter. 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. As with other kinds of options transactions, however, the writing of
an option on foreign currency will constitute only a partial hedge up to the
amount of the premium received and a 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 a Fund's position, a Fund may forfeit the entire amount of the
premium plus related transaction costs.
A 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 a Fund seeks to
close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, a 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 a 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 Funds 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 a 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
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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 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
securities held or to be acquired by a 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 a 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
a 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 a 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.
A Fund may sell securities index options prior to expiration in order to
close out its positions in securities index options which it has purchased. A
Fund may also allow options to expire unexercised.
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FUTURES TRANSACTIONS
The Equity Income Fund and Global High Yield 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 a Fund's portfolio
and for other appropriate risk management purposes. For example, a Fund may
purchase futures contracts as a substitute for the purchase of longer-term debt
securities to lengthen the average duration of a 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. Each Fund may
purchase and sell stock index futures to hedge the equity portion of those
Funds' securities portfolios 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 Funds may also purchase and sell other
futures when deemed appropriate, in order to hedge the equity or non-equity
portions of their portfolios. In addition, each Fund may, to the extent it
invests in foreign securities, enter into contracts for the future delivery of
foreign currencies to hedge against changes in currency exchange rates. Each of
the Funds may also purchase and write put and call options on futures contracts
of the type into which such Fund is authorized to enter 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 Funds also may enter into futures contracts traded on foreign futures
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 a 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
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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 a 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. Each Fund expects to earn interest
income on its initial margin deposits. A futures contract held by a Fund is
valued daily at the official settlement price of the exchange on 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 a 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, each Fund will mark-to-market its open futures positions.
A 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 a 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.
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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--a 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-Advisers to reflect the fair value of the
contract, in which case the positions will be valued by or under the direction
of the Trustees.
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. A 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, a 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. A 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
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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 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 a Fund's
securities portfolio with regard to market (systematic) risk, as distinguished
from stock-specific risk. The Funds may enter into stock index futures to the
extent that they have equity securities in their portfolios. Similarly, the
Funds may enter into futures on debt securities indexes (including the municipal
bond index) to the extent they have debt securities in their portfolios. By
establishing an appropriate "short" position in securities index futures, a 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, a 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. A
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 Funds do 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 a Fund, as seller, to deliver the amount of currency called for in
the contract at a specified future time
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for a specified price. A purchase of a currency futures contract creates an
obligation by a Fund, as purchaser, to take delivery of an amount of currency at
a specified future time at a specified price. A 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 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 a 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 a 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 Funds 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
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the Trust that the Funds will purchase or write only options on futures
contracts that are traded on a U.S. or foreign exchange or board of trade. The
Funds 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 (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 a 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 a
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 a
Fund's portfolio. Depending on the
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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.
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 a 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 a 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
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exercise may be greater than the price at which the debt securities might be
purchased in the securities market.
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, a 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 Funds 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 Funds 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,
a 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, a 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, a 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, a 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 a 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 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
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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 a 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 Funds 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 a Fund would have to
exercise options it has purchased in order to realize any profit and would be
less able to limit its 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
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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 Funds 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 movements
exceeding given minimum or maximum levels. A 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"). A 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. A Fund will
not enter into a swap agreement with any single party
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if the net amount owed or to be received under existing contracts with that
party would exceed 5% of the Fund's assets.
Whether a 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, a 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 a 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 Funds by
the Code may limit the Funds' 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 a 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 1940 Act, commodity pool, corporation, partnership,
proprietorship, organization, trust or other entity, employee benefit plan,
governmental entity, broker-dealer, 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.
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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
A 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, a 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, a Fund may
purchase an assignment of all or a portion of a lender's interest in a corporate
loan, in which case, a 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. A
Fund also may purchase a Participation Interest in a portion of the rights of a
lender in a corporate loan. In such a case, a Fund will be entitled to receive
payments of principal, interest and fees, if any, but generally will not be
entitled to enforce its rights directly against the agent bank or the borrower;
rather a Fund must rely on the lending institution for that purpose. A 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. A 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
B-52
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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 a Fund has
direct recourse against the borrower (which is unlikely), a 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 held by the agent bank for the benefit of a 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, a 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 a Fund acts as co-lender in connection with a participation
interest or when a Fund acquires a participation interest the terms of which
provide that a Fund will be in privity of contract with the corporate borrower,
a Fund will have direct recourse against the borrower in the event the borrower
fails to pay scheduled principal and interest. In all other cases, a Fund will
look to the agent bank to enforce appropriate credit remedies against the
borrower. In acquiring participation interests a Fund will conduct analysis and
evaluation of the financial condition of each such co-lender and participant to
ensure that the participation interest meets a Fund's qualitative standards.
There is a risk that there may not be a readily available market for loan
participation interests and, in some
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cases, this could result in a Fund disposing of such securities at a substantial
discount from face value or holding such security until maturity. When a 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 Funds consider loan participation interests not subject to puts
to be illiquid.
RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that a Fund invests in debt securities, it will be subject
to certain risks. The value of the debt securities held by a 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 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.
When and if available, debt securities may be purchased at a discount
from face value. However, the Funds do 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 Funds 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 each Fund will vary as the
aggregate value of the Funds' portfolio securities increases or decreases.
Moreover, the value of the debt securities that each 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
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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 Funds but will be reflected in the net asset value of the
Funds' 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 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. A 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 on account of such interest
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.
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).
FUNDAMENTAL INVESTMENT RESTRICTIONS
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The following restrictions may not be changed with respect to any Fund
without the approval of the majority of the outstanding voting securities of
that Fund (as defined under the 1940 Act). Investment restrictions that appear
below or elsewhere in this Statement of Additional Information that involve a
maximum percentage of securities or assets shall not be considered to be
violated unless an excess 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, a Fund.
The Trust may not, on behalf of any Fund:
(1) Act as an underwriter of securities issued by others, except to the
extent that a Fund may be considered an 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
Investment Company Act of 1940;
(3) With respect to 75% of each Fund's (except Global High Yield Fund)
total assets invest more than 5% of the value of the total assets of a 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 a Fund;
(4) 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 these Funds maintain 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 total assets.
(5) Purchase securities if such purchase would cause 25% or more in the
aggregate of the market value of the total assets of a 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 in respect to
investments in U.S. government securities or investments in repurchase
agreements with respect thereto (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 at such time that the 1940
B-56
<PAGE> 245
Act is amended to permit a registered investment company to elect to be
"periodically industry concentrated" (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 total assets in a particular industry) the Funds elect
to be so classified and the foregoing limitation shall no longer apply with
respect to the Funds;
(6) 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) or, commodities and commodity contracts. The Trust reserves the
freedom of action to hold and to sell real estate acquired for any 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 currencies 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
(7) Make loans to other persons, except loans of portfolio securities.
The purchase of debt obligations and the entry into repurchase agreements in
accordance with a Fund's investment objectives and policies are not deemed to be
loans for this purpose.
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 Funds. 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, a 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, a Fund may not purchase securities on
margin, except that the Fund may obtain such
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<PAGE> 246
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, a 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 and Section 4(2)
commercial paper 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. A Fund may
not invest more than 15% of its net assets in repurchase agreements
providing for settlement in more than seven days, or in other
instruments which for regulatory purposes or in the Sub-Adviser's
opinion may be deemed to be illiquid, such as a certain portion of
options traded in the over-the-counter market, and securities being used
to cover options a Fund has written.
(d) As an operating policy, a Fund may not purchase the
securities of other investment companies except to the permitted by the
1940 Act 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.
The Trustees have the ultimate responsibility for determining whether
specific securities are liquid or illiquid. The Trustees have delegated the
function of making day-to-day determinations of liquidity to the Sub-Advisers,
pursuant to guidelines approved by the Trustees.
Each Sub-Adviser takes into account a number of factors in determining
whether a Rule 144A security being considered for purchase by a Fund is liquid,
including at least the following:
(i) the frequency and size of trades and quotes for
the Rule 144A security relative to the size of the Fund's holding;
(ii) the number of dealers willing to purchase or sell the Rule
144A security and the number of other potential purchasers;
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<PAGE> 247
(iii) dealer undertakings to make a market in the Rule 144A
security; and
(iv) the nature of the Rule 144A security and the nature of the
market for the Rule 144A security (i.e., the time needed to dispose of the
security, the method of soliciting offers, and the mechanics of transfer).
To make the determination that an issue of 4(2) commercial paper is
liquid, a Sub-Adviser must conclude that the following conditions have been met:
(a) the 4(2) commercial paper is not traded
flat or in default as to principal or interest;
(b) the 4(2) commercial paper is rated:
(i) in one of the two highest rating categories by
at least two nationally recognized statistical rating organizations
("NRSROs"); or
(ii) if only one NRSRO rates the security, the 4(2) commercial
paper is rated in one of the two highest rating categories by that NRSRO; or
(iii) if the security is unrated, the Sub-Adviser has determined
that the security is of equivalent quality based on factors commonly used by
rating agencies; and
(c) there is a viable trading market for the
specific security, taking into account all relevant factors (e.g., whether the
security is the subject of a commercial paper program that is administered by an
issuing and paying agent bank and for which there exists a dealer willing to
make a market in the security, the size of trades relative to the size of the
Fund's holding or whether the 4(2) commercial paper is administered by a direct
issuer pursuant to a direct placement program).
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
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<PAGE> 248
persons" of the Trust for purposes of the 1940 Act are indicated by an asterisk.
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<PAGE> 249
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Richard M. Kernan, Jr. * Chairman and Trustee Director of MainStay VP Series Fund, Inc.
51 Madison Avenue from January 1987 to present; Chairman of
New York, NY 10010 the Board and Chief Executive Officer of
Age: 57 MainStay VP Series Fund, Inc. from August
1989 to present; Executive Vice President
and Chief Investment Officer of New York
Life Insurance Company from March 1995
to present; Executive Vice President prior
thereto; Member of the Board of Directors of
New York Life Insurance Company from
November 1996 to present and Chairman of
the Investment Committee from January
1997 to present; and Director, Greystone
Realty Corp. January 1997 to present.
Stephen C. Roussin* President, Chief Director and Chairperson, MainStay
51 Madison Avenue Executive Officer and Institutional Funds, Inc., 1997 to present;
New York, NY 10010 Trustee Senior Vice President, New York Life
Age: 34 Insurance Company, 1997 to present; Senior
Vice President, Smith Barney, 1994 to 1997;
and Division Sales Manager, Prudential
Securities, 1989 to 1994.
Harry G. Hohn* Trustee Retired Chairman and Chief Executive
51 Madison Avenue Officer, New York Life Insurance Company;
New York, NY 10010 Chairman of the Board and Chief Executive
Age: 65 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
1997; Director, Insurance Marketplace
Standards Association, 1996 to 1997;
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.
Edward J. Hogan Trustee Rear Admiral U.S. Navy (Retired);
Box 2321 Independent management consultant, 1992 to
Sun Valley, ID 83353 1997.
Age: 65
</TABLE>
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<PAGE> 250
<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 University,
Kissinger New York, NY, 1991 to present; Trustee,
Henderson Road Rockefeller University, 1995 to present;
South Kent, CT 06785 Trustee, Animal Medical Center, 1993 to
Age: 64 present; and Trustee, The Masters School,
1994 to present; Member, Board of
Overseers, Rockefeller Institute of
Government, Albany, NY, 1983-1992 (Board
dissolved).
Terry L. Lierman Trustee President, Capitol Associates, Inc., 1984 to
426 C Street, N.E. present; President, Employee Health
Washington, D.C. 20002 Programs, 1990 to present; Vice Chairman,
Age: 49 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; Commissioner,
State of Maryland, Higher Education
Commission, 1995 to present; Vice
Chairman, National Organization on
Fetal Alcohol Syndrome, 1993 to present;
Chief Executive Officer, Medical Crisis
Systems, 1997 to present; and Board
Member, Hollings Cancer Center, Medical
University of South Carolina, 1993 to
present.
</TABLE>
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<PAGE> 251
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
John B. McGuckian Trustee Chairman of the Board, Ulster Television
Ardverna plc, 1990 to present; Director, Ulster
Cloughmills Television plc, 1970 to present; Chairman of
Northern Ireland the Board, Tedcastle Holding Ltd. (energy),
BT4 49NL 1995 to present; Director, Cooneen Textiles
Age: 58 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 1997; and
Chairman of Senate and Senior Pro-
Chancellor, Queen's University, 1986 to
present.
Donald E. Nickelson Trustee Vice Chairman, Harbour Group Industries,
1701 Highway A-1-A Inc., 1991 to present; Director, PaineWebber
Suite 218 Group, 1980 to 1993; President,
Vero Beach, FL 32963 PaineWebber Group, 1988 to 1990;
Age: 65 Chairman of the Board, PaineWebber
Properties, 1985 to 1989; Director, Harbour
Group, 1986 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, Sugen,
Inc., 1992 to present; Chairman of the
Board, Omniquip International, Inc., 1996 to
present; Director, Carey Diversified,
L.L.C., Jan. 1, 1998 to present.
</TABLE>
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<PAGE> 252
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Donald K. Ross* Trustee Retired Chairman and Chief Executive
953 Cherokee Lane Officer, New York Life Insurance Company;
Franklin Lakes, NJ 07417 Director, New York Life Insurance
Age: 72 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.
Richard S. Trutanic Trustee Managing Director, The Somerset Group
1155 Connecticut Ave., N.W. (financial advisory firm), 1990 to present;
Suite 400 Chief Executive Officer and President,
Washington, DC 20036 Americap L.L.C. (financial advisory firm),
Age: 45 1997 to present; Senior Vice President,
Washington National Investment Corporation
(financial advisory firm), 1985 to 1990;
Director, Allin Communications
Corporation, 1996 to 1997; and Director and
Member of Executive Committee, Southern
Net, Inc., 1986 to 1990.
Walter W. Ubl* Trustee Senior Vice President, New York Life
85 East End Avenue Insurance Company, 1995 to 1997; Vice
Apt. 2N President, 1984 to 1995; Vice President in
New York, NY 10028 charge of Mutual Funds Department, 1989 to
Age: 56 1997 ; Director and Vice President, NYLIFE
Distributors Inc., 1993 to 1997; and Director
and Senior Vice President NYLIFE
Securities Inc., 1996 to 1997.
- ----------------------------------------------------------------------------------------------------------------
OFFICERS (OTHER THAN TRUSTEES)
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 253
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Jefferson C. Boyce Senior Vice President Chairman, Monitor Capital Advisors, Inc.,
51 Madison Avenue 1997 to present; Senior Vice President,
New York, NY 10010 MainStay Institutional Funds Inc., 1995 to
Age: 40 present; Senior Vice President, New York
Life 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 Officer Company, 1988 to present; Director, Vice
New York, NY 10010 President and Chief Financial Officer,
Age: 54 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.
</TABLE>
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<PAGE> 254
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
Richard Zuccaro Tax Vice President Vice President, New York Life Insurance
51 Madison Avenue Company, 1995 to present; Vice President --
New York, NY 10010 Tax, New York Life Insurance Company,
Age: 48 1986 to 1995; Tax Vice President, NYLIFE
Securities Inc., 1987 to present; Tax Vice
President, NAFCO, Inc., 1990 to present;
Tax Vice 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.
</TABLE>
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<PAGE> 255
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------
<S> <C> <C>
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: 41 General Counsel, New York Life Insurance
Company, 1996 to 1997; Assistant General
Counsel, New York Life Insurance
Company, 1994 to 1996; Secretary, Eclipse
Financial Asset Trust, 1994 to present;
Secretary, MainStay Institutional Funds Inc.,
MainStay VP Series Fund, Inc., New York
Life Fund Inc., 1994 to 1997; Assistant
Secretary, Eagle Strategies Corp. (registered
investment adviser), 1997 to present;
Secretary, Eagle Strategies Corp. (registered
investment adviser), 1996 to present; and
Assistant General Counsel, Dreyfus
Corporation, 1991 to 1993.
</TABLE>
*Messrs. Ross, Roussin, Hohn, Kernan and Ubl are deemed to be "interested
persons" of the Trust under the 1940 Act.
As indicated in the above table, certain Trustees and officers also hold
positions with MacKay-Shields, New York Life, NYLIFE Securities Inc. and/or
NYLIFE Distributors Inc.
Effective August 1, 1998, the Independent Trustees of the Trust receive
from the Trust an annual retainer of $45,000 and a fee of $2,000 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, 1997, the Trustees received the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same investment advisers as the Trust or
an investment adviser that is an affiliated person of one of the Trust's
investment advisers:
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<PAGE> 256
<TABLE>
<CAPTION>
Total Compensation
Aggregate From Registrant
Name of Compensation and Fund Complex
Trustee from the Trust Paid to Trustees
- ------- -------------- ----------------
<S> <C> <C>
Edward J. Hogan $48,000 $48,000
Nancy M. Kissinger $46,000 $46,000
Terry L. Lierman $48,000 $48,000
Donald E. Nickelson $52,000 $52,000
Richard S. Trutanic $46,000 $46,000
John B. McGuckian* $12,000 $12,000
</TABLE>
* Mr. McGuckian was elected to his position as Trustee of the
Trust on July 28, 1997.
THE MANAGER, THE SUB-ADVISERS AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Funds, MainStay Management,
Inc. (the "Manager"), subject to the supervision of the Trustees of the Trust
and in conformity with the stated policies of the Funds, administers the Funds'
business affairs and has investment advisory responsibilities.
The Trustees, including the Independent Trustees, approved the
Management Agreement at an in-person meeting held July 28, 1997. On April 27,
1998, the Trustees approved the Management Agreement with respect to the Funds.
On May 29, 1998, the sole initial shareholder of each of the Funds approved the
Management Agreement. The Management 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 each of the
Funds (as defined in the 1940 Act and in a rule under the 1940 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
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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 a Fund for any error or judgment by the Manager or for any loss sustained by
a 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 each of
the Funds, and except as indicated in the Prospectus under the heading "Manager,
Sub-Advisers 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;
(b) the fees to be paid to the Sub-Advisers pursuant to the Sub-Advisory
Agreements; and
(c) all expenses incurred by the Manager in connection with
administering the ordinary course of the Funds' business, other than those
assumed by the Trust.
SUB-ADVISORY AGREEMENTS
Pursuant to Sub-Advisory Agreements between the Manager and each of the
Sub-Advisers, subject to the supervision of the Trustees of the Trust and the
Manager and in conformity with the stated policies of each of the Funds and the
Trust, GAMCO; John A. Levin & Co.; Dalton, Greiner; Madison Square Advisors and
MacKay-Shields manage the Funds' portfolios, including the purchase, retention,
disposition and loan of securities.
The Trustees, including the Independent Trustees, approved the
Sub-Advisory Agreements at an in-person meeting held April 27, 1998. On May 29,
1998, the sole shareholder of each of the Funds approved the Sub-Advisory
Agreements with GAMCO; John A. Levin & Co.; Dalton, Greiner; Madison Square
Advisors and MacKay-Shields. The Sub-Advisory Agreements will remain in effect
for two years following their effective date, and will continue in effect
thereafter only if such continuance is specifically
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approved at least annually by the Trustees or by vote of a majority of the
outstanding voting securities of each of the Funds (as defined in the 1940 Act
and in a rule under the 1940 Act) and, in either case, by a majority of the
Trustees who are not "interested persons" of the Trust, the Manager, or the
Sub-Advisers (as the term is defined in the 1940 Act).
The Sub-Advisers have authorized any of their 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 they render, the Sub-Advisers bear the salaries
and expenses of all of their personnel.
The Sub-Advisory Agreements provide that the Sub-Advisers shall not be
liable for any error of judgment by the Sub-Advisers or for any loss suffered by
any of the Funds except in the case of the Sub-Advisers' willful misfeasance,
bad faith, gross negligence or reckless disregard of duty. The Agreements also
provide that they shall terminate automatically if assigned and that they 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 acts as the Principal Underwriter and Distributor of
the Funds' shares pursuant to the Distribution Agreement with the Trust dated
January 1, 1994. NYLIFE Securities Inc., an affiliated company, sells shares of
the Funds 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 connection with their distribution of Trust shares. In
addition, the Distributor will pay for a variety of account maintenance and
personal services to shareholders after the sale.
The Distribution Agreement with respect to the Funds 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 April 27,
1998.
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As disclosed in the Prospectus, each of the Funds has adopted separate
plans of distribution pursuant to Rule 12b-1 under the 1940 Act for each class
of shares of each Fund (the "Class A Plans", the "Class B Plans" and,
collectively, the "Plans"). Under the Class A Plans, Class A shares of each Fund
pay the Distributor a monthly fee at the annual rate of 0.25% of the average
daily net assets of each Fund's Class A shares for distribution or service
activities, as designated by the Distributor. The Class A Plans for each of the
Funds were approved by the sole initial shareholder of the Class A of shares of
each Fund on May 29, 1998. The Trustees, including a majority of the Independent
Trustees, by vote cast in person at a meeting called for the purpose of voting
on such plans, initially approved the Class A Plans for each of the Funds on
April 27, 1998.
As noted above, the Class B shares of each Fund also have adopted Rule
12b-1 distribution plans. Rule 12b-1 distribution plans were approved on May 29,
1998 by the sole initial shareholder of each of the Funds. The Trustees of the
Trust, including a majority of the Independent Trustees, by vote cast in person
at a meeting called for the purpose of voting on such Plans, initially approved
the Class B Plans of the Funds on April 27, 1998.
Under the current Class B plans, each 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 also pay a service fee to the Distributor
at the annual rate of 0.25% of the average daily net assets of the Funds' Class
B shares.
Once approved by a vote of a majority of the outstanding voting
securities of a class of shares of a Fund, each 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 a 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 Independent Trustees, 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
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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 a 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
Pursuant to an Accounting Agreement with the Trust, dated October 24,
1997, the Manager performs certain bookkeeping and pricing services for the
Funds. Each Fund will bear an allocable portion of the cost of providing these
services to the Trust.
In addition, each Fund may reimburse NYLIFE Securities, NYLIFE
Distributors and MainStay Shareholder Services for the cost of certain
correspondence to shareholders and the establishment of 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 each Fund, is responsible under its
Management Agreement for the payment of expenses related to each 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 Sub-Advisers,
(iii) certain fees and expenses of the Trust's Custodians and Transfer Agent,
(iv) the charges and expenses of the Trust's legal counsel and independent
accountants, (v) brokers'
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commissions and any issue or transfer taxes chargeable to the Trust, on behalf
of a Fund, in connection with its securities transactions, (vi) the fees of any
trade association of which a Fund or the Trust is a member, (vii) the cost of
share certificates representing shares of a Fund, (viii) reimbursement of a
portion of the organization expenses of a Fund and the fees and expenses
involved in registering and maintaining registration of the Trust and of its
shares with the SEC and registering the Trust as a broker or dealer and
qualifying its shares under state securities laws, 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 a Fund's business, (xi) any expenses assumed by the Fund
pursuant to its plan of distribution, (xii) all taxes and business fees payable
by a Fund to federal, state or other governmental agencies, and (xiii) costs
associated with the pricing of the Funds' shares. 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.
The Funds have entered into a committed line of credit with The Bank of
New York as agent, and various other lenders from whom a 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 Funds experience unusually large
redemption requests.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected
by brokers, and the Funds pay 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
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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.
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 Sub-Advisers attempt to achieve this result by selecting
broker-dealers to execute portfolio transactions on behalf of each Fund and
their 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
Conduct Rules of the NASD and such other policies as the Trustees may determine,
the Sub-Advisers may consider sales of shares of the Funds as a factor in the
selection of broker-dealers to execute the Funds' 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 on an exchange, 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 each Sub-Advisory Agreement and as permitted by Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act"), a Sub-Adviser may cause a
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 a Fund in excess of the amount other
broker-dealers would have charged for the
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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
Trust 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.
Although commissions paid on every transaction will, in the judgment of
the Sub-Advisers, 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 Trust and the Sub-Advisers' 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-Advisers 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 Trust, a commission higher than one charged elsewhere will not
be paid to such a firm solely because it provided Research to an Sub-Adviser.
Research provided by brokers is used for the benefit of all of the Sub-Advisers'
clients and not solely or necessarily for the benefit of the Trust. The
Sub-Advisers' investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort are sometimes used by the
Sub-Advisers as a consideration in the selection of brokers to execute portfolio
transactions.
In certain instances there may be securities which are suitable for a
Fund's portfolio as well as for that of another Fund or one or more of the other
clients of the Sub-Advisers.
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Investment decisions for a Fund and for the Sub-Advisers' 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 particular transaction as far as a Fund is concerned. The
Trust believes that over time its ability to participate in volume transactions
will produce better executions for the Funds.
The Sub-Advisory fee that the Manager pays on behalf of each Fund to the
Sub-Advisers will not be reduced as a consequence of the Sub-Advisers' receipt
of brokerage and research services. To the extent a 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-Advisers in serving both the Funds and other clients and, conversely,
such services obtained by the placement of brokerage business of other clients
would be useful to the Sub-Advisers in carrying out their obligations to the
Funds.
Investors may, subject to the approval of the Trust, the Manager and the
Sub-Adviser, purchase shares of a Fund with liquid securities that are eligible
for purchase by that 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.
NET ASSET VALUE
The net asset value per share of each Fund is determined by the Trust
daily as of the close of regular trading on the New
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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 each 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 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 Funds 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 cur-
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rency exchange contracts held by the Funds 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 Trust recognizes
dividend income and other distributions on the ex-dividend date, except that
certain dividends from foreign securities are recognized as soon as the Trust
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 Funds' net asset values
are 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 occur between
the time their prices are determined and the close of the New York Stock
Exchange will not be reflected in the Funds' calculation of net asset values
unless the Sub-Adviser deems that the particular event would materially affect
net asset value, in which case an adjustment may be made.
The proceeds received by each 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
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of creditors, will be specifically allocated to such Fund and constitute the
underlying assets of that Fund. The underlying assets of each Fund will be
segregated on the books of account, and will be charged with the liabilities in
respect to such Fund and with a share of the general liabilities of the Trust.
Expenses with respect to any two or more Funds will be allocated in proportion
to the net asset values of the respective Funds except where allocations of
direct expenses can otherwise be fairly made.
To the extent that any newly organized fund or class of shares receives,
on or before December 31, any seed capital, the net asset value of such fund(s)
or class(es) will be calculated as of December 31.
SHAREHOLDER INVESTMENT ACCOUNT
A Shareholder Investment Account is established for each investor in the
Funds, under which a record of the shares of each 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 a 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.
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PURCHASES, REDEMPTION AND REPURCHASE
PURCHASES AT NAV
A Fund's Class A shares maybe purchased at NAV, without payment of any
sales charge, by employees (and immediate family members) of GAMCO.
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 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.
DISTRIBUTIONS IN KIND
The Trust has agreed to redeem shares of each 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 applicable 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.
SUSPENSION OF REDEMPTIONS
The Trust may suspend the right of redemption of shares of any Fund and
may postpone payment for any period: (I) during which the New York Stock
Exchange is closed other than customary
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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 a 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. All Funds
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.
INDIVIDUAL RETIREMENT ACCOUNT ("IRA")
Shares of a 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.
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 (I) $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 a IRA contribution by a married couple is $4,000.
An individual who has not attained age 70-1/2 may make a 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
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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 (and reaching $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 individual's
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.
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 penalty tax. For
distributions made after 1997, the penalty tax does not apply to withdrawals up
to a total of $10,000 for qualified 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 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
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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 for this purpose. Unlike the traditional IRA, Roth IRAs
are not subject to minimum distribution requirements during the account owner's
lifetime. However, the amount in a Roth IRA is subject to required distribution
rules after the death of the account owner.
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 year old. The
maximum contribution is phased out for taxpayers 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 part of a distribution is taxable, a
penalty 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 a penalty tax upon distribution.
All income and capital gains deriving from IRA investments in the Fund
are reinvested and compounded 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 tax-deferred compounded earnings on IRA investments
can lead to substantial retirement and/or education savings.
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403(B)(7) TAX SHELTERED ACCOUNT
Shares of a Fund may also be purchased as the underlying investment for
tax sheltered custodial accounts (403(b) plans) 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 a 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 Funds' Custodian and
Transfer Agent designate New York Life 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 New York Life 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 a 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 each 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 and reflects fee
waivers and
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reimbursements in effect for each 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.
Quotations of each Fund's average annual total return will be calculated
according to the following SEC formula:
n
P(1+T) = 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)
Each 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 a
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 represents historical performance and the
investment return and principal value of an investment will
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fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost.
The yield of the Funds 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 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:
6
Yield = 2[(a-b +1) -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.
A 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 each 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 a Fund's performance including (I) realized and
unrealized capital gains and losses, which are reflected in calculations of a
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
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current dividend rate does not take into account the imposition 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 a Fund will
fluctuate over time, and any presentation of a Fund's yield, current dividend
rate, total return or tax-equivalent yield 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, total return or tax-equivalent yield
may be in any future period.
In addition, advertising for a 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 a 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 a
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 a Fund may
discuss the investment philosophy, personnel and assets under management of the
Fund's Manager and Sub-Adviser, and other pertinent facts relating to the
management of the Fund by the adviser.
From time to time any of the Funds 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 a 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
Russell 2000 Index,
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the Salomon Brothers 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, J.P. Morgan Emerging Markets 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 Funds. 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 Funds may include general
information about the services and products offered by the 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 FUNDS
The following summarizes certain federal income tax considerations
generally affecting the Funds and their stockholders. No attempt is made to
present a detailed explanation of the tax treatment of the Funds or their
stockholders, and the discussion here is not intended as a substitute for
careful tax planning. The discussion is based upon present provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the regulations
promulgated thereunder, and judicial and administrative ruling authorities, all
of which are subject to change, which change may be the retroactive.
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Prospective investors should consult their own tax advisors with regard to the
federal tax consequences of the purchase ownership, and disposition of Fund
shares, as well as the tax consequences arising under the laws of any state,
foreign country, or other taxing jurisdiction.
Each Fund intends to be treated as a regulated investment company
("RIC") under Subchapter M of the Code. To qualify as a regulated investment
company, each Fund must, among other things: (I) derive in each taxable year at
least 90% of its gross income from dividends, interest, payments with respect to
certain securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income derived with respect to its
business of investing in such stock, securities, or currencies ("Qualifying
Income Test"); (ii) diversify its holdings so that, at the end of each quarter
of the taxable year, (a) at least 50% of the market value of the Fund's assets
is represented by cash, cash items, 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, and (b) not more than 25% of
the value of its total assets is invested in the securities on any one issuer
(other than U.S. Government securities or the securities of other regulated
investment companies), or of two or more issuers which the Fund controls (as
that term is defined in the relevant provisions of the Code) and which are
determined to be engaged in the same or similar trades or businesses or related
trades or businesses; and (iii) distribute at least 90% of the sum of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of any net long-term capital
losses) and its net tax-exempt interest each taxable year. The Treasury
Department is authorized to promulgate regulations under which foreign currency
gains would constitute qualifying income for purposes of the Qualifying Income
Test only if such gains are directly related to investing in securities (or
options and futures with respect to securities). To date, no such regulations
have been issued.
Certain requirements relating to the qualification of a Fund as
regulated investment company may limit the extent to which a Fund will be able
to engage in certain investment practices, including transactions in futures
contracts and other types of derivative securities transactions. In addition, if
a Fund were
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unable to dispose of portfolio securities due to settlement problems relating to
foreign investments or due to the holding of illiquid securities, the Fund's
ability to qualify as a regulated investment company might be affected.
A Fund qualifying as a regulated investment company generally will not
be subject to U.S. federal income tax on its investment company taxable income
and net capital gains (any net long-term capital gains in excess of the net
short-term capital losses), if any, that it distributes to shareholders. Each
Fund intends to distribute to its shareholders, at least annually, substantially
all of its investment company taxable income and any net capital gains.
Generally, regulated investment companies, like the Funds, must
distribute amounts on a timely basis in accordance with a calendar year
distribution requirement in order to avoid a nondeductible 4% excise tax.
Generally, to avoid the tax, a regulated investment company must distribute
during each calendar year, (I) at least 98% of its ordinary income (not taking
into account any capital gains or losses) for the calendar year, (ii) at least
98% of its capital gains in excess of its capital losses (adjusted for certain
ordinary losses) for the 12-month period ending on October 31 of the calendar
year, and (iii) all ordinary income and capital gains for previous years that
were not distributed during such years. To avoid application of the excise tax,
each Fund intends to make its distributions in accordance with the calendar year
distribution requirement. A distribution is treated as paid on December 31 of
the calendar year if it is declared by a Fund in October, November or December
of that year to shareholders of record on a date in such a month and paid by the
Fund during January of the following calendar year. Such distributions are
taxable to shareholders in the calendar year in which the distributions are
declared, rather than the calendar year in which the distributions are received.
Provided that a Fund qualifies as a regulated investment company under
the Code, it generally will not be subject to any excise or income taxes in
Massachusetts. A 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 a Fund's earnings will be subject to tax in their hands.
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CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- GENERAL
Assuming a 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 sources (such as
interest) other 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 generally eliminated unless such shares are deemed to have been held
for more than 45 days. The 45-day holding period must occur during the 90-day
period beginning 45 days before the date on which the shares become ex-dividend.
In the case of dividends on certain preferred stock, the holding period
requirement is 90 days during a 180-day period. 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 and the
applicable holding period requirements are not met, 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 net capital gain, whether received in cash or
reinvested in Fund shares, will generally be taxable to shareholders as either
"20% Rate Gain" or "28% Rate Gain," depending upon the Fund's holding period for
the assets sold. "20% Rate Gains" arise from sales of assets held by a Fund for
more than 18 months and are subject to a maximum tax rate of 20%; "28% Rate
Gains" arise from sales of assets held by a Fund for more than one year but no
more than 18 months and are subject to a maximum tax rate of 28%. Net capital
gains from assets held for one year or less will be taxed as ordinary income.
Distributions will be subject to these capital gains rates regardless of how
long a shareholder has held Fund shares.
Any loss realized upon the redemption of shares within six months from
the date of their purchase will be treated as a
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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 a Fund within 30 days before or after a purchase of
shares of the same 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 a Fund for reinvestment, requiring federal income taxes
to be paid thereon by that Fund, the Fund intends to elect to treat such capital
gains as having been distributed to shareholders. As a result, such capital
gains will be taxable to 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 the relevant Fund shares by the
difference between their pro-rata share of such gains and their tax credit.
Distributions by a Fund result in a reduction in the net asset value of
a Fund's shares. Should a distribution reduce the net asset value below a
shareholder's cost basis, such distribution nevertheless would generally 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 a Fund's net investment income or net
capital gain may be characterized as a return of capital to shareholders or, 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.
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DISCOUNT
Certain of the bonds purchased by the Funds, 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 (or the price at which it was deemed issued for federal income tax
purposes) and its stated redemption price at maturity. Original issue discount
is treated for federal income tax purposes as income earned by a Fund over the
term 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 a 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 a 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 a 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 a 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.
TAXATION OF OPTIONS, FUTURES AND SIMILAR INSTRUMENTS
Many of the options, futures contracts and forward contracts entered
into by a 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. The resulting gain or loss generally is treated as
60/40 gain or loss, except for foreign
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currency gain or loss on such contracts, which generally is ordinary in
character.
Distribution of Fund gains from hedging transactions will be taxable to
shareholders. Generally, hedging transactions and certain other transactions in
options, futures and forward contracts undertaken by a Fund may result in
"straddles" for federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by a Fund. In addition, losses realized
by a 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, certain transactions (including options,
futures contracts, notional principal contracts, short sales and including short
sales against the box) 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 a Fund are not
entirely clear. The hedging transactions in which a Fund engages may increase
the amount of short-term capital gain realized by a Fund which is taxed as
ordinary income when distributed to shareholders.
A Fund may make one or more of the elections available under the Code
which are applicable to straddles. If a 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 may
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.
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The diversification requirements applicable to a Fund's status as a
regulated investment company may limit the extent to which a Fund will be able
to engage in transactions in options, futures contracts or forward contracts.
The Funds may engage in swap transactions. The tax treatment of swap
agreements is not entirely clear in certain respects. Accordingly, while the
Funds intend to account for such transactions in a manner they deem to be
appropriate, the IRS might challenge such treatment. If such a challenge were
successful, status of a Fund as a regulated investment company might be
affected. The Funds intend to monitor developments in this area.
PASSIVE FOREIGN INVESTMENT COMPANIES
Certain of the Funds 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 a 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.
A Fund may be eligible to elect alternative tax treatment with respect
to PFIC shares. Under an election that currently is available in some
circumstances, a 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. Alternatively,
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a Fund may elect to mark to market its PFIC shares at the end of each taxable
year, with the result that unrealized gains are treated as though they were
realized and reported as ordinary income. Any mark-to-market losses and any loss
from an actual disposition of PFIC shares would be deductible as ordinary losses
to the extent of any net mark-to-market gains included in income in prior years.
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 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 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 a Fund accrues income or other receivables or
accrues expenses or other liabilities denominated in a foreign currency and the
time a 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 a 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, a 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.
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COMMODITY INVESTMENTS
A regulated investment company is required under the Code to derive at
least 90% of its gross income from certain qualifying sources. 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 a 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 a Fund were capital
assets in the hands of the shareholder, and generally will be taxable to
stockholders as "20% Rate Gain" if the shares had been held for more than 18
months or as "28% Rate Gain" if the shares had been held for more than one year
but no more than 18 months. A loss realized by a shareholder on the redemption,
sale or exchange of shares of a 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 a 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 a 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
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the shareholder as a dividend rather than as redemption proceeds, might have
qualified as an exempt-interest dividend.
Under certain circumstances, the sales charge incurred in acquiring
shares of either 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 a
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 pursuant
to a right acquired upon the initial purchase of shares. 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. The portion of the sales charge affected by this rule
will be treated as a sales charge paid for the new shares and will be reflected
in their basis.
If reverse stock splits are done, a share may have a split holding
period reflecting the fact that part of the share represents a reinvested
dividend or distribution.
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 a Fund distribution in his or her own state and locality (or foreign
country).
Under the federal income tax law, a 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 (other than shares of the Money Market Fund), 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
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at the rate of 31% in the case of nonexempt shareholders who fail to furnish a
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 a Fund that the number furnished by the shareholder is
incorrect. In addition, both the Fund and the 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 a Fund from sources outside the
United States may be subject to foreign taxes which were paid or withheld at the
source. The payment of such taxes will reduce the amount of dividends and
distributions paid to the Funds' stockholders. Since the percentage of each
Fund's total assets (with the exception of the International Bond Fund and
International Equity Fund) which will be invested in foreign stocks and
securities will not be more than 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 a Fund will be
subject depends on the specific countries in which each Fund's assets will be
invested and the extent of the assets invested in each such country and,
therefore, cannot be determined in advance.
The International Bond Fund and the International Equity 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 a 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
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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. 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 a Fund
and any special tax considerations associated with foreign investments of a 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, each 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 a 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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ORGANIZATION AND CAPITALIZATION
GENERAL
The Funds are separate series of an open-end investment company, The
MainStay Funds ("Trust"), established under the laws of The Commonwealth of
Massachusetts by a Declaration of Trust dated January 9, 1986, as amended. The
Funds included herein commenced operations on June 1, 1997. The Tax Free Bond
Fund was originally formed as the MacKay-Shields MainStay Tax Free Bond Fund
pursuant to a Declaration of Trust on January 9, 1986 and became a series of the
Trust pursuant to a reorganization which occurred on May 29, 1987. The Total
Return Fund commenced operations on December 29, 1987. The Equity Index Fund
commenced operations on December 20, 1990. The California Tax Free Fund and New
York Tax Free Fund commenced operations on October 1, 1991. The International
Bond Fund and International Equity Fund commenced operations on September 13,
1994. The Strategic Income Fund and Strategic Value Fund commenced operations on
February 28 and October 22, 1997, respectively. The organizational expenses of
each 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 each Fund or class on matters affecting an individual
Fund or a particular class of shares issued by a 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
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
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normally be given in each agreement, obligation or instrument entered into or
executed by 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.
OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York,
10036, has been selected as independent accountants of the Trust.
LEGAL COUNSEL
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006,
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. Such persons are generally required to preclear all security
transactions with the Trust's Compliance Officer or his
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designee and to report all transactions on a regular basis. The Trust has
developed procedures for administration of the Code. The Sub-Advisers that are
unaffiliated with New York Life Insurance Company have adopted their own codes
of ethics to govern the personal trading activities of their personnel.
FINANCIAL STATEMENTS
Unaudited financial statements relating to the Funds will be prepared
semi-annually and distributed to shareholders. Audited financial statements will
be prepared annually and distributed to shareholders.
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THE MAINSTAY FUNDS
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
SEPTEMBER 1, 1998
AS SUPPLEMENTED JANUARY 13, 1999
- --------------------------------------------------------------------------------
The MainStay Funds (the "Trust") is an open-end management investment
company (or mutual fund) currently consisting of twenty-two series: Blue Chip
Growth Fund, California Tax Free Fund, Capital Appreciation Fund, Convertible
Fund, Equity Income Fund, Equity Index Fund, Global High Yield Fund, Government
Fund, Growth Opportunities Fund, High Yield Corporate Bond Fund, International
Bond Fund, International Equity Fund, Money Market Fund, New York Tax Free Fund,
Research Value Fund, Small Cap Growth Fund, Small Cap Value Fund, Strategic
Income Fund, Strategic Value Fund, Tax Free Bond Fund, Total Return Fund and
Value Fund (individually or collectively referred to as a "Fund" or the
"Funds"). MainStay Management, Inc. (the "Manager") serves as the manager for
the Funds and has entered into Sub- Advisory agreements with MacKay-Shields
Financial Corporation ("MacKay-Shields") with respect to seventeen of the Funds;
Monitor Capital Advisors, Inc. ("Monitor"), with respect to the Equity Index
Fund; Gabelli Asset Management Company ("GAMCO") with respect to the Blue Chip
Growth Fund; John A. Levin & Co., Inc. ("John A. Levin & Co.") with respect to
the Research Value Fund; Dalton Greiner, Hartman, Maher & Co., ("DGHM") with
respect to the Small Cap Value Fund; and Madison Square Advisors, Inc. ("Madison
Square Advisors") with respect to the Growth Opportunities Fund. MacKay-Shields,
Monitor, GAMCO, John A. Levin & Co., Dalton, Greiner and Madison Square Advisors
are sometimes jointly referred to as the "Sub-Advisers."
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the Prospectuses of the Funds dated September 1,
1998, 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).
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
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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.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE IN
STATEMENT OF
ADDITIONAL
INFORMATION
-----------
<S> <C>
ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND...........................................................6
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS.....................................................9
Repurchase Agreements....................................................................................9
Lending of Portfolio Securities.........................................................................11
Bank Obligations........................................................................................12
U.S. Government Securities..............................................................................13
Debt Securities.........................................................................................14
Convertible Securities..................................................................................14
Arbitrage...............................................................................................15
Foreign Securities......................................................................................16
Foreign Currency Transactions...........................................................................17
Foreign Index-Linked Instruments........................................................................21
Brady Bonds.............................................................................................22
Municipal Securities....................................................................................23
Industrial Development and Pollution Control Bonds......................................................28
Variable Rate Demand Notes ("VRDNs")....................................................................28
Floating and Variable Rate Securities...................................................................29
Zero Coupon Bonds.......................................................................................30
Standby Commitments -- Obligations with Puts Attached...................................................30
When-Issued Securities..................................................................................31
Mortgage-Related and Other Asset-Backed Securities......................................................32
Short Sales Against the Box.............................................................................42
Options on Securities...................................................................................43
Options on Foreign Currencies...........................................................................49
Securities Index Options................................................................................52
Futures Transactions....................................................................................54
Swap Agreements.........................................................................................65
Loan Participation Interests............................................................................67
Risks Associated with Debt Securities...................................................................70
Risks of Investing in High Yield Securities ("Junk Bonds")..............................................71
EQUITY INDEX FUND
SPECIAL CONSIDERATIONS..................................................................................72
</TABLE>
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<TABLE>
<S> <C>
TOTAL RETURN FUND
SPECIAL CONSIDERATIONS..................................................................................73
CALIFORNIA TAX FREE FUND AND NEW YORK TAX FREE FUND..............................................................73
SPECIAL CONSIDERATIONS..................................................................................73
Risk Factors Affecting California Municipal Securities..................................................73
Risk Factors Affecting New York Municipal Securities....................................................86
Special Considerations Affecting Puerto Rico...........................................................104
THE EQUITY INDEX FUND GUARANTEE.................................................................................109
FUNDAMENTAL INVESTMENT RESTRICTIONS.............................................................................111
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS.........................................................................113
TRUSTEES AND OFFICERS...........................................................................................119
THE MANAGER, THE SUB-ADVISERS AND THE DISTRIBUTOR...............................................................127
Management Agreement...................................................................................127
Distribution Agreement.................................................................................132
Other Services.........................................................................................140
Expenses Borne by the Trust............................................................................142
PORTFOLIO TRANSACTIONS AND BROKERAGE............................................................................143
NET ASSET VALUE.................................................................................................148
SHAREHOLDER INVESTMENT ACCOUNT..................................................................................151
SHAREHOLDER SERVICING AGENT.....................................................................................152
PURCHASES, REDEMPTION AND REPURCHASE............................................................................152
Letter of Intent ("LOI")...............................................................................152
Distributions in Kind..................................................................................152
Suspension of Redemptions..............................................................................153
CDSC Waivers...........................................................................................153
TAX-DEFERRED RETIREMENT PLANS...................................................................................154
Cash or Deferred Profit Sharing Plans Under Section 401(k)
for Corporations and Self-Employed Individuals................................................154
Individual Retirement Account ("IRA")..................................................................154
403(b)(7) Tax Sheltered Account........................................................................157
General Information....................................................................................157
CALCULATION OF PERFORMANCE QUOTATIONS...........................................................................158
</TABLE>
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<TABLE>
<S> <C>
TAX STATUS
......................................................................................................167
Taxation of the Funds..................................................................................167
Character of Distributions to Shareholders -- General..................................................170
Character of Distributions to Shareholders -- The Tax-Free
Funds.........................................................................................172
Discount ..............................................................................................173
Users of Bond-Financed Facilities......................................................................174
Taxation of Options, Futures and Similar Instruments...................................................174
Passive Foreign Investment Companies...................................................................176
Gains and Losses.......................................................................................177
Commodity Investments..................................................................................178
Dispositions of Fund Shares............................................................................178
Tax Reporting Requirements.............................................................................179
Foreign Taxes..........................................................................................180
State and Local Taxes - General........................................................................181
Explanation of Fund Distributions......................................................................182
Additional Information Regarding the Equity Index Fund.................................................183
Additional Information Regarding the California Tax Free
Fund and New York Tax Free Fund...............................................................183
Annual Statements......................................................................................184
General Information....................................................................................185
ORGANIZATION AND CAPITALIZATION.................................................................................186
General ..............................................................................................186
Voting Rights..........................................................................................186
Shareholder and Trustee Liability......................................................................187
OTHER INFORMATION...............................................................................................187
Independent Accountants................................................................................187
Legal Counsel..........................................................................................188
Share Ownership of the Funds...........................................................................188
Code of Ethics.........................................................................................194
FINANCIAL STATEMENTS............................................................................................194
</TABLE>
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ADDITIONAL INVESTMENT POLICIES OF THE MONEY MARKET FUND
Each Fund has a separate investment objective or objectives which it
pursues through separate investment policies, as described in the Prospectus.
The following discussion elaborates on the presentation of the Money Market
Fund's investment policies contained in the Prospectus.
The Fund may invest its assets in U.S. dollar-denominated securities of
U.S. or foreign issuers and in securities of foreign branches of U.S. banks,
such as negotiable certificates of deposit (Eurodollars. Since the portfolio of
the Fund may contain such securities, an investment therein involves investment
risks that are different in some respects from an investment in a fund which
invests only in debt obligations of U.S. domestic issuers. Such risks may
include future political and economic developments, the possible imposition of
foreign withholding taxes on interest income payable on the securities held in
the portfolio, possible seizure or nationalization of foreign deposits, the
possible establishment of exchange controls or the adoption of other foreign
governmental restrictions which might adversely affect the payment of the
principal of and interest on securities in the portfolio.
All of the assets of the Fund generally will be invested in obligations
which mature in 397 days or less and substantially all of these investments will
be held to maturity; however, securities collateralizing repurchase agreements
may have maturities in excess of 397 days. The Fund will, to the extent
feasible, make portfolio investments primarily in anticipation of or in response
to changing economic and money market conditions and trends. The dollar-weighted
average maturity of the Fund's portfolio may not exceed 90 days. Consistent with
the provisions of a rule of the Securities and Exchange Commission ("SEC"), the
Fund invests only in U.S. dollar-denominated money market instruments that
present minimal credit risk and, with respect to 95% of its total assets,
measured at the time of investment, that are of the highest quality. The
Sub-Adviser shall determine whether a security presents minimal credit risk
under procedures adopted by the Fund's Board of Trustees. A money market
instrument will be considered to be of the highest quality (1) if rated in the
highest rating category (i.e., Aaa or Prime-1 by Moody's, AAA or A-1 by S&P's)
by (I) any two nationally recognized statistical rating organizations ("NRSROs")
or, (ii) if rated by only one NRSRO, by that NRSRO; (2) if issued by an issuer
that has received a short-term rating from an NRSRO with
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respect to a class debt obligations that is comparable priority and security,
and that are rated in the highest rating category by (I) any two NRSRO's or,
(ii) if rated by only one NRSRO, by that NRSRO;(3) an unrated security that is
of comparable quality to a security in the highest rating category as determined
by the Sub-Adviser;(4)(I) with respect to a security that is subject to any
features that entitle the holder, under certain circumstances, to receive the
approximate amortized cost of the underlying security or securities plus accrued
interest "Demand Feature" or obligations of a person other than the issuer of
the security, under certain circumstances, to undertake to pay the principal
amount of the underlying security plus interest "Guarantees", the Guarantee has
received a rating from an NRSRO or the Guarantee is issued by a guarantor that
has received a rating from an NRSRO with respect to a class of debt obligations
that is comparable in priority and security to the Guarantee, with certain
exceptions, and (ii) the issuer of the Demand Feature or Guarantee, or another
institution, has undertaken promptly to notify the holder of the security in the
event that the Demand Feature or Guarantee is substituted with another Demand
Feature or Guarantee,(5) if it is a security issued by a money market fund
registered with the SEC under the 1940 Act; or (6) if it is a Government
Security. With respect to 5% of its total assets, measured at the time of
investment, the Fund may also invest in money market instruments that are in the
second-highest rating category for short-term debt obligations (i.e., rated Aa
or Prime-2 by Moody's or AA or A-2 by S&P).
The Fund may not invest more than 5% of its total assets, measured at
the time of investment, in securities of any one issuer that are of the highest
quality, except that the Fund may exceed this 5% limitation with respect to 25%
of its total assets for up to three business days after the purchase of
securities of any one issuer and except that this limitation shall not apply to
U.S. government securities or securities subject to certain Guarantees. The Fund
may not invest more than the greater of 1% of its total assets or one million
dollars, measured at the time of investment, in securities of any one issuer
that are in the second-highest rating category. Immediately after the
acquisition of any Demand Feature or Guarantee, the Fund, with respect to
seventy five percent of its total assets, shall not have invested more than ten
percent of its assets in securities issued by or subject to Demand Features or
Guarantees from the institution that issued the Demand Feature or Guarantee,
with certain exceptions. In addition, immediately after the acquisition of any
Demand Feature or Guarantee (or a security
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after giving effect to the Demand Feature or Guarantee) that is a not within the
highest rating category by NRSROs, the Fund shall not have invested more than
five percent of its total assets in securities issued by or subject to Demand
Features or Guarantees from the institution that issued the Demand Feature or
Guarantee. In the event that an instrument acquired by the Fund is downgraded or
otherwise ceases to be of the quality that is eligible for the Fund, the
Sub-Adviser, under procedures approved by the Board of Trustees shall promptly
reassess whether such security presents minimal credit risk and shall recommend
to the Valuation Committee of the Board (the "Valuation Committee") that the
Fund take such action as it determines is in the best interest of the Fund and
its shareholders. The Valuation Committee, after consideration of the
recommendation of the Sub- Adviser and such other information as it deems
appropriate, shall cause the Fund to take such action as it deems appropriate,
and shall report promptly to the Board the action it has taken and the reasons
for such action.
Pursuant to the rule, the Fund uses the amortized cost method of
valuing its investments, which facilitates the maintenance of the Fund's per
share net asset value at $1.00. The amortized cost method, which is normally
used to value all of the Fund's portfolio securities, involves initially valuing
a security at its cost and thereafter amortizing to maturity any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument.
The Trustees have also established procedures designed to stabilize, to
the extent reasonably possible, the Fund's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include review of the
Fund's portfolio by the Trustees, at such intervals as they deem appropriate, to
determine whether the Fund's net asset value calculated by using available
market quotations or market equivalents (the determination of value by reference
to interest rate levels, quotations of comparable securities and other factors)
deviates from $1.00 per share based on amortized cost.
The extent of deviation between the Fund's net asset value based upon
available market quotations or market equivalents and $1.00 per share based on
amortized cost will be periodically examined by the Trustees. If such deviation
exceeds 1/2 of 1%, the Trustees will promptly consider what action, if any, will
be initiated. In the event the Trustees determine that a deviation exists which
may result in material dilution or other unfair
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results to investors or existing shareholders, they will take such corrective
action as they regard to be necessary and appropriate, including the sale of
portfolio instruments prior to maturity to realize capital gains or losses or to
shorten average portfolio maturity; withholding part or all of dividends or
payment of distributions from capital or capital gains; redemptions of shares in
kind; or establishing a net asset value per share by using available market
quotations or equivalents. In addition, in order to stabilize the net asset
value per share at $1.00, the Trustees have the authority (1) to reduce or
increase the number of shares outstanding on a pro rata basis, and (2) to offset
each shareholder's pro rata portion of the deviation between the net asset value
per share and $1.00 from the shareholder's accrued dividend account or from
future dividends.
The Fund may hold cash for the purpose of stabilizing its net asset
value per share. Holdings of cash, on which no return is earned, would tend to
lower the yield on the Fund's shares.
The Fund may also, consistent with the provisions of the rule, invest
in securities with a face maturity of more than 397 days, provided that the
security is a variable or floating rate security that meets the guidelines of
Rule 2a-7 with respect to maturity.
INVESTMENT PRACTICES AND INSTRUMENTS COMMON TO MULTIPLE FUNDS
The Funds may engage in the following investment practices or invest in
the following instruments to the extent permitted in the Prospectus.
REPURCHASE AGREEMENTS
The Funds 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. The Equity Index Fund will enter into repurchase
agreements only with domestic banks with total assets in excess of one billion
dollars or primary government securities dealers reporting to the Federal
Reserve Bank of New York, and with respect to securities of the type in which
the Fund may invest. In addition, the Global High Yield Fund, International Bond
and International Equity Funds may enter into domestic or foreign
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repurchase agreements with certain sellers deemed to be creditworthy pursuant to
guidelines adopted 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
(usually not more than a week in the case of the Equity Index Fund, California
Tax Free Fund and New York Tax Free Fund) 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 a Fund as a dividend to shareholders. Subject
to applicable limitations, the Tax Free Bond Fund will enter into repurchase
agreements as a means of earning income on its cash reserves when, in the
judgment of the Sub-Adviser, shareholders would benefit more from receiving
taxable income thereon than from earning no income or tax-free income at a lower
rate on such reserves.
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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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-Advisers seek 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 Strategic Income Fund, Strategic Value Fund, California Tax Free
Fund and New York Tax Free Fund, Blue Chip Growth Fund, Research Value Fund,
Small Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity
Income Fund and Global High Yield Fund may enter into reverse repurchase
agreements. A Fund will maintain a segregated account consisting of liquid
assets to cover its obligations under reverse repurchase agreements. Each of the
California Tax Free Fund and New York Tax Free Fund will limit its investments
in reverse repurchase agreements and other borrowing to no more than 10% of its
total assets. Each of the Strategic Income Fund, Strategic Value Fund, Blue Chip
Growth Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities
Fund, Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund will
limit its investments in reverse repurchase agreements to no more than 5% of its
total assets.
LENDING OF PORTFOLIO SECURITIES
Each Fund, except the Tax Free Bond Fund and the Money Market Fund, may
seek to increase its income by lending portfolio securities. Under guidelines
adopted by the Funds' 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
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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 certain of the Funds, has entered into an agency agreement with
Merrill Lynch Portfolio Services, Inc. which acts as the Funds' 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 Funds'
Sub-Advisers.
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 a 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 lending Fund. In addition, pursuant to
guidelines adopted by the Board, each Fund is prohibited from lending more than
5% of its total 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 Funds 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.
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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. The
Equity Index Fund will not be subject to the above restriction to the extent it
invests in bank obligations of United States banks (including foreign branches)
which have more than $1 billion in total assets at the time of investment and
are members of the Federal Reserve System or are examined by the Comptroller of
the Currency or whose deposits are insured by the Federal Deposit Insurance
Corporation. The Equity Index Fund also may invest in certificates of deposit of
savings and loan associations (federally or state chartered and federally
insured) having total assets in excess of $1 billion.
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-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." The Equity Index Fund will
invest in such securities only when it is satisfied that the credit risk with
respect to the issuer is minimal.
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DEBT SECURITIES
Debt securities may have fixed, variable or floating (including inverse
floating) rates of interest. To the extent that a Fund invests in debt
securities, it will be subject to certain risks. The value of the debt
securities held by a Fund, and thus the NAV of the shares of a 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 a Fund's investments,
changes in relative values of the currencies in which a Fund's investments are
denominated relative to the U.S. dollar, and the extent to which a 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 a Fund,
and a decline in interest rates will increase the value of fixed income
securities held by a Fund.
CONVERTIBLE SECURITIES
The Capital Appreciation Fund, Convertible Fund, High Yield Corporate
Bond Fund, International Bond Fund, International Equity Fund, Strategic Income
Fund, Strategic Value Fund, Total Return Fund, Value Fund, Blue Chip Growth
Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities Fund,
Small Cap Growth Fund, Equity Income Fund and Global High Yield 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 Funds' portfolios 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 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
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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 a
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
Each Fund, except the California Tax Free Fund, Equity Index Fund,
International Bond Fund, International Equity Fund, New York Tax Free Fund and
Tax Free Bond Fund, may sell in one market
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a security which it owns and simultaneously purchase the same security in
another market, or 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 Funds do 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 a Fund.
FOREIGN SECURITIES
Except for the California Tax Free Fund, Government Fund, New York Tax
Free Fund and Tax Free Bond Fund, each Fund may invest 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. Under current SEC rules relating to the use of the amortized cost
method of portfolio securities valuation, the Money Market Fund is restricted to
purchasing U.S. dollar-denominated securities, but it is not otherwise precluded
from purchasing securities of foreign issuers.
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
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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 Funds may encounter substantial difficulties in
obtaining and enforcing judgments against non-U.S. resident individuals and
companies.
Investment in emerging market countries presents risks in greater
degree than, and in addition to, those presented by investment in foreign
issuers in general. Developing countries have economic structures that are less
mature. Furthermore, developing countries have less stable political systems and
may have high inflation, rapidly changing interest and currency exchange rates,
and their securities markets are substantially less developed. The economies of
developing countries generally are heavily dependent upon international trade,
and, accordingly, have been and may continue to be adversely affected by
barriers, exchange controls, managed adjustments in relative currency values and
other protectionist measures in the countries with which they trade. These
economies also have been and may continue to be adversely affected by economic
conditions in the countries with which they trade.
FOREIGN CURRENCY TRANSACTIONS
Many of the foreign securities in which the Funds invest 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 Funds' assets.
However, each Fund, except the California Tax Free Fund, the Equity Index Fund,
the Government Fund, the Money Market Fund, the New York Tax Free Fund and the
Tax Free Bond 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. Each of
these Funds 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
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portfolio securities due to a decline in the value of the foreign currencies
against the U.S. dollar. In addition, a 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 Funds 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 a Fund will be served by entering into such
a contract. Generally, the Sub-Adviser believes that the best interest of a Fund
will be served if a Fund is permitted to enter into forward contracts under
specified circumstances. First, when a 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, a 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 a Fund would also forego any gain it might have realized had rates
moved in the opposite direction. This
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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 a 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),
a 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, a 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, 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, a Fund may either make
delivery of the foreign currency or terminate its contractual obligation to
deliver the foreign currency by
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purchasing an offsetting contract obligating it to purchase at the same maturity
date the same amount of such foreign currency. If a 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 a 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.
A Fund's dealing in forward contracts will be limited to the
transactions described above. Of course, a 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. A 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, a 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 a 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 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 a
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
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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 Funds 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 a Fund's exposure
to currency exchange rate activity and could result in losses to the Fund if
currencies do not perform as investment managers anticipate. A 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 a 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.
A Fund's foreign currency transactions may be limited by the
requirements of Subchapter M of the Code for qualification as a regulated
investment company.
FOREIGN INDEX-LINKED INSTRUMENTS
As part of its investment program, and to maintain greater flexibility,
the International Bond Fund, International Equity Fund, Strategic Income Fund
and Global High Yield Fund may, subject to compliance with each Fund's
limitations applicable to its investment in debt securities, invest in
instruments issued by the U.S. or a foreign government or by private issuers
that return principal and/or pay interest to investors in amounts which are
linked to the level of a particular foreign index ("foreign index-linked
instruments"). Foreign index-linked instruments have the investment
characteristics of particular securities, securities indexes, futures contracts
or currencies. Such instruments may take a variety of forms, such as debt
instruments with interest or principal payments determined by reference to the
value of a currency or commodity at a future point in time.
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A foreign index may be based upon the exchange rate of a particular
currency or currencies or the differential between two currencies, or the level
of interest rates in a particular country or countries, or the differential in
interest rates between particular countries. In the case of foreign index-
linked instruments linking the interest component to a foreign index, the amount
of interest payable will adjust periodically in response to changes in the level
of the foreign index during the term of the foreign index-linked instrument.
BRADY BONDS
Each of the Convertible Fund, High Yield Corporate Bond Fund,
International Bond Fund, Strategic Income Fund, Strategic Value Fund, Total
Return Fund and Global High Yield 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 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
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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 subdivisions, 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
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.
Tax Anticipation Notes are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues,
to be payable from these specific future taxes. They are usually general
obligations of the issuer, secured by the taxing power for the payment of
principal and interest.
Revenue Anticipation Notes are issued in expectation of receipt of
other kinds of revenue, such as federal revenues. They, also, are usually
general obligations of the issuer.
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Bond Anticipation Notes are normally issued to provide interim
financial assistance until long-term financing can be arranged. The long-term
bonds then provide funds for the repayment of the notes.
Construction Loan Notes are sold to provide construction financing for
specific projects. After successful completion and acceptance, many projects
receive permanent financing through the FHA under the FNMA or GNMA.
Project Notes are instruments sold by the Department of Housing and
Urban Development ("HUD") but issued by a state or local housing agency to
provide financing for a variety of programs. They are backed by the full faith
and credit of the U.S. government, and generally carry a term of one year or
less.
Short-Term Discount Notes (tax-exempt commercial paper) are short-term
(365 days or less) promissory notes issued by municipalities to supplement their
cash flow.
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
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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 Funds. 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.
The Tax Free Bond Fund may invest more than 25% of its total assets in
Municipal Bonds the issuers of which are located in the same state and may
invest more than 25% of its total assets in Municipal Bonds the security of
which is derived from any one of the following categories: hospitals and health
facilities; turnpikes and toll roads; ports and airports; colleges and
universities; public housing authorities; general obligations of states and
localities; lease rental obligations of states and local authorities; state and
local housing finance authorities; municipal utilities systems; bonds that are
secured or backed by the Treasury or other U.S. government guaranteed
securities; or industrial development and pollution control bonds. There could
be economic, business or political developments which might affect all Municipal
Bonds of a similar type. However, the Fund believes that the most important
consideration affecting risk is the quality of Municipal Bonds.
The Tax Free Bond Fund may engage in short-term trading (selling
securities held for brief periods of time, usually less than three months) if
the Sub-Adviser believes that such transactions, net of costs including taxes,
if any, would improve the overall return on its portfolio. The needs of
different classes of lenders and borrowers and their changing preferences and
circumstances have in the past caused market dislocations unrelated to
fundamental creditworthiness and trends in interest rates which have presented
market trading opportunities. There
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can be no assurance that such dislocations will occur in the future or that the
Fund will be able to take advantage of them.
There are, in addition, a variety of hybrid and special types of
municipal obligations, such as municipal lease obligations, as well as numerous
differences in the security of Municipal Bonds both within and between the two
principal classifications described above. Municipal lease obligations are
municipal securities that may be supported by a lease or an installment purchase
contract issued by state and local government authorities to acquire funds to
obtain the use of a wide variety of equipment and facilities such as fire and
sanitation vehicles, computer equipment and other capital assets. These
obligations, which may be secured or unsecured, are not general obligations and
have evolved to make it possible for state and local governments to obtain the
use of property and equipment without meeting constitutional and statutory
requirements for the issuance of debt. Thus, municipal lease obligations have
special risks not normally associated with Municipal Bonds. These obligations
frequently contain "non-appropriation" clauses that provide that the
governmental issuer of the obligation has no obligation to make future payments
under the lease or contract unless money is appropriated for such purposes by
the legislative body on a yearly or other periodic basis. In addition to the
"nonappropriation" risk, many municipal lease obligations have not yet developed
the depth of marketability associated with Municipal Bonds; moreover, although
the obligations may be secured by the leased equipment, the disposition of the
equipment in the event of foreclosure might prove difficult. For the purpose of
each Fund's investment restrictions, the identification of the "issuer" of
Municipal Bonds which are not General Obligation Bonds is made by the Sub-
Adviser on the basis of the characteristics of the Municipal Bonds as described
above, the most significant of which is the source of funds for the payment of
principal of and interest on such Bonds.
In order to limit certain of these risks, the California Tax Free Fund,
New York Tax Free Fund and Tax Free Bond Fund will not invest more than 10% (15%
in the case of the Strategic Income Fund) of its total assets in municipal lease
obligations that are illiquid (along with all other illiquid securities). The
liquidity of municipal lease obligations purchased by the Funds will be
determined pursuant to guidelines approved by the Board of Trustees. Factors
considered in making such determinations may include: the frequency of trades
and quotes for the
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obligation; the number of dealers willing to purchase or sell the security and
the number of other potential buyers; the willingness of dealers to undertake to
make a market in the security; the nature of marketplace trades; the
obligation's rating; and, if the security is unrated, the factors generally
considered by a rating agency.
There may be other types of municipal securities that become available
which are similar to the foregoing described municipal securities in which each
Fund may invest.
INCOME LEVEL AND CREDIT RISK Municipal obligations are 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 municipalities to levy taxes. There is
also the possibility that as a result of litigation or other conditions, the
power or ability of any one or more issuers to pay, when due, principal or
interest on its or their municipal obligations may be materially affected.
Although the Funds' quality standards are designed to minimize the credit risk
of investing in Municipal Bonds, that risk cannot be entirely eliminated.
TAX CONSIDERATIONS With respect to the California Tax Free Fund, New
York Tax Free Fund and Tax Free Bond Fund, income derived by a Fund from taxable
investments, including but not limited to securities lending transactions,
repurchase transactions, options and futures transactions, and investments in
commercial paper, bankers' acceptances and certificates of deposit will be
taxable for federal, state and local income tax purposes when distributed to
shareholders. Income derived by a Fund from interest on direct obligations of
the U.S. government will be taxable for federal income tax purposes when
distributed to shareholders but, provided that the Fund meets the requirements
of state law and properly designates distributions to shareholders, such
distributions may be excludable from income for state personal income tax
purposes. A portion of original issue discount relating to stripped Municipal
Bonds and their coupons may also be treated as taxable income under certain
circumstances.
The Tax Reform Act of 1986 ("TRA") limited the types and volume of
Municipal Bonds qualifying for the federal income tax
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exemption for interest, and the Code treats tax-exempt interest on certain
Municipal Bonds as a tax preference item included in the alternative minimum tax
base for corporate and noncorporate shareholders. In addition, all tax-exempt
interest may result in or increase a corporation's liability under the corporate
alternative minimum tax, because a portion of the difference between corporate
"adjusted current earnings" and alternative minimum taxable income is treated as
a tax preference item. Further, an issuer's failure to comply with the detailed
and numerous requirements imposed by the Code after bonds have been issued may
cause the retroactive revocation of the tax-exempt status of certain Municipal
Bonds after their issuance. The Funds intend to monitor developments in the
municipal bond market to determine whether any defensive action should be taken.
INDUSTRIAL DEVELOPMENT AND POLLUTION CONTROL BONDS
Industrial Development Bonds which pay tax-exempt interest are, in most
cases, revenue bonds and are issued by, or on behalf of, public authorities to
raise money to finance various privately operated facilities for business,
manufacturing, housing, sports, and pollution control. These bonds are also used
to finance public facilities such as airports, mass transit systems, ports, and
parking. The payment of the principal and interest on such bonds is solely
dependent on the ability of the facility's user to meet its financial
obligations and the pledge, if any, of the real and personal property so
financed as security for such payments. These bonds 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.
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. Industrial Development Bonds issued after
the effective date of the TRA, as well as certain other bonds, are now
classified as "private activity bonds." Some, but not all, private activity
bonds issued after that date qualify to pay tax-exempt interest.
VARIABLE RATE DEMAND NOTES ("VRDNS")
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund may invest in tax-exempt obligations which contain a floating or variable
interest rate adjustment formula and an
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unconditional right of demand to receive payment of the unpaid principal balance
plus accrued interest upon a short notice period prior to specified dates,
generally at 30, 60, 90, 180 or 365-day intervals. The interest rates are
adjustable at various intervals to the prevailing market rate for similar
investments, such adjustment formula being calculated to maintain the market
value of the VRDN at approximately the par value of the VRDN on the adjustment
date. The adjustments are typically based upon the prime rate of a bank or some
other appropriate interest rate adjustment index.
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund may also invest in VRDNs in the form of participation interests
("Participating VRDNs") in variable rate tax-exempt obligations held by a
financial institution, typically a commercial bank ("Institution").
Participating VRDNs provide a Fund with a specified undivided interest (up to
100%) of the underlying obligation and the right to demand payment of the unpaid
principal balance plus accrued interest on the Participating VRDNs from the
Institution upon a specified number of days' notice, not to exceed seven days.
In addition, the Participating VRDN is backed up by an irrevocable letter of
credit or guaranty of the Institution. A Fund has an undivided interest in the
underlying obligation and thus participates on the same basis as the Institution
in such obligation, except that the Institution typically retains fees out of
the interest paid or the obligation for servicing the obligation, providing the
letter of credit and issuing the repurchase commitment.
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 Funds with a certain degree of protection
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against rises in interest rates, the Funds 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
Funds' limitations on investments in such securities.
ZERO COUPON BONDS
The Funds, except the Equity Index 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 Fund receives no payment on the investment in that year. Zero coupon
bonds tend to be more volatile than conventional debt securities.
STANDBY COMMITMENTS -- OBLIGATIONS WITH PUTS ATTACHED
The California Tax Free Fund, New York Tax Free Fund, Strategic Income
Fund and Tax Free Bond Fund may purchase municipal securities together with the
right to resell the securities to the seller at an agreed-upon price or yield
within a specified period prior to the maturity date of the securities. Although
it is not a put option in the usual sense, such a right to resell is commonly
known as a "put" and is also referred to as a "standby commitment." Each Fund
may pay for a standby commitment either separately, in cash, or in the form of a
higher price for the securities which are acquired subject to the
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standby commitment, thus increasing the cost of securities and reducing the
yield otherwise available from the same security. The Sub-Adviser understands
that the Internal Revenue Service (the "IRS") has issued a revenue ruling to the
effect that, under specified circumstances, a registered investment company will
be the owner of tax-exempt municipal obligations acquired subject to a put
option. The IRS has also issued private letter rulings to certain taxpayers
(which do not serve as precedent for other taxpayers) to the effect that
tax-exempt interest received by a regulated investment company with respect to
such obligations will be tax-exempt in the hands of the company and may be
distributed to its shareholders as exempt-interest dividends. The IRS has
subsequently announced that it will not ordinarily issue advance ruling letters
as to the identity of the true owner of property in cases involving the sale of
securities or participation interests therein if the purchaser has the right to
cause the security, or the participation interest therein, to be purchased by
either the seller or a third party. Each of the California Tax Free Fund, New
York Tax Free Fund and Tax Free Bond Fund intends to take the position that it
is the owner of any municipal obligations acquired subject to a standby
commitment and that tax-exempt interest earned with respect to such municipal
obligations will be tax-exempt in its hands; however, no assurance can be given
that this position would prevail if challenged. In addition, there is no
assurance that standby commitments will be available to a Fund, nor has the
California Tax Free Fund, New York Tax Free Fund or Tax Free Bond Fund assumed
that such commitments would continue to be available under all market
conditions.
A standby commitment may not be used to affect a Fund's valuation of
the municipal security underlying the commitment. Any consideration paid by a
Fund for the standby commitment, whether paid in cash or by paying a premium for
the underlying security, which increases the cost of the security and reduces
the yield otherwise available from the same security, will be accounted for by
the Fund as unrealized depreciation until the standby commitment is exercised or
has expired.
WHEN-ISSUED SECURITIES
The Funds 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
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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, that
Fund would earn no income; however, it is the Trust's intention that each 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 Trust 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 a 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 a Fund's net asset value or income will be exposed to additional
risk by the purchase of securities on a when-issued basis. Each 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
Each 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 Funds, to
the extent permitted in the Prospectus, may also invest in debt securities which
are secured with collateral consisting of 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
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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 a 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 corporation within the U.S.
Department of Housing and Urban
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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 as 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 Funds reserve 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
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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 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 Funds' 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 Funds 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 Funds' quality
standards.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES The mortgage-related
securities in which the Funds 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.
The California Tax Free Fund, New York Tax Free Fund and Equity Index
Fund, however, may not invest in non-government mortgage pass-through
securities. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable. No Fund will purchase mortgage-related securities or any other
assets which in the Sub-Advisers' opinion are illiquid if, as a result, more
than 10% (15% in the case of the International Equity, International Bond,
Strategic Income and Strategic Value Funds) of the value of the Fund's total
assets will be illiquid.
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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 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.
The eligible Funds will not invest in any privately issued CMOs that do
not meet the requirements of Rule 3a-7 under the 1940 Act if, as a result of
such investment, more than 5% of a Fund's net assets would be invested in any
one CMO, more than 10% of the Fund's net assets would be invested in CMOs and
other
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investment company securities in the aggregate, or the Fund would hold more than
3% of any outstanding issue of CMOs.
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 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
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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
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
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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 a
Fund's limitations on investment in illiquid securities.
Under certain circumstances, a Fund's investment in residual interests
in "real estate mortgage investment conduits" ("REMICs") may cause shareholders
of that 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 a
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 market, the depth and liquidity of which
will vary from time to time. 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
rule in determining whether to invest in residual interests.
GOVERNMENT FUND The Government Fund may invest in securities
collateralized by mortgages or pools of mortgages the issuer of which has
qualified to be treated as a "REMIC". 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
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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 market, the depth and liquidity of which
will vary from issue to issue and from time to time. 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 Government Fund will consider this rule 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
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developed and, accordingly, these securities may be deemed "illiquid" and
subject to a Fund's limitations on investment in illiquid securities.
RISKS ASSOCIATED WITH MORTGAGE-BACKED SECURITIES The value of some
mortgage-backed securities in which the Funds may invest may be particularly
sensitive to changes in prevailing interest rates, and, like the other
investments of the Funds, the ability of a Fund to successfully utilize these
instruments may depend in part upon the ability of an Sub-Adviser to forecast
interest rates and other economic factors correctly. If a 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 Funds
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 a Fund invested in such securities and wishing
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 a 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
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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 CARSSM ("Certificates for
Automobile Receivables(SM)"). CARSSM 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 CARSSM 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 institution
unaffiliated with the trustee or originator of the trust. An investor's return
on CARSSM 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-Advisers expect that other asset-backed securities (unrelated
to mortgage loans) will be offered to investors in the future. Consistent with
its investment objectives and policies, a Fund also may invest in other types of
asset-backed securities.
SHORT SALES AGAINST THE BOX
A short sale is a transaction in which a 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, a Fund owns or has the right to obtain securities equivalent in kind
and amount. Each of the Funds will only enter into short sales against the box.
A 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
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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, a Fund
could experience losses or delays in recovering gains on short sales. The Funds
will only enter into short sales against the box with brokers the Sub-Advisers
believe are creditworthy. Short sales against the box will be limited to no more
than 25% of a Fund's total assets.
OPTIONS ON SECURITIES
WRITING CALL OPTIONS Any Fund, except the Money Market Fund and the
Tax Free Bond Fund, may sell ("write") covered call options on the portfolio
securities of such Fund in an attempt to enhance investment performance. The
California Tax Free Fund and New York Tax Free Fund may purchase and sell both
put and call options on debt securities in standardized contracts traded on
national securities exchanges, boards of trade, or similar entities, or quoted
on NASDAQ, and agreements, sometimes called "cash puts," which may accompany
the purchase of a new issue of bonds from a dealer. A call option sold by a
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.
A 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
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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. A 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.
A 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 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
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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.
Each 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 a 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 Funds may, to the extent determined
appropriate by the Sub-Advisers, engage without limitation in the writing of
options on U.S. government securities. Subject to the limitation that all call
and put option writing transactions be covered, and limitations imposed on
regulated investment companies under federal tax law, the International Bond
Fund, International Equity Fund and Global High Yield Fund may, to the extent
determined appropriate by the Sub-Adviser, engage without limitation in the
writing of options on their portfolio securities.
WRITING PUT OPTIONS Each Fund, except the Money Market Fund and the
Tax Free Bond Fund, may also write covered put options. Put options written by
a Fund are agreements by a 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 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.
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The premium which the Funds receive 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 Funds 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 Funds also may effect a closing purchase transaction, in the case
of a put option, to permit the Funds to maintain their 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 a 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 Funds may also write straddles (combinations of
covered puts and calls on the same underlying security). The extent to which the
Funds 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 each Fund qualify
as such. Subject to the limitation that all call and put option writing
transactions be covered, the Funds may, to the extent determined appropriate by
the Sub-Advisers, engage without limitation in the writing of options on U.S.
government securities.
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PURCHASING OPTIONS Each Fund, except Money Market Fund and the Tax
Free Bond 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 Funds will engage in such
transactions only with firms the Sub-Advisers deem to be of sufficient
creditworthiness so as to minimize these risks.
The Funds may purchase put options on securities to protect their
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. A 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 a 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 Funds may also purchase call options on securities the Funds intend
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 securities remained below the sum of the premium and the
exercise
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price during the option period. In order to terminate an option position, the
Funds 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. Each Fund, except the Equity Index Fund, Money Market
Fund and Tax Free Bond Fund may 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 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 equivalent of a short sale against
the box. To implement this trading strategy, the Fund will simultaneously
execute with the same broker a purchase of shares of the common stock and an "in
the money" over-the-counter put option to sell the common stock to the broker
and generally 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 may require
that the Fund write a call option, which would enable the broker to profit in
the event the price of the stock rises above the exercise price of the call
option (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.
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A Fund's purpose in selling covered options is to realize greater
income than would be realized on portfolio securities transactions alone. A 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 a 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 Capital Appreciation Fund, Convertible
Fund, Government Fund, High Yield Corporate Bond Fund, Money Market Fund, Total
Return Fund and Value Fund will not purchase a put or call option if, as a
result, the amount of premiums paid for all put and call options then
outstanding would exceed 10% of the value of the Fund's total assets.
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 a 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
Each Fund, except the California Tax Free Fund, the Equity Index Fund,
the Government Fund, the Money Market Fund, the New York Tax Free Fund and the
Tax Free Bond Fund, may, to the extent that it invests in foreign securities,
purchase and write options on foreign currencies. A Fund may use foreign
currency options contracts for various reasons, including: to manage its
exposure to changes in currency exchange rates; as an efficient means of
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adjusting its overall exposure to certain currencies; or in an effort to enhance
its return.
A Fund may 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. A Fund may also 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. 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,
a Fund may purchase put options on the foreign currency. If the value of the
currency does decline, that Fund will have the right to sell such currency for a
fixed amount of dollars which exceeds the 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, a 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 a 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, a 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.
If a 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,
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the option will most likely not be exercised, and the diminution 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, a 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 a 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 writing options on foreign
currencies, a 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 a Fund is "covered" if
that 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 a 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 a Fund in liquid assets in a segregated account with
its custodian.
Options on foreign currencies to be written or purchased by a Fund will
be traded on U.S. and foreign exchanges or over-the-counter. 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. As with other kinds of options transactions, however, the writing of
an option on foreign currency will constitute only a partial hedge up to the
amount of the premium received and a Fund could be required to purchase or sell
foreign
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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 a Fund's position, a Fund may forfeit the entire amount of the
premium plus related transaction costs.
A 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 a Fund seeks to
close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, a 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 a 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 Funds may purchase call and put options on securities indexes (only
call options on the S&P 500 Composite Price Index in the case of the Equity
Index Fund) for the purpose of hedging against the risk of unfavorable price
movements which may adversely affect the value of a Fund's securities. The
Equity Index Fund may purchase call options on the S&P 500 Index to protect
against increases in the prices of securities underlying the Index that the
Equity Index Fund intends to purchase pending its ability to invest in such
securities in an orderly manner.
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
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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 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
securities held or to be acquired by a 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 a 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
a 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 a 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.
A Fund may sell securities index options prior to expiration in order
to close out its positions in securities index options which it has purchased. A
Fund may also allow options to expire unexercised.
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FUTURES TRANSACTIONS
The California Tax Free Fund, Convertible Fund, Government Fund, High
Yield Corporate Bond Fund, International Bond Fund, International Equity Fund,
New York Tax Free Fund, Strategic Income Fund, Strategic Value Fund, Tax Free
Bond Fund, Total Return Fund, Equity Income Fund and Global High Yield 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 a
Fund's portfolio and for other appropriate risk management purposes. For
example, a Fund may purchase futures contracts as a substitute for the purchase
of longer-term debt securities to lengthen the average duration of a Fund's
portfolio of fixed-income securities. The Government Fund may enter into futures
contracts and purchase and write options on futures, which are not U.S.
government securities, in order to attempt to hedge against changes in interest
rates and to seek current income. 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
Capital Appreciation Fund, Convertible Fund, Equity Index Fund, International
Equity Fund, Strategic Income Fund, Strategic Value Fund, Total Return Fund,
Value Fund, Blue Chip Growth Fund, Research Value Fund, Small Cap Value Fund,
Growth Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and Global
High Yield Fund may purchase and sell stock index futures to hedge the equity
portion of those Funds' securities portfolios 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). These Funds, and the
International Bond Fund, may also purchase and sell other futures when deemed
appropriate, in order to hedge the equity or non-equity portions of their
portfolios. In addition, each Fund, except the California Tax Free Fund, Equity
Index Fund, Government Fund, Money Market Fund, New York Tax Free Fund and Tax
Free Bond Fund may, to the extent it invests in foreign securities, enter into
contracts for the future delivery of foreign currencies to hedge against changes
in currency exchange rates. Each of the Funds may also purchase and write put
and call options on futures contracts of the type into which such Fund is
authorized to enter and may engage in related closing transactions. In the
United States, all such futures on
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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 Funds 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 a Fund to
risks that are materially greater than the risks associated with trading on U.S.
exchanges. The International Bond Fund, International Equity Fund, Blue Chip
Growth Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities
Fund, Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund are
not limited to the above-listed 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 a 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 a 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. Each Fund expects to earn interest
income on its initial margin deposits. A futures contract held by a Fund is
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valued daily at the official settlement price of the exchange on 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 a 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, each Fund will mark-to-market its open futures positions.
A 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 a 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--a 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-Advisers to reflect the fair value of the
contract, in which case
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the positions will be valued by or under the direction of the Trustees.
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. A 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, a 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. A 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.
Because the only futures contracts currently available to hedge the Tax
Free Bond Fund's portfolio of municipal obligations are futures on various U.S.
government securities and futures on a municipal securities index, perfect
correlation between that
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Fund's futures positions and portfolio positions may be difficult to achieve.
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 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 a Fund's
securities portfolio with regard to market (systematic) risk, as distinguished
from stock-specific risk. The Funds may enter into stock index futures to the
extent that they have equity securities in their portfolios. Similarly, the
Funds may enter into futures on debt securities indexes (including the municipal
bond index) to the extent they have debt securities in their portfolios. By
establishing an appropriate "short" position in securities index futures, a 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, a 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. A
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 Funds do 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 a 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
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creates an obligation by a Fund, as purchaser, to take delivery of an amount of
currency at a specified future time at a specified price. A 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 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 a 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 a 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 Funds 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
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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 Funds will
purchase or write only options on futures contracts that are traded on a U.S. or
foreign exchange or board of trade. The Funds 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 (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 a 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
a Fund's portfolio against the risk of rising interest rates, declining
securities prices or declining exchange rates
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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 a 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.
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 a 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.
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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 a 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.
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, a 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 Funds 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 Funds 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,
a 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, a 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.
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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 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, a 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, a 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 a 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
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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 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 a 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
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that such a market will develop. Although the Funds 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 a Fund would have to
exercise options it has purchased in order to realize any profit and would be
less able to limit its 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 International Bond Fund, International Equity Fund, Strategic Value
Fund, Strategic Income Fund, Blue Chip Growth Fund, Research Value Fund, Small
Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income
Fund and Global High Yield 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
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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 movements
exceeding given minimum or maximum levels. A 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"). A 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. A 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 a 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, a 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 a 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 Funds by
the Code may limit the Funds' 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 a Fund's ability to terminate existing swap agreements or
to realize amounts to be received under such agreements.
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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 1940 Act, commodity pool, corporation,
partnership, proprietorship, organization, trust or other entity, employee
benefit plan, governmental entity, broker-dealer, 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
A 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, a Fund would assume all of the rights of the
lender in a corporate loan, including the right to
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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, a Fund may purchase an assignment of all or a portion of a
lender's interest in a corporate loan, in which case, a 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. A Fund also may purchase a Participation
Interest in a portion of the rights of a lender in a corporate loan. In such a
case, a Fund will be entitled to receive payments of principal, interest and
fees, if any, but generally will not be entitled to enforce its rights directly
against the agent bank or the borrower; rather a Fund must rely on the lending
institution for that purpose. A 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. A 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 a Fund has direct recourse against the borrower (which
is unlikely), a 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
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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 held by the agent bank for the benefit of a 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, a 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 a Fund acts as co-lender in connection with a participation
interest or when a Fund acquires a participation interest the terms of which
provide that a Fund will be in privity of contract with the corporate borrower,
a Fund will have direct recourse against the borrower in the event the borrower
fails to pay scheduled principal and interest. In all other cases, a Fund will
look to the agent bank to enforce appropriate credit remedies against the
borrower. In acquiring participation interests a Fund will conduct analysis and
evaluation of the financial condition of each such co-lender and participant to
ensure that the participation interest meets a 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 a Fund
disposing of such securities at a substantial discount from face value or
holding such security until maturity. When a 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 Funds consider
loan participation interests not subject to puts to be illiquid.
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RISKS ASSOCIATED WITH DEBT SECURITIES
To the extent that a Fund invests in debt securities, it will be
subject to certain risks. The value of the debt securities held by a 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 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 Funds do 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, each 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 each Fund will vary as the
aggregate value of the Funds' portfolio securities increases or decreases.
Moreover, the value of the debt securities that each 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
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the value of securities subsequent to their acquisition will not affect cash
income or yields to maturity to the Funds but will be reflected in the net asset
value of the Funds' 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 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. A 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 on account of such interest
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.
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EQUITY INDEX FUND
SPECIAL CONSIDERATIONS
The Equity Index Fund is managed using mathematical algorithms to
determine which stocks are to be purchased or sold to replicate the S&P 500
Index to the extent feasible. From time to time, adjustments may be made in the
Fund's portfolio because of changes in the composition of the Index, but such
changes should be infrequent. No attempt is made to manage the portfolio in the
traditional sense using economic, financial and market analysis.
The Sub-Adviser believes that the indexing approach described above is
an effective method of simulating percentage changes in the S&P 500 Index.
"Standard & Poor's", "S&P 500", "S&P", "S&P 500", "Standard & Poor's
500" and "500" are trademarks of Standard & Poor's Corporation and have been
licensed for use by Monitor Capital Advisors, Inc. S&P does not sponsor,
endorse, sell or promote the Fund or represent the advisability of investing in
the Fund.
The Fund is not sponsored, endorsed, sold or promoted by S&P. S&P makes
no representation or warranty, express or implied, to the owners of the Fund or
any member of the public regarding the advisability of investing in securities
generally or in the Fund particularly or the ability of the S&P 500 Index to
track general stock market performance. S&P's only relationship to Monitor is
the licensing of certain trademarks and trade names of S&P and of the S&P 500
Index which is determined, composed and calculated by S&P without regard to
Monitor or the Fund. S&P has no obligation to take the needs of Monitor or the
owners of the Fund into consideration in determining, composing or calculating
the S&P 500 Index. S&P is not responsible for and has not participated in the
determination of the prices and amount of the Fund or the timing of the issuance
or sale of the Fund or in the determination or calculation of the equation by
which the Fund is to be converted into cash. S&P has no obligation or liability
in connection with the administration, marketing or trading of the Fund.
S&P does not guarantee the accuracy and/or the completeness of the S&P
500 Index or any data included therein and S&P shall have no liability for any
errors, omissions, or interruptions
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therein. S&P makes no warranty, express or implied, as to results to be obtained
by Monitor, owners of the Fund, or any other person or entity from the use of
the S&P 500 Index or any data included therein. S&P makes no express or implied
warranties, and expressly disclaims all warranties of merchantability or fitness
for a particular purpose or use with respect to the S&P 500 Index or any data
included therein. Without limiting any of the foregoing, in no event shall S&P
have any liability for any special, punitive, indirect, or consequential damages
(including lost profits), even if notified of the possibility of such damages.
TOTAL RETURN FUND
SPECIAL CONSIDERATIONS
Although the Total Return Fund does not intend to seek short-term
profits, securities in its portfolio will be sold whenever the Sub-Adviser
believes it is appropriate to do so without regard to the length of time the
particular security may have been held, subject to certain tax requirements for
qualification as a regulated investment company under the Code. A high turnover
rate involves greater expenses to the Fund and may increase the possibility of
shareholders realizing taxable capital gains. The Fund engages in portfolio
trading if it believes a transaction, net of costs (including custodian
charges), will help in achieving its investment objective.
CALIFORNIA TAX FREE FUND AND NEW YORK TAX FREE FUND
SPECIAL CONSIDERATIONS
RISK FACTORS AFFECTING CALIFORNIA MUNICIPAL SECURITIES
The following information as to certain California State ("State") risk
factors is given to investors in view of the policy of the MainStay California
Tax Free Fund of concentrating its investments in California municipal issuers.
Such information constitutes only a brief discussion, does not purport to be a
complete description and is based on information from sources believed by the
Trust to be reliable, including official statements relating to securities
offerings of California and municipal issuers, and periodic publications by
national ratings
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organizations. Such information, however, has not been independently verified by
the Trust.
Certain California constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives, as discussed
below, could adversely affect the market values and marketability of, or result
in default of, existing obligations of the State. Obligations of the State or
local governments may also be affected by budgetary pressures affecting the
State and economic conditions in the State. The following information
constitutes only a brief summary and is not intended as a complete description.
Certain of the California municipal securities in which the Fund may
invest may be obligations of issuers which rely in whole or in part on
California State revenues for payment of these obligations. Property tax
revenues and a portion of the State's General Fund surplus are distributed to
counties, cities and their various taxing entities and the State assumes certain
obligations theretofore paid out of local funds. Whether and to what extent a
portion of the State's General Fund will be distributed in the future to
counties, cities and their various entities, is unclear.
Certain of the California municipal securities may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, Proposition 13 added Article XIIIA to the
California Constitution. The effect of Article XIIIA is to limit ad valorem
taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues.
Legislation enacted by the California legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that notwithstanding
any other law, local agencies may not levy any ad valorem property tax except to
pay debt service on indebtedness approved by the voters prior to July 1, 1978,
and that each county will levy the maximum tax permitted by Article XIIIA of
$4.00 per $100 assessed valuation. The apportionment of property taxes in fiscal
years after 1978-79 was revised pursuant to Statutes of 1979, Chapter 282, which
provides relief funds from State moneys beginning in fiscal year 1979-80 and is
designed to provide a permanent system for sharing State taxes and budget funds
with local agencies. Under Chapter 282, cities and counties receive more of the
remaining property tax revenues collected under Proposition 13 instead of direct
State aid. School districts receive a correspondingly reduced amount of property
taxes, but receive compensation directly from the State and are given additional
relief.
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On November 4, 1986, California voters approved an initiative statute
known as "Proposition 62." This statute (i) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity; (ii)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction; (iii) restricts the use
of revenues from a special tax to the purposes or for the service for which the
special tax was imposed; (iv) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by Article
XIIIA of the California Constitution; (v) prohibits the imposition of
transaction taxes and sales taxes on the sale of real property by local
governments; (vi) requires that any tax imposed by a local government on or
after August 1, 1985 be ratified by a majority of the electorate within two
years of the adoption of the initiative or be terminated by November 15, 1988;
(vii) requires that, in the event a local government fails to comply with the
provisions of this measure, a reduction in the amount of tax revenue allocated
to such local government occur in an amount equal to the revenues received by
such entity attributable to the tax levied in violation of the initiative; and
(viii) permits these provisions to be amended exclusively by the voters of the
State of California. In September 1988, the California Court of Appeals held
that it was unconstitutional to require that local tax measures be submitted to
the electorate, as described in (vi) above.
In September 1995, the California Supreme Court upheld the
constitutionality of Proposition 62, creating uncertainty as to the legality of
certain local taxes enacted by non-charter cities in California without voter
approval.
On November 5, 1996, voters approved Proposition 218, entitled the
"Right to Vote on Taxes Act," which incorporates new Articles XIIIC and XIIID
into the California Constitution. These new provisions place limitations on the
ability of local government agencies to impose or raise various taxes, fees,
charges and assessments without voter approval. Certain "general taxes" imposed
after January 1, 1995 must be approved by voters in order to remain in effect.
In addition, Article XIIIC clarifies the right of local voters to reduce taxes,
fees, assessments or charges through local initiatives. There are a number of
ambiguities concerning the Proposition and its impact on local governments and
their bonded debt which will require interpretation by the courts or the
Legislature. Proposition 218
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does not affect the State or its ability to levy or collect taxes.
The State is subject to an annual appropriations limit imposed by
Article XIIIB of the State Constitution (the "Appropriations Limit"). The
Appropriations Limit does not restrict appropriations to pay debt service on the
bonds or other voter-authorized bonds. Article XIIIB prohibits the State from
spending "appropriations subject to limitation" in excess of the Appropriations
Limit. "Appropriations subject to limitation," with respect to the State, are
authorizations to spend "proceeds of taxes," which consist of tax revenues, and
certain other funds, including proceeds from regulatory licenses, user charges
or other fees to the extent that such proceeds exceed "the cost reasonably borne
by that entity in providing the regulation, product or service," but "proceeds
of taxes" exclude most State subventions to local governments, tax refunds and
some benefit payments such as unemployment insurance. No limit is imposed on
appropriations of funds which are not "proceeds of taxes," such as reasonable
user charges or fees and certain other non-tax funds.
Not included in the Appropriations Limit are appropriations for the
debt service costs of bonds existing or authorized by January 1, 1979, or
subsequently authorized by the voters, appropriations required to comply with
mandates of courts or the federal government and, pursuant to Proposition 111,
appropriations for qualified capital outlay projects and appropriations of
revenues derived from any increase in gasoline taxes and motor vehicle weight
fees above January 1, 1990 levels, and appropriation of certain special taxes
imposed by initiative (e.g., increased cigarette and tobacco taxes enacted by
Proposition 99 in 1988). The Appropriations Limit may also be exceeded in cases
of emergency.
The State's Appropriations Limit in each year is based on the limit for
the prior year, adjusted annually for changes in State per capita personal
income and changes in population, and adjusted, when applicable, for any
transfer of financial responsibility of providing services to or from another
unit of government. The measurement of change in population is a blended average
of statewide overall population growth, and change in attendance at local school
and community college ("K-14") districts. As amended by Proposition 111, the
Appropriations Limit is tested over consecutive two-year periods. Any excess of
the aggregate "proceeds of taxes" received over such a two-year period above the
combined Appropriations Limits for those two years is divided equally between
transfers to K-14 districts and refunds to taxpayers.
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The legislature enacted legislation to implement Article XIIIB which
defines certain terms used in Article XIIIB and sets forth the methods for
determining the Appropriations Limit. California Government Code Section 7912
requires an estimate of the Appropriations Limit to be included in the
Governor's Budget, and thereafter to be subject to the budget process and
established in the Budget Act.
On November 9, 1988, the State's voters approved Proposition 98, a
combined initiative constitutional amendment and statute called the "Classroom
Instructional Improvement and Accountability Act." Proposition 98 changed State
funding of public education below the university level and the operation of the
State Appropriations Limit, primarily by guaranteeing K-14 schools a minimum
share of General Fund revenues. Under Proposition 98 (as modified by Proposition
111, enacted on June 5, 1990), K-14 schools are guaranteed the greater of (a) in
general, a fixed percent of General Fund revenues ("Test 1"), (b) the amount
appropriated to K-14 schools in the prior year, adjusted for changes in the cost
of living (measured as in Article XIIIB by reference to State per capita
personal income) and enrollment ("Test 2"), or (c) a third test, which would
replace Test 2 in any year when the percentage growth in per capita General Fund
revenues from the prior year plus one half of one percent is less than the
percentage growth in State per capita personal income ("Test 3"). Under Test 3,
schools would receive the amount appropriated in the prior year adjusted for
changes in enrollment and per capita General Fund revenues, plus an additional
small adjustment factor. If Test 3 is used in any year, the difference between
Test 3 and Test 2 would become a "credit" to schools which would be the basis of
payments in future years when per capita General Fund revenue growth exceeds per
capita personal income growth. Legislation adopted prior to the end of the
1988-89 fiscal year, implementing Proposition 98, determined the K-14 schools'
funding guarantee under Test 1 to be 40.3 percent of the General Fund tax
revenues, based on 1986-87 appropriations. The percentage has been adjusted to
approximately 35 percent to account for a subsequent redirection of local
property taxes, since such redirection directly affects the share of General
Fund revenues to schools.
Proposition 98 permits the legislature by two-thirds vote of both
houses, with the Governor's concurrence, to suspend the K-14 schools' minimum
funding formula for a one-year period. Proposition 98 also contains provisions
transferring certain State tax revenues in excess of the Article XIIIB limit to
K-14 schools.
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During the recent recession, General Fund revenues for several years
were less than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage provided in
the law. The Legislature responded to these developments by designating the
"extra" Proposition 98 entitlements, and also intended that the "extra" payments
would not be included in the Proposition 98 "base" for calculating future years'
entitlements. By implementing these actions, per-pupil funding from Proposition
98 sources stayed almost constant at approximately $4,200 from Fiscal Year
1991-92 to Fiscal Year 1993-94.
In 1992, a lawsuit was filed, called California Teachers' Association
v. Gould, which challenged the validity of these off-budget loans. The
settlement of this case, finalized in July, 1996, provides, among other things,
that both the State and K-14 schools share in the repayment of prior years'
emergency loans to schools. Of the total $1.76 billion in loans, the State will
repay $935 million by forgiveness of the amount owed, while schools will repay
$825 million. The State share of the repayment will be reflected as an
appropriation above the current Proposition 98 base calculation. The schools'
share of the repayment will count as appropriations that count toward satisfying
the Proposition 98 guarantee, or from "below" the current base. Repayments are
spread over the eight-year period of 1994-95 through 2001-02 to mitigate any
adverse fiscal impact.
Substantially increased General Fund revenues, above initial budget
projections, in the fiscal year 1994-95 and thereafter have resulted or will
result in retroactive increases in Proposition 98 appropriations from subsequent
fiscal years' budgets. Because of the State's increasing revenues, per-pupil
funding at the K-12 level has increased by about 22% from the level in place
from 1991-92 through 1993-94, and is estimated at about $5,150 per ADA in
1997-98. A significant amount of the "extra" Proposition 98 monies in the last
few years have been allocated to special programs, most particularly an
initiative to allow each classroom from grades K-3 to have no more than 20
pupils by the end of the 1997-98 school year. There are also new initiatives for
reading skills and to upgrade technology in high schools.
Certain California municipal securities in the Fund may be obligations
which are secured in whole or in part by a mortgage or deed of trust on real
property. Upon the default of a mortgage or deed of trust with respect to
California real property, the creditor's nonjudicial foreclosure rights under
the power of sale contained in the mortgage or deed of trust are subject to the
constraints imposed by California law upon
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transfers of title to real property by private power of sale. During the
three-month period beginning with the filing of a formal notice of default, the
debtor is entitled to reinstate the home mortgage by making any overdue
payments. Under standard loan servicing procedures, the filing of the formal
notice of default does not occur unless at least three full monthly payments
have become due and remain unpaid. The power of sale is exercised by posting and
publishing a notice of sale for at least 20 days after expiration of the
three-month reinstatement period. Therefore, the effective minimum period for
foreclosing on a mortgage could be in excess of seven months after the initial
default. Such time delays in collections could disrupt the flow of revenues
available to an issuer for the payment of debt service on the outstanding
obligations if such defaults occur with respect to a substantial number of home
mortgages or deeds of trust securing an issuer's obligations.
Certain California municipal securities in the Fund may be obligations
which finance the acquisition of single family home mortgages for low- and
moderate-income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to the California
statutory limitations described above applicable to obligations secured by real
property. Under California anti-deficiency legislation, there is no personal
recourse against a mortgagor of a single family residence purchased with the
loan secured by the mortgage.
Under California law, mortgage loans secured by single family
owner-occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years of the term of the mortgage loan, and cannot in any
event exceed six months' advance interest on the amount prepaid in excess of 20
percent of the original principal amount of the mortgage loan. This limitation
could affect the flow of revenues available to an issuer for debt service on the
outstanding debt obligations which financed such home mortgages.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on
the Richter Scale struck Los Angeles. Significant property damage to private and
public facilities occurred in a four-county area including northern Los Angeles
County, Ventura County, and parts of Orange and San Bernardino Counties. The
possibility exists that another such earthquake could create a major dislocation
of the State economy.
Congress passed and the President signed (on August 22, 1996) the
Personal Responsibility and Work Opportunity Act of 1996 making a fundamental
reform of the current welfare system.
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Among many provisions, the Law includes: (I) conversion of Aid to Families with
Dependent Children from an entitlement program to a block grant titled Temporary
Assistance for Needy Families (TANF), with lifetime time limits on TANF
recipients, work requirements and other changes; (ii) provisions denying certain
federal welfare and public benefits to legal noncitizens, allowing states to
elect to deny additional benefits (including TANF) to legal noncitizens, and
generally denying almost all benefits to illegal immigrants; and (iii) changes
in the Food Stamp program, including reducing maximum benefits and imposing work
requirements.
As part of the 1997-98 Budget Act legislative package, the Legislature
and Governor agreed on a comprehensive reform of the State's public assistance
programs to implement the new federal law. The new basic State welfare program
is called California Work Opportunity and Responsibility to Kids Act
("CalWORKs"), which replaces the former Aid to Families with Dependent Children
(AFDC) and Greater Avenues to Independence (GAIN) programs effective January 1,
1998. Consistent with the federal law, CalWORKs contains new time limits on
receipt of welfare aid, both lifetime as well as for any current period of aid.
The centerpiece of CalWORKs is the linkage of eligibility to work participation
requirements. Administration of the new Welfare- to-Work programs will be
largely at the county level, and counties are given financial incentives for
success in this program.
Although the long-term impact of the new federal Law and CalWORKs
cannot be determined until there has been more experience, the State does not
presently anticipate that these new programs will have an adverse financial
impact on the General Fund. Overall TANF grants from the federal government are
expected to equal or exceed the amounts the State would have received under the
old AFDC program.
Pressures on the State's budget in the late 1980's and early 1990's
were caused by a combination of external economic conditions (including a
recession which began in 1990) and growth of the largest General Fund Programs -
K-14 education, health, welfare and corrections - at rates faster than the
revenue base. During this period, expenditures exceeded revenues in four out of
six years up to 1992-93, and the State accumulated and sustained a budget
deficit approaching $2.8 billion at its peak at June 30, 1993. Between the
1991-92 and 1994-95 Fiscal Years, each budget required multibillion dollar
actions to bring projected revenues and expenditures into balance, including
significant cuts in health and welfare program expenditures; transfers of
program responsibilities and funding from the State to local governments;
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transfer of about $3.6 billion in annual local property tax revenues from other
local governments to local school districts, thereby reducing State funding for
schools under Proposition 98; and revenue increases (particularly in the 1991-92
Fiscal Year budget), most of which were for a short duration.
Despite these budget actions, the effects of the recession led to
large, unanticipated budget deficits. By the 1993-94 Fiscal Year, the
accumulated deficit was so large that it was impractical to budget to retire it
in one year, so a two-year program was implemented, using the issuance of
revenue anticipation warrants to carry a portion of the deficit over the end of
the fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, again using cross-fiscal year
revenue anticipation warrants to partly finance the deficit into the 1995-96
fiscal year.
Another consequence of the accumulated budget deficits, together with
other factors such as disbursement of funds to local school districts "borrowed"
from future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the Legislature and the Governor failed to adopt a budget for
the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the State to
carry out its normal annual cash flow borrowing to replenish its cash reserves,
the State Controller issued registered warrants to pay a variety of obligations
representing prior years' or continuing appropriations, and mandates from court
orders. Available funds were used to make constitutionally-mandated payments,
such as debt service on bonds and warrants. Between July 1 and September 4,
1992, when the budget was adopted, the State Controller issued a total of
approximately $3.8 billion of registered warrants.
For several fiscal years during the recession, the State was forced to
rely on external debt markets to meet its cash needs, as a succession of notes
and revenue anticipation warrants were issued in the period from June 1992 to
July 1994, often needed to pay previously maturing notes or warrants. These
borrowings were used also in part to spread out the repayment of the accumulated
budget deficit over the end of a fiscal year, as noted earlier. The last and
largest of these borrowings was $4.0 billion of revenue anticipation warrants
which were issued in July, 1994 and matured on April 25, 1996.
The State's financial condition improved markedly during the 1995-96
and 1996-97 fiscal years, with a combination of better
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than expected revenues, slowdown in growth of social welfare programs, and
continued spending restraint based on the actions taken in earlier years. The
State's cash position also improved, and no external deficit borrowing has
occurred over the end of these two fiscal years.
The economy grew strongly during these fiscal years, and as a result,
the General Fund took in substantially greater tax revenues (around $2.2 billion
in 1995-96 and $1.6 billion in 1996-97) than were initially planned when the
budgets were enacted. These additional funds were largely directed to school
spending as mandated by Proposition 98, and to make up shortfalls from reduced
federal health and welfare aid. The accumulated budget deficit from the
recession years was finally eliminated. In the Governor's 1998-99 Budget
Proposal, released January 9, 1998, the Department of Finance reported that the
State's budget reserve (the SFEU) totaled $461 million as of June 30, 1997.
On January 9, 1997, the Governor released his proposed budget for the
1997-98 Fiscal Year (the "Proposed Budget"). The Proposed Budget estimated
General Fund revenues and transfers of about $50.7 billion, and proposed
expenditures of $50.3 billion. In May 1997, the Department of Finance increased
its revenue estimate for the upcoming fiscal year by $1.3 billion, in response
to the continued strong growth in the State's economy.
In May, 1997, action was taken by the California Supreme Court in an
ongoing lawsuit, PERS v. Wilson, which made final a judgment against the State
requiring an immediate payment from the General Fund to the Public Employees
Retirement Fund ("PERF") to make up certain deferrals in annual retirement fund
contributions which had been legislated in earlier years for budget savings, and
which the courts found to be unconstitutional. On July 30, 1997, following a
direction from the Governor, the Controller transferred $1.228 billion from the
General Fund to the PERF in satisfaction of the judgment, representing the
principal amount of the improperly deferred payments from 1995-96 and 1996-97.
In late 1997, the plaintiffs filed a claim with the State Board of
Control for payment of interest under the Court rulings in an amount of $308
million. The Department of Finance has recommended approval of this claim. If
approved by the Board of Control, the claim would become part of a claims bill
to be paid in the 1998-99 Fiscal Year.
Once the pension payment of $1.228 billion eliminated essentially all
the "increased" revenue in the budget, final agreement was reached within a few
weeks on a welfare reform
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package and the remainder of the budget. The Legislature passed the Budget Bill
on August 11, 1997, along with numerous related bills to implement its
provisions. On August 18, 1997, the Governor signed the Budget Act, but vetoed
approximately $314 million of specific spending items, primarily in health and
welfare and education areas from both the General Fund and Special Funds. Most
of this spending (approximately $200 million) was restored in later legislation
passed before the end of the Legislative Session.
The Budget Act anticipated General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and expenditures
of $52.8 billion (an 8.0 percent increase from the 1996-97 levels). The Budget
Act also included Special Fund expenditures of $14.4 billion (as against
estimated Special Fund revenues of $14.0 billion), and $2.1 billion of
expenditures from various Bond Funds. Following enactment of the Budget Act, the
State implemented its normal annual cash flow borrowing program, issuing $3.0
billion of notes which mature on June 30, 1998.
The following were major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contained a large increase
in funding for K-14 education under Proposition 98, reflecting strong revenues
which exceeded initial budgeted amounts. Part of the nearly $1.75 billion in
increased spending was allocated to prior fiscal years. Funds were provided to
fully pay for the cost-of-living-increase component of Proposition 98, and to
extend the class size reduction and reading initiatives.
2. The Budget Act reflected the $1.228 billion pension case judgment
payment, and brought funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts.
3. Funding from the General Fund for the University of California and
California State University was increased by about 6 percent ($121 million and
$107 million, respectively), and there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels, adjusted for caseload changes.
5. Health and welfare costs were contained, continuing generally the
grant levels from prior years, as part of the initial implementation of the new
CalWORKs program.
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6. Unlike prior years, this Budget Act did not depend on uncertain
federal budget actions. About $300 million in federal funds, already included in
the federal FY 1997 and 1998 budgets, was included in the Budget Act, to offset
incarceration costs for illegal aliens.
7. The Budget Act contained no tax increases, and no tax reductions.
The Renters Tax Credit was suspended for another year, saving approximately $500
million.
The Department of Finance released updated estimates for the 1997-98
Fiscal Year on January 9, 1998 as part of the Governor's 1998-99 Fiscal Year
Budget Proposal. Total revenues and transfers are projected at $52.9 billion, up
approximately $360 million from the Budget Act projection. Expenditures for the
fiscal year are expected to rise approximately $200 million above the original
Budget Act, to $53.0 billion. The balance in the budget reserve, the SFEU, is
projected to be $329 million at June 30, 1998, compared to $461 million at June
30, 1997.
At the end of the Legislative Session on September 13, 1997, the
Legislature passed and the Governor later signed several bills encompassing a
coordinated package of fiscal reforms, mostly to take effect after the 1997-98
Fiscal Year. Included in the package are a variety of phased-in tax cuts,
conformity with certain provisions of the federal tax reform law passed earlier
in the year, and reform of funding for county trial courts, with the State to
assume greater financial responsibility. The Department of Finance estimates
that the major impact of these fiscal reforms will occur in Fiscal Year 1998-99
and subsequent years.
On January 9, 1998, the Governor released his Budget Proposal for the
1998-99 Fiscal Year (the "Governor's Budget"). The Governor's Budget projects
total General Fund revenues and transfers of $55.4 billion, a $2.5 billion
increase (4.7 percent) over revised 1997-98 revenues. This revenue increase
takes into account reduced revenues of approximately $600 million from the 1997
tax cut package, but also assumes approximately $500 million additional revenues
primarily associated with capital gains realizations. The Governor's Budget
notes, however, that capital gains activity and the resultant revenues derived
from it are very hard to predict.
Total General Fund expenditures for 1998-99 are recommended at $55.4
billion an increase of $2.4 billion (4.5 percent) above the revised 1997-98
level. The Governor's Budget includes funds to pay the interest claim relating
to the court decision on pension fund payments, PERS v. Wilson. The Governor's
Budget
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projects that the State will carry out its normal intra-year cash flow external
borrowing in 1998-99, in an estimated amount of $3.0 billion. The Governor's
Budget projects that the budget reserve, the SFEU, will be $296 million at June
30, 1999, slightly lower than the projected level at June 30, 1998 PERS
liability.
The Governor's Budget projects Special Fund revenues of $14.7 billion,
and Special Fund expenditures of $15.2 billion, in the 1998-99 Fiscal Year. A
total of $3.2 billion of bond fund expenditures are also proposed.
On December 6, 1994, Orange County, California (the "County"), together
with its pooled investment funds (the "Funds") filed for protection under
Chapter 9 of the federal Bankruptcy Code, after reports that the Funds had
suffered significant market losses in their investments, causing a liquidity
crisis for the Funds and the County. More than 200 other public entities, most
of which, but not all, are located in the County, were also depositors in the
Funds. The bankruptcy filing stemmed from approximately $1.7 billion in losses
suffered by the County's investment pool due to investments in high risk
"derivative" securities. On June 12, 1996, it emerged from bankruptcy after the
successful sale of $880 million in municipal bonds allowed the County to pay off
the last of its creditors. On January 7, 1997, the County returned to the
municipal bond market with a $136 million bond issue maturing in 13 years at an
insured yield of 7.23%.
The State is a party to numerous legal proceedings, many of which
normally recur in governmental operations. In addition, the State is involved in
certain other legal proceedings which, if decided against the State, may require
the State to make significant future expenditures or may impair future revenue
sources.
The Bonds have received ratings of "A1" by Moody's Investors Service,
"A+" by Standard & Poor's, a division of The McGraw-Hill Companies and "AA-" by
Fitch ICBA, Inc. An explanation of the significance and status of such credit
ratings may be obtained from the rating agencies furnishing the same. There is
no assurance that such ratings will continue for any given period of time or
that they will not be revised or withdrawn entirely by any such rating agencies,
if in their respective judgments, circumstances so warrant. A revision or
withdrawal of any such credit rating could have an effect on the market price of
the Bonds. After the Bonds are rated, the State Treasurer intends to provide
appropriate periodic credit information to the bond
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rating agencies to assist in maintaining the ratings on the Bonds.
RISK FACTORS AFFECTING NEW YORK MUNICIPAL SECURITIES
The following information as to certain New York State ("State") and
New York City ("City") risk factors is given to investors in view of the policy
of the MainStay New York Tax Free Fund of concentrating its investments in New
York municipal issuers. Such information constitutes only a brief discussion,
does not purport to be a complete description and is based on information from
sources believed by the Trust to be reliable, including official statements
relating to securities offerings of New York and municipal issuers, and periodic
publications by national ratings organizations. Such information, however, has
not been independently verified by the Trust.
There are a number of methods by which the State itself may incur debt.
The State may issue general obligation bonds. Under the State Constitution, the
State may not, with limited exceptions for emergencies, undertake long-term
general obligation borrowing (i.e., borrowing for more than one year) unless the
borrowing is authorized in a specific amount for a single work or purpose by the
Legislature and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State. With the exception of general obligation housing bonds
(which must be paid in equal annual installments or installments that result in
substantially level or declining debt service payments, within 50 years after
issuance, commencing no more than three years after issuance), general
obligation bonds must be paid in equal annual installments or installments that
result in substantially level or declining debt service payments, within 40
years after issuance, beginning not more than one year after issuance of such
bonds.
The State may undertake short-term borrowings without voter approval
(I) in anticipation of the receipt of taxes and revenues, by issuing tax and
revenue anticipation notes (TRANs), and (ii) in anticipation of the receipt of
proceeds from the sale of duly authorized but unissued general obligation bonds,
by issuing bond anticipation notes (BANs). TRANs must mature within one year
from their dates of issuance and may not be refunded or refinanced beyond such
period. However, since 1990 the State's ability to issue TRANs has been limited
due to enactment of the fiscal reform program which created LGAC. BANs may only
be issued for the purposes and within the amounts for which bonds may be issued
pursuant to voter authorizations. Such BANs must be paid from the proceeds of
the sale of bonds in anticipation of
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which they were issued or from other sources within two years of the date of
issuance or, in the case of BANs for housing purposes, within five years of the
date of issuance. In order to provide flexibility within these maximum term
limits, the State has utilized the BANs authorization to conduct a commercial
paper program to fund disbursements eligible for general obligation bond
financing.
Pursuant to specific constitutional authorization, the State may also
directly guarantee certain public authority obligations. The State Constitution
provides for the State guarantee of the repayment of certain borrowings for
designated projects of the New York State Thruway Authority, the Job Development
Authority and the Port Authority of New York and New Jersey. The State has never
been called upon to make any direct payments pursuant to such guarantees. State
guaranteed bonds of the Port Authority of New York and New Jersey were fully
retired on December 31, 1996. State guaranteed bonds issued by the Thruway
Authority were fully retired on July 1, 1995.
In February 1997, the Job Development Authority (JDA) issued
approximately $85 million of State guaranteed bonds to refinance certain of its
outstanding bonds and notes in order to restructure and improve JDA's capital
finances. Due to concerns regarding the economic viability of its programs,
JDA's loan and loan guarantee activities were suspended in 1995. JDA recently
resumed its lending activities under a revised set of lending programs and
underwriting guidelines. As a result of the structural imbalances in JDA's
capital structure, and defaults in its loan portfolio and loan guarantee program
incurred between 1991 and 1996, JDA would have experienced a debt service cash
flow shortfall had it not completed the 1997 refinancing. JDA anticipates that
it will transact additional refinancings in 1999, 2000 and 2003 to complete its
long-term plan of finance and further alleviate cash flow imbalances which are
likely to occur in future years. The State does not anticipate that it will be
called upon to make any payments pursuant to the State guarantee in the 1998-99
fiscal year.
Payments of debt service on State general obligation and
State-guaranteed bonds and notes are legally enforceable obligations of the
State.
The State employs additional long-term financing mechanisms,
lease-purchase and contractual obligation financings, which involve obligations
of public authorities or municipalities that are State supported but not general
obligations of the State. Under these financing arrangements, certain public
authorities and municipalities have issued obligations to finance the
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construction and rehabilitation of facilities or the acquisition and
rehabilitation of equipment, and expect to meet their debt service requirements
through the receipt of rental or other contractual agreement by the State to
make payments to a public authority, municipality or other entity, the State's
obligation to make such payments is generally expressly made subject to
appropriation by the Legislature and the actual availability of money to the
State for making the payments. The State has also entered into a financing
arrangement with LGAC to restructure the way the State makes certain local aid
payments.
The State also participates in the issuance of certificates of
participation (COPs) in a pool of leases entered into by the State's Office of
General Services on behalf of several State departments and agencies interested
in acquiring operational equipment or in certain cases, real property.
Legislation enacted in 1986 established restrictions upon and centralized State
control, through the Comptroller and the Director of the Budget, over the
issuance of COPs representing the State's contractual obligation, subject to
annual appropriation by the Legislature and availability of money, to make
installment or lease-purchase payments for the State's acquisition of such
equipment or real property.
The State has never defaulted on any of its general obligation
indebtedness or its obligations under lease purchase or contractual-obligation
financing arrangements and has never been called upon to make any direct
payments pursuant to its guarantees.
The fiscal stability of the State is related in part to the fiscal
stability of its public authorities. For the purposes of this Annual Information
Statement, public authorities refer to public benefit corporations, created
pursuant to State law, other than local authorities. Public authorities are not
subject to the constitutional restrictions on the incurrence of debt which apply
to the State itself and may issue bonds and notes within the amounts and
restrictions set forth in legislative authorization. The State's access to the
public credit markets could be impaired and the market price of its outstanding
debt may be materially and adversely affected if any of its public authorities
were to default on their respective obligations. As of December 31, 1997, there
were 17 public authorities that had outstanding debt of $ 100 million or more,
and the aggregate outstanding debt, including refunding bonds, of all State
public authorities was $84 billion, only a portion of which constitutes
State-supported or State-related debt.
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In 1990, as part of a State fiscal reform program, legislation was enacted
creating LGAC, a public benefit corporation empowered to issue long-term
obligations to fund certain payments to local governments that had been
traditionally funded through the State's annual seasonal borrowing. The
legislation authorized LGAC to issue its bonds and notes in an amount to yield
net proceeds not in excess of $4.7 billion (exclusive of certain refunding
bonds). Over a period of years, the issuance of these long-term obligations,
which are to be amortized over no more than 30 years, was expected to eliminate
the need for continued short-term seasonal borrowing. The legislation also
dedicated revenues equal to one-quarter of the four cent State sales and use tax
to pay debt service on these bonds. The legislation also imposed a cap on the
annual seasonal borrowing of the State at $4.7 billion, less net proceeds of
bonds issued by LGAC and bonds issued to provide for capitalized interest,
except in cases where the Governor and the legislative leaders have certified
the need for additional borrowing and provided a schedule for reducing it to the
cap. If borrowing above the cap is thus permitted in any fiscal year, it is
required by law to be reduced to the cap by the fourth fiscal year after the
limit was first exceeded. This provision capping the seasonal borrowing was
included as a covenant with LGAC's bondholders in the resolution authorizing
such bonds.
As of June 1995, LGAC had issued bonds and notes to provide net
proceeds of $4.7 billion, completing the program. The impact of LGAC's
borrowing, as well as other changes in revenue and spending patterns, is that
the State has been able to meet its cash flow needs throughout the fiscal year
without relying on short-term seasonal borrowings.
Except for the Series 1998F Refunding Bonds maturing on September 15,
2008, Moody's Investors Service, Inc. ("Moody's") has given the Series 1998F
Refunding Bonds a rating of "A2" and Standard & Poor's Ratings Group ("S&P") has
given the Series 1998F Refunding Bonds a rating of "A." Moody's and S&P will
give the Series 1998F Refunding Bonds maturing on September 15,2008, a rating of
"Aaa" and AAA, respectively with the understanding that upon delivery of such
Bonds, a municipal bond insurance policy will be issued by Ambac Assurance
Corporation.
Ratings reflect only the respective views of such organizations, and an
explanation of the significance of such ratings must be obtained from the rating
agency furnishing the same. There is no assurance that a particular rating will
continue for any given period of time or that any such rating will not be
revised downward or withdrawn entirely if, in the judgment of the agency
originally establishing the rating,
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circumstances so wan-ant. A downward revision or withdrawal of such ratings, or
either of them, may have an effect on the market price of the Series 1998F
Refunding Bonds.
The State's current fiscal year began on April 1, 1998 and ends on
March 31, 1999 and is referred to herein as the State's 1998-99 fiscal year.
This section of the AIS reflects estimates of receipts and disbursements for the
State's 1998-99 fiscal year as formulated in the Financial Plan released on June
25, 1998. Additional information on the State's finances will be released in
quarterly updates to the Financial Plan. Information on the State's Capital
Program and Financing Plan for the 1998-99 through 2002-03 fiscal years will be
released on or before July 30, 1998. The update to the State's financial
projections based upon Generally Accepted Accounting Principles (GAAP) will be
released on or before September 1, 1998.
The Legislature adopted the debt service component of the State budget
for the 1998-99 fiscal year on March 30,1998 and the remainder of the budget on
April 18, 1998. In the period prior to adoption of the budget for die current
fiscal year, the Legislature also enacted appropriations to permit the State to
continue its operations and provide for other purposes. On April 25, 1998, the
Governor vetoed certain items that the Legislature added to the Executive
Budget. The Legislature had not overridden any of the Governors vetoes as of the
start of the legislative recess on June 19, 1998 (under the State Constitution,
the Legislature can override one or more of the Governor's vetoes with the
approval of two-thirds of the members of each house).
General Fund disbursements in 1998-99 are now projected to grow by
$2.43 billion over 1997-98 levels, or $690 million more than proposed in the
Governor's Executive Budget, as amended. The change in General Fund
disbursements from the Executive Budget to the enacted budget reflects
legislative additions (net of the value of the Governor's vetoes), actions taken
at the end of the regular legislative session, as well as spending that was
originally anticipated to occur in 1997-98 but is now expected to occur in
1998-99. The State projects that the 1998-99 State Financial Plan is balanced on
a cash basis, with an estimated reserve for future needs of $761 million.
The State's enacted budget includes several new multi-year tax
reduction initiatives, including acceleration of State-funded property and local
income tax relief for senior citizens under the School Tax Relief Program
(STAR), expansion of the child care income-tax credit for middle-income
families, a phased-in reduction of the general business tax, and reduction of
several other taxes and fees, including an accelerated phase-out of
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assessments on medical providers. The enacted budget also provides for
significant increases in spending for public schools, special education
programs, and for the State and City university systems. It also allocates $50
million for a new Debt Reduction Reserve Fund (DRRF) that may eventually be used
to pay debt service costs on or to prepay outstanding State-supported bonds.
The 1998-99 State Financial Plan projects a closing balance in the
General Fund of $1.42 billion that is comprised of a reserve of $761 million
available for future needs, a balance of $400 million in the Tax Stabilization
Reserve Fund (TSRF), a balance of $158 million in the Community Projects Fund
(CPF), and a balance of $100 million in the Contingency Reserve Fund (CRF). The
TSRF can be used in the event of an unanticipated General Fund cash operating
deficit, as provided under the State Constitution and State Finance Law. The CPF
is used to finance various legislative and executive initiatives. The CRF
provides resources to help finance any extraordinary litigation costs during the
fiscal year.
Many complex political, social and economic forces influence the
State's economy and finances, which may in turn affect the State's Financial
Plan. These forces may affect the State unpredictably from fiscal year to fiscal
year and are influenced by governments, institutions, and organizations that are
not subject to the State's control. The State Financial Plan is also necessarily
based upon forecasts of national and State economic activity. Economic forecasts
have frequently failed to predict accurately the timing and magnitude of changes
in the national and the State economies. The Division of Budget believes that
its projections of receipts and disbursements relating to the current State
Financial Plan, and the assumptions on which they are based, are reasonable.
Total General Fund receipts in 1998-99 are projected to be $37.56
billion, an increase of over $3 billion from the $34.55 billion recorded in
1997-98. This total includes $34.36 billion in tax receipts, $1.40 billion in
miscellaneous receipts, and $1.80 billion in transfers from other funds.
The transfer of a portion of the surplus recorded in 1997-98 to 1998-99
exaggerates the "real" growth in State receipts from year to year by depressing
reported 1997-98 figures and inflating 1998-99 projections. Conversely, the
incremental cost of tax reductions newly effective in 1998-99 and the impact of
statutes earmarking certain tax receipts to other funds work to depress apparent
growth below the underlying growth in receipts attributable to expansion of the
State's economy. On an adjusted
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basis, State tax revenues in 1998-99 fiscal year are projected to grow at
approximately 7.5 percent, following an adjusted growth roughly nine percent in
the 1997-98 fiscal year.
The personal income tax is imposed on die income of individuals,
estates and trusts and is based with certain I ns on federal definitions of
income and deductions. This tax continues to account for over half of the
State's General Fund receipts base. Net personal income tax collections are
projected to reach $21.24 billion, nearly $3.5 billion above the reported
1997-98 collection total. Since 1997 represented the completion of the 20
percent income tax reduction program enacted in 1995, growth from 1997 to 1998
will be unaffected by major income tax reductions. Adding to the projected
annual growth is the net impact of the transfer of the surplus from 1997-98 to
the current year which affects reported collections by over $2.4 billion on a
year-over-year basis, as partially offset by the diversion of slightly over
$700 million in income tax receipts to the STAR fund to finance the initial year
of the school tax reduction program. The STAR program was enacted in 1997 to
increase the State share of school funding and reduce residential school taxes.
Adjusted for these transactions, the growth in net income tax receipts is
roughly $1.7 billion, an increase of over 9 percent. This growth is largely a
function of over 8 percent growth in income tax liability projected for 1998 as
well as the impact of the 1997 tax year settlement on 1998-99 net collections.
User taxes and fees are comprised of three-quarters of the State four
percent sales and use tax (the balance, one percent, flows to support Local
Government Assistance Corporation (LGAC) debt service requirements), cigarette,
alcoholic beverage, container, and auto rental taxes, and a portion of the motor
fuel excise levies. Also included in this category am receipts from the motor
vehicle registration fees and alcoholic beverage license fees. A portion of the
motor fuel tax and motor vehicle registration fees and all of the highway use
tax are earmarked for dedicated transportation funds.
Receipts from user taxes and fees are projected to total $7.14 billion,
an increase of $107 million from reported collections in the prior year. The
sales tax component of this category accounts for all of the 1998-99 growth, as
receipts from all other sources decline $100 million. The growth in yield of the
sales tax in 1998-99, after adjusting for tax law and other changes, is
projected at 4.7 percent. The yields of most of the excise taxes in this
category show a long-term declining trend, particularly cigarette and alcoholic
beverage taxes. These General Fund declines are exacerbated in 1998-99 by
revenue losses from scheduled and enacted tax reductions, and by an
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increase in earmarking of motor vehicle registration fees to the Dedication
Highway and Bridge Trust Fund.
Business taxes include franchise taxes based generally on net income of
general business, bank and insurance corporations, as well as
gross-receipts-based taxes on utilities and gallonage-based petroleum business
taxes. Beginning in 1994, a IS percent surcharge on these levies began to be
phased out and, for most taxpayers, there is no surcharge liability for taxable
periods ending in 1997 and thereafter.
Total business tax collections in 1998-99 are now projected to be $4.96
billion, $91 million less than received in the prior fiscal year. The category
includes receipts from the largely income-based levies on general business
corporations, banks and insurance companies, gross receipts taxes on energy and
telecommunication service providers and a per-gallon imposition on petroleum
business. The year-over-year decline in projected receipts in this category is
largely attributable to statutory changes between the two years. These include
the first year of utility-tax rate cuts and the Power for Jobs tax reduction
program for energy providers, and the scheduled additional diversion of General
Fund petroleum business and utility tax receipts to other funds. In addition,
profit growth is also expected to slow in 1998.
Other taxes include receipts include estate, gift and real estate
transfer taxes, a tax on gains from the sale or transfer certain real estate
(this tax was repealed in 1996), a pari-mutuel tax and other minor levies. They
are no projected to total $1.02 billion - $75 million below last year's amount.
Two factors account for a significant part of the expected decline in
collections from this category. First, the effects of the elimination of the re
property gains tax collections; second, a decline in estate tax receipts,
following the explosive growth recorded in 1997-98, when receipts expanded by
over 16 percent.
Miscellaneous receipts include investment income, abandoned property
receipts, medical provider assessments, minor federal grants, receipts from
public authorities, and certain other license and fee revenues. Total
miscellaneous receipts are projected to reach $1.40 billion, down almost $200
million from the prior year, reflecting the loss of non-recurring receipts in
1997-98 and the growing effects of the phase-out of the medical provider
assessments.
Transfers from other funds to the General Fund consist primarily of tax
revenues in excess of debt one percent sales tax used to support payments to
LGAC. Transfers from other funds are
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expected to total $1.8 billion, or $222 million less than total receipts from
this category during 1997-98. Total transfers of sales taxes in excess of LGAC
debt service requirements are expected by approximately $51 million, while
transfers from all other funds are expected to fall by $273 million, primarily
reflecting the absence, in 1998-99, of a one-time transfer of nearly $200
million for retroactive reimbursement of certain social services claims from the
federal government.
General Fund disbursements in 1998-99, including transfers to support
capital projects, debt service and other funds are estimated at $36.78 billion.
This represents an increase of $2.43 billion or 7.1 percent from 1997-98. Nearly
one-half of the growth is for educational purposes, reflecting increased support
for public schools, special education programs and the State and City university
systems. The remaining increase is primarily for Medicaid, mental hygiene, and
other health and social welfare programs, including children and family
services. The 1998-99 Financial Plan also includes funds for the current
negotiated salary increases for State employees, as well as increased transfers
for debt service.
Grants to Local Governments is the largest category of General Fund
disbursements and includes financial assistance to local governments and
not-for-profit corporations, as well as entitlement benefits to individuals. The
1998-99 Financial Plan projects spending of $25.14 billion in this category, an
increase of $1.88 billion or 8.1 percent over the prior year. The largest annual
increases are for educational p Medicaid, other health and social welfare
programs, and community projects grants.
State operations spending reflects the administrative costs of
operating the State's agencies, including the prison system, mental hygiene
institutions, the State University system (SUNY), the Legislature, and the court
system. Personal service costs account for approximately 73 percent of spending
in this category. Since January 1995, the State's workforce has been reduced by
about 10 percent and is projected to remain at its current level of
approximately 19 1,000 persons in 1998-99.
State operations spending is projected at $6.70 billion, an increase of
$511 million or 8.3 percent the prior year. This increase is primarily due to an
additional payroll cycle in 1998-99, a 3.5 percent general salary increase on
October 1, 1998 for most State employees, the loss of federal receipts that
would otherwise lower General Fund spending in mental hygiene programs, and a
projected 15.6 percent increase in the Judiciary's budget.
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Disbursements in General State charges are estimated at $2.22 billion,
a decrease of $50 million from the prior year.
Debt service paid from the General Fund reflects debt service on
short-term obligations of the State, and includes only interest costs on the
State's commercial paper program. The 1998-99 debt service estimate is $11
million, reflecting relative stability in short-term interest rates. The State's
short-term TRAN borrowing program was eliminated in 1995.
Transfers to other funds from the General Fund are made primarily to
finance certain portions of State capital projects spending and debt service on
long-ten-n bonds where these costs are not funded from other sources. Transfers
in support of debt service are projected at $2.13 billion in 1998-99, an
increase of $110 million from 1997-98. The increase reflects the impact of
certain prior year bond sales (not of refunding savings), and certain bond sales
planned to occur during the 1998-99 fiscal year. The State Financial Plan also
establishes a transfer of $50 million to the new Debt Reduction Reserve Fund.
The Fund may be used, subject to enactment of new appropriations, to pay the
debt service costs on or to prepay State-supported bonds. Transfers in support
of capital projects provide General Fund support for projects not otherwise
financed through bond proceeds, dedicated taxes and other revenues, or federal
grants. These transfers are projected at $200 million for 1998-99, comparable to
last year. Remaining transfer's from the General Fund to other funds are
estimated to decline $59 million in 1998-99 to $327 million. This decline is
primarily the net impact of one-time transfers in 1997-98 to the State
University Tuition Stabilization Fund and to the Lottery Fund to support school
aid, offset by a 1998-99 increase in the State subsidy to the Roswell Park
Cancer Research Institute.
Special Revenue Funds are used to account for the proceeds of specific
revenue sources such as federal grants that are legally restricted, either by
the Legislature or outside parties, to expenditures for specified purposes.
Although activity in this fund type is expected to comprise approximately 41
percent of total governmental funds receipts in the 1998-99 fiscal year,
three-quarters of that activity relates to federally-funded programs.
Total disbursements for programs supported by Special Revenue Funds are
projected at $29.97 billion, an increase of $2.32 billion or 8.4 percent from
1997-98. Federal grants account for approximately three-quarters of all spending
in the Special Revenue fund type. Disbursements from federal funds are estimated
at $21.78 billion, an increase of $1.12 billion or 5.4 percent.
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The single largest program in this fund group is Medicaid, which is projected at
$13.65 billion, an increase of $465 million or 3.5 percent above last year.
Federal support for welfare programs is projected at $2.53 billion, similar to
1997-98. The remaining growth in federal funds is primarily due to the new Child
Health Plus program, estimated at $197 million in 1998-99. This program will
expand health insurance coverage to children of indigent families.
State special revenue spending is projected to be $8.19 billion, an
increase of $1.20 billion or 17.2 percent from last year's levels. Most of this
projected increase in spending is due to the $704 million cost of the first
phase of the STAR program, as well as $231 million in additional operating
assistance for mass transportation, and $113 million for the State share of the
new Child Health Plus program.
Capital Projects Funds account for the financial resources used in the
acquisition, construction, or rehabilitation of major State capital facilities,
and for capital assistance grants to certain local governments or public
authorities. This fund type consists of the Capital Projects Fund, which is
supported by tax receipts transferred from the General Fund, and various other
capital funds established to distinguish specific capital construction purposes
supported by other revenues. In the 1998-99 fiscal year, activity in these funds
is expected to comprise 5.5 percent of total governmental receipts.
Capital Projects Funds spending in fiscal year 1998-99 is projected at
$4.14 billion, an increase of $575 million or 16.1 percent from last year. The
major components of this expected growth are transportation and environmental
programs, including continued increased spending for 19196 Clean Water/Clean Air
Bond Act projects and higher projected disbursements from the Environmental
Protection Fund (EPF). Another significant component of this projected increase
is in the area of public protection, primarily for facility rehabilitation and
construction of additional prison capacity.
State law requires the Governor to propose a balanced budget each year.
In recent years, the State has closed projected budget gaps of $5.0 billion
(1995-96), $3.9 billion (1996-97), $2.3 billion (1997-98), and less than $1
billion (1998-99). The State, as a part of the 1998-99 Executive Budget
projections submitted to the Legislature in February 1998, projected a 1999-00
General Fund budget gap of approximately $1.77 billion and a 2000-01 gap of $3.7
billion. As a result of changes made in the 1998-99 enacted budget, the 1999-00
gap is now expected to be roughly $1.3 billion, or about $400 million less than
previously
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projected, after application of reserves created as part of the 1998-99 budget
process. Such reserves would not be available against subsequent year
imbalances.
Sustained growth in the State's economy could contribute to closing
projected budget gaps over the next several years, both in terms of
higher-than-projected tax receipts and in lower-than-expected entitlement
spending. However, the State's projections in 1999-00 currently assume actions
to achieve $600 million in lower disbursements and $250 million in additional
receipts from the settlement of State claims against the tobacco industry.
Consistent with past practice, the projections do not include any costs
associated with new collective bargaining agreements after the expiration of the
current round of contracts at the end of the 1998-99 fiscal year. The State
expects that the 1999-00 Financial Plan will achieve savings from initiatives by
State agencies to deliver services more efficiently, workforce management
efforts, maximization of federal and non-General Fund spending offsets, and
other actions necessary to bring projected disbursements and receipts into
balance.
The State will formally update its outyear projections of receipts and
disbursements for the 2000-01 and 2001-02 fiscal years as a part of the 1999-00
Executive Budget process, as required by law. The revised expectations for years
2000-01 and 2001-02 will reflect the cumulative impact of tax reductions and
spending commitments enacted over the last several years as well as new 1999-00
Executive Budget recommendations. The STAR program, which dedicates a portion of
personal income tax receipts fund school tax reductions, has a significant
impact on General Fund receipts. STAR is projected to reduce personal income tax
revenues available to the General Fund by an estimated $1.3 billion in 2000-01.
Measured from the 1998-99 base, scheduled reductions to estate and gift sales
and other taxes, reflecting tax cuts enacted in 1997-98 and 1998-99, will lower
General Fund taxes and fees by an estimated $1.8 billion in 2000-01.
Disbursement projections for the outyears currently assume additional outlays
for school aid, Medicaid, welfare reform, mental health community reinvestment,
and other multi-year spending commitments in law.
The Division of the Budget believes that the economic assumptions and
projections of receipts and disbursements accompanying the 1998-99 Executive
Budget are reasonable. However, the economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. Those factors can be very complex, can vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State but
by entities, such as the federal
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government, that are outside the State's control. Because of the uncertainty and
unpredictability of changes in these factors, their impact cannot be fully
included in the assumptions underlying the State's projections. For example,
there can be no assurance that the Legislature will enact the Governor's
proposals or that the State's actions will be sufficient to preserve budgetary
balance or to align recurring receipts and disbursements in either 1998-99 or in
future fiscal years.
Uncertainties with regard to the economy present the largest potential
risk to future budget balance in New York State. This risk includes either a
financial market or broader economic "correction" during the period, a risk
heightened by the relatively lengthy expansions currently underway. The
securities industry is more important to the New York economy than the national
economy, and a significant deterioration in stock market performance could
ultimately produce adverse changes in wage and employment levels. In addition, a
normal "forecast error" of one percentage point in the expected growth rate
could cumulatively raise or lower receipts by over $1 billion by the last year
of the 1998 through 2001 projection period. On the other hand, the national or
State economy may continue to perform better than projected, which could produce
beneficial short-term results in State receipts.
The State anticipates that its capital programs will be financed, in
part, through borrowings by the State and its public authorities in the 1998-99
fiscal year. The State expects to issue $528 million in general obligation bonds
(including $154 million for purposes of redeeming outstanding BANs) and $154
million in general obligation commercial paper. The State also anticipates the
issuance of up to a total of $419 million in Certificates of Participation to
finance equipment purchases (including costs of issuance, reserve funds, and
other costs) during the 1998-99 fiscal year. Of this amount, it is anticipated
that approximately $191 million will be issued to finance agency equipment
acquisitions, including amounts to address Statewide technology issues related
to Year 2000 compliance. Approximately $228 million will also be issued to
finance equipment acquisitions for welfare reform-related information technology
systems.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. These factors can be
very complex, may vary from fiscal year to fiscal year, and are frequently the
result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the federal government, that
are not under the control of the State. Because
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of the uncertainty and unpredictability of these factors, their impact cannot,
as a practical matter, be included in the assumptions underlying the State's
projections at this time.
The State Financial Plan is based upon forecasts of national and State
economic activity developed through both internal analysis and review of State
and national economic forecasts prepared by commercial forecasting services and
other public and private forecasters. Economic forecasts have frequently failed
to predict accurately the timing and magnitude of changes in the national and
the State economies. Many uncertainties exist in forecasts of both the national
and State economies, including consumer attitudes toward spending, the extent of
corporate and governmental restructuring, the condition of the financial sector,
federal fiscal and monetary policies, the level of interest rates, and the
condition of the world economy, which could have an adverse effect on the State.
There can be no assurance that the State economy will not experience results in
the current fiscal year that are worse than predicted, with corresponding
material and adverse effects on the State's projections of receipts and
disbursements.
Projections of total State receipts in the Financial Plan are based on
the State tax structure n effect during the fiscal year and on assumptions
relating to basic economic factors and their historical relationships to State
tax receipts. In preparing projections of State receipts, economic forecasts
relating to personal income, wages, consumption, profits and employment have
been particularly important. The projection of receipts from most tax or revenue
sources is generally made by estimating the change in yield of such tax or
revenue source caused by economic and other factors, rather than by estimating
the total yield of such tax or revenue source from its estimated tax base. The
forecasting methodology, however, ensures that State fiscal year collection
estimates for taxes that are based on a computation of annual liability, such as
the business and personal income taxes, are consistent with estimates of total
liability under such taxes.
Projections of total State disbursements are based on assumptions
relating to economic and demographic factors, levels of disbursements for
various services provided by local governments (where the cost is partially
reimbursed by the State), and the results of various administrative and
statutory mechanisms in controlling disbursements for State operations. Factors
that may affect the level of disbursements in the fiscal year include
uncertainties relating to the economy of the nation and the State, the policies
of the federal government, and changes in the demand for and use of State
services.
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An additional risk to the State Financial Plan arises from the
potential impact of certain litigation and of federal disallowances now pending
against the State, which could adversely affect the State's projections of
receipts and disbursements. The State Financial Plan assumes no significant
litigation or federal disallowance or other federal actions that could affect
State finances, but has significant reserves in the event of such an action.
The Division of the Budget believes that its projections of receipts
and disbursements relating to the current State Financial Plan, and the
assumptions on which they are based, are reasonable. Actual results, however,
could differ materially and adversely from the projections set fort herein. In
the past the State has taken management actions to address potential Financial
Plan shortfalls, and DOB believes it could take similar actions should variances
occur in its projections for the current fiscal year.
Despite recent budgetary surpluses recorded by the State, actions
affecting the level of receipts and disbursements, the relative strength of the
State and regional economy, and actions by the federal government have helped to
create projected structural budget gaps for the State. These gaps result from a
significant disparity between recurring revenues and the costs of maintaining or
increasing the level of support for State programs. To address a potential
imbalance in any given fiscal year, the State would be required to take actions
to increase receipts and/or reduce disbursements as it enacts the budget for
that year, and, under the State Constitution, the Governor is required to
propose a balanced budget each year. There can be no assurance, however, that
the Legislature will enact the Governor's proposals or that the State's actions
will be sufficient to preserve budgetary balance in a given fiscal year or to
align recurring receipts and disbursements in future fiscal years. For example,
the fiscal effects of tax reductions adopted in the last several fiscal years
(including 1998-99) are projected to grow more substantially beyond the 1998-99
fiscal year, with the incremental annual cost of all currently enacted tax
reductions estimated at over $4 billion by the time they are fully effective in
State fiscal year 2002-03. These actions will place pressure on future budget
balance in New York State.
New York State is currently addressing "Year 2000" data processing
compliance issues. The Year 2000 compliance issue ("Y2K") arises because most
computer software programs allocate two digits to the data field for "year" on
the assumption that the first two digits will be "19". Such programs will thus
interpret the year 2000 as the year 1900 absent reprogramming.
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Y2K could impact both the ability to enter data into computer programs and the
ability of such programs to correctly process data. There can be no guarantee,
however, that all of the State's mission-critical and high-priority computer
systems will be Year 2000 compliant and that there will not be an adverse impact
upon State operations or State finances as a result.
Constitutional challenges to State laws have limited the amount of
taxes which political subdivisions can impose on real property. In 1979, the
State's highest court declared unconstitutional a State law allowing localities
and school districts to impose a special increase in real estate property taxes
in order to raise funds for pensions and other uses. Additional court actions
have been brought against the State, certain agencies and municipalities
relating to financing, the amount of real estate tax, the use of tax revenues
and other matters.
An additional risk to the 1998-99 State Financial Plan arises from the
potential impact of certain litigation now pending against the State, which
could produce adverse effects on the State's projections of receipts and
disbursements.
Certain litigation pending against the State, its subdivisions and
their officers and employees could have a substantial and long-term adverse
effect on State finances. The State is a party to numerous legal proceedings,
many of which normally recur in governmental operations. Because of the
prospective nature of these proceedings, no estimate of the potential loss can
be made.
The State is a defendant in numerous legal proceedings pertaining to
matters incidental to the performance of routine governmental operations. Such
litigation includes, but is not limited to, claims asserted against the State
arising from alleged torts, alleged breaches of contracts, condemnation
proceedings and other alleged violations of State and Federal laws.
Included in the State's outstanding litigation are a number of cases
challenging the legality or the adequacy of a variety of significant social
welfare programs primarily involving the State's Medicaid and mental health
programs. Adverse judgments in these matters generally could result in
injunctive relief coupled with prospective changes in patient care which could
require substantial increased financing of the litigated programs in the future.
Because of the prospective nature of these matters, no provision for this
potential exposure has been made in the accompanying general purpose financial
statements.
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Actions commenced by several Indian nations claim that significant
amounts of land were unconstitutionally taken from the Indians in violation of
various treaties and agreements during the eighteenth and nineteenth centuries.
The claimants seek recovery of approximately six million acres of land as well
as compensatory and punitive damages.
In addition, the State is party to other claims and litigation which
its legal counsel has advised are not probable of adverse court decisions.
Although the amounts of potential losses, if any, are not presently
determinable, it is the State's opinion that its ultimate liability in these
cases is not expected to have a material adverse effect on the State's financial
position.
The national economy has maintained a robust rate of growth during the
past six quarters as the expansion, which is well into its seventh year,
continues. Since early 1992, approximately 16-1/2 million jobs have been added
nationally. The State economy has also continued to expand, but growth remains
somewhat slower than in the nation. Although the State has added over 400,000
jobs since late 1992, employment growth in the State has been hindered during
recent years by significant cutbacks in the computer and instrument
manufacturing, utility, defense, and banking industries. Government downsizing
has also moderated these job gains.
The fiscal health of the State may also be affected by the fiscal
health of New York City (City), which continues to receive significant financial
assistance from the State. State aid contributes to the City's ability to
balance its budget and meet its cash requirements. The State may also be
affected by the ability of the City and certain entities issuing debt for the
benefit of the City to market their securities successfully in the public credit
markets.
The City has achieved balanced operating results for each of its fiscal
years since 1981 as measured by the GAAP standards in force at that time. The
City prepares a four-year financial plan (Financial Plan) annually and updates
it periodically, and prepares a comprehensive annual financial report describing
its most recent fiscal year each October.
Certain localities outside New York City have experienced financial
problems and have requested and received additional State assistance during the
last several State fiscal years. The cities of Yonkers and Troy continue to
operate under State-ordered control agencies. The potential impact on the State
of any future requests by localities for additional oversight or
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financial assistance is not included in the projections of the State's receipts
and disbursements for the State's 1998-99 fiscal year.
Eighteen municipalities received extraordinary assistance during the
1996 legislative session through $50 million in special appropriations targeted
for distressed cities, and twenty-eight municipalities received more than $32
million in targeted unrestricted aid in the 1997-98 budget. Both of these
emergency aid packages were largely continued through the 1998-99 budget. The
State also dispersed an additional $21 million among all cities, towns and
villages after enacting a 3.9 percent increase in General Purpose State Aid in
1997-98 and continued this increase in 1998-99.
The 1998-99 budget includes an additional $29.4 million in unrestricted
aid targeted to 57 municipalities across the State. Other assistance for
municipalities with special needs totals more than $25.6 million. Twelve upstate
cities will receive $24.2 million in one-time assistance from a cash flow
acceleration of State aid.
The appropriation and allocation of general purpose local government
aid among localities, including New York City, is currently the subject of
investigation by a State commission. While the distribution of general purpose
local government aid was originally based on a statutory formula, in recent
years both the total amount appropriated and the amounts appropriated to
localities have been determined by the Legislature. A State commission was
established to study the distribution and amounts of general purpose local
government aid and recommend a new formula by June 30, 1999, which may change
the way aid is allocated.
Municipalities and school districts have engaged in substantial
short-term and long-term borrowings. In 1996, the total indebtedness of all
localities in the State other than New York City was approximately $20.0
billion. A small portion (approximately $77.2 million) of that indebtedness
represented borrowing to finance budgetary deficits and was issued pursuant to
enabling State legislation. State law requires the Comptroller to review and
make recommendations concerning the budgets of those local government units
other than New York City that are authorized by State law to issue debt to
finance deficits during the period that such deficit financing is outstanding.
Twenty-one localities had outstanding indebtedness for deficit financing at the
close of their fiscal year ending in 1996.
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Like the State, local governments must respond to changing political,
economic and financial influences over which they have little or no control.
Such changes may adversely affect the financial condition of certain local
governments. For example, the federal government may reduce (or in some cases
eliminate) federal funding of some local programs which, in turn, may require
local governments to fund these expenditures from their own resources. It is
also possible that the State, New York City, or any of their respective public
authorities may suffer serious financial difficulties that could jeopardize
local access to the public credit markets, which may adversely affect the
marketability of notes and bonds issued by localities within the State.
Localities may also face unanticipated problems resulting from certain pending
litigation, judicial decisions and long-range economic trends. Other large-scale
potential problems, such as declining urban populations, increasing
expenditures, and the loss of skilled manufacturing jobs, may also adversely
affect localities and necessitate State assistance.
SPECIAL CONSIDERATIONS AFFECTING PUERTO RICO
The following highlights some of the more significant financial trends
and problems affecting the Commonwealth of Puerto Rico (the Commonwealth or
Puerto Rico) and is based on information drawn from official statements and
prospectuses relating to the securities offerings of Puerto Rico and its
agencies and instrumentalities. Such information, however, has not been
independently verified by the Trust.
The Government of Puerto Rico has established programs directed at
developing the manufacturing and service sectors (with emphasis on the tourism
industry) of the economy and expanding and modernizing the island's
infrastructure. Domestic and foreign investment has been stimulated by selective
tax exemption, development loans, and other financial and tax incentives.
Infrastructure expansion and modernization have been to a large extent financed
by bonds and notes issues by the Commonwealth, its public corporations and
municipalities. Economic progress has been aided by significant increases in the
levels of education and occupational skills of the island's population.
The economy of Puerto Rico is fully integrated with that of the United
States mainland. During fiscal 1997, approximately 88% of Puerto Rico's exports
went to the United States mainland, which was also the source of approximately
62% of Puerto Rico's imports. In fiscal 1997, Puerto Rico experienced a $2.7
billion positive adjusted merchandise trade balance.
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The dominant sectors of the Puerto Rico economy are economy are
manufacturing and services. The manufacturing sector has experienced a basis
change over the years as a result of increased emphasis on higher wage, high
technology industries, such as pharmaceuticals, electronics, computers,
microprocessors, professional and scientific instruments, and certain high
technology machinery and equipment. The services sector, including finance,
insurance, real estate, wholesale and retail trade, and hotel and related
services, also plays a major role in economy It rates second only to
manufacturing in contribution to the gross domestic product and leads all
sectors in providing employment. In recent years, the services sector has
experienced significant growth in response to the expansion of the manufacturing
sector.
Puerto Rico's more than decade-long economic expansion continued
throughout the five-year period from fiscal 1993 through fiscal 1997. Almost
every sector of the economic participated and record levels of employment were
achieved. Factors behind this expansion included government-sponsored economic
development programs, periodic declines in the exchange value of the United
States dollar, increases in the level of federal transfers, and the relatively
low cost of borrowing.
Gross product in fiscal 1993 was $25.1 ($24.5 billion in 1992 prices)
and gross product in fiscal 1997 was $32.1 billion ($27.7 billion in 1992
prices). This represents an increase in gross product of 27.7% from fiscal 1993
to 1997 (13.0% in 1992 prices).
Since fiscal 1985, personal income, both aggregate and per capita, has
increased consistently each fiscal year. In fiscal 1997, aggregate personal
income was $32.1 billion ($30.0 billion in 1992 prices) and personal income per
capita was $8,509 ($7,957 in 1992 prices).
Personal income includes transfer payments to individuals in Puerto
Rico under various social programs. Total federal payments to Puerto Rico, which
include transfers to local government entities and expenditures of federal
agencies in Puerto Rico, in addition to federal transfer payments to
individuals, are lower on a per capita basis in Puerto Rico than in any state.
Transfer payments to individuals in fiscal 1997 were $7.3 billion, of which $5.2
billion, or 71.6%, represented entitlements to individuals who had previously
performed services or made contributions under programs such as Social Security,
Veteran's Benefits, Medicare and U.S. Civil Service retirement pensions.
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According to the Labor Department's Household Employment Survey, during
the first eight months of fiscal 1998, total employment increased 0.4% over the
same period in fiscal 1997. total monthly employment averaged 1,129,000 during
the first eight months of fiscal 1998, compared to 1,124,500 in the same period
of fiscal 1997. The seasonally adjusted unemployment rate for February 1998 was
14.1%.
The Planning Board's gross product forecast for fiscal 1998, made in
February 1998, projected an increase of 3.0% over fiscal 1997.
Puerto Rico has a diversified economy. During the period between fiscal
1993 and 1997, the manufacturing and services sectors generated the largest
portion of gross domestic product. Three sectors of the economy provide the most
employment: manufacturing, services and government.
For many years, United States companies operating in Puerto Rico
enjoyed a special tax credit that was available under Section 936 of the Code.
Originally, the credit provided an effective 100% federal tax exemption for
operating and qualifying investment income from Puerto Rico sources. Amendments
to Section 936 made in 1993 instituted two alternative methods for calculating
the credit and limited the amount of the credit that a qualifying company could
claim. These limitations area based on a percentage of qualifying income and on
qualifying expenditures on wages, other wage related benefit and qualifying
expenditures. As a result of amendments incorporated in the Small Business Job
Protection Act of 1996 enacted by the United States Congress and signed into law
by President Clinton on August 20, 1996, the tax credit is now being phased out
over a ten-year period for existing claimants and is no longer available for
corporations that establish operations in Puerto Rico after October 13, 1995
(including existing Section 936 Corporations to the extent substantially new
operations are established in Puerto Rico), the 1996 Amendments also moved the
credit based on the economic activity limitation to Section 30A of the Code and
phased it out over 10 years. In addition, the 1996 Amendments eliminated the
credit previously available for income derived from certain qualified
investments in Puerto Rico.
During 1997, Governor Rossello proposed to Congress the enactment of a
new permanent federal incentive program similar to what is now provided under
Section 30A. Such program would provide U.S. companies a tax credit based on
qualifying wages paid and other wage related expenses, such as fringe benefits,
as well as depreciation expenses for certain tangible assets and research and
development expenses. Under the Governor's
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proposal, the credit granted to qualifying companies would continue to effect
until Puerto Rico shows, among other things, substantial economic improvements
in terms of certain economic parameters. The fiscal 1998 budget submitted by
President Clinton to Congress in February 1997 included a proposal to modify
Section 30A to (I) extend the availability of the Section 30A Credit
indefinitely, (ii) make it available to companies establishing operations in
Puerto Rico after October 13, 1995, and (iii) eliminate the income cap. Although
said proposal was not included in the final fiscal 1998 federal budget,
President Clinton's fiscal 1999 budget submitted to Congress again included
these modifications to Section 30A. While the Government of Puerto Rico plans to
continue lobbying for this proposal, it is not possible at this time to predict
whether the Section 30A Credit will be modified.
It is not possible at this time to determine the long-term effect on
the Puerto Rico economy of the enactment of the 1996 Amendments. The Government
of Puerto does not believe there will be short-term or medium-term material
adverse effects on Puerto Rico's economy as a result of the enactment of the
1996 Amendment. The Government incentive programs to safeguard Puerto Rico's
competitive position.
Section 2 of Article VI of the Constitution of Puerto Rico provides
that direct obligations of the Commonwealth evidenced by full faith and credit
bonds or notes shall not be issued if the amount of the principal of and
interest on such bonds and notes and on all such bonds and notes theretofore
issued which is payable in any fiscal year, together with any amount paid by the
Commonwealth in the preceding fiscal year on account of bonds or notes
guaranteed by the Commonwealth, exceeds 15% of the average annual revenues
raised under the provisions of Commonwealth legislations and covered into the
Treasury of Puerto Rico in the two fiscal years proceeding the then current
fiscal year. Section 2 of Article VI does not limit the amount of debt that the
Commonwealth may guarantee so long as the 15% limitation is not exceeded.
Internal revenues consist principally of income taxes, property taxes and excise
taxes. Certain revenues, such as federal excise taxes on offshore shipments of
alcoholic beverages and tobacco products and customs duties, which are collected
by the United States Government and returned to the Treasury of Puerto Rico, and
motor vehicle fuel taxes and license fees, which are allocated to the Highway
Authority, are not included as internal revenues for the purpose of calculating
the debt limit, although they may be available for the payment of debt service.
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On February 26, 1997 legislation was introduced in the U.S. House of
Representatives proposing a mechanism to settle permanently the political
relationship between Puerto Rico and the United States, either through full
self-government (e.g., statehood or independence, including, as an alternative,
free association via a bilateral treaty) or continued commonwealth status. Under
the proposed legislation, failure to settle on full self-government after
completion of the referenda process provided therein would result in retention
of the current commonwealth status. On March 19, 1997, similar legislation was
introduced in the U.S. Senate. On March 4, 1998, the U.S. House of
Representatives voted in favor of the Political Status Act. It is not possible
at this time to predict, however, what course the legislation will follow in the
Senate, and whether it will be subsequently enacted into law.
With respect to pending and threatened litigation, excluding the
litigation mentioned in the following paragraph, the Commonwealth has reported
liabilities of approximately $106 million for awarded and anticipated
unfavorable judgments. This amount was included as other long-term liabilities
in the general long-term debt account group and represents the amount estimated
as a probable liability or a liability with a fixed or expected due date which
will require future available financial resources for its payment. Management
believes that the ultimate liability in excess of amounts provided, if any,
would not be significant.
The Commonwealth and various component units are defendants in a
lawsuit alleging violations of civil rights. Preliminary hearings and discovery
proceedings are in progress. The amounts claimed exceed $50 billion; however,
the ultimate liability cannot be presently determined. It is the opinion of
management that the claim is excessive and exaggerated. No provision for any
liability that may result upon adjudication of this lawsuit has been recognized
in the financial statements by the Commonwealth.
On January 22, 1996, the US District Court in Puerto Rico consolidated
all cases against the Commonwealth related to the complaints filed in 1979 by
the inmates of the correctional facilities in Puerto Rico. The Court ruled a
permanent order requiring the Commonwealth to comply with the requirement of the
minimum fixed living space per inmate. In the opinion of management, based on
advice of their legal counsel, this order will limit the imposition of further
fines and the fines already paid together with the accrued liability the general
long-term debt account group, (which amount to approximately $200 million at
June 30, 1997) shall be sufficient to carry out the Court's requirement.
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THE EQUITY INDEX FUND GUARANTEE
NYLIFE Inc. ("NYLIFE") and the Equity Index Fund have entered into a
Guaranty Agreement (the "Guarantee") for the benefit of shareholders. The
Guarantee has been issued for the benefit of all shareholders and has been
issued at no cost to the Equity Index Fund or its shareholders. The Guarantee
Date (as defined in the Prospectus) with respect to a particular Equity Index
Fund share will be 10 years after the purchase date of such share. If, on a
particular Guarantee Date, payments must be made under the terms of the
Guarantee, the terms of the Guarantee will obligate NYLIFE unconditionally and
irrevocably to pay to the Equity Index Fund's transfer and dividend disbursing
agent for the benefit of shareholders with that Guarantee Date an amount equal
to the difference between the Guaranteed Amount and net asset value per each
Guaranteed Share (as defined in the Prospectus) outstanding. The Equity Index
Fund's transfer and dividend disbursing agent will forward the difference
between the Guaranteed Amount and the net asset value directly to each
individual shareholder.
A Guaranteed Share is a unit that will at all times be equal to the net
asset value of one share initially purchased by the investor plus the net asset
value of all dividends and distributions attributable to such share (which
includes cumulative dividends and distributions paid with respect to any
additional shares of the Fund received as dividends and distributions) paid
during the period from the date of purchase to the Guarantee Date. A Guaranteed
Share (the unit to which the Guaranteed Amount will apply) is not the same as a
share of the Fund. Shareholders who redeem shares, or who elect to receive
dividends and distributions in cash, will own fewer units to which the
Guaranteed Amount applies (i.e., they will own fewer Guaranteed Shares) and
therefore will lose a portion of the benefit of the Guarantee with respect to
any such redemption or dividends or distributions received in cash.
NYLIFE will pay any amounts owing under the Guarantee to the Fund's
transfer and dividend disbursing agent on the third business day following a
Guarantee Date. A pro rata portion of any amounts so paid will then be forwarded
to each shareholder holding, as of the close of business on such date,
Guaranteed Shares with that Guarantee Date. If the Guarantee Date should fall on
a weekend or on a holiday, the Guarantee Date shall be the first business day
following the Guarantee Date. The Guarantee is intended to assure each owner of
Guaranteed Shares
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on a Guarantee Date that he or she will be able to recover, as of the Guarantee
Date, at a minimum, the Guaranteed Amount (with no adjustment for inflation or
the time value of money). The Guarantee will benefit any holder of such
Guaranteed Shares on the relevant Guarantee Date, who need not be the original
purchaser, and who, for example, may own such shares by gift or inheritance.
Although the Equity Index Fund does not intend to pay dividends and
distributions in cash to shareholders (unless a shareholder elects to receive
payments in cash), such dividends and distributions which are reinvested will be
taxable to shareholders. See "Tax Status." The Guaranteed Amount does not
reflect any adjustment for the payment of taxes by a shareholder on dividends
and distributions received from the Equity Index Fund.
The obligations, if any, of NYLIFE under the Guarantee shall be
discharged when all required payments are made in full to the transfer and
dividend disbursing agent for the benefit of the shareholders or if the Equity
Index Fund's net asset value on a Guarantee Date is such that no amounts are
payable to shareholders under the terms of the Guarantee. Payment obligations
under the Guarantee will be solely the obligations of NYLIFE. Neither the Equity
Index Fund, New York Life Insurance Company, Monitor, NYLIFE Distributors, any
of their affiliates nor any other party is undertaking any obligation to the
Equity Index Fund or its shareholders with respect to the Guarantee.
Although the Guarantee has been arranged for by the Equity Index Fund
and is created under contract between the Equity Index Fund and NYLIFE, the
Equity Index Fund has no interest in, and specifically disclaims any interest
in, the proceeds payable under the Guarantee, which are payable solely to the
shareholders with a particular Guarantee Date. The designation of such
shareholders as the sole beneficiaries of the Guarantee may not be changed by
either the Equity Index Fund or such shareholders. The Guarantee is neither
transferable nor assignable by the Equity Index Fund or the shareholders it
benefits, nor may the Equity Index Fund or its shareholders cancel or waive
rights under the Guarantee. The Guarantee cannot be surrendered by either the
Fund or its shareholders for cash, except in the event that payment is made
pursuant to its terms. Neither the Equity Index Fund nor its shareholders may
use the Guarantee as a pledge for a loan, nor may the Equity Index Fund or its
shareholders
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obtain any loan from NYLIFE with respect to amounts that may be payable pursuant
to the Guarantee.
The foregoing is only a summary, and not a complete statement of the
principal terms of the Guarantee. Reference is made to the Guarantee, a specimen
copy of which has been filed as an exhibit to the Registration Statement. This
summary is subject thereto and qualified in its entirety by such reference.
FUNDAMENTAL INVESTMENT RESTRICTIONS
The following restrictions may not be changed with respect to any Fund
without the approval of the majority of the outstanding voting securities of
that Fund (as defined in the 1940 Act). Investment restrictions that appear
below or elsewhere in this Statement of Additional Information that involve a
maximum percentage of securities or assets shall not be considered to be
violated unless an excess 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, a Fund.
The Trust may not, on behalf of any Fund:
1. With respect to 75% of each Fund's total assets invest more than 5%
of the value of the total assets of a 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 a Fund. This restriction does not apply to the California Tax Free
Fund, Equity Index Fund, International Bond Fund, New York Tax Free Fund and
Global High Yield 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 these Funds maintain 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 total assets (10% in
the case of the California Tax Free Fund and New York Tax Free Fund).
3. Purchase securities (or with respect to the California Tax Free
Fund, New York Tax Free Fund, and Tax Free Bond Fund
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purchase (I) Pollution Control and Industrial Development Bonds or (ii)
securities the interest from which is not exempt from regular federal income
tax) if such purchase would cause 25% or more in the aggregate of the market
value of the total assets of a 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 in respect to investments in U.S.
government securities or, with respect to each Fund except Strategic Value Fund,
investments in repurchase agreements with respect thereto (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 (a)
the above limitation does not apply to the Equity Index Fund to the extent that
the Standard & Poor's 500 Composite Stock Price Index is so concentrated; (b) up
to 40% of the High Yield Corporate Bond Fund's, Strategic Income Fund's and
Strategic Value Fund's total assets, taken at market value, may be invested in
each of the electric utility and telephone industries, but each Fund 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); (C) 25% or more of the market value of the total
assets of the Money Market Fund will be invested in the securities of banks and
bank holding companies, including certificates of deposit and bankers'
acceptances; and (d) at such time that the 1940 Act is amended to permit a
registered investment company to elect to be "periodically industry
concentrated" (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 total assets in a particular industry) the Funds elect to be so
classified and the foregoing limitation shall no longer apply with respect to
the Funds. With respect to the California Tax Free Fund and New York Tax Free
Fund, private activity bonds ultimately payable by companies within the same
industry are treated as if they were issued by issuers in the same industry for
purposes of this restriction.
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) or, in the case of the California Tax Free Fund and New York Tax
Free Fund, real
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estate investment trust securities; commodities and commodity contracts. The
Trust reserves the freedom of action to hold and to sell real estate acquired
for any 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 currencies (securities,
with respect to the Strategic Value Fund) 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.
5. Make loans to other persons, except loans of portfolio securities
(in the case of the California Tax Free Fund and New York Tax Free Fund, in an
amount not to exceed 10% of the value of each Fund's total assets in accordance
with applicable guidelines approved by the Board of Trustees and 30% in the case
of the Equity Index Fund). The purchase of debt obligations (and bankers'
acceptances and commercial paper in the case of the Equity Index Fund) and the
entry into repurchase agreements in accordance with a Fund's investment
objectives and policies are not deemed to be loans for this purpose.
6. Act as an underwriter of securities issued by others, except to the
extent that a Fund may be considered an underwriter within the meaning of the
1933 Act, as amended, in the disposition of portfolio securities.
7. Issue senior securities, except to the extent permitted under the
Investment Company Act of 1940.
The following fundamental investment restriction is applicable to the
Tax Free Bond Fund only. The Tax Free Bond Fund must:
1. Invest at least 80% of the Fund's net assets in securities the
interest on which is exempt from regular federal income tax, except that the
Fund may temporarily invest more than 20% of its net assets in securities the
interest income on which may be subject to regular federal income tax.
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 Funds. These represent
intentions
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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.
The following are non-fundamental restrictions of the Capital
Appreciation Fund, Convertible Fund, Government Fund, High Yield Corporate Bond
Fund, Money Market Fund, Tax Free Bond Fund, Total Return Fund and Value Fund.
Each of these Funds may not:
(a) purchase from or sell portfolio securities of a Fund to
any of the officers or Trustees of the Trust, its investment advisers,
its principal underwriter or the officers, or directors of its
Sub-Advisers or principal underwriter;
(b) invest more than 10% of the net assets of a Fund (taken at
market value at the time of the investment) in "illiquid securities,"
illiquid securities being defined to include securities subject to
legal or contractual restrictions on resale (other than restricted
securities eligible for resale pursuant to Rule 144A or Section 4(1)
under the Securities Act of 1933 determined to be liquid pursuant to
guidelines adopted by the Board), repurchase agreements maturing in
more than seven days, certain options traded over the counter that a
Fund has written, securities for which market quotations are not
available, or other securities which legally or in the opinion of the
Sub-Adviser are deemed illiquid;
(C) purchase the securities of other investment companies,
except to the extent permitted by the 1940 Act or in connection with
merger, consolidation, acquisition or reorganization;
(d) invest in other companies for the purpose of exercising
control or management;
(e) purchase securities on margin except in connection with
arbitrage transactions or make short sales, unless by virtue of its
ownership of other securities, it has the right to obtain securities
equivalent in kind and amount to the securities sold, except that the
Trust may obtain such short-term credits as may be necessary for the
clearance of
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purchases and sales of securities and in connection with transactions
involving forward foreign currency exchange contracts;
(f) purchase or sell any put or call options or any
combination thereof, except that the Trust may purchase and sell or
write (I) options on any futures contracts into which it may enter,
(ii) put and call options on currencies, securities indexes and covered
put and call options on securities, and (iii) may also engage in
closing purchase transactions with respect to any put and call option
position it has entered into; and except that the Government Fund may
not write any covered put options on U.S. government securities if, as
a result, more than 50% of its total assets (taken at current value)
would be subject to put options written by such Fund; or
(g) purchase, with respect to the Government Fund, any call
option, long futures contract or long option on a futures contract if,
at the date of purchase, realized net losses from such transactions
during the fiscal year to date exceed 5% of such Fund's average net
assets during such period.
The following are non-fundamental restrictions of the California Tax
Free Fund, Equity Index Fund and New York Tax Free Fund:
(a) A 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 or reorganization.
(b) The Funds may not invest more than 10% of the net assets
of a Fund (taken at market value at the time of the investment) in
"illiquid securities," illiquid securities being defined to include
securities subject to legal or contractual restrictions on resale
(other than restricted securities eligible for resale pursuant to Rule
144A or Section 4(1) under the Securities Act of 1933 determined to be
liquid pursuant to guidelines adopted by the Board).
(C) A Fund may not invest in other companies for the purpose
of exercising control or management.
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(d) A Fund may not purchase securities on margin, except in
connection with arbitrage transactions, or make short sales, unless it
owns the securities sold short or it has the right to obtain securities
equivalent in kind and amount to the securities sold, except that the
Trust may obtain such short-term credits as may be necessary for the
clearance of purchases and sales of securities. (This restriction has
no application to transactions in futures, options and foreign currency
exchange contracts).
The following are non-fundamental restrictions of the International
Bond Fund, International Equity Fund, Strategic Income Fund and Strategic Value
Fund:
(a) As an operating policy, a 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, a 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. This restriction is not applicable to the Strategic Income
Fund.
(C) As an operating policy, a 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 or Section 4(2)
commercial paper 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. A Fund may
not invest more than 15% of its net assets in repurchase agreements
providing for settlement in more than seven days, or in other
instruments which for regulatory purposes or in the Sub-Adviser's
opinion may be deemed to be illiquid, such as a certain portion of
options traded in the over-the-counter market, and securities being
used to cover options a Fund has written.
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(d) As an operating policy, a 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.
The following are non-fundamental restrictions of the Blue Chip Growth
Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities Fund,
Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund:
(a) As an operating policy, a 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, a 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, a 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 and Section 4(2) commercial paper 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. A Fund may not invest more than 15% of its net assets in repurchase
agreements providing for settlement in more than seven days, or in other
instruments which for regulatory purposes or in the Sub-Adviser's opinion may be
deemed to be illiquid, such as a certain portion of options traded in the
over-the-counter market, and securities being used to cover options a Fund has
written.
(d) As an operating policy, a Fund may not purchase the
securities of other investment companies except to the permitted by the 1940 Act
in connection with a merger, consolidated, acquisition, or reorganization.
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"Value" for the purposes of all investment restrictions shall mean the
value used in determining a Fund's net asset value.
In addition, though not a fundamental policy, the California Tax Free
and New York Tax Free Funds will not sell securities short, except that each
Fund reserves the right to sell securities short "against the box."
In addition, though not a fundamental policy, the Equity Index Fund may
not engage in arbitrage transactions, nor may it purchase warrants (excluding
those acquired by the Equity Index Fund in units or attached to securities), nor
will the Equity Index Fund sell securities short or buy on margin, except that
the Fund reserves the right to sell securities short "against the box."
The Trustees have the ultimate responsibility for determining whether
specific securities are liquid or illiquid. The Trustees have delegated the
function of making day-to-day determinations of liquidity to the Sub-Advisers,
pursuant to guidelines approved by the Trustees.
Each Sub-Adviser takes into account a number of factors in determining
whether a Rule 144A security being considered for purchase by a Fund is liquid,
including at least the following:
(I) the frequency and size of trades and quotes for the Rule
144A security relative to the size of the Fund's holding;
(ii) the number of dealers willing to purchase or sell the
144A security and the number of other potential purchasers;
(iii) dealer undertakings to make a market in the 144A
security; and
(iv) the nature of the 144A security and the nature of the
market for the 144A security (i.e., the time needed to dispose of the security,
the method of soliciting offers, and the mechanics of transfer).
To make the determination that an issue of 4(2) commercial paper is liquid, a
Sub-Adviser must conclude that the following conditions have been met:
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(a) the 4(2) commercial paper is not traded flat
or in default as to principal or interest;
(b) the 4(2) commercial paper is rated:
(I) in one of the two highest rating categories by at least
two nationally recognized statistical rating organizations ("NRSROs");or
(ii) if only one NRSRO rates the security, the 4(2) commercial
paper is rated in one of the two highest rating categories by that NRSRO; or
(iii) if the security is unrated, the Sub-Adviser has
determined that the security is of equivalent quality based on factors commonly
used by rating agencies; and
(C) there is a viable trading market for the specific
security, taking into account all relevant factors (e.g., whether the security
is the subject of a commercial paper program that is administered by an issuing
and paying agent bank and for which there exists a dealer willing to make a
market in the security, the size of trades relative to the size of the Fund's
holding or whether the 4(2) commercial paper is administered by a direct issuer
pursuant to a direct placement program).
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.
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<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- -------------------------
<S> <C> <C>
Richard M. Kernan, Jr. * Chairman and Trustee Director of MainStay VP Series Fund, Inc. from
51 Madison Avenue January 1987 to present; Chairman of the Board
New York, NY 10010 and Chief Executive Officer of MainStay VP
Age: 57 Series Fund, Inc. from August 1989 to present;
Executive Vice President and Chief Investment
Officer of New York Life Insurance Company
from March 1995 to present; Executive Vice
President prior thereto; Member of the Board
of Directors of New York Life Insurance
Company from November 1996 to present and
Chairman of the Investment Committee from January
1997 to present; and Director, Greystone Realty
Corp. January 1997 to present.
Stephen C. Roussin* President, Chief Executive Director and Chairperson, MainStay
51 Madison Avenue Officer and Trustee Institutional Funds, Inc., 1997 to
New York, NY 10010 present; Senior Vice President, New
Age: 34 York Life Insurance Company, 1997 to present;
Senior Vice President, Smith Barney, 1994 to
1997; and Division Sales Manager, Prudential
Securities, 1989 to 1994.
Harry G. Hohn* Trustee Retired Chairman and Chief Executive Officer,
51 Madison Avenue New York Life Insurance Company; Chairmanof the
New York, NY 10010 Board and Chief Executive Officer, New York Life
Age: 66 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 1997; Director,
Insurance Marketplace Standards Association, 1996
to 1997; 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.
Edward J. Hogan Trustee Rear Admiral U.S. Navy (Retired); Independent
Box 2321 Management Consultant, 1992 to 1997.
Sun Valley, ID 83353
Age: 65
</TABLE>
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<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 University,
Kissinger New York, NY, 1991 to present; Trustee,
Henderson Road Rockefeller University, 1995 to present;
South Kent, CT 06785 Trustee, Animal Medical Center, 1993 to
Age: 64 present; and Trustee, The Masters School,
1994 to present; Member, Board of Overseers,
Rockefeller Institute of Government, Albany,
NY, 1983-1992 (Board dissolved).
Terry L. Lierman Trustee President, Capitol Associates, Inc., 1984 to
426 C Street, N.E. present; President, Employee Health
Washington, D.C. 20002 Programs, 1990 to present; Vice Chairman,
Age: 50 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; Commissioner,
State of Maryland, Higher Education
Commission, 1995 to present; Vice Chairman,
National Organization on Fetal Alcohol
Syndrome, 1993 to present; Chief Executive
Officer, Medical Crisis Systems, 1997 to
present; and Board Member, Hollings Cancer
Center, Medical University of South
Carolina, 1993 to present.
John B. McGuckian Trustee Chairman of the Board, Ulster Television
Ardverna plc, 1990 to present; Director, Ulster
Cloughmills Television plc, 1970 to present; Chairman of
Northern Ireland the Board, Tedcastle Holding Ltd. (energy),
BT4 49NL 1995 to present; Director, Cooneen Textiles
Age: 58 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 1997; and
Chairman of Senate and Senior
Pro-Chancellor, Queen's University, 1986 to
present.
</TABLE>
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<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 Industries,
1701 Highway A-1-A Inc., 1991 to present; Director, PaineWebber
Suite 218 Group, 1980 to 1993; President, PaineWebber
Vero Beach, FL 32963 Group, 1988 to 1990; Chairman of the Board,
Age: 65 Paine Webber Properties, 1985 to 1989;
Director, Harbour Group, 1986 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, Sugen, Inc., 1992 to present;
Chairman of the Board, Omniquip
International, Inc., 1996 to present;
Director, Carey Diversified, L.L.C., January
1,1998 to present.
Donald K. Ross* Trustee Retired Chairman and Chief Executive
953 Cherokee Lane Officer, New York Life Insurance Company;
Franklin Lakes, NJ 07417 Director, New York Life Insurance Company,
Age: 72 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.
Richard S. Trutanic Trustee Managing Director, The Somerset Group
1155 Connecticut Ave. N.W., (financial advisory firm), 1990 to present;
Suite 400 Chief Executive Officer and President,
Washington, DC 20036 Americap L.L.C. (Financial Advisory Firm),
Age: 45 1997 to present; Senior Vice President,
Washington National Investment Corporation
(financial advisory firm), 1985 to 1990;
Director, Allin Communications Corporation,
1996 to 1997; and Director and Member of
Executive Committee, Southern Net, Inc.,
1986 to 1990.
</TABLE>
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<PAGE> 414
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- --------------------------
<S> <C> <C>
Walter W. Ubl* Trustee Senior Vice President, New York Life
85 East End Avenue Insurance Company, 1995 to 1997; Vice
Apt. 2N President, 1984 to 1995; Vice President in
New York, NY 10028 charge of Mutual Funds Department, 1989 to
Age: 56 1997; Director and Vice President, NYLIFE
Distributors Inc., 1993 to 1997; and
Director and Senior Vice President NYLIFE
Securities Inc., 1996 to 1997.
- ---------------------------------------------------------------------------------------------------------------------------------
OFFICERS (OTHER THAN TRUSTEES)
- ---------------------------------------------------------------------------------------------------------------------------------
Jefferson C. Boyce Senior Vice President Chairman, Monitor Capital Advisors, Inc.,
51 Madison Avenue 1997 to present; Senior Vice President,
New York, NY 10010 MainStay Institutional Funds Inc., 1995 to
Age: 40 present; Senior Vice President, New York
Life 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 Chief Vice President, New York Life Insurance
51 Madison Avenue Financial Officer Company, 1988 to present; Director, Vice
New York, NY 10010 President and Chief Financial Officer,
Age: 54 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.
</TABLE>
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<PAGE> 415
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- ----------------------------
<S> <C> <C>
Richard Zuccaro Tax Vice President Vice President, New York Life Insurance
51 Madison Avenue Company, 1995 to present; Vice President --
New York, NY 10010 Tax, New York Life Insurance Company, 1986
Age: 48 to 1995; Tax Vice President, NYLIFE
Securities Inc., 1987 to present; Tax Vice
President, NAFCO, Inc., 1990 to present; Tax
Vice 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.
</TABLE>
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<PAGE> 416
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION(S)
NAME, ADDRESS AND AGE POSITION(S) WITH TRUST DURING PAST 5 YEARS
- --------------------- ---------------------- ---------------------------
<S> <C> <C>
A. Thomas Smith III Secretary Vice President and Associate General
51 Madison Avenue Counsel, New York Life Insurance Company,
New York, NY 10010 1997 to present; Associate General Counsel,
Age: 41 New York Life Insurance Company, 1996 to
1997; Assistant General Counsel, New York
Life Insurance Company, 1994 to 1996;
Secretary, Eclipse Financial Asset Trust,
1994 to present; Secretary, MainStay
Institutional Funds Inc., MainStay VP Series
Fund, Inc., New York Life Fund Inc., 1994 to
1997; Assistant Secretary, Eagle Strategies
Corp. (registered investment adviser), 1997
to present; Secretary, Eagle Strategies
Corp. (registered investment adviser), 1996
to present; and Assistant General Counsel,
Dreyfus Corporation, 1991 to 1993.
</TABLE>
*Messrs. Ross, Roussin, Hohn, Kernan and Ubl are deemed to be "interested
persons" of the Trust under the 1940 Act.
As indicated in the above table, certain Trustees and officers also
hold positions with MacKay-Shields, Monitor, New York Life Insurance Company,
NYLIFE Securities Inc. and/or NYLIFE Distributors Inc.
Effective August 1, 1998, the Independent Trustees of the Trust receive
from the Trust an annual retainer of $45,000 and a fee of $2,000 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, 1997, the Trustees received the
following compensation from the Trust and from certain other investment
companies (as indicated) that have the same investment advisers as the Trust or
an investment adviser that is an affiliated person of one of the Trust's
investment advisers:
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<PAGE> 417
<TABLE>
<CAPTION>
Total Compensation
Aggregate From Registrant
Name of Compensation and Fund Complex
Trustee from the Trust Paid to Trustees
- ------- -------------- ----------------
<S> <C> <C>
Edward J. Hogan $48,000 $48,000
Nancy M. Kissinger $46,000 $46,000
Terry L. Lierman $48,000 $48,000
Donald E. Nickelson $52,000 $52,000
Richard S. Trutanic $46,000 $46,000
John B. McGuckian* $12,000 $12,000
</TABLE>
* Mr. McGuckian was elected to his position as Trustee of the
Trust on July 28, 1997.
As of August 1, 1998, the Trustees and officers of the Trust as a group
owned less than 1% of the outstanding shares of any class of beneficial interest
of each of the Funds.
THE MANAGER, THE SUB-ADVISERS AND THE DISTRIBUTOR
MANAGEMENT AGREEMENT
Pursuant to the Management Agreement for the Funds, MainStay
Management, Inc. (the "Manager"), subject to the supervision of the Trustees of
the Trust and in conformity with the stated policies of the Funds, administers
the Funds' business affairs and has investment advisory responsibilities.
The Trustees, including the Independent Trustees, approved the
Management Agreement with respect to the Funds then in operation, as well as the
Strategic Value Fund, at an in-person meeting held July 28, 1997. On April 27,
1998, the Trustees approved the Management Agreement with respect to the Blue
Chip Growth Fund, Research Value Fund, Small Cap Value Fund, Growth
Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and Global High
Yield Fund, and approved the continuation of the Agreement with respect to the
other Funds. On October 24, 1997, the shareholders of each of the Funds other
than the Strategic Value Fund approved the Management Agreement. The Management
Agreement for the Strategic Value Fund was approved by the Fund's sole
shareholder on October 21, 1997. On May 29, 1998, the sole initial shareholder
of Blue Chip Growth Fund, Research Value Fund, Small Cap Value Fund, Growth
Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and Global High
Yield Fund approved the Management Agreement
B-126
<PAGE> 418
with respect to those Funds. The Management 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 each
of the Funds (as defined in the 1940 Act and in a rule under the 1940 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 a Fund for any error or judgment by the Manager or for any loss sustained by
a 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 each
of the Funds, and except as indicated in the Prospectus under the heading
"Manager, Sub-Advisers 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;
(b) the fees to be paid to the Sub-Advisers pursuant to the
Sub-Advisory Agreements; and
(C) all expenses incurred by the Manager in connection with
administering the ordinary course of the Funds' business, other than those
assumed by the Trust.
SUB-ADVISORY AGREEMENTS
Pursuant to Sub-Advisory Agreements between the Manager and each of the
Sub-Advisers, subject to the supervision of the Trustees of the Trust and the
Manager and in conformity with the stated policies of each of the Funds and the
Trust, MacKay-Shields,
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<PAGE> 419
Monitor, GAMCO, John A. Levin & Co., Dalton, Greiner and Madison Square Advisors
manage the Funds' portfolios, including the purchase, retention, disposition and
loan of securities.
The Trustees, including the Independent Trustees, approved the
Sub-Advisory Agreements with MacKay-Shields and Monitor with respect to the
Funds then in operation, as well as the Strategic Value Fund, at an in-person
meeting held July 28, 1997. On April 27, 1998, the Trustees approved the
Sub-Advisory Agreement with GAMCO on behalf of the Blue Chip Growth Fund, the
Sub-Advisory Agreement with John A. Levin & Co. On behalf of the Research Value
Fund, the Sub-Advisory Agreement with Dalton, Greiner on behalf of the Small Cap
Value Fund, the Sub-Advisory Agreement with Madison Square Advisors on behalf of
the Growth Opportunities Fund, and the Sub-Advisory Agreement with
MacKay-Shields on behalf of Small Cap Growth Fund, Equity Income Fund and Global
High Yield Fund. On that date, the Trustees also approved the continuation of
the Sub-Advisory Agreements previously approved for the other funds. On October
24, 1997, the shareholders of each of the Funds other than the Strategic Value
Fund approved the Sub-Advisory Agreements with MacKay-Shields and Monitor. The
Sub-Advisory Agreement with respect to the Strategic Value Fund was approved by
that Fund's sole shareholder on October 21, 1998. On May 29, 1998 the sole
initial shareholder of Blue Chip Growth Fund, Research Value Fund, Small Cap
Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income Fund
and Global High Yield Fund approved the Sub-Advisory Agreements with respect to
those Funds. The Sub-Advisory Agreements will remain in effect for two years
following their 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 each of the Funds
(as defined in the 1940 Act and in a rule under the 1940 Act) and, in either
case, by a majority of the Trustees who are not "interested persons" of the
Trust, the Manager, MacKay-Shields or Monitor (as the term is defined in the
1940 Act).
The Sub-Advisers have authorized any of their 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 they render, the Sub-Advisers bear the salaries
and expenses of all of their personnel.
The Sub-Advisory Agreements provide that the Sub-Advisers shall not be
liable for any error of judgment by the Sub-Advisers
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<PAGE> 420
or for any loss suffered by any of the Funds except in the case of a
Sub-Adviser's willful misfeasance, bad faith, gross negligence or reckless
disregard of duty. The Agreements also provide that they shall terminate
automatically if assigned and that they may be terminated without penalty by
either party upon no more than 60 days' nor less than 30 days' written notice.
For the period from October 27, 1997 through December 31, 1997, the
amount of the Management fee paid and waived and/or reimbursed by each Fund; the
amount of the Sub-Advisory fee paid by the Manager from the Management fee; and
the amount of the Sub-Advisory fee waived and/or reimbursed were as follows
(the Blue Chip Growth Fund, Research Value Fund, Small Cap Value Fund, Growth
Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and Global High
Yield Fund had not commenced operations as of December 31, 1997):
<TABLE>
<CAPTION>
Management Sub-Advisory
Management Fee Waived Sub-Advisory Fee Waived
Fund Fee Paid* and/or Reimbursed Fee Paid* and/or Reimbursed
- ---- --------- ----------------- --------- -----------------
<S> <C> <C> <C> <C>
California Tax Free Fund..... $ 22,562 $ -- $ 11,281 $ --
Capital Appreciation Fund.... 1,996,154 -- 998,077 --
Convertible Fund............. 1,210,730 -- 605,365 --
Equity Index Fund+........... 149,354 223,441 74,559 --
Government Fund.............. 712,902 -- 356,451 --
High Yield Corporate Bond
Fund..................... 3,590,202 -- 1,795,101 --
International Bond Fund..... 24,178 18,134 15,111 12,089
International Equity Fund... 145,829 -- 87,497 --
Money Market Fund............ 165,694 205,316 82,847 102,658
New York Tax Free Fund....... 11,863 5,413 5,932 2,707
Strategic Income Fund++...... -- 74,218 -- 37,109
Strategic Value Fund++....... 23,276 -- 11,638 --
Tax Free Bond Fund........... 533,914 -- 266,957 --
Total Return Fund............ 1,431,434 -- 715,717 --
Value Fund................... 1,479,934 -- 739,967 --
</TABLE>
* After expense reimbursement or waiver.
+ The Equity Index Fund's expense limitation was terminated April 1,
1998.
++ The Strategic Income Fund commenced operations on February 28, 1997.
Effective February 28, 1998, the Fund's expense cap was terminated.
The Strategic Value commenced operations on October 21, 1997
In previous years, prior to a change in management structure, the Funds
paid an advisory fee directly to MacKay-Shields or Monitor. For the period from
January 1, 1997 through October 26, 1997 and the fiscal years ended December 31,
1996 and 1995, the amount of the advisory fee paid and waived and/or reimbursed,
by each Fund to MacKay-Shields or Monitor was as follows:
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<PAGE> 421
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
Advisory Advisory Advisory
Fee Waived Fee Waived Fee Waived
Advisory and/or Advisory and/or Advisory and/or
Reimbursed Fee Paid* Reimbursed Fee Paid* Reimbursed Fee Paid* Reimbursed
---------- -------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
California Tax Free Fund $ 44,678 $ 2,589 $ 45,307 $ 11,228 $ 29,964 $ 16,845
Capital Appreciation Fund 3,934,494 -- 3,429,258 -- 2,155,386
Convertible Fund......... 2,710,393 -- 2,444,000 -- 1,027,604
Equity Index Fund........ 256,066 -- 163,785 -- 81,072
Government Fund.......... 1,760,807 -- 2,643,801 -- 3,056,716
High Yield Corporate Bond 6,921,965 5,816,110 -- 3,930,939
Fund..................
International Bond Fund.. 65,696 52,556 68,489 54,933 52,534 42,028
International Equity Fund 384,003 -- 342,100 -- 166,703
Money Market Fund........ 407,638 396,862 397,071 473,155 391,304 282,975
New York Tax Free Fund... 25,025 13,579 29,457 19,911 31,482 14,241
Strategic Income Fund+... 61,282 40,291 N/A N/A N/A N/A
Strategic Value Fund+.... N/A N/A N/A N/A N/A N/A
Tax Free Bond Fund....... 1,217,473 -- 1,579,820 -- 1,610,982
Total Return Fund........ 3,025,045 -- 3,087,111 -- 2,396,247
Value Fund............... 2,976,469 -- 2,682,642 1,932,406
</TABLE>
-----------------------
+ The Strategic Income Fund commenced operations on February 28, 1997. The
Strategic Value Fund commenced operations on October 21, 1997.
* After expense reimbursement or waiver.
In previous years, prior to a change in management structure, the
Funds paid an administrative fee directly to NYLIFE Distributors Inc. as
administrator. For the period from January 1, 1997 through October 26, 1997
and the fiscal years ended December 31, 1996 and 1995 the amount of the
administration fee paid and waived and/or reimbursed by each Fund was as
follows:
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<PAGE> 422
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
Advisory Advisory Advisory
Fee Waived Fee Waived Fee Waived
Advisory and/or Advisory and/or Advisory and/or
Reimbursed Fee Paid* Reimbursed Fee Paid* Reimbursed Fee Paid* Reimbursed
- ---------- -------- ---------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
California Tax Free Fund...... $ 44,678 $ 2,589 $ 45,307 $ 11,228 $ 29,964 $ 16,845
Capital Appreciation Fund..... 3,934,494 -- 3,429,258 -- 2,155,386 --
Convertible Fund.............. 2,710,393 -- 2,444,000 -- 1,027,604 --
Equity Index Fund............. 605,767 418,496 365,118 290,022 327,287
Government Fund............... 1,760,807 -- 2,643,801 -- 3,056,716
High Yield Corporate Bond 6,921,965 -- 5,816,110 -- 3,930,939
Fund.......................
International Bond Fund....... 39,417 26,278 41,100 27,467 31,522 21,013
International Equity Fund..... 256,002 -- 228,066 -- 111,135 --
Money Market Fund............. 407,638 396,862 397,071 473,155 391,304 282,975
New York Tax Free Fund........ 25,025 13,579 29,457 19,911 31,481 14,242
Strategic Income Fund+........ 61,282 40,291 N/A N/A N/A N/A
Strategic Value Fund+......... N/A N/A N/A N/A N/A N/A
Tax Free Bond Fund............ 1,217,473 -- 1,579,820 -- 1,610,982 --
Total Return Fund............. 3,025,045 -- 3,087,111 -- 2,396,247 --
Value Fund.................... 2,976,469 -- 2,682,642 -- 1,932,406 --
</TABLE>
- -----------------------
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
* After expense reimbursement or waiver.
DISTRIBUTION AGREEMENT
NYLIFE Distributors acts as the Principal Underwriter and Distributor
of the Funds' shares pursuant to the Distribution Agreement with the Trust dated
January 1, 1994. NYLIFE Securities Inc., an affiliated company, sells shares of
the Funds 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 connection with their distribution of Trust 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 Funds 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
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<PAGE> 423
October 25, 1993. The Distribution Agreement for the International Bond Fund and
the International Equity Fund was approved by the Trustees, including a majority
of the Independent Trustees, at a meeting held on July 25, 1994. The
Distribution Agreement for the Strategic Income Fund was approved by the
Trustees, including a majority of the Independent Trustees at a meeting held on
January 27, 1997. The Distribution Agreement for the Strategic Value Fund was
approved by the Trustees, including a majority of the Independent Trustees, at a
meeting held on July 28, 1997. The Distribution Agreement for the Blue Chip
Growth Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities
Fund, Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund was
approved by the Trustees, including a majority of the Independent Trustees, on
April 27, 1998. On that date, Distribution Agreements for the other Funds were
reapproved by the Trustees, including a majority of the Independent Trustees.
Each of the Funds (except the Money Market Fund and the Equity Index
Fund, which does not offer Class B or Class C shares) has adopted separate plans
of distribution pursuant to Rule 12b-1 under the 1940 Act for each class of
shares of each Fund (the "Class A Plans," the "Class B Plans," the "Class C
Plans" and, collectively, the "Plans"). Under the Class A Plans, Class A shares
of each Fund pay the Distributor a monthly fee at the annual rate of 0.25% of
the average daily net assets of each Fund's Class A shares for distribution or
service activities, as designated by the Distributor. The Class A Plans for each
of the Funds other than the California Tax Free Fund, New York Tax Free Fund,
Equity Index Fund, Strategic Income Fund, Blue Chip Growth Fund, Research Value
Fund, Small Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund,
Equity Income Fund and Global High Yield Fund, were approved by the sole initial
shareholder of the Class A of shares of each Fund on December 31, 1994. The
Class A Plans were approved by the shareholders of the California Tax Free Fund,
New York Tax Free Fund and the Equity Index Fund at a Special Meeting of
Shareholders held on December 28, 1994 and the Class A Plan was approved by the
sole initial shareholder of the Strategic Income Fund on February 3, 1997 and by
the sole initial shareholder of the Strategic Value Fund on October 21, 1997.
Regarding the California Tax Free Fund, the New York Tax Free Fund and the
Equity Index Fund, the Trustees of the Trust, including a majority of the
Independent Trustees, by vote cast in person at a meeting called for the purpose
of voting on such Plans, initially approved the Plan now designated as the Class
A Plans on July 25, 1994. Regarding the
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<PAGE> 424
Strategic Income Fund, the Trustees of the Trust, including a majority of 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 January 27, 1997.
The Class A Plans for each of the Blue Chip Growth Fund, Research Value Fund,
Small Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity
Income Fund and Global High Yield Fund were approved by the sole shareholder of
the Class A shares of each of those Funds on May 29, 1998. The Trustees,
including a majority of the Independent Trustees, by vote cast at a meeting
called for the purpose of voting on such plans, initially approved the Class A
Plans for each of those Funds on April 27, 1998.
As noted above, the Class B shares of each Fund (except the Money
Market Fund and the Equity Index Fund, which does not offer Class B shares) also
have adopted Rule 12b-1 distribution plans. Originally, Rule 12b-1 plans of
distribution were adopted by each of the Funds (except the California Tax Free
Fund, New York Tax Free Fund and Money Market Fund) for the then sole existing
class of shares of the Funds. More specifically, Rule 12b-1 distribution plans
were approved on May 29, 1998 by the sole initial Class B shareholder of the
Blue Chip Growth Fund, Research Value Fund, Small Cap Value Fund, Growth
Opportunities Fund, Small Cap Growth Fund, Equity Income Fund and Global High
Yield Fund, on October 21, 1997 by the sole initial Class B shareholder of the
Strategic Value Fund, on February 3, 1997 by the sole initial shareholder of the
Strategic Income Fund, on September 8, 1994 by the sole initial shareholder of
each of the International Bond Fund and International Equity Fund, on April 25,
1988 by the shareholders of the Total Return Fund, on May 29, 1987 by the sole
initial shareholder of the Tax Free Bond Fund and on April 27, 1987 by the
shareholders of the Capital Appreciation Fund, Convertible Fund, Government
Fund, High Yield Corporate Bond Fund and Value Fund.
The Trustees of the Trust, including a majority of the Independent
Trustees, by vote cast in person at meetings called for the purpose of voting on
such Plans, initially approved the Plans of the Total Return Fund on October 26,
1987, initially approved the Plans of the Tax Free Bond Fund on April 27, 1987,
and initially approved the Plans of the Capital Appreciation Fund, Convertible
Fund, Government Fund, High Yield Corporate Bond Fund and Value Fund on April
28, 1986. In addition, on October 31, 1988, the Trustees of the Trust, including
a majority of the Independent Trustees, amended the Tax Free Bond Fund's Plan to
permanently reduce the amount of the distribution fee to
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<PAGE> 425
be imposed subsequent to that date. On October 26, 1992, the Trustees of the
Trust, including a majority of the Independent Trustees, amended each of the
plans of distribution to designate a portion of total amount of the distribution
fee as a service fee, to pay for a variety of account maintenance and personal
services to shareholders after the sale. On October 25, 1993, the Trustees of
the Trust, including a majority of the Independent Trustees, amended each of the
plans of distribution to reflect that NYLIFE Distributors would serve as
principal underwriter of the Funds' shares, effective January 1, 1994. Prior to
the implementation of the multi-class distribution system the distribution plans
in effect for the Funds were amended and redesignated and, now, are applicable
only to the Class B shares of each Fund. On October 30, 1995, the Trustees of
the Trust, including a majority of the Independent Trustees, amended the Class A
Plans and the Class B Plans to clarify that the Plans contemplate payment for
expenses that may generally be characterized as administrative.
Regarding the California Tax Free Fund and New York Tax Free Fund, the
Class B Plans were approved by the sole initial shareholder of the Class B
shares of each Fund on December 31, 1994. The Trustees of the Trust, including a
majority of the Independent Trustees, by vote cast in person at meetings called
for the purpose of voting on such Plans, initially approved such Plans now
designated as the Class B Plans on October 24, 1994.
Regarding the International Bond Fund and International Equity Fund,
the Trustees of the Trust, including a majority of the Independent Trustees, by
vote cast in person at meetings called for the purpose of voting on such Plans,
initially approved the distribution plans now designated as the Class B Plans on
July 25, 1994, and the Class A Plans on October 24, 1994. The Trustees of the
Trust, including a majority of the Independent Trustees, by vote cast in person
at a meeting called for the purpose of voting on such Plan, initially approved
the Class B Plan of the Strategic Income Fund on January 27, 1997. The Trustees
of the Trust, including a majority of the Independent Trustees, by vote cast in
person at a meeting called for the purpose of voting on such Plan, initially
approved the Class B Plan of the Strategic Value Fund on July 28, 1997. The
Trustees of the Trust, including a majority of the Independent Trustees, by vote
cast in person at a meeting called for the purpose of voting on such Plans,
initially approved the Class B Plans for the Blue Chip Growth Fund, Research
Value Fund, Small
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<PAGE> 426
Cap Value Fund, Growth Opportunities Fund, Small Cap Growth Fund, Equity Income
Fund and Global High Yield Fund on April 27, 1998.
On October 24, 1997, Class B shareholders for each of the Funds, other
than the Equity Index Fund, Money Market Fund, Strategic Income Fund and
Strategic Value Fund, approved a revision to the Class B Plans of each Fund to
revise the method of calculation of the distribution fee. The Trustees,
including a majority of the Independent Trustees, approved the revision at an
in-person meeting held July 28, 1997. The Class B shareholders approved the
revision at a meeting held October 24, 1997.
Under the current Class B plans, each Fund's Class B shares pay a
monthly distribution fee to the Distributor at the annual rate of 0.75% (0.25%
in the case of the California Tax Free Fund, New York Tax Free Fund and the Tax
Free Bond Fund) of the average daily net assets attributable to the Fund's Class
B shares. Pursuant to the Class B Plan, the Class B shares also pay a service
fee to the Distributor at the annual rate of 0.25% of the average daily net
assets of the Funds' Class B shares.
The Class C shares of each Fund (except the Money Market Fund and the
Equity Index Fund, which does not offer Class C shares) also have adopted Rule
12b-1 distribution plans. The Trustees of the Trust, including a majority of the
Independent Trustees, by vote cast in person at a meeting called for the purpose
of voting on such Plans, initially approved the Class C Plans of the Funds on
July 27, 1998.
Under the Class C plans, each Fund's Class C shares pay a monthly
distribution fee to the Distributor at the annual rate of 0.75% (0.50% in the
case of the California Tax Free Fund, New York Tax Free Fund and the Tax Free
Bond Fund) of the average daily net assets attributable to the Fund's Class C
shares. Pursuant to the Class C Plans, the Class C shares also pay a service fee
to the Distributor at the annual rate of 0.25% of the average daily net assets
of the Funds' Class C shares.
Each Plan shall continue in effect from year to year, 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 a Fund, and all material amendments of each Plan
must also be approved by the Trustees in the manner
B-135
<PAGE> 427
described above. Each Plan may be terminated at any time, without payment of any
penalty, by vote of a majority of the Independent Trustees, 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 the Class A, Class B and
Class C 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 a 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).
For the fiscal year ended December 31, 1997, the Funds paid
distribution and service fees pursuant to the Class A and Class B Plans as
follows (Class C shares were not offered prior to September 1, 1998):
B-136
<PAGE> 428
<TABLE>
<CAPTION>
Amount of Fee Amount of Fee
Pursuant to Pursuant to
Class A Plan Class B Plan
------------ ------------
<S> <C> <C>
California Tax Free Fund+........ $ 43,324 $ 29,795
Capital Appreciation Fund+...... 436,614 12,479,365
Convertible Fund+................ 160,596 7,496,884
Equity Index Fund................ 826,562 N/A
Government Fund+................. 41,839 5,572,110
High Yield Corporate Bond Fund+.. 447,670 25,344,441
International Bond Fund+......... 29,391 188,387
International Equity Fund+....... 44,218 567,206
Money Market Fund................ N/A N/A
New York Tax Free Fund+.......... 35,389 23,696
Strategic Income Fund++.......... 58,867 226,126
Strategic Value Fund++........... 5,136 10,314
Tax Free Bond Fund+.............. 32,364 2,207,368
Total Return Fund+............... 229,294 8,376,017
Value Fund+...................... 241,617 9,356,170
</TABLE>
- -----------------------
+ The Class B Plan was amended effective October 27, 1997. Figures reflect
calculation of fee pursuant to previous method for the period from January 1,
1997 through October 26, 1997 and calculation of fee pursuant to the current
method for the period from October 27, 1997 through December 31, 1997.
++The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
For the fiscal year ended December 31, 1997, 1996 and 1995, NYLIFE
Distributors retained the following amounts in sales charges for sales of Class
A shares of the Funds:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
1997 1996 1995
--------- ------------ --------
<S> <C> <C> <C>
California Tax Free Fund..... $ 6,958 $ 35,009 $ 57,181
Capital Appreciation Fund+... 201,562 1,430,417 718,806
Convertible Fund+............ 39,646 903,782 529,361
Equity Index Fund............ 329,059 1,968,993 308,486
Government Fund+............. 5,803 96,545 95,975
High Yield Corporate Bond
Fund+.................... 308,282 1,413,313 782,534
International Bond Fund+..... 5,235 54,586 10,984
International Equity Fund+... 121,009 91,571 63,684
Money Market Fund+........... N/A N/A N/A
New York Tax Free Fund....... 2,297 22,774 35,722
Strategic Income Fund++...... 14,008 N/A N/A
Strategic Value Fund++....... 344 N/A N/A
Tax Free Bond Fund+.......... 5,710 51,345 62,656
Total Return Fund+........... 50,232 334,470 233,202
Value Fund+.................. 112,844 574,807 413,692
</TABLE>
- -----------------------
+ The Fund began offering Class A shares on January 3, 1995.
++ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
B-137
<PAGE> 429
For the fiscal years ended December 31, 1997 and 1996, contingent
deferred sales charges were paid by investors on the redemption of Class B
shares of each Fund, as follows:
<TABLE>
<CAPTION>
Year Ended
Year Ended December 31,
December 31, 1997 1996
----------------- --------------
<S> <C> <C>
California Tax Free Fund......... $ 3,586 $ 2,008
Capital Appreciation Fund........ 1,485,899 966,555
Convertible Fund................. 1,466,588 852,359
Equity Index Fund................ N/A N/A
Government Fund.................. 788,647 952,234
High Yield Corporate Bond Fund... 2,684,352 1,482,294
International Bond Fund.......... 31,152 27,332
International Equity Fund........ 88,010 48,979
Money Market Fund+............... 779,844 640,623
New York Tax Free Fund........... 2,531 2,810
Strategic Income Fund++.......... 11,479 N/A
Strategic Value Fund++........... -- N/A
Tax Free Bond Fund............... 492,542 605,386
Total Return Fund................ 871,336 745,382
Value Fund....................... 996,052 712,915
</TABLE>
- -----------------------
+ The amount shown represents proceeds from contingent deferred sales
charges which were assessed on redemptions of shares which had
previously been exchanged from other Funds into the Money Market Fund.
++ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
For the fiscal year ended December 31, 1997, it is estimated that the
following amounts were spent on compensation to dealers with respect to the
Class A shares of each Fund: California Tax Free Fund spent $36,835; Capital
Appreciation Fund spent $1,231,407; Convertible Fund spent $246,918; Equity
Index Fund spent $3,332,052; Government Fund spent $33,248; High Yield Corporate
Bond Fund spent $2,144,790; International Bond Fund spent $34,080; International
Equity Fund spent $75,027; New York Tax Free Bond Fund spent $16,433; Strategic
Income Fund spent $169,199; Strategic Value Fund spent $141,685 Tax Free Bond
Fund spent $32,283; Total Return Fund spent $307,772; and Value Fund spent
$665,119.
For the fiscal year ended December 31, 1997, it is estimated that the
following amounts were spent for distribution-related activities with respect to
the Class B shares of each Fund:
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<PAGE> 430
<TABLE>
<CAPTION>
Approximate
Printing And Total Amount
Mailing Spent by
Sales Prospectuses to Compensation NYLIFE
Material other than to Compensation Sales Distributors
and Current Distribution to Sales Distribution With Respect
Advertising Shareholders Personnel Personnel Other Costs to Each Fund
----------- ------------ --------- --------- ----- ----- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
California Tax Free $451 $5,941 $12,935 $4,638 $7,356 $84,185 $115,506
Fund
Capital Appreciation 87,010 1,547,023 3,159,974 625,088 1,888,695 13,803,858 21,111,648
Fund
Convertible Fund 22,979 727,746 537,699 88,566 279,208 4,640,527 6,296,725
Govt. Fund 8,234 547,016 323,510 72,554 178,934 1,867,222 2,997,470
High Yield Corp. Fund 130,347 2,796,481 4,100,335 771,492 2,419,468 41,119,642 51,337,765
International Bond 1,446 17,869 52,794 8,395 29,550 249,823 359,877
Fund
International Equity 5,115 53,876 185,125 32,625 106,364 756,109 1,139,214
Fund
New York Tax Free 1,345 4,517 6,991 2,553 6,197 64,232 85,835
Fund
Tax Free Fund 3,774 407,263 269,467 53,290 172,880 1,277,394 2,184,068
Total Return Fund 39,072 1,007,008 1,307,798 262,631 777,495 5,737,640 9,131,644
Value Fund 56,482 1,149,205 1,983,639 394,408 1,177,580 9,955,251 14,716,565
Strategic Income 5,873 33,872 209,498 38,134 119,979 1,062,130 1,469,486
Fund*
Strategic Value Fund* (535) 6,051 (60,004) 12,737 (18,061) 286,835 227,023
======================================================================= =========================================== ================
Total 361,593 8,303,868 12,089,761 2,367,111 7,145,645 80,904,848 111,172,826
======================================================================= =========================================== ================
</TABLE>
-----------------------
* The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 22, 1997.
OTHER SERVICES
Pursuant to an Accounting Agreement with the Trust, dated October 24,
1997, the Manager performs certain bookkeeping and pricing services for the
Funds. Each Fund will bear an allocable portion of the cost of providing these
services to the Trust.
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<PAGE> 431
For the period from October 27, 1997 through December 31, 1997, the
amount of recordkeeping fees paid to the Manager by each Fund was as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
1997
--------------
<S> <C>
California Tax Free Fund..... N/A
Capital Appreciation Fund.... 41,466
Convertible Fund............. 21,595
Equity Index Fund............ N/A
Government Fund.............. 16,639
High Yield Corporate Bond
Fund..................... 68,994
International Bond Fund...... 2,608
International Equity Fund.... 5,460
Money Market Fund............ 12,407
New York Tax Free Fund....... N/A
Strategic Income Fund........ 4,701
Strategic Value Fund......... 2,323
Tax Free Bond Fund........... 13,665
Total Return Fund............ 28,016
Value Fund................... 31,142
</TABLE>
For the period January 1, 1997 through October 26, 1997 and the fiscal
years ended December 31, 1996 and 1995, the amount of recordkeeping fee paid to
NYLIFE Distributors, the previous Accounting Agent, by each Fund was as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, 1997 December 31, 1996 December 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
California Tax Free Fund.............. $ N/A $ N/A $ N/A
Capital Appreciation Fund............. 164,868 145,721 95,042
Convertible Fund...................... 108,332 81,568 57,184
Equity Index Fund..................... N/A N/A N/A
Government Fund....................... 80,879 114,622 128,798
High Yield Corporate Bond Fund........ 270,515 233,333 164,329
International Bond Fund............... 11,358 12,511 12,000
International Equity Fund............. 24,683 22,075 12,668
Money Market Fund..................... 54,915 62,593 53,064
New York Tax Free Fund................ N/A N/A N/A
Strategic Income Fund +............... 13,624 N/A N/A
Strategic Value Fund +................ N/A N/A N/A
Tax Free Bond Fund.................... 60,703 80,430 79,801
Total Return Fund..................... 119,962 126,154 103,032
Value Fund............................ 125,541 16,985 85,935
</TABLE>
----------------
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operation on October 21, 1997.
B-140
<PAGE> 432
In addition, each Fund may reimburse NYLIFE Securities, NYLIFE
Distributors and MainStay Shareholder Services for the cost of certain
correspondence to shareholders and the establishment of 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 each Fund, is responsible under its
Management Agreement for the payment of expenses related to each 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 Sub-Advisers,
(iii) certain fees and expenses of the Trust's Custodians and Transfer
Agent,(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 a Fund, in connection with its securities
transactions, (vi) the fees of any trade association of which a Fund or the
Trust is a member, (vii) the cost of share certificates representing shares of a
Fund, (viii) reimbursement of a portion of the organization expenses of a Fund
and the fees and expenses involved in registering and maintaining registration
of the Trust and of its shares with the SEC and registering the Trust as a
broker or dealer and qualifying its shares under state securities laws,
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 a Fund's business,
(xi) any expenses assumed by the Fund pursuant to its plan of distribution,(xii)
all taxes and business fees payable by a Fund to federal, state or other
governmental agencies, and (xiii) costs associated with the pricing of the
Funds' shares. 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.
Certain of the Funds have entered into a committed line of credit with
The Bank of New York as agent, and various other lenders from whom a Fund may
borrow up to 5% of its net assets in order to honor redemptions. The credit
facility is expected
B-141
<PAGE> 433
to be utilized in periods when the Funds experience unusually large redemption
requests.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Purchases and sales of securities on a securities exchange are effected
by brokers, and the Funds pay 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.
Regarding the California Tax Free Fund and New York Tax Free Fund,
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 a 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 Sub-Advisers attempt to achieve this result by selecting
broker-dealers to execute portfolio transactions on behalf of each Fund and
their 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
B-142
<PAGE> 434
commissions. Consistent with the foregoing primary considerations, the Conduct
Rules of the NASD and such other policies as the Trustees may determine, the
Sub-Advisers may consider sales of shares of the Funds as a factor in the
selection of broker-dealers to execute the Funds' 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 on an exchange, 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 each Sub-Advisory Agreement and as permitted by Section 28(e) of
the Securities Exchange Act of 1934 (the "1934 Act"), a Sub-Adviser may cause a
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 a 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 Trust 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.
Although commissions paid on every transaction will, in the judgment of
the Sub-Advisers, be reasonable in relation to the
B-143
<PAGE> 435
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 Trust and the
Sub-Advisers' 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-Advisers 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 Trust, a commission higher than one charged elsewhere will not
be paid to such a firm solely because it provided Research to an Sub-Adviser.
Research provided by brokers is used for the benefit of all of the Sub-Advisers'
clients and not solely or necessarily for the benefit of the Trust. The
Sub-Advisers' investment management personnel attempt to evaluate the quality of
Research provided by brokers. Results of this effort are sometimes used by the
Sub-Advisers as a consideration in the selection of brokers to execute portfolio
transactions.
In certain instances there may be securities which are suitable for a
Fund's portfolio as well as for that of another Fund or one or more of the other
clients of the Sub-Advisers. Investment decisions for a Fund and for the
Sub-Advisers' 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 particular
transaction as far as a Fund is concerned. The
B-144
<PAGE> 436
Trust believes that over time its ability to participate in volume transactions
will produce better executions for the Funds.
The Sub-Advisory fee that the Manager pays on behalf of each Fund to
the Sub-Advisers will not be reduced as a consequence of the Sub-Advisers'
receipt of brokerage and research services. To the extent a 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-Advisers in serving both the Funds and other clients and, conversely,
such services obtained by the placement of brokerage business of other clients
would be useful to the Sub-Advisers in carrying out their obligations to the
Funds.
For the fiscal years ended December 31, 1997, 1996 and 1995 each of the
following Funds paid brokerage commissions as follows:
<TABLE>
<CAPTION>
Total Brokerage Total Brokerage Commissions
Commissions Paid Paid to Affiliated Persons
---------------- ----------------------------
Year ended Year ended Year ended Year ended Year ended Year ended
Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Capital Appreciation Fund.... 1,349,716 $ 882,877 $ 681,250 $ -- $ --- $ ---
Convertible Fund............. 1,728,411 1,952,991 674,139 -- --- ---
Equity Index Fund............ 24,704 63,111 7,018 -- --- ---
Government Fund.............. 1,719 20,809 71,818 -- --- ---
High Yield Corporate Bond
Fund....................... 1,297,005 1,187,150 1,207,587 -- --- 1,970(0%)(1)
International Equity Fund.... 239,373 215,696 135,267 -- --- ---
Strategic Income Fund+....... 11,739 N/A N/A -- N/A N/A
Strategic Value Fund+........ 21,314 N/A N/A -- N/A N/A
Total Return Fund............ 609,009 399,858 436,507 -- --- ---
Value Fund................... 2,347,711 1,354,707 1,055,169 -- --- 5,074(0%)(1)
</TABLE>
B-145
<PAGE> 437
<TABLE>
<CAPTION>
Total Brokerage
Commissions Paid
Total Amount of Transactions to Brokers that
Where Commissions Paid Provided Research
----------------------------------------------------------------------- -----------------
Year Ended Year Ended Year Ended Year ended
December 31, 1997 December 31, 1996 December 31, 1995 December 31, 1997
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Capital Appreciation Fund...... 987,618,526 $ 571,478,397(0.0%)(2) $ 391,017,677(0.0%)(2) 1,349,716
Convertible Fund............... 1,608,359,897 1,296,465,108(0.0%)(2) 395,570,645(0.0%)(2) 1,728,411
Equity Index Fund.............. 21,540,769 64,348,135(0.0%)(2) 5,863,505(0.0%)(2) 24,704
Government Fund................ 12,111,250 275,083,720(0.0%)(2) 712,117,650(0.0%)(2) 1,719
High Yield Corporate Bond
Fund......................... 1,451,737,826 2,471,387,854(0.0%)(2) 1,414,045,455(0.0%)(2) 1,297,005
International Equity Fund...... 60,462,344 49,098,906(0.0%)(2) 33,559,758(0.0%)(2) 239,373
Strategic Income Fund+......... 41,537,454 N/A N/A 11,739
Strategic Value Fund+.......... 12,723,841 N/A N/A 21,314
Total Return Fund ............. 459,057,404 271,187,968(0.0%)(2) 604,631,476(0.0%)(2) 609,009
Value Fund .................... 1,523,756,743 848,170,710(0.0%)(2) 544,224,812(0.0%)(2) 2,347,711
</TABLE>
- -------------------------
(1) Percent of total commissions paid.
(2) Percent of total transactions involving the payment of commissions
effected through affiliated persons.
+ The Strategic Income Fund commenced operations on February 28, 1997.
The Strategic Value Fund commenced operations on October 21, 1997.
The California Tax Free Fund, International Bond Fund, Money Market
Fund, New York Tax Free Fund and Tax Free Bond Fund paid no brokerage
commissions during the fiscal years ended December 31, 1997, 1996 and 1995.
Capital Appreciation Fund held commercial paper of American Express
Credit Corp. valued at $30,000,000 and commercial paper of Prudential Funding
Corp. valued at $62,926,000; Equity Index Fund held common stock in Merrill
Lynch & Co., Inc. valued at $1,358,753, common stock of Schwab (Charles) Corp.
valued at $624,156, common stock of American Express Co. valued at $2,333,620
and common stock of Morgan Stanley, Dean Witter, Discover & Co. valued at
$1,970,814; International Equity Fund held commercial paper of Merrill Lynch &
Co. Inc. valued at $3,599,399 and common stock of HSBC Holdings PLC valued
$258,829; Convertible Fund held commercial paper of American Express Credit
Corp. Valued at $1,700,000, and common stock and preferred stock of Merrill
Lynch & Co., Inc. valued at $10,913,400 and $1,228,200, respectively; Total
Return Fund held commercial paper of American Express Credit Corp. valued at
$43,450,000, and bonds of Lehman Brothers Holdings Inc., 7.375%, due 5/15/07,
valued at $984,537; Value Fund held commercial paper of American Express Credit
Corp. valued at $29,820,000 and commercial paper of Prudential Funding Corp.
valued at $20,694,000; Government Fund held commercial paper of American
B-146
<PAGE> 438
Express Credit Corp. valued at $32,000,000 and commercial paper of Prudential
Funding Corp. Valued at $6,000,000; High Yield Corporate Bond Fund held
commercial paper of American Express Credit Corp. valued at $137,292,000 and
commercial paper of Prudential Funding Corp. valued at $25,000,000; Money Market
Fund held commercial paper of American Express Credit Corp. valued at $3,173,000
and commercial paper of Goldman Sachs Group L.P. valued at $14,483,450;
Strategic Income Fund held commercial paper of American Express Credit Corp.
valued at $3,000,000, bonds of Lehman Large Loan, Series 1997-LL1 Class A,
6.79%, due 6/12/04, valued at $203,666 and bonds of Merrill Lynch Mortgage
Investors, Inc., Series 1995-C2 Class A1, 7.1817%, due 6/15/21, valued at
$238,560; and Strategic Value Fund held commercial paper of American Express
Credit Corp. valued at $1,187,000 and commercial paper of Prudential Funding
Corp. valued at $1,115,000.
Investors may, subject to the approval of the Trust, the Manager and
the Sub-Adviser, purchase shares of a Fund with liquid securities that are
eligible for purchase by that 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.
NET ASSET VALUE
The net asset value per share of each Fund (other than the Money Market
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. The net asset value per share of
the Money Market Fund is also determined at noon on such days.
Portfolio securities of the Money Market Fund are valued at their
amortized cost, which does not take into account unrealized securities gains or
losses. While this method provides certainty in valuation, it may result in
periods during which value, as determined by amortized cost, is higher or lower
than the price the Money Market Fund would receive if it sold the instrument.
During periods of declining interest rates, the quoted yield on shares of the
Money Market Fund may tend to be higher than a like computation made by a fund
with identical investments utilizing a method of valuation based upon market
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prices and estimates of market prices for all of its portfolio instruments.
Thus, if the use of amortized cost by the Money Market Fund resulted in a lower
aggregate portfolio value on a particular day, a prospective investor in the
Money Market Fund would be able to obtain a somewhat higher yield if he or she
purchased shares of the Money Market Fund on that day, than would result from
investment in a fund utilizing solely market values, and existing investors in
the Money Market Fund would receive less investment income. The converse would
apply in a period of rising interest rates.
Portfolio securities of each other 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
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
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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 Funds 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 Funds 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 Trust recognizes
dividend income and other distributions on the ex-dividend date, except that
certain dividends from foreign securities are recognized as soon as the Trust 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 Funds' net asset values
are 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
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of the New York Stock Exchange will not be reflected in the Funds' calculation
of net asset values unless the Sub-Adviser deems that the particular event would
materially affect net asset value, in which case an adjustment will be made.
Because the Guarantee regarding the Equity Index Fund is payable to
shareholders directly (and not payable to the Equity Index Fund), and because it
represents only a contingent liability rather than an agreement to pay a
definite amount on the Guarantee Date, the Trustees believe that the Guarantee
should have no impact in determining the Equity Index Fund's net asset value.
The proceeds received by each 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 such Fund and constitute the underlying assets of that Fund. The underlying
assets of each Fund will be segregated on the books of account, and will be
charged with the liabilities in respect to such Fund and with a share of the
general liabilities of the Trust. Expenses with respect to any two or more Funds
will be allocated in proportion to the net asset values of the respective Funds
except where allocations of direct expenses can otherwise be fairly made.
To the extent that any newly organized fund or class of shares
receives, on or before December 31, any seed capital, the net asset value of
such fund(s) or class(es) will be calculated as of December 31.
SHAREHOLDER INVESTMENT ACCOUNT
A Shareholder Investment Account is established for each investor in
the Funds, under which a record of the shares of each 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 a Fund (other than the
Money Market 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.
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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, REDEMPTION AND REPURCHASE
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 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.
DISTRIBUTIONS IN KIND
The Trust has agreed to redeem shares of each 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 applicable Fund's portfolio. The
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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.
SUSPENSION OF REDEMPTIONS
The Trust may suspend the right of redemption of shares of any 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.
CDSC WAIVERS
The Prospectus identifies certain categories of Class B share
redemptions on which the contingent deferred sales charge ("CDSC") will be
waived. See "Tell Me the Details - Alternative Sales Arrangements - Deferred
Sales Charge Class B Shares." In addition to those categories, the CDSC will be
waived in connection with the following redemptions of Class B shares by
accounts established before January 1, 1998: (i) withdrawals from IRS qualified
and nonqualified retirement plans, individual retirement accounts, tax sheltered
accounts, and deferred compensation plans, where such withdrawals are permitted
under the terms of the plan or account (e.g., attainment of age 59 1/2,
separation from service, death, disability, loans, hardships, withdrawals of
excess contributions pursuant to applicable IRS rules, withdrawals based on life
expectancy under applicable IRS rules); (ii) preretirement transfers or
rollovers within a retirement plan where the proceeds of the redemption are
invested in proprietary products offered or distributed by New York Life or its
affiliates; (iii) living revocable trusts on the death of the beneficiary; (iv)
redemptions made within one year following the death or disability or a
shareholder; (v) redemptions by directors, Trustees, officers and employees (and
immediate family members) of the Trust and of New York Life and its affiliates
where no commissions have been paid; (vi)
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redemptions by employees of any dealer which has a soliciting dealer agreement
with the Distributor, and by any trust, pension, profit-sharing or benefit plan
for the benefit of such persons where no commissions have been paid; (vii)
redemptions by tax-exempt employee benefit plans resulting from the adoption or
promulgation of any law or regulation; (viii) redemptions by any state, country
or city, or any instrumentality, department, authority or agency thereof and by
trust companies and bank trust departments; and (ix) transfers to (a) other
funding vehicles sponsored or distributed by New York Life or an affiliated
company, or (b) guaranteed investment contracts, regardless of the sponsor,
within a retirement plan.
TAX-DEFERRED RETIREMENT PLANS
CASH OR DEFERRED PROFIT SHARING PLANS UNDER SECTION 401(k) FOR
CORPORATIONS AND SELF-EMPLOYED INDIVIDUALS
Shares of a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond 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.
All Funds, except the California Tax Free Fund, New York Tax Free Fund and Tax
Free Bond 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.
INDIVIDUAL RETIREMENT ACCOUNT ("IRA")
Shares of a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond Fund, may also be purchased as an underlying
investment for an IRA made available by NYLIFE Distributors. Three types of IRAs
are available -- a traditional IRA, the "Roth" IRA and the "Education" 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 (i) $2,000 or (ii)
the sum of (a) the compensation includible in the working
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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 contribution
to a traditional IRA which is deductible for federal income tax purposes. For
the 1998 tax year, a contribution is deductible only if the individual (and his
or her spouse, if applicable) has an adjusted gross income below a certain level
($50,000 for married individuals filing a joint return, with a phase-out of the
deduction for adjusted gross income between $50,000 and $60,000; $30,000 for a
single individual, with a phase-out for adjusted gross income between $30,000
and $40,000). These phase-out limits will gradually increase, eventually
reaching $50,000 - $60,000 for single filers in 2005 and thereafter (and
reaching $80,000 - $100,000 if married filing jointly in 2007 and thereafter).
In addition, a married individual may make a deductible IRA contribution even
though the individual's 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 ($0-$10,000 for non-participant spouses filing a
separate return). 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.
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 penalty tax. However,
there are exceptions for certain withdrawals, including: withdrawals up to a
total of $10,000 for qualified first-time homebuyer expenses or 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 IRA
distributions must begin and the minimum amount of such
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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 which
feature nondeductible contributions that 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 for this purpose. Unlike the traditional IRA, Roth IRAs
are not subject to minimum distribution requirements during the account owner's
lifetime. However, the amount in a Roth IRA is subject to required distribution
rules after the death of the account owner.
Education IRAs. 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
phased out for taxpayers 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 part of a distribution is taxable, a penalty 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 a penalty tax upon distribution.
All income and capital gains deriving from IRA investments in the Fund
are reinvested and compounded tax-deferred until distributed from the IRA. The
combination of annual
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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 tax-deferred compounded earnings on IRA investments can lead to substantial
retirement and/or education savings.
403(b)(7) TAX SHELTERED ACCOUNT
Shares of a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond Fund, may also be purchased as the underlying
investment for tax sheltered custodial accounts (403(b) plans) 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 a Fund, except the California Tax Free Fund, New York Tax
Free Fund and Tax Free Bond 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 Funds' Custodian and
Transfer Agent designate New York Life 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 New York Life 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.
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CALCULATION OF PERFORMANCE QUOTATIONS
From time to time, quotations of the Money Market Fund's "yield" and
"effective yield" may be included in advertisements or communications to
shareholders. These performance figures are calculated in the following manner:
A. Yield -- the net annualized yield based on a specified
seven-calendar day period calculated at simple interest rates. Yield is
calculated by determining the net change, exclusive of capital changes,
in the value of a hypothetical preexisting account having a balance of
one share at the beginning of the period, subtracting a hypothetical
charge reflecting deductions from shareholder accounts, and dividing
the difference by the value of the account at the beginning of the base
period to obtain the base period return. The yield is annualized by
multiplying the base period return by 365/7. The yield figure is stated
to the nearest hundredth of one percent. The yield of the Class A and
Class B shares of the Money Market Fund for the seven-day period ended
December 31, 1997 was 5.07% and 5.07%, respectively.
B. Effective Yield -- the net annualized yield for a specified
seven-calendar day period assuming a reinvestment of dividends
(compounding). Effective yield is calculated by the same method as
yield except the yield figure is compounded by adding one, raising the
sum to a power equal to 365 divided by 7, and subtracting one from the
result, according to the following formula: Effective Yield = [(Base
Period Return + 1) 365/7] - 1. The effective yield of the Class A and
Class B shares of the Money Market Fund for the seven-day period ended
December 31, 1997 was 5.20% and 5.20%, respectively.
The yield and effective yield of the Money Market Fund reflect
the reduction of certain fees otherwise payable and voluntary expense
limitations. Had there been no reduction of fees or expense
limitations, the yield and effective yield of the Money Market Fund
would have been 4.77% and 4.88%, respectively, for Class A shares and
4.77% and 4.88%, respectively, for Class B shares for the seven-day
period ended December 31, 1997.
As described above, yield and effective yield are based on historical
earnings and are not intended to indicate future
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performance. The "effective yield" will be slightly higher than the "yield"
because of the compounding effect of the assumed reinvestment of dividends.
Yield and effective yield will vary based on changes in market conditions and
the level of expenses.
From time to time a Fund, other than the Money Market 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 each 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 and reflects fee waivers and reimbursements in effect for each 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. The
performance information shown below for the period ended December 31, 1996
provides performance figures for both Class A and Class B shares of the Funds,
except in the case of the Equity Index Fund which offers only one class of
shares, Class A shares.
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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Quotations of each Fund's average annual total return will be
calculated according to the following SEC formula:
P(1+T)n = 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)
Each 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 a
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 average annual total returns of the Class A shares of the following
Funds for the one-year and, as applicable, five-year and ten-year periods ended
December 31, 1997 and the period from inception to December 31, 1997 were as
follows:*
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<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97 12/31/97 12/31/97 Return(a) Date
---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund 3.04% 5.64% N/A 6.11% 10/1/91
Capital Appreciation Fund (b)........ 17.27% 16.33% 18.28% 14.88% 5/1/86
Convertible Fund (b)................. 5.24% 12.38% 12.65% 9.99% 5/1/86
Equity Index Fund.................... 28.30% 18.45% N/A 17.83% 12/20/90
Government Fund (b).................. 4.21% 4.93% 6.69% 6.54% 5/1/86
High Yield Corporate
Bond Fund (b) 7.16% 13.11% 11.79% 10.49% 5/1/86
International Bond Fund (b).......... -2.75% N/A N/A 8.69% 9/13/94
International Equity Fund (b)........ -1.23% N/A N/A 3.35% 9/13/94
New York Tax Free Fund............... 3.52% 5.74% N/A 6.36% 10/1/91
Strategic Income Fund................ N/A N/A N/A 1.83% 2/28/97
Strategic Value Fund................. N/A N/A N/A -1.61% 10/22/97
Tax Free Bond Fund (b)............... 4.11% 5.18% 6.58% 6.19% 5/1/86
Total Return Fund (b)................ 11.74% 11.91% 12.48% 12.50% 12/29/87
Value Fund (b)....................... 15.18% 15.40% 16.43% 12.68% 5/1/86
</TABLE>
- ------------------
* Assumes the deduction of the maximum applicable initial sales charge.
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class B shares for the period from inception through December
31, 1994. Performance data for the two classes after this date vary
based on differences in their expense structures.
The average annual total returns of the Class B shares of the following
Funds for the one-year and, as applicable, five-year and ten-year periods ended
December 31, 1997, and the period from inception to December 31, 1997 were as
follows*:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97* 12/31/97* 12/31/97* Return(a) Date
---- --------- --------- --------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund (b)......... 2.63% 6.14% N/A 6.75% 10/1/91
Capital Appreciation Fund 18.45% 17.08% 18.77% 15.29% 5/1/86
Convertible Fund..................... 5.67% 13.00% 13.08% 10.35% 5/1/86
Government Fund...................... 3.54% 5.19% 6.99% 6.79% 5/1/86
High Yield Corporate
Bond Fund.......................... 6.55% 13.53% 12.11% 10.76% 5/1/86
International Bond Fund.............. -3.85% N/A N/A 9.08% 9/13/94
International Equity Fund............ -1.22% N/A N/A 3.85% 9/13/94
New York Tax Free Fund (b)........... 3.14% 6.26% N/A 7.03% 10/1/91
Strategic Income Fund................ N/A N/A N/A 1.02% 2/28/97
Strategic Value Fund................. N/A N/A N/A -0.96% 10/22/97
Tax Free Bond Fund................... 3.80% 5.70% 7.01% 6.56% 5/1/86
Total Return Fund.................... 12.65% 12.60% 12.93% 12.97% 12/29/87
Value Fund........................... 16.29% 16.11% 16.89% 13.07% 5/1/86
</TABLE>
- ------------------
* Assumes a complete redemption at the end of each year and the deduction
of the maximum applicable contingent deferred sales charge.
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class A shares for the period from inception
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through December 31, 1994. Performance data for the two classes after
this date vary based on differences in their expense structures.
The average annual total returns of the Class A shares of the following
Funds without deducting the applicable initial sales charge is as follows:
<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97 12/31/97 12/31/97 Return(a) Date
---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund 7.90% 6.62% N/A 6.89% 10/1/91
Capital Appreciation Fund (b)........ 24.10% 17.65% 18.95% 15.44% 5/1/86
Convertible Fund(b).................. 11.36% 13.66% 13.29% 10.52% 5/1/86
Equity Index Fund.................... 32.26% 19.17% N/A 18.35% 12/20/90
Government Fund(b)................... 9.12% 5.90% 7.18% 6.96% 5/1/86
High Yield Corporate
Bond Fund (b) 12.20% 14.15% 12.30% 10.92% 5/1/86
International Bond Fund (b).......... 1.83% N/A N/A 10.22% 9/13/94
International Equity Fund (b)........ 4.52% N/A N/A 5.14% 9/13/94
New York Tax Free Fund............... 8.39% 6.72% N/A 7.15% 10/1/91
Strategic Income Fund................ N/A N/A N/A 6.62% 2/28/97
Strategic Value Fund................. N/A N/A N/A 4.11% 10/22/97
Tax Free Bond Fund (b)............... 9.02% 6.15% 7.08% 6.61% 5/1/86
Total Return Fund (b)................ 18.24% 13.18% 13.10% 13.14% 12/29/87
Value Fund (b)....................... 21.88% 16.72% 17.09% 13.23% 5/1/86
</TABLE>
- ------------------
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class A shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class B shares for the period from inception through December
31, 1994. Performance data for the two classes after this date vary
based on differences in their expense structures.
The average annual total returns of the Class B shares of the following
Funds without deducting the applicable contingent deferred sales charge is as
follows:
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<TABLE>
<CAPTION>
Average
Year Five Years Ten Years Annual
Ended Ended Ended Total Inception
Fund 12/31/97 12/31/97 12/31/97 Return(a) Date
---- -------- -------- -------- --------- ----
<S> <C> <C> <C> <C> <C>
California Tax Free Fund (b)......... 7.63% 6.45% N/A 6.75% 10/1/91
Capital Appreciation Fund 23.45% 17.29% 18.77% 15.29% 5/1/86
Convertible Fund..................... 10.67% 13.24% 13.08% 10.35% 5/1/86
Government Fund...................... 8.54% 5.51% 6.99% 6.79% 5/1/86
High Yield Corporate
Bond Fund ..................... 11.55% 13.77% 12.11% 10.76% 5/1/86
International Bond Fund ............. 1.15% N/A N/A 9.57% 9/13/94
International Equity Fund ........... 3.78% N/A N/A 4.40% 9/13/94
New York Tax Free Fund (b)........... 8.14% 6.57% N/A 7.03% 10/1/91
Strategic Income Fund................ N/A N/A N/A 6.02% 2/28/97
Strategic Value Fund................. N/A N/A N/A 4.04% 10/22/97
Tax Free Bond Fund .................. 8.80% 6.02% 7.01% 6.56% 5/1/86
Total Return Fund ................... 17.65% 12.85% 12.93% 12.97% 12/29/87
Value Fund........................... 21.29% 16.33% 16.89% 13.07% 5/1/86
</TABLE>
- ------------------
(a) From inception to 12/31/97.
(b) Performance figures for the Fund's Class B shares, first offered to the
public on January 3, 1995, include the historical performance of the
Fund's Class A shares for the period from inception through December
31, 1994. Performance data for the two classes after this date vary
based on differences in their expense structures.
The performance data 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 each Fund, except the Money Market 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 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)6 -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
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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.
For the 30-day period ended December 31, 1997, the yield of each of the
following Funds was:
<TABLE>
<CAPTION>
30-Day
Period Ended
December 31,
1997
-------------
Fund Class A Class B
---- ------- -------
<S> <C> <C>
California Tax Free Fund.............. 4.74% 4.71%
Government Fund....................... 4.84% 4.34%
High Yield Corporate Bond Fund........ 6.77% 6.33%
International Bond Fund............... 4.57% 4.02%
New York Tax Free Fund................ 4.72% 4.69%
Tax Free Bond Fund.................... 4.81% 4.79%
Strategic Income Fund................. 5.93% 5.30%
</TABLE>
The California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund may publish its tax equivalent yield in advertisements and communications
to shareholders. The tax equivalent yield is calculated by determining the rate
of return that would have to be achieved on a fully taxable investment to
produce the after-tax equivalent of the Fund's yield, assuming certain tax
brackets for a Fund shareholder.
The table below illustrates the taxable yield equivalent to a tax-free
yield of 5.50%.*+
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<TABLE>
<CAPTION>
To Equal a 5.50% Tax
If Free Return, a Taxable
Your Federal Investment Would Have to
Marginal Tax Earn Without Fee Reduction
Rate is: or Expense Limit
------------ ---------------------------
<S> <C>
15.00% 6.47%
28.00% 7.64%
31.00% 7.97%
36.00% 8.59%
39.60% 9.11%
</TABLE>
--------------------
* This table reflects application of the regular Federal
income tax only; other taxes may be applicable with respect
to a particular shareholder. Such taxes could change the
information shown. Tax rates are subject to change.
Investors in the California and New York Tax Free Funds
should in particular note that the chart does not reflect
any state and local taxes that may be deductible in
computing Federal income tax liability.
+ This table is for illustrative purposes only; investors should consult
their tax advisers with respect to the tax implications of an
investment in a Fund that invests primarily in securities, the interest
on which is exempt from regular Federal income tax.
A 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 each 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 a Fund's performance including (i) realized and
unrealized capital gains and losses, which are reflected in calculations of a
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
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currently required for yield calculations. In addition, the current dividend
rate does not take into account the imposition 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 a Fund will
fluctuate over time, and any presentation of a Fund's yield, current dividend
rate, total return or tax-equivalent yield 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, total return or tax- equivalent yield
may be in any future period.
In addition, advertising for a 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 a 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 a
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 a Fund may
discuss the investment philosophy, personnel and assets under management of the
Fund's Manager and Sub-Adviser, and other pertinent facts relating to the
management of the Fund by the adviser.
From time to time any of the Funds 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 a Fund may be compared, in
advertisements, sales literature, and reports to shareholders, to: (i) unmanaged
indexes, such as the Standard &
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Poor's 500 Composite Stock Price Index, the Salomon Brothers 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 Funds. Advertisements for a Fund may also include general information
about the performance of unmanaged indexes with investment parameters similar to
the Fund's. 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 Funds may include general
information about the services and products offered by the 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 FUNDS
The following summarizes certain federal income tax considerations
generally affecting the Funds and their stockholders. No attempt is made to
present a detailed explanation of the tax treatment of the Funds or their
stockholders, and the discussion here is not intended as a substitute for
careful tax planning. The discussion is based
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upon present provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), the regulations promulgated thereunder, and judicial and administrative
ruling authorities, all of which are subject to change, which change may be
retroactive. Prospective investors should consult their own tax advisors with
regard to the federal tax consequences of the purchase, ownership, and
disposition of Fund shares, as well as the tax consequences arising under the
laws of any state, foreign country, or other taxing jurisdiction.
Each Fund intends to be treated as a regulated investment company
("RIC") under Subchapter M of the Code. To qualify as a regulated investment
company, each Fund must, among other things: (i) derive in each taxable year at
least 90% of its gross income from dividends, interest, payments with respect to
certain securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income derived with respect to its
business of investing in such stock, securities, or currencies ("Qualifying
Income Test"); (ii) diversify its holdings so that, at the end of each quarter
of the taxable year, (a) at least 50% of the market value of the Fund's assets
is represented by cash, cash items, 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, and (b) not more than 25% of
the value of its total assets is invested in the securities on any one issuer
(other than U.S. Government securities or the securities of other regulated
investment companies), or of two or more issuers which the Fund controls (as
that term is defined in the relevant provisions of the Code) and which are
determined to be engaged in the same or similar trades or businesses or related
trades or businesses; and (iii) distribute at least 90% of the sum of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of any net long-term capital
losses) and its net tax-exempt interest each taxable year. The Treasury
Department is authorized to promulgate regulations under which foreign currency
gains would constitute qualifying income for purposes of the Qualifying Income
Test only if such gains are directly related to investing in securities (or
options and futures with respect to securities). To date, no such regulations
have been issued.
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Certain requirements relating to the qualification of a Fund as
regulated investment company may limit the extent to which a Fund will be able
to engage in certain investment practices, including transactions in futures
contracts and other types of derivative securities transactions. In addition, if
a Fund were unable to dispose of portfolio securities due to settlement problems
relating to foreign investments or due to the holding of illiquid securities,
the Fund's ability to qualify as a regulated investment company might be
affected.
A Fund qualifying as a regulated investment company generally will not
be subject to U.S. federal income tax on its investment company taxable income
and net capital gains (any net long-term capital gains in excess of the net
short-term capital losses), if any, that it distributes to shareholders. Each
Fund intends to distribute to its shareholders, at least annually, substantially
all of its investment company taxable income and any net capital gains.
Generally, regulated investment companies, like the Fund, must
distribute amounts on a timely basis in accordance with a calendar year
distribution requirement in order to avoid a nondeductible 4% excise tax.
Generally, to avoid the tax, a regulated investment company must distribute
during each calendar year, (i) at least 98% of its ordinary income (not taking
into account any capital gains or losses) for the calendar year, (ii) at least
98% of its capital gains in excess of its capital losses (adjusted for certain
ordinary losses) for the 12-month period ending on October 31 of the calendar
year, and (iii) all ordinary income and capital gains for previous years that
were not distributed during such years. To avoid application of the excise tax,
each Fund intends to make its distributions in accordance with the calendar year
distribution requirement. A distribution is treated as paid on December 31 of
the calendar year if it is declared by a Fund in October, November or December
of that year to shareholders of record on a date in such a month and paid by the
Fund during January of the following calendar year. Such distributions are
taxable to shareholders in the calendar year in which the distributions are
declared, rather than the calendar year in which the distributions are received.
Provided that a Fund qualifies as a regulated investment company, under
the Code, it generally will not be subject to any excise or income taxes in
Massachusetts. A Fund's investments, if any, in REMIC residual interests (as
explained previously in
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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 a Fund's
earnings will be subject to tax in their hands.
Each Fund, other than the Equity Index Fund (which offers only one
class of shares) and the Strategic Income Fund and Strategic Value Fund, has
received a ruling from the IRS to the effect that differing distributions
between the classes of its shares will not result in a Fund's dividends and
other distributions being regarded as "preferential dividends" under the Code.
Generally, a preferential dividend is a dividend which a Fund cannot treat as
having been distributed for purposes of (I) determining whether the Fund
qualifies as a regulated investment company for federal tax purposes, and (ii)
determining the Fund's tax liability.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- GENERAL
Assuming a 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 sources (such as
interest) other 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 generally eliminated unless such
shares are deemed to have been held for more than 45 days. The 45-day holding
period must occur during the 90-day period beginning 45 days before the date on
which the shares become ex-dividend. In the case of dividends on certain
preferred stock, the holding period requirement is 90 days during a 180-day
period. 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 and the applicable holding period
requirements are not met, the shareholder's basis in its shares
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could be reduced by all or a portion of the amount of the dividends that
qualifies for the dividends-received deduction.
Distributions of net capital gain, whether received in cash or
reinvested in Fund shares, will generally be taxable to shareholders as either
"20% Rate Gain" or "28% Rate Gain," depending upon the Fund's holding period for
the assets sold. "20% Rate Gains" arise from sales of assets held by a Fund for
more than 18 months and are subject to a maximum tax rate of 20%; "28% Rate
Gains" arise from sales of assets held by a Fund for more than one year but no
more than 18 months and are subject to a maximum tax rate of 28%. Net capital
gains from assets held for one year or less will be taxed as ordinary income.
Distributions will be subject to these capital gains rates regardless of how
long a shareholder has held Fund shares.
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 a Fund
within 30 days before or after a purchase of shares of the same 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 a Fund for reinvestment, requiring federal income taxes
to be paid thereon by that Fund, the Fund intends to elect to treat such capital
gains as having been distributed to shareholders. As a result, such capital
gains will be taxable to 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 the relevant Fund shares by the
difference between their pro-rata share of such gains and their tax credit.
Except for distributions by the Money Market Fund, distributions by a
Fund result in a reduction in the net asset value of a Fund's shares. Should a
distribution reduce the net asset value below a shareholder's cost basis, such
distribution nevertheless would generally 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,
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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 a Fund's net investment income or net
capital gain may be characterized as a return of capital to shareholders or, 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.
CHARACTER OF DISTRIBUTIONS TO SHAREHOLDERS -- THE TAX-FREE FUNDS
The Code permits the character of tax-exempt interest distributed by a
regulated investment company to "flow through" as tax-exempt interest to its
shareholders, provided that 50% or more of the value of its assets at the end of
each quarter of its taxable year is invested in state, municipal or other
obligations the interest on which is exempt under Section 103(a) of the Code.
Each of the California Tax Free Fund, New York Tax Free Fund and Tax Free Bond
Fund (collectively, the "Tax Free Funds") intend to satisfy the 50% requirement
to permit their distributions of tax-exempt interest to be treated as such for
regular Federal income tax purposes in the hands of their shareholders.
Exempt-interest dividends must be taken into account by individual shareholders
in determining whether their total incomes are large enough to result in
taxation of up to 85% of their social security benefits and certain railroad
retirement benefits. None of the income distributions of the Tax Free Funds will
be eligible for the deduction for dividends received by corporations.
Although a significant portion of the distributions by the Tax Free
Funds generally is expected to be exempt from federal taxes, each of these Funds
may under certain circumstances invest in obligations the interest from which is
fully taxable, or, although exempt from the regular federal income tax, is
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subject to the alternative minimum tax. Similarly, gains from the sale or
exchange of obligations the interest on which is exempt from regular Federal
income tax will constitute taxable income to those Funds. In addition, a sale of
shares in such Fund (including a redemption of such shares and an exchange of
shares between two mutual funds) will be a taxable event, and may result in a
taxable gain or loss to a shareholder. Accordingly, it is possible that a
significant portion of the distributions of these Funds will constitute taxable
rather than tax-exempt income in the hands of a shareholder. Furthermore,
investors should be aware that tax laws may change, and issuers may fail to
follow applicable laws, causing a tax-exempt item to become taxable.
Exempt-interest dividends from the Tax Free Funds; ordinary dividends
from the Tax Free Funds, if any; capital gains distributions from the Tax Free
Funds and any capital gains or losses realized from the sale or exchange of
shares may be subject to state and local taxes. However, the portion of a
distribution of the Funds' tax-exempt income that is attributable to state and
municipal securities issued within the shareholder's own state may not be
subject, at least in some states, to state or local taxes.
Distributions derived from interest on certain private activity bonds
which is exempt from regular federal income tax are treated as a tax preference
item and may subject individual or corporate shareholders to liability (or
increased liability) for the alternative minimum tax. In addition, because a
portion of the difference between adjusted current earnings, as defined in the
Code, and alternative minimum taxable income is an addition to the alternative
minimum tax base, all distributions derived from interest which is exempt from
regular federal income tax are included in adjusted current earnings and may
subject corporate shareholders to or increase their liability for the
alternative minimum tax.
DISCOUNT
Certain of the bonds purchased by the Funds, 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 (or the price at which it was deemed issued for federal income tax
purposes) and its stated redemption price at
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maturity. Original issue discount is treated for federal income tax purposes as
income earned by a Fund over the term 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 a 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 a 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 a 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 a 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.
USERS OF BOND-FINANCED FACILITIES
Section 147(a) of the Code prohibits exemption from taxation of
interest on certain governmental obligations to persons who are "substantial
users" (or persons related thereto) of facilities financed thereby. No
investigation as to the users of the facilities financed by bonds in the
portfolios of the Tax Free Funds has been made by these Funds. Persons who may
be "substantial users" (or "related persons" of substantial users) of facilities
financed by private activity bonds should consult their tax advisers before
purchasing shares of a Fund since the acquisition of shares of the Tax Free Bond
Fund, California Tax Free Fund or New York Tax Free Fund may result in adverse
tax consequences to them.
TAXATION OF OPTIONS, FUTURES AND SIMILAR INSTRUMENTS
Many of the options, futures contracts and forward contracts entered
into by a 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
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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. 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.
Distribution of Fund gains from hedging transactions will be taxable to
shareholders. Generally, hedging transactions and certain other transactions in
options, futures and forward contracts undertaken by a Fund may result in
"straddles" for federal income tax purposes. The straddle rules may affect the
character of gains (or losses) realized by a Fund. In addition, losses realized
by a 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, certain transactions (including options,
futures contracts, notional principal contracts, short sales and short sales
against the box) 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 a Fund are not entirely clear. The
hedging transactions in which a Fund engages may increase the amount of
short-term capital gain realized by a Fund which is taxed as ordinary income
when distributed to shareholders.
A Fund may make one or more of the elections available under the Code
which are applicable to straddles. If a 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 may
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
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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 a Fund's status as a
regulated investment company may limit the extent to which a Fund will be able
to engage in transactions in options, futures contracts or forward contracts.
Regarding the Tax Free Bond Fund, the California Tax Free Fund and New
York Tax Free Fund, gains from certain transactions, including, for example,
transactions in options, futures, and other instruments, and from obligations
the interest on which is not exempt from Federal income tax, will be taxable
income to those Funds.
The International Bond Fund, International Equity Fund, Strategic Value
Fund and Strategic Income Fund may engage in swap transactions. The tax
treatment of swap agreements is not entirely clear in certain respects.
Accordingly, while the Funds intend to account for such transactions in a manner
they deem to be appropriate, the IRS might challenge such treatment. If such a
challenge were successful, status of a Fund as a regulated investment company
might be affected. The Funds intend to monitor developments in this area.
PASSIVE FOREIGN INVESTMENT COMPANIES
Certain of the Funds 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 a 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
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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.
A Fund may be eligible to elect alternative tax treatment with respect
to PFIC shares. Under an election that currently is available in some
circumstances, a 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. Alternatively, a Fund may elect to mark to
market its PFIC shares at the end of each taxable year, with the result that
unrealized gains are treated as though they were realized and reported as
ordinary income. Any mark-to-market losses and any loss from an actual
disposition of PFIC Shares would be deductible as ordinary losses to the extent
of any net mark-to-market gains included in income in prior years.
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 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 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 a Fund accrues income or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time a 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"
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gains or losses, may increase or decrease the amount of a 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, a 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. 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 a 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 a Fund were capital
assets in the hands of the shareholder, and generally will be taxable to
stockholders as "20% Rate Gain" if the shares had been held for more than 18
months or as "28% Rate Gain" if the shares had been held for more than one year
but no more than 18 months. A loss realized by a shareholder on the redemption,
sale or exchange of shares of a 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 a 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
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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 a 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.
Under certain circumstances, the sales charge incurred in acquiring
shares of either 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 a
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 pursuant
to a right acquired upon the initial purchase of shares. 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. The portion of the sales charge affected by this rule
will be treated as a sales charge paid for the new shares and will be reflected
in their basis.
If reverse stock splits are done, a share may have a split holding
period reflecting the fact that part of the share represents a reinvested
dividend or distribution.
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
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tax adviser to determine the tax status of a Fund distribution in his or her own
state and locality (or foreign country).
Under the federal income tax law, a 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 (other than shares of the Money Market Fund), 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 a 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 a Fund that the number furnished by the
shareholder is incorrect. In addition, both the Fund and the 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 a Fund from sources outside the
United States may be subject to foreign taxes which were paid or withheld at the
source. The payment of such taxes will reduce the amount of dividends and
distributions paid to the Funds' stockholders. Since the percentage of each
Fund's total assets (with the exception of the International Bond Fund and
International Equity Fund) which will be invested in foreign stocks and
securities will not be more than 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 a Fund will be
subject depends on the specific countries in which each Fund's assets will be
invested and the extent of the assets invested in each such country and,
therefore, cannot be determined in advance.
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The International Bond Fund and the International Equity 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 a 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. 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 a Fund
and any special tax considerations associated with foreign investments of a Fund
should be examined by shareholders with regard to their own tax situations.
Shareholders of the Tax Free Bond Fund, the California Tax Free Fund
and New York Tax Free Fund may be subject to state and local taxes on
distributions from the Fund, including distributions which are exempt from
federal income taxes. Some states exempt from the state personal income tax
distributions from a Fund derived from interest on obligations issued by the
U.S. government or by such state or its municipalities or
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political subdivisions. Each investor should consult his or her own tax adviser
to determine the tax status of distributions from the Funds in his or her own
state and locality.
Opinions relating to the validity of municipal securities and the
exemption of interest thereon from federal income tax are rendered by bond
counsel to the issuers. The Tax Free Bond Fund, California Tax Free Fund and New
York Tax Free Fund, the Sub-Adviser and its affiliates, and the Funds' counsel
make no review of proceedings relating to the issuance of state or municipal
securities or the bases of such opinions.
Due to the lack of adequate supply of certain types of tax-exempt
obligations, and other reasons, various instruments are being marketed which are
not "pure" state and local obligations, but which are thought to generate
interest excludable from taxable income under Code section 103. While a Fund may
invest in such instruments, it does not guarantee the tax-exempt status of the
income earned thereon or from any other investment. Thus, for example, were a
Fund to invest in an instrument thought to give rise to tax-exempt interest but
such interest ultimately were determined to be taxable, the Fund might have
invested more than 20% of its assets in taxable instruments. In addition, it is
possible in such circumstances that a Fund will not have met the 50% investment
threshold, described above, necessary for it to pay exempt-interest dividends.
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, each Fund will issue to
each shareholder a statement of the federal income tax status of all
distributions, including, in the case of the Tax Free Bond Fund, the California
Tax Free Fund and New York Tax Free Fund, a statement of the percentage of the
prior calendar year's distributions which the Fund has designated as tax-exempt,
the percentage of such tax-exempt distributions treated as a tax-preference item
for purposes of the alternative minimum tax, and in, the case of the Tax Free
Bond Fund, the source on a state-by-state basis of all distributions.
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ADDITIONAL INFORMATION REGARDING THE EQUITY INDEX FUND
If Shareholders receive distributions of amounts paid pursuant to such
distributions from the Fund may not be eligible for the dividends-received
deduction available to corporations.
In addition, although not considered likely, it is possible that
shareholders could be regarded for tax purposes as receiving a constructive
distribution(s) (which could be taxable) from the Fund to the extent that the
Guarantee is deemed to have value.
It is anticipated that capital gain or loss from the disposition of
shares will be eligible for treatment as long-term or short-term capital gain or
loss depending upon the shareholder's actual holding period for the shares.
Investors should be aware that, under IRS regulations, as a result of the
Guarantee, a shareholder's holding period for Fund shares might be deemed not to
commence until the Guarantee is paid or expires. In that event, the capital gain
or loss on the disposition of Fund shares would be short-term capital gain or
loss until such time as the shares have been held continuously by the
shareholder for the requisite long-term holding period (currently more than one
year for Federal income tax purposes) after the expiration or payment of the
Guarantee. The holding period for shares received from reinvestment of dividends
and distributions will commence no earlier than the reinvestment date but could
be delayed as described previously in this paragraph as a result of the
Guarantee.
ADDITIONAL INFORMATION REGARDING THE CALIFORNIA TAX FREE FUND AND NEW YORK TAX
FREE FUND
Under California law, a mutual fund which qualifies as a regulated
investment company must have at least 50% of its total assets in obligations
exempt from California personal income tax at the end of each quarter of its
taxable year in order to be eligible to pay dividends which will be exempt from
California personal income tax. Generally, shareholders who are California
residents will not incur California personal income tax on the amount of
exempt-interest dividends received by them from the California Tax Free Fund and
derived from California state and local issues, whether taken in cash or
reinvested in additional shares. However, other taxes, such as the franchise tax
may apply. Shareholders will normally be subject to California personal income
tax on dividends paid from interest income derived from taxable securities and
from securities issued by
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states other than California and its subsidiaries and on distributions of
capital gains.
Deductions for interest on indebtedness incurred or continued by a
shareholder to purchase or carry shares of the Fund may be disallowed in whole
or in part for California personal income tax purposes.
Exempt-interest dividends paid by the New York Tax Free Fund from
interest on qualifying New York bonds generally are exempt from New York State
and New York City personal income taxes, but not corporate franchise taxes.
Dividends and distributions of the Fund derived from taxable income and capital
gains are not exempt from New York State and New York City taxes. Deductions for
interest on indebtedness incurred or continued by a shareholder to purchase or
carry shares of the Fund may be disallowed in whole or in part for New York
State or New York City personal income tax purposes.
Dividends from the California Tax Free Fund or New York Tax Free Fund
(including exempt-interest dividends), capital gains distributions from a Fund,
and any capital gains or losses realized from the sale or exchange of shares may
be subject to state and local taxes (as well as Federal taxes). However, the
portion of a distribution of a Fund's tax-exempt income that is attributable to
state and municipal securities issued within the shareholder's own state
generally will not be subject to state or local taxes. Individuals are often
exempt from state and local personal income taxes on distributions of tax-exempt
interest income derived from obligations of issuers located in the state in
which they reside when these distributions are received directly from these
issuers, but are usually subject to such taxes on income derived from
obligations of issuers located in other jurisdictions. Shareholders are urged to
consult their tax advisers with specific reference to their own federal, state
and local tax situations.
ANNUAL STATEMENTS
Each shareholder of the California Tax Free Fund will be sent after the
close of the calendar year an annual statement as to the federal income tax and
California state personal income tax status of his or her dividends and
distributions from the Fund for the prior calendar year. Any dividends
attributable to interest on municipal obligations that are not California
municipal securities will be taxable as ordinary dividends for
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California state personal income tax purposes even if such dividends are
excluded from gross income for federal income tax purposes. These statements
will also designate the amount of exempt-interest dividends that is a specific
preference item for purposes of the federal individual and corporate alternative
minimum taxes. Each shareholder also will receive, if appropriate, various
written notices after the close of the Fund's prior taxable year as to the
federal income tax status of his or her dividends and distributions which were
received from the Fund during the Fund's prior taxable year. Shareholders should
consult their tax advisers as to any other state and local taxes that may apply
to these dividends and distributions. The dollar amount of dividends excluded or
exempt from federal income taxation or California state personal income
taxation, if any, will vary for each shareholder depending upon the size and
duration of each shareholder's investment in the Fund.
Each shareholder of the New York Tax Free Fund will be sent after the
close of the calendar year an annual statement as to the federal income tax and
New York State and New York City personal income tax status of his or her
dividends and distributions from the Fund for the prior calendar year. These
statements will also designate the amount of exempt-interest dividends that is a
specified preference item for purposes of the federal individual and corporate
alternative minimum taxes. Each shareholder also will receive, if appropriate,
various written notices after the close of the Fund's prior taxable year as to
the federal income tax status of his or her dividends and distributions which
were received from the Fund during the Fund's prior taxable year. Shareholders
should consult their tax advisers as to any other state and local taxes that may
apply to these dividends and distributions. The dollar amounts of dividends
excluded or exempt from federal income taxation or New York State and City
personal income taxation and the dollar amount subject to federal income
taxation or New York State and City personal income taxation, if any, will vary
for each shareholder depending upon the size and duration of each shareholder's
investment in the Fund.
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
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the U.S. and non-U.S. tax consequences of ownership of shares of a 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.
ORGANIZATION AND CAPITALIZATION
GENERAL
The Funds are separate series of an open-end investment company, The
MainStay Funds ("Trust"), established under the laws of The Commonwealth of
Massachusetts by a Declaration of Trust dated January 9, 1986, as amended. The
Tax Free Bond Fund was originally formed as the MacKay-Shields MainStay Tax Free
Bond Fund pursuant to a Declaration of Trust on January 9, 1986 and became a
series of the Trust pursuant to a reorganization which occurred on May 29, 1987.
The Total Return Fund commenced operations on December 29, 1987. The Equity
Index Fund commenced operations on December 20, 1990. The California Tax Free
Fund and New York Tax Free Fund commenced operations on October 1, 1991. The
International Bond Fund and International Equity Fund commenced operations on
September 13, 1994. The Strategic Income Fund and Strategic Value Fund commenced
operations on February 28 and October 22, 1997, respectively. The Blue Chip
Growth Fund, Research Value Fund, Small Cap Value Fund, Growth Opportunities
Fund, Small Cap Growth Fund, Equity Income Fund and Global High Yield Fund
commenced operations on June 1, 1998. The organizational expenses of each 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 each Fund or class on matters affecting an individual
Fund or a particular class of shares issued by a 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
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persons as Trustees. Shares have no preemptive or subscription rights and are
transferable.
SHAREHOLDER AND TRUSTEE LIABILITY
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 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.
OTHER INFORMATION
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New
York, 10036, has been selected as independent accountants of the Trust. The
Funds' Annual Reports, which are incorporated by reference in this SAI, have
been so incorporated in reliance on the reports of Price Waterhouse, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.
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LEGAL COUNSEL
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006,
passes upon certain legal matters in connection with the shares offered by the
Trust, and also acts as counsel to the Trust.
SHARE OWNERSHIP OF THE FUNDS
The following table sets forth information concerning beneficial and
record ownership, as of August 1, 1998, of the Funds' shares by each person who
beneficially or of record owns more than five percent of the voting securities
of any Fund:
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<TABLE>
<CAPTION>
Shares Percentage
Name and Address Beneficially Outstanding
Name of Fund of Shareholder Owned (1) Shares Owned
------------ -------------- --------- ------------
<S> <C> <C> <C>
New York Smith Barney Inc. 5.15% 78,7812
Tax Free Fund 00130797803
Class A 388 Greenwich Street
New York NY 10013-2339
New York Helen Ostreicher 6.51% 99,560
Tax Free Fund Agnes Zitter
Class A 1 Lakeside Dr East
Lawrence NY 11559-1718
New York NYLIFE Distributors Inc. 32.64% 499,488
Tax Free Fund c/o George Daoust
Class A PO Box 421
Parsippany NJ 07054-0421
Equity Index New York Life Trust Company 5.08% 928,267
Fund Client Accounts
Class A 51 Madison Avenue, Rm 117A
New York, NY 10010-1603
Blue Chip New York Life Insurance Company 7.39% 100,000
Growth Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York, NY 10010-1603
Equity Income New York Life Insurance Company 95.44% 900,000
Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Research Value New York Life Insurance Company 92.70% 900,000
Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Research Value New York Life Insurance Company 37.06% 100,000
Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Equity Income New York Insurance Company 52.17% 100,000
Fund Attn Jean Hoysradt
Class B New York, NY 10010-1603
</TABLE>
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<TABLE>
<S> <C> <C> <C>
Capital New York Life Trust Company 23.49% 1,604,888
Appreciation Client Accounts
Class A 51 Madison Avenue Rm 117A
New York NY 10010-1603
Value Fund New York Life Trust Company 23.19% 1,398,001
Class A Client Accounts
51 Madison Avenue Rm 117A
New York NY 10010-1603
Convertible New York Life Trust Company 10.43% 407,503
Fund Client Accounts
Class A 51 Madison Avenue Rm 117
New York NY 10010-1603
Government New York Life Trust Company 21.37% 436,447
Fund Client Accounts
Class A 51 Madison Avenue Rm 117A
Tax Free Schmitt Family Trust 12.87% 201,630
Bond Fund Dtd 9-13-91
Class A James S Schmitt & Don L Waters &
Kim Schmitt Fogarty TTEES
PO Box 1566
Savannah GA 31402-1566
Tax Free Michael N. Marks 10.95% 171,507
Bond Fund PO Box 529
Class A Pottsboro TX 75076-0529
Tax Free Jaroth II LLC 6.38% 99,944
Bond Fund Michael Zumbo TTEE
Class A Thomas Keane TTEE
14472 Wicks Blvd
San Leandro CA 94577-9712
Money Market Koch Industries Inc. 6.01% 6,163,213
Fund Darryl J Graham TTEE
Class A 1299 Ocean Avenue Suite 700
Santa Monica CA 90401-1036
Money Market New York Life Trust Company 7.09% 7,270,707
Fund Client Accounts
Class A 51 Madison Avenue Rm 117A
New York NY 10010-1603
</TABLE>
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<TABLE>
<S> <C> <C> <C>
International Merrill Lynch Pierce Fenner & 6.09% 85,309
Bond Fund Smith Inc - for the Sole Benefit
Class A of its Customers
Attn: Fund Administration 97T78
4800 Dear Lake Drive East 3rd FL
Jacksonville FL 32246-6484
International Defined Benefit Pension Trust of 5.30% 74,305
Bond Fund FMCNA
Class A c/o The Free Methodist Foundation
PO Box 580
8050 Spring Arbor Road
Strong Arbor MI 49283-0580
International NYLIFE Distributors 55.00% 770,905
Bond Fund Attn George Daoust
Class A 260 Cherry Hill Rd
Parsippany NJ 07054-1108
International New York Life Trust Company 5.55% 98,275
Equity Fund Clients Accounts
Class A New York NY 10010-1603
International NYLIFE Distributors 35.30% 625,090
Equity Fund Attn George Daoust
Class A 260 Cherry Hill Rd
Parsippany NJ 07054-1108
Total Return New York Life Trust Company 50.81% 2,748,715
Fund Client Accounts
Class A 51 Madison Avenue Rm 117A
New York NY 10010-1603
Strategic Income James C. Calano 5.54% 111,076
Fund 200 Boulder View Lane
Class A Boulder CO 80304-0491
Strategic Income New York Life Ins. General Account 33.39% 669,322
Fund Attn Richard Schwartz
Class A 260 Cherry Hill Rd
Parsippany NJ 07054-1187
Strategic Value New York Life Insurance Company 51.68% 916,417
Fund Attn Richard Schwartz
Class A 260 Cherry Hill Rd
Parsipany NJ 07054-1187
</TABLE>
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<TABLE>
<S> <C> <C> <C>
Blue Chip New York Life Insurance Company 75.86% 900,000
Growth Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Global High New York Life Insurance Company 97.31% 900,000
Yield Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 1010-1603
Global High Hedwig E. Martin TTEE 11.68% 21,886
Yield Fund FBO The Matin Survivors Tr
Class B u/a dtd 7/24/91
Novato CA 94947-2032
Global High New York Life Insurance Company 53.38% 100,000
Yield Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Growth Opportunities New York Life Insurance Company 94.17% 900,000
Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Growth Opportunities Attn Sonny Panaligan 11.12% 49,019
Fund c/o CTC Illinois Tr Co
Class B Wexford Clearing Services Corp FBO
County Employees Annuity TTEE
Benefit Fund 33
Chicago IL 60606
Growth Opportunities New York Life Trust Company 5.47% 24,109
Fund Cust for the IRA of
Class B Henry E Brantley Jr
585 Longville Church Rd
Longville LA 70652-5040
Growth Opportunities New York Life Insurance Company 22.68% 100,000
Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Small Cap New York Life Insurance Company 80.63% 900,000
Value Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
</TABLE>
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<TABLE>
<S> <C> <C> <C>
Small Cap New York Life Insurance Company 17.89% 100,000
Value Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
Small Cap New York Life Insurance Company 75.80% 900,000
Growth Fund Attn Jean Hoysradt
Class A 51 Madison Avenue
New York NY 10010-1603
Small Cap New York Life Insurance Company 10.95% 100,000
Growth Fund Attn Jean Hoysradt
Class B 51 Madison Avenue
New York NY 10010-1603
California Tax Jaroth II LLC 5.34% 102,427
Free Fund Michael Zumbo TTEE
Class A Thomas Keane TTEE
14472 Wicks Blvd
San Leandro CA 94577-6712
California Tax NYLIFE Distributors Inc. 14.14% 271,121
Free Fund c/o George Daoust
Class A PO Box 421
Parsippany NJ 07054-0421
California Tax Otto V. & Yvonne Louise-Ericksen 9.40% 180,210
Free Fund Tschudi Revoc Living Tst Dtd 9-8-88
Class A Otto V. & Yvonne Louise-Ericksen
Tschudi TTEES
1885 St Andrews Dr
Moraga CA 94556-1057
Strategic Income NYLIFE Distributors Inc. 9.39% 554,746
Fund Attn George Daoust
Class B 300 Interpace Parkway
Parsippany NJ 07054-1100
New York Tax Felice Brand 8.05% 52,074
Free Fund 156 Wright Ave
Class B Deer Park NY 11729-2224
New York Tax Henry Sheiman Irrevocable Trust 8.00% 51,771
Free Fund Dtd 03/06/97
Class B Robert Sheiman TTEE
David Brown TTEE
411 Theodore Fremd Ave Ste 3
Rye NY 10580-1411
</TABLE>
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<TABLE>
<S> <C> <C> <C>
California Tax William J & Elinor G. Potikian 9.08% 83,366
Free Fund Family Revocable Trust
Class B Dtd 8-17-93
Jacinda Potikian TTEE
4475 N College
Fresno CA 93704-3806
</TABLE>
- ----------------
(1) This information, not being within the knowledge of the Trust, has been
furnished by each of the above persons. Beneficial ownership is as
defined under Section 13(d) of the Securities Exchange Act of 1934.
Fractional Shares have been omitted.
(2) Mr. George Daoust, in connection with his position with NYLIFE
Distributors, has the power to vote all of the shares shown in the
above table owned by NYLIFE Distributors. Mr. Daoust disclaims
beneficial ownership of such shares.
NYLIFE Distributors Inc. is a corporation organized under the laws of
Delaware. NYLIFE Distributors Inc. is a wholly owned subsidiary of NYLIFE Inc.,
and an indirect wholly owned subsidiary of New York Life Insurance Company.
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 Sub-Adviser unless such power is the result of
their position with the Trust or Investment Sub-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
The financial statements of the Capital Appreciation Fund, California
Tax Free Fund, New York Tax Free Fund, Value Fund, Convertible Fund, Total
Return Fund, High Yield Corporate Bond Fund, Government Fund (formerly the
Government Plus Fund), Tax Free Bond Fund (formerly the MacKay-Shields MainStay
Tax Free Bond Fund), International Bond Fund, International Equity Fund, Equity
Index Fund, Money Market Fund, Strategic Income Fund and Strategic Value Fund,
including the Portfolio of Investments as of December
B-193
<PAGE> 485
31, 1997, the Statement of Assets and Liabilities as of December 31, 1997, the
Statement of Operations for the year ended December 31, 1997, the Statement of
Changes in Net Assets for the years ended December 31, 1997 and 1996, the Notes
to the Financial Statements and the Reports of Independent Accountants, all of
which are included in the 1997 Annual Reports to the Shareholders are hereby
incorporated by reference into this Statement of Additional Information.
An audited financial statement for NYLIFE Inc. as of December 31, 1997,
is included in this Statement of Additional Information.
B-194
