BLANCHARD
GROUP OF FUNDS
BLANCHARD
GROWTH & INCOME FUND
Prospectus
February 28, 1997
B L A N C H A R D
THE BLANCHARD GROUP OF FUNDS
BLANCHARD GROWTH & INCOME FUND
Blanchard Growth & Income Fund (the "Fund") seeks to provide long-term capital
appreciation and dividend income. The Fund, unlike many other investment
companies which directly acquire and manage their own portfolios of
securities, seeks its investment objective by investing all of its investable
assets in Growth and Income Portfolio (the "Portfolio"), an open-end
management investment company with investment objectives identical to those of
the Fund. Investors should carefully consider this investment approach. For
additional information regarding this investment structure, see "Unique
Characteristics of the Fund and Portfolio Structure", on page 20.
Blanchard Funds (the "Trust"), which currently consists of seven investment
portfolios, and Blanchard Precious Metals Fund, Inc., which currently consists
of one investment portfolio (each portfolio individually referred to as a
"Fund" and collectively as the "Funds") are open-end management investment
companies, which offer separate investment alternatives for different investor
needs. Virtus Capital Management, Inc. ("VCM") is the Funds' overall
investment manager. There is no guarantee that the Fund will achieve their
investment objectives.
Please read this Prospectus carefully and retain it for future reference. The
Fund's Statement of Additional Information, dated February 28, 1997, has been
filed with the Securities and Exchange Commission (the "SEC") and is
incorporated herein by reference. You may request a copy of the Statement of
Additional Information or a paper copy of this prospectus, if you have
received your prospectus electronically, by calling the Fund at 1-800-829-
3863.
INVESTMENT IN THE FUND IS SUBJECT TO RISK INCLUDING POSSIBLE LOSS OF PRINCIPAL
AND WILL FLUCTUATE IN VALUE. SHARES OF THE FUND ARE NOT BANK DEPOSITS OR
OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, SIGNET BANK OR THE CHASE
MANHATTAN BANK OR ANY OF THEIR RESPECTIVE AFFILIATES AND ARE NOT INSURED BY,
OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT, THE FEDERAL
DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
Prospectus dated February 28, 1997
TABLE OF CONTENTS
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HIGHLIGHTS 1 HOW TO INVEST 11
- ------------------------------------- -------------------------------------
The Fund's Objectives 1 Purchases by Mail 11
Fund Management 1 General Information 12
How to Invest and Redeem 1 INVESTOR SERVICES 13
Investor Services and Privileges 1
Dividends 2 -------------------------------------
Additional Information on Automatic Withdrawal Plan 13
Investment Policies,Techniques and Retirement Plans 13
Risk Factors 2 Exchange Privileges 13
SUMMARY OF FUND EXPENSES 3 HOW TO REDEEM 14
- ------------------------------------- -------------------------------------
General Information 15
FINANCIAL HIGHLIGHTS 4
- ------------------------------------- DISTRIBUTION OF SHARES OF THE FUND 15
-------------------------------------
FUND OBJECTIVE 5
- ------------------------------------- TAX MATTERS 17
-------------------------------------
INVESTMENT POLICIES 5 PERFORMANCE COMPUTATION
- ------------------------------------- INFORMATION 18
Investment Approach 5
Fund Structure 5 -------------------------------------
Other Investment Policies 5
Limiting Investment Risks 8 ADDITIONAL INFORMATION ABOUT THE
Risk Factors 8 FUND AND THE PORTFOLIO 19
-------------------------------------
MANAGEMENT OF THE FUND 9
The Fund 19
- ------------------------------------- Investor Meetings and Voting 20
The Portfolio 20
PORTFOLIO ADVISORY SERVICES 10 Unique Characteristics of the Fund
- ------------------------------------- and Portfolio Structure 20
The Portfolio Adviser 10
OTHER INFORMATION 21
EFFECTIVE OF BANKING LAWS 10 -------------------------------------
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HIGHLIGHTS
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THE FUND'S OBJECTIVES
The Fund, which is an open-end management investment company, invests in the
Portfolio which, in turn, invests in securities in accordance with investment
objectives, policies and restrictions identical to those of the Fund. The
Portfolio seeks to provide long-term capital appreciation and dividend income.
See "Fund Objectives" and "Investment Policies" (page 5).
FUND MANAGEMENT
VCM provides management services necessary for the Fund's operations. As of
January 31, 1997, VCM had more than $163.6 million in assets under management.
VCM receives monthly compensation from the Fund based on the amount of assets
under management. VCM evaluates the performance of the Fund's Portfolio
Adviser. The Portfolio Adviser is responsible for the selection of the
Portfolio's investments. See "Management of the Fund" (page 9).
The Chase Manhattan Bank, (the "Portfolio Adviser" or "Chase"), a wholly owned
subsidiary of The Chase Manhattan Corporation, a bank holding company, is a
commercial bank offering a wide range of banking and investment services to
customers throughout the United States and around the world. Its headquarters
is at 270 Park Avenue, New York, New York 10017. The Portfolio Adviser,
including its predecessor organizations, has over 100 years of money
management experience. See "Portfolio Advisory Services. The Portfolio
Adviser" (page 10).
HOW TO INVEST AND REDEEM
You may purchase shares of the Fund directly from Federated Securities Corp.
(the "Distributor") which is the Fund's principal distributor. You may also
purchase shares from broker-dealers who have entered into a dealer agreement
with the Distributor.
The minimum amount required to open an account in the Fund is $3,000 ($2,000
for qualified retirement plans, such as IRAs and Keoghs). The minimum
subsequent investment requirement is $200. The Fund has also adopted a
Distribution Plan which permits the reimbursement of distribution expenses by
the Fund in an amount not to exceed.25% of the average daily net assets of the
Fund on an annual basis. See "How to Invest" and "Distribution of Shares of
the Fund" (pages 11 and 15).
You may redeem your shares on any business day at the next determined net
asset value calculated after Federated Shareholder Services Company (the
"Transfer Agent") has received the redemption request in proper form. See "How
to Redeem" (page 14).
The Fund reserves the right to cease offering shares to new shareholders if
the Portfolio Adviser believes that the Fund's size may hamper its
effectiveness in managing the Portfolio. In this event, no new accounts will
be accepted until further review. Shareholders who have established accounts
prior to the closure date will be allowed to add to their investments.
INVESTOR SERVICES AND PRIVILEGES
The Fund offers certain investor services and privileges that may be suited to
your particular investment needs, including free Telephone Exchange
Privileges, Investment and Withdrawal Plans and various Retirement Plans. See
"Investor Services" (page 13).
DIVIDENDS
The Fund intends to declare dividends, if any, at least semi-annually from net
investment income. Dividends, if any, are automatically reinvested in
additional Fund shares at net asset value on the payment date and are
reflected in the statements we send you, unless you elect to receive them in
cash, in which case we will send you a check. See "Tax Matters" (page 17).
ADDITIONAL INFORMATION ON INVESTMENT POLICIES, TECHNIQUES AND RISK FACTORS.
The Fund is a non-diversified fund and may be invested in a limited number of
issues; thus, there may be greater risk in an investment in the Fund than in a
diversified investment company. Moreover, there are potential risks associated
with certain of the Fund's investments and additional risk considerations that
may be associated with certain techniques and strategies employed by the Fund,
including those relating to investments in foreign securities and futures and
options transactions.
SUMMARY OF FUND EXPENSES
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For a better understanding of the expenses you will incur directly or
indirectly when investing in the Fund, a summary for the Fund is set forth
below. The summary combines the Fund's operational expenses with the pro rata
portion of its Portfolio's operational expenses. See "Management of the Fund."
The trustees believe that the aggregate per share expenses of the Fund and the
Portfolio will be approximately equal to the expenses the Fund would incur if
its assets were invested directly in the type of securities held by the
Portfolio.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C> <C>
Maximum Sales Charge Imposed on Purchases (as a percentage of of-
fering price)..................................................... None
Maximum Sales Charge Imposed on Reinvested Dividends (as a percent-
age 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 applica-
ble).............................................................. None
Exchange Fee....................................................... None
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
(As a percentage of average net assets)
<S> <C> <C>
Management Fee (See "Management of the Fund") (after waiver) (1)... 0.40%
12b-1 Fees (after waiver) (2)...................................... 0.00%
Other Expenses (after waiver) (3).................................. 1.35%
Total Fund Operating Expenses (after waiver) (4)................. 1.75%
</TABLE>
(1) The management fee has been reduced to reflect the voluntary waiver by the
Manager. The Manager can terminate this voluntary waiver at any time at
its sole discretion. The maximum management fee is 1.10%.
(2) As a result of 12b-1 Fees of 0.25% per annum of the Fund's average daily
net assets, a shareholder who has been in the Fund for 14.5 years may pay
more than the economic equivalent of the maximum front-end sales charges
permitted by the rules of the National Association of Securities Dealers,
Inc. The 12b-1 fees have been reduced to reflect the voluntary waiver by
the Distributor. The Distributor can terminate this voluntary waiver at
any time at its sole discretion. Effective November 14, 1996, the
maximum 12b-1 fee was reduced from 0.50% to 0.25%.
(3) Other Expenses would have been 1.48% absent the voluntary waiver by the
Administrator. The Administrator can terminate this voluntary waiver at
any time at its sole discretion.
(4) Total Fund Operating Expenses would have been 3.08% absent the voluntary
waivers described above in notes 1, 2 and 3.
Annual Operating Expenses were 1.90% for the fiscal year ended October 31,
1996. The Annual Operating Expenses in the table above are estimated based on
expenses expected to be incurred for the fiscal year ending October 31, 1997.
<TABLE>
<CAPTION>
EXAMPLE 1 year 3 years 5 years 10 years
- ------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a
$1,000 investment, assuming (1) 5% annual re-
turn and (2) redemption at the end of each time
period......................................... $18 $55 $95 $206
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF FUTURE EXPENSES,
AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. IN ADDITION, THE
5% ANNUAL RETURN SHOULD NOT BE CONSIDERED REPRESENTATIVE OF PAST OR FUTURE
RETURNS, AND ACTUAL RETURNS MAY BE GREATER OR LESS THAN THE ILLUSTRATION
ABOVE.
BLANCHARD GROWTH & INCOME FUND
FINANCIAL HIGHLIGHTS
- -------------------------------------------------------------------------------
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
The following table has been audited by Deloitte & Touche LLP, the Fund's
independent auditors. Their report, dated December 20, 1996, on the Fund's
financial statements for the year then ended October 31, 1996, and on the
following table for the year ended October 31, 1996, is included in the Annual
Report, which is incorporated by reference. The financial highlights for the
year ended October 31, 1995 were audited by other auditors, whose report
thereon dated December 22, 1995, expressed an unqualified opinion. This table
should be read in conjunction with the Fund's financial statements and notes
thereto, which may be obtained from the Fund.
<TABLE>
<CAPTION>
YEAR ENDED
OCTOBER 31,
---------------
1996 1995
- ---------------------------------------------------- ------- ------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 8.11 $ 7.00
- ----------------------------------------------------
INCOME FROM INVESTMENT OPERATIONS
- ----------------------------------------------------
Net investment income/(loss) 0.06 (0.03)
- ----------------------------------------------------
Net realized and unrealized gain on investments 1.44 1.15
- ---------------------------------------------------- ------- ------
Total from investment operations 1.50 1.12
- ---------------------------------------------------- ------- ------
LESS DISTRIBUTIONS
- ----------------------------------------------------
Distributions in excess of net investment income -- (0.01)
- ----------------------------------------------------
Distributions from net realized gain on investments (0.16) --
- ---------------------------------------------------- ------- ------
Total distributions (0.16) (0.01)
- ---------------------------------------------------- ------- ------
NET ASSET VALUE, END OF PERIOD $ 9.45 $ 8.11
- ---------------------------------------------------- ------- ------
TOTAL RETURN (A) 18.77% 16.03%
- ----------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
- ----------------------------------------------------
Expenses (b) 1.90% 3.81%
- ----------------------------------------------------
Net investment income (loss) 0.83% (0.64%)
- ----------------------------------------------------
Expense waiver/reimbursement (c) 1.71% 0.77%
- ----------------------------------------------------
SUPPLEMENTAL DATA
- ----------------------------------------------------
Net assets, end of period (000 omitted) $15,549 $6,443
- ----------------------------------------------------
</TABLE>
(a) Based on net asset value.
(b) Reflects the Fund's proportionate share of the respective Portfolio's
expenses and the Fund's fee waivers and expense reimbursements by the
Funds' Manager, Distributor and Administrator.
(c) This voluntary expense decrease is reflected in both the expense and net
investment income ratios shown above.
Further information about the Fund's performance is contained in the Fund's
Annual Report, dated October 31, 1996, which can be obtained free of charge.
FUND OBJECTIVE
- -------------------------------------------------------------------------------
The Blanchard Growth & Income Fund seeks to provide long-term capital
appreciation and dividend income. The Fund is not intended to be a complete
investment program, and there is no assurance it will achieve its objectives.
INVESTMENT POLICIES
- -------------------------------------------------------------------------------
INVESTMENT APPROACH
The Fund seeks to achieve its objective by investing all of its investable
assets in the Portfolio. The Portfolio invests in common stocks of issuers
with a broad range of market capitalizations. Under normal market conditions,
the Portfolio will invest at least 80% of its total assets in common stocks.
In addition, the Portfolio may invest up to 20% of its total assets in
convertible securities.
The Portfolio's advisers intend to utilize both quantitative and fundamental
research to identify undervalued stocks with a catalyst for positive change.
The advisers believe that the market risk involved in seeking capital
appreciation will be moderated to an extent by the anticipated dividend
returns on the stocks in which the Portfolio invests.
The Portfolio is classified as a "non-diversified" fund under federal
securities law. The Portfolio's assets may be more concentrated in the
securities of any single issuer or group of issuers than if the Portfolio were
diversified.
The Portfolio may invest any portion of its assets not invested as described
above in high quality money market instruments and repurchase agreements. For
temporary defensive purposes, the Portfolio may invest without limitation in
these instruments as well as investment grade debt securities. To the extent
that the Portfolio departs from its investment policies during temporary
defensive periods, the Fund's investment objective may not be achieved.
FUND STRUCTURE
The Portfolio has an objective identical to that of the Fund. The Fund may
withdraw its investment from the Portfolio at any time if the Trustees
determine that it is in the best interest of the Fund to do so. Upon any such
withdrawal, the Trustees would consider what action might be taken, including
investing all of the Fund's investable assets in another pooled investment
entity having substantially the same objective and policies as the Fund or
retaining an investment adviser to manage the Fund's assets directly.
OTHER INVESTMENT PRACTICES
The Portfolio may also engage in the following investment practices, when
consistent with the Portfolio's overall objective and policies. These
practices, and certain associated risks, are more fully described in the
Statement of Additional Information.
FOREIGN SECURITIES. The Portfolio may invest up to 20% of its total assets in
foreign securities, including Depositary Receipts. Since foreign securities
are normally denominated and traded in
foreign currencies, the values of the Portfolio's foreign investments may be
affected favorably or unfavorably by currency exchange rates and exchange
control regulations. There may be less information publicly available about
foreign companies than U.S. companies, and they are not generally subject to
accounting, auditing and financial reporting standards and practices
comparable to those in the U.S. The securities of foreign companies may be
less liquid and more volatile than the securities of comparable U.S.
companies. Foreign settlement procedures and trade regulations may involve
certain risks (such as delay in payment or delivery of securities or in the
recovery of the Portfolio's assets held abroad) and expenses. It is possible
that nationalization or expropriation of assets, imposition of currency
exchange controls, confiscatory taxation, political or financial instability
and diplomatic developments could affect the value of the Portfolio's
investments in certain foreign countries. Foreign laws may restrict the
ability to invest in certain countries or issuers and special tax
considerations will apply to foreign securities. The risks can increase if the
Portfolio invests in securities of issuers in emerging markets.
The Portfolio may invest its assets in securities of foreign issuers in the
form of American Depositary Receipts, European Depositary Receipts, Global
Depositary Receipts or other similar securities representing securities of
foreign issuers (collectively, "Depositary Receipts"). The Portfolio treats
Depositary Receipts as interests in the underlying securities for purposes of
its investment policies. The Portfolio will limit its investment in Depositary
Receipts not sponsored by the issuer of the underlying securities to no more
than 5% of the value of its net assets (at the time of investment).
SUPRANATIONAL AND ECU OBLIGATIONS. The Portfolio may invest in securities
issued by supranational organizations, which include organizations such as The
World Bank, the European Community, the European Coal and Steel Community and
the Asian Development Bank. The Portfolio may also invest in securities
denominated in the ECU, which is a "basket" consisting of specified amounts of
the currencies of certain member states of the European Community. These
securities are typically issued by European governments and supranational
organizations.
CONVERTIBLE SECURITIES. The Portfolio may invest up to 20% of its net assets
in convertible securities, which are securities generally offering fixed
interest or dividend yields which may be converted either at a stated price or
stated rate for common or preferred stock. Although to a lesser extent than
with fixed-income securities generally, the market value of convertible
securities tends to decline as interest rates increase, and increase as
interest rates decline. Because of the conversion feature, the market value of
convertible securities also tends to vary with fluctuations in the market
value of the underlying common or preferred stock. There are no rating
limitations applicable to the convertible securities in which the Portfolio
may invest.
MONEY MARKET INSTRUMENTS. The Portfolio may invest in cash or high-quality,
short-term money market instruments. Such instruments may include U.S.
Government securities, commercial paper of domestic and foreign issuers and
obligations of domestic and foreign banks. Investments in foreign money market
instruments may involve certain risks associated with foreign investment.
INVESTMENT GRADE DEBT SECURITIES. Investment grade debt securities are
securities rated in the category BBB or higher by Standard & Poor's
Corporation ("S&P"), Baa or higher by Moody's Investors Services, Inc.
("Moody's") or the equivalent by another national rating organization, or, if
unrated, determined by the advisers to be of comparable quality.
REPURCHASE AGREEMENTS, SECURITIES LOANS AND FORWARD COMMITMENTS. The Portfolio
may enter into agreements to purchase and resell securities at an agreed-upon
price and time. The Portfolio also has the ability to lend portfolio
securities in an amount equal to not more than 30% of its total assets to
generate additional income. These transactions must be fully collateralized at
all times. The Portfolio may purchase securities for delivery at a future
date, which may increase its overall investment exposure and involves a risk
of loss if the value of the securities declines prior to the settlement date.
These transactions involve some risk to the Portfolio if the other party
should default on its obligation and the Portfolio is delayed or prevented
from recovering the collateral or completing the transaction.
BORROWINGS AND REVERSE REPURCHASE AGREEMENTS. The Portfolio may borrow money
from banks for temporary or short-term purposes, but will not borrow for
leveraging purposes. The Portfolio may also sell and simultaneously commit to
repurchase a portfolio security at an agreed-upon price and time, to avoid
selling securities during unfavorable market conditions in order to meet
redemptions. Whenever the Portfolio enters into a reverse repurchase
agreement, it will establish a segregated account in which it will maintain
liquid assets on a daily basis in an amount at least equal to the repurchase
price (including accrued interest). The Portfolio would be required to pay
interest on amounts obtained through reverse repurchase agreements, which are
considered borrowings under federal securities laws.
STAND-BY COMMITMENTS. The Portfolio may enter into put transactions, including
transactions sometimes referred to as stand-by commitments, with respect to
securities in its portfolio. In these transactions, the Portfolio would
acquire the right to sell a security at an agreed upon price within a
specified period prior to its maturity date. These transactions involve some
risk to the Portfolio if the other party should default on its obligation and
the Portfolio is delayed or prevented from recovering the collateral or
completing the transaction. Acquisition of puts will have the effect of
increasing the cost of the securities subject to the put and thereby reducing
the yields otherwise available from such securities.
OTHER INVESTMENT COMPANIES. The Portfolio may invest up to 10% of its total
assets in shares of other investment companies, subject to applicable
regulatory limitations.
STRIPS. The Portfolio may invest up to 20% of its total assets in separately
traded principal and interest components of securities backed by the full
faith and credit of the U.S. Government, including instruments known as
"STRIPS". The value of these instruments tends to fluctuate more in response
to changes in interest rates than the value of ordinary interest-paying debt
securities with similar maturities. The risk is greater when the period to
maturity is longer.
DERIVATIVES AND RELATED INSTRUMENTS. The Portfolio may invest its assets in
derivative and related instruments to hedge various market risks or to
increase the Portfolio's income or gain. Some of these instruments will be
subject to asset segregation requirements to cover the Portfolio's
obligations. The Portfolio may (i) purchase, write and exercise call and put
options on securities and securities indexes (including using options in
combination with securities, other options or derivative instruments); (ii)
enter into swaps, futures contracts and options on futures contracts; (iii)
employ forward currency contracts; and (iv) purchase and sell structured
products, which are instruments designed to restructure or reflect the
characteristics of certain other investments.
There are a number of risks associated with the use of derivatives and related
instruments and no assurance can be given that any strategy will succeed. The
value of certain derivatives or related instruments in which the Portfolio
invests may be particularly sensitive to changes in prevailing economic
conditions and market value. The ability of the Portfolio to successfully
utilize these instruments may depend in part upon the ability of the
Portfolio's advisers to forecast these factors
correctly. Inaccurate forecasts could expose the Portfolio to a risk of loss.
There can be no guarantee that there will be a correlation between price
movements in a hedging instrument and in the portfolio assets being hedged.
The Portfolio is not required to use any hedging strategies. Hedging
strategies, while reducing risk of loss, can also reduce the opportunity for
gain. Derivatives transactions not involving hedging may have speculative
characteristics, involve leverage and result in more risk to the Portfolio
than hedging strategies using the same instruments. There can be no assurance
that a liquid market will exist at a time when the Portfolio seeks to close
out a derivatives position. Activities of large traders in the futures and
securities markets involving arbitrage, "program trading," and other
investment strategies may cause price distortions in derivatives markets. In
certain instances, particularly those involving over-the-counter transactions
or forward contracts, there is a greater potential that a counterparty or
broker may default. In the event of a default, the Portfolio may experience a
loss. For additional information concerning derivatives, related instruments
and the associated risks, see the Statement of Additional Information.
PORTFOLIO TURNOVER. The frequency of the Portfolio's portfolio transactions
will vary from year to year. The Portfolio's investment policies may lead to
frequent changes in investments, particularly in periods of rapidly changing
market conditions. High portfolio turnover rates would generally result in
higher transaction costs, including brokerage commissions or dealer mark-ups,
and would make it more difficult for the Portfolio to qualify as a regulated
investment company under Federal tax law.
LIMITING INVESTMENT RISKS
Specific investment restrictions help the Portfolio limit investment risks for
the Fund's shareholders. These restrictions prohibit the Portfolio from: (a)
with respect to 50% of its total assets, holding more than 10% of the voting
securities of any issuer; (b) investing more than 15% of its net assets in
illiquid securities (which include securities restricted as to resale unless
they are determined to be readily marketable in accordance with procedures
established by the Board of Trustees); or (c) investing more than 25% of its
total assets in any one industry. A complete description of these and other
investment policies is included in the Statement of Additional Information.
Except for restriction (c) above and investment policies designated as
fundamental in the Statement of Additional Information, the investment
objective and policies of the Portfolio and the investment policies of the
Fund are not fundamental. Shareholder approval is not required to change any
non-fundamental investment policy. However, in the event of a change in the
Fund's or Portfolio's investment objective or policies, shareholders will be
given at least 30 days prior written notice.
RISK FACTORS
The net asset value of the shares of the Fund can be expected to fluctuate
based on the value of the securities held by the Portfolio. The Fund does not
constitute a balanced or complete investment program. The Fund is subject to
the following general risks and considerations associated with equity
investing, as well as the risks discussed herein. 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 stcok prices generally increase and periods when stock prices generally
decrease.
Because the Portfolio is "non-diversified," the value of the Fund's shares is
more susceptible to developments affecting issuers in which the Portfolio
invests.
For a discussion of certain other risks associated with the Portfolio's
additional investment activities, see "Other Investment Practices" above."
MANAGEMENT OF THE FUND
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BOARD OF TRUSTEES. The Board of Trustees (the "Board" or the "Trustees") is
responsible for managing the business affairs of the Fund 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. VCM is responsible for managing the Fund and overseeing the
investment of its assets, subject at all times to the supervision of the Board
members. In addition, VCM selects, monitors and evaluates the Portfolio
Adviser. VCM will review the Portfolio Adviser's performance record
periodically, and will make changes if necessary, subject to Board member and
shareholder approval.
MANAGEMENT FEES. Under the terms of the management contract, VCM receives a
monthly fee of .70% of the Fund's average daily net assets and the Portfolio
Adviser receives .40% per annum of the Fund's average daily net assets
directly from the Portfolio, as described below. The total fee of 1.10% is
higher than the fees paid by most investment companies.
The portion of the fee based upon the average daily net assets of the Fund
shall be accrued daily at the rate of 1/365th of the applicable percentage
applied to the daily net assets of the Fund.
The management contract provides for the voluntary waiver of expenses by VCM
from time to time. VCM can terminate this voluntary waiver of expenses at any
time with respect to the Fund at its sole discretion. VCM has also undertaken
to reimburse the Fund for operating expenses in excess of limitations
established by certain states.
The Portfolio pays for all its expenses including legal and auditing expenses;
registration fees; taxes on the sales of portfolio securities; brokerage
commissions; Portfolio trustee fees; expenses connected with the execution,
recording and settlement of security transactions; fees and expenses of the
Portfolio's custodian for all services to the Portfolio; expenses of preparing
and mailing reports to investors and to government agencies and commissions;
expenses of meetings of investors and the advisory fees of .40% of the
Portfolio's average daily net assets payable to the Portfolio Adviser under
the Investment Advisory Agreement. In addition, the Portfolio pays an
administrative fee to The Chase Manhattan Bank at an annual rate of .05% of
the Portfolio's average daily net assets pursuant to an Administration
Agreement wherein Chase provides facilities and personnel necessary to operate
the Portfolio.
VCM'S BACKGROUND. Virtus Capital Management, Inc., a Maryland corporation
formed in 1995, is a wholly owned subsidiary of Signet Banking Corporation.
Signet Banking Corporation is a multi-state, multi-bank holding company which
has provided investment management services since 1956. VCM, which is a
registered investment adviser, manages, in addition to the Funds, The Virtus
Funds, three fixed income common trust funds with $163.6 million in assets. As
part of their regular banking operations, Signet Bank may make loans to public
companies.
PORTFOLIO ADVISORY SERVICES
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THE PORTFOLIO ADVISER
Chase acts as investment adviser to the Portfolio pursuant to an Investment
Advisory Agreement and has overall responsibility for investment decisions of
the Portfolio, subject to the oversight of the Board of Trustees. Chase is a
wholly owned subsidiary of The Chase Manhattan Corporation, a bank holding
company. Chase and its predecessors have over 100 years of money management
experience. For its investment advisory services to the Portfolio, Chase is
entitled to receive an annual fee computed daily and paid monthly based at an
annual rate equal to 0.40% of the Portfolio's average daily net assets. Chase
is located at 270 Park Avenue, New York, New York 10017.
Chase Asset Management, Inc. ("CAM"), a registered investment adviser, is the
sub-investment adviser to the Portfolio pursuant to a Sub-Investment Advisory
Agreement between CAM and Chase. CAM is a wholly-owned operating subsidiary of
Chase. CAM makes investment decisions for the Portfolio on a day-to-day basis.
For these services, CAM is entitled to receive a fee, payable by Chase from
its advisory fee, at an annual rate equal to 0.20% of the Portfolio's average
daily net assets. CAM was recently formed for the purpose of providing
discretionary investment advisory services to institutional clients and to
consolidate Chase's investment management function. The same individuals who
serve as portfolio managers for Chase also serve as portfolio managers for
CAM. CAM is located at 1211 Avenue of the Americas, New York, New York 10036.
PORTFOLIO MANAGER. Dave Klassen, Director of Domestic Equity Portfolio
Management at Chase, and Greg Adams, Director of U.S. Equity Research at
Chase, have been responsible for the day-to-day management of the Portfolio
since March 1995. Mr. Klassen joined Chase in March 1992 and, in addition to
managing the Growth and Income Portfolio, is a manager of the Vista Small Cap
Equity Fund and the Capital Growth Portfolio. Prior to joining Chase, Mr.
Klassen was a Vice President and portfolio manager at Dean Witter Reynolds,
responsible for managing several mutual funds and other accounts. Mr. Adams
joined Chase in 1987 and is also a manager of the Vista Balanced Fund and the
Vista Large Cap Equity Fund. In addition, Mr. Adams has been responsible for
overseeing the proprietary computer model program, which scans over 1600
equity securities in their quest for attractive value, used in the U.S. equity
selection process.
EFFECT OF BANKING LAWS
- -------------------------------------------------------------------------------
The Portfolio Adviser has received the opinion of its legal counsel that it
may provide services described in its Investment Advisory Agreement and
Custodian Agreement with the Portfolio, without violating the federal banking
law commonly known as the Glass-Steagall Act. Similarly, VCM believes, based
on advice of its counsel, that VCM may perform services described in its
management contract with the Fund, without violating the Act. The Act
generally bars banks from publicly underwriting or distributing certain
securities.
Decisions of the U.S. Supreme Court and banking regulators support the
position that a bank may act as investment adviser to a registered, open-ended
investment company. Based on the advice of its counsel, the Portfolio Adviser
and VCM each believe that it may serve as investment adviser to a registered,
open-end investment company.
Regarding the performance of custodial activities, the staff of the Office of
the Comptroller of the Currency, which supervises national banks, has issued
opinion letters stating that national banks may engage in custodial
activities. Therefore, the Portfolio Adviser believes, based on advice of
counsel, that it may serve as Custodian to the Portfolio as an appropriate,
incidental national banking function and as a proper adjunct to its serving as
Portfolio Adviser to the Portfolio.
Possible future changes in federal law or administrative or judicial
interpretations of current or future law, however, could prevent the Portfolio
Adviser from continuing to perform investment advisory or custodial services
for the Portfolio, and could prevent VCM from continuing to perform management
services for the Fund. If that occurred, the Fund's trustees would then
consider what action would be in the best interest of the Fund's shareholders.
HOW TO INVEST
- -------------------------------------------------------------------------------
You may purchase shares of the Fund from Federated Securities Corp., the
Fund's principal Distributor. Federated Securities Corp. is a subsidiary of
Federated Investors. You may also purchase shares from broker-dealers who have
entered into a dealer agreement with the Distributor at net asset value which
is computed once daily as of the close of the options exchanges (normally 4:15
P.M New York time). If your order is received after the above time, your
shares will be purchased at the net asset value on the next business day. The
Fund's net asset value per share is determined by dividing the value of the
Fund's net assets by the total number of its shares outstanding. 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.
For your initial investment, there is a $3,000 minimum requirement. The
minimum initial investment requirement for qualified pension plans (IRAs,
Keoghs, etc.) is $2,000. The minimum investment requirement for additional
investments in the Fund is at least $200 per investment. (The foregoing
minimum investment requirements may be modified or waived at any time at our
discretion.) We charge no redemption fee when you redeem your shares and there
is no fee on reinvestment of any dividends or distributions.
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 Fund 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 cancelled and you could be
liable for any losses or fees incurred. Payments transmitted by check are
accepted subject to collection at full face amount.
Orders 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.
PURCHASES 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: State Street Bank and
Trust Company, ABA number 011000028, Account number 0627-975-6, Boston,
Massachusetts 02266, indicating your account number and the account
registration. Shares cannot be purchased by wire on holidays when wire
transfers are restricted. Questions on wire purchases should be directed to
your shareholder services representative at the telephone number listed on
your account statement.
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 transferral 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 pre-
designated 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 days after the form is
received.
GENERAL INFORMATION
All ordinary income, dividends and capital gain 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 date
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 (on or about
the 10th day) 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 if
the value of the account drops below $10,000 due to transfer or redemption of
shares. In a 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 a 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 PRIVILEGES
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 and such exchanges
may be made at net asset value without paying a redemption fee or sales charge
upon such exchange. Before making an exchange, you should read the Prospectus
concerning the participating fund into which your exchange is being made. The
other funds currently offered in the Blanchard Group of Funds are Blanchard
Capital Growth Fund, Blanchard Global Growth Fund, Blanchard Flexible Income
Fund, Blanchard Short-Term Flexible Income Fund, Blanchard Flexible Tax-Free
Bond Fund and Blanchard Precious Metals Fund, Inc. For information on The
Virtus Funds, please call 1-800-829-3863.
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 Fund's 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. In order to protect itself and shareholders from
liability for unauthorized or fraudulent telephone transactions, the Fund will
use reasonable procedures such as recording calls in an attempt to verify the
identity of a person making a telephone redemption request. As a result of the
Fund's policy, neither the 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. 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 fund are qualified for
sale. We do not place any limit on the number of exchanges that may be made.
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 the Fund to the disadvantage of
other shareholders, we reserve the right to modify or terminate this Exchange
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 your shares by telephone by calling 1-800-829-
3863, prior to 4:00 P.M., Eastern time. All calls will be recorded. Redemption
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 the Fund or the Transfer Agent. Proceeds from
redemption requests received on holidays when wire transfers are restricted
will be wired the following business day. Questions about telephone
redemptions on days when wire transfers are restricted should be directed to
your shareholder services representative at the telephone number listed on
your account statement.
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 revise these instructions, simply complete and file a new
telephone redemption authorization form. There is no charge for this service.
As long as the identification procedures described above are followed, neither
the 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 Privileges," for additional
information with respect to losses resulting from unauthorized telephone
transactions.
You may also request, by placing a call to the applicable 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 Fund does 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 the Transfer Agent 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, Massachusetts 02266-8612, the
Fund's Transfer Agent. Where share certificates have been issued, the
certificates must be endorsed and must accompany the redemption request.
Signatures on redemption requests for amounts in excess of $25,000 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
associations, 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 (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 Transfer Agent prior to 4:00 P.M. Eastern 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 involuntarily 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.
DISTRIBUTION OF SHARES OF THE FUND
- -------------------------------------------------------------------------------
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.
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
of Trustees, provided that for any period the total amount of fees
representing an expense to the Trust shall not exceed an annual rate of .25 of
1% of the average daily net assets of shares of the Fund held in the accounts
during the period for which the brokers, dealers, and administrators provide
services. Any fees paid by the distributor with respect to shares of the Fund
pursuant to the distribution plan will be reimbursed by the Trust from the
assets of the shares of the Fund. Effective November 14, 1996, the maximum
12b-1 fee was reduced from 0.50% to 0.25%.
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
dealer. 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 their customers
invested in the Trust for providing administrative services. This fee, if
paid, will be reimbursed by VCM and not the Trust.
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>
MAXIMUM AVERAGE AGGREGATE DAILY NET
AMINISTRATIVE FEED ASSETS OF THE TRUST
- ------------------ -----------------------------------
<S> <C>
.150% on the first $250 million
.125% on the next $250 million
.100% on the next $250 million
.075% on assets in excess of $750 million
</TABLE>
The administrative fee received during any fiscal year for the Fund shall be
at least $75,000. Federated Administrative Services may voluntarily waive a
portion of its fee.
TRANSFER AGENT AND DIVIDEND DISBURSING AGENT. Federated Shareholder Services
Company, P. O. Box 8600, Boston, Massachusetts, 02266-8600, is the Fund's
Transfer Agent and Dividend Disbursing Agent.
TAX MATTERS
- -------------------------------------------------------------------------------
The Fund intends to qualify each year and elect to be treated as a separate
"regulated investment company" under Subchapter M of the Internal Revenue Code
of 1986, as amended (the "Code"). A regulated investment company that
distributes all of its taxable income to its shareholders in accordance with
the timing requirements imposed by the Code, which the Fund intends to do, is
not subject to Federal income tax on the amounts so distributed. If for any
taxable year the Fund does not qualify for the treatment as a regulated
investment company, all its taxable income will be subject to tax at regular
corporate rates without any deduction for distributions to its shareholders,
and such distributions, in turn, will be taxable to the shareholders as
ordinary dividends to the extent of the Fund's current and accumulated
earnings and profits. Because the Fund invests all of its assets in the
Portfolio which is classified as a partnership for Federal income tax
purposes, the Fund will be deemed to own a proportionate share of the income
of the Portfolio in which it invests, for purposes of determining whether it
qualifies as a regulated investment company.
The Trust is organized as a Massachusetts business trust and, under current
law, is not liable for any income or franchise tax in the Commonwealth of
Massachusetts as long as the Fund (and each other series of the Trust)
qualifies as a regulated investment company under the Code.
Distributions by the Fund of its ordinary income (net of expenses) and the
excess, if any, of its net short-term capital gain over its net long-term
capital loss are generally taxable to shareholders as ordinary income. Such
distributions are treated as dividends for Federal income tax purposes. A
portion of the ordinary income dividends paid by the Fund with respect to a
given year (essentially, the portion attributable to qualifying dividends
received by the underlying Portfolio from domestic corporations during the
year) may qualify for the 70% dividends-received deductions for corporate
shareholders. Distributions by the Fund of the excess, if any, of its net
long-term capital gain over its net short-term capital loss are designated as
capital gain dividends and are taxable to shareholders as long-term capital
gains, regardless of their holding periods in their shares. Ordinary income
and capital gain dividends from the Fund may also be subject to state and
local taxes.
Investors should carefully consider the tax implications of purchasing shares
just prior to a dividend record date. Investors purchasing shares just prior
to an ordinary income or capital gain dividend record date will be taxed on
the entire dividend received, even though their cost for shares already
reflected the amount of such dividend.
Distributions to shareholders will be treated in the same manner for Federal
income tax purposes whether received in cash or reinvested in additional Fund
shares. In general, distributions by the Fund are taken into account by
shareholders in the year in which they are made. However, certain
distributions made during January will be treated as having been paid by the
Fund and received by its shareholders on December 31 of the preceding year. A
statement setting forth the Federal income
tax status of all distributions made (or deemed made) during the year,
including the allocation to ordinary income dividends (and any portion thereof
which qualify for the dividends-received deduction for corporations) and
capital gain dividends, will be sent to the Fund's shareholders promptly after
the end of each year.
A shareholder will recognize gains or losses upon the sale or redemption of
shares of the Fund in an amount equal to the difference between the proceeds
of the sale or redemption and the shareholder's adjusted tax basis in the
shares. Any loss realized upon a taxable disposition of shares within six
months from the date of their purchase will be treated as a long-term capital
loss to the extent of any capital gain dividends received on such shares. All
or a portion of any loss realized upon a taxable disposition of shares of the
Fund may be disallowed if other shares of the Fund are purchased within 30
days before or after such disposition.
Under the back-up withholding rules of the Code, a shareholder may be subject
to 31% withholding of Federal income tax on dividends and redemption payments
made by the Fund. To avoid this back-up withholding, you must provide the Fund
with a correct taxpayer identification number (which for an individual is
usually one's Social Security number) or certify that you are a corporation or
otherwise exempt from or not subject to back-up withholding.
The foregoing discussion of Federal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus and is subject
to change by legislative or administrative action. You should also review the
more detailed discussion of Federal income tax considerations in the Statement
of Additional Information for the Fund. In addition, you should consult with
your own tax advisor as to the tax consequences of investing in the Fund,
including the application of state and local taxes to you, which may differ
from the Federal income tax consequences described above.
PERFORMANCE COMPUTATION INFORMATION
- -------------------------------------------------------------------------------
Advertisements and communications to investors regarding the Fund may cite
certain performance, ranking and rating information of the Fund and the
Portfolio and may make performance comparisons to other funds or to relevant
indices, as described below.
TOTAL RETURN. Cumulative total return data is computed by considering all
elements of return, including reinvestment of dividends and capital gain
distributions, 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.
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., CDA and Morningstar, Inc. In addition, because the
Fund invests 100% of its assets in the portfolio which has identical
investment objectives, the Fund may cite the performance and ranking
information of its Portfolio (which includes the performance of predecessor
mutual funds prior to their conversion to the Portfolio) and may make certain
performance, ranking and rating comparisons. The Fund may also discuss the
past performance, ranking and rating of the 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, or the total return of indexes of U.S.
markets, world markets, individual countries undergoing privatization, or of
world indexes of countries undergoing privatization, 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 Fund Investors. The Fund may also
compare the historical returns on various investments, performance indexes of
those investments or 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 management in selecting the type
and quality of securities in which the Fund may invest, and is affected by
operating, distribution and marketing expenses.
ADDITIONAL INFORMATION ABOUT THE FUND AND THE PORTFOLIO
- -------------------------------------------------------------------------------
THE FUND
The Fund is a non-diversified series of Blanchard Funds (the "Trust"), a
Massachusetts business trust organized on January 24, 1986 which currently
consists of seven series of shares. The other series of the Trust's shares of
beneficial interest, which are offered pursuant to separate prospectuses, are
Blanchard Capital Growth Fund, Blanchard Global Growth Fund, Blanchard
Flexible Income Fund, Blanchard Short-Term Flexible Income Fund and Blanchard
Flexible Tax-Free Bond Fund.
The Fund is classified as a "non-diversified" investment company under the
1940 Act, which means that the Fund is not limited by the 1940 Act in the
proportion of its assets that may be invested in the securities of a single
issuer. The Fund intends, however, to comply with the diversification
requirements imposed by the U.S. Internal Revenue Code of 1986, as amended,
for qualification as a regulated investment company. See "Tax Matters" in the
Prospectus and in the Statement of Additional Information.
INVESTOR MEETINGS AND VOTING
Under Massachusetts law, the Trust and its series are generally not required
to hold annual or special shareholder meetings. However, special meetings of
shareholders may be held for such purposes as electing trustees, changing
fundamental policies, approving an investment management/advisory agreement or
approving a distribution and marketing plan, if any, and, at the request of
the shareholders, to replace Trustees. Shareholders holding 10% or more of the
Trust's outstanding shares may call a special meeting of shareholders.
Trustees may be removed by the Trustees or by shareholders at a special
meeting called for this purpose. Shareholders shall be given access to a list
of the names and addresses of all other shareholders, the number of
shareholders and the cost of mailing a request to them.
Whenever a vote is requested on matters pertaining to the Portfolio, the Trust
will hold a meeting of the Fund's shareholders and will cast its vote as
instructed by the Fund's shareholders. Shares of the Fund for which no voting
instructions have been received will be voted in the same proportion as those
shares for which voting instructions are received. As with any mutual fund,
other investors in the Portfolio could control the results of voting at the
Portfolio level.
The Fund's shares represent shares of beneficial interest. Each share has
equal rights with respect to voting matters of the Fund. In the event of
dissolution or liquidation of the Fund, holders of Fund shares will receive
pro rata, subject to the rights of creditors, the proceeds of the sale of the
Fund's assets less its liabilities. There are no preemptive or conversion
rights applicable to the shares of the Fund. Shares of the Fund, when issued,
will be fully paid, non-assessable and transferable. The trustees may create
additional series or classes of shares without shareholder approval. Each
series of the Trust is responsible only for its own expenses and operating
costs and incurs no liability with respect to the expenses and costs of any
other series, other than those which affect the series as a group and are
allocated among the series based upon their relative average net assets during
the year.
THE PORTFOLIO
The Portfolio is organized as a trust under the laws of the State of New York.
The Portfolio's Declaration of Trust provides that the Fund and other entities
investing in the Portfolio (e.g., other investment companies, insurance
company separate accounts and common and commingled trust funds) will be
liable for all obligations of the Portfolio. However, the risk of the Fund's
incurring financial loss on account of such liability is limited to
circumstances in which both inadequate insurance existed and the Portfolio
itself was unable to meet its obligations. Accordingly, the Trustees believe
that neither the Fund nor their shareholders will be adversely affected by
reason of the Fund's investing in the Portfolio.
UNIQUE CHARACTERISTICS OF THE FUND AND PORTFOLIO STRUCTURE
Unlike other mutual funds which directly acquire and manage their own
portfolio securities, the Fund invests all of its investable assets in the
Portfolio, a separate registered investment company. Therefore, a
shareholder's interest in the Portfolio's securities is indirect. In addition
to selling a beneficial interest to the Fund, the Portfolio may sell
beneficial interests to other mutual funds or institutional investors. Such
investors will invest in the Portfolio on the same terms and conditions and
will pay a proportionate share of the Portfolio's expenses. However, other
investors investing in the Portfolio are not required to sell their shares at
the same public offering price as the Fund, and may bear different
levels of ongoing expenses than the Fund. Shareholders of the Fund should be
aware that these differences may result in differences in returns experienced
in the different funds that invest in the Portfolio. Such differences in
returns are also present in other mutual fund structures.
Smaller funds investing in the Portfolio may be materially affected by the
actions of larger funds investing in the Portfolio. For example, if a large
fund withdraws from the Portfolio, the remaining funds may experience higher
pro rata operating expenses, thereby producing lower returns. Additionally,
the Portfolio may become less diverse, resulting in increased portfolio risk.
However, this possibility also exists for traditionally structured funds which
have large or institutional investors. Funds with a greater pro rata ownership
in the Portfolio could have effective voting control of the operations of the
Portfolio. Whenever the Trust is requested to vote on matters pertaining to
the Portfolio, the Trust will hold a meeting of shareholders of the Fund and
will cast all of its votes in the same proportion as do the Fund's
shareholders. Shares of the Fund for which no voting instructions have been
received will be voted in the same proportion as those shares for which voting
instructions are received. Certain changes in the Portfolio's objective,
policies or restrictions may require the Trust to withdraw the Fund's interest
in the Portfolio. Any withdrawal could result in a distribution in kind of
portfolio securities (as opposed to a cash distribution from the Portfolio).
The Fund could incur brokerage fees or other transaction costs in converting
such securities to cash. In addition, a distribution in kind may result in a
less diversified portfolio of investments or adversely affect the liquidity of
the Fund.
State securities regulations generally do not permit the same individuals who
are disinterested Trustees of the Trust to be Trustees of the Portfolio absent
the adoption of written procedures by a majority of the disinterested Trustees
of the Trust reasonably appropriate to deal with potential conflicts of
interest up to and including creating a separate Board of Trustees. The
Trustees of the Trust, including a majority of the disinterested Trustees,
have adopted procedures they believe are reasonably appropriate to deal with
any conflict of interest up to and including creating a separate Board of
Trustees.
Investors in the Fund may obtain information about whether an investment in
the Portfolio may be available through other funds by calling 1-800-829-3863.
OTHER INFORMATION
- -------------------------------------------------------------------------------
This Prospectus omits certain information contained in the registration
statement of the Fund filed with the SEC. Copies of the registration
statement, including items omitted herein, may be obtained from the SEC by
paying the charges prescribed under its rules and regulations. The Statement
of Additional Information included in the registration statement may be
obtained without charge from the Fund.
For information about the Trustees and officers of the Fund and the Portfolio
see the Statement of Additional Information.
The Code of Ethics of the Portfolio Adviser and the Fund prohibits all
affiliated personnel from engaging in personal investment activities which
compete with or attempt to take advantage of the Fund's planned portfolio
transactions. The objective of the Code of Ethics of both the Fund and
Portfolio Adviser is that their operations be carried out for the exclusive
benefit of the Fund's shareholders. Both organizations maintain careful
monitoring of compliance with the Code of Ethics.
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and in the
Statement of Additional Information, and information or representations not
herein contained, if given or made, must not be relied upon as having been
authorized by the Fund. This Prospectus does not constitute an offer or
solicitation in any jurisdiction in which such offering may not lawfully be
made.
INDEPENDENT AUDITORS. Deloitte & Touche LLP, 2500 One PPG Place, Pittsburgh,
Pennsylvania 15222-5401, has been appointed the independent auditors for the
Fund.
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 Chase,
or any other bank. They are not insured by the FDIC. They involve risk,
including possible loss of principal invested.
B L A N C H A R D
Cusip 093265304
G01386-04(2/97) (2280) I1PC0297
THE BLANCHARD GROUP OF FUNDS
BLANCHARD CAPITAL GROWTH FUND
PROSPECTUS
Blanchard Capital Growth Fund (the `Fund'') seeks long-term capital
growth. The Fund, unlike many other investment companies which directly
acquire and manage their own portfolios of securities, seeks its investment
objective by investing all of its investable assets in Capital Growth
Portfolio (the `Portfolio''), an open-end management investment company
with an investment objective identical to that of the Fund. Investors
should carefully consider this investment approach. For additional
information regarding this investment structure, see `Unique
Characteristics of the Fund and Portfolio Structure''on page 21.
Blanchard Funds (the `Trust''), which currently consists of seven
investment portfolios, and Blanchard Precious Metals Fund, Inc., which
currently consists of one investment portfolio (each portfolio individually
referred to as a `Fund'' and collectively as the ``Funds'') are open-end
management investment companies, which offer separate investment
alternatives for different investor needs. Virtus Capital Management, Inc.
(`VCM'') is the Funds' overall investment manager. There is no guarantee
that the Fund will achieve its investment objective.
Please read this Prospectus carefully and retain it for future reference.
The Fund's Statement of Additional Information, dated February 28, 1997,
has been filed with the Securities and Exchange Commission (the `SEC'')
and is incorporated herein by reference. You may request a copy of the
Statement of Additional Information or a paper copy of this prospectus, if
you have received your prospectus electronically, by calling the Fund at 1-
800-829-3863.
INVESTMENT IN THE FUND IS SUBJECT TO RISK INCLUDING POSSIBLE LOSS OF
PRINCIPAL AND WILL FLUCTUATE IN VALUE. SHARES OF THE FUND ARE NOT BANK
DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, SIGNET BANK OR
THE CHASE MANHATTAN BANK OR ANY OF THEIR RESPECTIVE AFFILIATES AND ARE NOT
INSURED BY, OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S. GOVERNMENT,
THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY
OTHER AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
Prospectus dated February 28, 1997
TABLE OF CONTENTS
HIGHLIGHTS 1
THE FUND'S OBJECTIVE 1
Fund Management 1
How to Invest and Redeem 2
Investor Services and Privileges 2
Dividends 2
Additional Information on Investment
Policies, Techniques and Risk Factors 3
SUMMARY OF FUND EXPENSES 4
FINANCIAL HIGHLIGHTS 5
FUND OBJECTIVE 5
INVESTMENT POLICIES 5
Investment Approach 5
Fund Structure 5
Other Investment Practices 5
Limiting Investment Risks 8
Risk Factors 8
MANAGEMENT OF THE FUND 9
PORTFOLIO ADVISORY SERVICES 10
The Portfolio's Advisers 10
EFFECT OF BANKING LAWS 10
HOW TO INVEST 11
Purchases by Mail 11
General Information 12
INVESTOR SERVICES 12
Automatic Withdrawal Plan 12
Retirement Plans 13
Exchange Privileges 13
HOW TO REDEEM 14
General Information 15
DISTRIBUTION OF SHARES OF THE FUND 15
TAX MATTERS 17
PERFORMANCE COMPUTATION INFORMATION 18
ADDITIONAL INFORMATION ABOUT THE FUND
AND THE PORTFOLIO 19
The Fund 19
Investor Meetings and Voting 20
The Portfolio 20
Unique Characteristics of the Fund and
Portfolio Structure 21
OTHER INFORMATION 21
HIGHLIGHTS
THE FUND'S OBJECTIVE
The Fund, which is an open-end management investment company, invests in
the Portfolio which, in turn, invests in securities in accordance with
investment objectives, policies and restrictions identical to those of the
Fund. The Portfolio seeks to provide long-term capital growth. See `Fund
Objective''and ``Investment Policies'' (page 5).
FUND MANAGEMENT
VCM provides management services necessary for the Fund's operations. As of
January 31, 1997, VCM had more than $163.6 million in assets under
management. VCM receives monthly compensation from the Fund based on the
amount of assets under management. VCM evaluates the performance of the
Fund's Portfolio Adviser. The Portfolio Adviser is responsible for the
selection of the Portfolio's investments. See `Management of the Fund''
(page 9).
The Chase Manhattan Bank (the `Portfolio Adviser'' or ``Chase''), a wholly
owned subsidiary of The Chase Manhattan Corporation, a registered bank
holding company, is a commercial bank offering a wide range of banking and
investment services to customers throughout the United States and around
the world. Its headquarters is at 270 Park Avenue, New York, New York
10017. The Portfolio Adviser, including its predecessor organizations, has
over 100 years of money management experience. See `Portfolio Advisory
Services- The Portfolio Adviser''(page 10).
HOW TO INVEST AND REDEEM
You may purchase shares of the Fund directly from Federated Securities
Corp. (the `Distributor'') which is the Fund's principal distributor. You
may also purchase shares from broker-dealers who have entered into a dealer
agreement with the Distributor.
The minimum amount required to open an account in the Fund is $3,000
($2,000 for qualified retirement plans, such as IRAs and Keoghs). The
minimum subsequent investment requirement is $200. The Fund has also
adopted a Distribution Plan which permits the reimbursement of distribution
expenses by the Fund in an amount not to exceed .50% of the average daily
net assets of the Fund on an annual basis. See `How to Invest'' and
`Distribution of Shares of the Fund'' (pages 11 and 15).
You may redeem your shares on any business day at the next determined net
asset value calculated after Federated Shareholder Services Company (the
`Transfer Agent'') has received the redemption request in proper form. See
`How to Redeem'' (page 14).
The Fund reserves the right to cease offering shares to new shareholders if
the Portfolio Adviser believes that the Fund's size may hamper its
effectiveness in managing the Portfolio. In this event, no new accounts
will be accepted until further review. Shareholders who have established
accounts prior to the closure date will be allowed to add to their
investments.
INVESTOR SERVICES AND PRIVILEGES
The Fund offers certain investor services and privileges that may be suited
to your particular investment needs, including free Telephone Exchange
Privileges, Investment and Withdrawal Plans and various Retirement Plans.
See `Investor Services'' (page 12).
DIVIDENDS
The Fund intends to declare dividends, if any, at least annually from net
investment income. Dividends, if any, are automatically reinvested in
additional Fund shares at net asset value on the payment date and are
reflected in the statements we send you, unless you elect to receive them
in cash, in which case we will send you a check. See `Tax Matters'' (page
17).
ADDITIONAL INFORMATION ON INVESTMENT POLICIES, TECHNIQUES AND RISK FACTORS.
The Fund is a non-diversified fund and may be invested in a limited number
of issues; thus, there may be greater risk in an investment in the Fund
than in a diversified investment company. Moreover, there are potential
risks associated with certain of the Fund's investments and additional risk
considerations that may be associated with certain techniques and
strategies employed by the Fund, including those relating to investments in
foreign securities and futures and options transactions.
SUMMARY OF FUND EXPENSES
- -------------------------------------------------------------------------------
For a better understanding of the expenses you will incur directly or
indirectly when investing in the Fund, a summary for the Fund is set forth
below. The summary combines the Fund's operational expenses with the pro rata
portion of its Portfolio's operational expenses. See "Management of the Fund."
The trustees believe that the aggregate per share expenses of the Fund and the
Portfolio will be approximately equal to the expenses the Fund would incur if
its assets were invested directly in the type of securities held by the
Portfolio.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum Sales Charge Imposed on Purchases (as a percentage of offer-
ing 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 Fees........................................................ None
<CAPTION>
ANNUAL INVESTMENT SHARES OPERATING EXPENSES
(As a percentage of average net assets)
<S> <C>
Management Fee (See "Management of the Fund") (after waiver) (1)..... 0.40%
12b-1 Fees (after waiver) (2)........................................ 0.00%
Other Expenses (after expense reimbursements) (3).................... 6.05%
Total Fund Operating Expenses (after waivers and reimbursements)
(4).................................................................. 6.45%
</TABLE>
(1) The management fee has been reduced to reflect the voluntary waiver by the
Manager. The Manager can terminate this voluntary waiver at any time at
its sole discretion. The maximum management fee is 1.10%.
(2) As a result of 12b-1 Fees of 0.50% per annum of the Fund's average daily
net assets, a shareholder who has been in the Fund for 14.5 years may pay
more than the economic equivalent of the maximum front-end sales charges
permitted by the rules of the National Association of Securities Dealers,
Inc. The 12b-1 fees have been reduced to reflect the voluntary waiver by
the Distributor. The Distributor can terminate this voluntary waiver at
any time at its sole discretion. The maximum 12b-1 fee is 0.50%.
(3) Other Expenses would have been 13.70% absent the voluntary waiver by the
Administrator and reimbursement of other operating expenses by the
Manager.
(4) Total Fund Operating Expenses would have been 14.40% absent the voluntary
waivers and reimbursements described above in notes 1, 2 and 3.
Annual Operating Expenses were 6.53% for the fiscal year ended October 31,
1996. The Annual Operating Expenses in the table above are estimated based on
expenses expected to be incurred for the fiscal year ending October 31, 1997.
<TABLE>
<CAPTION>
EXAMPLE 1 year 3 years 5 years 10 years
- ------- ------ ------- ------- --------
<S> <C> <C> <C> <C>
You would pay the following expenses on a
$1,000 investment, assuming (1) 5% annual re-
turn and (2) redemption at the end of each time
period......................................... $64 $189 $311 $600
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES, AND ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. IN
ADDITION, THE 5% ANNUAL RETURN SHOULD NOT BE CONSIDERED REPRESENTATIVE OF PAST
OR FUTURE RETURNS, AND ACTUAL RETURNS MAY BE GREATER OR LESS THAN THE
ILLUSTRATION ABOVE.
BLANCHARD CAPITAL GROWTH FUND
FINANCIAL HIGHLIGHTS
- -------------------------------------------------------------------------------
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
The following table has been audited by Deloitte & Touche LLP, the Fund's
independent auditors. Their report, dated December 20, 1996, on the Fund's
financial statements for the year then ended October 31, 1996, and on the
following table for the year ended October 31, 1996, is included in the Annual
Report, which is incorporated by reference. The financial highlights for the
year ended October 31, 1995 were audited by other auditors, whose report
thereon dated December 22, 1995, expressed an unqualified opinion. This table
should be read in conjunction with the Fund's financial statements and notes
thereto, which may be obtained from the Fund.
<TABLE>
<CAPTION>
YEAR ENDED
OCTOBER 31,
---------------
1996 1995
- ------------------------------------------------ ------ ------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 7.66 $ 7.00
- ------------------------------------------------
INCOME FROM INVESTMENT OPERATIONS
- ------------------------------------------------
Net operating loss (0.44) (0.26)
- ------------------------------------------------
Net realized and unrealized gain on investments 1.56 0.92
- ------------------------------------------------ ------ ------
Total from investment operations 1.12 0.66
- ------------------------------------------------ ------ ------
NET ASSET VALUE, END OF PERIOD $ 8.78 $ 7.66
- ------------------------------------------------ ------ ------
TOTAL RETURN (A) 14.62% 9.43%
- ------------------------------------------------
RATIOS TO AVERAGE NET ASSETS
- ------------------------------------------------
Expenses (b) 6.53% 6.19%
- ------------------------------------------------
Net operating loss (4.93%) (4.20%)
- ------------------------------------------------
Expense waiver/reimbursement (c) 7.93% 1.97%
- ------------------------------------------------
SUPPLEMENTAL DATA
- ------------------------------------------------
Net assets, end of period (000 omitted) $1,706 $1,711
- ------------------------------------------------
</TABLE>
(a) Based on net asset value.
(b) Reflects the Fund's proportionate share of the respective Portfolio's
expenses and the Fund's fee waivers and expense reimbursements by the
Funds' Manager, Distributor and Administrator.
(c) This voluntary expense decrease is reflected in both the expense and net
investment income ratios shown above.
FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE FUND'S
ANNUAL REPORT, DATED OCTOBER 31, 1996, WHICH CAN BE OBTAINED FREE OF CHARGE.
FUND OBJECTIVE
Blanchard Capital Growth Fund seeks long-term capital growth. The Fund is
not intended to be a complete investment program, and there is no assurance
it will achieve its objective.
INVESTMENT POLICIES
INVESTMENT APPROACH
The Fund seeks to achieve its objective by investing all of its investable
assets in the Portfolio. The Portfolio will invest primarily in a broad
portfolio of common stocks. Under normal market conditions, the Portfolio
will invest at least 80% of its total assets in common stocks. The
Portfolio will seek to invest in stocks of companies with capitalizations
of $750 million to $4.0 billion. Current income, if any, is a
consideration incidental to the Portfolio's objective of long-term capital
growth. The Portfolio's advisers intend to utilize both quantitative and
fundamental research to identify undervalued stocks with a catalyst for
positive change.
The Portfolio is classified as a "non-diversified" fund under federal
securities law. The Portfolio's assets may be more concentrated in the
securities of any single issuer or group of issuers than if the Portfolio
were diversified.
The Portfolio may invest any portion of its assets not invested in common
stocks in high quality money market instruments and repurchase agreements.
For temporary defensive purposes, the Portfolio may invest without
limitation in these instruments. To the extent that the Portfolio departs
from its investment policies during temporary defensive periods, the Fund's
investment objective may not be achieved.
FUND STRUCTURE
The Portfolio has an objective identical to that of the Fund. The Fund may
withdraw its investment from the Portfolio at any time if the Trustees
determine that it is in the best interest of the Fund to do so. Upon any
such withdrawal, the Trustees would consider what action might be taken,
including investing all of the Fund's investable assets in another pooled
investment entity having substantially the same objective and policies as
the Fund or retaining an investment adviser to manage the Fund's assets
directly.
OTHER INVESTMENT PRACTICES
The Portfolio may also engage in the following investment practices, when
consistent with the Portfolio's overall objective and policies. These
practices, and certain associated risks, are more fully described in the
Statement of Additional Information.
FOREIGN SECURITIES. The Portfolio may invest up to 20% of its total assets
in foreign securities, including Depositary Receipts. Since foreign
securities are normally denominated and traded in foreign currencies, the
values of the Portfolio's foreign investments may be affected favorably or
unfavorably by currency exchange rates and exchange control regulations.
There may be less information publicly available about foreign companies
than U.S. companies, and they are not generally subject to accounting,
auditing and financial reporting standards and practices comparable to
those in the U.S. The securities of foreign companies may be less liquid
and more volatile than the securities of comparable U.S. companies.
Foreign settlement procedures and trade regulations may involve certain
risks (such as delay in payment or delivery of securities or in the
recovery of the Portfolio's assets held abroad) and expenses. It is
possible that nationalization or expropriation of assets, imposition of
currency exchange controls, confiscatory taxation, political or financial
instability and diplomatic developments could affect the value of the
Portfolio's investments in certain foreign countries. Foreign laws may
restrict the ability to invest in certain countries or issuers and special
tax considerations will apply to foreign securities. The risks can increase
if the Portfolio invests in securities of issuers in emerging markets.
The Portfolio may invest its assets in securities of foreign issuers in the
form of American Depositary Receipts, European Depositary Receipts, Global
Depositary Receipts or other similar securities representing securities of
foreign issuers (collectively, "Depositary Receipts"). The Portfolio
treats Depositary Receipts as interests in the underlying securities for
purposes of its investment policies. The Portfolio will limit its
investment in Depositary Receipts not sponsored by the issuer of the
underlying securities to no more than 5% of the value of its net assets (at
the time of investment).
MONEY MARKET INSTRUMENTS. The Portfolio may invest in cash or high-
quality, short-term money market instruments. Such instruments may include
U.S. Government securities, commercial paper of domestic and foreign
issuers and obligations of domestic and foreign banks. Investments in
foreign money market instruments may involve certain risks associated with
foreign investment.
REPURCHASE AGREEMENTS, SECURITIES LOANS AND FORWARD COMMITMENTS. The
Portfolio may enter into agreements to purchase and resell securities at an
agreed-upon price and time. The Portfolio also has the ability to lend
portfolio securities in an amount equal to not more than 30% of its total
assets to generate additional income. These transactions must be fully
collateralized at all times. The Portfolio may purchase securities for
delivery at a future date, which may increase its overall investment
exposure and involves a risk of loss if the value of the securities
declines prior to the settlement date. These transactions involve some
risk to the Portfolio if the other party should default on its obligation
and the Portfolio is delayed or prevented from recovering the collateral or
completing the transaction.
BORROWING AND REVERSE REPURCHASE AGREEMENTS. The Portfolio may borrow
money from banks for temporary or short-term purposes, but will not borrow
for leveraging purposes. The Portfolio may also sell and simultaneously
commit to repurchase a portfolio security at an agreed-upon price and time,
to avoid selling securities during unfavorable market conditions in order
to meet redemptions. Whenever the Portfolio enters into a reverse
repurchase agreement, it will establish a segregated account in which it
will maintain liquid assets on a daily basis in an amount at least equal to
the repurchase price (including accrued interest). The Portfolio would be
required to pay interest on amounts obtained through reverse repurchase
agreements, which are considered borrowing under federal securities laws.
STAND-BY COMMITMENTS. The Portfolio may enter into put transactions,
including transactions sometimes referred to as stand-by commitments, with
respect to money market instruments in its portfolio. In these
transactions, the Portfolio would acquire the right to sell a security at
an agreed upon price within a specified period prior to its maturity date.
These transactions involve some risk to the Portfolio if the other party
should default on its obligation and the Portfolio is delayed or prevented
from recovering the collateral or completing the transaction. Acquisition
of puts will have the effect of increasing the cost of the securities
subject to the put and thereby reducing the yields otherwise available from
such securities.
CONVERTIBLE SECURITIES. The Portfolio may invest up to 20% of its net
assets in convertible securities, which are securities generally offering
fixed interest or dividend yields which may be converted either at a stated
price or stated rate for common or preferred stock. Although to a lesser
extent than with fixed-income securities generally, the market value of
convertible securities tends to decline as interest rates increase, and
increase as interest rates decline. Because of the conversion feature, the
market value of convertible securities also tends to vary with fluctuations
in the market value of the underlying common or preferred stock. There are
no rating limitations applicable to the convertible securities in which the
Portfolio may invest.
OTHER INVESTMENT COMPANIES. The Portfolio may invest up to 10% of its
total assets in shares of other investment companies, subject to applicable
regulatory limitations.
STRIPS. The Portfolio may invest up to 20% of its total assets in
separately traded principal and interest components of securities backed by
the full faith and credit of the U.S. Government, including instruments
known as "STRIPS". The value of these instruments tends to fluctuate more
in response to changes in interest rates than the value of ordinary
interest-paying debt securities with similar maturities. The risk is
greater when the period to maturity is longer.
DERIVATIVES AND RELATED INSTRUMENTS. The Portfolio may invest its assets
in derivative and related instruments to hedge various market risks or to
increase the Portfolio's income or gain. Some of these instruments will be
subject to asset segregation requirements to cover the Portfolio's
obligations. The Portfolio may (i) purchase, write and exercise call and
put options on securities and securities indexes (including using options
in combination with securities, other options or derivative instruments);
(ii) enter into swaps, futures contracts and options on futures contracts;
(iii) employ forward currency contracts; and (iv) purchase and sell
structured products, which are instruments designed to restructure or
reflect the characteristics of certain other investments.
There are a number of risks associated with the use of derivatives and
related instruments and no assurance can be given that any strategy will
succeed. The value of certain derivatives or related instruments in which
the Portfolio invests may be particularly sensitive to changes in
prevailing economic conditions and market value. The ability of the
Portfolio to successfully utilize these instruments may depend in part upon
the ability of the Portfolio's advisers to forecast these factors
correctly. Inaccurate forecasts could expose the Portfolio to a risk of
loss. There can be no guarantee that there will be a correlation between
price movements in a hedging instrument and in the Portfolio assets being
hedged. The Portfolio is not required to use any hedging strategies.
Hedging strategies, while reducing risk of loss, can also reduce the
opportunity for gain. Derivatives transactions not involving hedging may
have speculative characteristics, involve leverage and result in more risk
to the Portfolio than hedging strategies using the same instruments. There
can be no assurance that a liquid market will exist at a time when the
Portfolio seeks to close out a derivatives position. Activities of large
traders in the futures and securities markets involving arbitrage, "program
trading," and other investment strategies may cause price distortions in
derivatives markets. In certain instances, particularly those involving
over-the-counter transactions or forward contracts, there is a greater
potential that a counterparty or broker may default. In the event of a
default, the Portfolio may experience a loss. For additional information
concerning derivatives, related instruments and the associated risks, see
the Statement of Additional Information.
PORTFOLIO TURNOVER. The frequency of the Portfolio's portfolio
transactions will vary from year to year. The Portfolio's investment
policies may lead to frequent changes in investments, particularly in
periods of rapidly changing market conditions. High portfolio turnover
rates would generally result in high transaction costs, including brokerage
commissions or dealer mark-ups, and would make it more difficult for the
Portfolio to qualify as a regulated investment company under federal tax
law.
LIMITING INVESTMENT RISKS
Specific investment restrictions help the Portfolio limit investment risks
for the Fund's shareholders. These restrictions prohibit the Portfolio
from: (a) with respect to 50% of its total assets, holding more than 10%
of the voting securities of any issuer; (b) investing more than 15% of its
net assets in illiquid securities (which include securities restricted as
to resale unless they are determined to be readily marketable in accordance
with procedures established by the Board of Trustees of the Portfolio); or
(c) investing more than 25% of its total assets in any one industry. A
complete description of these and other investment policies is included in
the Statement of Additional Information. Except for restriction (c) above
and investment policies designated as fundamental in the Statement of
Additional Information, the investment objective and policies of the
Portfolio and the investment policies of the Fund are not fundamental.
Shareholder approval is not required to change any non-fundamental
investment policy. However, in the event of a change in the Fund's or
Portfolio's investment objective or policies, shareholders will be given at
least 30 days' prior written notice.
RISK FACTORS
The Fund does not constitute a balanced or complete investment program, and
the net asset value of the shares of the Fund can be expected to fluctuate
based on the value of the securities held by the Portfolio. The Portfolio
is subject to the following general risks and considerations associated
with equity investing, as well as the risks discussed herein. 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.
Because the Portfolio is "non-diversified," the value of the Fund's shares
is more susceptible to developments affecting issuers in which the
Portfolio invests.
For a discussion of certain other risks associated with the Portfolio's
additional investment activities, see "Other Investment Practices" above.
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 Fund 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. VCM is responsible for managing the Fund and overseeing the
investment of its assets, subject at all times to the supervision of the
Board members. In addition, VCM selects, monitors and evaluates the
Portfolio Adviser. VCM will review the Portfolio Adviser's performance
record periodically, and will make changes if necessary, subject to Board
member and shareholder approval.
MANAGEMENT FEES. Under the terms of the management contract, VCM receives a
monthly fee of .70% of the Fund's average daily net assets and the
Portfolio Adviser receives .40% per annum of the Fund's average daily net
assets directly from the Portfolio, as described below. The total fee of
1.10% is higher than the fees paid by most investment companies.
The portion of the fee based upon the average daily net assets of the Fund
shall be accrued daily at the rate of 1/365th of the applicable percentage
applied to the daily net assets of the Fund.
The management contract provides for the voluntary waiver of expenses by
VCM from time to time. VCM can terminate this voluntary waiver of expenses
at any time with respect to the Fund at its sole discretion. VCM has also
undertaken to reimburse the Fund for operating expenses in excess of
limitations established by certain states.
The Portfolio pays for all its expenses including legal and auditing
expenses; registration fees; taxes on the sales of portfolio securities;
brokerage commissions; Portfolio trustee fees; expenses connected with the
execution, recording and settlement of security transactions; fees and
expenses of the Portfolio's custodian for all services to the Portfolio;
expenses of preparing and mailing reports to investors and to government
agencies and commissions; expenses of meetings of investors and the
advisory fees of .40% of the Portfolio's average daily net assets payable
to the Portfolio Adviser under the Investment Advisory Agreement. In
addition, the Portfolio pays an administrative fee to The Chase Manhattan
Bank at an annual rate of .05% of the Portfolio's average daily net assets
pursuant to an Administration Agreement wherein Chase provides facilities
and personnel necessary to operate the Portfolio.
VCM'S BACKGROUND. Virtus Capital Management, Inc., a Maryland corporation
formed in 1995, is a wholly owned subsidiary of Signet Banking Corporation.
Signet Banking Corporation is a multi-state, multi-bank holding company
which has provided investment management services since 1956. VCM, which is
a registered investment adviser, manages, in addition to the Funds, The
Virtus Funds, three fixed income common trust funds with $163.6 million in
assets. As part of their regular banking operations, Signet Bank may make
loans to public companies.
PORTFOLIO ADVISORY SERVICES
THE PORTFOLIO'S ADVISERS
Chase acts as investment adviser to the Portfolio pursuant to an Investment
Advisory Agreement and has overall responsibility for investment decisions
of the Portfolio, subject to the oversight of the Board of Trustees. Chase
is a wholly owned subsidiary of The Chase Manhattan Corporation, a bank
holding company. Chase and its predecessors have over 100 years of money
management experience. For its investment advisory services to the
Portfolio, Chase is entitled to receive an annual fee computed daily and
paid monthly based at an annual rate equal to 0.40% of the Portfolio's
average daily net assets. Chase is located at 270 Park Avenue, New York,
New York 10017.
Chase Asset Management, Inc. (`CAM''), a registered investment adviser, is
the sub-investment adviser to the Portfolio pursuant to a Sub-Investment
Advisory Agreement between CAM and Chase. CAM is a wholly-owned operating
subsidiary of Chase. CAM makes investment decisions for the Portfolio on a
day-to-day basis. For these services, CAM is entitled to receive a fee,
payable by Chase from its advisory fee, at an annual rate equal to 0.20% of
the Portfolio's average daily net assets. CAM was recently formed for the
purpose of providing discretionary investment advisory services to
institutional clients and to consolidate Chase's investment management
function. The same individuals who serve as portfolio managers for Chase
also serve as portfolio managers for CAM. CAM is located at 1211 Avenue of
the Americas, New York, New York 10036.
PORTFOLIO MANAGER. Dave Klassen, Director of Domestic Equity Management at
Chase, and Tony Gleason, Vice President of Chase, have been responsible for
the day-to-day management of the Portfolio since September, 1995. Mr.
Klassen joined Chase in March 1992 and, in addition to managing the Capital
Growth Portfolio, is a manager of the Vista Small Cap Equity Fund and the
Growth and Income Portfolio. Prior to joining Chase, Mr. Klassen was a
Vice-President and portfolio manager at Dean Witter Reynolds, responsible
for managing several mutual funds and other accounts. Mr. Gleason is also
responsible for managing the Vista Equity Income Fund. Mr. Gleason joined
Chase in 1995 with 10 years of investment experience. Prior to joining
Chase, Mr. Gleason spent nine years as a Vice President and Portfolio
Manager with Prudential Equity Management. In addition, the portfolio
managers utilize a computer model program, which scans over 1600 equity
securities in their quest for attractive value, used in the U.S. equity
selection process.
EFFECT OF BANKING LAWS
The Portfolio Adviser has received the opinion of its legal counsel that it
may provide services described in its Investment Advisory Agreement and
Custodian Agreement with the Portfolio, without violating the federal
banking law commonly known as the Glass-Steagall Act. Similarly, VCM
believes, based on advice of its counsel, that VCM may perform services
described in its management contract with the Fund, without violating the
Act. The Act generally bars banks from publicly underwriting or
distributing certain securities.
Decisions of the U.S. Supreme Court and banking regulators support the
position that a bank may act as investment adviser to a registered, open-
ended investment company. Based on the advice of its counsel, the Portfolio
Adviser and VCM each believe that it may serve as investment adviser to a
registered, open-end investment company.
Regarding the performance of custodial activities, the staff of the Office
of the Comptroller of the Currency, which supervises national banks, has
issued opinion letters stating that national banks may engage in custodial
activities. Therefore, the Portfolio Adviser believes, based on advice of
counsel, that it may serve as Custodian to the Portfolio as an appropriate,
incidental national banking function and as a proper adjunct to its serving
as Portfolio Adviser to the Portfolio.
Possible future changes in federal law or administrative or judicial
interpretations of current or future law, however, could prevent the
Portfolio Adviser from continuing to perform investment advisory or
custodial services for the Portfolio, and could prevent VCM from continuing
to perform management services for the Fund. If that occurred, the Fund's
trustees would then consider what action would be in the best interest of
the Fund's shareholders.
HOW TO INVEST
You may purchase shares of the Fund from Federated Securities Corp., the
Fund's principal Distributor. Federated Securities Corp. is a subsidiary of
Federated Investors. You may also purchase shares from broker-dealers who
have entered into a dealer agreement with the Distributor at net asset
value which is computed once daily as of the close of the options exchanges
(normally 4:15 P.M. New York time). If your order is received after the
above time, your shares will be purchased at the net asset value on the
next business day. The Fund's net asset value per share is determined by
dividing the value of the Fund's net assets by the total number of its
shares outstanding. 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.
For your initial investment, there is a $3,000 minimum requirement. The
minimum initial investment requirement for qualified pension plans (IRAs,
Keoghs, etc.) is $2,000. The minimum investment requirement for additional
investments in the Fund is at least $200 per investment. (The foregoing
minimum investment requirements may be modified or waived at any time at
our discretion.) We charge no redemption fee when you redeem your shares
and there is no fee on reinvestment of any dividends or distributions.
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 Fund 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
cancelled and you could be liable for any losses or fees incurred. Payments
transmitted by check are accepted subject to collection at full face
amount.
Orders 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.
PURCHASES 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: State Street Bank and
Trust Company, ABA number 011000028, Account number 0627-975-6, Boston,
Massachusetts 02266, indicating your account number and the account
registration. Shares cannot be purchased by wire on holidays when wire
transfers are restricted. Questions on wire purchases should be directed to
your shareholder services representative at the telephone number listed on
your account statement.
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 transferral 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 pre-designated 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 days after the form is received.
GENERAL INFORMATION
All ordinary income, dividends and capital gain 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 date 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 (on or
about the 10th day) 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 if the value of the account drops below $10,000 due to
transfer or redemption of shares. In a 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 a 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 PRIVILEGES
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 and
such exchanges may be made at net asset value without paying a redemption
fee or sales charge upon such exchange. Before making an exchange, you
should read the Prospectus concerning the participating fund into which
your exchange is being made. The other funds currently offered in the
Blanchard Group of Funds are Blanchard Growth & Income Fund, Blanchard
Global Growth Fund, Blanchard Flexible Income Fund, Blanchard Short-Term
Flexible Income Fund, Blanchard Flexible Tax-Free Bond Fund and Blanchard
Precious Metals Fund, Inc. For information on The Virtus Funds, please
call 1-800-829-3863.
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 Fund's 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. In order to protect itself and
shareholders from liability for unauthorized or fraudulent telephone
transactions, the Fund will use reasonable procedures such as recording
calls in an attempt to verify the identity of a person making a telephone
redemption request. As a result of the Fund's policy, neither the 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. 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 fund are qualified for
sale. We do not place any limit on the number of exchanges that may be
made. 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 the Fund to
the disadvantage of other shareholders, we reserve the right to modify or
terminate this Exchange 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 your shares by telephone by calling
1-800-829-3863, prior to 4:00 P.M., Eastern time. All calls will be
recorded. Redemption 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 the Fund or the
Transfer Agent. Proceeds from redemption requests received on holidays when
wire transfers are restricted will be wired the following business day.
Questions about telephone redemptions on days when wire transfers are
restricted should be directed to your shareholder services representative
at the telephone number listed on your account statement.
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 revise these instructions, simply complete and file a
new telephone redemption authorization form. There is no charge for this
service. As long as the identification procedures described above are
followed, neither the 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
Privileges,''for additional information with respect to losses resulting
from unauthorized telephone transactions.
You may also request, by placing a call to the applicable 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 Fund does
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 the
Transfer Agent 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, Massachusetts 02266-8612.
Where share certificates have been issued, the certificates must be
endorsed and must accompany the redemption request. Signatures on
redemption requests for amounts in excess of $25,000 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
associations, 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 (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 Transfer Agent prior to 4:00 P.M. Eastern 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
involuntarily 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.
DISTRIBUTION OF SHARES OF THE FUND
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.
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 of Trustees, provided that for any period the total
amount of fees representing an expense to the Trust shall not exceed an
annual rate of .50% of the average daily net assets of shares of the Fund
held in the accounts during the period for which the brokers, dealers, and
administrators provide services. Any fees paid by the distributor with
respect to shares of the Fund pursuant to the distribution plan will be
reimbursed by the Trust from the assets of the shares 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 dealer. 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 their customers
invested in the Trust for providing administrative services. This fee, if
paid, will be reimbursed by VCM and not the Trust.
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:
MAXIMUM AVERAGE AGGREGATE DAILY NET
ADMINISTRATIVE FEE ASSETS OF THE TRUST
.150% on the first $250 million
.125% on the next $250 million
.100% on the next $250 million
.075% on assets in excess of $750 million
The administrative fee received during any fiscal year for the Fund shall
be at least $75,000. Federated Administrative Services may voluntarily
waive a portion of its fee.
TRANSFER AGENT. Federated Shareholder Services Company, P. O. Box 8600,
Boston, Massachusetts, 02266-8600, is the Fund's Transfer Agent and
Dividend Disbursing Agent.
TAX MATTERS
The Fund intends to qualify each year and elect to be treated as a separate
`regulated investment company'' under Subchapter M of the Internal Revenue
Code of 1986, as amended (the `Code''). A regulated investment company
that distributes all of its taxable income to its shareholders in
accordance with the timing requirements imposed by the Code, which the Fund
intends to do, is not subject to Federal income tax on the amounts so
distributed. If for any taxable year the Fund does not qualify for the
treatment as a regulated investment company, all its taxable income will be
subject to tax at regular corporate rates without any deduction for
distributions to its shareholders, and such distributions, in turn, will be
taxable to the shareholders as ordinary dividends to the extent of the
Fund's current and accumulated earnings and profits. Because the Fund
invests all of its assets in the Portfolio which is classified as a
partnership for Federal income tax purposes, the Fund will be deemed to own
a proportionate share of the income of the Portfolio in which it invests,
for purposes of determining whether it qualifies as a regulated investment
company.
The Trust is organized as a Massachusetts business trust and, under current
law, is not liable for any income or franchise tax in the Commonwealth of
Massachusetts as long as the Fund (and each other series of the Trust)
qualifies as a regulated investment company under the Code.
Distributions by the Fund of its ordinary income (net of expenses) and the
excess, if any, of its net short-term capital gain over its net long-term
capital loss are generally taxable to shareholders as ordinary income. Such
distributions are treated as dividends for Federal income tax purposes. A
portion of the ordinary income dividends paid by the Fund with respect to a
given year (essentially, the portion attributable to qualifying dividends
received by the underlying Portfolio from domestic corporations during the
year) may qualify for the 70% dividends-received deductions for corporate
shareholders. Distributions by the Fund of the excess, if any, of its net
long-term capital gain over its net short-term capital loss are designated
as capital gain dividends and are taxable to shareholders as long-term
capital gains, regardless of their holding periods in their shares.
Ordinary income and capital gain dividends from the Fund may also be
subject to state and local taxes.
Investors should carefully consider the tax implications of purchasing
shares just prior to a dividend record date. Investors purchasing shares
just prior to an ordinary income or capital gain dividend record date will
be taxed on the entire dividend received, even though their cost for shares
already reflected the amount of such dividend.
Distributions to shareholders will be treated in the same manner for
Federal income tax purposes whether received in cash or reinvested in
additional Fund shares. In general, distributions by the Fund are taken
into account by shareholders in the year in which they are made. However,
certain distributions made during January will be treated as having been
paid by the Fund and received by its shareholders on December 31 of the
preceding year. A statement setting forth the Federal income tax status of
all distributions made (or deemed made) during the year, including the
allocation to ordinary income dividends (and any portion thereof which
qualify for the dividends-received deduction for corporations) and capital
gain dividends, will be sent to the Fund's shareholders promptly after the
end of each year.
A shareholder will recognize gains or losses upon the sale or redemption of
shares of the Fund in an amount equal to the difference between the
proceeds of the sale or redemption and the shareholder's adjusted tax basis
in the shares. Any loss realized upon a taxable disposition of shares
within six months from the date of their purchase will be treated as a
long-term capital loss to the extent of any capital gain dividends received
on such shares. All or a portion of any loss realized upon a taxable
disposition of shares of the Fund may be disallowed if other shares of the
Fund are purchased within 30 days before or after such disposition.
Under the back-up withholding rules of the Code, a shareholder may be
subject to 31% withholding of Federal income tax on dividends and
redemption payments made by the Fund. To avoid this back-up withholding,
you must provide the Fund with a correct taxpayer identification number
(which for an individual is usually one's Social Security number) or
certify that you are a corporation or otherwise exempt from or not subject
to back-up withholding.
The foregoing discussion of Federal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus and is
subject to change by legislative or administrative action. You should also
review the more detailed discussion of Federal income tax considerations in
the Statement of Additional Information for the Fund. In addition, you
should consult with your own tax advisor as to the tax consequences of
investing in the Fund, including the application of state and local taxes
to you, which may differ from the Federal income tax consequences described
above.
PERFORMANCE COMPUTATION INFORMATION
Advertisements and communications to investors regarding the Fund may cite
certain performance, ranking and rating information of the Fund and the
Portfolio and may make performance comparisons to other funds or to
relevant indices, as described below.
TOTAL RETURN. Cumulative total return data is computed by considering all
elements of return, including reinvestment of dividends and capital gain
distributions, 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.
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., CDA and Morningstar, Inc. In addition, because
the Fund invests 100% of its assets in the portfolio which has identical
investment objectives, the Fund may cite the performance and ranking
information of its Portfolio (which includes the performance of predecessor
mutual funds prior to their conversion to the Portfolio) and may make
certain performance, ranking and rating comparisons. The Fund may also
discuss the past performance, ranking and rating of the 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, or the total
return of indexes of U.S. markets, world markets, individual countries
undergoing privatization, or of world indexes of countries undergoing
privatization, 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 Fund Investors. The Fund
may also compare the historical returns on various investments, performance
indexes of those investments or 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 management in selecting
the type and quality of securities in which the Fund may invest, and is
affected by operating, distribution and marketing expenses.
ADDITIONAL INFORMATION ABOUT THE FUND AND THE PORTFOLIO
THE FUND
The Fund is a non-diversified series of Blanchard Funds (the `Trust''), a
Massachusetts business trust organized on January 24, 1986 which currently
consists of seven series of shares. The other series of the Trust's shares
of beneficial interest, which are offered pursuant to separate
prospectuses, are Blanchard Growth & Income Fund, Blanchard Global Growth
Fund, Blanchard Flexible Income Fund, Blanchard Short-Term Flexible Income
Fund and Blanchard Flexible Tax-Free Bond Fund.
The Fund is classified as a `non-diversified'' investment company under
the 1940 Act, which means that the Fund is not limited by the 1940 Act in
the proportion of its assets that may be invested in the securities of a
single issuer. The Fund intends, however, to comply with the
diversification requirements imposed by the U.S. Internal Revenue Code of
1986, as amended, for qualification as a regulated investment company. See
`Tax Matters'' in the Prospectus and in the Statement of Additional
Information.
INVESTOR MEETINGS AND VOTING
Under Massachusetts law, the Trust and its series are generally not
required to hold annual or special shareholder meetings. However, special
meetings of shareholders may be held for such purposes as electing
trustees, changing fundamental policies, approving an investment
management/advisory agreement or approving a distribution and marketing
plan, if any, and, at the request of the shareholders, to replace trustees.
Shareholders holding 10% or more of the Trust's outstanding shares may call
a special meeting of shareholders. Trustees may be removed by the Trustees
or by shareholders at a special meeting called for this purpose.
Shareholders shall be given access to a list of the names and addresses of
all other shareholders, the number of shareholders and the cost of mailing
a request to them.
Whenever a vote is requested on matters pertaining to the Portfolio, the
Trust will hold a meeting of the Fund's shareholders and will cast its vote
as instructed by the Fund's shareholders. Shares of the Fund for which no
voting instructions have been received will be voted in the same proportion
as those shares for which voting instructions are received. As with any
mutual fund, other investors in the Portfolio could control the results of
voting at the Portfolio level.
The Fund's shares represent shares of beneficial interest. Each share has
equal rights with respect to voting matters of the Fund. In the event of
dissolution or liquidation of the Fund, holders of Fund shares will receive
pro rata, subject to the rights of creditors, the proceeds of the sale of
the Fund's assets less its liabilities. There are no preemptive or
conversion rights applicable to the shares of the Fund. Shares of the Fund,
when issued, will be fully paid, non-assessable and transferable. The
trustees may create additional series or classes of shares without
shareholder approval. Each series of the Trust is responsible only for its
own expenses and operating costs and incurs no liability with respect to
the expenses and costs of any other series, other than those which affect
the series as a group and are allocated among the series based upon their
relative average net assets during the year.
THE PORTFOLIO
The Portfolio is organized as a trust under the laws of the State of New
York. The Portfolio's Declaration of Trust provides that the Fund and other
entities investing in the Portfolio (e.g., other investment companies,
insurance company separate accounts and common and commingled trust funds)
will be liable for all obligations of the Portfolio. However, the risk of
the Fund's incurring financial loss on account of such liability is limited
to circumstances in which both inadequate insurance existed and the
Portfolio itself was unable to meet its obligations. Accordingly, the
trustees believe that neither the Fund nor their shareholders will be
adversely affected by reason of the Fund's investing in the Portfolio.
UNIQUE CHARACTERISTICS OF THE FUND AND PORTFOLIO STRUCTURE
Unlike other mutual funds which directly acquire and manage their own
portfolio securities, the Fund invests all of its investable assets in the
Portfolio, a separate registered investment company. Therefore, a
shareholder's interest in the Portfolio's securities is indirect. In
addition to selling a beneficial interest to the Fund, the Portfolio may
sell beneficial interests to other mutual funds or institutional investors.
Such investors will invest in the Portfolio on the same terms and
conditions and will pay a proportionate share of the Portfolio's expenses.
However, other investors investing in the Portfolio are not required to
sell their shares at the same public offering price as the Fund and may
bear different levels of ongoing expenses than the Fund. Shareholders of
the Fund should be aware that these differences may result in differences
in returns experienced in the different funds that invest in the Portfolio.
Such differences in returns are also present in other mutual fund
structures.
Smaller funds investing in the Portfolio may be materially affected by the
actions of larger funds investing in the Portfolio. For example, if a
large fund withdraws from the Portfolio, the remaining funds may experience
higher pro rata operating expenses, thereby producing lower returns.
Additionally, the Portfolio may become less diverse, resulting in increased
portfolio risk. However, this possibility also exists for traditionally
structured funds which have large or institutional investors. Funds with a
greater pro rata ownership in the Portfolio could have effective voting
control of the operations of the Portfolio. Whenever the Trust is
requested to vote on matters pertaining to the Portfolio, the Trust will
hold a meeting of shareholders of the Fund and will cast all of its votes
in the same proportion as do the Fund's shareholders. Shares of the Fund
for which no voting instructions have been received will be voted in the
same proportion as those shares for which voting instructions are received.
Certain changes in the Portfolio's objective, policies or restrictions may
require the Trust to withdraw the Fund's interest in the Portfolio. Any
withdrawal could result in a distribution in kind of portfolio securities
(as opposed to a cash distribution from the Portfolio). The Fund could
incur brokerage fees or other transaction costs in converting such
securities to cash. In addition, a distribution in kind may result in a
less diversified portfolio of investments or adversely affect the liquidity
of the Fund.
State securities regulations generally do not permit the same individuals
who are disinterested Trustees of the Trust to be Trustees of the Portfolio
absent the adoption of written procedures by a majority of the
disinterested Trustees of the Trust reasonably appropriate to deal with
potential conflicts of interest up to and including creating a separate
Board of Trustees. The Trustees of the Trust, including a majority of the
disinterested Trustees, have adopted procedures they believe are reasonably
appropriate to deal with any conflict of interest up to and including
creating a separate Board of Trustees.
Investors in the Fund may obtain information about whether an investment in
the Portfolio may be available through other funds by calling 1-800-829-
3863.
OTHER INFORMATION
This Prospectus omits certain information contained in the registration
statement of the Fund filed with the SEC. Copies of the registration
statement, including items omitted herein, may be obtained from the SEC by
paying the charges prescribed under its rules and regulations. The
Statement of Additional Information included in the registration statement
may be obtained without charge from the Fund.
For information about the Trustees and officers of the Fund and the
Portfolio see the Statement of Additional Information.
The Code of Ethics of the Portfolio Adviser and the Fund prohibits all
affiliated personnel from engaging in personal investment activities which
compete with or attempt to take advantage of the Fund's planned portfolio
transactions. The objective of the Code of Ethics of both the Fund and
Portfolio Adviser is that their operations be carried out for the exclusive
benefit of the Fund's shareholders. Both organizations maintain careful
monitoring of compliance with the Code of Ethics.
No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and in the
Statement of Additional Information, and information or representations not
herein contained, if given or made, must not be relied upon as having been
authorized by the Fund. This Prospectus does not constitute an offer or
solicitation in any jurisdiction in which such offering may not lawfully be
made.
INDEPENDENT AUDITORS. Deloitte & Touche LLP, 2500 One PPG Place,
Pittsburgh, PA 15222-5401, has been appointed the independent auditors for
the Fund.
STATEMENT OF ADDITIONAL INFORMATION
BLANCHARD GROWTH & INCOME FUND
FEDERATED INVESTORS TOWER
PITTSBURGH, PA 15222-3779
This Statement is not a prospectus but should be read in conjunction with
the current prospectus dated February 28, 1997 (the `Prospectus''),
pursuant to which the Blanchard Growth & Income Fund (the `FUND'') is
offered. Please retain this document for future reference.
To obtain a copy of the Prospectus or a paper copy of this Statement of
Additional Information, if you have received your Statement of Additional
Information electronically, please call the FUND at 1-800-829-3863.
TABLE OF CONTENTS Page
General Information and History 1
Investment Objectives, Policies and Restrictions 1
Portfolio Transactions 11
Computation of Net Asset Value 12
Performance Information 13
Additional Purchase and Redemption Information 14
Tax Matters 14
The Management of the FUND 18
Management Services 25
Administrative Services 25
Distribution Plan 26
Description of the FUND 26
Shareholder Reports 27
Appendix A 28
Appendix B 30
Manager
Virtus Capital Management, Inc.
Portfolio Adviser
The Chase Manhattan Bank
Distributor
Federated Securities Corp.
Transfer Agent
Federated Shareholder Services Company
Independent Auditors
Deloitte & Touche LLP
Dated: February 28, 1997
FEDERATED SECURITIES CORP.
GENERAL INFORMATION AND HISTORY
As described in the Blanchard Growth & Income Fund's (the `FUND'')
Prospectus, the FUND is a non-diversified series of Blanchard Funds, a
Massachusetts business trust that was organized under the name `Blanchard
Strategic Growth Fund''(the ``Trust''). The trustees of the Trust approved
the change in the name of the Trust on December 4, 1990.
Effective March 31, 1996, the merger of The Chase Manhattan
Corporation with and into Chemical Banking Corporation was consummated and
Chemical Banking Corporation thereupon changed its name to The Chase
Manhattan Corporation. The Chase Manhattan Corporation is now the parent of
The Chase Manhattan Bank, the adviser to the Growth & Income Portfolio (the
`Portfolio'').
INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS
The FUND seeks its investment objectives by investing 100% of its net
assets in the Growth & Income Portfolio (the `Portfolio''). The Portfolio
has investment objectives identical to the FUND and invests in accordance
with investment policies and restrictions identical to those of the FUND.
The investment objectives of the FUND and the Portfolio may not be
changed except by a majority vote of shareholders.
The investment policies of the FUND and the Portfolio, as described
below, are not fundamental and may be changed without shareholder approval.
INVESTMENT POLICIES
The Prospectus sets forth the investment objective and various
investment policies of the Portfolio. This Statement of Additional
Information supplements and should be read in conjunction with the related
sections of the Prospectus. For descriptions of the securities ratings of
Moody's Investors Service, Inc. (`Moody's''), Standard & Poor's Ratings
Group (`Standard & Poor's'') and Fitch Investors Service, Inc. (``Fitch''),
see Appendix B.
U.S. GOVERNMENT SECURITIES - U.S. Government Securities include (1)
U.S. Treasury obligations, which generally differ only in their interest
rates, maturities and times of issuance, including: U.S. Treasury bills
(maturities of one year or less), U.S. Treasury notes (maturities of one to
ten years) and U.S. Treasury bonds (generally maturities of greater than
ten years); and (2) obligations issued or guaranteed by U.S. Government
agencies and instrumentalities which are supported by any of the following:
(a) the full faith and credit of the U.S. Treasury, (b) the right of the
issuer to borrow any amount listed to a specific line of credit from the
U.S. Treasury, (c) discretionary authority of the U.S. Government to
purchase certain obligations of the U.S. Government agency or
instrumentality or (d) the credit of the agency or instrumentality.
Agencies and instrumentalities of the U.S. Government include but are not
limited to: Federal Land Banks, Federal Financing Banks, Banks for
Cooperatives, Federal Intermediate Credit Banks, Farm Credit Banks, Federal
Home Loan Banks, Federal Home Loan Mortgage Corporation, Federal National
Mortgage Association, Student Loan Marketing Association, United States
Postal Service, Chrysler Corporate Loan Guarantee Board, Small Business
Administration, Tennessee Valley Authority and any other enterprise
established or sponsored by the U.S. Government. Certain U.S. Government
Securities, including U.S. Treasury bills, notes and bonds, Government
National Mortgage Association certificates and Federal Housing
Administration debentures, are supported by the full faith and credit of
the United States. Other U.S. Government Securities are issued or
guaranteed by federal agencies or government sponsored enterprises and are
not supported by the full faith and credit of the United States. These
securities include obligations that are supported by the right of the
issuer to borrow from the U.S. Treasury, such as obligations of the Federal
Home Loan Banks, and obligations that are supported by the creditworthiness
of the particular instrumentality, such as obligations of the Federal
National Mortgage Association or Federal Home Loan Mortgage Corporation.
For a description of certain obligations issued or guaranteed by U.S.
Government agencies and instrumentalities, see Appendix A.
In addition, certain U.S. Government agencies and instrumentalities
issue specialized types of securities, such as guaranteed notes of the
Small Business Administration, Federal Aviation Administration, Department
of Defense, Bureau of Indian Affairs and Private Export Funding
Corporation, which often provide higher yields than are available from the
more common types of government-backed instruments. However, such
specialized instruments may only be available from a few sources, in
limited amounts, or only in very large denominations; they may also require
specialized capability in portfolio servicing and in legal matters related
to government guarantees. While they may frequently offer attractive
yields, the limited-activity markets of many of these securities means
that, if the Portfolio were required to liquidate any of them, it might not
be able to do so advantageously; accordingly, the Portfolio investing in
such securities normally to hold such securities to maturity or pursuant to
repurchase agreements, and would treat such securities (including
repurchase agreements maturing in more than seven days) as illiquid for
purposes of its limitation on investment in illiquid securities.
BANK OBLIGATIONS - Investments in bank obligations are limited to
those of U.S. banks (including their foreign branches) which have total
assets at the time of purchase in excess of $1 billion and the deposits of
which are insured by either the Bank Insurance Fund or the Savings
Association Insurance Fund of the Federal Deposit Insurance Corporation,
and foreign banks (including their U.S. branches) having total assets in
excess of $10 billion (or the equivalent in other currencies), and such
other U.S. and foreign commercial banks which are judged by the advisers to
meet comparable credit standing criteria.
Bank obligations include negotiable certificates of deposit, bankers'
acceptances, fixed time deposits and deposit notes. A certificate of
deposit is a short-term negotiable certificate issued by a commercial bank
against funds deposited in the bank and is either interest-bearing or
purchased on a discount basis. A bankers' acceptance is a short-term draft
drawn on a commercial bank by a borrower, usually in connection with an
international commercial transaction. The borrower is liable for payment
as is the bank, which unconditionally guarantees to pay the draft at its
face amount on the maturity date. Fixed time deposits are obligations of
branches of United States banks or foreign banks which are payable at a
stated maturity date and bear a fixed rate of interest. Although fixed
time deposits do not have a market, there are no contractual restrictions
on the right to transfer a beneficial interest in the deposit to a third
party. Fixed time deposits subject to withdrawal penalties and with
respect to which the Portfolio cannot realize the proceeds thereon within
seven days are deemed "illiquid" for the purposes of its restriction on
investments in illiquid securities. Deposit notes are notes issued by
commercial banks which generally bear fixed rates of interest and typically
have original maturities ranging from eighteen months to five years.
Banks are subject to extensive governmental regulations that may limit
both the amounts and types of loans and other financial commitments that
may be made and the interest rates and fees that may be charged. The
profitability of this industry is largely dependent upon the availability
and cost of capital funds for the purpose of financing lending operations
under prevailing money market conditions. Also, general economic
conditions play an important part in the operations of this industry and
exposure to credit losses arising from possible financial difficulties of
borrowers might affect a bank's ability to meet its obligations. Bank
obligations may be general obligations of the parent bank or may be limited
to the issuing branch by the terms of the specific obligations or by
government regulation. Investors should also be aware that securities of
foreign banks and foreign branches of United States banks may involve
foreign investment risks in addition to those relating to domestic bank
obligations.
DEPOSITARY RECEIPTS - The Portfolio will limit its investment in
Depository Receipts not sponsored by the issuer of the underlying security
to no more than 5% of the value of its net assets (at the time of
investment). A purchaser of an unsponsored Depositary Receipt may not have
unlimited voting rights and may not receive as much information about the
issuer of the underlying securities as with a sponsored Depositary Receipt.
ECU OBLIGATIONS - The specific amounts of currencies comprising the
ECU may be adjusted by the Council of Ministers of the European Community
to reflect changes in relative values of the underlying currencies. The
Trustees do not believe that such adjustments will adversely affect holders
of ECU-denominated securities or the marketability of such securities.
SUPRANATIONAL OBLIGATIONS - Supranational organizations, include
organizations such as The World Bank, which was chartered to finance
development projects in developing member countries; the European
Community, which is a twelve-nation organization engaged in cooperative
economic activities; the European Coal and Steel Community, which is an
economic union of various European nations steel and coal industries; and
the Asian Development Bank, which is an international development bank
established to lend funds, promote investment and provide technical
assistance to member nations of the Asian and Pacific regions.
CORPORATE REORGANIZATIONS - In general, securities that are the
subject of a tender or exchange offer or proposal sell at a premium to
their historic market price immediately prior to the announcement of the
offer or proposal. The increased market price of these securities may also
discount what the stated or appraised value of the security would be if the
contemplated action were approved or consummated. These investments may be
advantageous when the discount significantly overstates the risk of the
contingencies involved; significantly undervalues the securities, assets or
cash to be received by shareholders of the prospective portfolio company as
a result of the contemplated transaction; or fails adequately to recognize
the possibility that the offer or proposal may be replaced or superseded by
an offer or proposal of greater value. The evaluation of these
contingencies requires unusually broad knowledge and experience on the part
of the advisers that must appraise not only the value of the issuer and its
component businesses as well as the assets or securities to be received as
a result of the contemplated transaction, but also the financial resources
and business motivation of the offer or as well as the dynamics of the
business climate when the offer or proposal is in progress. Investments in
reorganization securities may tend to increase the turnover ratio of the
Portfolio and increase its brokerage and other transaction expenses.
WARRANTS AND RIGHTS - Warrants basically are options to purchase
equity securities at a specified price for a specific period of time.
Their prices do not necessarily move parallel to the prices of the
underlying securities. Rights are similar to warrants but normally have a
shorter duration and are distributed directly by the issuer to
shareholders. Rights and warrants have no voting rights, receive no
dividends and have no rights with respect to the assets of the issuer.
COMMERCIAL PAPER - Commercial paper consists of short-term (usually
from 1 to 270 days) unsecured promissory notes issued by corporations in
order to finance their current operations. A variable amount master demand
note (which is a type of commercial paper) represents a direct borrowing
arrangement involving periodically fluctuating rates of interest under a
letter agreement between a commercial paper issuer and an institutional
lender pursuant to which the lender may determine to invest varying
amounts.
REPURCHASE AGREEMENTS - The Portfolio will enter into repurchase
agreements only with member banks of the Federal Reserve System and
securities dealers believed creditworthy, and only if fully collateralized
by securities in which the Portfolio is permitted to invest. Under the
terms of a typical repurchase agreement, the Portfolio would acquire an
underlying debt instrument for a relatively short period (usually not more
than one week) subject to an obligation of the seller to repurchase the
instrument and the Portfolio to resell the instrument at a fixed price and
time, thereby determining the yield during the Portfolio's holding period.
This procedure results in a fixed rate of return insulated from market
fluctuations during such period. A repurchase agreement is subject to the
risk that the seller may fail to repurchase the security. Repurchase
agreements are considered under the 1940 Act to be loans collateralized by
the underlying securities. All repurchase agreements entered into by the
Portfolio will be fully collateralized at all times during the period of
the agreement in that the value of the underlying security will be at least
equal to the amount of the loan, including the accrued interest thereon,
and the Portfolio or its custodian or sub-custodian will have possession of
the collateral, which the Board of Trustees believes will give it a valid,
perfected security interest in the collateral. Whether a repurchase
agreement is the purchase and sale of a security or a collateralized loan
has not been conclusively established. This might become an issue in the
event of the bankruptcy of the other party to the transaction. In the event
of default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities would not be owned by the
Portfolio, but would only constitute collateral for the seller's obligation
to pay the repurchase price. Therefore, the Portfolio may suffer time
delays and incur costs in connection with the disposition of the
collateral. The Board of Trustees believes that the collateral underlying
repurchase agreements may be more susceptible to claims of the seller's
creditors than would be the case with securities owned by the Portfolio.
Repurchase agreements maturing in more than seven days are treated as
illiquid for purposes of the Portfolio's restrictions on purchases of
illiquid securities. Repurchase agreements are also subject to the risks
described below with respect to stand-by commitments.
FORWARD COMMITMENTS - In order to invest the Portfolio's assets
immediately, while awaiting delivery of securities purchased on a forward
commitment basis, short-term obligations that offer same-day settlement and
earnings will normally be purchased. When a commitment to purchase a
security on a forward commitment basis is made, procedures are established
consistent with the General Statement of Policy of the Securities and
Exchange Commission concerning such purchases. Since that policy currently
recommends that an amount of the Portfolio's assets equal to the amount of
the purchase be held aside or segregated to be used to pay for the
commitment, a separate account of the Portfolio consisting of cash, cash
equivalents or high quality debt securities equal to the amount of the
Portfolio's commitments securities will be established at the Portfolio's
custodian bank. For the purpose of determining the adequacy of the
securities in the account, the deposited securities will be valued at
market value. If the market value of such securities declines, additional
cash, cash equivalents or highly liquid securities will be placed in the
account daily so that the value of the account will equal the amount of
such commitments by the Portfolio.
Although it is not intended that such purchases would be made for
speculative purposes, purchases of securities on a forward commitment basis
may involve more risk than other types of purchases. Securities purchased
on a forward commitment basis and the securities held in the Portfolio's
portfolio are subject to changes in value based upon the public's
perception of the issuer and changes, real or anticipated, in the level of
interest rates. Purchasing securities on a forward commitment basis can
involve the risk that the yields available in the market when the delivery
takes place may actually be higher or lower than those obtained in the
transaction itself. On the settlement date of the forward commitment
transaction, the Portfolio will meet its obligations from then available
cash flow, sale of securities held in the separate account, sale of other
securities or, although it would not normally expect to do so, from sale of
the forward commitment securities themselves (which may have a value
greater or lesser than the Portfolio's payment obligations). The sale of
securities to meet such obligations may result in the realization of
capital gains or losses.
To the extent the Portfolio engages in forward commitment
transactions, it will do so for the purpose of acquiring securities
consistent with its investment objective and policies and not for the
purpose of investment leverage, and settlement of such transactions will be
within 90 days from the trade date.
REVERSE REPURCHASE AGREEMENTS - Reverse repurchase agreements involve
the sale of securities held by the Portfolio with an agreement to
repurchase the securities at an agreed upon price and date. The repurchase
price is generally equal to the original sales price plus interest.
Reverse repurchase agreements are usually for seven days or less and cannot
be repaid prior to their expiration dates. Reverse repurchase agreements
involve the risk that the market value of the portfolio securities
transferred may decline below the price at which the Portfolio is obliged
to purchase the securities.
STRIPPED OBLIGATIONS - The principal and interest components of United
States Treasury bonds with remaining maturities of longer than ten years
are eligible to be traded independently under the Separate Trading of
Registered Interest and Principal of Securities ("STRIPS") program. Under
the STRIPS program, the principal and interest components are separately
issued by the United States Treasury at the request of depository financial
institutions, which then trade the component parts separately. The
interest component of STRIPS may be more volatile than that of United
States Treasury bills with comparable maturities. The Portfolio has no
present intention of investing more than 5% of its net assets in STRIPS.
ILLIQUID SECURITIES - For purposes of its limitation on investments in
illiquid securities, the Portfolio may elect to treat as liquid, in
accordance with procedures established by the Board of Trustees, certain
investments in restricted securities for which there may be a secondary
market of qualified institutional buyers as contemplated by Rule 144A under
the Securities Act of 1933, as amended (the "Securities Act") and
commercial obligations issued in reliance on the so-called "private
placement" exemption from registration afforded by Section 4(2) of the
Securities Act ("Section 4(2) paper"). Rule 144A provides an exemption
from the registration requirements of the Securities Act for the resale of
certain restricted securities to qualified institutional buyers. Section
4(2) paper is restricted as to disposition under the federal securities
laws, and generally is sold to institutional investors such as the
Portfolio who agree that they are purchasing the paper for investment and
not with a view to public distribution. Any resale of Section 4(2) paper
by the purchaser must be in an exempt transaction.
One effect of Rule 144A and Section 4(2) is that certain restricted
securities may now be liquid, though there is no assurance that a liquid
market for Rule 144A securities or Section 4(2) paper will develop or be
maintained. The Trustees have adopted policies and procedures for the
purpose of determining whether securities that are eligible for resale
under Rule 144A and Section 4(2) paper are liquid or illiquid for purposes
of the limitation on investment in illiquid securities. Pursuant to those
policies and procedures, the Trustees have delegated to the advisers the
determination as to whether a particular instrument is liquid or illiquid,
requiring that consideration be given to, among other things, the frequency
of trades and quotes for the security, the number of dealers willing to
sell the security and the number of potential purchasers, dealer
undertakings to make a market in the security, the nature of the security
and the time needed to dispose of the security. The Trustees will
periodically review the Portfolio's purchases and sales of Rule 144A
securities and Section 4(2) paper.
STAND-BY COMMITMENTS - In a put transaction, the Portfolio acquires
the right to sell a security at an agreed upon price within a specified
period prior to its maturity date, and a stand-by commitment entitles the
Portfolio to same-day settlement and to receive an exercise price equal to
the amortized cost of the underlying security plus accrued interest, if
any, at the time of exercise. Stand-by commitments are subject to certain
risks, which include the inability of the issuer of the commitment to pay
for the securities at the time the commitment is exercised, the fact that
the commitment is not marketable by the Portfolio, and that the maturity of
the underlying security will generally be different from that of the
commitment.
SECURITIES LOANS - To the extent specified in the prospectus, the
Portfolio is permitted to lend its securities to broker-dealers and other
institutional investors in order to generate additional income. Such loans
of portfolio securities may not exceed 30% of the value of the Portfolio's
total assets. In connection with such loans, the Portfolio will receive
collateral consisting of cash, cash equivalents, U.S. Government securities
or irrevocable letters of credit issued by financial institutions. Such
collateral will be maintained at all times in an amount equal to at least
102% of the current market value plus accrued interest of the securities
loaned. The Portfolio can increase its income through the investment of
such collateral. The Portfolio continues to be entitled to the interest
payable or any dividend-equivalent payments received on a loaned security
and, in addition, to receive interest on the amount of the loan. However,
the receipt of any dividend-equivalent payments by the Portfolio on a
loaned security from the borrower will not qualify for the
dividends-received deduction. Such loans will be terminable at any time
upon specified notice. The Portfolio might experience risk of loss if the
institutions with which it has engaged in portfolio loan transactions
breach their agreements with the Portfolio. The risks in lending portfolio
securities, as with other extensions of secured credit, consist of possible
delays in receiving additional collateral or in the recovery of the
securities or possible loss of rights in the collateral should the borrower
experience financial difficulty. Loans will be made only to firms deemed
by the advisers to be of good standing and will not be made unless, in the
judgment of the advisers, the consideration to be earned from such loans
justifies the risk.
ADDITIONAL POLICIES REGARDING DERIVATIVES AND RELATED TRANSACTIONS
INTRODUCTION
As explained more fully below, the Portfolio may employ derivative and
related instruments as tools in the management of portfolio assets. Put
briefly, a `derivative'' instrument may be considered a security or other
instrument which derives its value from the value or performance of other
instruments or assets, interest or currency exchange rates, or indexes. For
instance, derivatives include futures, options, forward contracts,
structured notes and various over-the-counter instruments.
Like other investment tools or techniques, the impact of using
derivatives strategies or related instruments depends to a great extent on
how they are used. Derivatives are generally used by portfolio managers in
three ways: First, to reduce risk by hedging (offsetting) an investment
position. Second, to substitute for another security particularly where it
is quicker, easier and less expensive to invest in derivatives. Lastly, to
speculate or enhance portfolio performance. When used prudently,
derivatives can offer several benefits, including easier and more effective
hedging, lower transaction costs, quicker investment and more profitable
use of portfolio assets. However, derivatives also have the potential to
significantly magnify risks, thereby leading to potentially greater losses
for the Portfolio.
The Portfolio may invest its assets in derivative and related
instruments subject only to the Portfolio's investment objective and
policies and the requirement that the Portfolio maintain segregated
accounts consisting of liquid assets, such as cash, U.S. Government
securities, or other high-grade debt obligations (or, as permitted by
applicable regulation, enter into certain offsetting positions) to cover
its obligations under such instruments with respect to positions where
there is no underlying portfolio asset so as to avoid leveraging the
Portfolio.
The value of some derivative or related instruments in which the
Portfolio may invest may be particularly sensitive to changes in prevailing
interest rates or other economic factors, and -- like other investments of
the Portfolio -- the ability of a Portfolio to successfully utilize these
instruments may depend in part upon the ability of the advisers to forecast
interest rates and other economic factors correctly. If the advisers
inaccurately forecast such factors and have taken positions in derivative
or similar instruments contrary to prevailing market trends, the Portfolio
could be exposed to the risk of a loss. The Portfolio might not employ any
or all of the strategies described herein, and no assurance can be given
that any strategy used will succeed.
Set forth below is an explanation of the various derivatives
strategies and related instruments the Portfolio may employ along with
risks or special attributes associated with them. This discussion is
intended to supplement the Portfolio's current prospectuses as well as
provide useful information to prospective investors.
RISK FACTORS
As explained more fully below and in the discussions of particular
strategies or instruments, there are a number of risks associated with the
use of derivatives and related instruments:
o There can be no guarantee that there will be a correlation
between price movements in a hedging vehicle and in the portfolio
assets being hedged. As incorrect correlation could result in a
loss on both the hedged assets in the Portfolio and the hedging
vehicle so that the portfolio return might have been greater had
hedging not been attempted. This risk is particularly acute in
the case of `cross-hedges'' between currencies.
o The advisers may incorrectly forecast interest rates, market
values or other economic factors in utilizing a derivatives
strategy. In such a case, the Portfolio may have been in a better
position had it not entered into such strategy.
o Hedging strategies, while reducing risk of loss, can also reduce
the opportunity for gain. In other words, hedging usually limits
both potential losses as well as potential gains.
o Strategies not involving hedging may increase the risk to the
Portfolio. Certain strategies, such as yield enhancement, can
have speculative characteristics and may result in more risk to
the Portfolio than hedging strategies using the same instruments.
o There can be no assurance that a liquid market will exist at a
time when the Portfolio seeks to close out an option, futures
contract or other derivative or related position. Many exchanges
and boards of trade limit the amount of fluctuation permitted in
option or futures contract prices during a single day; once the
daily limit has been reached on particular contract, no trades
may be made that day at a price beyond that limit. In addition,
certain instruments are relatively new and without a significant
trading history. As a result, there is no assurance that an
active secondary market will develop or continue to exist.
Finally, over-the-counter instruments typically do not have a
liquid market. Lack of a liquid market for any reason may prevent
the Portfolio from liquidating an unfavorable position.
o Activities of large traders in the futures and securities markets
involving arbitrage, `program trading,'' and other investment
strategies may cause price distortions in these markets.
o In certain instances, particularly those involving over-the-
counter transactions or forward contracts, there is a greater
potential that a counterparty or broker may default or be unable
to perform on its commitments. In the event of such a default,
the Portfolio may experience a loss.
o In transactions involving currencies, the value of the currency
underlying an instrument may fluctuate due to many factors,
including economic conditions, interest rates, governmental
policies and market forces.
SPECIFIC USES AND STRATEGIES
Set forth below are explanations of various strategies involving
derivatives and related instruments which may be used by the Portfolio.
OPTIONS ON SECURITIES, SECURITIES INDEXES AND DEBT INSTRUMENTS. The
Portfolio may PURCHASE, SELL or EXERCISE call and put options on:
o securities;
o securities indexes; and
o debt instruments.
Although in most cases these options will be exchange-traded, the
Portfolio may also purchase, sell or exercise over-the-counter options.
Over-the-counter options differ from exchange-traded options in that they
are two-party contracts with price and other terms negotiated between buyer
and seller. As such, over-the-counter options generally have much less
market liquidity and carry the risk of default or nonperformance by the
other party.
One purpose of purchasing put options is to protect holdings in an
underlying or related security against a substantial decline in market
value. One purpose of purchasing call options is to protect against
substantial increases in prices of securities the Portfolio intends to
purchase pending its ability to invest in such securities in an
orderly manner. The Portfolio may also use combinations of options to
minimize costs, gain exposure to markets or take advantage of price
disparities or market movements. For example, the Portfolio may sell
put or call options it has previously purchased or purchase put or
call options it has previously sold. These transactions may result in
a net gain or loss depending on whether the amount realized on the
sale is more or less than the premium and other transaction costs paid
on the put or call option which is sold. The Portfolio may write a
call or put option in order to earn the related premium from such
transactions. Prior to exercise or expiration, an option may be closed
out by an offsetting purchase or sale of a related option. The
Portfolio will not write uncovered options.
In addition to the general risk factors noted above, the purchase and
writing of options involve certain special risks. During the option period,
the Portfolio writing a covered call (i.e., where the underlying securities
are held by the Portfolio) has, in return for the premium on the option,
given up the opportunity to profit from a price increase in the underlying
securities above the exercise price, but has retained the risk of loss
should the price of the underlying securities decline. The writer of an
option has no control over the time when it may be required to fulfill its
obligation as a writer of the option. Once an option writer has received an
exercise notice, it cannot effect a closing purchase transaction in order
to terminate its obligation under the option and must deliver the
underlying securities at the exercise price.
If a put or call option purchased by the Portfolio is not sold when it
has remaining value, and if the market price of the underlying security, in
the case of a put, remains equal to or greater than the exercise price or,
in the case of a call, remains less than or equal to the exercise price,
the Portfolio will lose its entire investment in the option. Also, where a
put or call option on a particular security is purchased to hedge against
price movements in a related security, the price of the put or call option
may move more or less than the price of the related security. There can be
no assurance that a liquid market will exist when the Portfolio seeks to
close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, the Portfolio may be unable
to close out a position.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Portfolio may
purchase or sell:
o interest-rate futures contracts;
o futures contracts on specified instruments or indices; and
o options on these futures contracts (`futures options'').
The futures contracts and futures options may be based on various
instruments or indices in which the Portfolio may invest such as foreign
currencies, certificates of deposit, Eurodollar time deposits, securities
indices, economic indices (such as the Consumer Price Indices compiled by
the U.S. Department of Labor).
Futures contracts and futures options may be used to hedge portfolio
positions and transactions as well as to gain exposure to markets. For
example, the Portfolio may sell a futures contract -- or buy a futures
option -- to protect against a decline in value, or reduce the duration, of
portfolio holdings. Likewise, these instruments may be used where the
Portfolio intends to acquire an instrument or enter into a position. For
example, the Portfolio may purchase a futures contract -- or buy a futures
option -- to gain immediate exposure in a market or otherwise offset
increases in the purchase price of securities or currencies to be acquired
in the future. Futures options may also be written to earn the related
premiums.
When writing or purchasing options, the Portfolio may simultaneously
enter into other transactions involving futures contracts or futures
options in order to minimize costs, gain exposure to markets, or take
advantage of price disparities or market movements. Such strategies may
entail additional risks in certain instances. The Portfolio may engage in
cross-hedging by purchasing or selling futures or options on a security or
currency different from the security or currency position being hedged to
take advantage of relationships between the two securities or currencies.
Investments in futures contracts and options thereon involve risks
related to those associated with options transactions discussed above. The
Portfolio will only enter into futures contracts or options or futures
contracts which are traded on a U.S. or foreign exchange or board of trade,
or similar entity, or quoted on an automated quotation system.
FORWARD CONTRACTS. The Portfolio may use foreign currency and
interest-rate forward contracts for various purposes as described below.
Foreign currency exchange rates may fluctuate significantly over short
periods of time. They generally are determined by the forces of supply and
demand in the foreign exchange markets and the relative merits of
investments in different countries, actual or perceived changes in interest
rates and other complex factors, as seen from an international perspective.
The Portfolio that may invest in securities denominated in foreign
currencies may, in addition to buying and selling foreign currency futures
contracts and options on foreign currencies and foreign currency futures,
enter into forward foreign currency exchange contracts to reduce the risks
or otherwise take a position in anticipation of changes in foreign exchange
rates. A forward foreign currency exchange contract involves an obligation
to purchase or sell a specific currency at a future date, which may be a
fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. By entering into a
forward foreign currency contract, the Portfolio `locks in'' the exchange
rate between the currency it will deliver and the currency it will receive
for the duration of the contract. As a result, the Portfolio reduces its
exposure to changes in the value of the currency it will deliver and
increases its exposure to changes in the value of the currency it will
exchange into. The effect on the value of the Portfolio is similar to
selling securities denominated in one currency and purchasing securities
denominated in another. Transactions that use two foreign currencies are
sometimes referred to as `cross-hedges.''
The Portfolio may enter into these contracts for the purpose of
hedging against foreign exchange risk arising from the Portfolio's
investments or anticipated investments in securities denominated in foreign
currencies. The Portfolio may also enter into these contracts for purposes
of increasing exposure to a foreign currency or to shift exposure to
foreign currency fluctuations from one country to another.
The Portfolio may also use forward contracts to hedge against changes
in interest-rates, increase exposure to a market or otherwise take
advantage of such changes. An interest-rate forward contract involves the
obligation to purchase or sell a specific debt instrument at a fixed price
at a future date.
INTEREST RATE AND CURRENCY TRANSACTIONS. The Portfolio may employ
currency and interest rate management techniques, including transactions in
options (including yield curve options), futures, options on futures,
forward foreign currency exchange contracts, currency options and futures
and currency and interest rate swaps. The aggregate amount of the
Portfolio's net currency exposure will not exceed the total net asset value
of its portfolio. However, to the extent that the Portfolio is fully
invested while also maintaining currency positions, it may be exposed to
greater combined risk.
The Portfolio will only enter into interest rate and currency swaps on
a net basis, i.e., the two payment streams are netted out, with the
Portfolio receiving or paying, as the case may be, only the net amount of
the two payments. Interest rate and currency swaps do not involve the
delivery of securities, the underlying currency, other underlying assets or
principal. Accordingly, the risk of loss with respect to interest rate and
currency swaps is limited to the net amount of interest or currency
payments that the Portfolio is contractually obligated to make. If the
other party to an interest rate or currency swap defaults, the Portfolio's
risk of loss consists of the net amount of interest or currency payments
that the Portfolio is contractually entitled to receive. Since interest
rate and currency swaps are individually negotiated, the Portfolio expects
to achieve an acceptable degree of correlation between their portfolio
investments and their interest rate or currency swap positions.
The Portfolio may hold foreign currency received in connection with
investments in foreign securities when it would be beneficial to convert
such currency into U.S. dollars at a later date, based on anticipated
changes in the relevant exchange rate.
The Portfolio may purchase or sell without limitation as to a
percentage of its assets forward foreign currency exchange contracts when
the advisers anticipate that the foreign currency will appreciate or
depreciate in value, but securities denominated in that currency do not
present attractive investment opportunities and are not held by the
Portfolio. In addition, the Portfolio may enter into forward foreign
currency exchange contracts in order to protect against adverse changes in
future foreign currency exchange rates. The Portfolio may engage in
cross-hedging by using forward contracts in one currency to hedge against
fluctuations in the value of securities denominated in a different currency
if its advisers believe that there is a pattern of correlation between the
two currencies. Forward contracts may reduce the potential gain from a
positive change in the relationship between the U.S. Dollar and foreign
currencies. Unanticipated changes in currency prices may result in poorer
overall performance for the Portfolio than if it had not entered into such
contracts. The use of foreign currency forward contracts will not
eliminate fluctuations in the underlying U.S. dollar equivalent value of
the prices of or rates of return on the Portfolio's foreign currency
denominated portfolio securities and the use of such techniques will
subject the Portfolio to certain risks.
The matching of the increase in value of a forward contract and the
decline in the U.S. dollar equivalent value of the foreign currency
denominated asset that is the subject of the hedge generally will not be
precise. In addition, the Portfolio may not always be able to enter into
foreign currency forward contracts at attractive prices, and this will
limit the Portfolio's ability to use such contract to hedge or cross-hedge
its assets. Also, with regard to the Portfolio's use of cross-hedges,
there can be no assurance that historical correlations between the movement
of certain foreign currencies relative to the U.S. dollar will continue.
Thus, at any time poor correlation may exist between movements in the
exchange rates of the foreign currencies underlying the Portfolio's
cross-hedges and the movements in the exchange rates of the foreign
currencies in which the Portfolio's assets that are the subject of such
cross-hedges are denominated.
The Portfolio may enter into interest rate and currency swaps to the
maximum allowed limits under applicable law. The Portfolio will typically
use interest rate swaps to shorten the effective duration of its portfolio.
Interest rate swaps involve the exchange by the Portfolio with another
party of their respective commitments to pay or receive interest, such as
an exchange of fixed rate payments for floating rate payments. Currency
swaps involve the exchange of their respective rights to make or receive
payments in specified currencies.
STRUCTURED PRODUCTS. The Portfolio may invest in interests in entities
organized and operated solely for the purpose of restructuring the
investment characteristics of certain other investments. This type of
restructuring involves the deposit with or purchase by an entity, such as a
corporation or trust, or specified instruments (such as commercial bank
loans) and the issuance by that entity of one or more classes of securities
(`structured products'') backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued structured products to create securities
with different investment characteristics such as varying maturities,
payment priorities and interest rate provisions, and the extent of the
payments made with respect to structured products is dependent on the
extent of the cash flow on the underlying instruments. The Portfolio may
invest in structured products which represent derived investment positions
based on relationships among different markets or asset classes.
The Portfolio may also invest in other types of structured products,
including, among others, inverse floaters, spread trades and notes linked
by a formula to the price of an underlying instrument. Inverse floaters
have coupon rates that vary inversely at a multiple of a designated
floating rate (which typically is determined by reference to an index rate,
but may also be determined through a dutch auction or a remarketing agent
or by reference to another security) (the "reference rate"). As an
example, inverse floaters may constitute a class of CMOs with a coupon rate
that moves inversely to a designated index, such as LIBOR (London Interbank
Offered Rate) or the Cost of Funds Index. Any rise in the reference rate
of an inverse floater (as a consequence of an increase in interest rates)
causes a drop in the coupon rate while any drop in the reference rate of an
inverse floater causes an increase in the coupon rate. A spread trade is
an investment position relating to a difference in the prices or interest
rates of two securities where the value of the investment position is
determined by movements in the difference between the prices or interest
rates, as the case may be, of the respective securities. When the Portfolio
invests in notes linked to the price of an underlying instrument, the price
of the underlying security is determined by a multiple (based on a formula)
of the price of such underlying security. A structured product may be
considered to be leveraged to the extent its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. Because they are linked to their underlying markets or
securities, investments in structured products generally are subject to
greater volatility than an investment directly in the underlying market or
security. Total return on the structured product is derived by linking
return to one or more characteristics of the underlying instrument.
Because certain structured products of the type in which the Portfolio may
invest may involve no credit enhancement, the credit risk of those
structured products generally would be equivalent to that of the underlying
instruments. The Portfolio may invest in a class of structured products
that is either subordinated or unsubordinated to the right of payment of
another class. Subordinated structured products typically have higher
yields and present greater risks than unsubordinated structured products.
Although the Portfolio's purchase of subordinated structured products would
have similar economic effect to that of borrowing against the underlying
securities, the purchase will not be deemed to be leverage for purposes of
the Portfolio's fundamental investment limitation related to borrowing and
leverage.
Certain issuers of structured products may be deemed to be,
"investment companies" as defined in the 1940 Act. As a result, the
Portfolio's investments in these structured products may be limited by the
restrictions contained in the 1940 Act. Structured products are typically
sold in private placement transactions and there currently is no action
trading market for structured products. As a result, certain structured
products in which the Portfolio invests may be deemed illiquid and subject
to its limitation on illiquid investments.
Investments in structured products generally are subject to greater
volatility than an investment directly in the underlying market or
security. In addition, because structured products are typically sold in
private placement transactions, there currently is no active trading market
for structured products.
Additional Restrictions on the Use of Futures and Option Contracts
The Portfolio is not a "commodity pool" (i.e., a pooled investment
vehicle which trades in commodity futures contracts and options thereon and
the operator of which is registered with the CFTC and futures contracts and
futures options will be purchased, sold or entered into only for bona fide
hedging purposes, provided that the Portfolio may enter into such
transactions for purposes other than bona fide hedging if, immediately
thereafter, the sum of the amount of its initial margin and premiums on
open contracts and options would not exceed 5% of the liquidation value of
the Portfolio's portfolio, provided, further, that, in the case of an
option that is in-the-money, the in-the-money amount may be excluded in
calculating the 5% limitation.
When the Portfolio purchases a futures contract, an amount of cash or
cash equivalents or high quality debt securities will be deposited in a
segregated account with the Portfolio's custodian or sub-custodian so that
the amount so segregated, plus the initial deposit and variation margin
held in the account of its broker, will at all times equal the value of the
futures contract, thereby insuring that the use of such futures is
unleveraged.
The Portfolio's ability to engage in the transactions described herein
may be limited by the current federal income tax requirement that the
Portfolio derive less than 30% of its gross income from the sale or other
disposition of stock or securities held for less than three months.
INVESTMENT RESTRICTIONS
The Portfolio has adopted the following investment restrictions which
may not be changed without approval by a "majority of the outstanding
shares" of the Portfolio which, as used in this Statement of Additional
Information, means the vote of the lesser of (i) 67% or more of the total
beneficial interests of a Portfolio present at a meeting, if the holders of
more than 50% of the outstanding total beneficial interests of a Portfolio
are present or represented by proxy, or (ii) more than 50% of the
outstanding total beneficial interests of a Portfolio.
The Portfolio may not:
(1) borrow money, except that the Portfolio may borrow money for
temporary or emergency purposes, or by engaging in reverse repurchase
transactions, in an amount not exceeding 33-1/3% of the value of its
total assets at the time when the loan is made and may pledge,
mortgage or hypothecate no more than 1/3 of its net assets to secure
such borrowings. Any borrowings representing more than 5% of the
Portfolio's total assets must be repaid before the Portfolio may make
additional investments;
(2) make loans, except that the Portfolio may: (i) purchase and
hold debt instruments (including without limitation, bonds, notes,
debentures or other obligations and certificates of deposit, bankers'
acceptances and fixed time deposits) in accordance with its investment
objectives and policies; (ii) enter into repurchase agreements with
respect to portfolio securities; and (iii) lend portfolio securities
with a value not in excess of one-third of the value of its total
assets;
(3) purchase the securities of any issuer (other than securities
issued or guaranteed by the U.S. government or any of its agencies or
instrumentalities, or repurchase agreements secured thereby) if, as a
result, more than 25% of the Portfolio's total assets would be
invested in the securities of companies whose principal business
activities are in the same industry. Notwithstanding the foregoing,
with respect to the Portfolio's permissible futures and options
transactions in U.S. government securities, positions in such options
and futures shall not be subject to this restriction;
(4) purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments but this shall
not prevent the Portfolio from (i) purchasing or selling options and
futures contracts or from investing in securities or other instruments
backed by physical commodities or (ii) engaging in forward purchase or
sales of foreign currencies or securities;
(5) purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not
prevent the Portfolio from investing in securities or other
instruments backed by real estate or securities of companies engaged
in the real estate business). Investments by the Portfolio in
securities backed by mortgages on real estate or in marketable
securities of companies engaged in such activities are not hereby
precluded;
(6) issue any senior security (as defined in the 1940 Act),
except that (a) the Portfolio may engage in transactions that may
result in the issuance of senior securities to the extent permitted
under applicable regulations and interpretations of the 1940 Act or an
exemptive order; (b) the Portfolio may acquire other securities, the
acquisition of which may result in the issuance of a senior security,
to the extent permitted under applicable regulations or
interpretations of the 1940 Act; and (c) subject to the restrictions
set forth above, the Portfolio may borrow money as authorized by the
1940 Act. For purposes of this restriction, collateral arrangements
with respect to permissible options and futures transactions,
including deposits of initial and variation margin, are not considered
to be the issuance of a senior security; or
(7) underwrite securities issued by other persons except insofar
as the Portfolio may technically be deemed to be an underwriter under
the Securities Act of 1933 in selling a portfolio security.
For purposes of investment restriction (5) above, real estate
includes Real Estate Limited Partnerships. For purposes of investment
restriction (3) above, industrial development bonds, where the
payment of principal and interest is the ultimate responsibility of
companies within the same industry, are grouped together as an
`industry.'' Supranational organizations are collectively considered
to be members of a single `industry'' for purposes of restriction (3)
above.
In addition, the Portfolio is subject to the following non-
fundamental restrictions which may be changed without shareholder
approval:
(1) The Portfolio may not, with respect to 50% of its assets,
hold more than 10% of the outstanding voting securities of an issuer.
(2) The Portfolio may not make short sales of securities, other
than short sales `against the box,'' or purchase securities on margin
except for short-term credits necessary for clearance of portfolio
transactions, provided that this restriction will not be applied to
limit the use of options, futures contracts and related options, in
the manner otherwise permitted by the investment restrictions,
policies and investment program of the Portfolio.
(3) The Portfolio may not purchase or sell interests in oil, gas
or mineral leases.
(4) The Portfolio may not invest more than 15% of its net assets
in illiquid securities.
(5) The Portfolio may not write, purchase or sell any put or
call option or any combination thereof, provided that this shall not
prevent (i) the purchase, ownership, holding or sale of warrants where
the grantor of the warrants is the issuer of the underlying
securities, (ii) the writing, purchasing or selling of puts, calls or
combinations thereof with respect to portfolio securities or (iii)
with respect to the Portfolio's permissible futures and options
transactions, the writing, purchasing, ownership, holding or selling
of futures and options positions or of puts, calls or combinations
thereof with respect to futures.
(6) The Portfolio may invest up to 5% of its total assets in the
securities of any one investment company, but may not own more than 3%
of the securities of any one investment company or invest more than
10% of its total assets in the securities of other investment
companies.
It is the Portfolio's position that proprietary strips, such as CATS
and TIGRS, are United States Government securities. However, the Portfolio
has been advised that the staff of the Securities and Exchange Commission's
Division of Investment Management does not consider these to be United
States Government securities, as defined under the Investment Company Act
of 1940, as amended.
For purposes of the Portfolio's investment restrictions, the issuer of
a tax-exempt security is deemed to be the entity (public or private)
ultimately responsible for the payment of the principal of and interest on
the security.
In order to permit the sale of its beneficial interests in certain
states, the Portfolio may make commitments more restrictive than the
investment policies and limitations described above and in the prospectus.
Should the Portfolio determine that any such commitment is no longer in its
best interests, it will revoke the commitment by terminating sales of its
beneficial interests in the state involved. In order to comply with certain
federal and state statutes and regulatory policies, as a matter of
operating policy, the Portfolio will not: (i) invest more than 5% of its
assets in companies which, including predecessors, have a record of less
than three years' continuous operation, (ii) invest in warrants valued at
the lower of cost or market, in excess of 5% of the value of its net
assets, and no more than 2% of such value may be warrants which are not
listed on the New York or American Stock Exchanges, or (iii) purchase or
retain in its portfolio any securities issued by an issuer any of whose
officers, directors, trustees or security holders is an officer or trustee
of the Trust or Portfolio, or is an officer or director of the Adviser, if
after the purchase of the securities of such issuer by the Portfolio one or
more of such persons owns beneficially more than 1/2 of 1% of the shares or
securities, or both, all taken at market value, of such issuer, and such
persons owning more than 1/2 of 1% of such shares or securities together
own beneficially more than 5% of such shares or securities, or both, all
taken at market value.
If a percentage or rating restriction on investment or use of assets
set forth herein or in the Prospectus is adhered to at the time a
transaction is effected, later changes in percentage resulting from any
cause other than actions by the Portfolio will not be considered a
violation. If the value of the Portfolio's holdings of illiquid securities
at any time exceeds the percentage limitation applicable at the time of
acquisition due to subsequent fluctuations in value or other reasons, the
Board of Trustees will consider what actions, if any, are appropriate to
maintain adequate liquidity.
PORTFOLIO TRANSACTIONS
Specific decisions to purchase or sell securities for the Portfolio
are made by a portfolio manager who is an employee of the Portfolio Adviser
and who is appointed and supervised by senior officers of the Portfolio
Adviser. Changes in the Portfolio's investments are reviewed by the Board
of Trustees. The Portfolio's portfolio manager may serve other clients of
the Portfolio Adviser in a similar capacity.
The frequency of the Portfolio's portfolio transactions, the portfolio
turnover rate, will vary from year to year depending upon market
conditions. Because a high turnover rate may increase transaction costs and
the possibility of taxable short-term gains, the Portfolio Adviser will
weigh the added costs of short-term investment against anticipated gains.
The Portfolio Adviser does not anticipate that portfolio turnover will
result in adverse tax consequences. However, high portfolio turnover may
result in high transaction costs to the Portfolio. For the fiscal years
ended October 31, 1996 and 1995, the portfolio turnover rate for the
Portfolio was 62% and 71%, respectively.
The primary consideration in placing portfolio security transactions
with broker-dealers for execution is to obtain and maintain the
availability of execution at the most favorable prices and in the most
effective manner possible. The Portfolio Adviser attempts to achieve this
result by selecting broker-dealers to execute portfolio transactions on
behalf of the Portfolio and other clients of the Portfolio Adviser on the
basis of their professional capability, the value and quality of their
brokerage services, and the level of their brokerage commissions. Debt
securities are traded principally in the over-the-counter market through
dealers acting on their own account and not as brokers. In the case of
securities traded in the over-the-counter market (where no stated
commissions are paid but the prices include a dealer's markup or markdown),
the Portfolio Adviser normally seeks to deal directly with the primary
market makers unless, in its opinion, best execution is available
elsewhere. In the case of securities purchased from underwriters, the cost
of such securities generally includes a fixed underwriting commission or
concession. From time to time, soliciting dealer fees are available to the
Portfolio Adviser on the tender of the Portfolio's portfolio securities in
so-called tender or exchange offers. Such soliciting dealer fees are in
effect recaptured for the Portfolios by the Portfolio Adviser. At present,
no other recapture arrangements are in effect.
Under Section 28(e) of the Securities Exchange Act of 1934, the
Portfolio Adviser may cause the Portfolio to pay a broker-dealer which
provides brokerage and research services to the Adviser an amount of
commission for effecting a securities transaction for the Portfolio in
excess of the amount other broker-dealers would have charged for the
transaction if the Portfolio Adviser determines in good faith that the
greater commission is reasonable in relation to the value of the brokerage
and research services provided by the executing broker-dealer viewed in
terms of either a particular transaction or the Portfolio Adviser's overall
responsibilities to the Portfolio or to its clients. Not all of such
services are useful or of value in advising the Portfolio.
The term `brokerage and research services'' includes advice as to the
value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or of purchasers or
sellers of securities, furnishing analyses and reports concerning issues,
industries, securities, economic factors and trends, portfolio strategy and
the performance of accounts, and effecting securities transactions and
performing functions incidental thereto such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment
of the Portfolio Adviser, be reasonable in relation to the value of the
brokerage services provided, commissions exceeding those which another
broker might charge may be paid to broker-dealers who were selected to
execute transactions on behalf of the Portfolio and the Portfolio Adviser's
other clients as part of providing advice as to the availability of
securities or of purchasers or sellers of securities and services in
effecting securities transactions and performing functions incidental
thereto, such as clearance and settlement.
Broker-dealers may be willing to furnish statistical, research and
other factual information or services (`Research'') to the Portfolio
Adviser for no consideration other than brokerage or underwriting
commissions. Securities may be bought or sold through such broker-dealers,
but at present, unless otherwise directed by the Portfolio, a commission
higher than one charged elsewhere will not be paid to such a firm solely
because it provided Research to the Portfolio Adviser.
The Portfolio Adviser's investment management personnel will attempt
to evaluate the quality of Research provided by brokers. Results of this
effort are sometimes used by the Portfolio Adviser as a consideration in
the selection of brokers to execute portfolio transactions. However, the
Portfolio Adviser would be unable to quantify the amount of commissions
which are paid as a result of such Research because a substantial number of
transactions are effected through brokers which provide Research but which
are selected principally because of their execution capabilities.
The management fees that the Funds pay to the Portfolio Adviser will
not be reduced as a consequence of the Adviser's receipt of brokerage and
research services. To the extent the Portfolio's portfolio transactions are
used to obtain such services, the brokerage commissions paid by the
Portfolio will exceed those that might otherwise be paid, by an amount
which cannot be presently determined. Such services would be useful and of
value to the Portfolio Adviser in serving the Portfolio and other clients
and, conversely, such services obtained by the placement of brokerage
business of other clients would be useful to the Portfolio Adviser in
carrying out its obligations to the Portfolio. While such services are not
expected to reduce the expenses of the Portfolio Adviser, the Portfolio
Adviser would, through use of the services, avoid the additional expenses
which would be incurred if it should attempt to develop comparable
information through its own staff.
In certain instances, there may be securities that are suitable for
the Portfolio as well as one or more of the Portfolio Adviser's other
clients. Investment decisions for the Portfolio and for the Portfolio
Adviser's other clients are made with a view to achieving their respective
investment objectives. It may develop that the same investment decision is
made for more than one client or that a particular security is bought or
sold for only one client even though it might be held by, or bought or sold
for, other clients. Likewise, a particular security may be bought for one
or more clients when one or more clients are selling that same security.
Some simultaneous transactions are inevitable when several clients receive
investment advice from the same investment adviser, particularly when the
same security is suitable for the investment objectives of more than one
client. When the Portfolio or the Portfolio Adviser's other clients are
simultaneously engaged in the purchase or sale of the same security, the
securities are allocated among clients in a manner believed to be equitable
to each. It is recognized that in some cases this system could have a
detrimental effect on the price or volume of the security as far as the
Portfolio is concerned. However, it is believed that the ability of the
Portfolio to participate in volume transactions will generally produce
better executions for the Portfolio.
COMPUTATION OF NET ASSET VALUE
The net asset value of the FUND is determined at 4:15 P.M. New York
Time, on each day that the New York Stock Exchange is open for business and
on such other days as there is sufficient trading in the FUND's securities
to affect materially the net asset value per share of the FUND. The FUND
will be closed on New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
The Portfolio will invest in foreign securities, and as a result, the
calculation of the FUND's net asset value may not take place
contemporaneously with the determination of the prices of certain of the
portfolio securities used in the calculation. Occasionally, events which
affect the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of the New
York Stock Exchange and will therefore not be reflected in the computation
of the FUND's net asset value. If events materially affecting the value of
such securities occur during such period, then these securities will be
valued at their fair value as determined in good faith under procedures
established by and under the supervision of the Trustees of the Portfolio.
Portfolio securities which are traded both on an exchange and in the over-
the-counter market, will be valued according to the broadest and most
representative market. All assets and liabilities initially expressed in
foreign currency values will be converted into U.S. Dollar values at the
mean between the bid and offered quotations of the currencies against U.S.
Dollars as last quoted by any recognized dealer. When portfolio securities
are traded, the valuation will be the last reported sale price on the day
of valuation. (For securities traded on the New York Stock Exchange, the
valuation will be the last reported sales price as of the close of the
Exchange's regular trading session, currently 4:15 P.M. New York Time.) If
there is no such reported sale or the valuation is based on the Over-the-
Counter market, the securities will be valued at the last available bid
price or at the mean between the bid and asked prices, as determined by the
Trustees. As of the date of this Statement of Additional Information, such
securities will be valued by the latter method. Securities for which
reliable quotations are not readily available and all other assets will be
valued at their respective fair market value as determined in good faith
by, or under procedures established by, the Trustees of the Portfolio.
Money market instruments with less than sixty days remaining to
maturity when acquired by the Portfolio will be valued on an amortized cost
basis by the Portfolio, excluding unrealized gains or losses thereon from
the valuation. This is accomplished by valuing the security at cost and
then assuming a constant amortization to maturity of any premium or
discount. If the Portfolio acquires a money market instrument with more
than sixty days remaining to its maturity, it will be valued at current
market value until the 60th day prior to maturity, and will then be valued
on an amortized cost basis based upon the value on such date unless the
Trustees of the Portfolio determine during such 60-day period that this
amortized cost value does not represent fair market value.
All liabilities incurred or accrued are deducted from the FUND's total
assets. The resulting net assets are divided by the number of shares of the
FUND outstanding at the time of the valuation and the result (adjusted to
the nearest cent) is the net asset value per share.
Orders to purchase or redeem Shares of the FUND received by dealers
prior to 4:00 P.M. (Eastern Time) will be confirmed at the previous
offering or redemption price computed as of the close of trading on the
options exchanges (normally 4:15 P.M New York Time), provided the order is
received by the FUND's Transfer Agent prior to 4:00 P.M. on that day. It is
the responsibility of the dealer to insure that all orders are transmitted
timely to the FUND. Orders received by dealers after 4:00 P.M. will be
confirmed at the next computed offering or redemption price.
PERFORMANCE INFORMATION
For purposes of quoting and comparing the performance of the FUND to
that of other mutual funds and to stock or other relevant indices in
advertisements or in reports to Shareholders, performance will be stated
both in terms of total return and in terms of yield. The total return basis
combines principal and dividend income changes for the periods shown.
Principal changes are based on the difference between the beginning and
closing net asset values for the period and assumes reinvestment of
dividends and distributions paid by the FUND. Dividends and distributions
are comprised of net investment income and net realized capital gains.
Under the rules of the Commission, funds advertising performance must
include total return quotes calculated according to the following formula:
P(1 + T)n = ERV
Where P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)
ERV = ending redeemable value of a hypothetical $1,000 payment made
at the beginning of the 1, 5 or 10 year periods or at the end of
the 1, 5 or 10 year periods (or fractional portion thereof)
Under the foregoing formula the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication, and
will cover one, five, and ten year periods or a shorter period dating from
the effectiveness of the FUND's registration statement. In calculating the
ending redeemable value, the pro rata share of the account opening fee is
deducted from the initial $1,000 investment and all dividends and
distributions by the FUND are assumed to have been reinvested at net asset
value as described in the prospectus on the reinvestment dates during the
period. Total return, or `T'' in the formula above, is computed by finding
the average annual compounded rates of return over the 1, 5 and 10 year
periods (or fractional portion thereof) that would equate the initial
amount invested to the ending redeemable value.
The FUND's annual total return, for the fiscal year ended October 31,
1996 and from inception through October 31, 1995 was 18.77% and 17.39%,
respectively.
The FUND may also from time to time include in such advertising a
total return figure that is not calculated according to the formula set
forth above in order to compare more accurately the FUND's performance with
other measures of investment return. For example, in comparing the FUND's
total return with data published by Lipper Analytical Services, Inc. or
similar independent services or financial publications, the FUND calculates
its aggregate total return for the specified periods of time by assuming
the reinvestment of each dividend or other distribution at net asset value
on the reinvestment date. Percentage increases are determined by
subtracting the initial net asset value of the investment from the ending
net asset value and by dividing the remainder by the beginning net asset
value. The FUND does not, for these purposes, deduct the pro rata share of
the account opening fee, which was in effect until December, 1994, from the
initial value invested. THE FUND WILL, HOWEVER, DISCLOSE THE PRO RATA SHARE
OF THE ACCOUNT OPENING FEE AND WILL DISCLOSE THAT THE PERFORMANCE DATA DOES
NOT REFLECT SUCH NON-RECURRING CHARGE AND THAT INCLUSION OF SUCH CHARGE
WOULD REDUCE THE PERFORMANCE QUOTED. Such alternative total return
information will be given no greater prominence in such advertising than
the information prescribed under the Commission's rules.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The FUND reserves the right to close an account that has dropped below
$1,000 in value for a period of three months or longer other than as a
result of a decline in the net asset value per share. Shareholders are
notified at least 60 days prior to any proposed redemption and are invited
to add to their account if they wish to continue as shareholders of the
FUND, however, the FUND does not presently contemplate making such
redemptions and the FUND will not redeem any shares held in tax-sheltered
retirement plans.
The FUND has elected to be governed by Rule 18f-1 of the 1940 Act,
under which the FUND is obligated to redeem the shares of any shareholder
solely in cash up to the lesser of 1% of the net asset value of the FUND or
$250,000 during any 90-day period. Should any shareholder's redemption
exceed this limitation, the FUND can, at its sole option, redeem the excess
in cash or in portfolio securities. Such securities would be selected
solely by the FUND and valued as in computing net asset value. In these
circumstances a shareholder selling such securities would probably incur a
brokerage charge and there can be no assurance that the price realized by a
shareholder upon the sale of such securities will not be less than the
value used in computing net asset value for the purpose of such redemption.
TAX MATTERS
The following is only a summary of certain additional tax
considerations generally affecting the FUND and its shareholders that are
not described in the Prospectus. No attempt is made to present a detailed
explanation of the tax treatment of the FUND or its shareholders, and the
discussions here and in the Prospectus are not intended as substitutes for
careful tax planning.
Qualification as a Regulated Investment Company
The FUND has elected to be taxed as a regulated investment company
(`RIC'') under Subchapter M of the Internal Revenue Code of 1986, as
amended (the `Code''). As a RIC, the FUND is not subject to federal income
tax on the portion of its net investment income (i.e., taxable interest,
dividends and other taxable ordinary income, net of expenses) and capital
gain net income (i.e., the excess of capital gains over capital losses)
that it distributes to shareholders, provided that it distributes at least
90% of its investment company taxable income (i.e., net investment income
and the excess of net short-term capital gain over net long-term capital
loss) for the taxable year (the `Distribution Requirement''), and
satisfies certain other requirements of the Code that are described below.
Distributions by the FUND made during the taxable year or, under specified
circumstances, within twelve months after the close of the taxable year,
will be considered distributions of income and gains of the taxable year
and can therefore satisfy the Distribution Requirement. Because the FUND
invests all of its assets in the Portfolio, which is classified as a
partnership for federal income tax purposes, the FUND will be deemed to own
a proportionate share of the assets and income of the Portfolio for
purposes of determining whether the FUND satisfies the requirements
(described more fully below) necessary to qualify as a regulated investment
company.
In addition to satisfying the Distribution Requirement, a RIC must:
(1) derive at least 90% of its gross income from dividends, interest,
certain payments with respect to securities loans, gains from the sale or
other disposition of stock or securities or foreign currencies (to the
extent such currency gains are directly related to the company's principal
business of investing in stock or securities) and other income (including
gains from options, futures or forward contracts) derived with respect to
its business of investing in such stock, securities or currencies (the
`Income Requirement''); and (2) derive less than 30% of its gross income
(exclusive of certain gains on designated hedging transactions that are
offset by realized or unrealized losses on offsetting positions) from the
sale or other disposition of stock, securities or foreign currencies (or
options, futures or forward contracts thereon) held for less than three
months (the `Short-Short Gain Test''). Because of the Short-Short Gain
Test, the FUND may have to limit the sale of appreciated securities that it
held for less than three months. However, foreign currency gains that are
directly related to the company's investment in stock or securities are not
treated as short-short gains. Similarly, the Short-Short Gain Test will not
prevent the FUND from disposing of investments at a loss, since losses are
disregarded for this purpose. Interest (including original issue discount)
received by the FUND at maturity or upon the disposition of a security held
for less than three months is not treated as gross income derived from the
sale or other disposition of a security within the meaning of the Short-
Short Gain Test. However, income attributable to realized market
appreciation will be so treated for this purpose.
In general, gain or loss recognized by the Portfolio on the
disposition of an asset (and allocated to the FUND) will be a capital gain
or loss. However, gain recognized on the disposition of a debt obligation
purchased at a market discount will be treated as ordinary income to the
extent of the portion of the discount that accrued while the Portfolio held
the obligation. In addition, under the rules of Code Section 988, a portion
of gain or loss recognized on the disposition of a debt obligation
denominated in a foreign currency or an option with respect thereto, and
(with certain exceptions) gain or loss recognized on the disposition of a
foreign currency forward contract, futures contract, option or similar
financial instrument, or of foreign currency itself, will generally be
treated as ordinary income or loss.
In general, for purposes of determining whether capital gain or loss
recognized by the FUND (through its Portfolio) on the disposition of an
asset is long-term or short-term, the holding period of the asset may be
affected if (1) the asset is used to close a `short sale'' (which may
include the acquisition of a put option) or is substantially identical to
another asset so used, (2) the asset is otherwise held by the Portfolio as
part of a `straddle'' (as defined) or (3) the asset is stock and the
Portfolio grants an in-the-money qualified covered call option with respect
thereto. In addition, the FUND may be required to defer the recognition of
a loss on a disposition of an asset held as part of a straddle to the
extent of any unrecognized gain on the offsetting position.
Any gain allocated to the FUND on the lapse of, or any gain or loss
allocated to it from a closing transaction with respect to, an option
written by the Portfolio will be treated as a short-term capital gain or
loss. For purposes of the Short-Short Gain Test, the holding period of such
an option will commence on the date it is written and end on the date it
lapses or the date a closing transaction is entered into. Accordingly, the
Portfolio may be limited in its ability to write options which expire
within three months and to enter into closing transactions at a gain within
three months of the writing of options.
Regulated futures contracts, certain foreign currency contracts, and
options on stock indexes and futures contracts are subject to special tax
treatment as `Section 1256 contracts.'' Such contracts are treated as if
they are sold for their fair market value on the last business day of the
taxable year, even though a taxpayer's obligations (or rights) under such
contracts have not terminated as of such date. Gain or loss recognized as a
consequence of the year-end deemed disposition of Section 1256 contracts is
taken into account for the taxable year together with any gain or loss
recognized upon the actual termination of such contracts during the year.
The combined capital gain or loss for the year with respect to Section 1256
contracts is generally treated as 60% long-term capital gain or loss and
40% short-term capital gain or loss. (The Portfolio may elect not to have
this special tax treatment apply to Section 1256 contracts that are part of
a `mixed straddle'' with other investments that are not Section 1256
contracts.) The IRS has held in private rulings that constructive gains
arising from deemed year-end dispositions of Section 1256 contracts will
not be taken into account for purposes of the Short-Short Gain Test.
Treasury Regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain
(i.e., the excess of net long-term capital gain over net short-term capital
loss) for any taxable year, to elect (unless it has made a taxable year
election for excise tax purposes as discussed below) to treat all or any
part of any net capital loss, any net long-term capital loss or any net
foreign currency loss incurred after October 31 as if it were incurred in
the succeeding year.
In addition to the requirements described above, the FUND must satisfy
an asset diversification test in order to qualify as a regulated investment
company. Under this test, at the close of each quarter of a RIC's taxable
year, at least 50% of the value of its assets must consist of cash and cash
items, U.S. Government securities, securities of other RICs, and securities
of other issuers (as to which the RIC has not invested more than 5% of the
value of its total assets in securities of such issuer and as to which it
does not hold more than 10% of the outstanding voting securities of such
issuer), and no more than 25% of the value of its total assets may be
invested in the securities of any one issuer (other than U.S. Government
securities and securities of other RICs), or in two or more issuers which
the RIC controls and which are engaged in the same or similar trades or
businesses. Generally, an option (call or put) with respect to a security
is treated as issued by the issuer of the security and not the issuer of
the option.
If for any taxable year the FUND does not qualify as a RIC, all of its
taxable income (including its net capital gain) will be subject to tax at
regular corporate rates without any deduction for distributions to
shareholders, and such distributions will be taxable to the shareholders as
ordinary dividends to the extent of the FUND's current and accumulated
earnings and profits. Such distributions generally will be eligible for the
dividends-received deduction in the case of corporate shareholders.
Excise Tax on Regulated Investment Companies
A 4% non-deductible excise tax is imposed on a RIC that fails to
distribute in each calendar year an amount equal to 98% of its ordinary
taxable income for the calendar year and 98% of its capital gain net income
for the one-year period ended on October 31 of the year. The balance of
such income must be distributed during the next calendar year.
The FUND intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and capital gain net income
prior to the end of each calendar year to avoid liability for the excise
tax. The FUND may in certain circumstances have to liquidate portfolio
investments in order to effect such distributions.
FUND Distributions
The FUND intends to distribute substantially all of its investment
company taxable income for each taxable year. Such distributions will be
taxable to shareholders as ordinary income and treated as dividends for
federal income tax purposes, but will qualify for the 70% dividends-
received deduction for corporate shareholders only to the extent discussed
below.
The FUND may either retain or distribute to shareholders its net
capital gain for each taxable year. The FUND currently intends to
distribute such gains annually. Net capital gain distributed and designated
as a capital gain dividend is taxable to shareholders as long-term capital
gain, regardless of the shareholder's holding period in his shares and the
time when such gain was recognized by the Portfolio.
If the FUND elects to retain its net capital gain, it will be taxed
thereon (except to the extent of any available capital loss carryovers) at
the 35% corporate tax rate. In this case, the FUND would expect to elect to
have shareholders of record on the last day of the taxable year treated as
if each received a distribution of his pro rata share of the gain, with the
result that each would be required to report his pro rata share of such
gain on his tax return as a long-term capital gain, would receive a
refundable tax credit for his pro rata share of the tax paid by the FUND on
the gain, and would increase the tax basis for his shares by an amount
equal to the deemed distribution less the credit.
Ordinary income dividends distributed by the FUND will qualify for the
70% dividends-received deduction generally available to corporations (other
than corporations, such as S corporations, which are not eligible for the
deduction) to the extent of the portion of the distribution attributed to
`qualifying dividends'' received by the Portfolio during the taxable year
from domestic corporations. A dividend received by the Portfolio will not
be treated as a qualifying dividend (1) if it was received with respect to
stock that the Portfolio held for less than 46 days (91 days in the case of
certain preferred stock), subject to the limitations of Code Sections
246(c)(3) and (4) and 246A. Moreover, the dividends-received deduction for
a corporate shareholder will also be disallowed if the corporate
shareholder fails to satisfy the foregoing requirements with respect to its
FUND shares or the FUND fails to satisfy them with respect to its interest
in the Portfolio.
Investment income that may be received by the Portfolio from foreign
sources may be subject to foreign taxes withheld at the source. The United
States has entered into tax treaties with a number of foreign countries,
which entitle the Portfolio to reduced rates of, or exemptions from, taxes
on such income. It is impossible to determine the effective rate of foreign
tax in advance since the future mix of the Portfolio's investments in
various countries is not known.
Distributions by the FUND that do not constitute ordinary income
dividends or capital gain dividends will be treated as a return of capital
to the extent of (and in reduction of) the shareholders' tax basis in their
shares; any excess will be treated as gain from a sale of the shares, as
discussed more fully below.
Distributions by the FUND will be treated in the manner described
above whether they are paid in cash or reinvested in additional shares of
the FUND (or of another fund). In addition, if a shareholder's cost for his
shares already reflects undistributed (realized or unrealized) income or
gain, a subsequent distribution of such amounts will be taxable to the
shareholder in the manner described above, although economically it
constitutes a return of capital.
Ordinarily, shareholders are required to take distributions into
account in the year in which they are made. However, dividends declared by
the FUND in October, November or December of any calendar year and payable
to shareholders of record on a specified date in such a month will be
deemed to have been received by the shareholders (and made by the FUND) on
December 31 of such year if such dividends are actually paid in January of
the following year. Shareholders will be advised annually as to the U.S.
federal income tax consequences of distributions made (or deemed made)
during the year.
The FUND will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of dividends and the proceeds of redemption paid to
any shareholder (1) who has provided either an incorrect tax identification
number or no number at all to the FUND, (2) who is subject to backup
withholding pursuant to a notice from the IRS for failure to report
interest or dividend income properly, or (3) who has not otherwise
certified to the FUND that it is not subject to backup withholding.
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or redemption of
his shares in an amount equal to the difference between the amount realized
on the shares and his adjusted tax basis in them. All or a portion of any
loss so recognized may be disallowed if the shareholder purchases other
shares of the FUND within 30 days before or after the disposition. In
general, gain or loss arising from a sale or redemption of FUND shares will
constitute capital gain or loss, and will be long-term capital gain or loss
if the shares were held longer than one year. However, a capital loss
arising from a disposition of shares held for six months or less will be
treated as a long-term capital loss to the extent of any amount of capital
gain dividends received on the shares. For this purpose, the special
holding period rules of Code Section 246(c)(3) and (4) (alluded to above in
connection with the dividends-received deduction for corporations) will
generally apply. Capital losses in any year are deductible only to the
extent of capital gains plus, in the case of noncorporate taxpayers, $3,000
of ordinary income.
Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation,
or foreign partnership (`foreign shareholder''), depends on whether the
income received from the FUND is `effectively connected'' with a U.S.
trade or business carried on by the shareholder.
If the income is not effectively connected in the above sense,
ordinary income dividends distributed to a foreign shareholder will be
subject to U.S. withholding tax at the rate of 30% (or a lower treaty rate,
if one applies) of the gross amount of the dividend. Such a shareholder
would generally be exempt from U.S. federal income tax on gains realized on
a sale of FUND shares and capital gain dividends.
If income from the FUND is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income
dividends, capital gain dividends, and gain realized upon the sale of FUND
shares will be subject to U.S. federal income tax at the rates applicable
to U.S. citizens or domestic corporations.
In the case of foreign noncorporate shareholders, the FUND may be
required to withhold U.S. federal income tax at a rate of 31% on
distributions that are otherwise exempt from withholding tax (or taxable at
a reduced treaty rate) unless they furnish the FUND with proper
notification of their exempt status.
The tax consequences to foreign shareholders entitled to claim the
benefits of applicable treaties may differ from one treaty to another.
Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in the
FUND, including the applicability of any foreign taxes.
Effect of Future Legislation; Local Tax Considerations
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and the Treasury Regulations as in effect
on the date of this Statement of Additional Information. Future legislative
or administrative changes or court decisions may significantly alter the
conclusions expressed herein, perhaps with retroactive effect.
Rules of state and local taxation of dividends from regulated
investment companies often differ from the rules for U.S. federal income
taxation described above. Shareholders are urged to consult their tax
advisers as to the consequences of their investing in the FUND in light of
their particular circumstances.
THE MANAGEMENT OF THE FUND
Officers and Trustees are listed with their birthdates, addresses,
principal occupations, and present positions, including any affiliation
with Virtus Capital Management, Inc., Signet Trust Company, Federated
Investors, Federated Securities Corp., Federated Shareholder Services
Company, and Federated Administrative Services or the Funds (as defined
below).
John F. Donahue(1)(2) CHAIRMAN AND TRUSTEE OF THE FUND;
Federated Investors Tower Chairman and Trustee,
Pittsburgh, PA Federated Investors, Federated
BIRTHDATE: July 28, 1924 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,
Trustee, or Managing
General Partner of the Funds.
Mr. Donahue is the father of
J. Christopher Donahue, Executive Vice
President of the Fund.
Thomas G. Bigley TRUSTEE OF THE FUND; Director, Oberg
28th Floor Manufacturing Co.;
One Oxford Centre Chairman of the Board, Children's
Pittsburgh, PA Hospital of Pittsburgh;
BIRTHDATE: February 3, 1934 Director, Trustee or Managing General
Partner of the Funds;
formerly, Senior Partner, Ernst & Young LLP.
John T. Conroy, Jr.(3) TRUSTEE OF THE FUND; President,
John R. Wood and Associates, Inc., Investment Properties
3255 Tamiami Trail North Realtors Corporation; Senior Vice-
Naples, FL President, John R. Wood and
BIRTHDATE: June 23, 1937 Associates, Inc., Realtors; President,
Northgate Village
Development Corporation; Partner or
Trustee in private real
estate ventures in Southwest Florida;
Director, Trustee, or
Managing General Partner of the Funds;
formerly, President,
Naples Property Management, Inc.
Wood/IPC Commercial Department
William J. Copeland(3) TRUSTEE OF THE FUND; Director and
One PNC Plaza - 23rd Floor Member of the Executive
Pittsburgh, PA Committee, Michael Baker, Inc.;
BIRTHDATE: July 4, 1918 Director, Trustee, or
Managing General Partner of the Funds;
formerly, Vice Chairman and Director,
PNC Bank, N.A., and PNC Bank
Corp. and Director, Ryan Homes, Inc.
James E. Dowd(3) TRUSTEE OF THE FUND; Attorney-at-law;
571 Hayward Mill Road Director, The Emerging Germany Fund, Inc.;
Concord, MA Director, Trustee, or
BIRTHDATE: May 18, 1922 Managing General Partner of the Funds.
Lawrence D. Ellis, M.D.(1) TRUSTEE OF THE FUND; Professor of
3471 Fifth Avenue, Suite 1111 Medicine and Member,
Pittsburgh, PA Board of Trustees, University of
BIRTHDATE: October 11, 1932 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, Trustee, or
Managing General Partner of the Funds.
Edward L. Flaherty, Jr.(3) TRUSTEE OF THE FUND; Attorney-at-law;
Miller, Ament, Henny & Kochuba Shareholder, Miller, Ament, Henny &
205 Ross Street Kochuba; Director, Eat'N Park Restaurants,
Pittsburgh, PA Inc., and Statewide Settlement Agency,
BIRTHDATE: June 18, 1924 Inc.; Director, Trustee, or Managing
General Partner of the Funds;
formerly, Counsel, Horizon Financial,
F.A., Western Region.
Edward C. Gonzales(1) PRESIDENT, TRUSTEE AND TREASURER OF THE
Federated Investors Tower FUND; Vice Chairman, Treasurer, and Trustee,
Pittsburgh, PA Federated Investors; Vice President,
BIRTHDATE: October 22, 1930 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;
Chairman, Treasurer, and Trustee,
Federated Administrative Services; Trustee
or Director of some of the Funds;
President, Executive Vice President and
Treasurer of some of the Funds.
Peter E. Madden TRUSTEE OF THE FUND; Consultant; State
Seacliff Representative, Commonwealth of
526 Bellevue Avenue Massachusetts; Director, Trustee, or
Newport, RI Managing General Partner of the Funds;
BIRTHDATE: March 16, 1942 formerly, President,
State Street Bank and Trust Company and
State Street Boston Corporation.
Gregor F. Meyer TRUSTEE OF THE FUND; Attorney-at-law;
Miller, Ament, Henny & Kochuba Shareholder, Miller,
205 Ross Street Ament, Henny & Kochuba; Chairman,
Pittsburgh, PA Meritcare, Inc.; Director, Eat'N Park
BIRTHDATE: October 6, 1926 Restaurants, Inc.; Director, Trustee, or
Managing General Partner of the Funds.
John E. Murray, Jr., J.D., S.J.D. TRUSTEE OF THE FUND; President, Law
President, Duquesne University Professor, Duquesne University;
Pittsburgh, PA Consulting Partner, Mollica, Murray and
BIRTHDATE: December 20, 1932 Hogue; Director, Trustee or Managing Partner
of the Funds.
Wesley W. Posvar TRUSTEE OF THE FUND; Professor,
1202 Cathedral of Learning International Politics and
University of Pittsburgh Management Consultant; Trustee,
Pittsburgh, PA Carnegie Endowment for
BIRTHDATE: September 14, 1925 International Peace, RAND Corporation,
Online Computer Library Center, Inc., and
U.S. Space Foundation; Chairman,
Czecho Management Center; Director,
Trustee, or Managing
General Partner of the Funds; President
Emeritus, University of Pittsburgh;
founding Chairman, National Advisory
Council for Environmental Policy and
Technology and Federal Emergency
Management Advisory Board.
Marjorie P. Smuts TRUSTEE OF THE FUND; Public
4905 Bayard Street relations/marketing consultant;
Pittsburgh, PA Conference Coordinator, Non-profit
BIRTHDATE: June 21, 1935 entities; Director, Trustee, or Managing
General Partner of the Funds.
J. Christopher Donahue EXECUTIVE VICE PRESIDENT OF THE FUND;
Federated Investors Tower President and Trustee, Federated Investors,
Pittsburgh, PA Federated Advisers, Federated Management.
BIRTHDATE: April 11, 1949 and Federated Research; President and
Director, Federated Research Corp. and
Federated Global Research Corp.; President,
Passport Research, Ltd.; Trustee,
Federated Administrative Services,
Federated Shareholder Services Company,
and Federated Shareholder Services;
Director, Federated Services Company;
President or Executive Vice President of
the Funds; Director, Trustee, or
Managing General Partner of some of the
Funds. Mr. Donahue is the son of
John F. Donahue, Chairman and Trustee of
the Fund.
John W. McGonigle EXECUTIVE VICE PRESIDENT AND SECRETARY
Federated Investors Tower OF THE FUND;
Pittsburgh, PA Executive Vice President, Secretary,
BIRTHDATE: October 26, 1938 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.
Richard B. Fisher VICE PRESIDENT OF THE FUND; Executive
Federated Investors Tower Vice President and Trustee, Federated
Pittsburgh, PA Investors; Chairman and Director,
BIRTHDATE: May 17, 1923 Federated Securities Corp.; President
or Vice President of Some of the Funds;
Director or Trustee of some of the Funds.
Joseph S. Machi VICE PRESIDENT AND ASSISTANT TREASURER
Federated Investors Tower OF THE FUND;
BIRTHDATE: May 22, 1962 Vice President, Federated Administrative
Services; Vice President and Assistant
Treasurer of some of the Funds.
(1) This Trustee is deemed to be an `interested person'' of the Trust as
defined in the Investment Company Act of 1940.
(2) Member of the Executive Committee. The Executive Committee of the
Board of Trustees handles the responsibilities of the Board of
Trustees between meetings of the Board.
(3) Member of the Audit Committee. The Audit Committee is responsible for
reviewing compliance with all internal controls and all regulations
related to the financial reporting process.
THE FUNDS
As referred to in the list of Trustees and Officers, `Funds''
includes the following investment companies:
111 Corcoran Funds; Arrow Funds; Automated Government Money Trust;
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; Intermediate Municipal Trust;
International Series, Inc.; Investment Series Funds, Inc.; Investment
Series Trust; Liberty Term Trust, Inc. - 1999; Liberty U.S. Government
Money Market Trust; Liquid Cash Trust; Managed Series Trust; Money Market
Management, Inc.; Money Market Obligations Trust; Money Market Trust;
Municipal Securities Income Trust; Newpoint Funds; Peachtree Funds; RIMCO
Monument Funds; Targeted Duration Trust; Tax-Free Instruments Trust; The
Planters Funds; The Starburst Funds; The Starburst Funds II; The Virtus
Funds; Trust for Financial Institutions; Trust for Government Cash
Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S.
Treasury Obligations; and World Investment Series, Inc.
FUND OWNERSHIP
As of February 3, 1997, Officers and Trustees owned less than 1% of
the outstanding shares of the FUND.
To the best knowledge of the FUND, as of February 3, 1997, one
shareholder owned 5% or more of the outstanding shares of the FUND.
Stephens Inc., Little Rock, Arkansas, owned approximately 310,647 shares
(19.54%).
The Trustees and officers of the Portfolio and their age and principal
occupations for at least the past five years are set forth below. Their
titles may have varied during that period. Asterisks indicate those
Trustees who are ``nterested persons'' (as defined in the 1940 Act) of the
Portfolio. Unless otherwise indicated below, the address of each officer is
6 St. James Avenue, Suite 900, Boston, Massachusetts 02116.
PRINCIPAL OCCUPATIONS YEAR FIRST
TRUSTEE AGE FOR THE LAST FIVE BECAME
YEARS A TRUSTEE
Fergus Reid, III 64 Chairman and Chief 1984
971 West Road Executive Officer,
New Canaan, CT 06840 Lumelite Corporation,
since September 1985;
Trustee, Morgan
Stanley Portfolios.
Richard E. Ten Haken 62 Former District 1984
4 Barnfield Road Superintendent of
Pittsford, NY 14534 Schools, Monroe No. 2
and Orleans Counties,
New York; Chairman of
the Finance and the
PRINCIPAL OCCUPATIONS YEAR FIRST
TRUSTEE AGE FOR THE LAST FIVE BECAME
YEARS A TRUSTEE
Audit and Accounting
Committees, Member of
the Executive
Committee; Chairman of
the Board and
President, New York
State Teachers'
Retirement System.
William J. Armstrong 54 Vice President and 1987
49 Aspen Way Treasurer, Ingersoll-
Upper Saddle River, NJ Rand Company.
07458
John R.H. Blum 67 Attorney in Private 1984
322 Main Street Practice; formerly a
Lakeville, CT 06039 Partner in the law
firm of Richards,
O'Neil & Allegaert;
Commissioner of
Agriculture - State of
Connecticut, 1992-
1995.
*Joseph J. Harkins 65 Retired; Commercial 1990
257 Plantation Circle Sector Executive and
South Executive Vice
Ponte Vedra Beach, FL President of The Chase
32082 Manhattan Bank, N.A.
from 1985 through
1989. He has been
PRINCIPAL OCCUPATIONS YEAR FIRST
TRUSTEE AGE FOR THE LAST FIVE BECAME
YEARS A TRUSTEE
employed by Chase in
numerous capacities
and offices since
1954. Director of
Blessings Corporation,
Jefferson Insurance
Company of New York,
Monticello Insurance
Company and National.
60 Consultant, Republic 1992
Bank of New York;
*H. Richard formerly, Senior
Vartabedian Investment Officer,
P.O. Box 296 Division Executive of
Beach Road the Investment
Hendrick's Head Management Division of
Southport, ME 04576 The Chase Manhattan
Bank, N.A., 1980
through 1991.
Principal Occupations Year First
Trustee Age For the Last Five Became
Years a Trustee
Stuart W. Cragin, Jr. 63 Retired; formerly 1992
108 Valley Road President, Fairfield
Cos Cob, CT 06807 Testing Laboratory,
Principal Occupations Year First
Trustee Age For the Last Five Became
Years a Trustee
Inc. He has previously
served in a variety of
marketing,
manufacturing and
general management
positions with Union
Camp Corp., Trinity
Paper & Plastics
Corp., and Conover
Industries
Irving L. Thode 65 Retired; Vice 1992
80 Perkins Road President of Quotron
Greenwich, CT 06830 Systems. He has
previously served in a
number of executive
positions with Control
Data Corp., including
President of its Latin
American Operations,
and General Manager of
its Data Services
business.
W. Perry Neff 69 Independent Financial 1989
Trustee Consultant; Director
RR 1 Box 102 of North America Life
Weston, VT 05181 Assurance Co.,
Petroleum & Resources
Principal Occupations Year First
Trustee Age For the Last Five Became
Years a Trustee
Corp. and The Adams
Express Co.; Formerly
Director and Chairman
of The Hanover Funds,
Inc.; Formerly
Director, Chairman and
President of The
Hanvover Investment
Funds Inc.
Roland R. Eppley, Jr. 64 Retired; formerly 1988
Trustee President and Chief
105 Coventry Place Executive Officer,
Palm Beach Gardens, FL Eastern States
33418 Bankcard Association
Inc. (1971-1988);
Director, Janel
Hydraulics, Inc.;
Formerly, Director of
The Hanover Funds,
Inc.
Principal Occupations Year First
Trustee Age For the Last Five Became
Years a Trustee
Principal Occupations Year First
Trustee Age For the Last Five Became
Years a Trustee
W.D. MacCallan 69 Director of The Adams 1989
Trustee Express Co. and
624 East 45th Street Petroleum & Resources
Savannah, GA 31405 Corp.; formerly
Chairman of the Board
and Chief Executive
Officer of The Adams
Express Co. and
Petroleum & Resources
Corp.; formerly
Director of The
Hanover Fund, Inc. and
The Hanover Investment
Funds, Inc.
* Interested Trustees as defined under the 1940 Act.
Remuneration of Trustees and Certain Executive Officers:
Each Trustee is reimbursed for expenses incurred in attending each
meeting of the Board of Trustees or any committee thereof. Each Trustee who
is not an affiliate of the Portfolio Adviser is compensated for his or her
services according to a fee schedule which recognizes the fact that each
Trustee also serves as a Trustee of other investment companies advised by
the Portfolio Adviser. Each Trustee receives a fee, allocated among all
investment companies for which the Trustee serves, which consists of an
annual retainer component and a meeting fee component. Effective August 21,
1995, each Trustee receives a quarterly retainer of $12,000 and an
additional per meeting fee of $1,500. Prior to August 21, 1995, the
quarterly retainer was $9,000 and the per-meeting fee was $1,000. The
Chairman of the Trustees and the Chairman of the Investment Committee each
receive a 50% increment over regular Trustee total compensation for serving
in such capacities for all the investment companies advised by the
Portfolio Adviser.
OFFICERS AND TRUSTEES OF THE FUNDS COMPENSATION
NAME, POSITION AGGREGATE TOTAL COMPENSATION
WITH THE FUNDS COMPENSATION FROM PAID TO TRUSTEES
THE FUNDS(1) FROM THE FUNDS AND
FUND COMPLEX*
John F. Donahue, $-0- $-0- for the Fund
Chairman and Trustee Complex
Thomas G. Bigley, $117.71 $3,700 for the Fund
Trustee Complex
John T. Conroy, Jr., $117.71 $4,042 for the Fund
Trustee Complex
William J. Copeland, $117.71 $4,042 for the Fund
Trustee Complex
James E. Dowd, $117.71 $4,042 for the Fund
Trustee Complex
Lawrence D. Ellis, $107.36 $3,700 for the Fund
M.D., Trustee Complex
Edward L. Flaherty, $117.71 $4,042 for the Fund
Jr., Trustee Complex
Edward C. Gonzales, $-0- $-0- for the Fund
President, Trustee Complex
and Treasurer
Peter E. Madden, $107.36 $3,700 for the Fund
Trustee Complex
Gregory F. Meyer, $107.36 $3,700 for the Fund
Trustee Complex
John E. Murray, Jr., $107.36 $3,700 for the Fund
J.D., S.J.D., Complex
Trustee
Wesley W. Posvar, $107.36 $3,700 for the Fund
Trustee Complex
Marjorie P. Smuts, $107.36 $3,700 for the Fund
Trustee Complex
(1) The aggregate compensation is provided for the Funds which was
comprised of seven portfolios on
December 31, 1996. Information is furnished for the period from May 2,
1996, date of election of
Trustees, to December 31, 1996.
* The total compensation is provided for the Fund Complex, which
consists of Blanchard Precious Metals Fund, Inc., The Virtus Funds and the
Trust for the calendar year ended December 31, 1996.
Set forth below is information regarding compensation paid or accrued
during the fiscal year ended October 31, 1996 for each Trustee of the
Trust:
Growth and Pension or Total
Income Retirement Compensation
Portfolio(1) Benefits from "Fund
Accrued Complex"(2)
as Fund
Expenses
Fergus Reid, $14,393.16 0 $78,456.65
III, Trustee
Richard E. Ten $9,595.45 0 $52,304.39
Haken, Trustee
William J. $9,595.45 0 $46,632.34
Armstrong,
Trustee
John R.H. $9,595.45 0 $51,304.37
Blum, Trustee
Joseph J. $9,376.63 0 $52,304.39
Harkins,
Trustee
H. Richard $18,159.13 0 $74,804.44
Vartabedian,
Trustee
Stuart W. $9,595.45 0 $52,304.39
Cragin, Jr.,
Trustee
Irving L. $9,595.45 0 $52,304.39
Thode, Trustee
(1) Prior to January 1, 1995, the Portfolio did not pay the Trustees
expenses directly. Rather, the Trustees payments accrued against the
underlying Fund, the Vista Growth and Income Fund. Data reflects Trustee
compensation as if the Portfolio had paid such expenses directly. As of
January 1, 1995, Trustee compensation will be paid by the Portfolio
directly. Mr. Vartabedian received a 50% increment over regular Trustee
compensation for serving as Chairman of the Portfolio. This incremental
amount was paid by the Portfolio directly.
(2) Data reflects total compensation earned during the period January 1,
1995 to December 31, 1995 for service as a Trustee to all thirty-two
(Portfolios) Funds advised by the Portfolio Adviser.
Vista Funds Retirement Plan for Eligible Trustees
Effective August 21, 1995, the Trustees also instituted a Retirement
Plan for Eligible Trustees (the "Plan") pursuant to which each Trustee (who
is not an employee of any of the Portfolios, the Portfolio Adviser,
Administrator or distributor or any of their affiliates) may be entitled to
certain benefits upon retirement from the Board of Trustees. Pursuant to
the Plan, the normal retirement date is the date on which the eligible
Trustee has attained age 65 and has completed at least five years of
continuous service with one or more of the investment companies advised by
the Portfolio Adviser (collectively, the "Covered Portfolios"). Each
Eligible Trustee is entitled to receive from the Covered Portfolios an
annual benefit commencing on the first day of the calendar quarter
coincident with or following his date of retirement equal to 10% of the
highest annual compensation received from the Covered Portfolios multiplied
by the number of such Trustee's years of service (not in excess of 10
years) completed with respect to any of the Covered Portfolios. Such
benefit is payable to each eligible Trustee in monthly installments for the
life of the Trustee.
Set forth below in the table below are the estimated annual benefits
payable to an eligible Trustee upon retirement assuming various
compensation and years of service classifications. The estimated credited
years of service for Messrs. Reid, Ten Haken, Armstrong, Blum, Harkins,
Vartabedian, Cragin, Thode, Neff, Epply and MacCallan are 11, 11, 8, 11, 3,
3, 3, 6, 7 and 6, respectively.
Years of
Service Highest Annual Compensation Paid by All Vista
Funds
40,000 45,000 50,000 55,000
10 40,000 45,000 50,000 55,000
9 36,000 40,500 45,000 49,500
8 32,000 36,000 40,000 44,000
7 28,000 31,500 35,000 38,500
6 24,000 27,000 30,000 33,000
5 20,000 22,500 25,000 27,500
DEFERRED COMPENSATION PLAN
Effective August 21, 1995, the Trustees instituted a Deferred
Compensation Plan for Eligible Trustees (the "Deferred Compensation Plan")
pursuant to which each Trustee (who is not an employee of any of the Funds,
the Portfolio Adviser, Administrator or Distributor or any of their
affiliates) may enter into agreements with the Funds whereby payment of the
Trustees' fees are deferred until the payment date elected by the Trustee
(or the Trustee's termination of service). The deferred amounts are deemed
invested in shares of the Fund on whose Board the Trustee sits. The
deferred amounts are paid out in a lump sum or over a period of several
years as elected by the Trustee at the time of deferral. If a deferring
Trustee dies prior to the distribution of amounts held in the deferral
account, the balance of the deferral account will be distributed to the
Trustee's designated beneficiary in a single lump sum payment as soon as
practicable after such deferring Trustee's death. The following Eligible
Trustees have executed a deferred compensation agreement for the 1996
calendar year: Messrs. Ten Haken, Thode and Vartabedian.
MANAGEMENT SERVICES
Manager to the Trust
The Trust's manager is Virtus Capital Management, Inc. (`VCM''), a
wholly-owned subsidiary of Signet Banking Corporation. Because of the
internal controls maintained by Signet Banking Corporation to restrict the
flow of non-public information, Fund investments are typically made without
any knowledge of Signet Banking Corporation or its affiliates' lending
relationships with an issuer.
The manager 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 services, VCM receives an annual management fee as described
in the prospectus. For the fiscal year ended October 31, 1996, and for the
period from July 12, 1995, to October 31, 1995, the amount paid or accrued
by the FUND to VCM was $85,166 and $6,416, respectively, all of which was
waived. For the period November 1, 1994, to July 11, 1995, the amount paid
or accrued by the FUND to Sheffield Management Corporation was $14,683, all
of which was waived.
ADMINISTRATIVE SERVICES
Federated Administrative Services, which is a subsidiary of Federated
Investors, provides administrative personnel and services to the Funds for
the fees set forth in the prospectus. For the fiscal year ended October 31,
1996 and for the period from July 12, 1995 to October 31, 1995, the amount
paid or accrued by the FUND to Federated Administrative Services was
$75,000 and $23,014, respectively.
Transfer Agent & Dividend Disbursing Agent
Federated Shareholder Services Company serves as transfer agent and
dividend disbursing agent for the FUND. The fee paid to the transfer agent
is based upon the size, type and number of accounts and transactions made
by shareholders.
Federated Shareholder Services Company also maintains FUND accounting
records. The fee paid for this service is based upon the level of the
FUND's average net assets for the period plus out-of-pocket expenses.
DISTRIBUTION PLAN
The Trust has adopted a Plan for Shares of the FUND pursuant to Rule
12b-1 which was promulgated by the Securities and Exchange Commission
pursuant to the Investment Company Act of 1940. The Plan provides that the
FUND's Distributor shall act as the Distributor of shares, and it permits
the payment of fees to brokers and dealers for distribution and
administrative services and to administrators for administrative services.
The Plan is designed to (i) stimulate brokers and dealers to provide
distribution and administrative support services to the FUND and its
shareholders and (ii) stimulate administrators to render administrative
support services to the FUND and its shareholders. These services are to be
provided by a representative who has knowledge of the shareholders'
particular circumstances and goals, and include, but are not limited to:
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 the FUND; assisting clients in changing dividend options, account
designations, and addresses; and providing such other services as the Trust
reasonably requests.
Other benefits which the FUND hopes to achieve through the Plan
include, but are not limited to the following: (1) an efficient and
effective administrative system; (2) a more efficient use of assets of
shareholders by having them rapidly invested in the FUND with a minimum of
delay and administrative detail; and (3) an efficient and reliable records
system for shareholders and prompt responses to shareholder requests and
inquiries concerning their accounts.
By adopting the Plan, the then Board of Trustees expected that the
FUND will be able to achieve a more predictable flow of cash for investment
purposes and to meet redemptions. This will facilitate more efficient
portfolio management and assist the FUND in seeking to achieve its
investment objectives. By identifying potential investors in shares whose
needs are served by the FUND's objectives, and properly servicing these
accounts, the FUND may be able to curb sharp fluctuations in rates of
redemptions and sales.
For the fiscal year ended October 31, 1996, the FUND paid $60,833 in
distribution services fees, all of which was waived.
DESCRIPTION OF THE FUND
Shareholder and Trustee Liability. The FUND is a series of an entity
of the type commonly known as a `Massachusetts business trust''. Under
Massachusetts law, shareholders of such a trust may, under certain
circumstances, be held personally liable for the obligations of the trust.
The FUND's Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations for the FUND and requires
that notice of such disclaimer be given in each agreement, obligation, or
instrument entered into or executed by the FUND or the Trustees. The
Declaration of Trust provides for indemnification out of the FUND property
of any shareholder held personally liable for the obligations of the FUND.
The Declaration of Trust also provides that the FUND shall, upon
request, assume the defense of any claim made against any shareholders for
any act or obligation of the FUND and satisfy any judgment thereon. Thus,
the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the FUND itself
would be unable to meet its obligations. VCM believes that, in view of the
above, the risk of personal liability to shareholders is remote. The
Declaration of Trust further provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the
conduct of his office.
Voting Rights. The FUND's capital consists of shares of beneficial
interest. Shares of the FUND entitle the holders to one vote per share. The
shares have no preemptive or conversion rights. The voting and dividend
rights and the right of redemption are described in the Prospectus. Shares
are fully paid and nonassessable, except as set forth under `Shareholder
and Trustee Liability''above. The shareholders have certain rights, as set
forth in the Declaration of Trust, to call a meeting for any purpose,
including the purpose of voting on removal of one or more Trustees.
The FUND may be terminated upon the sale of its assets to another
open-end management company if approved by the vote of the holders of a
majority of the outstanding shares of the FUND. The FUND may also be
terminated upon liquidation and distribution of its assets, if approved by
a majority shareholder vote of the FUND. Shareholders of the FUND shall be
entitled to receive distributions as a class of the assets belonging to the
FUND. The assets of the FUND received for the issue or sale of the shares
of the FUND and all income earnings and the proceeds thereof, subject only
to the rights of creditors, are specially allocated to the FUND, and
constitute the underlying assets of the FUND.
SHAREHOLDER REPORTS
Shareholders received an Annual Report containing financial statements
audited by the FUND's independent accountants for the fiscal year ended
October 31, 1996. The Financial Statements for the fiscal year ended
October 31, 1996 are incorporated herein by reference to the Annual Report
of the FUND filed with the U.S. Securities and Exchange Commission (File
Nos. 33-3165 and 811-4579). A copy of the Annual Report may be obtained
without charge by contacting the FUND at 1-800-829-3863.
APPENDIX A
DESCRIPTION OF CERTAIN OBLIGATIONS
ISSUED OR GUARANTEED BY U.S. GOVERNMENT
AGENCIES OR INSTRUMENTALITIES
FEDERAL FARM CREDIT SYSTEM NOTES AND BONDS -- are bonds issued by a
cooperatively owned nationwide system of banks and associations supervised
by the Farm Credit Administration, an independent agency of the U.S.
Government. These bonds are not guaranteed by the U.S. Government.
MARITIME ADMINISTRATION BONDS -- are bonds issued and provided by the
Department of Transportation of the U.S. Government and are guaranteed by
the U.S. Government.
FNMA BONDS -- are bonds guaranteed by the Federal National Mortgage
Association. These bonds are not guaranteed by the U.S. Government.
FHA DEBENTURES -- are debentures issued by the Federal Housing
Administration of the U.S. Government and are guaranteed by the U.S.
Government.
FHA INSURED NOTES -- are bonds issued by the Farmers Home
Administration, the U.S. Government and are guaranteed by the U.S.
Government.
GNMA CERTIFICATES -- are mortgage-backed securities which represent a
partial ownership interest in a pool of mortgage loans issued by lenders
such as mortgage bankers, commercial banks and savings and loan
associations. Each mortgage loan included in the pool is either insured by
the Federal Housing Administration or guaranteed by the Veterans
Administration and therefore guaranteed by the U.S. Government. As a
consequence of the fees Paid to GNMA and the issuer of GNMA Certificates,
the coupon rate of interest of GNMA Certificates is lower than the interest
paid on the VA-guaranteed or FHA-insured mortgages underlying the
Certificates. The average life of a GNMA Certificate is likely to be
substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by mortgagors and
mortgage foreclosures may result in the return of the greater part of
principal invested far in advance of the maturity of the mortgages in the
pool. Foreclosures impose no risk to principal investment because of the
GNMA guarantee. As the prepayment rate of individual mortgage pools will
vary widely, it is not possible to accurately predict the average life of a
particular issue of GNMA Certificates. The yield which will be earned on
GNMA Certificates may vary from their coupon rates for the following
reasons: (i) Certificates may be issued at a premium or discount, rather
than at par; (ii) Certificates may trade in the secondary market at a
premium or discount after issuance; (iii) interest is earned and compounded
monthly which has the effect of raising the effective yield earned on the
Certificates; and (iv) the actual yield of each Certificate is affected by
the prepayment of mortgages included in the mortgage pool underlying the
Certificates. Principal which is so prepaid will be reinvested although
possibly at a lower rate. In addition, prepayment of mortgages included in
the mortgage pool underlying a GNMA Certificate purchased at a premium
could result in a loss to the Portfolio. Due to the large amount of GNMA
Certificates outstanding and active participation in the secondary market
by securities dealers and investors, GNMA Certificates are highly liquid
instruments. Prices of GNMA Certificates are readily available from
securities dealers and depend on, among other things, the level of market
rates, the Certificate's coupon rate and the prepayment experience of the
pool of mortgages backing each Certificate. If agency securities are
purchased at a premium above principal, the premium is not guaranteed by
the issuing agency and a decline in the market value to par may result in a
loss of the premium, which may be particularly likely in the event of a
prepayment. When and if available, U.S. Government obligations may be
purchased at a discount from face value.
GNMA FHLMC BONDS and GNMA FNMA BONDS -- are mortgage-backed bonds
issued by the Federal Home Loan Mortgage Corporation and the Federal
National Mortgage Association, respectively, and are guaranteed by the U.S.
Government.
GSA PARTICIPATION CERTIFICATES -- are participation certificates
issued by the General Services Administration of the U.S. Government and
are guaranteed by the U.S. Government.
NEW COMMUNITIES DEBENTURES -- are debentures issued in accordance with
the provisions of Title IV of the Housing and Urban Development Act of
1968, as supplemented and extended by Title VII of the Housing and Urban
Development Act of 1970, the payment of which is guaranteed by the U.S.
Government.
PUBLIC HOUSING BONDS -- are bonds issued by public housing and urban
renewal agencies in connection with programs administered by the Department
of Housing and Urban Development of the U.S. Government, the payment of
which is secured by the U.S. Government.
PENN CENTRAL TRANSPORTATION CERTIFICATES -- are certificates issued by
Penn Central Transportation and guaranteed by the U.S. Government.
SBA DEBENTURES -- are debentures fully guaranteed as to principal and
interest by the Small Business Administration of the U.S. Government.
WASHINGTON METROPOLITAN AREA TRANSIT AUTHORITY BONDS -- are bonds
issued by the Washington Metropolitan Area Transit Authority and are
guaranteed by the U.S. Government.
FHLMC BONDS -- are bonds issued and guaranteed by the Federal Home
Loan Mortgage Corporation. These bonds are not guaranteed by the U.S.
Government.
FEDERAL HOME LOAN BANK NOTES AND BONDS -- are notes and bonds issued
by the Federal Home Loan Bank System and are not guaranteed by the U.S.
Government.
STUDENT LOAN MARKETING ASSOCIATION ("SALLIE MAE") NOTES AND BONDS --
are notes and bonds issued by the Student Loan Marketing Association and
are not guaranteed by the U.S. Government.
D.C. ARMORY BOARD BONDS -- are bonds issued by the District of
Columbia Armory Board and are guaranteed by the U.S. Government.
EXPORT-IMPORT BANK CERTIFICATES -- are certificates of beneficial
interest and participation certificates issued and guaranteed by the
Export-Import Bank of the U.S. and are guaranteed by the U.S. Government.
In the case of securities not backed by the "full faith and credit" of
the U.S. Government, the investor must look principally to the agency
issuing or guaranteeing the obligation for ultimate repayment, and may not
be able to assert a claim against the U.S. Government itself in the event
the agency or instrumentality does not meet its commitments.
Investments may also be made in obligations of U.S. Government
agencies or instrumentalities other than those listed above.
APPENDIX B
DESCRIPTION OF RATINGS
A description of the rating policies of Moody's, S&P and Fitch with
respect to bonds and commercial paper appears below.
MOODY'S INVESTORS SERVICE'S CORPORATE BOND RATINGS
Aaa--Bonds which are rated "Aaa" are judged to be of the best quality
and carry the smallest degree of investment risk. 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
qualities and are to be considered as upper medium grade obligations.
Factors giving security to principal and interest are considered adequate
but elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa--Bonds which are rated "Baa" are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba--Bonds which are rated "Ba" are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B--Bonds which are rated "B" generally lack characteristics of a
desirable investment. Assurance of interest and principal payments or of
maintenance and other terms of the contract over any long period of time
may be small.
Caa--Bonds which are rated "Caa" are of poor standing. Such issues
may be in default or there may be present elements of danger with respect
to principal or interest.
Ca--Bonds which are rated "Ca" represent obligations which are
speculative in high degree.
Such issues are often in default or have other marked shortcomings.
C--Bonds which are rated "C" are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers "1", "2", and "3" to certain of
its rating classifications. 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.
STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATINGS
AAA--This is the highest rating assigned by Standard & Poor's to a
debt obligation and indicates an extremely strong capacity to repay
principal and pay interest.
AA--Bonds rated "AA" also qualify as high quality debt obligations.
Capacity to pay principal and interest is very strong, and differs from
"AAA" issues only in small degree.
A--Bonds rated "A" have a strong capacity to repay principal and pay
interest, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher rated categories.
BBB--Bonds rated "BBB" are regarded as having an adequate capacity to
repay principal and pay interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to repay
principal and pay interest for bonds in this category than for higher rated
categories.
BB-B-CCC-CC-C--Bonds rated "BB", "B", "CCC", "CC" and "C" are
regarded, on balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal in accordance with
the terms of the obligations. BB indicates the lowest degree of
speculation and C the highest degree of speculation. While such bonds will
likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse
conditions.
CI--Bonds rated "CI" are income bonds on which no interest is being
paid.
D--Bonds rated "D" are in default. The "D" category is used when
interest payments or principal payments are not made on the date due even
if the applicable grace period has not expired unless S&P believes that
such payments will be made during such grace period. The "D" rating is
also used upon the filing of a bankruptcy petition if debt service payments
are jeopardized.
The ratings set forth above may be modified by the addition of a plus
or minus to show relative standing within the major rating categories.
MOODY'S INVESTORS SERVICE'S COMMERCIAL PAPER RATINGS
Prime-1--Issuers (or related supporting institutions) rated "Prime-1"
have a superior ability for repayment of senior short-term debt
obligations. "Prime-1" repayment ability will often be evidenced by many
of the following characteristics: leading market positions in
well-established industries, high rates of return on funds employed,
conservative capitalization structures with moderate reliance on debt and
ample asset protection, broad margins in earnings coverage of fixed
financial charges and high internal cash generation, and well-established
access to a range of financial markets and assured sources of alternate
liquidity.
Prime-2--Issuers (or related supporting institutions) rated "Prime-2"
have a strong ability for repayment of senior short-term debt obligations.
This will normally be evidenced by many of the characteristics cited above
but to a lesser degree. Earnings trends and coverage ratios, while sound,
will be more subject to variation. Capitalization characteristics, while
still appropriate, may be more affected by external conditions. Ample
alternative liquidity is maintained.
Prime-3--Issuers (or related supporting institutions) rated "Prime-3"
have an acceptable ability for repayment of senior short-term obligations.
The effect of industry characteristics and market compositions may be more
pronounced. Variability in earnings and profitability may result in
changes in the level of debt protection measurements and the requirement
for relatively high financial leverage. Adequate alternate liquidity is
maintained.
Not Prime--Issuers rated "Not Prime" do not fall within any of the
Prime rating categories.
STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATINGS
A S&P commercial paper rating is current assessment of the likelihood
of timely payment of debt having an original maturity of no more than 365
days. Ratings are graded in several categories, ranging from "A-1" for the
highest quality obligations to "D" for the lowest. The four categories are
as follows:
A-1--This highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus (+) sign
designation.
A-2--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1".
A-3--Issues carrying this designation have adequate capacity for
timely payment. They are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the bigger
designations.
B--Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C--This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
D--Debt rated "D" is in payment default. The "D" rating category is
used when interest payments or principal payments are not made on the date
due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
FITCH BOND RATINGS
AAA--Bonds rated AAA by Fitch are 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 rated AA by Fitch are 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 issues is generally rated F-1+ by Fitch.
A--Bonds rated A by Fitch are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and repay
principal is considered to be strong, but may be more vulnerable to adverse
changes in economic conditions and circumstances than bonds with higher
ratings.
BBB--Bonds rated BBB by Fitch are 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 consequences 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.
Plus and minus signs are used by Fitch to indicate the relative
position of a credit within a rating category. Plus and minus signs,
however, are not used in the AAA category.
FITCH SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of generally up to three years,
including commercial paper, certificates of deposit, medium-term notes, and
municipal and investment notes.
The short-term rating places greater emphasis than a long-term rating
on the existence of liquidity necessary to meet the issuer's obligations in
a timely manner.
Fitch's short-term ratings are as follows:
F-1+--Issues assigned this rating are regarded as having the strongest
degree of assurance for timely payment.
F-1--Issues assigned this rating reflect an assurance of timely
payment only slightly less in degree than issues rated F-1+.
F-2--Issues assigned this rating have a satisfactory degree of
assurance for timely payment but the margin of safety is not as great as
for issues assigned F-1+ and F-1 ratings.
F-3--Issues assigned this rating have characteristics suggesting that
the degree of assurance for timely payment is adequate, although near-term
adverse changes could cause these securities to be rated below investment
grade.
LOC--The symbol LOC indicates that the rating is based on a letter of
credit issued by a commercial bank.
Like higher rated bonds, bonds rated in the Baa or BBB categories are
considered to have adequate capacity to pay principal and interest.
However, such bonds may have speculative characteristics, and changes in
economic conditions or other circumstances are more likely to lead to a
weakened capacity to make principal and interest payments than is the case
with higher grade bonds.
After purchase by the Portfolio, a security may cease to be rated or
its rating may be reduced below the minimum required for purchase by the
Portfolio. Neither event will require a sale of such security by the
Portfolio. However, the Portfolio's investment manager will consider such
event in its determination of whether the Portfolio should continue to hold
the security. To the extent the ratings given by Moody's, S&P or Fitch may
change as a result of changes in such organizations or their rating
systems, the Portfolio will attempt to use comparable ratings as standards
for investments in accordance with the investment policies contained the
Prospectus and statement of additional information.
G01386-07 (2/97)
093265304
STATEMENT OF ADDITIONAL INFORMATION
BLANCHARD CAPITAL GROWTH FUND
FEDERATED INVESTORS TOWER
PITTSBURGH, PA 15222-3779
This Statement is not a Prospectus but should be read in conjunction with
the current Prospectus dated February 28, 1997 (the "Prospectus"), pursuant
to which the Blanchard Capital Growth FUND (the "FUND") is offered. Please
retain this document for future reference.
To obtain a copy of the Prospectus or a paper copy of this Statement of
Additional Information, if you have received your Statement of Additional
Information electronically, please call the FUND at 1-800-829-3863.
TABLE OF CONTENTS Page
General Information and History 1
Investment Objective, Policies and Restrictions 1
Portfolio Transactions 11
Computation of Net Asset Value 12
Performance Information 13
Additional Purchase and Redemption Information 14
Tax Matters 14
The Management of the FUND 18
Management Services 26
Administrative Services 27
Distribution Plan 27
Description of the FUND 27
Shareholder Reports 28
Appendix A 29
Appendix B 32
Manager
Virtus Capital Management, Inc.
Portfolio Adviser
The Chase Manhattan Bank
Distributor
Federated Securities Corp.
Transfer Agent
Federated Shareholder Services Company
Independent Auditors
Deloitte & Touche LLP
Dated: February 28, 1997
FEDERATED SECURITIES CORP.
GENERAL INFORMATION AND HISTORY
As described in Blanchard Capital Growth's (the "FUND") Prospectus,
the FUND is a non-diversified series of Blanchard Funds, a Massachusetts
business trust that was organized under the name "Blanchard Strategic
Growth Fund" (the "Trust"). The trustees of the Trust approved the change
in the name of the Trust on December 4, 1990.
Effective March 31, 1996, the merger of The Chase Manhattan
Corporation with and into Chemical Banking Corporation was consummated and
Chemical Banking Corporation thereupon changed its name to The Chase
Manhattan Corporation. The Chase Manhattan Corporation is now the parent of
The Chase Manhattan Bank, the adviser to the Capital Growth Portfolio (the
`Portfolio'').
INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS
The FUND seeks its investment objective by investing 100% of its
assets in the Capital Growth Portfolio (the "Portfolio"). The Portfolio has
an investment objective identical to the FUND and invests in accordance
with investment policies and restrictions identical to those of the FUND.
The investment objective of the FUND and the Portfolio may not be
changed except by a majority vote of shareholders.
The investment policies of the FUND and the Portfolio, as described
below, are not fundamental and may be changed without shareholder approval.
INVESTMENT POLICIES
The Prospectus sets forth the investment objective and various
investment policies of the Portfolio. This Statement of Additional
Information supplements and should be read in conjunction with the related
sections of the Prospectus. For descriptions of the securities ratings of
Moody's Investors Service, Inc. (`Moody's''), Standard & Poor's Ratings
Group (`Standard & Poor's'') Ratings Group (``Standard & Poor's'') and
Fitch Investors Service, Inc. (`Fitch''), see Appendix B.
U.S. GOVERNMENT SECURITIES - U.S. Government Securities include (1)
U.S. Treasury obligations, which generally differ only in their interest
rates, maturities and times of issuance, including: U.S. Treasury bills
(maturities of one year or less), U.S. Treasury notes (maturities of one to
ten years) and U.S. Treasury bonds (generally maturities of greater than
ten years); and (2) obligations issued or guaranteed by U.S. Government
agencies and instrumentalities which are supported by any of the following:
(a) the full faith and credit of the U.S. Treasury, (b) the right of the
issuer to borrow any amount listed to a specific line of credit from the
U.S. Treasury, (c) discretionary authority of the U.S. Government to
purchase certain obligations of the U.S. Government agency or
instrumentality or (d) the credit of the agency or instrumentality.
Agencies and instrumentalities of the U.S. Government include but are not
limited to: Federal Land Banks, Federal Financing Banks, Banks for
Cooperatives, Federal Intermediate Credit Banks, Farm Credit Banks, Federal
Home Loan Banks, Federal Home Loan Mortgage Corporation, Federal National
Mortgage Association, Student Loan Marketing Association, United States
Postal Service, Chrysler Corporate Loan Guarantee Board, Small Business
Administration, Tennessee Valley Authority and any other enterprise
established or sponsored by the U.S. Government. Certain U.S. Government
Securities, including U.S. Treasury bills, notes and bonds, Government
National Mortgage Association certificates and Federal Housing
Administration debentures, are supported by the full faith and credit of
the United States. Other U.S. Government Securities are issued or
guaranteed by federal agencies or government sponsored enterprises and are
not supported by the full faith and credit of the United States. These
securities include obligations that are supported by the right of the
issuer to borrow from the U.S. Treasury, such as obligations of the Federal
Home Loan Banks, and obligations that are supported by the creditworthiness
of the particular instrumentality, such as obligations of the Federal
National Mortgage Association or Federal Home Loan Mortgage Corporation.
For a description of certain obligations issued or guaranteed by U.S.
Government agencies and instrumentalities, see Appendix A.
In addition, certain U.S. Government agencies and instrumentalities
issue specialized types of securities, such as guaranteed notes of the
Small Business Administration, Federal Aviation Administration, Department
of Defense, Bureau of Indian Affairs and Private Export Funding
Corporation, which often provide higher yields than are available from the
more common types of government-backed instruments. However, such
specialized instruments may only be available from a few sources, in
limited amounts, or only in very large denominations; they may also require
specialized capability in portfolio servicing and in legal matters related
to government guarantees. While they may frequently offer attractive
yields, the limited-activity markets of many of these securities means
that, if the Portfolio were required to liquidate any of them, it might not
be able to do so advantageously; accordingly, the Portfolio investing in
such securities normally to hold such securities to maturity or pursuant to
repurchase agreements, and would treat such securities (including
repurchase agreements maturing in more than seven days) as illiquid for
purposes of its limitation on investment in illiquid securities.
BANK OBLIGATIONS - Investments in bank obligations are limited to
those of U.S. banks (including their foreign branches) which have total
assets at the time of purchase in excess of $1 billion and the deposits of
which are insured by either the Bank Insurance Fund or the Savings
Association Insurance Fund of the Federal Deposit Insurance Corporation,
and foreign banks (including their U.S. branches) having total assets in
excess of $10 billion (or the equivalent in other currencies), and such
other U.S. and foreign commercial banks which are judged by the advisers to
meet comparable credit standing criteria.
Bank obligations include negotiable certificates of deposit, bankers'
acceptances, fixed time deposits and deposit notes. A certificate of
deposit is a short-term negotiable certificate issued by a commercial bank
against funds deposited in the bank and is either interest-bearing or
purchased on a discount basis. A bankers' acceptance is a short-term draft
drawn on a commercial bank by a borrower, usually in connection with an
international commercial transaction. The borrower is liable for payment
as is the bank, which unconditionally guarantees to pay the draft at its
face amount on the maturity date. Fixed time deposits are obligations of
branches of United States banks or foreign banks which are payable at a
stated maturity date and bear a fixed rate of interest. Although fixed
time deposits do not have a market, there are no contractual restrictions
on the right to transfer a beneficial interest in the deposit to a third
party. Fixed time deposits subject to withdrawal penalties and with
respect to which the Portfolio cannot realize the proceeds thereon within
seven days are deemed "illiquid" for the purposes of its restriction on
investments in illiquid securities. Deposit notes are notes issued by
commercial banks which generally bear fixed rates of interest and typically
have original maturities ranging from eighteen months to five years.
Banks are subject to extensive governmental regulations that may limit
both the amounts and types of loans and other financial commitments that
may be made and the interest rates and fees that may be charged. The
profitability of this industry is largely dependent upon the availability
and cost of capital funds for the purpose of financing lending operations
under prevailing money market conditions. Also, general economic
conditions play an important part in the operations of this industry and
exposure to credit losses arising from possible financial difficulties of
borrowers might affect a bank's ability to meet its obligations. Bank
obligations may be general obligations of the parent bank or may be limited
to the issuing branch by the terms of the specific obligations or by
government regulation. Investors should also be aware that securities of
foreign banks and foreign branches of United States banks may involve
foreign investment risks in addition to those relating to domestic bank
obligations.
DEPOSITARY RECEIPTS - The Portfolio will limit its investment in
Depository Receipts not sponsored by the issuer of the underlying security
to no more than 5% of the value of its net assets (at the time of
investment). A purchaser of an unsponsored Depositary Receipt may not have
unlimited voting rights and may not receive as much information about the
issuer of the underlying securities as with a sponsored Depositary Receipt.
CORPORATE REORGANIZATIONS - In general, securities that are the
subject of a tender or exchange offer or proposal sell at a premium to
their historic market price immediately prior to the announcement of the
offer or proposal. The increased market price of these securities may also
discount what the stated or appraised value of the security would be if the
contemplated action were approved or consummated. These investments may be
advantageous when the discount significantly overstates the risk of the
contingencies involved; significantly undervalues the securities, assets or
cash to be received by shareholders of the prospective portfolio company as
a result of the contemplated transaction; or fails adequately to recognize
the possibility that the offer or proposal may be replaced or superseded by
an offer or proposal of greater value. The evaluation of these
contingencies requires unusually broad knowledge and experience on the part
of the advisers that must appraise not only the value of the issuer and its
component businesses as well as the assets or securities to be received as
a result of the contemplated transaction, but also the financial resources
and business motivation of the offer or as well as the dynamics of the
business climate when the offer or proposal is in progress. Investments in
reorganization securities may tend to increase the turnover ratio of the
Portfolio and increase its brokerage and other transaction expenses.
WARRANTS AND RIGHTS - Warrants basically are options to purchase
equity securities at a specified price for a specific period of time.
Their prices do not necessarily move parallel to the prices of the
underlying securities. Rights are similar to warrants but normally have a
shorter duration and are distributed directly by the issuer to
shareholders. Rights and warrants have no voting rights, receive no
dividends and have no rights with respect to the assets of the issuer.
COMMERCIAL PAPER - Commercial paper consists of short-term (usually
from 1 to 270 days) unsecured promissory notes issued by corporations in
order to finance their current operations. A variable amount master demand
note (which is a type of commercial paper) represents a direct borrowing
arrangement involving periodically fluctuating rates of interest under a
letter agreement between a commercial paper issuer and an institutional
lender pursuant to which the lender may determine to invest varying
amounts.
REPURCHASE AGREEMENTS - The Portfolio will enter into repurchase
agreements only with member banks of the Federal Reserve System and
securities dealers believed creditworthy, and only if fully collateralized
by securities in which the Portfolio is permitted to invest. Under the
terms of a typical repurchase agreement, the Portfolio would acquire an
underlying debt instrument for a relatively short period (usually not more
than one week) subject to an obligation of the seller to repurchase the
instrument and the Portfolio to resell the instrument at a fixed price and
time, thereby determining the yield during the Portfolio's holding period.
This procedure results in a fixed rate of return insulated from market
fluctuations during such period. A repurchase agreement is subject to the
risk that the seller may fail to repurchase the security. Repurchase
agreements are considered under the 1940 Act to be loans collateralized by
the underlying securities. All repurchase agreements entered into by the
Portfolio will be fully collateralized at all times during the period of
the agreement in that the value of the underlying security will be at least
equal to the amount of the loan, including the accrued interest thereon,
and the Portfolio or its custodian or sub-custodian will have possession of
the collateral, which the Board of Trustees believes will give it a valid,
perfected security interest in the collateral. Whether a repurchase
agreement is the purchase and sale of a security or a collateralized loan
has not been conclusively established. This might become an issue in the
event of the bankruptcy of the other party to the transaction. In the event
of default by the seller under a repurchase agreement construed to be a
collateralized loan, the underlying securities would not be owned by the
Portfolio, but would only constitute collateral for the seller's obligation
to pay the repurchase price. Therefore, the Portfolio may suffer time
delays and incur costs in connection with the disposition of the
collateral. The Board of Trustees believes that the collateral underlying
repurchase agreements may be more susceptible to claims of the seller's
creditors than would be the case with securities owned by the Portfolio.
Repurchase agreements maturing in more than seven days are treated as
illiquid for purposes of the Portfolio's restrictions on purchases of
illiquid securities. Repurchase agreements are also subject to the risks
described below with respect to stand-by commitments.
FORWARD COMMITMENTS - In order to invest the Portfolio's assets
immediately, while awaiting delivery of securities purchased on a forward
commitment basis, short-term obligations that offer same-day settlement and
earnings will normally be purchased. When a commitment to purchase a
security on a forward commitment basis is made, procedures are established
consistent with the General Statement of Policy of the Securities and
Exchange Commission concerning such purchases. Since that policy currently
recommends that an amount of the Portfolio's assets equal to the amount of
the purchase be held aside or segregated to be used to pay for the
commitment, a separate account of the Portfolio consisting of cash, cash
equivalents or high quality debt securities equal to the amount of the
Portfolio's commitments securities will be established at the Portfolio's
custodian bank. For the purpose of determining the adequacy of the
securities in the account, the deposited securities will be valued at
market value. If the market value of such securities declines, additional
cash, cash equivalents or highly liquid securities will be placed in the
account daily so that the value of the account will equal the amount of
such commitments by the Portfolio.
Although it is not intended that such purchases would be made for
speculative purposes, purchases of securities on a forward commitment basis
may involve more risk than other types of purchases. Securities purchased
on a forward commitment basis and the securities held in the Portfolio's
portfolio are subject to changes in value based upon the public's
perception of the issuer and changes, real or anticipated, in the level of
interest rates. Purchasing securities on a forward commitment basis can
involve the risk that the yields available in the market when the delivery
takes place may actually be higher or lower than those obtained in the
transaction itself. On the settlement date of the forward commitment
transaction, the Portfolio will meet its obligations from then available
cash flow, sale of securities held in the separate account, sale of other
securities or, although it would not normally expect to do so, from sale of
the forward commitment securities themselves (which may have a value
greater or lesser than the Portfolio's payment obligations). The sale of
securities to meet such obligations may result in the realization of
capital gains or losses.
To the extent the Portfolio engages in forward commitment
transactions, it will do so for the purpose of acquiring securities
consistent with its investment objective and policies and not for the
purpose of investment leverage, and settlement of such transactions will be
within 90 days from the trade date.
REVERSE REPURCHASE AGREEMENTS - Reverse Repurchase Agreements involve
the sale of securities held by the Portfolio with an agreement to
repurchase the securities at an agreed upon price and date. The repurchase
price is generally equal to the original sales price plus interest.
Reverse repurchase agreements are usually for seven days or less and cannot
be repaid prior to their expiration dates. Reverse repurchase agreements
involve the risk that the market value of the portfolio securities
transferred may decline below the price at which the Portfolio is obliged
to purchase the securities.
STRIPPED OBLIGATIONS - The principal and interest components of United
States Treasury bonds with remaining maturities of longer than ten years
are eligible to be traded independently under the Separate Trading of
Registered Interest and Principal of Securities ("STRIPS") program. Under
the STRIPS program, the principal and interest components are separately
issued by the United States Treasury at the request of depository financial
institutions, which then trade the component parts separately. The
interest component of STRIPS may be more volatile than that of United
States Treasury bills with comparable maturities. The Portfolio has no
present intention of investing more than 5% of its net assets in STRIPS.
ILLIQUID SECURITIES - For purposes of its limitation on investments in
illiquid securities, the Portfolio may elect to treat as liquid, in
accordance with procedures established by the Board of Trustees, certain
investments in restricted securities for which there may be a secondary
market of qualified institutional buyers as contemplated by Rule 144A under
the Securities Act of 1933, as amended (the "Securities Act") and
commercial obligations issued in reliance on the so-called "private
placement" exemption from registration afforded by Section 4(2) of the
Securities Act ("Section 4(2) paper"). Rule 144A provides an exemption
from the registration requirements of the Securities Act for the resale of
certain restricted securities to qualified institutional buyers. Section
4(2) paper is restricted as to disposition under the federal securities
laws, and generally is sold to institutional investors such as the
Portfolio who agree that they are purchasing the paper for investment and
not with a view to public distribution. Any resale of Section 4(2) paper
by the purchaser must be in an exempt transaction.
One effect of Rule 144A and Section 4(2) is that certain restricted
securities may now be liquid, though there is no assurance that a liquid
market for Rule 144A securities or Section 4(2) paper will develop or be
maintained. The Trustees have adopted policies and procedures for the
purpose of determining whether securities that are eligible for resale
under Rule 144A and Section 4(2) paper are liquid or illiquid for purposes
of the limitation on investment in illiquid securities. Pursuant to those
policies and procedures, the Trustees have delegated to the advisers the
determination as to whether a particular instrument is liquid or illiquid,
requiring that consideration be given to, among other things, the frequency
of trades and quotes for the security, the number of dealers willing to
sell the security and the number of potential purchasers, dealer
undertakings to make a market in the security, the nature of the security
and the time needed to dispose of the security. The Trustees will
periodically review the Portfolio's purchases and sales of Rule 144A
securities and Section 4(2) paper.
STAND-BY COMMITMENTS - In a put transaction, the Portfolio acquires
the right to sell a security at an agreed upon price within a specified
period prior to its maturity date, and a stand-by commitment entitles the
Portfolio to same-day settlement and to receive an exercise price equal to
the amortized cost of the underlying security plus accrued interest, if
any, at the time of exercise. Stand-by commitments are subject to certain
risks, which include the inability of the issuer of the commitment to pay
for the securities at the time the commitment is exercised, the fact that
the commitment is not marketable by the Portfolio, and that the maturity of
the underlying security will generally be different from that of the
commitment.
SECURITIES LOANS - To the extent specified in the Prospectus, the
Portfolio is permitted to lend its securities to broker-dealers and other
institutional investors in order to generate additional income. Such loans
of portfolio securities may not exceed 30% of the value of the Portfolio's
total assets. In connection with such loans, the Portfolio will receive
collateral consisting of cash, cash equivalents, U.S. Government securities
or irrevocable letters of credit issued by financial institutions. Such
collateral will be maintained at all times in an amount equal to at least
102% of the current market value plus accrued interest of the securities
loaned. The Portfolio can increase its income through the investment of
such collateral. The Portfolio continues to be entitled to the interest
payable or any dividend-equivalent payments received on a loaned security
and, in addition, to receive interest on the amount of the loan. However,
the receipt of any dividend-equivalent payments by the Portfolio on a
loaned security from the borrower will not qualify for the
dividends-received deduction. Such loans will be terminable at any time
upon specified notice. The Portfolio might experience risk of loss if the
institutions with which it has engaged in portfolio loan transactions
breach their agreements with the Portfolio. The risks in lending portfolio
securities, as with other extensions of secured credit, consist of possible
delays in receiving additional collateral or in the recovery of the
securities or possible loss of rights in the collateral should the borrower
experience financial difficulty. Loans will be made only to firms deemed
by the advisers to be of good standing and will not be made unless, in the
judgment of the advisers, the consideration to be earned from such loans
justifies the risk.
ADDITIONAL POLICIES REGARDING DERIVATIVES AND RELATED TRANSACTIONS
INTRODUCTION
As explained more fully below, the Portfolio may employ derivative and
related instruments as tools in the management of portfolio assets. Put
briefly, a `derivative'' instrument may be considered a security or other
instrument which derives its value from the value or performance of other
instruments or assets, interest or currency exchange rates, or indexes. For
instance, derivatives include futures, options, forward contracts,
structured notes and various over-the-counter instruments.
Like other investment tools or techniques, the impact of using
derivatives strategies or related instruments depends to a great extent on
how they are used. Derivatives are generally used by portfolio managers in
three ways: First, to reduce risk by hedging (offsetting) an investment
position. Second, to substitute for another security particularly where it
is quicker, easier and less expensive to invest in derivatives. Lastly, to
speculate or enhance portfolio performance. When used prudently,
derivatives can offer several benefits, including easier and more effective
hedging, lower transaction costs, quicker investment and more profitable
use of portfolio assets. However, derivatives also have the potential to
significantly magnify risks, thereby leading to potentially greater losses
for the Portfolio.
The Portfolio may invest its assets in derivative and related
instruments subject only to the Portfolio's investment objective and
policies and the requirement that the Portfolio maintain segregated
accounts consisting of liquid assets, such as cash, U.S. Government
securities, or other high-grade debt obligations (or, as permitted by
applicable regulation, enter into certain offsetting positions) to cover
its obligations under such instruments with respect to positions where
there is no underlying portfolio asset so as to avoid leveraging the
Portfolio.
The value of some derivative or related instruments in which the
Portfolio may invest may be particularly sensitive to changes in prevailing
interest rates or other economic factors, and -- like other investments of
the Portfolio -- the ability of the Portfolio to successfully utilize these
instruments may depend in part upon the ability of the advisers to forecast
interest rates and other economic factors correctly. If the advisers
inaccurately forecast such factors and have taken positions in derivative
or similar instruments contrary to prevailing market trends, the Portfolio
could be exposed to the risk of a loss. The Portfolio might not employ any
or all of the strategies described herein, and no assurance can be given
that any strategy used will succeed.
Set forth below is an explanation of the various derivatives
strategies and related instruments the Portfolio may employ along with
risks or special attributes associated with them. This discussion is
intended to supplement the Prospectus as well as provide useful information
to prospective investors.
RISK FACTORS
As explained more fully below and in the discussions of particular
strategies or instruments, there are a number of risks associated with the
use of derivatives and related instruments:
There can be no guarantee that there will be a correlation between
price movements in a hedging vehicle and in the portfolio assets being
hedged. As incorrect correlation could result in a loss on both the hedged
assets in the Portfolio and the hedging vehicle so that the portfolio
return might have been greater had hedging not been attempted. This risk is
particularly acute in the case of `cross-hedges'' between currencies.
The advisers may incorrectly forecast interest rates, market values or
other economic factors in utilizing a derivatives strategy. In such a case,
the Portfolio may have been in a better position had it not entered into
such strategy.
Hedging strategies, while reducing risk of loss, can also reduce the
opportunity for gain. In other words, hedging usually limits both potential
losses as well as potential gains.
Strategies not involving hedging may increase the risk to the
Portfolio. Certain strategies, such as yield enhancement, can have
speculative characteristics and may result in more risk to the Portfolio
than hedging strategies using the same instruments.
There can be no assurance that a liquid market will exist at a time
when the Portfolio seeks to close out an option, futures contract or other
derivative or related position. Many exchanges and boards of trade limit
the amount of fluctuation permitted in option or futures contract prices
during a single day; once the daily limit has been reached on particular
contract, no trades may be made that day at a price beyond that limit. In
addition, certain instruments are relatively new and without a significant
trading history. As a result, there is no assurance that an active
secondary market will develop or continue to exist. Finally, over-the-
counter instruments typically do not have a liquid market. Lack of a liquid
market for any reason may prevent the Portfolio from liquidating an
unfavorable position.
Activities of large traders in the futures and securities markets
involving arbitrage, `program trading,'' and other investment strategies
may cause price distortions in these markets.
In certain instances, particularly those involving over-the-counter
transactions or forward contracts, there is a greater potential that a
counterparty or broker may default or be unable to perform on its
commitments. In the event of such a default, the Portfolio may experience a
loss.
In transactions involving currencies, the value of the currency
underlying an instrument may fluctuate due to many factors, including
economic conditions, interest rates, governmental policies and market
forces.
SPECIFIC USES AND STRATEGIES
Set forth below are explanations of various strategies involving
derivatives and related instruments which may be used by the Portfolio.
OPTIONS ON SECURITIES, SECURITIES INDEXES AND DEBT INSTRUMENTS. The
Portfolio may PURCHASE, SELL or EXERCISE call and put options on:
o securities;
o securities indexes; and
o debt instruments.
Although in most cases these options will be exchange-traded, the
Portfolio may also purchase, sell or exercise over-the-counter options.
Over-the-counter options differ from exchange-traded options in that they
are two-party contracts with price and other terms negotiated between buyer
and seller. As such, over-the-counter options generally have much less
market liquidity and carry the risk of default or nonperformance by the
other party.
One purpose of purchasing put options is to protect holdings in an
underlying or related security against a substantial decline in market
value. One purpose of purchasing call options is to protect against
substantial increases in prices of securities the Portfolio intends to
purchase pending its ability to invest in such securities in an orderly
manner. The Portfolio may also use combinations of options to minimize
costs, gain exposure to markets or take advantage of price disparities or
market movements. For example, the Portfolio may sell put or call options
it has previously purchased or purchase put or call options it has
previously sold. These transactions may result in a net gain or loss
depending on whether the amount realized on the sale is more or less than
the premium and other transaction costs paid on the put or call option
which is sold. The Portfolio may write a call or put option in order to
earn the related premium from such transactions. Prior to exercise or
expiration, an option may be closed out by an offsetting purchase or sale
of a related option. The Portfolio will not write uncovered options.
In addition to the general risk factors noted above, the purchase and
writing of options involve certain special risks. During the option period,
the Portfolio writing a covered call (i.e., where the underlying securities
are held by the Portfolio) has, in return for the premium on the option,
given up the opportunity to profit from a price increase in the underlying
securities above the exercise price, but has retained the risk of loss
should the price of the underlying securities decline. The writer of an
option has no control over the time when it may be required to fulfill its
obligation as a writer of the option. Once an option writer has received an
exercise notice, it cannot effect a closing purchase transaction in order
to terminate its obligation under the option and must deliver the
underlying securities at the exercise price.
If a put or call option purchased by the Portfolio is not sold when it
has remaining value, and if the market price of the underlying security, in
the case of a put, remains equal to or greater than the exercise price or,
in the case of a call, remains less than or equal to the exercise price,
the Portfolio will lose its entire investment in the option. Also, where a
put or call option on a particular security is purchased to hedge against
price movements in a related security, the price of the put or call option
may move more or less than the price of the related security. There can be
no assurance that a liquid market will exist when the Portfolio seeks to
close out an option position. Furthermore, if trading restrictions or
suspensions are imposed on the options markets, the Portfolio may be unable
to close out a position.
Futures Contracts and Options on Futures Contracts. The Portfolio may
purchase or sell:
o interest-rate futures contracts;
o futures contracts on specified instruments or indices; and
o options on these futures contracts (`futures options'').
The futures contracts and futures options may be based on various
instruments or indices in which the Portfolio may invest such as foreign
currencies, certificates of deposit, Eurodollar time deposits, securities
indices, economic indices (such as the Consumer Price Indices compiled by
the U.S. Department of Labor).
Futures contracts and futures options may be used to hedge portfolio
positions and transactions as well as to gain exposure to markets. For
example, the Portfolio may sell a futures contract -- or buy a futures
option -- to protect against a decline in value, or reduce the duration, of
portfolio holdings. Likewise, these instruments may be used where the
Portfolio intends to acquire an instrument or enter into a position. For
example, the Portfolio may purchase a futures contract -- or buy a futures
option -- to gain immediate exposure in a market or otherwise offset
increases in the purchase price of securities or currencies to be acquired
in the future. Futures options may also be written to earn the related
premiums.
When writing or purchasing options, the Portfolio may simultaneously
enter into other transactions involving futures contracts or futures
options in order to minimize costs, gain exposure to markets, or take
advantage of price disparities or market movements. Such strategies may
entail additional risks in certain instances. The Portfolio may engage in
cross-hedging by purchasing or selling futures or options on a security or
currency different from the security or currency position being hedged to
take advantage of relationships between the two securities or currencies.
Investments in futures contracts and options thereon involve risks
related to those associated with options transactions discussed above. The
Portfolio will only enter into futures contracts or options or futures
contracts which are standardized and traded on a U.S. or foreign exchange
or board of trade, or similar entity, or quoted on an automated quotation
system.
FORWARD CONTRACTS. The Portfolio may use foreign currency and
interest-rate forward contracts for various purposes as described below.
Foreign currency exchange rates may fluctuate significantly over short
periods of time. They generally are determined by the forces of supply and
demand in the foreign exchange markets and the relative merits of
investments in different countries, actual or perceived changes in interest
rates and other complex factors, as seen from an international perspective.
The Portfolio that may invest in securities denominated in foreign
currencies may, in addition to buying and selling foreign currency futures
contracts and options on foreign currencies and foreign currency futures,
enter into forward foreign currency exchange contracts to reduce the risks
or otherwise take a position in anticipation of changes in foreign exchange
rates. A forward foreign currency exchange contract involves an obligation
to purchase or sell a specific currency at a future date, which may be a
fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. By entering into a
forward foreign currency contract, the Portfolio `locks in'' the exchange
rate between the currency it will deliver and the currency it will receive
for the duration of the contract. As a result, the Portfolio reduces its
exposure to changes in the value of the currency it will deliver and
increases its exposure to changes in the value of the currency it will
exchange into. The effect on the value of the Portfolio is similar to
selling securities denominated in one currency and purchasing securities
denominated in another. Transactions that use two foreign currencies are
sometimes referred to as `cross-hedges.''
The Portfolio may enter into these contracts for the purpose of
hedging against foreign exchange risk arising from the Portfolio's
investments or anticipated investments in securities denominated in foreign
currencies. The Portfolio may also enter into these contracts for purposes
of increasing exposure to a foreign currency or to shift exposure to
foreign currency fluctuations from one country to another.
The Portfolio may also use forward contracts to hedge against changes
in interest-rates, increase exposure to a market or otherwise take
advantage of such changes. An interest-rate forward contract involves the
obligation to purchase or sell a specific debt instrument at a fixed price
at a future date.
INTEREST RATE AND CURRENCY TRANSACTIONS. The Portfolio may employ
currency and interest rate management techniques, including transactions in
options (including yield curve options), futures, options on futures,
forward foreign currency exchange contracts, currency options and futures
and currency and interest rate swaps. The aggregate amount of the
Portfolio's net currency exposure will not exceed the total net asset value
of its portfolio. However, to the extent that the Portfolio is fully
invested while also maintaining currency positions, it may be exposed to
greater combined risk.
The Portfolio will only enter into interest rate and currency swaps on
a net basis, i.e., the two payment streams are netted out, with the
Portfolio receiving or paying, as the case may be, only the net amount of
the two payments. Interest rate and currency swaps do not involve the
delivery of securities, the underlying currency, other underlying assets or
principal. Accordingly, the risk of loss with respect to interest rate and
currency swaps is limited to the net amount of interest or currency
payments that the Portfolio is contractually obligated to make. If the
other party to an interest rate or currency swap defaults, the Portfolio's
risk of loss consists of the net amount of interest or currency payments
that the Portfolio is contractually entitled to receive. Since interest
rate and currency swaps are individually negotiated, the Portfolio expects
to achieve an acceptable degree of correlation between their portfolio
investments and their interest rate or currency swap positions.
The Portfolio may hold foreign currency received in connection with
investments in foreign securities when it would be beneficial to convert
such currency into U.S. dollars at a later date, based on anticipated
changes in the relevant exchange rate.
The Portfolio may purchase or sell without limitation as to a
percentage of its assets forward foreign currency exchange contracts when
the advisers anticipate that the foreign currency will appreciate or
depreciate in value, but securities denominated in that currency do not
present attractive investment opportunities and are not held by the
Portfolio. In addition, the Portfolio may enter into forward foreign
currency exchange contracts in order to protect against adverse changes in
future foreign currency exchange rates. The Portfolio may engage in
cross-hedging by using forward contracts in one currency to hedge against
fluctuations in the value of securities denominated in a different currency
if its advisers believe that there is a pattern of correlation between the
two currencies. Forward contracts may reduce the potential gain from a
positive change in the relationship between the U.S. Dollar and foreign
currencies. Unanticipated changes in currency prices may result in poorer
overall performance for the Portfolio than if it had not entered into such
contracts. The use of foreign currency forward contracts will not
eliminate fluctuations in the underlying U.S. dollar equivalent value of
the prices of or rates of return on the Portfolio's foreign currency
denominated portfolio securities and the use of such techniques will
subject the Portfolio to certain risks.
The matching of the increase in value of a forward contract and the
decline in the U.S. dollar equivalent value of the foreign currency
denominated asset that is the subject of the hedge generally will not be
precise. In addition, the Portfolio may not always be able to enter into
foreign currency forward contracts at attractive prices, and this will
limit the Portfolio's ability to use such contract to hedge or cross-hedge
its assets. Also, with regard to the Portfolio's use of cross-hedges,
there can be no assurance that historical correlations between the movement
of certain foreign currencies relative to the U.S. dollar will continue.
Thus, at any time poor correlation may exist between movements in the
exchange rates of the foreign currencies underlying the Portfolio's
cross-hedges and the movements in the exchange rates of the foreign
currencies in which the Portfolio's assets that are the subject of such
cross-hedges are denominated.
The Portfolio may enter into interest rate and currency swaps to the
maximum allowed limits under applicable law. The Portfolio will typically
use interest rate swaps to shorten the effective duration of its portfolio.
Interest rate swaps involve the exchange by the Portfolio with another
party of their respective commitments to pay or receive interest, such as
an exchange of fixed rate payments for floating rate payments. Currency
swaps involve the exchange of their respective rights to make or receive
payments in specified currencies.
STRUCTURED PRODUCTS. The Portfolio may invest in interests in entities
organized and operated solely for the purpose of restructuring the
investment characteristics of certain other investments. This type of
restructuring involves the deposit with or purchase by an entity, such as a
corporation or trust, or specified instruments (such as commercial bank
loans) and the issuance by that entity of one or more classes of securities
(`structured products'') backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued structured products to create securities
with different investment characteristics such as varying maturities,
payment priorities and interest rate provisions and the extent of the
payments made with respect to structured products is dependent on the
extent of the cash flow on the underlying instruments. The Portfolio may
invest in structured products which represent derived investment positions
based on relationships among different markets of asset classes.
The Portfolio may also invest in other types of structured products,
including among others, inverse floaters, spread trades and notes linked by
a formula to the price of an underlying instrument. Inverse floaters have
coupon rates that vary inversely at a multiple of a designated floating
rate (which typically is determined by reference to an index rate, but may
also be determined through a dutch auction or a remarketing agent or by
reference to another security) (the `reference rate''). As an example,
inverse floaters may constitute a class of CMOs with a coupon rate that
moves inversely to a designated index, such as LIBOR (London Interbank
Offered Rate) or the Cost of Funds Index. Any rise in the reference rate
of an inverse floater (as a consequence of an increase in interest rates)
causes a drop in the coupon rate while any drop in the reference rate of an
inverse floater causes an increase in the coupon rate. A spread trade is
an investment position relating to a difference in the prices or interest
rates of two securities where the value of the investment position is
determined by movements in the difference between the prices or interest
rates, as the case may be, of the respective securities. When the Portfolio
invests in notes linked to the price of an underlying instrument, the price
of the underlying security is determined by a multiple (based on a formula)
of the price of such underlying security. A structured product may be
considered to be leveraged to the extent its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. Because they are linked to their underlying markets or
securities, investments in structured products generally are subject to
greater volatility than an investment directly in the underlying market or
security. Total return on the structured product is derived by linking
return to one or more characteristics of the underlying instrument.
Because certain structured products of the type in which the Portfolio may
invest may involve no credit enhancement, the credit risk of those
structured products generally would be equivalent to that of the underlying
instruments. The Portfolio may invest in a class of structured products
that is either subordinated or unsubordinated to the right of payment of
another class. Subordinated structured products typically have higher
yields and present greater risks than unsubordinated structured products.
Although the Portfolio's purchase of subordinated structured products would
have similar economic effect to that of borrowing against the underlying
securities, the purchase will not be deemed to be leverage for purposes of
the Portfolio's fundamental investment limitation related to borrowing and
leverage.
Certain issuers of structured products may be deemed to be,
"investment companies" as defined in the 1940 Act. As a result, the
Portfolio's investments in these structured products may be limited by the
restrictions contained in the 1940 Act. Structured products are typically
sold in private placement transactions and there currently is no action
trading market for structured products. As a result, certain structured
products in which the Portfolio invests may be deemed illiquid and subject
to its limitation on illiquid investments.
Investments in structured products generally are subject to greater
volatility than an investment directly in the underlying market or
security. In addition, because structured products are typically sold in
private placement transactions, there currently is no active trading market
for structured products.
Additional Restrictions on the Use of Futures and Option Contracts
The Portfolio is not a "commodity pool" (i.e., a pooled investment
vehicle which trades in commodity futures contracts and options thereon and
the operator of which is registered with the CFTC and futures contracts and
futures options will be purchased, sold or entered into only for bona fide
hedging purposes, provided that the Portfolio may enter into such
transactions for purposes other than bona fide hedging if, immediately
thereafter, the sum of the amount of its initial margin and premiums on
open contracts and options would not exceed 5% of the liquidation value of
the Portfolio's portfolio, provided, further, that, in the case of an
option that is in-the-money, the in-the-money amount may be excluded in
calculating the 5% limitation.
When the Portfolio purchases a futures contract, an amount of cash or
cash equivalents or high quality debt securities will be deposited in a
segregated account with the Portfolio's custodian so that the amount so
segregated, plus the initial deposit and variation margin held in the
account of its broker, will at all times equal the value of the futures
contract, thereby insuring that the use of such futures is unleveraged.
The Portfolio's ability to engage in the transactions described herein
may be limited by the current federal income tax requirement that the
Portfolio derive less than 30% of its gross income from the sale or other
disposition of stock or securities held for less than three months.
INVESTMENT RESTRICTIONS
The Portfolio has adopted the following investment restrictions which
may not be changed without approval by a "majority of the outstanding
shares" of the Portfolio which, as used in this Statement of Additional
Information, means the vote of the lesser of (i) 67% or more of the total
beneficial interests of a Portfolio present at a meeting, if the holders of
more than 50% of the outstanding total beneficial interests of a Portfolio
are present or represented by proxy, or (ii) more than 50% of the
outstanding total beneficial interests of a Portfolio.
The Portfolio may not:
(1) borrow money, except that the Portfolio may borrow
money for temporary or emergency purposes, or by engaging in
reverse repurchase transactions, in an amount not exceeding 33-
1/3% of the value of its total assets at the time when the loan
is made and may pledge, mortgage or hypothecate no more than 1/3
of its net assets to secure such borrowings. Any borrowing
representing more than 5% of the Portfolio's total assets must be
repaid before the Portfolio may make additional investments;
(2) make loans, except that the Portfolio may: (i)
purchase and hold debt instruments (including without limitation,
bonds, notes, debentures or other obligations and certificates of
deposit, bankers' acceptances and fixed time deposits) in
accordance with its investment objectives and policies; (ii)
enter into repurchase agreements with respect to portfolio
securities; and (iii) lend portfolio securities with a value not
in excess of one-third of the value of its total assets;
(3) purchase the securities of any issuer (other than
securities issued or guaranteed by the U.S. government or any of
its agencies or instrumentalities, or repurchase agreements
secured thereby) if, as a result, more than 25% of the
Portfolio's total assets would be invested in the securities of
companies whose principal business activities are in the same
industry. Notwithstanding the foregoing, with respect to the
Portfolio's permissible futures and options transactions in U.S.
government securities, positions in such options and futures
shall not be subject to this restriction;
(4) purchase or sell physical commodities unless acquired
as a result of ownership of securities or other instruments but
this shall not prevent the Portfolio from (i) purchasing or
selling options and futures contracts or from investing in
securities or other instruments backed by physical commodities or
(ii) engaging in forward purchase or sales of foreign currencies
or securities;
(5) purchase or sell real estate unless acquired as a
result of ownership of securities or other instruments (but this
shall not prevent the Portfolio from investing in securities or
other instruments backed by real estate or securities of
companies engaged in the real estate business). Investments by
the Portfolio in securities backed by mortgages on real estate or
in marketable securities of companies engaged in such activities
are not hereby precluded;
(6) issue any senior security (as defined in the 1940 Act),
except that (a) the Portfolio may engage in transactions that may
result in the issuance of senior securities to the extent
permitted under applicable regulations and interpretation of the
1940 Act or an exemptive order; (b) the Portfolio may acquire
other securities, the acquisition of which may result in the
issuance of a senior security, to the extent permitted under
applicable regulations or interpretations of the 1940 Act; and
(c) subject to the restrictions set forth above, the Portfolio
may borrow money as authorized by the 1940 Act. For purposes of
this restriction, collateral arrangements with respect to
permissible options and futures transactions, including deposits
of initial and variation margin, are not considered to be the
issuance of a senior security; or
(7) underwrite securities backed by other persons except
insofar as the Portfolio may technically be deemed to be an
underwriter under the Securities Act of 1933 in selling a
portfolio security.
For purposes of investment restriction (5) above, real
estate includes Real Estate Limited Partnerships. For purposes
of investment restriction (3) above, industrial development
bonds, where the payment of principal and interest is the
ultimate responsibility of companies within the same industry,
are grouped together as an "industry." Supranational
organizations are collectively considered to be members of a
single `industry'' for purposes of restriction (3) above.
In addition, the Portfolio is subject to the following non-
fundamental restrictions which may be changed without shareholder
approval:
(1) The Portfolio may not, with respect to 50% of its
assets, hold more than 10% of the outstanding voting securities
of an issuer.
(2) The Portfolio may not make short sales of securities,
other than short sales `against the box,'' or purchase
securities on margin except for short-term credits necessary for
clearance of portfolio transaction, provided that this
restriction will not be applied to limit the use of options,
futures contracts and related options, in the manner otherwise
permitted by the investment restrictions, policies and investment
program of the Portfolio.
(3) The Portfolio may not purchase or sell interests in
oil, gas or mineral leases.
(4) The Portfolio may not invest more than 15% of its net
assets in illiquid securities.
(5) The Portfolio may not write, purchase or sell any put
or call option or any combination thereof, provided that this
shall not prevent (i) the purchase, ownership, holding or sale of
warrants where the grantor of the warrants is the issuer of the
underlying securities; (ii) the writing, purchasing or selling of
puts, calls or combinations thereof with respect to portfolio
securities or (iii) with respect to the Portfolio's permissible
futures and options transactions, the writing, purchasing,
ownership, holding or selling of futures and options positions or
of puts, calls or combinations thereof with respect to futures.
(6) The Portfolio may invest up to 5% of its total assets
in the securities of any one investment company, but may not own
more than 3% of the securities of any one investment company or
invest more than 10% of its total assets in the securities of
other investment companies.
It is the Portfolio's position that proprietary strips, such as CATS
and TIGRS, are United States Government securities. However, the Portfolio
has been advised that the staff of the Securities and Exchange Commission's
Division of Investment Management does not consider these to be United
States Government securities, as defined under the Investment Company Act
of 1940, as amended.
For purposes of the Portfolio's investment restrictions, the issuer of
a tax-exempt security is deemed to be the entity (public or private)
ultimately responsible for the payment of the principal of and interest on
the security.
In order to permit the sale of its beneficial interests in certain
states, the Portfolio may make commitments more restrictive than the
investment policies and limitations described above and in the Prospectus.
Should the Portfolio determine that any such commitment is no longer in its
best interests, it will revoke the commitment by terminating sales of its
beneficial interests in the state involved. In order to comply with
certain federal and state statutes and regulatory policies, as a matter of
operating policy, the Portfolio will not: (i) invest more than 5% of its
assets in companies which, including predecessors, have a record of less
than three years' continuous operation, (ii) invest in warrants valued at
the lower of cost or market, in excess of 5% of the value of its net
assets, and no more than 2% of such value may be warrants which are not
listed on the New York or American Stock Exchanges, or (iii) purchase or
retain in its portfolio any securities issued by an issuer any of whose
officers, directors, trustees or security holders is an officer or trustee
of the Trust or Portfolio, or is an officer or director of the Adviser, if
after the purchase of the securities of such issuer by the Portfolio one or
more of such persons owns beneficially more than 1/2 of 1% of the shares or
securities, or both, all taken at market value, of such issuer, and such
persons owning more than 1/2 of 1% of such shares or securities together
own beneficially more than 5% of such shares or securities, or both, all
taken at market value.
If a percentage or rating restriction on investment or use of assets
set forth herein or in the Prospectus is adhered to at the time a
transaction is effected later changes in percentage resulting from any
cause other than actions by the Portfolio will not be considered a
violation. If the value of the Portfolio's holdings of illiquid securities
at any time exceeds the percentage limitation applicable at the time of
acquisition due to subsequent fluctuations in value or other reasons, the
Board of Trustees will consider what actions, if any, are appropriate to
maintain adequate liquidity.
PORTFOLIO TRANSACTIONS
Specific decisions to purchase or sell securities for the Portfolio
are made by a portfolio manager who is an employee of the Portfolio Adviser
and who is appointed and supervised by senior officers of the Portfolio
Adviser. Changes in the Portfolio's investments are reviewed by the Board
of Trustees. The Portfolio's portfolio manager may serve other clients of
the Portfolio Adviser in a similar capacity.
The frequency of the Portfolio's portfolio transactions, the portfolio
turnover rate, will vary from year to year depending upon market
conditions. Because a high turnover rate may increase transaction costs and
the possibility of taxable short-term gains, the Portfolio Adviser will
weigh the added costs of short-term investment against anticipated gains.
The Portfolio Adviser does not anticipate that portfolio turnover will
result in adverse tax consequences. However, high portfolio turnover may
result in high transaction costs to the Portfolio. For the fiscal years
ended October 31, 1996 and 1995, the portfolio turnover rate for the
Portfolio was 90% and 86%, respectively.
The primary consideration in placing portfolio security transactions
with broker-dealers for execution is to obtain and maintain the
availability of execution at the most favorable prices and in the most
effective manner possible. The Portfolio Adviser attempts to achieve this
result by selecting broker-dealers to execute portfolio transactions on
behalf of the Portfolio and other clients of the Portfolio Adviser on the
basis of their professional capability, the value and quality of their
brokerage services, and the level of their brokerage commissions. Debt
securities are traded principally in the over-the-counter market through
dealers acting on their own account and not as brokers. In the case of
securities traded in the over-the-counter market (where no stated
commissions are paid but the prices include a dealer's markup or markdown),
the Portfolio Adviser normally seeks to deal directly with the primary
market makers unless, in its opinion, best execution is available
elsewhere. In the case of securities purchased from underwriters, the cost
of such securities generally includes a fixed underwriting commission or
concession. From time to time, soliciting dealer fees are available to the
Portfolio Adviser on the tender of the Portfolio's portfolio securities in
so-called tender or exchange offers. Such soliciting dealer fees are in
effect recaptured for the Portfolios by the Portfolio Adviser. At present,
no other recapture arrangements are in effect.
Under Section 28(e) of the Securities Exchange Act of 1934, the
Portfolio Adviser may cause the Portfolio to pay a broker-dealer which
provides brokerage and research services to the Adviser an amount of
commission for effecting a securities transaction for the Portfolio in
excess of the amount other broker-dealers would have charged for the
transaction if the Portfolio Adviser determines in good faith that the
greater commission is reasonable in relation to the value of the brokerage
and research services provided by the executing broker-dealer viewed in
terms of either a particular transaction or the Portfolio Adviser's overall
responsibilities to the Portfolio or to its clients. Not all of such
services are useful or of value in advising the Portfolio.
The term "brokerage and research services" includes advice as to the
value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or of purchasers or
sellers of securities, furnishing analyses and reports concerning issues,
industries, securities, economic factors and trends, portfolio strategy and
the performance of accounts, and effecting securities transactions and
performing functions incidental thereto such as clearance and settlement.
Although commissions paid on every transaction will, in the judgment
of the Portfolio Adviser, be reasonable in relation to the value of the
brokerage services provided, commissions exceeding those which another
broker might charge may be paid to broker-dealers who were selected to
execute transactions on behalf of the Portfolio and the Portfolio Adviser's
other clients as part of providing advice as to the availability of
securities or of purchasers or sellers of securities and services in
effecting securities transactions and performing functions incidental
thereto, such as clearance and settlement.
Broker-dealers may be willing to furnish statistical, research and
other factual information or services ("Research") to the Portfolio Adviser
for no consideration other than brokerage or underwriting commissions.
Securities may be bought or sold through such broker-dealers, but at
present, unless otherwise directed by the Portfolio, a commission higher
than one charged elsewhere will not be paid to such a firm solely because
it provided Research to the Portfolio Adviser.
The Portfolio Adviser's investment management personnel will attempt
to evaluate the quality of Research provided by brokers. Results of this
effort are sometimes used by the Portfolio Adviser as a consideration in
the selection of brokers to execute portfolio transactions. However, the
Portfolio Adviser would be unable to quantify the amount of commissions
which are paid as a result of such Research because a substantial number of
transactions are effected through brokers which provide Research but which
are selected principally because of their execution capabilities.
The advisory fees that the FUND pays to the Portfolio Adviser will not
be reduced as a consequence of the Adviser's receipt of brokerage and
research services. To the extent the Portfolio's portfolio transactions are
used to obtain such services, the brokerage commissions paid by the
Portfolio will exceed those that might otherwise be paid, by an amount
which cannot be presently determined. Such services would be useful and of
value to the Portfolio Adviser in serving the Portfolio and other clients
and, conversely, such services obtained by the placement of brokerage
business of other clients would be useful to the Portfolio Adviser in
carrying out its obligations to the Portfolio. While such services are not
expected to reduce the expenses of the Portfolio Adviser, the Portfolio
Adviser would, through use of the services, avoid the additional expenses
which would be incurred if it should attempt to develop comparable
information through its own staff.
In certain instances, there may be securities that are suitable for
the Portfolio as well as one or more of the Portfolio Adviser's other
clients. Investment decisions for the Portfolio and for the Portfolio
Adviser's other clients are made with a view to achieving their respective
investment objectives. It may develop that the same investment decision is
made for more than one client or that a particular security is bought or
sold for only one client even though it might be held by, or bought or sold
for, other clients. Likewise, a particular security may be bought for one
or more clients when one or more clients are selling that same security.
Some simultaneous transactions are inevitable when several clients receive
investment advice from the same investment adviser, particularly when the
same security is suitable for the investment objectives of more than one
client. When the Portfolio or the Portfolio Adviser's other clients are
simultaneously engaged in the purchase or sale of the same security, the
securities are allocated among clients in a manner believed to be equitable
to each. It is recognized that in some cases this system could have a
detrimental effect on the price or volume of the security as far as the
Portfolio is concerned. However, it is believed that the ability of the
Portfolio to participate in volume transactions will generally produce
better executions for the Portfolio.
COMPUTATION OF NET ASSET VALUE
The net asset value of the FUND is determined at 4:15 P.M. New York
Time, on each day that the New York Stock Exchange is open for business and
on such other days as there is sufficient trading in the FUND's securities
to affect materially the net asset value per share of the FUND. The FUND
will be closed on New Year's Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
The Portfolio will invest in foreign securities, and as a result, the
calculation of the FUND's net asset value may not take place
contemporaneously with the determination of the prices of certain of the
portfolio securities used in the calculation. Occasionally, events which
affect the values of such securities and such exchange rates may occur
between the times at which they are determined and the close of the New
York Stock Exchange and will therefore not be reflected in the computation
of the FUND's net asset value. If events materially affecting the value of
such securities occur during such period, then these securities will be
valued at their fair value as determined in good faith under procedures
established by and under the supervision of the Trustees of the Portfolio.
Portfolio securities which are traded both on an exchange and in the over-
the-counter market, will be valued according to the broadest and most
representative market. All assets and liabilities initially expressed in
foreign currency values will be converted into U.S. Dollar values at the
mean between the bid and offered quotations of the currencies against U.S.
Dollars as last quoted by any recognized dealer. When portfolio securities
are traded, the valuation will be the last reported sale price on the day
of valuation. (For securities traded on the New York Stock Exchange, the
valuation will be the last reported sales price as of the close of the
Exchange's regular trading session, currently 4:15 P.M. New York Time.) If
there is no such reported sale or the valuation is based on the Over-the-
Counter market, the securities will be valued at the last available bid
price or at the mean between the bid and asked prices, as determined by the
Trustees. As of the date of this Statement of Additional Information, such
securities will be valued by the latter method. Securities for which
reliable quotations are not readily available and all other assets will be
valued at their respective fair market value as determined in good faith
by, or under procedures established by, the Trustees of the Portfolio.
Money market instruments with less than sixty days remaining to
maturity when acquired by the Portfolio will be valued on an amortized cost
basis by the Portfolio, excluding unrealized gains or losses thereon from
the valuation. This is accomplished by valuing the security at cost and
then assuming a constant amortization to maturity of any premium or
discount. If the Portfolio acquires a money market instrument with more
than sixty days remaining to its maturity, it will be valued at current
market value until the 60th day prior to maturity, and will then be valued
on an amortized cost basis based upon the value on such date unless the
Trustees of the Portfolio determine during such 60-day period that this
amortized cost value does not represent fair market value.
All liabilities incurred or accrued are deducted from the FUND's total
assets. The resulting net assets are divided by the number of shares of the
FUND outstanding at the time of the valuation and the result (adjusted to
the nearest cent) is the net asset value per share.
Orders to purchase or redeem shares of the FUND received by dealers
prior to 4:00 P.M. (Eastern Time) will be confirmed at the previous
offering or redemption price computed as of the close of trading on the
options exchanges (normally 4:15 P.M. New York Time), provided the order is
received by the FUND's Transfer Agent prior to 4:00 P.M. on that day. It is
the responsibility of the dealer to insure that all orders are transmitted
timely to the FUND. Orders received by dealers after 4:00 P.M. will be
confirmed at the next computed offering or redemption price.
PERFORMANCE INFORMATION
For purposes of quoting and comparing the performance of the FUND to
that of other mutual funds and to stock or other relevant indices in
advertisements or in reports to Shareholders, performance will be stated
both in terms of total return and in terms of yield. The total return basis
combines principal and dividend income changes for the periods shown.
Principal changes are based on the difference between the beginning and
closing net asset values for the period and assumes reinvestment of
dividends and distributions paid by the FUND. Dividends and distributions
are comprised of net investment income and net realized capital gains.
Under the rules of the Commission, funds advertising performance must
include total return quotes calculated according to the following formula:
P(1 + T)n = ERV
Where P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)
ERV = ending redeemable value of a hypothetical $1,000 payment made
at the beginning of the 1, 5 or 10 year periods or at the end
of the 1, 5 or 10 year periods (or fractional portion
thereof)
Under the foregoing formula the time periods used in advertising will
be based on rolling calendar quarters, updated to the last day of the most
recent quarter prior to submission of the advertising for publication, and
will cover one, five, and ten year periods or a shorter period dating from
the effectiveness of the FUND's registration statement. In calculating the
ending redeemable value, the pro rata share of the account opening fee is
deducted from the initial $1,000 investment and all dividends and
distributions by the FUND are assumed to have been reinvested at net asset
value as described in the Prospectus on the reinvestment dates during the
period. Total return, or "T" in the formula above, is computed by finding
the average annual compounded rates of return over the 1, 5 and 10 year
periods (or fractional portion thereof) that would equate the initial
amount invested to the ending redeemable value.
The FUND's annual total return for the fiscal year ended October 31,
1996 and from inception through October 31, 1995 was 14.62% and 11.99%,
respectively.
The FUND may also from time to time include in such advertising a
total return figure that is not calculated according to the formula set
forth above in order to compare more accurately the FUND's performance with
other measures of investment return. For example, in comparing the FUND's
total return with data published by Lipper Analytical Services, Inc. or
similar independent services or financial publications, the FUND calculates
its aggregate total return for the specified periods of time by assuming
the reinvestment of each dividend or other distribution at net asset value
on the reinvestment date. Percentage increases are determined by
subtracting the initial net asset value of the investment from the ending
net asset value and by dividing the remainder by the beginning net asset
value. The FUND does not, for these purposes, deduct the pro rata share of
the account opening fee from the initial value invested. THE FUND WILL,
HOWEVER, DISCLOSE THE PRO RATA SHARE OF THE ACCOUNT OPENING FEE, WHICH WAS
IN EFFECT UNTIL DECEMBER 1994, AND WILL DISCLOSE THAT THE PERFORMANCE DATA
DOES NOT REFLECT SUCH NON-RECURRING CHARGE AND THAT INCLUSION OF SUCH
CHARGE WOULD REDUCE THE PERFORMANCE QUOTED. Such alternative total return
information will be given no greater prominence in such advertising than
the information prescribed under the Commission's rules.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The FUND reserves the right to close an account that has dropped below
$1,000 in value for a period of three months or longer other than as a
result of a decline in the net asset value per share. Shareholders are
notified at least 60 days prior to any proposed redemption and are invited
to add to their account if they wish to continue as shareholders of the
FUND, however, the FUND does not presently contemplate making such
redemptions and the FUND will not redeem any shares held in tax-sheltered
retirement plans.
The FUND has elected to be governed by Rule 18f-1 of the 1940 Act,
under which the FUND is obligated to redeem the shares of any shareholder
solely in cash up to the lesser of 1% of the net asset value of the FUND or
$250,000 during any 90-day period. Should any shareholder's redemption
exceed this limitation, the FUND can, at its sole option, redeem the excess
in cash or in portfolio securities. Such securities would be selected
solely by the FUND and valued as in computing net asset value. In these
circumstances a shareholder selling such securities would probably incur a
brokerage charge and there can be no assurance that the price realized by a
shareholder upon the sale of such securities will not be less than the
value used in computing net asset value for the purpose of such redemption.
TAX MATTERS
The following is only a summary of certain additional tax
considerations generally affecting the FUND and its shareholders that are
not described in the Prospectus. No attempt is made to present a detailed
explanation of the tax treatment of the FUND or its shareholders, and the
discussions here and in the Prospectus are not intended as substitutes for
careful tax planning.
Qualification as a Regulated Investment Company
The FUND has elected to be taxed as a regulated investment company
("RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended
(the "Code"). As a RIC, the FUND is not subject to federal income tax on
the portion of its net investment income (i.e., taxable interest, dividends
and other taxable ordinary income, net of expenses) and capital gain net
income (i.e., the excess of capital gains over capital losses) that it
distributes to shareholders, provided that it distributes at least 90% of
its investment company taxable income (i.e., net investment income and the
excess of net short-term capital gain over net long-term capital loss) for
the taxable year (the "Distribution Requirement"), and satisfies certain
other requirements of the Code that are described below. Distributions by
the FUND made during the taxable year or, under specified circumstances,
within twelve months after the close of the taxable year, will be
considered distributions of income and gains of the taxable year and can
therefore satisfy the Distribution Requirement. Because the FUND invests
all of its assets in the Portfolio, which is classified as a partnership
for federal income tax purposes, the FUND will be deemed to own a
proportionate share of the assets and income of the Portfolio for purposes
of determining whether the FUND satisfies the requirements (described more
fully below) necessary to qualify as a regulated investment company.
In addition to satisfying the Distribution Requirement, a RIC must:
(1) derive at least 90% of its gross income from dividends, interest,
certain payments with respect to securities loans, gains from the sale or
other disposition of stock or securities or foreign currencies (to the
extent such currency gains are directly related to the company's principal
business of investing in stock or securities) and other income (including
gains from options, futures or forward contracts) derived with respect to
its business of investing in such stock, securities or currencies (the
"Income Requirement"); and (2) derive less than 30% of its gross income
(exclusive of certain gains on designated hedging transactions that are
offset by realized or unrealized losses on offsetting positions) from the
sale or other disposition of stock, securities or foreign currencies (or
options, futures or forward contracts thereon) held for less than three
months (the "Short-Short Gain Test"). Because of the Short-Short Gain Test,
the FUND may have to limit the sale of appreciated securities that it held
for less than three months. However, foreign currency gains that are
directly related to the company's investment in stock or securities are not
treated as short-short gains. Similarly, the Short-Short Gain Test will not
prevent the FUND from disposing of investments at a loss, since losses are
disregarded for this purpose. Interest (including original issue discount)
received by the FUND at maturity or upon the disposition of a security held
for less than three months is not treated as gross income derived from the
sale or other disposition of a security within the meaning of the Short-
Short Gain Test. However, income attributable to realized market
appreciation will be so treated for this purpose.
In general, gain or loss recognized by the Portfolio on the
disposition of an asset (and allocated to the FUND) will be a capital gain
or loss. However, gain recognized on the disposition of a debt obligation
purchased at a market discount will be treated as ordinary income to the
extent of the portion of the discount that accrued while the Portfolio held
the obligation. In addition, under the rules of Code Section 988, a portion
of gain or loss recognized on the disposition of a debt obligation
denominated in a foreign currency or an option with respect thereto, and
(with certain exceptions) gain or loss recognized on the disposition of a
foreign currency forward contract, futures contract, option or similar
financial instrument, or of foreign currency itself, will generally be
treated as ordinary income or loss.
In general, for purposes of determining whether capital gain or loss
recognized by the FUND (through its Portfolio) on the disposition of an
asset is long-term or short-term, the holding period of the asset may be
affected if (1) the asset is used to close a "short sale" (which may
include the acquisition of a put option) or is substantially identical to
another asset so used, (2) the asset is otherwise held by the Portfolio as
part of a "straddle" (as defined) or (3) the asset is stock and the
Portfolio grants an in-the-money qualified covered call option with respect
thereto. In addition, the FUND may be required to defer the recognition of
a loss on a disposition of an asset held as part of a straddle to the
extent of any unrecognized gain on the offsetting position.
Any gain allocated to the FUND on the lapse of, or any gain or loss
allocated to it from a closing transaction with respect to, an option
written by the Portfolio will be treated as a short-term capital gain or
loss. For purposes of the Short-Short Gain Test, the holding period of such
an option will commence on the date it is written and end on the date it
lapses or the date a closing transaction is entered into. Accordingly, the
Portfolio may be limited in its ability to write options which expire
within three months and to enter into closing transactions at a gain within
three months of the writing of options.
Regulated futures contracts, certain foreign currency contracts, and
options on stock indexes and futures contracts are subject to special tax
treatment as "Section 1256 contracts." Such contracts are treated as if
they are sold for their fair market value on the last business day of the
taxable year, even though a taxpayer's obligations (or rights) under such
contracts have not terminated as of such date. Gain or loss recognized as a
consequence of the year-end deemed disposition of Section 1256 contracts is
taken into account for the taxable year together with any gain or loss
recognized upon the actual termination of such contracts during the year.
The combined capital gain or loss for the year with respect to Section 1256
contracts is generally treated as 60% long-term capital gain or loss and
40% short-term capital gain or loss. (The Portfolio may elect not to have
this special tax treatment apply to Section 1256 contracts that are part of
a "mixed straddle" with other investments that are not Section 1256
contracts.) The IRS has held in private rulings that constructive gains
arising from deemed year-end dispositions of Section 1256 contracts will
not be taken into account for purposes of the Short-Short Gain Test.
Treasury Regulations permit a regulated investment company, in
determining its investment company taxable income and net capital gain
(i.e., the excess of net long-term capital gain over net short-term capital
loss) for any taxable year, to elect (unless it has made a taxable year
election for excise tax purposes as discussed below) to treat all or any
part of any net capital loss, any net long-term capital loss or any net
foreign currency loss incurred after October 31 as if it were incurred in
the succeeding year.
In addition to the requirements described above, the FUND must satisfy
an asset diversification test in order to qualify as a regulated investment
company. Under this test, at the close of each quarter of a RIC's taxable
year, at least 50% of the value of its assets must consist of cash and cash
items, U.S. Government securities, securities of other RICs, and securities
of other issuers (as to which the RIC has not invested more than 5% of the
value of its total assets in securities of such issuer and as to which it
does not hold more than 10% of the outstanding voting securities of such
issuer), and no more than 25% of the value of its total assets may be
invested in the securities of any one issuer (other than U.S. Government
securities and securities of other RICs), or in two or more issuers which
the RIC controls and which are engaged in the same or similar trades or
businesses. Generally, an option (call or put) with respect to a security
is treated as issued by the issuer of the security and not the issuer of
the option.
If for any taxable year the FUND does not qualify as a RIC, all of its
taxable income (including its net capital gain) will be subject to tax at
regular corporate rates without any deduction for distributions to
shareholders, and such distributions will be taxable to the shareholders as
ordinary dividends to the extent of the FUND's current and accumulated
earnings and profits. Such distributions generally will be eligible for the
dividends-received deduction in the case of corporate shareholders.
Excise Tax on Regulated Investment Companies
A 4% non-deductible excise tax is imposed on a RIC that fails to
distribute in each calendar year an amount equal to 98% of its ordinary
taxable income for the calendar year and 98% of its capital gain net income
for the one-year period ended on October 31 of the year. The balance of
such income must be distributed during the next calendar year.
The FUND intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and capital gain net income
prior to the end of each calendar year to avoid liability for the excise
tax. The FUND may in certain circumstances have to liquidate portfolio
investments in order to effect such distributions.
FUND Distributions
The FUND intends to distribute substantially all of its investment
company taxable income for each taxable year. Such distributions will be
taxable to shareholders as ordinary income and treated as dividends for
federal income tax purposes, but will qualify for the 70% dividends-
received deduction for corporate shareholders only to the extent discussed
below.
The FUND may either retain or distribute to shareholders its net
capital gain for each taxable year. The FUND currently intends to
distribute such gains annually. Net capital gain distributed and designated
as a capital gain dividend is taxable to shareholders as long-term capital
gain, regardless of the shareholder's holding period in his shares and the
time when such gain was recognized by the Portfolio.
If the FUND elects to retain its net capital gain, it will be taxed
thereon (except to the extent of any available capital loss carryovers) at
the 35% corporate tax rate. In this case, the FUND would expect to elect to
have shareholders of record on the last day of the taxable year treated as
if each received a distribution of his pro rata share of the gain, with the
result that each would be required to report his pro rata share of such
gain on his tax return as a long-term capital gain, would receive a
refundable tax credit for his pro rata share of the tax paid by the FUND on
the gain, and would increase the tax basis for his shares by an amount
equal to the deemed distribution less the credit.
Ordinary income dividends distributed by the FUND will qualify for the
70% dividends-received deduction generally available to corporations (other
than corporations, such as S corporations, which are not eligible for the
deduction) to the extent of the portion of the distribution attributed to
"qualifying dividends" received by the Portfolio during the taxable year
from domestic corporations. A dividend received by the Portfolio will not
be treated as a qualifying dividend (1) if it was received with respect to
stock that the Portfolio held for less than 46 days (91 days in the case of
certain preferred stock), subject to the limitations of Code Sections
246(c)(3) and (4) and 246A. Moreover, the dividends-received deduction for
a corporate shareholder will also be disallowed if the corporate
shareholder fails to satisfy the foregoing requirements with respect to its
FUND shares or the FUND fails to satisfy them with respect to its interest
in the Portfolio.
Investment income that may be received by the Portfolio from foreign
sources may be subject to foreign taxes withheld at the source. The United
States has entered into tax treaties with a number of foreign countries,
which entitle the Portfolio to reduced rates of, or exemptions from, taxes
on such income. It is impossible to determine the effective rate of foreign
tax in advance since the future mix of the Portfolio's investments in
various countries is not known.
Distributions by the FUND that do not constitute ordinary income
dividends or capital gain dividends will be treated as a return of capital
to the extent of (and in reduction of) the shareholders' tax basis in their
shares; any excess will be treated as gain from a sale of the shares, as
discussed more fully below.
Distributions by the FUND will be treated in the manner described
above whether they are paid in cash or reinvested in additional shares of
the FUND (or of another fund). In addition, if a shareholder's cost for his
shares already reflects undistributed (realized or unrealized) income or
gain, a subsequent distribution of such amounts will be taxable to the
shareholder in the manner described above, although economically it
constitutes a return of capital.
Ordinarily, shareholders are required to take distributions into
account in the year in which they are made. However, dividends declared by
the FUND in October, November or December of any calendar year and payable
to shareholders of record on a specified date in such a month will be
deemed to have been received by the shareholders (and made by the FUND) on
December 31 of such year if such dividends are actually paid in January of
the following year. Shareholders will be advised annually as to the U.S.
federal income tax consequences of distributions made (or deemed made)
during the year.
The FUND will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of dividends and the proceeds of redemption paid to
any shareholder (1) who has provided either an incorrect tax identification
number or no number at all to the FUND, (2) who is subject to backup
withholding pursuant to a notice from the IRS for failure to report
interest or dividend income properly, or (3) who has not otherwise
certified to the FUND that it is not subject to backup withholding.
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or redemption of
his shares in an amount equal to the difference between the amount realized
on the shares and his adjusted tax basis in them. All or a portion of any
loss so recognized may be disallowed if the shareholder purchases other
shares of the FUND within 30 days before or after the disposition. In
general, gain or loss arising from a sale or redemption of FUND shares will
constitute capital gain or loss, and will be long-term capital gain or loss
if the shares were held longer than one year. However, a capital loss
arising from a disposition of shares held for six months or less will be
treated as a long-term capital loss to the extent of any amount of capital
gain dividends received on the shares. For this purpose, the special
holding period rules of Code Section 246(c)(3) and (4) (alluded to above in
connection with the dividends-received deduction for corporations) will
generally apply. Capital losses in any year are deductible only to the
extent of capital gains plus, in the case of noncorporate taxpayers, $3,000
of ordinary income.
Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation,
or foreign partnership ("foreign shareholder"), depends on whether the
income received from the FUND is "effectively connected" with a U.S. trade
or business carried on by the shareholder.
If the income is not effectively connected in the above sense,
ordinary income dividends distributed to a foreign shareholder will be
subject to U.S. withholding tax at the rate of 30% (or a lower treaty rate,
if one applies) of the gross amount of the dividend. Such a shareholder
would generally be exempt from U.S. federal income tax on gains realized on
a sale of FUND shares and capital gain dividends.
If income from the FUND is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income
dividends, capital gain dividends, and gain realized upon the sale of FUND
shares will be subject to U.S. federal income tax at the rates applicable
to U.S. citizens or domestic corporations.
In the case of foreign noncorporate shareholders, the FUND may be
required to withhold U.S. federal income tax at a rate of 31% on
distributions that are otherwise exempt from withholding tax (or taxable at
a reduced treaty rate) unless they furnish the FUND with proper
notification of their exempt status.
The tax consequences to foreign shareholders entitled to claim the
benefits of applicable treaties may differ from one treaty to another.
Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in the
FUND, including the applicability of any foreign taxes.
Effect of Future Legislation; Local Tax Considerations
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and the Treasury Regulations as in effect
on the date of this Statement of Additional Information. Future legislative
or administrative changes or court decisions may significantly alter the
conclusions expressed herein, perhaps with retroactive effect.
Rules of state and local taxation of dividends from regulated
investment companies often differ from the rules for U.S. federal income
taxation described above. Shareholders are urged to consult their tax
advisers as to the consequences of their investing in the FUND in light of
their particular circumstances.
THE MANAGEMENT OF THE FUND
Officers and Trustees are listed with their birthdates, addresses,
principal occupations, and present positions, including any affiliation
with Virtus Capital Management, Inc., Signet Trust Company, Federated
Investors, Federated Securities Corp., Federated Shareholder Services
Company, and Federated Administrative Services or the Funds (as defined
below).
John F. Donahue(1)(2) CHAIRMAN AND TRUSTEE OF THE FUND;
Chairman and Trustee,
Federated Investors Tower Federated Investors, Federated
Advisers, Federated
Pittsburgh, PA Management, and Federated Research;
Chairman and
BIRTHDATE: JULY 28, 1924 Director, Federated Research Corp. and
Federated Global Research Corp.; Chairman,
Passport Research, Ltd.; Chief Executive
Officer and Director, Trustee, or Managing
General Partner of the Funds. Mr.
Donahue is the father of
J. Christopher Donahue, Executive Vice
President of the Fund.
Thomas G. Bigley TRUSTEE OF THE FUND; Director, Oberg
Manufacturing Co.;
28th Floor Chairman of the Board, Children's
Hospital of Pittsburgh;
One Oxford Centre Director, Trustee or Managing General
Partner of the Funds;
Pittsburgh, PA formerly, Senior Partner, Ernst & Young LLP.
BIRTHDATE: FEBRUARY 3, 1934
John T. Conroy, Jr.(3) TRUSTEE OF THE FUND; President,
Investment Properties
John R. Wood and Associates, Inc., Realtors Corporation; Senior Vice-
President, John R. Wood and
3255 Tamiami Trail North Associates, Inc., Realtors; President,
Northgate Village
Naples, FL Development Corporation; Partner or
Trustee in private real
BIRTHDATE: JUNE 23, 1937 estate ventures in Southwest Florida;
Director, Trustee, or
Managing General Partner of the Funds;
formerly, President,
Naples Property Management, Inc.
Wood/IPC Commercial Department
William J. Copeland(3) TRUSTEE OF THE FUND; Director and
Member of the Executive
One PNC Plaza - 23rd Floor Committee, Michael Baker, Inc.;
Director, Trustee, or
Pittsbugh, PA Managing General Partner of the Funds;
formerly, Vice
BIRTHDATE: JULY 4, 1918 Chairman and Director, PNC Bank, N.A.,
and PNC Bank
Corp. and Director, Ryan Homes, Inc.
James E. Dowd(3) TRUSTEE OF THE FUND; Attorney-at-law;
Director, The
571 Hayward Mill Road Emerging Germany Fund, Inc.; Director,
Trustee, or
Concord, MA Managing General Partner of the Funds.
BIRTHDATE: MAY 18, 1922
Lawrence D. Ellis, M.D.(1) TRUSTEE OF THE FUND; Professor of
Medicine and Member,
3471 Fifth Avenue, Suite 1111 Board of Trustees, University of
Pittsburgh; Medical
Pittsburgh, PA Director, University of Pittsburgh
Medical Center-
BIRTHDATE: OCTOBER 11, 1932 Downtown, Member, Board of Directors,
University of
Pittsburgh Medical Center; formerly,
Hematologist,
Oncologist, and Internist, Presbyterian
and Montefiore
Hospitals; Director, Trustee, or
Managing General Partner of
the Funds.
Edward L. Flaherty, Jr.(3) TRUSTEE OF THE FUND; Attorney-at-law;
Shareholder, Miller,
Miller, Ament, Henny & Kochuba Ament, Henny & Kochuba; Director, Eat'N
Park Restaurants,
205 Ross Street Inc., and Statewide Settlement Agency,
Inc.; Director,
Pittsburgh, PA Trustee, or Managing General Partner of
the Funds;
BIRTHDATE: JUNE 18, 1924 formerly, Counsel, Horizon Financial,
F.A., Western Region.
Edward C. Gonzales(1) PRESIDENT, TRUSTEE AND TREASURER OF THE
FUND; Vice
Federated Investors Tower Chairman, Treasurer, and Trustee,
Federated Investors;
Pittsburgh, PA Vice President, Federated Advisers,
Federated Management, Federated Research,
BIRTHDATE: OCTOBER 22, 1930 Federated Research Corp.,
Federated Global Research Corp. and Passport
Research, Ltd.; Executive Vice
President and Director,
Federated Securities Corp.; Trustee,
Federated Shareholder Services Company;
Chairman, Treasurer,
and Trustee, Federated Administrative
Services; Trustee
or Director of some of the Funds;
President, Executive
Vice President and Treasurer of some of
the Funds.
Peter E. Madden TRUSTEE OF THE FUND; Consultant; State
Representative,
Seacliff Commonwealth of Massachusetts;
Director, Trustee, or
526 Bellevue Avenue Managing General Partner of the Funds;
formerly, President,
Newport, RI State Street Bank and Trust Company and
State Street Boston Corporation.
BIRTHDATE: MARCH 16, 1942
Gregor F. Meyer TRUSTEE OF THE FUND; Attorney-at-law;
Shareholder, Miller,
Miller, Ament, Henny & Kochuba Ament, Henny & Kochuba; Chairman,
Meritcare, Inc.;
205 Ross Street Director, Eat'N Park Restaurants, Inc.;
Director, Trustee, or
Pittsburgh, PA Managing General Partner of the Funds.
BIRTHDATE: OCTOBER 6, 1926
John E. Murray, Jr., J.D., S.J.D. TRUSTEE OF THE FUND; President, Law
Professor, Duquesne
President, Duquesne University University; Consulting Partner,
Mollica, Murray and Hogue;
Pittsburgh, PA Director, Trustee or Managing Partner
of the Funds.
BIRTHDATE: DECEMBER 20, 1932
Wesley W. Posvar TRUSTEE OF THE FUND; Professor,
International Politics and
1202 Cathedral of Learning Management Consultant; Trustee,
Carnegie Endowment for
University of Pittsburgh International Peace, RAND Corporation,
Online Computer
Pittsburgh, PA Library Center, Inc., and U.S. Space
Foundation; Chairman,
BIRTHDATE: SEPTEMBER 14, 1925 Czecho Management Center; Director,
Trustee, or Managing
General Partner of the Funds; President
Emeritus, University
of Pittsburgh; founding Chairman,
National Advisory
Council for Environmental Policy and
Technology and
Federal Emergency Management Advisory Board.
Marjorie P. Smuts TRUSTEE OF THE FUND; Public
relations/marketing consultant;
4905 Bayard Street Conference Coordinator, Non-profit
entities; Director,
Pittsburgh, PA Trustee, or Managing General Partner of
the Funds.
BIRTHDATE: JUNE 21, 1935
J. Christopher Donahue EXECUTIVE VICE PRESIDENT OF THE FUND;
President and
Federated Investors Tower Trustee, Federated Investors, Federated
Advisers, Federated
Pittsburgh, PA Management, and Federated Research;
President and
BIRTHDATE: APRIL 11, 1949 Director, Federated Research Corp. and
Federated Global
Research Corp.; President, Passport
Research, Ltd.; Trustee,
Federated Administrative Services,
Federated Shareholder
Services Company, and Federated
Shareholder Services;
Director, Federated Services Company;
President or
Executive Vice President of the Funds;
Director, Trustee, or
Managing General Partner of some of the
Funds.
Mr. Donahue is the son of John F. Donahue,
Chairman and
Trustee of the Fund.
John W. McGonigle EXECUTIVE VICE PRESIDENT AND SECRETARY
OF THE FUND;
Federated Investors Tower Executive Vice President, Secretary,
and Trustee, Federated
Pittsbugh, PA Investors; Trustee, Federated Advisers,
Federated
BIRTHDATE: OCTOBER 26, 1938 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.
Richard B. Fisher VICE PRESIDENT OF THE FUND; Executive
Federated Investors Tower Vice President and
Pittsburgh, PA Trustee, Federated Investors; Chairman
BIRTHDATE: May 17, 1923 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 VICE PRESIDENT AND ASSISTANT TREASURER
Federated Investors Tower OF THE FUND; Vice
Pittsburgh, PA President, Federated Administrative
BIRTHDATE: May 22, 1962 Services; Vice President
and Assistant Treasurer of some of the
Funds.
(1) This Trustee is deemed to be an `interested person'' of the Trust as
defined in the Investment Company Act of 1940.
(2) Member of the Executive Committee. The Executive Committee of the
Board of Trustees handles the responsibilities of the Board of Trustees
between meetings of the Board.
(3) Member of the Audit Committee. The Audit Committee is responsible for
reviewing compliance with all internal controls and all regulations related
to the financial reporting process.
As referred to in the list of Trustees and Officers, `Funds''
includes the following investment companies:
111 Corcoran Funds; Arrow Funds; Automated Government Money Trust;
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; Intermediate Municipal Trust;
International Series, Inc.; Investment Series Funds, Inc.; Investment
Series Trust; Liberty Term Trust, Inc. - 1999; Liberty U.S. Government
Money Market Trust; Liquid Cash Trust; Managed Series Trust; Money Market
Management, Inc.; Money Market Obligations Trust; Money Market Trust;
Municipal Securities Income Trust; Newpoint Funds; Peachtree Funds; RIMCO
Monument Funds; Targeted Duration Trust; Tax-Free Instruments Trust; The
Planters Funds; The Starburst Funds; The Starburst Funds II; The Virtus
Funds; Trust for Financial Institutions; Trust for Government Cash
Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S.
Treasury Obligations; and World Investment Series, Inc.
FUND OWNERSHIP
As of February 3, 1997, Officers and Trustees owned less than 1% of
the outstanding shares of the FUND.
To the best knowledge of the FUND, as of February 3, 1997, one
shareholder owned 5% or more of the outstanding shares of the FUND:
Fairfield Tire Center Inc., Fairfield, California, owned approximately
22,625 shares (11.65%).
The Trustees and officers of the Portfolio and their age and principal
occupations for at least the past five years are set forth below. Their
titles may have varied during that period. Asterisks indicate those
Trustees who are "interested persons" (as defined in the 1940 Act) of the
Portfolio. Unless otherwise indicated below, the address of each officer is
6 St. James Avenue, Suite 900, Boston, Massachusetts 02116.
PRINCIPAL OCCUPATIONS YEAR FIRST
TRUSTEE AGE FOR THE LAST FIVE BECAME
YEARS A TRUSTEE
Fergus Reid, III 64 Chairman and Chief 1984
971 West Road Executive Officer,
New Canaan, CT 06840 Lumelite Corporation,
since September 1985;
Trustee, Morgan
Stanley Portfolios.
Richard E. Ten Haken 62 Former District 1984
4 Barnfield Road Superintendent of
Pittsford, NY 14534 Schools, Monroe No. 2
and Orleans Counties,
New York; Chairman of
the Finance and the
Audit and Accounting
Committees, Member of
the Executive
Committee; Chairman of
the Board and
President, New York
State Teachers'
Retirement System.
William J. Armstrong 54 Vice President and 1987
49 Aspen Way Treasurer, Ingersoll-
Upper Saddle River, NJ Rand Company.
07458
PRINCIPAL OCCUPATIONS YEAR FIRST
TRUSTEE AGE FOR THE LAST FIVE BECAME
YEARS A TRUSTEE
John R.H. Blum 67 Attorney in Private 1984
322 Main Street Practice; formerly a
Lakeville, CT 06039 Partner in the law
firm of Richards,
O'Neil & Allegaert;
Commissioner of
Agriculture - State of
Connecticut, 1992-
1995.
*Joseph J. Harkins 65 Retired; Commercial 1990
257 Plantation Circle Sector Executive and
South Executive Vice
Ponte Vedra Beach, FL President of The Chase
32082 Manhattan Bank, N.A.
from 1985 through
1989. He has been
employed by Chase in
numerous capacities
and offices since
1954. Director of
Blessings Corporation,
Jefferson Insurance
Company of New York,
Monticello Insurance
Company and National.
*H. Richard 60 Consultant, Republic 1992
Vartabedian Bank of New York;
P.O. Box 296 formerly, Senior
Beach Road Investment Officer,
Hendrick's Head Division Executive of
Southport, ME 04576 the Investment
Management Division of
The Chase Manhattan
Bank, N.A., 1980
through 1991.
Stuart W. Cragin, Jr. 63 Retired; formerly 1992
108 Valley Road President, Fairfield
Cos Cob, CT 06807 Testing Laboratory,
Inc. He has previously
served in a variety of
marketing,
manufacturing and
general management
positions with Union
Camp Corp., Trinity
Paper & Plastics
Corp., and Conover
Industries.
Irving L. Thode 65 Retired; Vice 1992
80 Perkins Road President of Quotron
Greenwich, CT 06830 Systems. He has
previously served in a
number of executive
positions with Control
Data Corp., including
President of its Latin
American Operations,
and General Manager of
its Data Services
business.
W. Perry Neff Independent Financial 1989
Trustee Consultant; Director
RR 1 Box 102 of North America Life
Weston, VT 05181 Assurance Co.,
Petroleum & Resources
Corp. and The Adams
Express Co.; Director
and Chairman of The
Hanover Funds, Inc.;
Formerly Director,
Chairman and President
of The Hanvover
Investment Funds Inc.
PRINCIPAL OCCUPATIONS YEAR FIRST
TRUSTEE AGE FOR THE LAST FIVE BECAME
YEARS A TRUSTEE
Roland R. Eppley, Jr. 64 Retired; formerly 1988
Trustee President and Chief
105 Coventry Place Executive Officer,
Palm Beach Gardens, FL Eastern States
33418 Bankcard Association
Inc. (1971-1988);
Director, Janel
Hydraulics, Inc.;
Formerly, Director of
The Hanover Funds,
Inc.
W.D. MacCallan 69 Director of The Adams 1989
Trustee Express Co. and
624 East 45th Street Petroleum & Resources
Savannah, GA 31405 Corp.; formerly
Chairman of the Board
and Chief Executive
Officer of The Adams
Express Co. and
Petroleum & Resources
Corp.; formerly
Director of The
Hanover Fund, Inc. and
The Hanover Investment
Funds, Inc.
* Interested Trustees as defined under the 1940 Act.
Remuneration of Trustees and Certain Executive Officers:
Each Trustee is reimbursed for expenses incurred in attending each
meeting of the Board of Trustees or any committee thereof. Each Trustee who
is not an affiliate of the Portfolio Adviser is compensated for his or her
services according to a fee schedule which recognizes the fact that each
Trustee also serves as a Trustee of other investment companies advised by
the Portfolio Adviser. Each Trustee receives a fee, allocated among all
investment companies for which the Trustee serves, which consists of an
annual retainer component and a meeting fee component. Effective August 21,
1995, each Trustee receives a quarterly retainer of $12,000 and an
additional per meeting fee of $1,500. Prior to August 21, 1995, the
quarterly retainer was $9,000 and the per-meeting fee was $1,000. The
Chairman of the Trustees and the Chairman of the Investment Committee each
receive a 50% increment over regular Trustee total compensation for serving
in such capacities for all the investment companies advised by the
Portfolio Adviser.
OFFICERS AND TRUSTEES OF THE FUNDS COMPENSATION
NAME, POSITION AGGREGATE TOTAL COMPENSATION
WITH THE FUNDS COMPENSATION FROM PAID TO TRUSTEES
THE FUNDS(1) FROM THE FUNDS AND
FUND COMPLEX*
John F. Donahue, $-0- $-0- for the Fund
Chairman and Trustee Complex
Thomas G. Bigley, $101.18 $3,700 for the Fund
Trustee Complex
John T. Conroy, Jr., $111.03 $4,042 for the Fund
Trustee Complex
William J. Copeland, $111.03 $4,042 for the Fund
Trustee Complex
James E. Dowd, $111.03 $4,042 for the Fund
Trustee Complex
Lawrence D. Ellis, $101.18 $3,700 for the Fund
M.D., Trustee Complex
Edward L. Flaherty, $111.03 $4,042 for the Fund
Jr., Trustee Complex
Edward C. Gonzales, $-0- $-0- for the Fund
President, Trustee Complex
and Treasurer
Peter E. Madden, $101.18 $3,700 for the Fund
Trustee Complex
Gregory F. Meyer, $101.18 $3,700 for the Fund
Trustee Complex
John E. Murray, Jr., $101.18 $3,700 for the Fund
J.D., S.J.D., Complex
Trustee
Wesley W. Posvar, $101.18 $3,700 for the Fund
Trustee Complex
Marjorie P. Smuts, $101.18 $3,700 for the Fund
Trustee Complex
(1) The aggregate compensation is provided for the Funds which was
comprised of seven portfolios on December 31, 1996. Information is
furnished for the period from May 2, 1996, date of election of Trustees, to
December 31, 1996.
* The total compensation is provided for the Fund Complex, which
consists of Blanchard Precious Metals Fund, Inc., The Virtus Funds and the
Trust for the calendar year ended December 31, 1996.
Set forth below is information regarding compensation paid or accrued
during the fiscal year ended October 31, 1996 for each Trustee of the
Portfolio:
Capital Pension or Total
Growth Retirement Compensation
Portfolio(1) Benefits from "Fund
Accrued Complex"(2)
as Fund
Expenses
Fergus Reid, III, $7,594.67 0 $78,456.65
Trustee
Richard E. Ten Haken, $5,063.12 0 $52,304.39
Trustee
William J. Armstrong, $5,063.12 0 $46,632.34
Trustee
John R.H. Blum, $4,955.42 0 $51,304.37
Trustee
Joseph J. Harkins, $5,063.12 0 $52,304.39
Trustee
H. Richard $13,376.62 0 $74,804.44
Vartabedian, Trustee
Stuart W. Cragin, Jr., $5,063.12 0 $52,304.39
Trustee
Irving L. Thode, $5,063.12 0 $52,304.39
Trustee
(1) Prior to January 1, 1995, the Portfolio did not pay the Trustees
expenses directly. Rather, the Trustees payments accrued against the
underlying Fund, the Vista Growth and Income Fund. Data reflects
Trustee compensation as if the Portfolio had paid such expenses
directly. As of January 1, 1995, Trustee compensation will be paid by
the Portfolio directly. Mr. Vartabedian received a 50% increment over
regular Trustee compensation for serving as Chairman of the Portfolio.
This incremental amount was paid by the Portfolio directly.
(2) Data reflects total compensation earned during the period January 1,
1995 to December 31, 1995 for service as a Trustee to all thirty-two
(Portfolios) Funds advised by the Portfolio Adviser.
VISTA FUNDS RETIREMENT PLAN FOR ELIGIBLE TRUSTEES
Effective August 21, 1995, the Trustees also instituted a Retirement
Plan for Eligible Trustees (the "Plan") pursuant to which each Trustee (who
is not an employee of any of the Portfolios, the Portfolio Adviser,
Administrator or distributor or any of their affiliates) may be entitled to
certain benefits upon retirement from the Board of Trustees. Pursuant to
the Plan, the normal retirement date is the date on which the eligible
Trustee has attained age 65 and has completed at least five years of
continuous service with one or more of the investment companies advised by
the Portfolio Adviser (collectively, the "Covered Portfolios"). Each
Eligible Trustee is entitled to receive from the Covered Portfolios an
annual benefit commencing on the first day of the calendar quarter
coincident with or following his date of retirement equal to 10% of the
highest annual compensation received from the Covered Portfolios multiplied
by the number of such Trustee's years of service (not in excess of 10
years) completed with respect to any of the Covered Portfolios. Such
benefit is payable to each eligible Trustee in monthly installments for the
life of the Trustee.
Set forth in the table below are the estimated annual benefits payable
to an eligible Trustee upon retirement assuming various compensation and
years of service classifications. The estimated credited years of service
for Messrs. Reid, Ten Haken, Armstrong, Blum, Harkins, Vartabedian, Cragin,
Thode, Neff, Epply and MacCallan, are 11, 11, 8, 11, 3, 3, 3, 6, 7 and 6,
respectively.
Years of
Service Highest Annual Compensation Paid by All Vista
Funds
40,000 45,000 50,000 55,000
10 40,000 45,000 50,000 55,000
9 36,000 40,500 45,000 49,500
8 32,000 36,000 40,000 44,000
7 28,000 31,500 35,000 38,500
6 24,000 27,000 30,000 33,000
5 20,000 22,500 25,000 27,500
DEFERRED COMPENSATION PLAN
Effective August 21, 1995, the Trustees instituted a Deferred
Compensation Plan for Eligible Trustees (the "Deferred Compensation Plan")
pursuant to which each Trustee (who is not an employee of any of the Funds,
the Portfolio Adviser, Administrator or Distributor or any of their
affiliates) may enter into agreements with the Funds whereby payment of the
Trustees' fees are deferred until the payment date elected by the Trustee
(or the Trustee's termination of service). The deferred amounts are deemed
invested in shares of the Fund on whose Board the Trustee sits. The
deferred amounts are paid out in a lump sum or over a period of several
years as elected by the Trustee at the time of deferral. If a deferring
Trustee dies prior to the distribution of amounts held in the deferral
account, the balance of the deferral account will be distributed to the
Trustee's designated beneficiary in a single lump sum payment as soon as
practicable after such deferring Trustee's death. The following Eligible
Trustees have executed a deferred compensation agreement for the 1996
calendar year: Messrs. Ten Haken, Thode and Vartabedian.
MANAGEMENT SERVICES
Manager to the Trust
The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which
is a division of Signet Trust Company, a wholly-owned subsidiary of Signet
Banking Corporation. Because of the internal controls maintained by Signet
Banking Corporation to restrict the flow of non-public information, FUND
investments are typically made without any knowledge of Signet Banking
Corporation or its affiliates' lending relationships with an issuer.
The manager 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 services, VCM receives an annual management fee as described
in the Prospectus. For the fiscal year ended October 31, 1996 and for the
period July 12, 1995, to October 31, 1995, the amount paid or accrued by
the FUND to VCM was $12,080 and $2,415, respectively, all of which was
waived. For the period November 1, 1994, to July 11, 1995, the amount paid
or accrued by the FUND to Sheffield Management Corporation was $5,526, all
of which was waived.
ADMINISTRATIVE SERVICES
Federated Administrative Services, which is a subsidiary of Federated
Investors, provides administrative personnel and services to the FUND for
the fees set forth in the Prospectus. For the fiscal year ended October 31,
1996 and for the period July 12, 1995 to October 31, 1995, the amount paid
or accrued by the FUND to Federated Administrative Services was $75,000 and
$23,014, respectively, of which $62,466 was waived for the fiscal year
ended October 31, 1994.
Transfer Agent & Dividend Disbursing Agent
Federated Shareholder Services Company serves as transfer agent and
dividend disbursing agent for the FUND. The fee paid to the transfer agent
is based upon the size, type and number of accounts and transactions made
by shareholders.
Federated Shareholder Services Company also maintains FUND accounting
records. The fee paid for this service is based upon the level of the
FUND's average net assets for the period plus out-of-pocket expenses.
DISTRIBUTION PLAN
The Trust has adopted a Plan for Shares of the FUND pursuant to Rule
12b-1 which was promulgated by the Securities and Exchange Commission
pursuant to the Investment Company Act of 1940. The Plan provides that the
FUND's Distributor shall act as the Distributor of shares, and it permits
the payment of fees to brokers and dealers for distribution and
administrative services and to administrators for administrative services.
The Plan is designed to (i) stimulate brokers and dealers to provide
distribution and administrative support services to the FUND and its
shareholders and (ii) stimulate administrators to render administrative
support services to the FUND and its shareholders. These services are to be
provided by a representative who has knowledge of the shareholders'
particular circumstances and goals, and include, but are not limited to:
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 the FUND; assisting clients in changing dividend options, account
designations, and addresses; and providing such other services as the Trust
reasonably requests.
Other benefits which the FUND hopes to achieve through the Plan
include, but are not limited to the following: (1) an efficient and
effective administrative system; (2) a more efficient use of assets of
shareholders by having them rapidly invested in the FUND with a minimum of
delay and administrative detail; and (3) an efficient and reliable records
system for shareholders and prompt responses to shareholder requests and
inquiries concerning their accounts.
By adopting the Plan, the then Board of Trustees expected that the
FUND will be able to achieve a more predictable flow of cash for investment
purposes and to meet redemptions. This will facilitate more efficient
portfolio management and assist the FUND in seeking to achieve its
investment objectives. By identifying potential investors in shares whose
needs are served by the FUND's objectives, and properly servicing these
accounts, the FUND may be able to curb sharp fluctuations in rates of
redemptions and sales.
For the fiscal year ended October 31, 1996, the FUND paid $8,629 in
distribution services fees, all of which was waived.
DESCRIPTION OF THE FUND
Shareholder and Trustee Liability. The FUND is a series of an entity
of the type commonly known as a "Massachusetts business trust". Under
Massachusetts law, shareholders of such a trust may, under certain
circumstances, be held personally liable for the obligations of the trust.
The FUND's Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations for the FUND and requires
that notice of such disclaimer be given in each agreement, obligation, or
instrument entered into or executed by the FUND or the Trustees. The
Declaration of Trust provides for indemnification out of the FUND property
of any shareholder held personally liable for the obligations of the FUND.
The Declaration of Trust also provides that the FUND shall, upon
request, assume the defense of any claim made against any shareholders for
any act or obligation of the FUND and satisfy any judgment thereon. Thus,
the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the FUND itself
would be unable to meet its obligations. VCM believes that, in view of the
above, the risk of personal liability to shareholders is remote. The
Declaration of Trust further provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he
would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the
conduct of his office.
Voting Rights. The FUND's capital consists of shares of beneficial
interest. Shares of the FUND entitle the holders to one vote per share. The
shares have no preemptive or conversion rights. The voting and dividend
rights and the right of redemption are described in the Prospectus. Shares
are fully paid and nonassessable, except as set forth under "Shareholder
and Trustee Liability" above. The shareholders have certain rights, as set
forth in the Declaration of Trust, to call a meeting for any purpose,
including the purpose of voting on removal of one or more Trustees.
The FUND may be terminated upon the sale of its assets to another
open-end management company if approved by the vote of the holders of a
majority of the outstanding shares of the FUND. The FUND may also be
terminated upon liquidation and distribution of its assets, if approved by
a majority shareholder vote of the FUND. Shareholders of the FUND shall be
entitled to receive distributions as a class of the assets belonging to the
FUND. The assets of the FUND received for the issue or sale of the shares
of the FUND and all income earnings and the proceeds thereof, subject only
to the rights of creditors, are specially allocated to the FUND, and
constitute the underlying assets of the FUND.
SHAREHOLDER REPORTS
Shareholders received an Annual Report containing financial statements
audited by the FUND's independent accountants for the fiscal year ended
October 31, 1996. The Financial Statements for the fiscal year ended
October 31, 1996 are incorporated herein by reference to the Annual Report
of the FUND filed with the U.S. Securities and Exchange Commission (File
Nos. 33-3165 and 811-4579). A copy of the Annual Report may be obtained
without charge by contacting the FUND at 1-800-829-3863.
APPENDIX A
DESCRIPTION OF CERTAIN OBLIGATIONS
ISSUED OR GUARANTEED BY U.S. GOVERNMENT
AGENCIES OR INSTRUMENTALITIES
FEDERAL FARM CREDIT SYSTEM NOTES AND BONDS -- are bonds issued by a
cooperatively owned nationwide system of banks and associations supervised
by the Farm Credit Administration, an independent agency of the U.S.
Government. These bonds are not guaranteed by the U.S. Government.
MARITIME ADMINISTRATION BONDS -- are bonds issued and provided by the
Department of Transportation of the U.S. Government and are guaranteed by
the U.S. Government.
FNMA BONDS -- are bonds guaranteed by the Federal National Mortgage
Association. These bonds are not guaranteed by the U.S. Government.
FHA DEBENTURES -- are debentures issued by the Federal Housing
Administration of the U.S. Government and are guaranteed by the U.S.
Government.
FHA INSURED NOTES -- are bonds issued by the Farmers Home
Administration, the U.S. Government and are guaranteed by the U.S.
Government.
GNMA CERTIFICATES -- are mortgage-backed securities which represent a
partial ownership interest in a pool of mortgage loans issued by lenders
such as mortgage bankers, commercial banks and savings and loan
associations. Each mortgage loan included in the pool is either insured by
the Federal Housing Administration or guaranteed by the Veterans
Administration and therefore guaranteed by the U.S. Government. As a
consequence of the fees Paid to GNMA and the issuer of GNMA Certificates,
the coupon rate of interest of GNMA Certificates is lower than the interest
paid on the VA-guaranteed or FHA-insured mortgages underlying the
Certificates. The average life of a GNMA Certificate is likely to be
substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by mortgagors and
mortgage foreclosures may result in the return of the greater part of
principal invested far in advance of the maturity of the mortgages in the
pool. Foreclosures impose no risk to principal investment because of the
GNMA guarantee. As the prepayment rate of individual mortgage pools will
vary widely, it is not possible to accurately predict the average life of a
particular issue of GNMA Certificates. The yield which will be earned on
GNMA Certificates may vary from their coupon rates for the following
reasons: (i) Certificates may be issued at a premium or discount, rather
than at par; (ii) Certificates may trade in the secondary market at a
premium or discount after issuance; (iii) interest is earned and compounded
monthly which has the effect of raising the effective yield earned on the
Certificates; and (iv) the actual yield of each Certificate is affected by
the prepayment of mortgages included in the mortgage pool underlying the
Certificates. Principal which is so prepaid will be reinvested although
possibly at a lower rate. In addition, prepayment of mortgages included in
the mortgage pool underlying a GNMA Certificate purchased at a premium
could result in a loss to the Portfolio. Due to the large amount of GNMA
Certificates outstanding and active participation in the secondary market
by securities dealers and investors, GNMA Certificates are highly liquid
instruments. Prices of GNMA Certificates are readily available from
securities dealers and depend on, among other things, the level of market
rates, the Certificate's coupon rate and the prepayment experience of the
pool of mortgages backing each Certificate. If agency securities are
purchased at a premium above principal, the premium is not guaranteed by
the issuing agency and a decline in the market value to par may result in a
loss of the premium, which may be particularly likely in the event of a
prepayment. When and if available, U.S. Government obligations may be
purchased at a discount from face value.
GNMA FHLMC BONDS and GNMA FNMA BONDS -- are mortgage-backed bonds
issued by the Federal Home Loan Mortgage Corporation and the Federal
National Mortgage Association, respectively, and are guaranteed by the U.S.
Government.
GSA PARTICIPATION CERTIFICATES -- are participation certificates
issued by the General Services Administration of the U.S. Government and
are guaranteed by the U.S. Government.
NEW COMMUNITIES DEBENTURES -- are debentures issued in accordance with
the provisions of Title IV of the Housing and Urban Development Act of
1968, as supplemented and extended by Title VII of the Housing and Urban
Development Act of 1970, the payment of which is guaranteed by the U.S.
Government.
PUBLIC HOUSING BONDS -- are bonds issued by public housing and urban
renewal agencies in connection with programs administered by the Department
of Housing and Urban Development of the U.S. Government, the payment of
which is secured by the U.S. Government.
PENN CENTRAL TRANSPORTATION CERTIFICATES -- are certificates issued by
Penn Central Transportation and guaranteed by the U.S. Government.
SBA DEBENTURES -- are debentures fully guaranteed as to principal and
interest by the Small Business Administration of the U.S. Government.
WASHINGTON METROPOLITAN AREA TRANSIT AUTHORITY BONDS -- are bonds
issued by the Washington Metropolitan Area Transit Authority and are
guaranteed by the U.S. Government.
FHLMC BONDS -- are bonds issued and guaranteed by the Federal Home
Loan Mortgage Corporation. These bonds are not guaranteed by the U.S.
Government.
FEDERAL HOME LOAN BANK NOTES AND BONDS -- are notes and bonds issued
by the Federal Home Loan Bank System and are not guaranteed by the U.S.
Government.
STUDENT LOAN MARKETING ASSOCIATION ("SALLIE MAE") NOTES AND BONDS --
are notes and bonds issued by the Student Loan Marketing Association and
are not guaranteed by the U.S. Government.
D.C. ARMORY BOARD BONDS -- are bonds issued by the District of
Columbia Armory Board and are guaranteed by the U.S. Government.
EXPORT-IMPORT BANK CERTIFICATES -- are certificates of beneficial
interest and participation certificates issued and guaranteed by the
Export-Import Bank of the U.S. and are guaranteed by the U.S. Government.
In the case of securities not backed by the "full faith and credit" of
the U.S. Government, the investor must look principally to the agency
issuing or guaranteeing the obligation for ultimate repayment, and may not
be able to assert a claim against the U.S. Government itself in the event
the agency or instrumentality does not meet its commitments.
Investments may also be made in obligations of U.S. Government
agencies or instrumentalities other than those listed above.
APPENDIX B
DESCRIPTION OF RATINGS
A description of the rating policies of Moody's, S&P and Fitch with
respect to bonds and commercial paper appears below.
MOODY'S INVESTORS SERVICE'S CORPORATE BOND RATINGS
Aaa--Bonds which are rated "Aaa" are judged to be of the best quality
and carry the smallest degree of investment risk. 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
qualities and are to be considered as upper medium grade obligations.
Factors giving security to principal and interest are considered adequate
but elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa--Bonds which are rated "Baa" are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba--Bonds which are rated "Ba" are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B--Bonds which are rated "B" generally lack characteristics of a
desirable investment. Assurance of interest and principal payments or of
maintenance and other terms of the contract over any long period of time
may be small.
Caa--Bonds which are rated "Caa" are of poor standing. Such issues
may be in default or there may be present elements of danger with respect
to principal or interest.
Ca--Bonds which are rated "Ca" represent obligations which are
speculative in high degree.
Such issues are often in default or have other marked shortcomings.
C--Bonds which are rated "C" are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers "1", "2", and "3" to certain of
its rating classifications. 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.
STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATINGS
AAA--This is the highest rating assigned by Standard & Poor's to a
debt obligation and indicates an extremely strong capacity to repay
principal and pay interest.
AA--Bonds rated "AA" also qualify as high quality debt obligations.
Capacity to pay principal and interest is very strong, and differs from
"AAA" issues only in small degree.
A--Bonds rated "A" have a strong capacity to repay principal and pay
interest, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher rated categories.
BBB--Bonds rated "BBB" are regarded as having an adequate capacity to
repay principal and pay interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to repay
principal and pay interest for bonds in this category than for higher rated
categories.
BB-B-CCC-CC-C--Bonds rated "BB", "B", "CCC", "CC" and "C" are
regarded, on balance, as predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal in accordance with
the terms of the obligations. BB indicates the lowest degree of
speculation and C the highest degree of speculation. While such bonds will
likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse
conditions.
CI--Bonds rated "CI" are income bonds on which no interest is being
paid.
D--Bonds rated "D" are in default. The "D" category is used when
interest payments or principal payments are not made on the date due even
if the applicable grace period has not expired unless S&P believes that
such payments will be made during such grace period. The "D" rating is
also used upon the filing of a bankruptcy petition if debt service payments
are jeopardized.
The ratings set forth above may be modified by the addition of a plus
or minus to show relative standing within the major rating categories.
MOODY'S INVESTORS SERVICE'S COMMERCIAL PAPER RATINGS
Prime-1--Issuers (or related supporting institutions) rated "Prime-1"
have a superior ability for repayment of senior short-term debt
obligations. "Prime-1" repayment ability will often be evidenced by many
of the following characteristics: leading market positions in
well-established industries, high rates of return on funds employed,
conservative capitalization structures with moderate reliance on debt and
ample asset protection, broad margins in earnings coverage of fixed
financial charges and high internal cash generation, and well-established
access to a range of financial markets and assured sources of alternate
liquidity.
Prime-2--Issuers (or related supporting institutions) rated "Prime-2"
have a strong ability for repayment of senior short-term debt obligations.
This will normally be evidenced by many of the characteristics cited above
but to a lesser degree. Earnings trends and coverage ratios, while sound,
will be more subject to variation. Capitalization characteristics, while
still appropriate, may be more affected by external conditions. Ample
alternative liquidity is maintained.
Prime-3--Issuers (or related supporting institutions) rated "Prime-3"
have an acceptable ability for repayment of senior short-term obligations.
The effect of industry characteristics and market compositions may be more
pronounced. Variability in earnings and profitability may result in
changes in the level of debt protection measurements and the requirement
for relatively high financial leverage. Adequate alternate liquidity is
maintained.
Not Prime--Issuers rated "Not Prime" do not fall within any of the
Prime rating categories.
STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATINGS
A S&P commercial paper rating is current assessment of the likelihood
of timely payment of debt having an original maturity of no more than 365
days. Ratings are graded in several categories, ranging from "A-1" for the
highest quality obligations to "D" for the lowest. The four categories are
as follows:
A-1--This highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus (+) sign
designation.
A-2--Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1".
A-3--Issues carrying this designation have adequate capacity for
timely payment. They are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the bigger
designations.
B--Issues rated "B" are regarded as having only speculative capacity
for timely payment.
C--This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
D--Debt rated "D" is in payment default. The "D" rating category is
used when interest payments or principal payments are not made on the date
due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
FITCH BOND RATINGS
AAA--Bonds rated AAA by Fitch are 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 rated AA by Fitch are 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 issues is generally rated F-1+ by Fitch.
A--Bonds rated A by Fitch are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and repay
principal is considered to be strong, but may be more vulnerable to adverse
changes in economic conditions and circumstances than bonds with higher
ratings.
BBB--Bonds rated BBB by Fitch are 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 consequences 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.
Plus and minus signs are used by Fitch to indicate the relative
position of a credit within a rating category. Plus and minus signs,
however, are not used in the AAA category.
FITCH SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of generally up to three years,
including commercial paper, certificates of deposit, medium-term notes, and
municipal and investment notes.
The short-term rating places greater emphasis than a long-term rating
on the existence of liquidity necessary to meet the issuer's obligations in
a timely manner.
FITCH'S SHORT-TERM RATINGS ARE AS FOLLOWS:
F-1+--Issues assigned this rating are regarded as having the strongest
degree of assurance for timely payment.
F-1--Issues assigned this rating reflect an assurance of timely
payment only slightly less in degree than issues rated F-1+.
F-2--Issues assigned this rating have a satisfactory degree of
assurance for timely payment but the margin of safety is not as great as
for issues assigned F-1+ and F-1 ratings.
F-3--Issues assigned this rating have characteristics suggesting that
the degree of assurance for timely payment is adequate, although near-term
adverse changes could cause these securities to be rated below investment
grade.
LOC--The symbol LOC indicates that the rating is based on a letter of
credit issued by a commercial bank.
Like higher rated bonds, bonds rated in the Baa or BBB categories are
considered to have adequate capacity to pay principal and interest.
However, such bonds may have speculative characteristics, and changes in
economic conditions or other circumstances are more likely to lead to a
weakened capacity to make principal and interest payments than is the case
with higher grade bonds.
After purchase by the Portfolio, a security may cease to be rated or
its rating may be reduced below the minimum required for purchase by the
Portfolio. Neither event will require a sale of such security by the
Portfolio. However, the Portfolio's investment manager will consider such
event in its determination of whether the Portfolio should continue to hold
the security. To the extent the ratings given by Moody's, S&P or Fitch may
change as a result of changes in such organizations or their rating
systems, the Portfolio will attempt to use comparable ratings as standards
for investments in accordance with the investment policies contained the
Prospectus and statement of additional information.
G01386-08 (2/97)
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