Blanchard
Group of Funds
Blanchard
Asset Allocation Fund
Prospectus
November 30, 1996
Blanchard
BLANCHARD ASSET ALLOCATION FUND
(A PORTFOLIO OF BLANCHARD FUNDS)
PROSPECTUS
The shares of Blanchard Asset Allocation Fund (the "Fund") offered by this
prospectus represent interests in a diversified portfolio in Blanchard Funds
(the "Trust"), an open-end management investment company (a mutual fund). The
Fund seeks to maximize total return over the long term by allocating its
assets among stocks, bonds, short-term instruments, and other investments.
INVESTMENT PRODUCTS ARE NOT DEPOSITS, OBLIGATIONS OF, OR GUARANTEED BY ANY
BANK. THEY ARE NOT INSURED BY THE FDIC. THEY INVOLVE RISK, INCLUDING THE
POSSIBLE LOSS OF PRINCIPAL INVESTED.
This prospectus contains the information you should read and know before you
invest in the Fund. Keep this prospectus for future reference.
The Fund has also filed a Statement of Additional Information dated November
30, 1996, with the Securities and Exchange Commission. The information
contained in the Statement of Additional Information is incorporated by
reference into this prospectus. You may request a copy of the Statement of
Additional Information or a paper copy of this prospectus if you have received
this copy electronically, free of charge, by calling 1-800-829-3863. To obtain
other information, or make inquiries about the Fund, contact Signet Financial
Services, Inc. at 1-800-829-3863. The Statement of Additional Information,
material incorporated by reference into this document and other information
regarding the Fund, is maintained electronically with the SEC at Internet Web
site (http://www.sec.gov).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
Prospectus dated November 30, 1996
TABLE OF CONTENTS
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SUMMARY OF FUND EXPENSES 1
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FINANCIAL HIGHLIGHTS 2
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GENERAL INFORMATION 3
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WHO MAY WANT TO INVEST 3
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INVESTMENT INFORMATION 3
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Investment Objective 3
Investment Policies 3
Additional Risk Considerations 16
Investment Risks Associated with
Investment in Equity and Debt
Securities 17
Portfolio Turnover 17
BLANCHARD FUNDS INFORMATION 18
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Management of the Fund 18
Distribution of Fund Shares 19
Administration of the Funds 20
Expenses of the Fund 20
NET ASSET VALUE 21
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HOW TO INVEST 21
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Purchases by Mail 22
General Information 22
INVESTOR SERVICES 23
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Automatic Withdrawal Plan 23
Retirement Plans 23
Exchange Privilege 23
HOW TO REDEEM 24
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General Information 25
SHAREHOLDER INFORMATION 25
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Voting Rights 25
EFFECT OF BANKING LAWS 26
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TAX INFORMATION 26
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Federal Income Tax 26
PERFORMANCE INFORMATION 27
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Total Return 27
Yield Information 27
Distribution Rate 27
Comparative Results 28
FINANCIALS 29
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INDEPENDENT AUDITORS' REPORT 37
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ADDRESSES 38
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BLANCHARD ASSET ALLOCATION FUND
SUMMARY OF FUND EXPENSES
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<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price).................................. None
Maximum Sales Charge Imposed on Reinvested Dividends
(as a percentage of offering price).................................. None
Contingent Deferred Sales Charge (as a percentage of original
purchase price or redemption proceeds, as applicable)................ None
Redemption Fees (as a percentage of amount redeemed, if applicable)... None
Exchange Fee.......................................................... None
<CAPTION>
ANNUAL INVESTMENT SHARES OPERATING EXPENSES
(As a percentage of average net assets)
<S> <C>
Management Fee (after waiver) (1)..................................... 0.00%
12b-1 Fees (2)........................................................ 0.00%
Other Expenses (after waivers) (3).................................... 1.00%
Total Fund Operating Expenses (after waivers) (4)................... 1.00%
</TABLE>
(1) The management fee has been reduced to reflect the voluntary waiver by the
Investment Adviser. The Adviser may terminate this voluntary waiver at any
time at its sole discretion. The maximum management fee is 1.00%.
(2) The Fund has no present intention of paying or accruing 12b-1 fees during
the fiscal year ending September 30, 1997. If the Fund were paying or
accruing 12b-1 fees, the Fund would be able to pay up to 0.25% of its
average daily net assets.
(3) Other Expenses would be 5.39% absent the voluntary waivers of the
custodian fees and a portion of the administrative fees and the assumption
of other operating expenses by the adviser.
(4) Total Fund Operating Expenses are estimated to be 6.39 absent the
voluntary waivers and assumption described above in notes 1 and 3.
Total operating expenses in the table above are based on expenses expected
during the fiscal year ending September 30, 1997. The total operating expenses
were 1.00% for the period ended September 30, 1996, and would have been 7.24%
absent the waivers of the management fee, administrative fee, custodian fee,
and the assumption of other operating expenses by the adviser.
THE PURPOSE OF THIS TABLE IS TO ASSIST AN INVESTOR IN UNDERSTANDING THE
VARIOUS COSTS AND EXPENSES THAT A SHAREHOLDER WILL BEAR, EITHER DIRECTLY OR
INDIRECTLY. FOR MORE COMPLETE DESCRIPTIONS OF THE VARIOUS COSTS AND EXPENSES,
SEE "HOW TO INVEST." WIRE-TRANSFERRED REDEMPTIONS MAY BE SUBJECT TO AN
ADDITIONAL FEE.
<TABLE>
<CAPTION>
EXAMPLE 1 year 3 years
- ------- ------ -------
<S> <C> <C>
You would pay the following expenses on a $1,000 investment as-
suming (1) 5% annual return and (2) redemption at the end of
each time period. The Fund charges no redemption fees........... $10 $32
</TABLE>
THE ABOVE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
BLANCHARD ASSET ALLOCATION FUND
FINANCIAL HIGHLIGHTS
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(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD)
Reference is made to the Report of Independent Auditors on page 37.
<TABLE>
<CAPTION>
PERIOD ENDED
SEPTEMBER 30,
1996 (A)
- ------------------------------------------------------------ -------------
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- ------------------------------------------------------------
INCOME FROM INVESTMENT OPERATIONS
- ------------------------------------------------------------
Net investment income 0.17
- ------------------------------------------------------------
Net realized and unrealized gain on investments and futures
contracts 0.34
- ------------------------------------------------------------ ------
Total from investment operations 0.51
- ------------------------------------------------------------ ------
NET ASSET VALUE, END OF PERIOD $10.51
- ------------------------------------------------------------ ------
TOTAL RETURN (B) 5.10%
- ------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
- ------------------------------------------------------------
Expenses 1.00%*
- ------------------------------------------------------------
Net investment income 5.39%*
- ------------------------------------------------------------
Expense waiver/reimbursement (c) 6.24%*
- ------------------------------------------------------------
SUPPLEMENTAL DATA
- ------------------------------------------------------------
<CAPTION>
Net assets, end of period (000 omitted) $3,368
<S> <C>
- ------------------------------------------------------------
Portfolio turnover 33%
- ------------------------------------------------------------
</TABLE>
* Computed on an annualized basis.
(a) Reflects operations for the period from June 6, 1996 (date of initial
public investment) to September 30, 1996.
(b) Based on net asset value.
(c) This voluntary expense decrease is reflected in both the expense and net
investment income ratios shown above.
(See Notes which are an integral part of the Financial Statements)
GENERAL INFORMATION
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The Trust was established as a Massachusetts business trust under a
Declaration of Trust dated January 24, 1986. The Declaration of Trust permits
the Trust to offer separate series of shares of beneficial interest
representing interests in separate portfolios of securities. The shares in any
one portfolio may be offered in separate classes. With respect to this Fund,
as of the date of this prospectus, the Board of Trustees (the "Board" or
"Trustees") has not established separate classes of shares. A minimum initial
investment of $3,000 ($2,000 for qualified retirement plans, such as IRAs and
Keoghs) is required. The minimum subsequent investment requirement for the
Fund is $200. The Fund is advised by Virtus Capital Management, Inc.
Fund shares are sold and redeemed at net asset value.
WHO MAY WANT TO INVEST
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The Fund is designed for long-term investors who are willing to tolerate
market fluctuation in pursuit of potentially high long-term returns. Since the
Fund uses options and futures to gain additional economic exposure to the
stock and bond markets, Fund share prices can fluctuate significantly. When a
shareholder sells his or her shares, they may be worth more or less than what
the shareholder paid for them.
INVESTMENT INFORMATION
- -------------------------------------------------------------------------------
INVESTMENT OBJECTIVE
The investment objective of the Fund is to maximize total return over the long
term by allocating its assets among stocks, bonds, short-term instruments, and
other instruments. The investment objective cannot be changed without
shareholder approval. While there is no assurance that the Fund will achieve
its investment objective, it endeavors to do so by following the investment
policies described in this prospectus.
INVESTMENT POLICIES
The Fund's investment policies permit investments in any type of domestic
security (and in foreign equity securities that trade on the United States
securities exchanges, and foreign income securities that are denominated in
U.S. dollars), in any proportion deemed appropriate by Mellon Capital
Management Corporation (the "Portfolio Adviser"), except as noted below. In
addition, the Fund may invest in options and futures contracts. The Portfolio
Adviser has broad latitude in selecting the class of investments and market
sectors in which the Fund will invest. The Fund is not a "balanced" fund and,
therefore, will not be required to continually maintain at least 25% of its
assets in fixed income senior securities. Unlike shareholders of other types
of funds, a shareholder of the Fund confers substantially more investment
discretion on the Portfolio Adviser, enabling the Portfolio Adviser to
allocate the Fund's investments among a wide variety of investment choices.
In seeking to maximize total return, the Portfolio Adviser allocates the
Fund's investments principally among three major asset classes (as discussed
below): stocks, bonds, and short-term instruments.
Options and futures may be used, separately or in combination, to gain
additional economic exposure to an asset class. See "Derivative Contracts and
Securities" and "Futures and Options on Futures."
The Portfolio Adviser regularly reviews the Fund's investment allocation, and
will vary such allocation to emphasize the asset classes that, in the
Portfolio Adviser's then-current judgment, provide the most favorable total
return outlook. While the Fund's investments will generally be spread among
the asset classes in varying proportions, there is no limitation on the amount
that may be invested in any one asset class, and the Fund may at times be
fully invested in stocks, bonds, or short-term instruments if the Portfolio
Adviser perceives those asset classes to offer the most favorable total return
outlook. In addition, options and futures may be used to gain additional
economic exposure to an asset class.
In making asset allocation decisions, the Portfolio Adviser will evaluate
projections of risk, market conditions, economic conditions, volatility,
yields, and returns, among others. The Portfolio Adviser seeks to diversify
the Fund's holdings within each asset class, in order to moderate risks. The
Portfolio Adviser will use database systems to help analyze past situations
and trends, portfolio management professionals to determine asset allocation,
and its own credit analysis as well as credit analyses provided by rating
services.
The Fund seeks total return over the long term; however, asset shifts among
classes will be made at the Portfolio Adviser's discretion.
The short-term instrument class includes all types of securities and short-
term instruments with remaining maturities of three years or less. The
Portfolio Adviser will seek to maximize total return within the short-term
instrument class by taking advantage of yield differentials between different
instruments and issuers. Short-term instruments may include corporate debt
securities such as commercial paper and notes; asset-backed securities;
government securities issued by the United States government or its agencies
or instrumentalities; bank deposits and other financial institution
obligations; repurchase agreements involving any type of security; and other
similar short-term instruments. These instruments must be denominated in
United States dollars.
The bond class includes all varieties of domestic fixed-income securities. The
Portfolio Adviser seeks to maximize total returns within the bond class by
adjusting the Fund's investments in securities with different credit
qualities, maturities, and coupon or dividend rates, and by seeking to take
advantage of yield differentials between securities. Securities in this class
may include bonds, notes, adjustable rate preferred stocks, convertible bonds,
mortgage-related and asset-backed securities, domestic government and
government agency securities, zero coupon bonds, and other intermediate and
long-term securities. As with the short-term class, these securities must be
denominated in United States dollars.
At no time will more than 20% of the Fund's assets in any asset category be
invested in foreign securities.
The stock class consists of a diversified portfolio of common stocks selected
by the Portfolio Adviser from those stocks which trade on the United States
securities exchanges, including those stocks which comprise the Standard &
Poor's 500 Composite Stock Price Index* (the "S&P 500 Index"), although
the Fund does not track the S&P 500 Index or attempt to track the S&P 500
Index's returns by holding a representative sample of this Index.
The Fund may buy and sell options and futures contracts to manage its exposure
to changing security prices, as an efficient means of managing allocations
between asset classes and as a means of increasing total return. The Fund may
invest in options and futures based on any type of security or index,
including options and futures not traded on exchanges.
Some options and futures strategies, including selling futures, buying puts,
and writing calls, tend to hedge the Fund's investments against price
fluctuations. Other strategies including buying futures, writing puts, and
buying calls, tend to increase market exposure. Options and futures may be
combined with each other or with forward contracts, in order to adjust the
risk and return characteristics of an overall strategy.
In addition to strategies designed to hedge its portfolio, the Fund may
purchase put options or write call options on United States stock indexes and
government securities to attempt to profit from declines in stock or bond
prices. The Adviser may enter into these strategies when it anticipates
negative returns from the underlying stock or bond markets. If prices do not
decline as anticipated, the Fund may experience losses from short strategies
that are not offset by gains from its other investments.
CORPORATE DEBT SECURITIES. The corporate bonds, notes, and convertible debt
securities in which the Fund may invest must be rated, at the time of
purchase, BBB or better by Standard and Poor's Ratings Group ("S&P"), or Fitch
Investors Services ("Fitch"), or Baa or better by Moody's Investors Service,
Inc. (Moody's), or, if unrated, be of comparable quality as determined by the
Fund's adviser. (If a security's rating is reduced below the required minimum
after the Fund has purchased it, the Fund is not required to sell the
security, but may consider doing so.) Bonds rated "BBB" by Standard & Poor's
or Fitch or "Baa" by Moody's have speculative characteristics. Changes in
economic conditions or other circumstances are more likely to lead to a
weakened capacity to make principal and interest payments than higher rated
bonds.
COMMERCIAL PAPER. The Fund may invest in commercial paper rated A-1 by S&P, or
Prime-1 by Moody's, or F-1 by Fitch and money market instruments (including
commercial paper) which are unrated but of comparable quality, including
Canadian Commercial Paper ("CCPs") and Europaper.
CONVERTIBLE SECURITIES. The Fund may invest in convertible securities.
Convertible securities are fixed income securities which may be exchanged or
converted into a predetermined number of the issuer's underlying common stock
at the option of the holder during a specified time period. Convertible
securities may take the form of convertible preferred stock, convertible bonds
or debentures, units consisting of "usable" bonds and warrants or a
combination of the features of several of these securities.
- --------
* "Standard & Poor's(R)", "S&P(R)", and "S&P 500(R)" and "Standard & Poor's
500" are trademarks of McGraw Hill, Inc. and have been licensed for use by
Mellon Capital Management Corporation ("MCM").
The Fund is not sponsored, endorsed, sold or promoted by Standard & Poor's
("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
ZERO COUPON SECURITIES. The Fund may invest in zero coupon bonds and zero
coupon convertible securities. The Fund may invest in zero coupon bonds in
order to receive the rate of return through the appreciation of the bond. This
application is extremely attractive in a falling rate environment as the price
of the bond rises rapidly in value as opposed to regular coupon bonds. A zero
coupon bond makes no periodic interest payments and the entire obligation
becomes due only upon maturity.
Zero coupon convertible securities are debt securities which are issued at a
discount to their face amount and do no entitle the holder to any periodic
payments of interest prior to maturity. Rather, interest earned on zero coupon
convertible securities accretes at a stated yield until the security reaches
its face amount at maturity. Zero coupon convertible securities are
convertible into a specific number of shares of the issuer's common stock. In
addition, zero coupon convertible securities usually have put features that
provide the holder with the opportunity to sell the bonds to the issuer at a
stated price before maturity.
Generally, the price of zero coupon securities are more sensitive to
fluctuations in interest than are conventional bonds and convertible
securities. In addition, federal tax law requires the holder of a zero coupon
security to recognize income from the security prior to the receipt of cash
payments. To maintain its qualification as a regulated investment company and
to avoid liability of federal income taxes, the Fund will be required to
distribute income accrued from zero coupon securities which it owns, and may
have to sell portfolio securities (perhaps at disadvantageous times) in order
to generate cash to satisfy these distribution requirements.
BANK INSTRUMENTS. The Fund may invest in instruments of domestic and foreign
banks and savings and loans (such as certificates of deposit, demand and time
deposits, savings shares, and bankers' acceptances) if they have capital,
surplus, and undivided profits over $100,000,000, or if the principal
- --------
Footnote continued from page 5.
the ability of the S&P 500 Index to track general stock market performance.
S&P's only relationship to MCM 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 MCM or the Fund. S&P has no obligation to
take the needs of MCM 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 THEREIN. S&P MAKES NO WARRANTY, EXPRESS
OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY MCM, 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.
amount of the instrument is insured by the Bank Insurance Fund ("BIF"), which
is administered by the Federal Deposit Insurance Corporation ("FDIC") or the
Savings Association Insurance Fund ("SAIF"), which is administered by the
FDIC. These instruments may include Eurodollar Certificates of Deposit
("ECDs"), Yankee Certificates of Deposit ("Yankee CDs"), and Eurodollar Time
Deposits ("ETDs").
AMERICAN DEPOSITORY RECEIPTS ("ADRS"). The Fund may invest in ADRs. ADRs are
receipts typically issued by an American bank or trust company that evidence
ownership of underlying securities issued by a foreign issuer.
FLOATING RATE CORPORATE DEBT OBLIGATIONS. The Fund expects to invest in
floating rate corporate debt obligations, including increasing rate
securities. Floating rate securities are generally offered at an initial
interest rate which is at or above prevailing market rates. The interest rate
paid on these securities is then reset periodically (commonly every 90 days)
to an increment over some predetermined interest rate index. Commonly utilized
indices include the three-month Treasury bill rate, the six-month Treasury
bill rate, the one-month or three-month London Interbank Offered Rate (LIBOR),
the prime rate of a bank, the commercial paper rates, or the longer-term rates
on U.S. Treasury securities.
Increasing rate securities, which currently do not make up a significant share
of the market in corporate debt securities, are generally offered at an
initial interest rate which is at or above prevailing market rates. Interest
rates are reset periodically (most commonly every 90 days) at different levels
on a predetermined scale. These levels of interest are ordinarily set at
progressively higher increments over time. Some increasing rate securities
may, by agreement, revert to a fixed rate status. These securities may also
contain features which allow the issuer the option to convert the increasing
rate of interest to a fixed rate under such terms, conditions, and limitations
as are described in each issue's prospectus.
FIXED RATE CORPORATE DEBT OBLIGATIONS. The Fund will also invest in fixed rate
securities, including fixed rate securities with short-term characteristics.
Fixed rate securities with short-term characteristics are long-term debt
obligations but are treated in the market as having short maturities because
call features of the securities may make them callable within a short period
of time. A fixed rate security with short-term characteristics would include a
fixed income security priced close to call or redemption price or a fixed
income security approaching maturity, where the expectation of call or
redemption is high.
Fixed rate securities tend to exhibit more price volatility during times of
rising or falling interest rates than securities with floating rates of
interest. This is because floating rate securities, as described above, behave
like short-term instruments in that the rate of interest they pay is subject
to periodic adjustments based on a designated interest rate index. Fixed rate
securities pay a fixed rate of interest and are more sensitive to fluctuating
interest rates. In periods of rising interest rates, the value of a fixed rate
security is likely to fall. Fixed rate securities with short-term
characteristics are not subject to the same price volatility as fixed rate
securities without such characteristics. Therefore, they behave more like
floating rate securities with respect to price volatility.
VARIABLE RATE DEMAND NOTES. The Fund may purchase variable rate demand notes.
Variable rate demand notes are long-term corporate debt instruments that have
variable or floating interest rates and provide the Fund with the right to
tender the security for repurchase at its stated principal amount
plus accrued interest. Such securities typically bear interest at a rate that
is intended to cause the securities to trade at par. The interest rate may
float or be adjusted at regular intervals (ranging from daily to annually),
and is normally based on a published interest rate or interest rate index.
Many variable rate demand notes allow the Fund to demand the repurchase of the
security on not more than seven days prior notice. Other notes only permit the
Fund to tender the security at the time of each interest rate adjustment or at
other fixed intervals. See "Demand Features."
U.S. GOVERNMENT SECURITIES. The Fund may invest in U.S. government securities,
which generally include direct obligations of the U.S. Treasury (such as U.S.
Treasury bills, notes, and bonds) and obligations (including mortgage-backed
securities, bonds, notes and discount notes) issued or guaranteed by the
following U.S. government agencies or instrumentalities: Farm Credit System,
including the National Bank for Cooperatives, Farm Credit Banks, and Banks for
Cooperatives; Farmers Home Administration; Federal Home Loan Banks; Federal
Home Loan Mortgage Corporation; Federal National Mortgage Association;
Government National Mortgage Association; and Student Loan Marketing
Association. These securities are backed by: the full faith and credit of the
U.S. Treasury; the issuer's right to borrow an amount limited to a specific
line of credit from the U.S. Treasury; the discretionary authority of the U.S.
government to purchase certain obligations of agencies or instrumentalities;
or the credit of the agency or instrumentality issuing the obligations.
Examples of agencies and instrumentalities, the securities of which are
permissible investments which may not always receive financial support from
the U.S. government are: Farm Credit System, including the National Bank for
Cooperatives, Farm Credit Banks, and Banks for Cooperatives; Federal Home Loan
Banks; Federal National Mortgage Association; Student Loan Marketing
Association; and Federal Home Loan Mortgage Corporation.
MORTGAGE-BACKED SECURITIES. The Fund may invest in mortgage-backed securities
rated BBB or Baa or better by a nationally recognized statistical rating
organization, or which are of comparable quality in the judgment of the
Adviser. Mortgage-backed securities are securities that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage
loans on real property.) There are currently four basic types of mortgage-
backed securities: (i) those issued or guaranteed by the U.S. government or
one of its agencies or instrumentalities, such as Government National Mortgage
Association ("Ginnie Mae"), the Federal National Mortgage Association ("Fannie
Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac"); (ii) those
issued by private issuers that represent an interest in or are collateralized
by mortgage-backed securities issued or guaranteed by the U.S. government or
one of its agencies or instrumentalities; (iii) those issued by private
issuers that represent an interest in or are collateralized by whole loans or
mortgage-backed securities without a government guarantee but usually having
some form private credit enhancement; and (iv) 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.
The privately issued mortgage-related securities provide for a periodic
payment consisting of both interest and/or principal. The interest portion of
these payments will be distributed by the Fund as income, and the capital
portion will be reinvested.
ADJUSTABLE RATE MORTGAGE SECURITIES ("ARMS"). The Fund may invest in ARMS.
ARMS are pass-through mortgage-backed securities with adjustable rather
than fixed interest rates. The ARMS in which the Fund invests are issued by
Ginnie Mae, Fannie Mae, and Freddie Mac and
are actively traded. The underlying mortgages which collateralize ARMS
issued by Ginnie Mae are fully guaranteed by the Federal Housing
Administration or Veterans Administration, while those collateralizing ARMS
issued by Fannie Mae or Freddie Mac are typically conventional residential
mortgages conforming to strict underwriting size and maturity constraints.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS"). The Fund may invest in CMOs.
CMOs are debt obligations collateralized by mortgage loans or mortgage
pass-through securities. Typically, CMOs are collateralized by Ginnie Mae,
Fannie Mae or Freddie Mac certificates, but may be collateralized by whole
loans or private pass-through securities. CMOs may have fixed or floating
rates of interest.
The Fund will invest only in CMOs that are rated BBB or Baa or better by a
nationally recognized statistical rating organization. The Fund may also
invest in certain CMOs which are issued by private entities such as
investment banking firms and companies related to the construction
industry. The CMOs in which the Fund may invest may be: (i) 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) 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; (iii) collateralized by pools of mortgages
in which payment of principal and interest is dependent upon the underlying
pool of mortgages with no U.S. government guarantee; or (iv) other
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 any agency or instrumentality of the U.S. government.
REAL ESTATE MORTGAGE INVESTMENT CONDUITS ("REMICS"). The Fund may invest in
REMICs. REMICs are offerings of multiple class mortgage-backed securities
which qualify and elect treatment as such under provisions of the Internal
Revenue Code, as amended. Issuers of REMICs may take several forms, such as
trusts, partnerships, corporations, associations, or segregated pools of
mortgages. Once REMIC status is elected and obtained, the entity is not
subject to federal income taxation. Instead, income is passed through the
entity and is taxed to the person or persons who hold interests in the
REMIC. A REMIC interest must consist of one or more classes of "regular
interests," some of which may offer adjustable rates of interest, and a
single class of "residual interests." To qualify as a REMIC, substantially
all the assets of the entity must be in assets directly or indirectly
secured principally by real property.
ASSET-BACKED SECURITIES. The Fund may invest in asset-backed securities.
Asset-backed securities have structural characteristics similar to mortgage-
backed securities but have underlying assets that generally are not mortgage
loans or interests in mortgage loans. The Fund may invest in asset-backed
securities rated BBB or Baa or better by a nationally recognized statistical
rating organization including, but not limited to, interests in pools of
receivables, such as motor vehicle installment obligations and credit card
receivables, equipment leases, manufactured housing (mobile home) leases, or
home equity loans. These securities may be in the form of pass-through
instruments or asset-backed bonds. The securities are issued by non-
governmental entities and carry no direct or indirect government guarantee.
INVESTMENT RISKS OF MORTGAGE-BACKED AND ASSET-BACKED SECURITIES. Mortgage-
backed and asset-backed securities generally pay back principal and
interest over the life of the security. At the time the Fund reinvests the
payments and any unscheduled prepayments of principal received, the Fund
may receive a rate of interest which is actually lower than the rate of
interest paid on these securities ("prepayment risks"). Mortgage-backed and
asset-backed securities are subject to higher prepayment risks than most
other types of debt instruments with prepayment risks because the
underlying mortgage loans or the collateral supporting asset-backed
securities may be prepaid without penalty or premium. Prepayment risks on
mortgage-backed securities tend to increase during periods of declining
mortgage interest rates because many borrowers refinance their mortgages to
take advantage of the more favorable rates. Prepayments on mortgage-backed
securities are also affected by other factors, such as the frequency with
which people sell their homes or elect to make unscheduled payments on
their mortgages. Although asset-backed securities generally are less likely
to experience substantial prepayments than are mortgage-backed securities,
certain factors that affect the rate of prepayments on mortgage-backed
securities also affect the rate of prepayments on asset-backed securities.
While mortgage-backed securities generally entail less risk of a decline
during periods of rapidly rising interest rates, mortgage-backed securities
may also have less potential for capital appreciation than other similar
investments (e.g., investments with comparable maturities) because as
interest rates decline, the likelihood increases that mortgages will be
prepaid. Furthermore, if mortgage-backed securities are purchased at a
premium, mortgage foreclosures and unscheduled principal payments may
result in some loss of a holder's principal investment to the extent of the
premium paid. Conversely, if mortgage-backed securities are purchased at a
discount, both a scheduled payment of principal and an unscheduled
prepayment of principal would increase current and total returns and would
accelerate the recognition of income, which would be taxed as ordinary
income when distributed to shareholders.
Asset-backed securities present certain risks that are not presented by
mortgage-backed securities. Primarily, these securities do not have the
benefit of the same security interest in the related collateral. Credit
card receivables are generally unsecured and the debtors are entitled to
the protection of a number of state and federal consumer credit laws, many
of which give such debtors the right to set off certain amounts owed on the
credit cards, thereby reducing the balance due. Most issuers of asset-
backed securities backed by motor vehicle installment purchase obligations
permit the servicer of such receivables to retain possession of the
underlying obligations. If the servicer sells these obligations to another
party, there is a risk that the purchaser would acquire an interest
superior to that of the holders of the related asset-backed securities.
Further, if a vehicle is registered in one state and is then re-registered
because the owner and obligor moves to another state, such re-registration
could defeat the original security interest in the vehicle in certain
cases. In addition, because of the large number of vehicles involved in a
typical issuance and technical requirements under state laws, the trustee
for the holders of asset-backed securities backed by automobile receivables
may not have a proper security interest in all of the obligations backing
such receivables. Therefore, there is the possibility that recoveries on
repossessed collateral may not, in some cases, be available to support
payments on these securities.
SHORT-TERM INSTRUMENTS. The Fund may invest in U.S. and foreign short-term
money market instruments, including:
. commercial paper rated A-1 or A-2 by S&P, Prime-1 or Prime-2 by Moody's,
or F-1 or F-2 by Fitch, and Europaper (dollar-denominated commercial
paper issued outside the United States) rated A-1, A-2, Prime-1, or
Prime-2;
. instruments of domestic and foreign banks and savings and loans (such as
certificates of deposit, demand and time deposits, savings shares, and
bankers' acceptances) if they have capital, surplus, and undivided
profits of over $100,000,000, or if the principal amount of the
instrument is insured by the Bank Insurance Fund, which is administered
by the Federal Deposit Insurance Corporation ("FDIC"), or the Savings
Association Insurance Fund, which is also administered by the FDIC. These
instruments may include Eurodollar Certificates of Deposit ("ECDs"),
Yankee Certificates of Deposit ("Yankee CDs"), and Eurodollar Time
Deposits ("ETDs");
. obligations of the U.S. government or its agencies or instrumentalities;
. repurchase agreements;
. securities of other investment companies; and
. other short-term instruments which are not rated but are determined by
the Adviser to be of comparable quality to the other obligations in which
the Fund may invest.
OPTIONS TRANSACTIONS. The Fund may engage in options transactions. The Fund
may purchase and sell options both to increase total return and to hedge
against the effect of changes in the value of portfolio securities due to
anticipated changes in interest rates and market conditions.
The Fund may write (i.e., sell) covered call options and covered put options.
By writing a call option, the Fund becomes obligated during the term of the
option to deliver the securities underlying the option upon payment of the
exercise price. By writing a put option, the Fund becomes obligated during the
term of the option to purchase the securities underlying the option at the
exercise price if the option is exercised.
All options written by the Fund must be "covered" options. This means that, so
long as the Fund is obligated as the writer of a call option, it will own the
underlying securities subject to the option (or in the case of call options on
U.S. Treasury bills, substantially similar securities) or have the right to
obtain such securities without payment of further consideration (or have the
right to sell the underlying securities without payment of further
consideration, or have segregated cash in the amount of any additional
consideration).
The Fund will be considered "covered" with respect to a put option it writes,
if so long as it is obligated as the writer of the put option, it deposits and
maintains with its custodian in a segregated account liquid assets having a
value equal to or greater than the exercise price of the option (or has the
right to purchase a put option with an exercise price equal to or greater than
the exercise price of the written put option).
The principal reason for writing call or put options is to manage price
volatility (or risk). In addition, the Fund will attempt to obtain, through a
receipt of premiums, a greater current return than would be realized on the
underlying securities alone. The Fund receives a premium from writing a call
or put option which it retains whether or not the option is exercised. By
writing a call option, the Fund might lose the potential for gain on the
underlying security while the option is open, and by writing a put option, the
Fund might become obligated to purchase the underlying security for more than
its current market price upon exercise. The Fund will write put options only on
securities which the Fund wishes to have in its portfolio and where the Fund has
determined, as an investment consideration, that it is willing to pay the
exercise price of the option.
The Fund may purchase put options and call options. Such investments in put
and call options may not exceed 5% of the Fund's assets, represented by the
premium paid, and will only relate to specific securities (or groups of
specific securities) in which the Fund may invest. The Fund may purchase call
and put options for the purpose of offsetting previously written call and put
options of the same series. If the Fund is unable to effect a closing purchase
transaction with respect to covered options it has written, the Fund will not
be able to sell the underlying securities or dispose of assets held in a
segregated account until the options expire or are exercised. Put options may
also be purchased to protect against price movements in particular securities
in the Fund's portfolio. A put option gives the Fund, in return for a premium,
the right to sell the underlying securities to the writer (seller) at a
specified price during the term of the option. The Fund will purchase options
only to the extent permitted by the policies of state securities authorities
in states where shares of the Fund is qualified for offer and sale.
The Fund may generally purchase and write over-the-counter options on
portfolio securities in negotiated transactions with the buyers or writers of
the options since options on the portfolio securities held by the Fund are not
traded on an exchange. The Fund purchases and writes options only with
investment dealers and other financial institutions (such as commercial banks
or savings and loan associations) deemed creditworthy by the Fund's investment
adviser.
Over-the-counter options are two-party contracts with price and terms
negotiated between buyer and seller. In contrast, exchange-traded options are
third-party contracts with standardized strike prices and expiration dates and
are purchased from a clearing corporation. Exchange-traded options have a
continuous liquid market while over-the-counter options may not.
FUTURES AND OPTIONS ON FUTURES. The Fund may purchase and sell futures
contracts to hedge against the effect of changes in the value of portfolio
securities due to anticipated changes in interest rates and market conditions.
In addition, the Fund may use futures contracts as a means of increasing total
return. Futures contracts call for the delivery of particular instruments at a
certain time in the future. These instruments may include interest rate
instruments, fixed income securities, Eurodollars, or contracts based on stock
indices. The seller of the contract agrees to make delivery of the type of
instrument called for in the contract, and the buyer agrees to take delivery
of the instrument at the specified future time.
Stock index futures contracts are based on indices that reflect the market
value of common stock of the firms included in the indices. An index future
contract is an agreement to which two parties agree to take or make delivery
of an amount of cash equal to the difference between the value of the index at
the close of the last trading day of the contract and the price at which the
index contract was originally written.
The Fund may also write call options and purchase put options on futures
contracts as a hedge to attempt to protect securities in its portfolio against
decreases in value. When the Fund writes a call option on a futures contract, it
is undertaking the obligation of selling a futures contract at a fixed price at
any time during a specified period if the option is exercised. Conversely, as
purchaser of a put option on a futures contract, the Fund is entitled (but not
obligated) to sell a futures contract at the fixed price during the life of the
option.
The Fund may also write put options and purchase call options on futures
contracts as hedges against rising purchase prices of portfolio securities.
The Fund will use these transactions to attempt to protect its ability to
purchase portfolio securities in the future at price levels existing at the
time it enters into the transactions. When the Fund writes a put option on a
futures contract, it is undertaking to buy a particular futures contract at a
fixed price at any time during a specified period if the option is exercised.
As a purchaser of a call option on a futures contract, the Fund is entitled
(but not obligated) to purchase a futures contract at a fixed price at any
time during the life of the option.
The Fund may not purchase or sell futures contracts or related options if
immediately thereafter the sum of the amount of margin deposits on the Fund's
existing futures positions and premiums paid for related options would exceed
5% of the market value of the Fund's total assets. In addition, certain
provisions of the Internal Revenue Code of 1986, as amended (the "Code"), may
limit the Fund's use of futures contracts and options. When the Fund purchases
futures contracts, an amount of cash and cash equivalents, equal to the
underlying commodity value of the futures contracts (less any related margin
deposits), will be deposited in a segregated account with the Fund's custodian
(or the broker, if legally permitted) to collateralize the position and
thereby insure that the use of such futures contract is unleveraged. When the
Fund sells futures contracts, it will either own or have the right to receive
the underlying future or security, or will make deposits to collateralize the
position as discussed above.
RISKS. When the Fund uses futures and options on futures as hedging
devices, there is a risk that the prices of the securities subject to the
futures contracts may not correlate perfectly with the prices of the
securities in the Fund's portfolio. This may cause the futures contract and
any related options to react differently than the portfolio securities to
market changes. In addition, the Fund's investment adviser could be
incorrect in its expectations about the direction or extent of market
factors such as stock price movements. In these events, the Fund may lose
money on the futures contract or option.
It is not certain that a secondary market for positions in futures
contracts or for options will exist at all times. Although the investment
adviser will consider liquidity before entering into these transactions,
there is no assurance that a liquid secondary market on an exchange or
otherwise will exist for any particular futures contract or option at any
particular time. A Fund's ability to establish and close out futures and
options positions depends on this secondary market.
SHORT SELLING. The Fund may make short sales with respect to futures, pursuant
to a fundamental policy. Short sales are transactions in which the Fund sells
a security it does not own in anticipation of a decline in the market value of
that security. To complete such a transaction, the Fund must borrow the
security to make delivery to the buyer. The Fund then is obligated to replace
the security borrowed by purchasing it at the market price at the time of
replacement. The price at such time may be more or less than the price at
which the security was sold by the Fund. Until the security is replaced, the
Fund is required to pay to the lender amounts equal to any dividends or
interest which accrue during the period of the loan. To borrow the security, the
Fund also may be required to pay a premium, which would increase the cost of the
security sold. The proceeds of the short sale will be retained by the broker, to
the extent necessary to meet margin requirements, until the short position is
closed out.
Until the Fund replaces a borrowed security in connection with a short sale,
the Fund will be required to maintain a daily segregated account, containing
cash or U.S. government securities, at such a level that (i) the amount
deposited in the account plus the amount deposited with the broker as
collateral will at all times equal to at least 100% of the current value of
the security sold short and (ii) the amount deposited in the segregated
account plus the amount deposited with the broker as collateral will not be
less than the market value of the security at the time it was sold short.
SPECIAL RISKS ASSOCIATED WITH SHORT SELLING. The Fund will incur a loss as
a result of the short sale if the price of the security increases between
the date of the short sale and the date on which the Fund replaces the
borrowed security; conversely, the Fund will realize a gain if the security
declines in price between those dates. This result is the opposite of what
one would expect from a cash purchase of a long position in a security. The
amount of any gain will be decreased, and the amount of any loss increased,
by the amount of any premium or amounts in lieu of interest the Fund may be
required to pay in connection with a short sale.
LEVERAGE THROUGH BORROWING. The Fund may borrow for investment purposes
pursuant to a fundamental policy. This borrowing, which is known as
leveraging, generally will be unsecured, except to the extent the Fund enters
into the reverse repurchase agreements described below. The Investment Company
Act of 1940 requires the Fund to maintain continuous asset coverage (that is,
total assets including borrowings, less liabilities exclusive of borrowings)
of 300% of the amount borrowed. If the 300% asset coverage should decline as a
result of market fluctuations or other reasons, the Fund may be required to
sell some of its portfolio holdings within three days to reduce the debt and
restore the 300% asset coverage, even though it may be disadvantageous from an
investment standpoint to sell securities at that time.
SPECIAL RISKS ASSOCIATED WITH LEVERAGING. Borrowing by the Fund creates an
opportunity for increased net income but, at the same time, creates special
risk considerations. For example, leveraging may exaggerate the effect on
net asset value of any increase or decrease in the market value of the
Fund's portfolio. To the extent the income derived from securities
purchased with borrowed funds exceeds the interest the Fund will have to
pay, the Fund's net income will be greater than if borrowing were not used.
Conversely, if the income from the assets retained with borrowed funds is
not sufficient to cover the cost of borrowing, the net income of the Fund
will be less than if borrowing were not used, and, therefore, the amount
available for distribution to shareholders as dividends will be reduced.
The Fund also may be required to maintain minimum average balances in
connection with such borrowing or to pay a commitment or other fee to
maintain a line of credit; either of these requirements would increase the
cost of borrowing over the stated interest rate.
Among the forms of borrowing in which the Fund may engage is the entry into
reverse repurchase agreements with banks, brokers or dealers. These
transactions involve the transfer by the Fund of an underlying debt instrument
in return for cash proceeds based on a percentage of the value of the
security. The Fund retains the right to receive interest and principal
payments on the security. At an agreed upon future date, the Fund repurchases
the security at an agreed-upon price. In certain types
of agreements, there is no agreed upon repurchase date, and interest payments
are calculated daily, often based on the prevailing U.S. government securities
or other high-quality liquid debt securities at least equal to the aggregate
amount of its reverse repurchase obligations, plus accrued interest, in
certain cases, in accordance with releases promulgated by the Securities and
Exchange Commission. The Securities and Exchange Commission views reverse
repurchase transactions as collateralized borrowings by the Fund. These
agreements, which are treated as if reestablished each day, are expected to
provide the Fund with a flexible borrowing tool.
REPURCHASE AGREEMENTS. The securities in which the Fund invests may be
purchased pursuant to repurchase agreements. Repurchase agreements are
arrangements in which banks, broker/dealers, and other recognized financial
institutions sell securities to the Fund and agree at the time of sale to
repurchase them at a mutually agreed upon time and price. To the extent that
the original seller does not repurchase the securities from the Fund, the Fund
could receive less than the repurchase price on any sale of such securities.
INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES. The Fund may invest in
the securities of other investment companies, but will not own more than 3% of
the total outstanding voting stock of any investment company, invest more than
5% of total assets in any one investment company, or invest more than 10% of
total assets in investment companies in general. The Fund will invest in other
investment companies primarily for the purpose of investing short-term cash
which has not yet been invested in other portfolio instruments. It should be
noted that investment companies incur certain expenses such as management fees
and, therefore, any investment by the Fund in shares of another investment
company would be subject to such duplicate expenses. VCM will waive its
investment advisory fee on assets invested in securities of open-end
investment companies.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS. The Fund may purchase
securities on a when-issued or delayed delivery basis. These transactions are
arrangements in which the Fund purchases securities with payment and delivery
scheduled for a future time. The seller's failure to complete these
transactions may cause the Fund to miss a price or yield considered to be
advantageous. Settlement dates may be a month or more after entering into
these transactions, and the market value of the securities purchased may vary
from the purchase prices. Accordingly, the Fund may pay more or less than the
market value of the securities on the settlement date.
The Fund may dispose of a commitment prior to settlement if the Portfolio
Adviser deems it appropriate to do so. In addition, the Fund may enter into
transactions to sell its purchase commitments to third parties at current
market values and simultaneously acquire other commitments to purchase similar
securities at later dates. The Fund may realize short-term profits or losses
upon the sale of such commitments.
LENDING OF PORTFOLIO SECURITIES. In order to generate additional income, the
Fund may lend portfolio securities on a short-term or long-term basis, to
broker/dealers, banks, or other institutional borrowers of securities. The
Fund will only enter into loan arrangements with broker/dealers, banks, or
other institutions which the Portfolio Adviser has determined are creditworthy
under guidelines established by the Trustees and will receive collateral in
the form of cash or U.S. government securities equal to at least 100% of the
value of the securities loaned at all times. This policy is fundamental and
cannot be changed without the approval of holders of a majority of the Fund's
shares.
There is the risk that when lending portfolio securities, the securities may
not be available to the Fund on a timely basis and the Fund may, therefore,
lose the opportunity to sell the securities at a desirable price. In addition,
in the event that a borrower of securities would file for bankruptcy or become
insolvent, disposition of the securities may be delayed pending court action.
RESTRICTED AND ILLIQUID SECURITIES. The Fund may invest in restricted
securities. Restricted securities are any securities in which the Fund may
otherwise invest pursuant to its investment objective and policies but which
are subject to restrictions on resale under federal securities law. However,
the Fund will limit investments in illiquid securities, including (where
applicable) restricted securities not determined by the Trustees to be liquid,
non-negotiable time deposits, over-the-counter options, and repurchase
agreements providing for settlement in more than seven days after notice, to
15% of its net asset.
BORROWING MONEY. The Fund will not borrow money directly or through reverse
repurchase agreements (arrangements in which the Fund sells a portfolio
instrument for a percentage of its cash value with an agreement to buy it back
on a set date) or pledge securities except, under certain circumstances, the
Fund may borrow up to one-third of the value of its total assets and pledge
assets as necessary to secure such borrowings. This policy is fundamental and
cannot be changed without the approval of holders of a majority of the Fund's
shares.
DIVERSIFICATION. With respect to 75% of the value of total assets, the Fund
will not invest more than 5% in securities of any one issuer, other than cash,
cash items or securities issued or guaranteed by the government of the United
States or its agencies or instrumentalities and repurchase agreements
collateralized by U.S. government securities or acquire more than 10% of the
outstanding voting securities of any one issuer. This policy is fundamental
and cannot be changed without the approval of holders of a majority of the
Fund's shares.
DERIVATIVE CONTRACTS AND SECURITIES. The term "derivative" has traditionally
been applied to certain contracts (including, futures, forward, option and
swap contracts) that "derive" their value from changes in the value of an
underlying security, currency, commodity or index. Certain types of securities
that incorporate the performance characteristics of these contracts are also
referred to as "derivatives." The term has also been applied to securities
"derived" from the cash flows from underlying securities, mortgages or other
obligations.
Derivative contracts and securities can be used to reduce or increase the
volatility of an investment portfolio's total performance. While the response
of certain derivative contracts and securities to market changes may differ
from traditional investments, such as stock and bonds, derivatives do not
necessarily present greater market risks than traditional investments. The
Fund will only use derivative contracts for the purposes disclosed in the
applicable prospectus sections above. To the extent that the Fund invests in
securities that could be characterized as derivatives, it will only do so in a
manner consistent with its investment objectives, policies and limitations.
ADDITIONAL RISK CONSIDERATIONS
FOREIGN SECURITIES. The Fund may invest in foreign securities. Investing in
foreign securities can carry higher returns and risks than those associated
with domestic investments.
FOREIGN COMPANIES. Differences between investing in foreign and U.S. companies
include:
. less publicly available information about foreign companies;
. the lack of uniform financial accounting standards applicable to foreign
companies;
. less readily available market quotations on foreign companies;
. differences in government regulation and supervision of foreign
securities exchanges, brokers, listed companies, and banks;
. generally lower foreign securities market volume;
. the likelihood that foreign securities may be less liquid or more
volatile;
. generally higher foreign brokerage commissions;
. possible difficulty in enforcing contractual obligations or obtaining
court judgments abroad because of differences in the legal systems;
. unreliable mail service between countries; and
. political or financial changes which adversely affect investments in some
countries.
U.S. GOVERNMENT POLICIES. In the past, U.S. government policies have
discouraged or restricted certain investments abroad. Although the Fund is
unaware of any current restrictions which would materially adversely affect
its ability to meet its investment objective and policies, investors are
advised that these U.S. government policies could be reinstituted.
INVESTMENT RISKS ASSOCIATED WITH INVESTMENT IN EQUITY AND DEBT SECURITIES
As with other mutual funds that invest in equity securities, the Fund is
subject to market risks. That is, the possibility exists that common stocks
will decline over short or even extended periods of time. The United States
equity market tends to be cyclical, experiencing both periods when stock
prices generally increase and periods when stock prices generally decrease.
In addition, with respect to fixed income securities, investors should be
aware that prices of fixed income securities generally fluctuate inversely to
the direction of interest rates.
PORTFOLIO TURNOVER
Although the Fund does not intend to invest for the purpose of seeking short-
term profits, securities in its portfolio will be sold whenever the Portfolio
Adviser believes it is appropriate to do so in light of the Fund's investment
objective, without regard to the length of time a particular security may have
been held. The Portfolio Adviser does not anticipate that the Fund's annual
turnover rate will exceed 200% under normal market conditions. A higher rate
of portfolio turnover may lead to increased costs and may also result in
higher taxes paid by the Fund's shareholders.
BLANCHARD FUNDS INFORMATION
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MANAGEMENT OF THE FUND
BOARD OF TRUSTEES. The Board of Trustees (the "Board" or the "Trustees") is
responsible for managing the business affairs of the Trust and for exercising
all of the powers of the Fund except those reserved for the shareholders. The
Executive Committee of the Board of Trustees handles the Board's
responsibilities between meetings of the Board.
MANAGER. Virtus Capital Management, Inc. ("VCM"), the Fund's Manager, is
responsible for managing the Fund and overseeing the investment of its assets.
In addition, VCM selects, monitors, and evaluates the Fund's Portfolio
Adviser. VCM will review the Portfolio Adviser's performance record
periodically, and will make exchanges, if necessary, subject to Board and
shareholder approval.
MANAGEMENT FEES. VCM receives an annual management fee of 1.00% of the Fund's
average net assets. The fee paid by the Fund, while higher than the management
fee paid by other mutual funds in general, is comparable to fees paid by other
mutual funds with similar objectives and policies. The management contract
provides for the voluntary waiver of expenses by the VCM from time to time.
VCM can terminate this voluntary waiver of expenses at any time at its sole
discretion. VCM has also undertaken to reimburse the Fund for operating
expenses in excess of limitations established by certain states.
VCM'S BACKGROUND. VCM, a Maryland corporation formed in 1995, is a wholly-
owned subsidiary of Signet Banking Corporation. Signet Banking Corporation is
a multi-state holding company which has provided investment management
services since 1956. VCM, which is a registered investment adviser, had more
than $2.3 billion in assets under management as of January 31, 1996. As part
of its regular banking operations, Signet Bank may make loans to public
companies. Thus, it may be possible, from time to time, for the Fund to hold
or acquire the securities of issuers which are also lending clients of Signet
Bank. The lending relationship will not be a factor in the selection of
securities.
THE PORTFOLIO ADVISER. Pursuant to the terms of an investment sub-advisory
agreement between the Fund's Manager, VCM, and Mellon Capital Management
Corporation, a Delaware corporation (the "Portfolio Adviser "), the Portfolio
Adviser furnishes portfolio advisory services for the Fund. Under the terms of
the sub-advisory agreement, the Portfolio Adviser has discretion to purchase
and sell securities for the Fund, except as limited by the Fund's investment
objective, policies and restrictions. Although the Portfolio Adviser's
activities are subject to general oversight by VCM and the Trustees, selection
of specific securities in which the Fund may invest are made by the Portfolio
Adviser. For the services provided and the expenses incurred by the Portfolio
Adviser pursuant to the sub-advisory agreement, the Portfolio Adviser is
entitled to receive an annual sub-advisory fee equal to .50% of the Fund's
average daily net assets up to $50 million; .375% on net assets between $50
million and $200 million, and .25% on net assets in excess of $200 million,
payable by VCM, in quarterly installments. The Portfolio Adviser may elect to
waive some or all of its fee. In no event shall the Fund be responsible for
any fees due to the Portfolio Adviser for its services to VCM.
THE PORTFOLIO ADVISER'S BACKGROUND. The Portfolio Adviser, which is located at
595 Market Street, 30th Floor, San Francisco, CA 94105, is a registered
investment advisory firm founded in 1983.
The Portfolio Adviser manages assets of approximately $46 billion. The
Portfolio Adviser is an indirect, wholly-owned subsidiary of Mellon Bank
Corporation.
Dr. Tom Hazuka and Dr. Charles Jacklin are responsible for the day-to-day
management of the Fund.
Dr. Tom Hazuka is Executive Vice President of Mellon Capital Management
Corporation. As Chief Investment Officer, he is responsible for the portfolio
management and trading of domestic and international equities and fixed
income, as well as Tactical Asset Allocation strategies. Dr. Hazuka joined
Mellon Capital Management in 1986, as Manager of Fixed Income, in order to
create a fixed income capability. He was also given responsibility for Equity
Portfolio Management in 1988, and for Equity Arbitrage Trading in 1989. Dr.
Hazuka worked at Wells Fargo Investment Advisors from 1981 through 1986
primarily in a research capacity. Dr. Hazuka received his Ph.D. in Finance
from Stanford University in 1981. He received an M.B.A. from the University of
Connecticut in 1973, and a B.S. in Electrical Engineering from Stevens
Institute of Technology in 1966.
Dr. Jacklin is Senior Vice President and Director of Asset Allocation
Strategies at Mellon Capital Management Corporation. He is responsible for
overseeing domestic, international and global asset allocation strategies.
Prior to joining Mellon Capital Management Corporation, Dr. Jacklin was on the
finance faculty of Stanford University's Graduate School of Business. In
addition, he has been an instructor for the Stanford--London Business School
International Investment Management Program, the Stanford Financial Management
Program, and the Pacific Coast Banking School. For the academic year 1990-
1991, Dr. Jacklin served as Senior Staff Economist for Financial Markets and
Banking for the President's Council of Economic Advisers in Washington D.C.
While at the Council, he had primary responsibility for all matters related to
financial markets and banking. Prior to joining Stanford in 1987, Dr. Jacklin
also served on the finance faculty at the University of Chicago's Graduate
School of Business. From 1978 through 1980, Dr. Jacklin worked as a consultant
with Ernst & Ernst. Dr. Jacklin received his Ph.D. in Finance from Stanford
University in 1985, and M.B.A. from the University of Illinois in 1978, and a
B.S. in Mathematics, cum laude, from the University of Maryland in 1976.
DISTRIBUTION OF FUND SHARES
Federated Securities Corp. is the principal distributor for shares of the
Fund. It is a Pennsylvania corporation organized on November 14, 1969, and is
the principal distributor for a number of investment companies. Federated
Securities Corp. is a subsidiary of Federated Investors.
DISTRIBUTION PLAN. According to the provisions of a distribution plan adopted
pursuant to Investment Company Act Rule 12b-1, the Distributor may select
brokers and dealers to provide distribution and administrative services as to
shares of the Fund. The Distributor may also select administrators (including
financial institutions, fiduciaries, custodians for public funds and
investment advisers) to provide administrative services. Administrative
services may include, but are not limited to, the following functions:
providing office space, equipment, telephone facilities, and various personnel
including clerical, supervisory, and computer as necessary or beneficial to
establish and maintain shareholder accounts and records; processing purchase
and redemption transactions and automatic investments of client account cash
balances; answering routine client inquiries regarding shares; assisting
clients in changing dividend options, account designations, and addresses; and
providing such other services as the Fund reasonably requests for its shares.
Brokers, dealers and administrators will receive fees based upon shares owned
by their clients or customers. The schedules of such fees and the basis upon
which such fees will be paid will be determined from time to time by the Board,
provided that for any period the total amount of fees representing an expense to
the Fund shall not exceed an annual rate of .25% of the average daily net assets
of shares of the Fund held in accounts during the period for which the brokers,
dealers, and administrators provide services. Any fees paid by the distributor
with respect to shares of a Fund pursuant to the distribution plan will be
reimbursed by the Fund from the assets of the Fund.
The distributor will, periodically, uniformly offer to pay cash or promotional
incentives in the form of trips to sales seminars at luxury resorts, tickets
or other items to all dealers selling shares of the Fund. Such payments will
be predicated upon the amount of shares of the Fund that are sold by the
dealers. Such payments, if made, will be in addition to amounts paid under the
distribution plan and will not be an expense of the Fund.
ADMINISTRATIVE ARRANGEMENTS. The distributor may pay financial institutions a
fee based upon the average net asset value of shares of the Fund of their
customers invested in the Trust for providing administrative services. This
fee, if paid, will be reimbursed by VCM and not the Trust.
GLASS-STEAGALL ACT. The Glass-Steagall Act prohibits a depository institution
(such as a commercial bank or a savings and loan association) from being an
underwriter or distributor of most securities. In the event the Glass-Steagall
Act is deemed to prohibit depository institutions from acting in the
administrative capacities described above or should Congress relax current
restrictions on depository institutions, the Board of Trustees will consider
appropriate changes in the administrative services.
State securities laws governing the ability of depository institutions to act
as underwriters or distributors of securities may differ from interpretations
given to the Glass-Steagall Act and, therefore, banks and financial
institutions may be required to register as dealers pursuant to state law.
ADMINISTRATION OF THE FUNDS
ADMINISTRATIVE SERVICES. Federated Administrative Services, a subsidiary of
Federated Investors, provides the Fund with certain administrative personnel
and services necessary to operate the Fund. Such services include shareholder
servicing and certain legal and accounting services. Federated Administrative
Services provides these at an annual rate as specified below:
<TABLE>
<CAPTION>
AVERAGE COMBINED AGGREGATE DAILY NET
MAXIMUM ASSETS OF THE TRUST/BLANCHARD PRECIOUS
AMINISTRATIVE FEED METALS FUND, INC. AND THE VIRTUS FUNDS
---------------- --------------------------------------
<S> <C>
.15% on the first $250 million
.125% on the next $250 million
.10% on the next $250 million
.075% on assets in excess of $750 million
</TABLE>
The administrative fee received during any fiscal year shall be at least
$75,000. Federated Administrative Services may voluntarily waive a portion of
its fee.
EXPENSES OF THE FUND
The Fund pays all of its own expenses and its allocable share of the Trust's
expenses. These expenses include, but are not limited to: the cost of
organizing the Trust and continuing its existence; Trustees fees; investment
advisory and administrative services; printing prospectuses and other Fund
documents for shareholders; registering the Trust and the Fund; taxes and
commissions; issuing purchasing, repurchasing and redeeming shares; fees for
custodian, transfer agent, dividend disbursing agent, shareholders servicing
agents, and registrars; printing, mailing, auditing, accounting, and legal
expenses; reports to shareholders and government agencies; meeting of Trustees
and shareholders and proxy solicitations therefore; insurance premiums;
association membership dues; and such nonrecurring and extraordinary expenses
as may arise. However, the adviser may voluntarily waiver and/or reimburse
some expenses.
BROKERAGE TRANSACTIONS. Subject to the supervision of the Board and VCM,
decisions to buy and sell specific securities for the Fund are made by its
Portfolio Adviser. The Portfolio Adviser is authorized, subject to most
favorable price and execution, to place portfolio transactions with brokerage
firms that provide assistance in the distribution of Fund shares and/or supply
research. The Board has also authorized the Fund to allocate brokerage to the
Portfolio Adviser or an affiliated broker-dealer as well as to use the
Distributor, on an agency basis, or affiliates thereof, to effect portfolio
transactions which are executed on United States and foreign stock exchanges
or which are traded in the over-the-counter market. The Fund has adopted
certain procedures incorporating the standards of Rule 17e-1 of the 1940 Act,
which require that the commissions paid to the Portfolio Adviser or the
Distributor or to affiliated broker-dealers must be "reasonable and fair
compared to the commission, fee, or other remuneration received, or to be
received, by other brokers in connection with comparable transactions
involving similar securities during a comparable period of time." From time to
time, the Fund may purchase portfolio securities directly from dealers acting
as principals, underwriters or market makers. As these transactions are
usually conducted on a net basis, no brokerage commissions are paid by the
Fund. Transactions are allocated to various dealers selected by VCM or the
Portfolio Adviser primarily on the basis of prompt execution of orders at the
most favorable prices. Transactions may be allocated based on the sale of Fund
shares. The Fund has determined that the foregoing arrangements are in the
best interest of the Fund's shareholders.
NET ASSET VALUE
- -------------------------------------------------------------------------------
The Fund's net asset value per share fluctuates. It is determined by dividing
the sum of the market value of all securities and other assets, less
liabilities, by the number of shares outstanding.
HOW TO INVEST
- -------------------------------------------------------------------------------
You may purchase shares of any Fund from Federated Securities Corp., the
Fund's principal Distributor. You may also purchase shares from broker-dealers
who have entered into a dealer agreement with the Distributor at net asset
value, which is determined as of the close of trading (normally 4:00 p.m., New
York time) on the New York Stock Exchange. If your order is received after the
above time, your shares will be purchased at the net asset value of the next
business day. The Fund determines the net asset value of its shares on each
day that the New York Stock Exchange is open for business and on such other
days as there is sufficient trading in its securities to affect materially its
net asset value per share.
The minimum initial investment requirement is $3,000 and the minimum initial
investment requirement for qualified pension plans (IRAs, Keoghs, etc.) is
$2,000. The minimum investment requirement for additional investments is at
least $200 per investment. (The foregoing minimum investment requirements may be
modified or waived at any time at our discretion.)
PURCHASES BY MAIL
To purchase shares of the Fund by mail, simply send a completed Application
(included with this Prospectus or obtainable from the Fund), to the Blanchard
Group of Funds, P.O. Box 8612, Boston, Massachusetts 02266-8612, together with
a check payable to the Blanchard Group of Funds in payment for the shares. If
you need assistance in completing the application, call 1-800-829-3863.
All purchases must be made in U.S. dollars and checks must be drawn on a
United States bank. Payment for shares may not be made by third party checks;
however, second party checks are acceptable when properly endorsed. We reserve
the right to limit the number of checks for one account processed at one time.
If your check does not clear, your purchase will be canceled and you could be
liable for any losses or fees incurred. Payments transmitted by check are
accepted subject to collection at full face amount.
Order by mail are considered received after payment by check is converted into
Federal Funds. This is generally the next business day after the Transfer
Agent receives the check.
PURCHASE BY WIRE. You may also purchase shares by bank wire. For opening new
accounts in this manner, please call 1-800-829-3863 (toll free) before wiring
your funds, and furnish the following information: the account registration
and address, and your taxpayer identification number (for individuals, a
Social Security number). When making additional investments by wire to your
existing accounts, please provide your account numbers. You must include your
name and telephone number, the amount being wired and the name of the wiring
bank with both new and existing account purchases.
You should instruct your bank to wire Federal funds to: State Street Bank and
Trust Company of New York, ABA # 011000028, DDA # 0627-975-6, Boston, MA
indicating the name of the Fund, your account number and the account
registration.
AUTOMATIC INVESTMENT PLANS. Regular monthly purchases of shares may be made by
direct deposit of Social Security and certain other government checks into
your account. Fund shares may be purchased at regular intervals selected by
you by automatic transferal of funds from a bank checking account that you may
designate. All such purchases require a minimum of $100 per transaction. Call
1-800-829-3863 for information and forms required to establish these Plans.
BY TELEPHONE. This service allows you to purchase additional shares quickly
and conveniently through an electronic transfer of money. When you make an
additional purchase by telephone, Blanchard will automatically debit your
predesignated bank account for the desired amount. To establish the telephone
purchase option on your new account you must complete the section on the
application and attach a "voided" check from your bank account. If your
account is already established, please call 1-800-829-3863 to request the
appropriate form. This option will become effective ten business days after
the form is received.
GENERAL INFORMATION
Dividends on the Fund are declared and paid annually. Capital gains realized
by the Fund, if any, will be distributed once every 12 months.
All ordinary income, dividends and capital gains distributions, if any, are
automatically reinvested at net asset value in additional Fund shares unless
we receive written notice from you, at least 30 days prior to the record day
of such distribution, requesting that your dividends and distributions be
distributed to you in cash. See "Tax Matters".
We reserve the right to suspend the offering of Fund shares for a period of
time. We also reserve the right to reject any purchase order.
No share certificates will be issued for shares unless requested in writing.
In order to facilitate redemptions and transfers, most shareholders elect not
to receive certificates. Shares are held in unissued form by the Transfer
Agent. Shares for which certificates have been issued cannot be redeemed,
unless the certificates are received together with the redemption request in
proper form. Share certificates are not issued for fractional shares.
INVESTOR SERVICES
- -------------------------------------------------------------------------------
AUTOMATIC WITHDRAWAL PLAN
If you purchase $10,000 or more of Fund shares, you may establish an Automatic
Withdrawal Plan to authorize a specified dollar amount to be paid periodically
to a designated payee. Under this Plan, all income dividends and capital gains
distributions will be reinvested in shares in your account at the applicable
payment dates' closing net asset value.
Your specified withdrawal payments are made monthly or quarterly in any amount
you choose, but not less than $100 per month or $300 quarterly. Please note
that any redemptions of your shares, which may result in a gain or loss for
tax purposes, may involve the use of principal, and may eventually use up all
of the shares in your account. Such payments do not provide a guaranteed
annuity and may be terminated for any shareholder by the Fund if the value of
the account drops below $10,000 due to transfer or redemption of shares. In
such a case, the shareholder will be notified that the withdrawal payments
will be terminated. The cost of administering the Automatic Withdrawal Plan
for the benefit of shareholders is the Fund expense.
RETIREMENT PLANS
We offer a Prototype Pension and Profit Sharing Plan, including Keogh Plans,
IRAs SEP-IRA Plans, IRA Rollover Accounts and 403(b) Plans. Plan support
services are available by calling 1-800-829-3863.
EXCHANGE PRIVILEGE
You may exchange your Fund shares for shares of another Fund in the Blanchard
Group of Funds or for Investment Shares of The Virtus Funds, on the basis of
relative net asset values per share at the time of exchange. No fees are
charged when you exchange from one Fund to another within the Blanchard Group
of Funds or into one of the aforementioned portfolios of The Virtus Funds.
Before making an exchange, you should read the Prospectus concerning the Fund
into which your exchange is being made.
To request an exchange by telephone, simply call 1-800-829-3863, prior to 4:00
p.m. New York time. Exchanges can be made in this manner only after you have
completed and sent to the Transfer Agent the telephone exchange authorization
form that is included on the New Account Application accompanying this
Prospectus and only if your account registration has not changed within the last
30 days.
It is the Funds' policy to mail to you at your address of record, within five
business days after any telephone call transaction, a written confirmation
statement of the transaction. All calls will be recorded for your protection.
As a result of the Funds' policy, neither the Fund nor its transfer agent will
be responsible for any claims, losses or expenses for acting on telephone
instructions that they reasonably believe to be genuine. Since you may bear
the risk of loss in the event of an unauthorized telephone transaction, you
should verify the accuracy of telephone transactions immediately upon receipt
of your confirmation statement.
Exchanges can only be made between accounts with identical account
registration and in states where shares of the other Funds are qualified for
sale. We do not place any limit on the number of exchanges that may be made
and charge no fee for effecting an exchange. The dollar amount of an exchange
must meet the initial investment requirement of the Fund into which the
exchange is being made. All subsequent exchanges into that Fund must be at
least $1,000. We may modify or suspend the Exchange Privilege at any time upon
60 days' written notice.
Any exchange of shares is, in effect, a redemption of shares in one Fund and a
purchase of the other fund. You should consider the possible tax effects of an
exchange. To prevent excessive trading between Funds to the disadvantage of
other shareholders, we reserve the right to modify or terminate this Privilege
with respect to any shareholder.
A COMPLETED PURCHASE APPLICATION MUST BE RECEIVED BY THE TRANSFER AGENT BEFORE
THE AUTOMATIC WITHDRAWAL PLAN, OR EXCHANGE PRIVILEGE MAY BE USED.
HOW TO REDEEM
- -------------------------------------------------------------------------------
You may redeem your shares on any business day at the next determined net
asset value calculated after your redemption request has been accepted by the
Transfer Agent as described below.
BY TELEPHONE. You may redeem you shares by telephone by calling 1-800-829-
3863, prior to 4:00 p.m. New York time. All calls will be recorded.
Redemptions of Fund shares can be made in this manner only after you have
executed and filed with the Transfer Agent the telephone redemption
authorization form which may be obtained from your Fund or the Transfer Agent.
You may elect on the telephone redemption authorization form to have a
redemption in any amount of $250 or more mailed either to your registered
address, to your bank account, or to any other person you may designate.
Should you wish to review these instructions, simply complete and file a new
telephone redemption authorization form. There is no charge for this service.
Neither your Fund nor the Transfer Agent will be responsible for any claims,
losses or expenses for acting on telephone instructions that they reasonably
believe to be genuine. See "Investor Services--Exchange Privilege," for
additional information with respect to losses resulting from unauthorized
telephone transactions.
You may also request, by placing a call to the telephone number set forth
above, redemption proceeds to be wired directly to the bank account that you
have designated on the authorization form. The minimum amount that may be
redeemed in this manner is $1,000. A check for proceeds of less than $1,000
will be mailed to your address of record. The Funds do not impose a charge for
this service.
However, the proceeds of a wire redemption may be subject to the usual and
customary charges imposed by State Street Bank for the wiring of funds.
Under extraordinary market conditions, it may be difficult for you to redeem
your shares by telephone. Under these circumstances, you should consider
redeeming your shares by mail, as described below.
BY MAIL. All other redemption requests should be made in writing to the
Blanchard Group of Funds, P.O. Box 8612, Boston, MA 02266-8612. Where share
certificates have been issued, the certificates must be endorsed and must
accompany the redemption request. Signatures on redemption request for any
amount and endorsed share certificates submitted for redemption must be
accompanied by signature guarantees from any eligible guarantor institution
approved by the Transfer Agent in accordance with its Standards, Procedures
and Guidelines for the Acceptance of Signature Guarantees ("Signature
Guarantee Guidelines"). Eligible guarantor institutions generally include
banks, broker-dealers, credit unions, national securities exchanges,
registered securities association, clearing agencies and savings associations.
All eligible guarantor institutions must participate in the Securities
Transfer Agents Medallion Program ("STAMP") in order to be approved by the
Transfer Agent pursuant to the Signature Guarantee Guidelines. Copies of the
Signature Guarantee Guidelines and information on STAMP can be obtained from
the Transfer Agent at 1-800-462-9102. Signatures on redemption requests for
any amount must be guaranteed (as described above) if the proceeds are not to
be paid to the registered owner at the registered address, or the registered
address has changed within the previous 60 days. The letter of instruction or
a stock assignment must specify the account number and the exact number of
shares or dollar amount to be redeemed. It must be signed by all registered
shareholders in precisely the same way as originally registered. The letter of
instruction must also include any other supporting legal documents, if
required, in the case of estates, trusts, guardianships, custodianships,
corporations, partnerships, pension or profit sharing plans, or other
organizations.
GENERAL INFORMATION
Your redemption request becomes effective when it is received in proper form
by the Funds' Transfer Agent prior to 4:00 p.m., New York time, or your
redemption will occur on the following business day. We will make payment for
redeemed shares within seven days after receipt by the Transfer Agent.
However, we may delay the forwarding of redemption proceeds on shares which
were recently purchased until the purchase check has cleared, which may take
up to 7 days or more. We may suspend the right of redemption when the New York
Stock Exchange is closed or when trading on the Exchange is restricted, and
under certain extraordinary circumstances in accordance with the rules of the
SEC. Due to the relatively high cost of handling small investments, we reserve
the right upon 60 days' written notice to redeem, at net asset value, the
shares of any shareholder whose account has a value of less than $1,000, other
than as a result of a decline in the net asset value per share. We do not
presently contemplate making such involuntary redemptions and will not redeem
any shares held in tax-sheltered retirement plans in this category. We also
reserve the right upon notice to shareholders to charge a fee for any services
provided herein that are currently free of charge.
SHAREHOLDER INFORMATION
- -------------------------------------------------------------------------------
VOTING RIGHTS
Each share of the Fund gives the shareholder one vote in Trustee elections and
other matters submitted to shareholders for vote. All shares of all classes of
each portfolio in the Trust have equal voting rights, except that in matters
affecting only a particular Fund or class, only shareholders of that Fund or
class are entitled to vote. As a Massachusetts business trust, the Trust is not
required to hold annual shareholder meetings. Shareholder approval will be
sought only for certain changes in the operation of the Trust or the Fund and
for the election of Trustees under certain circumstances.
Trustees may be removed by the Trustees or by shareholders at a special
meeting. A special meeting of the shareholders shall be called by the Trustees
upon the written request of shareholders owning at least 10% of the Trust's
outstanding shares.
EFFECT OF BANKING LAWS
- -------------------------------------------------------------------------------
Banking laws and regulations presently prohibit a bank holding company
registered under the federal Bank Holding Company Act of 1956 or any bank or
non-bank affiliate thereof from sponsoring, organizing, controlling or
distributing the shares of a registered, open-end investment company
continuously engaged in the issuance of its shares, and prohibit banks
generally from issuing, underwriting, or distributing securities. However,
such banking laws and regulations do not prohibit such a holding company
affiliate or banks generally from acting as investment adviser, transfer agent
or custodian to such an investment company or from purchasing shares of such a
company as agent for and upon the order of such a customer. Signet Trust
Company is subject to such banking laws and regulations.
Signet Trust Company believes, based on the advice of its counsel, that VCM
may perform the services for the Fund contemplated by its advisory agreement
with the Trust without violation of the Glass-Steagall Act or other applicable
banking laws or regulations. Changes in either federal or state statutes and
regulations relating to the permissible activities of banks and their
subsidiaries or affiliates, as well as further judicial or administrative
decisions or interpretations of such or future statutes and regulations, could
prevent VCM from continuing to perform all or a part of the above services for
its customers and/or the Fund. If it were prohibited from engaging in these
customer-related activities, the Trustees would consider alternative advisers
and means of continuing available investment services. In such event, changes
in the operation of the Fund may occur, including possible termination of any
automatic or other Fund share investment and redemption services then being
provided by VCM. It is not expected that existing shareholders would suffer
any adverse financial consequences (if another adviser with equivalent
abilities to VCM is found) as a result of any of these occurrences.
TAX INFORMATION
- -------------------------------------------------------------------------------
FEDERAL INCOME TAX
The Fund will pay no federal income tax because it expects to meet
requirements of the Internal Revenue Code applicable to regulated investment
companies and to receive the special tax treatment afforded to such companies.
The Fund will be treated as a single, separate entity for federal income tax
purposes so that income (including capital gains) and losses realized by the
other portfolios of Blanchard Funds will not be combined for tax purposes with
those realized by the Fund.
Unless otherwise exempt, shareholders are required to pay federal income tax
on any dividends and other distribution, including capital gains, received.
This applies whether dividends and distributions are received in cash or as
additional shares.
Shareholders are urged to consult their own tax advisers regarding the status
of their accounts under state and local laws.
PERFORMANCE INFORMATION
- -------------------------------------------------------------------------------
Advertisements and communications to investors regarding the Fund may cite
certain performance and ranking information and may make performance
comparisons to other funds or to relevant indices, as described below. In
addition, the Fund's Portfolio Adviser and other outside analysts may, from
time to time, report on the market outlook for their investments as well as
comment on the historical reasons for these investments including as a hedge
against inflation. The Fund's performance may be calculated both in terms of
total return and on the basis of current yield over any period of time and may
include a computation of the Fund's distribution rate.
TOTAL RETURN
Cumulative total return data is computed by considering all elements of
return, including reinvestment of dividends and capital gains distribution,
over a stated period of time. Cumulative total return figures are not
annualized and represent the aggregate percentage or dollar value change over
the period in question.
Average annual return will be quoted for at least the one, five and ten year
periods ending on a recent calendar quarter (or if such periods have not yet
elapsed, at the end of a shorter period corresponding to the life of the Fund
for performance purposes). Average annual total return figures are annualized
and, therefore, represent the average annual percentage change over the period
in question.
YIELD INFORMATION
The term "yield" refers to the income generated by an investment over a one-
month or 30-day period. This income is computed by dividing the net investment
income per share earned during such period by the maximum public offering
price per share on the last day of the period, and then annualizing such 30-
day (or one month) yield in accordance with a formula prescribed by the SEC
which provides for compounding on a semi-annual basis. The Fund may also quote
tax-equivalent yield, which shows the taxable yield that an investor would
have to earn before taxes to equal the Fund's tax-free yield. The tax-
equivalent yield is calculated by dividing the Fund's tax-exempt yield by the
result of one minus any combination of the stated federal, state, or city tax
rate. If only a portion of the Fund's income is tax-exempt only that portion
is adjusted in the calculation.
DISTRIBUTION RATE
The Fund may also quote distribution rates and/or effective distribution rates
in sales literature or other shareholders communications. The Fund's
distribution rate is computed by dividing the most recent monthly distribution
per share annualized by dividing the distribution rate by the ratio used to
annualize the distribution and reinvesting the resulting amount for a full
year on the basis of such ratio. The effective distribution rate will be
higher than the distribution rate because of the compounding effect of the
assumed reinvestment. The Fund's distribution rate may differ from its yield
because the distribution rate may contain net investment income and other items
of income (such as returns of capital), while yield reflects only earned
interest and dividend items of income.
COMPARATIVE RESULTS
From time to time in advertisements or sales material, the Fund may discuss
its performance rating and may be compared to the performance of other mutual
funds or mutual fund indexes as published by widely recognized independent
mutual fund reporting services such as Lipper Analytical Services, Inc., CDS
and Morningstar, Inc. The Fund may also discuss the past performance and
ranking of its Portfolio Adviser, and compare its performance to various
investment indexes. The Fund may use performance information as reported in
publications of general interest, national, financial and industry
publications such as Forbes or Money Magazine and various investment
newsletters such as Donoghue's Money Letter. In addition, the Fund may compare
its total return to the total return of indexes of U.S. markets or world
markets, to that of other mutual funds, individual country indexes, or other
recognized indexes.
From time to time, the Fund may provide information on certain markets or
countries and specific equity securities and quote published editorial
comments and/or information from newspapers, magazines, investment newsletters
and other publications such as The Wall Street Journal, Money Magazine,
Forbes, Barron's, USA Today and Mutual Funds Magazine. The Fund may also
compare the historical returns on various investments, performance indexes of
those investments and economic indicators. In addition, the Fund may reprint
articles about the Fund and provide them to prospective shareholders. The
Distributor may also make available economic, financial and investment reports
to shareholders and prospective shareholders. In order to describe these
reports, the Fund may include descriptive information on the reports in
advertising literature sent to the public prior to the mailing of a
prospectus. Performance information may be quoted numerically or may be
presented in a table, graph, chart or other illustration. It should be noted
that such performance ratings and comparisons may be made with funds which may
have different investment restrictions, objectives, policies or techniques
than the Fund, and that such other funds or market indicators may be comprised
of securities that differ significantly from the Fund's investments.
Performance information will vary from time to time and past results are not
necessarily representative of future results. You should remember that the
Fund's performance is a function of portfolio managers in selecting the type
and quality of securities in which the Fund may invest, and is affected by
operation, distribution and marketing expenses.
BLANCHARD ASSET ALLOCATION FUND
PORTFOLIO OF INVESTMENTS
SEPTEMBER 30, 1996
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
OR CONTRACTS VALUE
------------ ---------------------------------------------------- ----------
<C> <S> <C>
COMMERCIAL PAPER--17.6%
<CAPTION>
------------------------------------------------------------------
<C> <S> <C>
$ 150,000 CIESCO, Inc., 5.48%, 12/17/1996 $ 148,421
----------------------------------------------------
150,000 Du Pont (E.I.) de Nemours & Co., 5.28%, 12/6/1996 148,665
----------------------------------------------------
150,000 Ford Motor Credit Corp., 5.31%, 12/26/1996 148,220
----------------------------------------------------
150,000 General Electric Co., 5.21%, 12/23/1996 148,286
---------------------------------------------------- ----------
TOTAL COMMERCIAL PAPER (IDENTIFIED COST $593,028) 593,592
---------------------------------------------------- ----------
OPTIONS--7.8%
<CAPTION>
------------------------------------------------------------------
<C> <S> <C>
35 (a)Call option on S&P 500, expires 12/20/1996 strike 156,625
at 655
----------------------------------------------------
15 (a)Call option on S&P 500, expires 12/20/1996 strike 105,750
at 625
---------------------------------------------------- ----------
TOTAL OPTIONS (IDENTIFIED COST $118,650) 262,375
---------------------------------------------------- ----------
U.S. TREASURY--64.1%
<CAPTION>
------------------------------------------------------------------
<C> <S> <C>
15,000 United States Treasury Bill, 12/19/1996 14,840
----------------------------------------------------
1,815,000 United States Treasury Bond, 8.75%, 5/15/2017 2,145,668
---------------------------------------------------- ----------
TOTAL U.S. TREASURY (IDENTIFIED COST $2,115,354) 2,160,508
---------------------------------------------------- ----------
(B) REPURCHASE AGREEMENT--9.0%
<CAPTION>
------------------------------------------------------------------
<C> <S> <C>
303,100 CS First Boston, Inc., 5.60%, dated 9/30/1996, due
10/1/1996
(AT AMORTIZED COST) 303,100
---------------------------------------------------- ----------
TOTAL INVESTMENTS (IDENTIFIED COST $3,130,132) (C) $3,319,575
---------------------------------------------------- ----------
</TABLE>
(a) Non-income producing securities.
(b) The repurchase agreement is fully collateralized by U.S. Government and /
or agency obligations based on market prices at the date of the portfolio.
(c) The cost of investments for federal tax purposes amount to $3,130,132. The
unrealized appre- ciation of investments on a federal tax basis amounts to
$189,443, at September 30, 1996.
Note: The categories of investments are shown as a percentage of net assets
($3,368,329) at September 30, 1996.
(See Notes which are an integral part of the Financial Statements)
BLANCHARD ASSET ALLOCATION FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1996
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
- ------------------------------------------------------------------
Total investments in securities, at value (identified and tax cost
$3,130,132) $3,319,575
- ------------------------------------------------------------------
Income receivable 60,033
- ------------------------------------------------------------------ ----------
Total assets 3,379,608
- ------------------------------------------------------------------
LIABILITIES:
- ------------------------------------------------------------------
Accrued expenses 11,279
- ------------------------------------------------------------------ ----------
Net Assets for 320,633 shares outstanding $3,368,329
- ------------------------------------------------------------------ ----------
NET ASSETS CONSIST OF:
- ------------------------------------------------------------------
Paid in capital $3,200,150
- ------------------------------------------------------------------
Net unrealized appreciation of investments and futures contracts 213,243
- ------------------------------------------------------------------
Accumulated net realized loss on investments and futures contracts (98,943)
- ------------------------------------------------------------------
Undistributed net investment income 53,879
- ------------------------------------------------------------------ ----------
Total Net Assets $3,368,329
- ------------------------------------------------------------------ ----------
NET ASSET VALUE, OFFERING PRICE AND REDEMPTION PROCEEDS PER SHARE:
- ------------------------------------------------------------------
$3,368,329/ 320,633 shares outstanding $10.51
- ------------------------------------------------------------------ ----------
</TABLE>
(See Notes which are an integral part of the Financial Statements)
BLANCHARD ASSET ALLOCATION FUND
STATEMENT OF OPERATIONS
PERIOD ENDED SEPTEMBER 30, 1996 (A)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
INVESTMENT INCOME:
<S> <C> <C> <C>
- ------------------------------------------------------------------
Interest $ 63,878
- ------------------------------------------------------------------
EXPENSES:
- ---------------------------------------------------------
Management fee $ 9,999
- ---------------------------------------------------------
Administrative personnel and services fee 23,836
- ---------------------------------------------------------
Custodian fees 2,605
- ---------------------------------------------------------
Transfer and dividend disbursing agent fees and expenses 7,718
- ---------------------------------------------------------
Auditing fees 4,995
- ---------------------------------------------------------
Portfolio accounting fees 19,176
- ---------------------------------------------------------
Printing and postage 544
- ---------------------------------------------------------
Miscellaneous 3,566
- --------------------------------------------------------- -------
Total expenses 72,439
- ---------------------------------------------------------
Waivers and reimbursements--
- ------------------------------------------------
Waiver of management fee $ (9,999)
- ------------------------------------------------
Waiver of administrative personnel and services
fee (23,836)
- ------------------------------------------------
Waiver of custodian fees (2,605)
- ------------------------------------------------
Reimbursement of other operating expenses (26,000)
- ------------------------------------------------ --------
Total waivers and reimbursements (62,440)
- --------------------------------------------------------- -------
Net expenses 9,999
- ------------------------------------------------------------------ --------
Net investment income 53,879
- ------------------------------------------------------------------ --------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FUTURES
CONTRACTS:
- ------------------------------------------------------------------
Net realized loss on investments and futures contracts (98,943)
- ------------------------------------------------------------------
Net change in unrealized appreciation of investments and futures
contracts 213,243
- ------------------------------------------------------------------ --------
Net realized and unrealized gain on investments and futures
contracts 114,300
- ------------------------------------------------------------------ --------
Change in net assets resulting from operations $168,179
- ------------------------------------------------------------------ --------
</TABLE>
(a) For the period from June 6, 1996 (date of initial public investment) to
September 30, 1996.
(See Notes which are an integral part of the Financial Statements)
BLANCHARD ASSET ALLOCATION FUND
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERIOD ENDED
SEPTEMBER 30,
1996 (A)
- ---------------------------------------------------------------- -------------
<S> <C>
INCREASE (DECREASE) IN NET ASSETS:
- ----------------------------------------------------------------
OPERATIONS--
- ----------------------------------------------------------------
Net investment income $ 53,879
- ----------------------------------------------------------------
Net realized (loss) on investments and futures contracts
($68,583 net gain, as computed for federal tax purposes) (98,943)
- ----------------------------------------------------------------
Net change in unrealized appreciation of investments and futures
contracts 213,243
- ---------------------------------------------------------------- ----------
Change in net assets resulting from operations 168,179
- ---------------------------------------------------------------- ----------
SHARE TRANSACTIONS--
- ----------------------------------------------------------------
Proceeds from sale of shares 3,200,250
- ----------------------------------------------------------------
Net asset value of shares issued to shareholders in payment
of distributions declared --
- ----------------------------------------------------------------
Cost of shares redeemed (100)
- ---------------------------------------------------------------- ----------
Change in net assets resulting from share transactions 3,200,150
- ---------------------------------------------------------------- ----------
Change in net assets 3,368,329
- ----------------------------------------------------------------
NET ASSETS:
- ----------------------------------------------------------------
Beginning of period --
- ---------------------------------------------------------------- ----------
End of period (including undistributed net investment income of
$53,879) $3,368,329
- ---------------------------------------------------------------- ----------
</TABLE>
(a) For the period from June 6, 1996 (date of initial public investment) to
September 30, 1996.
(See Notes which are an integral part of the Financial Statements)
BLANCHARD ASSET ALLOCATION FUND
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
- -------------------------------------------------------------------------------
(1) ORGANIZATION
Blanchard Funds (the "Trust") is registered under the Investment Company Act
of 1940, as amended (the "Act") as an open-end, management investment company.
The Trust consists of seven portfolios. The financial statements included
herein are only those of Blanchard Asset Allocation Fund (the "Fund"), a
diversified portfolio. The financial statements of the other portfolios are
presented separately. The assets of each portfolio are segregated and a
shareholder's interest is limited to the portfolio in which shares are held.
The investment objective of the Fund is to maximize total return over the long
term by allocating its assets among stocks, bonds, short-term instruments, and
other instruments.
(2) SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. These
policies are in conformity with generally accepted accounting principles.
INVESTMENT VALUATIONS--U.S. government securities are generally valued at
the mean of the latest bid and asked price as furnished by an independent
pricing service. Short-term securities are valued at the prices provided by
an independent pricing service. However, short-term securities with
remaining maturities of sixty days or less at the time of purchase may be
valued at amortized cost, which approximates fair market value.
REPURCHASE AGREEMENTS--It is the policy of the Fund to require the
custodian bank to take possession, to have legally segregated in the
Federal Reserve Book Entry System, or to have segregated within the
custodian bank's vault, all securities held as collateral under repurchase
agreement transactions. Additionally, procedures have been established by
the Fund to monitor, on a daily basis, the market value of each repurchase
agreement's collateral to ensure that the value of collateral at least
equals the repurchase price to be paid under the repurchase agreement
transaction.
The Fund will only enter into repurchase agreements with banks and other
recognized financial institutions, such as broker/dealers, which are deemed
by the Fund's adviser to be creditworthy pursuant to the guidelines and/or
standards reviewed or established by the Board of Trustees (the
"Trustees"). Risks may arise from the potential inability of counterparties
to honor the terms of the repurchase agreement. Accordingly, the Fund could
receive less than the repurchase price on the sale of collateral
securities.
INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS--Interest income and expenses
are accrued daily. Bond premium and discount, if applicable, are amortized
as required by the Internal Revenue Code, as amended (the "Code").
Distributions to shareholders are recorded on the ex-dividend date.
----------------------------------------------------------------------------
FEDERAL TAXES--It is the Fund's policy to comply with the provisions of the
Code applicable to regulated investment companies and to distribute to
shareholders each year substantially all of its income. Accordingly, no
provisions for federal tax are necessary.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS--The Fund may engage in when-
issued or delayed delivery transactions. The Fund records when-issued
securities on the trade date and maintains security positions such that
sufficient liquid assets will be available to make payment for the
securities purchased. Securities purchased on a when-issued or delayed
delivery basis are marked to market daily and begin earning interest on the
settlement date.
FUTURES CONTRACTS--The Fund purchases stock index futures contracts to
manage cashflows, enhance yield, and to potentially reduce transaction
costs. Upon entering into a stock index futures contract with a broker, the
Fund is required to deposit in a segregated account a specified amount of
cash or U.S. government securities. Futures contracts are valued daily and
unrealized gains or losses are recorded in a "variation margin" account.
Daily, the Fund receives from or pays to the broker a specified amount of
cash based upon changes in the variation margin account. When a contract is
closed, the Fund recognizes a realized gain or loss. For the period ended
September 30, 1996, the Fund had realized gains on Futures Contracts of
$9,715. Futures contracts have market risks, including the risk that the
change in the value of the contract may not correlate with changes in the
value of the underlying securities.
At September 30, 1996, the Fund had outstanding futures contracts as set
forth below:
<TABLE>
<CAPTION>
EXPIRATION UNREALIZED
DATE CONTRACTS TO RECEIVE POSITION APPRECIATION
------------- -------------------------- -------- ------------
<S> <C> <C> <C>
December 1996 1 S&P 500 December Futures Long $23,800
</TABLE>
OPTIONS TRANSACTIONS--The Fund may purchase over-the-counter put options to
hedge against the effects of fluctuations in interest rates and other
market conditions. The risk associated with purchasing and option is that
the Fund pays a premium whether or not the option is exercised.
Additionally, the Fund bears the risk of loss of premium and change in
market value should the counterparty not perform under the contact. Put
options purchases are accounted for in the same manner as portfolio
securities.
USE OF ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts of assets, liabilities,
expenses and revenues reported in the financial statements. Actual results
could differ from those estimated.
OTHER--Investment transactions are accounted for on the trade date.
(3) SHARES OF BENEFICIAL INTEREST
The Declaration of Trust permits the Trustees to issue an unlimited number of
full and fractional shares of beneficial interest (without par value).
- -------------------------------------------------------------------------------
Transactions in shares were as follows:
<TABLE>
<CAPTION>
PERIOD ENDED
SEPTEMBER 30,
1996*
- --------------------------------------------------------- -------------
<S> <C>
Shares sold 320,643
- ---------------------------------------------------------
Shares issued to shareholders in payment of distributions
declared --
- ---------------------------------------------------------
Shares redeemed (10)
- --------------------------------------------------------- -------
Net change resulting from share transactions 320,633
- --------------------------------------------------------- -------
</TABLE>
*For the period from June 6, 1996 (date of initial public investment) to
September 30, 1996.
(4) MANAGEMENT FEE AND OTHER TRANSACTIONS WITH AFFILIATES
MANAGEMENT FEE--Virtus Capital Management Inc., the Fund's manager, (the
"Manager"), receives for its services an annual management fee equal to
1.00% of the Fund's average daily net assets. The Manager may voluntarily
choose to waive any portion of its fee and/or reimburse certain operating
expenses of the Fund. The Manager can modify or terminate this voluntary
waiver and/or reimbursement at any time at its sole discretion.
SUB-ADVISORY FEE--Under the terms of a sub-advisory agreement between the
Manager and the Mellon Capital Management Corporation (the "Portfolio
Adviser") the Portfolio Adviser receives an annual fee from the Manager
equal to 0.50% of the Fund's average daily net assets up to $50 million,
0.375% of the Fund's net assets between $50 million and $200 Million, and
0.25% on net assets in excess of $200 million, payable by the Manager, in
quarterly installments.
ADMINISTRATIVE FEE--Federated Administrative Services ("FAS") provides the
Fund with certain administrative personnel and services. The fee paid to
FAS is based on the level of average combined aggregate net assets of the
Trust, the Blanchard Precious Metals Fund Inc., and the Virtus Funds, all
of which are advised by the Manager, for the period. The administrative fee
received during the period of the Administrative Services Agreement shall
be at least $75,000 per portfolio. FAS may voluntarily choose to waive a
portion of its fee.
DISTRIBUTION SERVICES FEE--The Fund has adopted a Distribution Plan (the
"Plan") pursuant to Rule 12b-1 under the Act. Under the terms of the Plan,
the Fund will reimburse Federated Securities Corp. ("FSC"), the principal
distributor, from the net assets of the Fund to finance activities intended
to result in the sale of the Fund's shares. The Plan provides that the Fund
may incur distribution expenses up to 0.25% of the average daily net assets
of the Fund, annually, to reimburse FSC. As of September 30, 1996, the fund
accrued no Distribution Services Fee and has no current intention of
accruing this fee.
TRANSFER AGENT AND DIVIDEND DISBURSING AGENT FEES--Federated Services
Company ("FServ"), through its subsidiary, Federated Shareholder Services
Company ("FSSC") serves as transfer and dividend disbursing agent for the
Fund. The fee paid to FSSC is based on the size, type, and number of
accounts and transactions made by shareholders.
PORTFOLIO ACCOUNTING FEES--FServ maintains the Fund's accounting records
for which it receives a fee. The fee is based on the level of the Fund's
average daily net assets for the period, plus out-of-pocket expenses.
----------------------------------------------------------------------------
CUSTODIAN FEES--Signet Trust Company is the Fund's custodian. The fee is
based on the level of the Fund's average daily net assets for the period,
plus out-of-pocket expenses. The custodian may voluntarily choose to waive
a portion of its fee.
GENERAL--Certain of the Officers and Trustees of the Trust are Officers and
Directors or Trustees of the above companies.
(5) INVESTMENT TRANSACTIONS
Purchases and sales of investments, excluding short-term securities, for
the period ended September 30, 1996, were as follows:
<TABLE>
<S> <C>
----- ----------
PURCHASES $3,647,972
----- ----------
SALES $ 763,512
----- ----------
</TABLE>
INDEPENDENT AUDITORS' REPORT
- -------------------------------------------------------------------------------
To the Board of Trustees of BLANCHARD FUNDS
and the Shareholders of BLANCHARD ASSET ALLOCATION FUND:
We have audited the accompanying statement of assets and liabilities,
including the portfolio of investments, of Blanchard Asset Allocation Fund as
of September 30, 1996, and the related statements of operations and changes in
net assets, and financial highlights for the period from June 6, 1996 to
September 30, 1996. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express
an opinion on these financial statements and financial highlights based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. Our procedures included confirmation of the
securities owned as of September 30, 1996 by correspondence with the custodian
and brokers; where replies were not received from brokers, we performed other
auditing procedures. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the above mentioned financial statements and financial
highlights referred to above present fairly, in all material respects, the
financial position of Blanchard Asset Allocation Fund as of September 30,
1996, the results of its operations, the changes in its net assets and its
financial highlights for the period from June 6, 1996 to September 30, 1996 in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Pittsburgh, Pennsylvania
November 15, 1996
ADDRESSES
- --------------------------------------------------------------------------------
Blanchard Asset Allocation Fund Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
- ---------------------------------------------------------------------------
Distributor
Federated Securities Corp. Federated Investors Tower
Pittsburgh, Pennsylvania 15222-3779
- ---------------------------------------------------------------------------
Manager
Virtus Capital Management, Inc. 707 East Main Street
Suite 1300
Richmond, Virginia 23219
- ---------------------------------------------------------------------------
Portfolio Adviser
Mellon Capital Management 595 Market Street, 30th Floor
Corporation San Francisco, California 94105
- ---------------------------------------------------------------------------
Custodian
Signet Trust Company 7 North Eighth Street
Richmond, Virginia 23219
- ---------------------------------------------------------------------------
Transfer Agent and Dividend Disbursing
Agent
Federated Shareholder Services Federated Investors Tower
Company Pittsburgh, Pennsylvania 15222-3779
- ---------------------------------------------------------------------------
Independent Auditors
Deloitte & Touche LLP 2500 One PPG Place
Pittsburgh, Pennsylvania 15222
- ---------------------------------------------------------------------------
The Blanchard Group of Funds are available through Signet Financial Services,
Inc., member NASD, and are advised by an affiliate, Virtus Capital Management,
Inc., which is compensated for this service.
Investment products are not deposits, obligations of, or guaranteed by any
bank. They are not insured by the FDIC. They involve risk, including the
possible loss of principal invested.
(2194)
CUSIP 093212504
G01386-06 (11/96)
BLANCHARD ASSET ALLOCATION FUND
(A PORTFOLIO OF BLANCHARD FUNDS)
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information should be read with the
prospectus of the Blanchard Asset Allocation Fund dated November 30,
1996. This Statement is not a prospectus itself. You may request a copy
of the prospectus, or a paper copy of this Statement of Additional
Information, if you have received it electronically, free of charge by
calling 1-800-829-3863.
FEDERATED INVESTORS TOWER
PITTSBURGH, PENNSYLVANIA 15222-3779
Statement dated November 30, 1996
VIRTUS CAPITAL MANAGEMENT, INC.
INVESTMENT ADVISER
FEDERATED SECURITIES CORP.
DISTRIBUTOR
CUSIP 093212504
G01386-15 (11/96)
GENERAL INFORMATION ABOUT THE FUND 1
INVESTMENT OBJECTIVES AND POLICIES 1
INVESTMENT LIMITATIONS 5
BLANCHARD ASSET ALLOCATION FUND MANAGEMENT8
Fund Ownership 12
Trustees Compensation 13
Trustee Liability 13
INVESTMENT ADVISORY SERVICES 13
Manager of the Fund 13
Management Fees 13
Portfolio Adviser of the Fund 14
Sub-Advisory Fees 14
OTHER SERVICES 14
Administrative Services 14
Custodian 14
Transfer Agent and Dividend Disbursing
Agent 14
Independent Accountants 14
BROKERAGE TRANSACTIONS 14
PURCHASING SHARES 15
Distribution Plan 15
Administrative Arrangements 15
Conversion to Federal Funds 15
DETERMINING NET ASSET VALUE 15
Determining Market Value of Securities 15
Trading in Foreign Securities 16
EXCHANGE PRIVILEGE 16
Requirements for Exchange 16
Making an Exchange 16
REDEEMING SHARES 16
Redemption in Kind 16
MASSACHUSETTS PARTNERSHIP LAW 17
TAX STATUS 17
The Fund's Tax Status 17
Foreign Taxes 17
Shareholders' Tax Status 17
TOTAL RETURN 17
YIELD 18
PERFORMANCE COMPARISONS 18
APPENDIX 19
GENERAL INFORMATION ABOUT THE FUND
The Fund is a portfolio of Blanchard Funds (the `Trust''). The Trust was
established as a Massachusetts business trust under a Declaration of Trust
dated January 24, 1986. The Declaration of Trust permits the Trust to offer
separate series of shares of beneficial interest representing interests in
separate portfolios of securities.
INVESTMENT OBJECTIVES AND POLICIES
The Fund's investment objective is to maximize total return over the long
term by allocating its assets among stocks, bonds, short-term instruments
and other instruments. The investment objective cannot be changed without
the approval of shareholders. Unless indicated otherwise, the policies
described below may be changed by the Trustees without shareholder
approval. Shareholders will be notified before any material change in these
policies becomes effective.
WARRANTS
The Fund may invest in warrants. Warrants are basically options to
purchase common stock at a specific price (usually at a premium above the
market value of the optioned common stock at issuance) valid for a specific
period of time. Warrants may have a life ranging from less than a year to
twenty years or may be perpetual. However, most warrants have expiration
dates after which they are worthless. In addition, if the market price of
the common stock does not exceed the warrant's exercise price during the
life of the warrant, the warrant will expire as worthless. Warrants have
no voting rights, pay no dividends, and have no rights with respect to the
assets of the corporation issuing them. The percentage increase or
decrease in the market price of the warrant may tend to be greater than the
percentage increase or decrease in the market price of the optioned common
stock. The Fund will not invest more than 5% of the value of its total
assets in warrants. No more than 2% of this 5% may be in warrants which are
not listed on the New York or American Stock Exchanges. Warrants required
in units or attached to securities may be deemed to be without value for
purposes of this policy.
CONVERTIBLE SECURITIES
Convertible bonds and convertible preferred stocks are fixed income
securities that generally retain the investment characteristics of fixed
income securities until they have been converted but also react to
movements in the underlying equity securities. The holder is entitled to
receive the fixed income of a bond or the dividend preference of a
preferred stock until the holder elects to exercise the conversion
privilege. Usable bonds are corporate bonds of appropriate rating or
comparable quality (as described in the prospectus) that can be used, in
whole or in part, customarily at full face value, in lieu of cash to
purchase the issuer's common stock. When owned as part of a unit along with
warrants, which are options to buy the common stock, they function as
convertible bonds, except that the warrants generally will expire before
the bond's maturity. Convertible securities are senior to equity securities
and, therefore, have a claim to assets of the corporation prior to the
holders of common stock in the case of liquidation. However, convertible
securities are generally subordinated to similar nonconvertible securities
of the same company. The interest income and dividends from convertible
bonds and preferred stocks provide a stable stream of income with generally
higher yields than common stocks, but lower than non-convertible securities
of similar quality.
The Fund will exchange or convert the convertible securities held in its
portfolio into shares of the underlying common stock in instances in which,
in the adviser's opinion, the investment characteristics of the underlying
common shares will assist the Fund in achieving its investment objective.
Otherwise, the Fund will hold or trade the convertible securities. In
selecting convertible securities for the Fund, the adviser evaluates the
investment characteristics of the convertible security as a fixed income
instrument and the investment potential of the underlying equity security
for capital appreciation. In evaluating these matters with respect to a
particular convertible security, the adviser considers numerous factors,
including the economic and political outlook, the value of the security
relative to other investment alternatives, trends in the determinants of
the issuer's profits, and the issuer's management capability and practices.
COLLATERALIZED MORTGAGE OBLIGATIONS ("CMOS")
The following example illustrates how mortgage cash flows are prioritized
in the case of CMOs -- most of the CMOs in which the Fund invests use the
same basic structure:
(1)Several classes of securities are issued against a pool of mortgage
collateral. The most common structure contains four tranches of
securities: the first three (A, B, and C bonds) pay interest at their
stated rates beginning with the issue date and the final tranche (Z
bonds) typically receives any excess income from the underlying
investments after payments are made to the other tranches and receives
no principal or interest payments until the shorter maturity tranches
have been retired, but then receives all remaining principal and
interest payments.
(2)The cash flows from the underlying mortgages are applied first to pay
interest and then to retire securities.
(3)The tranches of securities are retired sequentially. All principal
payments are directed first to the shortest-maturity tranche (or A
bonds). When those securities are completely retired, all principal
payments are then directed to the next-shortest-maturity tranche (or B
bonds). This process continues until all of the tranches have been paid
off.
Because the cash flow is distributed sequentially instead of pro rata, as
with pass-through securities, the cash flows and average lives of CMOs are
more predictable, and there is a period of time during which the investors
in the longer-maturity classes receive no principal paydowns. One or more
of the tranches often bear interest at an adjustable rate. The interest
portion of these payments is distributed by the Fund as income, and the
principal portion is reinvested.
WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS
These transactions are made to secure what is considered to be an
advantageous price and yield for the Fund. No fees or other expenses, other
than normal transaction costs, are incurred. However, liquid assets of the
Fund sufficient to make payment for the securities to be purchased are
segregated on the Fund's records at the trade date. These assets are marked
to market daily and are maintained until the transaction has been settled.
The Fund does not intend to engage in when-issued and delayed delivery
transactions to an extent that would cause the segregation of more than 20%
of the total value of its assets.
REPURCHASE AGREEMENTS
The Fund or its custodian will take possession of the securities subject to
repurchase agreements, and these securities will be marked to market daily.
To the extent that the original seller does not repurchase the securities
from the Fund, the Fund could receive less than the repurchase price on any
sale of such securities. In the event that such a defaulting seller filed
for bankruptcy or became insolvent, disposition of such securities by the
Fund might be delayed pending court action. The Fund believes that under
the regular procedures normally in effect for custody of the Fund's
portfolio securities subject to repurchase agreements, a court of competent
jurisdiction would rule in favor of the Fund and allow retention or
disposition of such securities. The Fund will only enter into repurchase
agreements with banks and other recognized financial institutions, such as
broker/dealers, which are deemed by the Fund's adviser to be creditworthy
pursuant to guidelines established by the Trustees.
LENDING OF PORTFOLIO SECURITIES
As a fundamental policy of the Fund, the Fund may lend portfolio
securities. The collateral received when the Fund lends portfolio
securities must be valued daily and, should the market value of the loaned
securities increase, the borrower must furnish additional collateral to the
Fund. During the time portfolio securities are on loan, the borrower pays
the Fund any dividends or interest paid on such securities. Loans are
subject to termination at the option of the Fund or the borrower. The Fund
may pay reasonable administrative and custodial fees in connection with a
loan and may pay a negotiated portion of the interest earned on the cash or
equivalent collateral to the borrower or placing broker. The Fund would not
have the right to vote securities on loan, but would terminate the loan and
regain the right to vote if that were considered important with respect to
the investment.
RESTRICTED AND ILLIQUID SECURITIES
The Fund may invest in commercial paper issued in reliance on the exemption
from registration afforded by Section 4(2) of the Securities Act of 1933.
Section 4(2) commercial paper is restricted as to disposition under federal
securities law and is generally sold to institutional investors, such as
the Fund, who agree that they are purchasing the paper for investment
purposes and not with a view to public distribution. Any resale by the
purchaser must be in an exempt transaction. Section 4(2) commercial paper
is normally resold to other institutional investors like the Fund through
or with the assistance of the issuer or investment dealers who make a
market in Section 4(2) commercial paper, thus providing liquidity.
The ability of the Trustees to determine the liquidity of certain
restricted securities is permitted under a Securities and Exchange
Commission (the "SEC") staff position set forth in the adopting release for
Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-
exclusive safe-harbor for certain secondary market transactions involving
registration for resales of otherwise restricted securities to qualified
institutional buyers.
The Rule was expected to further enhance the liquidity of the secondary
market for securities eligible for resale under the Rule. The Fund believes
that the staff of the SEC has left the question of determining the
liquidity of all restricted securities to the Trustees. The Trustees may
consider the following criteria in determining the liquidity of certain
restricted securities:
o the frequency of trades and quotes for the security;
o the number of dealers willing to purchase or sell the security and the
number of other potential buyers;
o dealer undertakings to make a market in the security; and
o the nature of the security and the nature of the marketplace trades.
FUTURES CONTRACTS
A futures contract is a firm commitment by two parties: the seller who
agrees to make delivery of the specific type of security called for in the
contract ("going short") and the buyer who agrees to take delivery of the
security ("going long") at a certain time in the future. For example, in
the fixed income securities market, prices move inversely to interest
rates. A rise in the rate means a drop in the price. In order to hedge its
holdings of fixed income securities against a rise in market interest
rates, the Fund could enter into contracts to deliver securities at a
predetermined price (i.e., "go short") to protect itself against the
possibility that the prices of its fixed income securities may decline
during the Fund's anticipated holding period. The Fund would "go long"
(agree to purchase securities in the future at a predetermined price) to
hedge against a decline in market interest rates. The Fund may use futures
contracts for hedging purposes and to increase total return.
"MARGIN" IN FUTURES TRANSACTIONS
Unlike the purchase or sale of a security, the Fund does not pay or receive
money upon the purchase or sale of a futures contract. Rather, the Fund is
required to deposit an amount of "initial margin" in cash or U.S. Treasury
bills with its custodian (or the broker, if legally permitted). The nature
of initial margin in futures transactions is different from that of margin
in securities transactions in that initial margin in futures transactions
does not involve the borrowing of funds by the Fund to finance the
transactions. Initial margin is in the nature of a performance bond or good
faith deposit on the contract which is returned to the Fund upon
termination of the futures contract, assuming all contractual obligations
have been satisfied.
A futures contract held by the 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 the
Fund but is instead settlement between the Fund and the broker of the
amount one would owe the other if the futures contract expired. In
computing its daily net asset value, the Fund will mark to market its open
futures positions.
The Fund is also required to deposit and maintain margin when it writes
call options on futures contracts.
PUT OPTIONS ON FUTURES CONTRACTS
The Fund may purchase put options on futures contracts to protect portfolio
securities against decreases in value resulting from market factors, such
as an anticipated increase in interest rates. Unlike entering directly into
a futures contract, which requires the purchaser to buy a financial
instrument on a set date at a specified price, the purchase of a put option
on a futures contract entitles (but does not obligate) its purchaser to
decide on or before a future date whether to assume a short position at the
specified price.
Generally, if the hedged portfolio securities decrease in value during the
term of an option, the related futures contracts will also decrease in
value and the option will increase in value. In such an event, the Fund
will normally close out its option by selling an identical option. If the
hedge is successful, the proceeds received by the Fund upon the sales of
the second option will be large enough to offset both the premium paid by
the Fund for the original option plus the decrease in value of the hedged
securities.
Alternatively, the Fund may exercise its put option to close out the
position. To do so, it would simultaneously enter into a futures contract
of the type underlying the option (for a price less than the strike price
of the option) and exercise the option. The Fund would then deliver the
futures contract in return for payment of the strike price. If the Fund
neither closes out nor exercises an option, the option will expire on the
date provided in the option contract, and only the premium paid for the
contract will be lost.
The Fund may also write put options on futures contracts to protect against
rising purchase prices of portfolio securities.
The Fund may use put options on futures contracts for hedging purposes and
to increase total return.
CALL OPTIONS ON FUTURES CONTRACTS
In addition to purchasing put options on futures, the Fund may write listed
and over-the-counter call options on futures contracts to hedge its
portfolio against an increase in market interest rates or a decrease in
stock prices. When the Fund writes a call option on a futures contract, it
is undertaking the obligation of assuming a short futures position (selling
a futures contract) at the fixed strike price at any time during the life
of the option if the option is exercised. As stock prices fall or market
interest rates rise, causing the prices of futures to go down, the Fund's
obligation under a call option on a future (to sell a futures contract)
costs less to fulfill, causing the value of the Fund's call option position
to increase.
In other words, as the underlying futures price goes down below the strike
price, the buyer of the option has no reason to exercise the call, so that
the Fund keeps the premium received for the option. This premium can
substantially offset the drop in value of the Fund's portfolio securities.
Prior to the expiration of a call written by the Fund, or exercise of it by
the buyer, the Fund may close out the option by buying an identical option.
If the hedge is successful, the cost of the second option will be less than
the premium received by the Fund for the initial option. The net premium
income of the Fund will then substantially offset the decrease in value of
the hedged securities.
The Fund will not maintain open positions in futures contracts it has sold
or call options it has written on futures contracts if, in the aggregate,
the value of the open positions (marked to market) exceeds the current
market value of its securities portfolio plus or minus the unrealized gain
or loss on those open positions, adjusted for the correlation of volatility
between the hedged securities and the futures contracts. If this limitation
is exceeded at any time, the Fund will take prompt action to close out a
sufficient number of open contracts to bring its open futures and options
positions within this limitation.
The Fund may also purchase call options on futures contracts as hedges
against rising purchase prices of portfolio securities.
The Fund may use call options on futures contracts for hedging purposes and
to increase total return.
STOCK INDEX OPTIONS
The Fund may purchase put options on stock indices listed on national
securities exchanges or traded in the over-the-counter market. A stock
index fluctuates with changes in the market value of the stocks included in
the index.
The effectiveness of purchasing stock index options will depend upon the
extent to which price movements in the Fund's portfolio correlate with
price movements of the stock index selected. Because the value of an index
option depends upon movements in the level of the index rather than the
price of a particular stock, whether the Fund will realize a gain or loss
from the purchase of the option on an index depends upon movements in the
level of stock prices in the stock market generally or, in the case of
certain indices, in an industry or market segment, rather than movements in
the price of a particular stock. Accordingly, successful use by the Fund of
options on stock indices will be subject to the availability of the Fund's
adviser to predict correctly movements in the directions of the stock
market generally or of a particular industry. This requires different
skills and techniques than predicting changes in the prices of individual
stocks.
OVER-THE-COUNTER OPTIONS
The Fund may purchase and write over-the-counter options on portfolio
securities in negotiated transactions with the buyers or writers of the
options when options on the portfolio securities held by the Fund are not
traded on an exchange.
REVERSE REPURCHASE AGREEMENTS
The Fund may also enter into reverse repurchase agreements pursuant to a
fundamental policy. These transactions are similar to borrowing cash. In a
reverse repurchase agreement, the Fund transfers possession of a portfolio
instrument to another person, such as a financial institution, broker, or
dealer, in return for a percentage of the instrument's market value in
cash, and agrees that on a stipulated date in the future the Fund will
repurchase the portfolio instrument by remitting the original consideration
plus interest at an agreed upon rate. The use of reverse repurchase
agreements may enable the Fund to avoid selling portfolio instruments at a
time when a sale may be deemed to be disadvantageous, but the ability to
enter into reverse repurchase agreements does not ensure that the Fund will
be able to avoid selling portfolio instruments at a disadvantageous time.
When effecting reverse repurchase agreements, liquid assets of the Fund in
a dollar amount sufficient to make payment for the obligations to be
purchased are segregated at the trade date. These securities are marked to
market daily and are maintained until the transaction is settled.
INVESTMENT LIMITATIONS
BUYING ON MARGIN
The Fund will not purchase securities on margin, but may obtain such
short-term credits as are necessary for clearance of transactions,
except that the Fund may make margin payments in connection with its
use of financial futures contracts or related options and
transactions.
BORROWING MONEY
The Fund will not issue senior securities, except that (a) the Fund
may borrow money directly or through reverse repurchase agreements in
amounts up to one-third of the value of its total assets, including
the amount borrowed, either (i) as a temporary, extraordinary, or
emergency measure or to facilitate management of the Fund by enabling
the Fund to meet redemption requests when the liquidation of portfolio
securities is deemed to be inconvenient or disadvantageous, or (ii)
for investment purposes. The Fund will not purchase any securities for
the purpose stated under clause "(i)" above while any borrowings in
excess of 5% of its total assets are outstanding.
PLEDGING ASSETS
The Fund will not mortgage, pledge, or hypothecate any assets except
to secure permitted borrowings. For purposes of this limitation, the
following will not be deemed to be pledges of the Fund's assets: (a)
the deposit of assets in escrow in connection with the writing of
covered put or call options and the purchase of securities on a when-
issued or delayed delivery basis; and (b) collateral arrangement with
respect to (i) the purchase and sale of stock options (and options on
stock indices) and (ii) initial or variation margin for futures
contracts. Margin deposits for the purchase and sale of futures
contracts and related options are not deemed to be a pledge.
DIVERSIFICATION OF INVESTMENTS
With respect to securities comprising 75% of the value of its total
assets, the Fund will not purchase securities issued by any one issuer
(other than cash, cash items, or securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities, and repurchase
agreements collateralized by such securities) if, as a result, more
than 5% of the value of its total assets would be invested in the
securities of that issuer, or if it would own more than 10% of the
outstanding voting securities of that issuer.
UNDERWRITING
The Fund will not underwrite any issue of securities, except as it may
be deemed to be an underwriter under the Securities Act of 1933 in
connection with the sale of securities in accordance with its
investment objective, policies, and limitations.
INVESTING IN REAL ESTATE
The Fund will not purchase or sell real estate, including limited
partnership interests, although it may invest in the securities of
companies whose business involves the purchase or sale of real estate
or in securities which are secured by real estate or interests in real
estate.
INVESTING IN COMMODITIES
The Fund will not purchase or sell commodities, commodity contracts,
or commodity futures contracts except to the extent that the Fund may
engage in transactions involving financial futures contracts or
options on financial futures contracts.
SELLING SHORT
The Fund will not sell securities short unless (1) it owns, or has a
right to acquire, an equal amount of such securities or (2) if it does
not own the securities, it has segregated an amount of its other
assets equal to the lesser of the market value of the securities sold
short or the amount required to acquire such securities. While in a
short position, the Fund will retain the securities, rights, or
segregated assets.
LENDING CASH OR SECURITIES
The Fund will not lend any of its assets, except portfolio securities
up to one-third of the value of its total assets. This shall not
prevent the Fund from purchasing or holding U.S. government
obligations, money market instruments, variable rate demand notes,
bonds, debentures, notes, certificates of indebtedness, or other debt
securities, entering into repurchase agreements, or engaging in other
transactions where permitted by the Fund's investment objective,
policies, and limitations or the Trust's Declaration of Trust.
CONCENTRATION OF INVESTMENTS
The Fund will not invest 25% or more of the value of its total assets
in any one industry (other than securities issued by the U.S.
government, its agencies or instrumentalities).
ISSUING SENIOR SECURITIES
The Fund will not issue senior securities except for delayed-delivery
and when-issued transactions and futures contracts, each of which
might be considered a senior security.
The above investment limitations are fundamental and cannot be changed
without shareholder approval. The following investment limitations may be
changed by the Trustees without shareholder approval. Shareholders will be
notified before any material change in these limitations becomes effective.
INVESTING IN NEW ISSUERS
The Fund will not invest more than 5% of the value of its total assets
in securities of issuers with records of less than three years of
continuous operations, including the operation of any predecessor.
INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES
OF THE TRUST
The Fund will not purchase or retain the securities of any issuer if
the officers and Trustees of the Trust or the Fund's investment
adviser owning individually more than 1/2 of 1% of the issuer's
securities together own more than 5% of the issuer's securities.
INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES
The Fund will limit its investment in other investment companies to no
more than 3% of the total outstanding voting stock of any investment
company, invest no more than 5% of its total assets in any one
investment company, and invest no more than 10% of its total assets in
investment companies in general. The Fund will purchase securities of
investment companies only in open-market transactions involving only
customary broker's commissions. However, these limitations are not
applicable if the securities are acquired in a merger, consolidation,
or acquisition of assets.
INVESTING IN RESTRICTED SECURITIES
The Fund will not invest more than 10% of the value of its total
assets in securities subject to restrictions on resale under the
Securities Act of 1933, except for commercial paper issued under
Section 4(2) of the Securities Act of 1933 and certain other
restricted securities which meet the criteria for liquidity as
established by the Trustees.
INVESTING IN ILLIQUID SECURITIES
The Fund will not invest more than 15% of the value of its net assets
in illiquid securities, including repurchase agreements providing for
settlement in more than seven days after notice, non-negotiable fixed
time deposits with maturities over seven days, over-the-counter
options, and certain restricted securities not determined by the
Trustees to be liquid.
INVESTING IN MINERALS
The Fund will not purchase interests in oil, gas, or other mineral
exploration or development programs or leases, although it may invest
in the securities of issuers which invest in or sponsor such programs.
PURCHASING SECURITIES TO EXERCISE CONTROL
The Fund will not purchase securities of a company for the purpose of
exercising control or management.
INVESTING IN WARRANTS
The Fund will not invest more than 5% of the value of its net assets
in warrants. No more than 2% of this 5% may be warrants which are not
listed on the New York Stock Exchange or the American Stock Exchange.
INVESTING IN PUT OPTIONS
The Fund will not purchase put options on securities unless the
securities are held in the Fund's portfolio and not more than 5% of
the value of the Fund's total assets would be invested in premiums on
put option positions.
WRITING COVERED CALL OPTIONS
The Fund will not write call options on securities unless the
securities are held in the Fund's portfolio or unless the Fund is
entitled to them in deliverable form without further payment or after
segregating cash in the amount of any further payment.
Except with respect to borrowing money, if a percentage limitation is
adhered to at the time of investment, a later increase or decrease in
percentage resulting from any change in value or net assets will not result
in a violation of such restriction.
For purposes of its policies and limitations, the Fund considers
certificates of deposit and demand and time deposits issued by a U.S.
branch of a domestic bank or savings and loan association having capital,
surplus, and undivided profits in excess of $100,000,000 at the time of
investment to be "cash items."
To comply with registration requirements in certain states, the Fund will
limit the aggregate value of the assets underlying covered call options or
put options written by the Fund to not more than 25% of its net assets.
BLANCHARD ASSET ALLOCATION FUND MANAGEMENT
Officers and Trustees are listed with their addresses, birthdates, present
positions with Blanchard Asset Allocation Fund, and principal occupations.
John F. Donahue@*
Federated Investors Tower
Pittsburgh, PA
Birthdate: July 28, 1924
Chairman and Trustee
Chairman and Trustee, Federated Investors, Federated Advisers, Federated
Management, and Federated Research; Chairman and Director, Federated
Research Corp. and Federated Global Research Corp.; Chairman, Passport
Research, Ltd.; Chief Executive Officer and Director or Trustee of the
Funds. Mr. Donahue is the father of J. Christopher Donahue, Executive Vice
President of the Trust .
Thomas G. Bigley
28th Floor, One Oxford Centre
Pittsburgh, PA
Birthdate: February 3, 1934
Trustee
Chairman of the Board, Children's Hospital of Pittsburgh; formerly, Senior
Partner, Ernst & Young LLP; Director, MED 3000 Group, Inc.; Trustee,
University of Pittsburgh; Director or Trustee of the Funds.
John T. Conroy, Jr.
Wood/IPC Commercial Department
John R. Wood and Associates, Inc., Realtors
3255 Tamiami Trail North
Naples, FL
Birthdate: June 23, 1937
Trustee
President, Investment Properties Corporation; Senior Vice-President, John
R. Wood and Associates, Inc., Realtors; Partner or Trustee in private real
estate ventures in Southwest Florida; formerly, President, Naples Property
Management, Inc. and Northgate Village Development Corporation; Director or
Trustee of the Funds.
William J. Copeland
One PNC Plaza - 23rd Floor
Pittsburgh, PA
Birthdate: July 4, 1918
Trustee
Director and Member of the Executive Committee, Michael Baker, Inc.;
formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp.;
Director, Ryan Homes, Inc.; Director or Trustee of the Funds.
James E. Dowd
571 Hayward Mill Road
Concord, MA
Birthdate: May 18, 1922
Trustee
Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director or
Trustee of the Funds.
Lawrence D. Ellis, M.D.*
3471 Fifth Avenue, Suite 1111
Pittsburgh, PA
Birthdate: October 11, 1932
Trustee
Professor of Medicine, University of Pittsburgh; Medical Director,
University of Pittsburgh Medical Center - Downtown; Member, Board of
Directors, University of Pittsburgh Medical Center; formerly, Hematologist,
Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Director
or Trustee of the Funds.
Edward L. Flaherty, Jr.@
Miller, Ament, Henny & Kochuba
205 Ross Street
Pittsburgh, PA
Birthdate: June 18, 1924
Trustee
Attorney of Counsel, Miller, Ament, Henny & Kochuba; Director, Eat'N Park
Restaurants, Inc.; formerly, Counsel, Horizon Financial, F.A., Western
Region; Director or Trustee of the Funds.
Edward C. Gonzales
Federated Investors Tower
Pittsburgh, PA
Birthdate: October 22, 1930
President, Treasurer and Trustee
Vice Chairman, Treasurer, and Trustee, Federated Investors; Vice President,
Federated Advisers, Federated Management, Federated Research, Federated
Research Corp., Federated Global Research Corp. and Passport Research,
Ltd.; Executive Vice President and Director, Federated Securities Corp.;
Trustee, Federated Shareholder Services Company; Trustee or Director of
some of the Funds; President, Executive Vice President and Treasurer of
some of the Funds.
Peter E. Madden
One Royal Palm Way
100 Royal Palm Way
Palm Beach, FL
Birthdate: March 16, 1942
Trustee
Consultant; Former State Representative, Commonwealth of Massachusetts;
formerly, President, State Street Bank and Trust Company and State Street
Boston Corporation; Director or Trustee of the Funds.
Gregor F. Meyer
Miller, Ament, Henny & Kochuba
205 Ross Street
Pittsburgh, PA
Birthdate: October 6, 1926
Trustee
Attorney, Member of Miller, Ament, Henny & Kochuba; Chairman, Meritcare,
Inc.; Director, Eat'N Park Restaurants, Inc.; Director or Trustee of the
Funds.
John E. Murray, Jr., J.D., S.J.D.
President, Duquesne University
Pittsburgh, PA
Birthdate: December 20, 1932
Trustee
President, Law Professor, Duquesne University; Consulting Partner, Mollica,
Murray and Hogue; Director or Trustee of the Funds.
Wesley W. Posvar
1202 Cathedral of Learning
University of Pittsburgh
Pittsburgh, PA
Birthdate: September 14, 1925
Trustee
Professor, International Politics; Management Consultant; Trustee, Carnegie
Endowment for International Peace, RAND Corporation, Online Computer
Library Center, Inc., National Defense University, U.S. Space Foundation
and Czech Management Center; President Emeritus, University of Pittsburgh;
Founding Chairman, National Advisory Council for Environmental Policy and
Technology, Federal Emergency Management Advisory Board and Czech
Management Center; Director or Trustee of the Funds.
Marjorie P. Smuts
4905 Bayard Street
Pittsburgh, PA
Birthdate: June 21, 1935
Trustee
Public relations/Marketing/Conference Planning, Manchester Craftsmen's
Guild; Restaurant Consultant, Frick Art & History Center; Conference
Coordinator, University of Pittsburgh Art History Department; Director or
Trustee of the Funds.
J. Christopher Donahue
Federated Investors Tower
Pittsburgh, PA
Birthdate: April 11, 1949
Executive Vice President
President and Trustee, Federated Investors, Federated Advisers, Federated
Management, and Federated Research; President and Director, Federated
Research Corp. and Federated Global Research Corp.; President, Passport
Research, Ltd.; Trustee, Federated Shareholder Services Company, and
Federated Shareholder Services; Director, Federated Services Company;
President or Executive Vice President of the Funds; Director or Trustee of
some of the Funds. Mr. Donahue is the son of John F. Donahue, Chairman and
Trustee of the Company.
John W. McGonigle
Federated Investors Tower
Pittsburgh, PA
Birthdate: October 26, 1938
Executive Vice President and Secretary
Executive Vice President, Secretary, and Trustee, Federated Investors;
Trustee, Federated Advisers, Federated Management, and Federated Research;
Director, Federated Research Corp. and Federated Global Research Corp.;
Trustee, Federated Shareholder Services Company; Director, Federated
Services Company; President and Trustee, Federated Shareholder Services;
Director, Federated Securities Corp.; Executive Vice President and
Secretary of the Funds; Treasurer of some of the Funds.
Richard B. Fisher
Federated Investors Tower
Pittsburgh, PA
Birthdate: May 17, 1923
Vice President
Executive Vice President and Trustee, Federated Investors; Chairman and
Director, Federated Securities Corp.; President or Vice President of some
of the Funds; Director or Trustee of some of the Funds.
Joseph S. Machi
Federated Investors Tower
Pittsburgh, PA
Birthdate: May 22, 1962
Vice President and Assistant Treasurer
Vice President and Assistant Treasurer of some of the Funds.
* This Trustee is deemed to be an "interested person" as defined in the
Investment Company Act of 1940.
@ Member of the Executive Committee. The Executive Committee of the Board
of Trustees handles the responsibilities of the Board between meetings of
the Board.
As used in the table above, "The Funds" and "Funds" mean the following
investment companies: 111 Corcoran Funds; Annuity Management Series; Arrow
Funds; Automated Government Money Trust; BayFunds; Blanchard Funds;
Blanchard Precious Metals Fund, Inc.; Cash Trust Series II; Cash Trust
Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash
Trust; Federated Adjustable Rate U.S. Government Fund, Inc.; Federated
American Leaders Fund, Inc.; Federated ARMs Fund; Federated Equity Funds;
Federated Equity Income Fund, Inc.; Federated Fund for U.S. Government
Securities, Inc.; Federated GNMA Trust; Federated Government Income
Securities, Inc.; Federated Government Trust; Federated High Income Bond
Fund, Inc.; Federated High Yield Trust; Federated Income Securities Trust;
Federated Income Trust; Federated Index Trust; Federated Institutional
Trust; Federated Insurance Series; Federated Investment Portfolios;
Federated Investment Trust; Federated Master Trust; Federated Municipal
Opportunities Fund, Inc.; Federated Municipal Securities Fund, Inc.;
Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated
Short-Term U.S. Government Trust; Federated Stock and Bond Fund, Inc.;
Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return
Series, Inc.; Federated U.S. Government Bond Fund; Federated U.S.
Government Securities Fund: 1-3 Years; Federated U.S. Government Securities
Fund: 2-5 Years; Federated U.S. Government Securities Fund: 5-10 Years;
Federated Utility Fund, Inc.; First Priority Funds; Fixed Income
Securities, Inc.; High Yield Cash Trust; Independence One Mutual Funds;
Intermediate Municipal Trust; International Series, Inc.; Investment Series
Funds, Inc.; Investment Series Trust; Liberty U.S. Government Money Market
Trust; Liquid Cash Trust; Managed Series Trust; Marshall Funds, Inc.; Money
Market Management, Inc.; Money Market Obligations Trust; Money Market
Trust; Municipal Securities Income Trust; Newpoint Funds; Peachtree Funds;
RIMCO Monument Funds; SouthTrust Vulcan Funds; Star Funds; Targeted
Duration Trust; Tax-Free Instruments Trust; The Biltmore Funds; The
Biltmore Municipal Funds; The Monitor Funds; The Planters Funds; The
Starburst Funds; The Starburst Funds II; The Virtus Funds; Tower Mutual
Funds; Trust for Financial Institutions; Trust for Government Cash
Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S.
Treasury Obligations; Vision Group of Funds, Inc.; andWorld Investment
Series, Inc.
FUND OWNERSHIP
Officers and Trustees own less than 1% of the Fund's outstanding shares.
As of September 30, 1996, no shareholder of record owned 5% or more of the
outstanding shares of the Fund.
TRUSTEES' COMPENSATION
AGGREGATE
NAME, COMPENSATION
POSITION WITH FROM TOTAL COMPENSATION PAID
TRUST TRUST* FROM FUND COMPLEX +
John F. Donahue $0 $0 for the Fund Complex
Thomas G. Bigley $1,200.64 $3,563.04 for the Fund Complex
John T. Conroy, Jr. $1,309.44 $3,888.27 for the Fund Complex
William J. Copeland $1,309.44 $3,888.27 for the Fund Complex
James E. Dowd $1,309.44 $3,888.27 for the Fund Complex
Lawrence D. Ellis, M.D. $1,200.64 $3,563.04 for the Fund Complex
Edward L. Flaherty, Jr. $1,309.44 $3,563.04 for the Fund Complex
Edward C. Gonzales $0 $0 for the Fund Complex
Peter E. Madden $1,200.64 $3,563.04 for the Fund Complex
Gregor F. Meyer $1,200.64 $3,563.04 for the Fund Complex
John E. Murray, Jr. $1,200.64 $3,563.04 for the Fund Complex
Wesley W. Posvar $1,200.64 $3,563.04 for the Fund Complex
Marjorie P. Smuts$1,200.64 $3,563.04 for the Fund Complex
*Information is furnished for the fiscal year ended September 30, 1996.
+The information is provided for the last calendar year.
Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund, Inc. and
The Virtus Funds.
TRUSTEE LIABILITY
The Trust's Declaration of Trust provides that the Trustees are not liable
for errors of judgment or mistakes of fact or law. However, they are not
protected against any liability to which they would otherwise be subject by
reason of willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of their office.
INVESTMENT ADVISORY SERVICES
MANAGER OF THE FUND
The Fund's manager is Virtus Capital Management, Inc. (`VCM'' or
`Adviser''). VCM is a wholly-owned subsidiary of Signet Banking
Corporation. Because of internal controls maintained by Signet Bank to
restrict the flow of non-public information, Fund investments are typically
made without any knowledge of Signet Bank's or it affiliates' lending
relationships with an issuer.
VCM shall not be liable to the Trust, the Fund, or any shareholder of the
Fund for any losses that may be sustained in the purchase, holding, or sale
of any security, or for anything done or omitted by it, except acts or
omissions involving willful misfeasance, bad faith, gross negligence, or
reckless disregard of the duties imposed upon it by its contract with the
Trust.
MANAGEMENT FEES
For its management services, VCM receives an annual management fee as
described in the prospectus. From December 31, 1995 (date of Fund's
inception) to the fiscal year ended September 30, 1996, the Fund's
investment management fee paid to VCM was $9,999, all of which was waived.
PORTFOLIO ADVISER OF THE FUND
The Fund's Portfolio Adviser is Mellon Capital Management Corporation. The
Portfolio Adviser shall not be liable to the Manager, the Trust, the Fund,
or any shareholder of the Fund for any losses that may be sustained in the
purchase, holding, lending, or sale of any security or for anything done or
omitted by it, except acts or omissions involving willful misfeasance, bad
faith, gross negligence, or reckless disregard of the duties imposed upon
it by its contract with the Manager.
SUB-ADVISORY FEES
For its sub-advisory services, the Portfolio Adviser receives an annual
sub-advisory fee as described in the Prospectus.
STATE EXPENSE LIMITATIONS
The Fund has undertaken to comply with the expense limitations
established by certain states for investment companies whose shares
are registered for sale in those states. If the Fund's normal
operating expenses (including the investment advisory fee, but not
including brokerage commissions, interest, taxes, and extraordinary
expenses) exceed 2-1/2% per year of the first $30 million of average
net assets, 2% per year of the next $70 million of average net assets,
and 1-1/2% per year of the remaining average net assets, VCM has
agreed to reimburse the Fund for its expenses over the limitation.
If the Fund's monthly projected operating expenses exceed this
limitation, the management fee paid will be reduced by the amount of
the excess, subject to an annual adjustment. If the expense limitation
is exceeded, the amount to be reimbursed by VCM will be limited, in
any single fiscal year, by the amount of the management fee.
This arrangement is not part of the management contract and may be
amended or rescinded in the future.
OTHER SERVICES
ADMINISTRATIVE SERVICES
Federated Administrative Services, a subsidiary of Federated Investors,
provides administrative personnel and services to the Fund for a fee as
described in the prospectus.
CUSTODIAN
Signet Trust Company, Richmond, Virginia, is custodian for the securities
and cash of the Fund. Under the Custodian Agreement, Signet Trust Company
holds the Fund's portfolio securities in safekeeping and keeps all
necessary records and documents relating to its duties. The custodian
receives an annual fee equal to .16% of the Fund's average daily net
assets.
TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
Federated Shareholder Services Company, Pittsburgh, Pennsylvania, is
transfer agent for the shares of the Fund and dividend disbursing agent for
the Fund.
INDEPENDENT ACCOUNTANTS
Deloitte & Touche LLP, 2500 One PPG Place, Pittsburgh, Pennsylvania 15222-
5401 has been appointed the independent public accountants for the Fund.
BROKERAGE TRANSACTIONS
The Adviser may select brokers and dealers who offer brokerage and research
services. These services may be furnished directly to the Fund or to the
Adviser and may include:
o advice as to the advisability of investing in securities;
o security analysis and reports;
o economic studies;
o industry studies;
o receipt of quotations for portfolio evaluations; and
o similar services.
The Adviser exercises reasonable business judgment in selecting brokers who
offer brokerage and research services to execute securities transactions.
They determine in good faith that commissions charged by such persons are
reasonable in relationship to the value of the brokerage and research
services provided.
Research services provided by brokers and dealers may be used by the
Adviser in advising the Fund and other accounts. To the extent that receipt
of these services may supplant services for which the Adviser might
otherwise have paid, it would tend to reduce their expenses.
From December 31, 1995 (date of fund's inception) to fiscal year ended
September 30, 1996, the Fund paid no brokerage commissions.
PURCHASING SHARES
Except under certain circumstances described in the prospectus, shares are
sold at their net asset value on days the New York Stock Exchange and the
Federal Reserve Wire System are open for business. The minimum initial
investment in the Fund by an investor is $3,000, except for qualified
pension plans (IRAs, Keoghs, etc.), which have a minimum initial investment
of $2,000.
DISTRIBUTION PLAN
With respect to the Fund, the Trust has adopted a Plan pursuant to Rule
12b-1 which was promulgated by the Securities and Exchange Commission
pursuant to the Investment Company Act of 1940 (the `Plan''). The Plan
provides for payment of fees to Federated Securities Corp. to finance any
activity which is principally intended to result in the sale of the Fund's
shares subject to the Plan. Such activities may include the advertising and
marketing of shares of the Fund; preparing, printing, and distributing
prospectuses and sales literature to prospective shareholders, brokers, or
administrators; and implementing and operating the Plan. Pursuant to the
Plan, Federated Securities Corp. may pay fees to brokers and others for
such services.
The Trustees expect that the adoption of the Plan will result in the sale
of a sufficient number of shares so as to allow the Fund to achieve
economic viability. It is also anticipated that an increase in the size of
the Fund will facilitate more efficient portfolio management and assist the
Fund in seeking to achieve its investment objectives.
From June 6, 1996 (the fund's date of initial public investment) to fiscal
year ended September 30, 1996, the Fund accrued no distribution service
fees. The Fund has no present intention of paying or accruing 12b-1 fees
during the fiscal year ending September 30, 1997.
ADMINISTRATIVE ARRANGEMENTS
The administrative services include, but are not limited to, providing
office space, equipment, telephone facilities, and various personnel,
including clerical, supervisory, and computer, as is necessary or
beneficial to establish and maintain shareholders' accounts and records,
process purchase and redemption transactions, process automatic investments
of client account cash balances, answer routine client inquiries regarding
the Fund, assist clients in changing dividend options, account
designations, and addresses, and providing such other services as the Fund
may reasonably request.
CONVERSION TO FEDERAL FUNDS
It is the Fund's policy to be as fully invested as possible so that maximum
interest may be earned. To this end, all payments from shareholders must be
in federal funds or be converted into federal funds.
DETERMINING NET ASSET VALUE
The net asset value generally changes each day. The days on which the net
asset value is calculated by the Fund are described in the prospectus.
DETERMINING MARKET VALUE OF SECURITIES
Market or fair values of the Fund's securities are determined as follows:
o for equity securities, according to the last sale price on a national
securities exchange, if applicable;
o in the absence of recorded sales for listed equity securities, according
to the mean between the last closing bid and asked prices;
o for unlisted equity securities, latest bid prices;
o for bonds and other fixed income securities, as determined by an
independent pricing service;
o for short-term obligations, according to the mean between bid and asked
prices as furnished by an independent pricing service, or for short-term
obligations with remaining maturities of 60 days or less at the time of
purchase, at amortized cost; or
o for all other securities, at fair value as determined in good faith by
the Trustees.
Prices provided by independent pricing services may be determined without
relying exclusively on quoted prices and may reflect: institutional trading
in similar groups of securities, yield, quality, coupon rate, maturity,
type of issue, trading characteristics, and other market data.
The Fund will value options at their market values established by the
exchanges at the close of option trading on such exchanges unless the
Trustees determine in good faith that another method of valuing option
positions is necessary.
Over-the-counter put options will be valued at the mean between the bid and
the asked prices. Covered call options will be valued at the last sale
price on the national exchange on which such option is traded. Unlisted
call options will be valued at the latest bid price as provided by brokers.
TRADING IN FOREIGN SECURITIES
Trading in foreign securities may be completed at times which vary from the
closing of the New York Stock Exchange. In computing the net asset value,
the Fund values foreign securities at the latest closing price on the
exchange on which they are traded immediately prior to the closing of the
New York Stock Exchange. Certain foreign currency exchange rates may also
be determined at the latest rate prior to me closing of the New York Stock
Exchange. Foreign securities quoted in foreign currencies are translated
into U.S. dollars at current rates. Occasionally, events that affect these
values and exchange rates may occur between the times at which they are
portfolio securities, these securities may be valued at their fair value as
determined in good faith by the Trustees, although the actual calculation
may be done by others.
EXCHANGE PRIVILEGE
REQUIREMENTS FOR EXCHANGE
Shareholders using the exchange privilege must exchange shares having a net
asset value of at least $1,000. Before the exchange, the shareholder must
receive a prospectus of the fund for which the exchange is being made.
This privilege is available to shareholders resident in any state in which
the fund shares being acquired may be sold. Upon receipt of proper
instructions and required supporting documents, shares submitted for
exchange are redeemed and the proceeds invested in shares of the other
fund. Further information on the exchange privilege and prospectuses may be
obtained by calling 1-800-829-3863.
MAKING AN EXCHANGE
Instructions for exchanges may be given in writing. Written instructions
may require a signature guarantee.
REDEEMING SHARES
The Fund redeems shares at the next computed net asset value after the
Funds' transfer agent receives the redemption request. Redemptions will be
made on days on which the Fund computes its net asset value. Redemption
requests cannot be executed on days on which the New York Stock Exchange is
closed or on federal holidays restricting wire transfers. Redemption
procedures are explained in the prospectus under `How to Redeem.''
REDEMPTION IN KIND
Although the Trust intends to redeem shares in cash, it reserves the right
under certain circumstances to pay the redemption price in whole or in part
by a distribution of securities from the respective fund's portfolio. To
satisfy registration requirements in a particular state, redemption in kind
will be made in readily marketable securities to the extent that such
securities are available. If this state's policy changes, the Fund reserves
the right to redeem in kind by delivering those securities it deems
appropriate.
Redemption in kind will be made in conformity with applicable Securities
and Exchange Commission rules, taking such securities at the same value
employed in determining net asset value and selecting the securities in a
manner the Trustees determine to be fair and equitable.
The Trust has elected to be governed by Rule 18f-1 under the Investment
Company Act of 1940 under which the Trust is obligated to redeem shares for
any one shareholder in cash only up to the lesser of $250,000 or 1% of the
Fund's net asset value during any 90-day period.
Redemption in kind is not as liquid as a cash redemption. If redemption is
made in kind, shareholders receiving their securities and selling them
before their maturity could receive less than the redemption value of their
securities and could incur certain transaction costs.
MASSACHUSETTS PARTNERSHIP LAW
Under certain circumstances, shareholders may be held personally liable as
partners under Massachusetts law for acts or obligations of the Trust. To
protect shareholders, the Trust has filed legal documents with
Massachusetts that expressly disclaim the liability of shareholders for
such acts or obligations of the Trust. These documents require notice of
this disclaimer to be given in each agreement, obligation, or instrument
the Trust or its Trustees enter into or sign.
In the unlikely event a shareholder is held personally liable for
obligations of the Trust, the Trust is required to use its property to
protect or compensate the shareholder. On request, the Trust will defend
any claim made and pay any judgment against a shareholder for any act or
obligation of the Trust. Therefore, financial loss resulting from liability
as a shareholder will occur only if the Trust cannot meet its obligations
to indemnify shareholders and pay judgments against them from its assets.
TAX STATUS
THE FUND'S TAX STATUS
The Fund will pay no federal income tax because it expects to meet the
requirements of Subchapter M of the Internal Revenue Code applicable to
regulated investment companies and to receive the special tax treatment
afforded to such companies. To qualify for this treatment, the Fund must,
among other requirements:
o derive at least 90% of its gross income from dividends, interest, and
gains from the sale of securities;
o derive less than 30% of its gross income from the sale of securities
held less than three months;
o invest in securities within certain statutory limits; and
o distribute to its shareholders at least 90% of its net income earned
during the year.
FOREIGN TAXES
Investment income on certain foreign securities in which the Fund may
invest may be subject to foreign withholding or other taxes that could
reduce the return on these securities. Tax treaties between the United
States and foreign countries, however, may reduce or eliminate the amount
of foreign taxes to which the Fund would be subject.
SHAREHOLDERS' TAX STATUS
Shareholders are subject to federal income tax on dividends received as
cash or additional shares. The dividends received deduction for
corporations will apply to ordinary income distributions to the extent the
distribution represents amounts that would qualify for the dividends
received deduction to the Fund if the Fund were a regular corporation and
to the extent designated by the Fund as so qualifying. These dividends and
any short-term capital gains are taxable as ordinary income.
CAPITAL GAINS
Shareholders will pay federal tax at capital gains rates on long-term
capital gains distributed to them regardless of how long they have held
Fund shares.
TOTAL RETURN
Cumulative total return reflects the Fund's total performance over a
specific period of time. This total return assumes and is reduced by the
payment of the maximum sales load. Any applicable redemption fee is
deducted from the ending value of the investment based on the lesser of the
original purchase price or the net asset value of shares redeemed.
The Fund's cumulative total return from June 6, 1996 (the fund's date of
inception) to September 30, 1996, was 5.10%.
YIELD
The yield for the Fund is determined by dividing the net investment income
per share (as defined by the Securities and Exchange Commission) earned by
the Fund over a thirty-day period by the maximum offering price per share
of the Fund on the last day of the period. This value is then annualized
using semi-annual compounding. This means that the amount of income
generated during the thirty-day period is assumed to be generated each
month over a twelve-month period and is reinvested every six months. The
yield does not necessarily reflect income actually earned by the Fund
because of certain adjustments required by the Securities and Exchange
Commission and, therefore, may not correlate to the dividends or other
distributions paid to shareholders.
To the extent that financial institutions and broker/dealers charge fees in
connection with services provided in conjunction with an investment in the
Fund, the performance will be reduced for those shareholders paying those
fees.
The Fund's yield for the thirty-day period ended September 30, 1996, was
5.20%.
PERFORMANCE COMPARISONS
The Fund's performance depends upon such variables as:
o portfolio quality;
o average portfolio maturity;
o type of instruments in which the portfolio is invested;
o changes in interest rates and market value of portfolio securities;
o changes in Fund expenses; and
o various other factors.
The Fund's performance fluctuates on a daily basis largely because net
earnings and maximum offering price per share fluctuate daily. Both net
earnings and offering price per share are factors in the computation of
yield and total return.
Investors may use financial publications and/or indices to obtain a more
complete view of the Fund's performance. When comparing performance,
investors should consider all relevant factors such as the composition of
any index used, prevailing market conditions, portfolio compositions of
other funds, and methods used to value portfolio securities and compute
offering price. The financial publications and/or indices which the Fund
uses in advertising may include:
o LIPPER ANALYTICAL SERVICES, INC., ranks funds in various fund categories
by making comparative calculations using total return. Total return
assumes the reinvestment of all income dividends and capital gains
distributions, if any. From time to time, the Fund will quote its Lipper
ranking in the ``growth'' category in advertising and sales literature.
o STANDARD & POOR'S DAILY STOCK PRICE INDEX 500 COMMON STOCKS, a composite
index of common stocks in industry, transportation, and financial and
public utility companies, can be used to compare to the total returns of
funds whose portfolios are invested primarily in common stocks. In
addition, the Standard & Poor's Index assumes reinvestment of all
dividends paid by stocks listed on its index. Taxes due on any of these
distributions are not included, nor are brokerage or other fees
calculated in Standard & Poor's figures.
Advertisements and other sales literature for the Fund may quote total
returns which are calculated on non-standardized base periods. These total
returns also represent the historic change in the value of an investment in
the Fund based on monthly reinvestment of dividends over a specified period
of time.
Advertisements may quote performance information which does not reflect the
effect of the sales charge.
APPENDIX
STANDARD AND POOR'S RATINGS GROUP CORPORATE BOND RATINGS
AAA-Debt rated `AAA'' has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA-Debt rated `AA'' has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A-Debt rated `A'' has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in higher
rated categories.
BBB-Debt rated `BBB'' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher rated
categories.
BB, B-Debt rated BB or B, is regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates a low degree of
speculation.
NR-Indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that Standard &
Poor's does not rate a particular type of obligation as a matter of policy.
PLUS (+) OR MINUS(-):-The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
MOODY'S INVESTORS SERVICE, INC., CORPORATE BOND RATINGS
AAA-Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to
as `gilt edged.'' Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such
issues.
AA-Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group, they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there may
be other elements present which make the long-term risks appear somewhat
larger than in AAA securities.
A-Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
BAA-Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present, but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and, in fact, have speculative characteristics
as well.
BA-Bonds which are Ba are judged to have speculative elements; their future
cannot be considered as well-assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B-Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
NR-Not rated by Moody's.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from Aa through B in its corporate or municipal bond rating
system. The modifier 1 indicates that the security ranks in the higher end
of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks in the lower end
of its generic rating category.
FITCH INVESTORS SERVICE, INC., LONG-TERM DEBT RATINGS
AAA-Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA-Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated `AAA.'' Because bonds rated in
the `AAA'' and ``AA'' categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is
generally rated `F-1+.''
A-Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered strong,
but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB-Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds and, therefore, impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
BB-Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
However, business and financial alternatives can be identified which could
assist the obligor in satisfying its debt service requirements.
B-Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued
timely payment of principal and interest reflects the obligor's limited
margin of safety and the need for reasonable business and economic activity
throughout the life of the issue.
NR-NR indicates that Fitch does not rate the specific issue.
PLUS (+) OR MINUS (-): Plus and minus signs are used with a rating symbol
to indicate the relative position of a credit within the rating category.
Plus and minus signs, however, are not used in the AAA category.
STANDARD AND POOR'S RATINGS GROUP COMMERCIAL PAPER RATINGS
A-1-This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus sign (+) designation.
A-2-Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
MOODY'S INVESTORS SERVICE, INC., COMMERCIAL PAPER RATINGS
PRIME-1-Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well established industries;
high rates of return on funds employed; conservative capitalization
structures with moderate reliance on debt and ample asset protection; broad
margins in earning coverage of fixed financial charges and high internal
cash generation; well-established access to a range of financial markets
and assured sources of alternative liquidity.
PRIME-2-Issuers rated Prime-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but
to a lesser degree. Earnings trends and coverage ratios, while sound, will
be more subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
FITCH INVESTORS SERVICE, INC., SHORT-TERM RATINGS
F-1+-EXCEPTIONALLY STRONG CREDIT QUALITY. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1-VERY STRONG CREDIT QUALITY. Issues assigned to this rating reflect an
assurance of timely payment only slightly less in degree than issues rated
F-1+.
F-2-GOOD CREDIT QUALITY. Issues carrying this rating have a satisfactory
degree of assurance for timely payment but the margin of safety is not as
the F-1+ and F-1 ratings.
Dear Shareholders,
Set forth below is the Manager's Discussion and Review for the Blanchard
Asset Allocation Fund for the fiscal year ended September 30, 1996.
- --------------------------------------------------------------------------------
Value of a $10,000 Investment in the
Blanchard Asset Allocation Fund
inception 6/6/96 through 9/30/96 as compared to the
Standard & Poor's 500 for the same period
<TABLE>
<CAPTION>
Avg. Annual Total Return for the
period ended September 30, 1996*
<S> <C>
Start of Performance
(6/6/96) (cumulative) 5.10%
</TABLE>
[CHART APPEARS HERE]
*The average annual returns quoted reflect reinvestment of distributions. Total
return includes changes in principal value. Past performance is no guarantee of
future results.
+Source: The Standard & Poor's 500 is an unmanaged composite index of the U.S.
Stock Market performance. Investment cannot be made in an index.
This chart is for comparative purposes only and is not intended to reflect on
future performance of the Blanchard Asset Allocation Fund.
- --------------------------------------------------------------------------------
The Blanchard Asset Allocation Fund had a total return (price change plus
income) of 2.84% for the quarter ended September 30, 1996. By comparison, the
S&P 500 Index rose 3.06% and the Lehman Brothers Long-Term Treasury Index
returned 1.52% for the same period. From the Fund's inception through September
30, 1996, the fund's return was 5.10% whereas the S&P 500 had a total return of
2.80% and long maturity U.S. Treasuries returned 2.40%.
The third quarter of 1996 was characterized by changing sentiment regarding
the pace of economic growth and the need for Federal Reserve monetary policy
intervention.
The quarter started with economic data pointing to a job market that had
heated up considerably, forecasting a rise in inflation. As the quarter
progressed, employmentreports alternately indicated that the labor market
conditions had softened and then strengthened and then softened again. The
markets followed the characteristics of the economic cycle and behaved in
similar fashion. Two Federal Reserve meetings came and went with no change in
interest rates despite much speculation and trepidation. The equity market was
able to recover from an initial downdraft and post a respectable gain due to
the continued solid earnings growth of corporate America. Bond yields
fluctuated considerably in response to the shifting tone of the incoming
statistics but remained within a 1/2% range during the quarter.
During the third quarter of 1996, the Blanchard Asset Allocation Fund
continued to invest aggressively in both equities and bonds. In mid-July the
asset allocation began to identify equities as the favored asset class as the
expected return on equities rose. This was due to the combined effects of
falling stock prices and moderate increases in expected corporate earnings. As
a result, the Fund increased its exposure to equities during the month of July.
Following that move, stocks rallied substantially through the end of September.
Looking forward, the Fund is fully invested with a bullish outlook for both
equities and bonds.
Thank you for your continued patronage. We look forward to serving you in the
months and years ahead.
Sincerely,
/s/ Thomas B. Hazuka
Thomas B. Hazuka, Ph.D.
Chief Investment Officer
Mellon Capital Management Corporation
Portfolio Manager of the Blanchard Asset
Allocation Fund
This report must be preceded or accompanied by the fund's prospectus dated
November 30, 1996, and, together with financial statements contained therein,
constitutes the fund's annual report.
Cusip 093212504
G01386-14 (11/96)
APPENDIX
BLANCHARD ASSET ALLOCATION FUND.
A. The graphic presentation here displayed consists of a legend below the
graph indicating the components of the corresponding chart. The line graph
chart is a visual representation of the narrative text around it, which
shows that an initial investment of $10,000 in Blanchard Asset Allocation
Fund on June 6, 1996, would have grown to $10,510 by September 30, 1996, as
compared to the Standard & Poor's 500 Index, which would have grown to
$10,348. The "x" axis reflects the cost of investment, the "y" axis
reflects computation periods from June 1996 to September 1996, and the
right margin reflects a total investment range from $0 to $13,000. The
chart further indicates the ending market value attributable to principal,
as well as the ending market value attributable to capital gains and
reinvested dividends.
