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PAINEWEBBER FINANCIAL SERVICES GROWTH FUND INC.
PAINEWEBBER UTILITY INCOME FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
Each Fund named above is, or is a series of, a professionally managed, open-
end management investment company. The Funds are designed for investors
generally seeking capital appreciation by investing principally in equity
securities. PaineWebber Financial Services Growth Fund Inc. ("Financial
Services Growth Fund" or "Corporation"), a Maryland corporation, invests
primarily in equity securities of companies in the financial services
industries. PaineWebber Utility Income Fund ("Utility Income Fund"), a
diversified series of PaineWebber Managed Investments Trust ("Trust"), a
Massachusetts business trust, also seeks to provide current income and invests
primarily in equity securities and bonds of companies in the utility
industries.
The investment adviser, administrator and distributor for each Fund is
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
subsidiary of PaineWebber Incorporated ("PaineWebber"). As distributor for the
Funds, Mitchell Hutchins has appointed PaineWebber to serve as the exclusive
dealer for the sale of Fund shares.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the Funds' current Prospectus, dated August 1,
1998. A copy of the Prospectus may be obtained by calling any PaineWebber
investment executive or correspondent firm or by calling toll-free 1-800-647-
1568. This Statement of Additional Information is dated August 1, 1998.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Funds' investment policies and limitations. Except as otherwise
indicated in the Prospectus or Statement of Additional Information, there are
no policy limitations on a Fund's ability to use the investments or techniques
discussed in these documents.
YIELD FACTORS AND RATINGS. Standard & Poor's, a division of The McGraw-Hill
Companies, Inc. ("S&P"), Moody's Investors Service, Inc. ("Moody's"), and
other nationally recognized statistical rating organizations ("NRSROs") are
private services that provide ratings of the credit quality of debt
obligations (bonds) and certain other securities. A description of the ratings
assigned to corporate debt obligations by S&P and Moody's is included in the
Appendix to this Statement of Additional Information. The Funds may use these
ratings in determining whether to purchase, sell or hold a security. It should
be emphasized, however, that ratings are general and are not absolute
standards of quality. Consequently, securities with the same maturity,
interest rate and rating may have different market prices.
Utility Income Fund is authorized to invest up to 5% of its net assets in
non-investment grade bonds and convertible debt securities--"non-investment
grade" means that the securities are not rated at the time of purchase within
one of the four highest grades assigned by S&P or Moody's, comparably rated by
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NRSRO or determined by Mitchell Hutchins to be of comparable quality. These
securities are also commonly referred to as "junk bonds." Lower rated debt
securities generally offer a higher current yield than that available for
investment grade issues; however, they involve higher risks. Lower rated
securities may be less sensitive to interest rate changes than higher rated
investments, but are more sensitive to adverse market conditions. During an
economic downturn or period of rising interest rates, their issuers may
experience financial stress that adversely affects their ability to pay
interest and repay principal and may increase the possibility of default. In
addition, such issuers may not have more traditional methods of financing
available to them and may be unable to repay debt at maturity by refinancing.
Lower rated bonds are frequently unsecured by collateral and will not receive
payment until more senior claims are paid in full. The prices for lower rated
securities often are more volatile than those of higher rated securities in
response to market conditions. The market for these securities is thinner and
less active, which may limit the Fund's ability to sell them at fair value in
response to changes in the economy or financial markets. Adverse publicity and
investor perceptions, whether or not based on fundamental analysis, may also
decrease the values and liquidity of lower rated securities, especially in a
thinly traded market.
The market for lower rated bonds has expanded rapidly in recent years, and
its growth paralleled a long economic expansion. In the past, the prices of
many lower rated bonds declined substantially, reflecting an expectation that
many issuers of such securities might experience financial difficulties. As a
result, the yields on lower rated bonds rose dramatically. However, such
higher yields did not reflect the value of the income stream that holders of
such securities expected, but rather the risk that holders of such securities
could lose a substantial portion of their value as a result of the issuers'
financial restructuring or default. There can be no assurance that such
declines will not recur.
RISK CONSIDERATIONS RELATING TO FOREIGN SECURITIES. The Funds may hold
securities of foreign issuers that are not registered with the Securities and
Exchange Commission ("SEC"), and foreign issuers may not be subject to SEC
reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by the Funds than is
available concerning U.S. companies. Foreign companies are not generally
subject to uniform accounting, auditing and financial reporting standards or
to other regulatory requirements comparable to those applicable to U.S.
companies.
The Funds may invest in foreign securities by purchasing American Depository
Receipts ("ADRs"). The Funds also may purchase securities of foreign issuers
in foreign markets and purchase European Depository Receipts ("EDRs"), Global
Depository Receipts ("GDRs") or other securities convertible into securities
of issuers based in foreign countries. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted. Generally, ADRs, in registered form, are denominated in U.S.
dollars and are designed for use in the U.S. securities markets, EDRs are
similar to ADRs but generally are in bearer form, may be denominated in other
currencies and are designed for use in European securities markets. GDRs are
similar to EDRs and are designed for use in several international markets.
ADRs are receipts typically issued by a U.S. bank or trust company evidencing
ownership of the underlying securities. For purposes of each Fund's investment
policies, ADRs, EDRs and GDRs are deemed to have the same classification as
the underlying securities they represent. Thus, an ADR, EDR or GDR
representing ownership of common stock will be treated as common stock.
The Funds anticipate that their brokerage transactions involving foreign
securities of companies headquartered in countries other than the United
States will be conducted primarily on the principal exchanges of such
countries. Transactions on foreign exchanges are usually subject to fixed
commissions that are generally higher than negotiated commissions on U.S.
transactions, although each Fund will endeavor to achieve the best net results
in effecting its portfolio transactions. There is generally less government
supervision and regulation of exchanges and brokers in foreign countries than
in the United States.
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Investments in foreign government debt securities involve special risks. The
issuer of the debt or the governmental authorities that control the repayment
of the debt may be unable or unwilling to pay interest or repay principal when
due in accordance with the terms of such debt, and the Funds may have limited
legal recourse in the event of default. Foreign government debt securities
differ from debt obligations issued by private entities in that, generally,
remedies for defaults must be pursued in the courts of the defaulting party.
Legal recourse is, therefore, somewhat limited. Political conditions,
especially a sovereign entity's willingness to meet the terms of its debt
obligations, are of considerable significance. Also, there can be no assurance
that the holders of commercial bank loans to the same sovereign entity may not
contest payments to the holders of foreign government debt securities in the
event of default under commercial bank loan agreements.
Investment income on certain foreign securities in which The Funds may
invest may be subject to foreign withholding or other taxes that could reduce
the return on these securities. Tax treaties between the United States and
foreign countries, however, may reduce or eliminate the amount of foreign
taxes to which these Funds would be subject.
FOREIGN CURRENCY TRANSACTIONS. Although the Funds value their assets daily
in U.S. dollars, they do not intend to convert their holdings of foreign
currencies to U.S. dollars on a daily basis. The Funds' foreign currencies
generally will be held as "foreign currency call accounts" at foreign branches
of foreign or domestic banks. These accounts bear interest at negotiated rates
and are payable upon relatively short demand periods. If a bank became
insolvent, the Funds could suffer a loss of some or all of the amounts
deposited. The Funds may convert foreign currency to U.S. dollars from time to
time. Although foreign exchange dealers generally do not charge a stated
commission or fee for conversion, the prices posted generally include a
"spread," which is the difference between the prices at which the dealers are
buying and selling foreign currencies.
ILLIQUID SECURITIES. Each Fund may invest up to 10% of its net assets in
illiquid securities. The term "illiquid securities" for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the amount at which a Fund has valued the
securities and includes, among other things, purchased over-the-counter
("OTC") options, repurchase agreements maturing in more than seven days and
restricted securities other than those Mitchell Hutchins has determined are
liquid pursuant to guidelines established by each Fund's board of trustees or
board of directors ("board"). The assets used as cover for OTC options written
by the Funds will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Funds may repurchase any OTC options they
write at a maximum price to be calculated by a formula set forth in the option
agreements. The cover for an OTC option written subject to this procedure
would be considered illiquid only to the extent that the maximum repurchase
price under the formula exceeds the intrinsic value of the option.
Restricted securities are not registered under the Securities Act of 1933
("1933 Act") and may be sold only in privately negotiated or other exempted
transactions or after a 1933 Act registration statement has become effective.
Where registration is required, a Fund may be obligated to pay all or part of
the registration expenses and a considerable period may elapse between the
time of the decision to sell and the time a Fund may be permitted to sell a
security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, a Fund might obtain a less
favorable price than prevailed when it decided to sell.
However, not all restricted securities are illiquid. To the extent that
foreign securities are freely tradeable in the country in which they are
principally traded, they are not considered illiquid, even if they are
restricted
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in the United States. A large institutional market has developed for many U.S.
and foreign securities certain securities that are not registered under the
1933 Act. Institutional investors generally will not seek to sell these
instruments to the general public, but instead will often depend either on an
efficient institutional market in which such unregistered securities can be
readily resold or on an issuer's ability to honor a demand for repayment.
Therefore, the fact that there are contractual or legal restrictions on resale
to the general public or certain institutions is not dispositive of the
liquidity of such investments.
Institutional markets for restricted securities also have developed as a
result of Rule 144A, which establishes a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers. Such markets include automated systems for the trading,
clearance and settlement of unregistered securities of domestic and foreign
issuers, such as the PORTAL System sponsored by the National Association of
Securities Dealers, Inc. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held
by a Fund, however, could affect adversely the marketability of such portfolio
securities and the Fund might be unable to dispose of such securities promptly
or at favorable prices.
Each board has delegated the function of making day-to-day determinations of
liquidity to Mitchell Hutchins, pursuant to guidelines approved by the board.
Mitchell Hutchins takes into account a number of factors in reaching liquidity
decisions, including (1) the frequency of trades for the security, (2) the
number of dealers that make quotes for the security, (3) the number of dealers
that have undertaken to make a market in the security, (4) the number of other
potential purchasers and (5) the nature of the security and how trading is
effected (e.g., the time needed to sell the security, how offers are solicited
and the mechanics of transfer). Mitchell Hutchins monitors the liquidity of
restricted securities in each Fund's portfolio and reports periodically on
such decisions to the applicable board.
MONEY MARKET INSTRUMENTS. Each Fund may invest in money market instruments,
including U.S. Treasury bills and other obligations issued or guaranteed as to
interest and principal by the U.S. government or one of its agencies or
instrumentalities; obligations of banks, savings associations, insurance
companies and mortgage bankers; investment grade commercial paper and other
short-term obligations of U.S. or foreign issuers, including variable and
floating rate securities issued by foreign governments and their political
subdivisions, agencies or instrumentalities; other investment companies that
invest exclusively in money market instruments and repurchase agreements. In
addition, each Fund may hold cash and may invest in participation interests in
money market instruments.
REPURCHASE AGREEMENTS. A repurchase agreement is a transaction in which a
Fund purchases securities from a bank or recognized securities dealer and
simultaneously commits to resell the securities to the bank or dealer at an
agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased securities.
The Fund maintains custody of the underlying securities prior to their
repurchase; thus, the obligation of the bank or dealer to pay the repurchase
price on the date agreed to is, in effect, secured by such securities. If the
value of these securities is less than the repurchase price, plus any agreed-
upon additional amount, the other party to the agreement must provide
additional collateral so that at all times the collateral is at least equal to
the repurchase price, plus any agreed-upon additional amount. The difference
between the total amount to be received upon repurchase of the securities and
the price that was paid by a Fund upon acquisition is accrued as interest and
included in its net investment income. Repurchase agreements carry certain
risks not associated with direct investments in securities, including possible
declines in the market value of the underlying securities and delays and costs
to a Fund if the other party to a repurchase agreement becomes insolvent.
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The Funds intend to enter into repurchase agreements only with banks and
dealers in transactions believed by Mitchell Hutchins present minimal credit
risks in accordance with guidelines established by each board. Mitchell
Hutchins reviews and monitors the creditworthiness of those institutions under
each board's general supervision.
REVERSE REPURCHASE AGREEMENTS. Each Fund may enter into reverse repurchase
agreements with banks and securities dealers up to an aggregate value of not
more than 5% of the Fund's net assets. Such agreements involve the sale of
securities held by a Fund subject to that Fund's agreement to repurchase the
securities at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest. Such agreements are considered to be borrowings and
may be entered into only for temporary or emergency purposes. While a reverse
repurchase agreement is outstanding, the Fund's custodian segregates assets to
cover the Fund's obligations under the reverse repurchase agreement. See
"Investment Policies and Restrictions--Segregated Accounts."
LENDING OF PORTFOLIO SECURITIES. Each Fund is authorized to lend up to 33
1/3% of its total assets to broker-dealers or institutional investors that
Mitchell Hutchins deems qualified, but only when the borrower maintains with
that Fund's custodian bank acceptable collateral, marked to market daily, in
an amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends. Acceptable collateral is limited to cash, U.S.
government securities and irrevocable letters of credit that meet certain
guidelines established by Mitchell Hutchins. Each Fund may reinvest cash
collateral in money market instruments or other short-term liquid investments.
In determining whether to lend securities to a particular broker-dealer or
institutional investor, Mitchell Hutchins will consider, and during the period
of the loan will monitor, all relevant facts and circumstances, including the
creditworthiness of the borrower. Each Fund will retain authority to terminate
any loans at any time. Each Fund may pay reasonable fees in connection with a
loan and may pay the borrower or placing broker a negotiated portion of the
interest earned on the cash or money market instruments held as collateral.
Each Fund will receive amounts equivalent to any dividends, interest or other
distributions on the securities loaned. Each Fund will regain record ownership
of loaned securities to exercise beneficial rights, such as voting and
subscription rights and rights to dividends, interest or other distributions,
when regaining such rights is considered to be in the Fund's interest.
Pursuant to procedures adopted by the boards governing each Fund's
securities lending program, PaineWebber has been retained to serve as lending
agent for each Fund. The boards also have authorized the payment of fees
(including fees calculated as a percentage of invested cash collateral) to
PaineWebber for these services. Each board periodically reviews all portfolio
securities loan transactions for which PaineWebber acted as lending agent.
SHORT SALES "AGAINST THE BOX". Each Fund may engage in short sales of
securities it owns or has the right to acquire at no added cost through
conversion or exchange of other securities it owns (short sales "against the
box"). To make delivery to the purchaser in a short sale, the executing broker
borrows the securities being sold short on behalf of a Fund, and that Fund is
obligated to replace the securities borrowed at a date in the future. When a
Fund sells short, it establishes a margin account with the broker effecting
the short sale and deposits collateral with the broker. In addition, that Fund
maintains with its custodian, in a segregated account, the securities that
could be used to cover the short sale. Each Fund incurs transaction costs,
including interest expense, in connection with opening, maintaining and
closing short sales against the box. No Fund currently expects to have
obligations under short sales at any time during the coming year that exceed
5% of its net assets.
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A Fund might make a short sale "against the box" to hedge against market
risks when Mitchell Hutchins believes that the price of a security may
decline, thereby causing a decline in the value of a security owned by a Fund
or a security convertible into or exchangeable for a security owned by a Fund.
In such case, any loss in a Fund's long position after the short sale should
be reduced by a gain in the short position. Conversely, any gain in the long
position should be reduced by a loss in the short position. The extent to
which gains or losses in the long position are reduced will depend upon the
amount of the securities sold short relative to the amount of the securities a
Fund owns, either directly or indirectly, and in the case where a Fund owns
convertible securities, changes in the investment values or conversion
premiums of such securities.
SEGREGATED ACCOUNTS. When a Fund enters into certain transactions to make
future payments to third parties, including reverse repurchase agreements or
the purchase of securities on a when-issued or delayed delivery basis, it will
maintain with an approved custodian in a segregated account cash or liquid
securities, marked to market daily, in an amount at least equal to the Fund's
obligation or commitment under such transactions. As described below under
"Hedging and Related Strategies Using Derivative Contracts," segregated
accounts may also be required in connection with certain transactions
involving options or futures contracts (and, for Utility Income Fund, certain
interest rate protection transactions or forward currency contracts.)
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
each Fund may purchase securities on a "when-issued" or delayed delivery
basis. A security purchased on a when-issued or delayed delivery basis is
recorded as an asset on the commitment date and is subject to changes in
market value, generally based upon changes in the level of interest rates.
Thus, fluctuation in the value of the security from the time of the commitment
date will affect a Fund's net asset value. When the Fund agrees to purchase
securities on a when-issued or delayed delivery basis, its custodian
segregates assets to cover the amount of the commitment. See "Investment
Policies and Restrictions--Segregated Accounts." The Fund purchases when-
issued securities only with the intention of taking delivery, but may sell the
right to acquire the security prior to delivery if Mitchell Hutchins deems it
advantageous to do so, which may result in a gain or loss to the Fund.
SPECIAL CONSIDERATIONS CONCERNING UTILITY INCOME FUND--UTILITY
INDUSTRIES. Utility companies in the United States and in foreign countries
are generally subject to regulation. In the United States, most utility
companies are regulated by state and/or federal authorities. Such regulation
is intended to ensure appropriate standards of service and adequate capacity
to meet public demand. Prices are also regulated, with the intention of
protecting the public while ensuring that the rate of return earned by utility
companies is sufficient to allow them to attract capital in order to grow and
continue to provide appropriate services. There can be no assurance that such
pricing policies or rates of return will continue in the future.
The nature of regulation of utility industries is evolving both in the
United States and in foreign countries. Changes in regulation in the United
States increasingly allow utility companies to provide services and products
outside their traditional geographic areas and lines of business, creating new
areas of competition within the industries. Although certain companies may
develop more profitable opportunities, others may be forced to defend their
core businesses and may be less profitable.
The regulation of foreign utility companies may or may not be comparable to
that in the United States. Foreign regulatory systems vary from country to
country, and may evolve in ways different from regulation in the United
States.
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Utility Income Fund's investment policies seek to enable it to capitalize on
evolving investment opportunities throughout the world. For example, the rapid
growth of certain foreign economies will necessitate expansion of capacity in
the utility industries in those countries. Although many foreign utility
companies currently are government-owned, thereby limiting current investment
opportunities for the Fund, Mitchell Hutchins believes that, in order to
attract significant capital for growth, foreign governments may seek global
investors through the privatization of their utility industries.
Privatization, which refers to the trend toward investor ownership of assets
rather than government ownership, is expected to occur in newer, faster-
growing economies and also in more mature economies. In addition, the economic
unification of European markets may improve economic growth, reduce costs and
increase competition in Europe, which will result in opportunities for
investment by the Fund in European utility industries. Of course, there is no
assurance that such favorable developments will occur or that investment
opportunities in foreign markets for the Fund will increase.
The revenues of domestic and foreign utility companies generally reflect the
economic growth and developments in the geographic areas in which they do
business. Mitchell Hutchins takes into account anticipated economic growth
rates and other economic developments when selecting securities of utility
companies. Further descriptions of specific segments within the global utility
industries are set forth below.
Electric. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric
energy, although many also provide other energy-related services. Domestic
electric utility companies in general recently have been favorably affected by
lower fuel and financing costs and the full or near completion of major
construction programs. In addition, many of these companies recently have
generated cash flows in excess of current operating expenses and construction
expenditures, permitting some degree of diversification into unregulated
businesses. Some electric utilities have also taken advantage of the right to
sell power outside of their traditional geographic areas. Electric utility
companies have historically been subject to the risks associated with
increases in fuel and other operating costs, high interest costs on borrowings
needed for capital construction programs, costs associated with compliance
with environmental, nuclear facility and other safety regulations and changes
in the regulatory climate. For example, in the United States, the construction
and operation of nuclear power facilities is subject to increased scrutiny by,
and evolving regulations of, the Nuclear Regulatory Commission. Increased
scrutiny might result in higher operating costs and higher capital
expenditures, with the risk that regulators may disallow inclusion of these
costs in rate authorizations.
Telecommunications. The telephone communications industry is a distinct
utility industry segment that is subject to different risks and opportunities.
Companies that provide telephone services and access to the telephone networks
comprise the largest portion of this segment. The telephone industry is large
and highly concentrated. Telephone companies in the United States are still
experiencing the effects of the break-up of American Telephone & Telegraph
Company, which occurred in 1984. Since that date the number of local and long-
distance companies and the competition among such companies has increased. In
addition, since 1984, companies engaged in telephone communication services
have expanded their nonregulated activities into other businesses, including
cellular telephone services, data processing, equipment retailing and software
services. This expansion has provided significant opportunities for certain
telephone companies to increase their earnings and dividends at faster rates
than have been allowed in traditional regulated businesses. Increasing
competition and other structural changes, however, could adversely affect the
profitability of such utilities.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy
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Regulatory Commission, which is reducing its regulation of the industry. Many
companies have diversified into oil and gas exploration and development,
making returns more sensitive to energy prices. In the recent decade, gas
utility companies have been adversely affected by disruption in the oil
industry and have also been affected by increased concentration and
competition.
Water. Water supply utilities are companies that collect, purify, distribute
and sell water. In the United States and around the world, the industry is
highly fragmented, because most of the supplies are owned by local
authorities. Companies in this industry are generally mature and are
experiencing little or no per capita volume growth. Mitchell Hutchins believes
that favorable investment opportunities may result from consolidation within
this industry.
There can be no assurance that the positive developments noted above,
including those relating to business growth and changing regulation, will
occur or that risk factors other than those noted above will not develop in
the future.
INVESTMENT LIMITATIONS OF THE FUNDS
FUNDAMENTAL LIMITATIONS. The following investment limitations cannot be
changed for a Fund without the affirmative vote of the lesser of (1) more than
50% of the outstanding shares of the Fund or (2) 67% or more of the shares of
the Fund present at a shareholders' meeting if more than 50% of the
outstanding shares are represented at the meeting in person or by proxy. If a
percentage restriction is adhered to at the time of an investment or
transaction, later changes in percentage resulting from a change in values of
portfolio securities or the amount of total assets will not be considered a
violation of any of the following limitations.
Each Fund will not:
(1) purchase securities of any one issuer if, as a result, more than 5% of
the Fund's total assets would be invested in securities of that issuer or the
Fund would own or hold more than 10% of the outstanding voting securities of
that issuer, except that up to 25% of the Fund's total assets may be invested
without regard to this limitation, and except that this limitation does not
apply to securities issued or guaranteed by the U.S. government, its agencies
and instrumentalities or to securities issued by other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental restriction: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the securities
having the same sponsor, and mortgage- and asset-backed securities issued by a
finance or other special purpose subsidiary that are not guaranteed by the
parent company will be considered to be issued by a separate issuer from the
parent company.
(2) purchase any security if, as a result of that purchase, 25% or more of
the Fund's total assets would be invested in securities of issuers having
their principal business activities in the same industry, except that this
limitation does not apply to securities issued or guaranteed by the U.S.
government, its agencies or instrumentalities or to municipal securities and
except that (a) Financial Services Growth Fund, under normal circumstances,
will invest 25% or more of its total assets in the related group of industries
consisting of the financial services industries and (b) Utility Income Fund,
under normal circumstances, will invest 25% or more of its total assets in the
utility industries as a group. For this purpose, utility industries consist of
companies primarily engaged in the ownership or operation of facilities used
in the generation, transmission or distribution of electricity,
telecommunications, gas, or water.
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(3) issue senior securities or borrow money, except as permitted under the
Investment Company Act of 1940 ("1940 Act") and then not in excess of 33 1/3%
of the Fund's total assets (including the amount of the senior securities
issued but reduced by any liabilities not constituting senior securities) at
the time of the issuance or borrowing, except that the Fund may borrow up to
an additional 5% of its total assets (not including the amount borrowed) for
temporary or emergency purposes.
(4) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investments in government
obligations, commercial paper, certificates of deposit, bankers' acceptances
or similar instruments will not be considered the making of a loan.
(5) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter under
the federal securities laws in connection with its disposition of portfolio
securities.
(6) purchase or sell real estate, except that investments in securities of
issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except that
the Fund may exercise rights under agreements relating to such securities,
including the right to enforce security interests and to hold real estate
acquired by reason of such enforcement until that real estate can be
liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Fund may purchase, sell or
enter into financial options and futures, forward and spot currency contracts,
swap transactions and other financial contracts or derivative instruments.
NON-FUNDAMENTAL LIMITATIONS. The following investment restrictions may be
changed by each board without shareholder approval.
Each Fund will not:
(1) invest more than 10% of its net assets in illiquid securities, a term
which means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund has
valued the securities and includes, among other things, repurchase agreements
maturing in more than seven days.
(2) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Fund may make
margin deposits in connection with its use of financial options and futures,
forward and spot currency contracts, swap transactions and other financial
contracts or derivative instruments.
(3) engage in short sales of securities or maintain a short position, except
that the Fund may (a) sell short "against the box" and (b) maintain short
positions in connection with its use of financial options and futures, forward
and spot currency contracts, swap transactions and other financial contracts
or derivative instruments.
(4) purchase securities of other investment companies, except to the extent
permitted by the 1940 Act and except that this limitation does not apply to
securities received or acquired as dividends, through offers of exchange, or
as a result of reorganization, consolidation, or merger (and except that, a
Fund will not purchase securities of registered open-end investment companies
or registered unit investment trusts in reliance on Sections 12(d)(1)(F) or
12(d)(1)(G) of the 1940 Act).
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
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STRATEGIES USING DERIVATIVE CONTRACTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. Mitchell Hutchins may use a
variety of financial instruments ("Derivative Instruments"), including certain
options, futures contracts (sometimes referred to as "futures") and options on
futures contracts, to attempt to hedge a Fund's portfolio. In particular, each
Fund may use the Derivative Instruments described below, except that only
Utility Income Fund may use forward currency contracts. Utility Income Fund
may use these strategies to attempt to enhance income and also may enter into
certain interest rate protection transactions. A Fund may enter into
transactions using one or more types of Derivative Instruments under which the
full value of its portfolio is at risk. Under normal circumstances, however, a
Fund's use of these instruments will place at risk a much smaller portion of
its assets. The particular Derivative Instruments that may be used by the
Funds are described below.
OPTIONS ON EQUITY AND DEBT SECURITIES AND FOREIGN CURRENCIES--A call option
is a short-term contract pursuant to which the purchaser of the option, in
return for a premium, has the right to buy the security or currency underlying
the option at a specified price at any time during the term of the option. The
writer of the call option, who receives the premium, has the obligation, upon
exercise of the option during the option term, to deliver the underlying
security or currency against payment of the exercise price. A put option is a
similar contract that gives its purchaser, in return for a premium, the right
to sell the underlying security or currency at a specified price during the
option term. The writer of the put option, who receives the premium, has the
obligation, upon exercise of the option during the option term, to buy the
underlying security or currency at the exercise price.
OPTIONS ON STOCK INDEXES--A stock index assigns relative values to the
stocks included in the index and fluctuates with changes in the market values
of those stocks. A stock index option operates in the same way as a more
traditional stock option, except that exercise of a stock index option is
effected with cash payment and does not involve delivery of securities. Thus,
upon exercise of a stock index option, the purchaser will realize, and the
writer will pay, an amount based on the difference between the exercise price
and the closing price of the stock index.
STOCK INDEX FUTURES CONTRACTS--A stock index futures contract is a bilateral
agreement pursuant to which one party agrees to accept, and the other party
agrees to make, delivery of an amount of cash equal to a specified dollar
amount times the difference between the stock index value at the close of
trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the stocks comprising the index is
made. Generally, contracts are closed out prior to the expiration date of the
contract.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS--Interest rate and
foreign currency futures contracts are bilateral agreements pursuant to which
one party agrees to make, and the other party agrees to accept, delivery of a
specified type of debt security or currency at a specified future time and at
a specified price. Although such futures contracts by their terms call for
actual delivery or acceptance of debt securities or currency, in most cases
the contracts are closed out before the settlement date without the making or
taking of delivery.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities or currency, except that an option on a futures contract
gives the purchaser the right, in return for the premium, to assume a position
in a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a security
or currency, at a specified price at any time during the option term. Upon
exercise of the option, the delivery of the futures position to the holder of
the option
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will be accompanied by delivery of the accumulated balance that represents the
amount by which the market price of the futures contract exceeds, in the case
of a call, or is less than, in the case of a put, the exercise price of the
option on the future. The writer of an option, upon exercise, will assume a
short position in the case of a call and a long position in the case of a put.
FORWARD CURRENCY CONTRACTS--A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by
the parties, at a price set at the time the contract is entered into.
GENERAL DESCRIPTION OF HEDGING STRATEGIES. Hedging strategies can be broadly
categorized as "short hedges" and "long hedges." A short hedge is a purchase
or sale of a Derivative Instrument intended partially or fully to offset
potential declines in the value of one or more investments held in a Fund's
portfolio. Thus, in a short hedge a Fund takes a position in a Derivative
Instrument whose price is expected to move in the opposite direction of the
price of the investment being hedged. For example, a Fund might purchase a put
option on a security to hedge against a potential decline in the value of that
security. If the price of the security declined below the exercise price of
the put, a Fund could exercise the put and thus limit its loss below the
exercise price to the premium paid plus transaction costs. In the alternative,
because the value of the put option can be expected to increase as the value
of the underlying security declines, a Fund might be able to close out the put
option and realize a gain to offset the decline in the value of the security.
Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that a Fund intends to acquire. Thus, in a
long hedge, a Fund takes a position in a Derivative Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, a Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the
exercise price of the call, a Fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, a Fund might be able to offset the price increase by
closing out an appreciated call option and realizing a gain.
Each Fund may purchase and write (sell) covered straddles on securities or
indices of securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where
the exercise price of the put is equal to the exercise price of the call. A
Fund might enter into a long straddle when Mitchell Hutchins believes it is
likely that the prices of the securities will be more volatile during the term
of the option than the option pricing implies. A short straddle is a
combination of a call and a put written on the same security where the
exercise price of the put is equal to the exercise price of the call. A Fund
might enter into a short straddle when Mitchell Hutchins believes it unlikely
that the prices of the securities will be as volatile during the term of the
option as the option pricing implies.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that a Fund
owns or intends to acquire. Derivative Instruments on stock indices, in
contrast, generally are used to hedge against price movements in broad equity
market sectors in which a Fund has invested or expects to invest. Derivative
Instruments on debt securities may be used to hedge either individual
securities or broad fixed income market sectors.
The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, a Fund's
ability to use Derivative Instruments may be limited by tax considerations.
See "Taxes."
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In addition to the products, strategies and risks described below and in the
Funds' Prospectus, Mitchell Hutchins expects to discover additional
opportunities in connection with options, futures contracts and other hedging
techniques. These new opportunities may become available as Mitchell Hutchins
develops new techniques, as regulatory authorities broaden the range of
permitted transactions and as new options, futures contracts, foreign currency
contracts or other techniques are developed. Mitchell Hutchins may utilize
these opportunities to the extent that they are consistent with each Fund's
investment objective and permitted by each Fund's investment limitations and
applicable regulatory authorities. The Funds' Prospectus or this Statement of
Additional Information will be supplemented to the extent that new products or
techniques involve materially different risks than those described below or in
the Prospectus.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVE INSTRUMENTS. The use of
Derivative Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow.
(1) Successful use of most Derivative Instruments depends upon the ability
of Mitchell Hutchins to predict movements of the overall securities, interest
rate or currency exchange markets, which requires different skills than
predicting changes in the prices of individual securities. While Mitchell
Hutchins is experienced in the use of Derivative Instruments, there can be no
assurance that any particular hedging strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative Instrument
used in a short hedge increased by less than the decline in value of the
hedged investment, the hedge would not be fully successful. Such a lack of
correlation might occur due to factors affecting the markets in which
Derivative Instruments are traded rather than the value of the investments
being hedged. The effectiveness of hedges using Derivative Instruments on
indices will depend on the degree of correlation between price movements in
the index and price movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if a Fund entered into a
short hedge because Mitchell Hutchins projected a decline in the price of a
security in that Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Derivative Instrument. Moreover, if the price of
the Derivative Instrument declined by more than the increase in the price of
the security, that Fund could suffer a loss. In either such case, the Fund
would have been in a better position had it not hedged at all.
(4) As described below, a Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Derivative Instruments involving obligations to third parties
(i.e., Derivative Instruments other than purchased options). If the Fund was
unable to close out its positions in such Derivative Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the positions expired or matured. These requirements might impair a
Fund's ability to sell a portfolio security or make an investment at a time
when it would otherwise be favorable to do so, or require that the Fund sell a
portfolio security at a disadvantageous time. A Fund's ability to close out a
position in a Derivative Instrument prior to expiration or maturity depends on
the existence of a liquid secondary market or, in the absence of such a
market, the ability and willingness of a contra party to enter into a
transaction closing out the position. Therefore, there is no assurance that
any hedging position in a Derivative Instrument can be closed out at a time
and price that is favorable to a Fund.
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COVER FOR STRATEGIES USING DERIVATIVE CONTRACTS. Transactions using
Derivative Instruments, other than purchased options, expose the Funds to an
obligation to another party. A Fund will not enter into any such transactions
unless it owns either (1) an offsetting ("covered") position in securities,
other options or futures contracts or (2) cash and liquid securities, with a
value sufficient at all times to cover its potential obligations to the extent
not covered as provided in (1) above. Each Fund will comply with SEC
guidelines regarding cover for hedging transactions and will, if the
guidelines so require, set aside cash or liquid securities in a segregated
account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they
are replaced with similar assets. As a result, the commitment of a large
portion of a Fund's assets to cover or segregated accounts could impede
portfolio management or the Fund's ability to meet redemption requests or
other current obligations.
OPTIONS. The Funds may purchase put and call options, and write (sell)
covered put or call options, on equity and debt securities, stock indices and
foreign currencies. The purchase of call options may serve as a long hedge,
and the purchase of put options may serve as a short hedge. Writing covered
call options serves as a limited short hedge, because declines in the value of
the hedged investment would be offset to the extent of the premium received
for writing the option. However, if the security appreciates to a price higher
than the exercise price of the call option, it can be expected that the option
will be exercised and the affected Fund will be obligated to sell the security
at less than its market value. Writing covered put options may serve as a
limited long hedge because increases in the value of the hedged investment
would be offset to the extent of the premium received for writing the option.
However, if the security depreciates to a price lower than the exercise price
of the put option, it can be expected that the put option will be exercised
and the Fund will be obligated to purchase the security at more than its
market value. If the covered call option is an OTC option, the securities or
other assets used as cover would be considered illiquid to the extent
described under "Investment Policies and Restrictions-Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration
dates of up to nine months. Options that expire unexercised have no value.
A Fund may effectively terminate its right or obligation under an option by
entering into a closing transaction. For example, a Fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, a Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a
closing sale transaction. Closing transactions permit a Fund to realize
profits or limit losses on an option position prior to its exercise or
expiration.
The Funds may purchase and write both exchange-traded and OTC options.
Exchange markets for options on debt securities and foreign currencies exist
but are relatively new, and these instruments are primarily traded on the OTC
market. Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction.
In contrast, OTC options are contracts between a Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization
guarantee. Thus, when a Fund purchases or writes an OTC option, it relies on
the contra party to make or take delivery of the underlying
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investment upon exercise of the option. Failure by the contra party to do so
would result in the loss of any premium paid by the Fund as well as the loss
of any expected benefit of the transaction.
Generally, the OTC debt options or foreign currency options used by the
Funds are European-style options. This means that the option is only
exercisable immediately prior to its expiration. This is in contrast to
American-style options, which are exercisable at any time prior to the
expiration date of the option.
The Funds' ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Funds intend to
purchase or write only those exchange-traded options for which there appears
to be a liquid secondary market. However, there can be no assurance that such
a market will exist at any particular time. Closing transactions can be made
for OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the
Funds will enter into OTC options only with contra parties that are expected
to be capable of entering into closing transactions with the Funds, there is
no assurance that a Fund will in fact be able to close out an OTC option
position at a favorable price prior to expiration. In the event of insolvency
of the contra party, a Fund might be unable to close out an OTC option
position at any time prior to its expiration.
If a Fund were unable to effect a closing transaction for an option it had
purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered put or
call option written by the Fund could cause material losses because the Fund
would be unable to sell the investment used as cover for the written option
until the option expires or is exercised.
A Fund may purchase and write put and call options on stock indices in much
the same manner as the more traditional options discussed above, except the
index options may serve as a hedge against overall fluctuations in the equity
securities market (or market sectors) rather than anticipated increases or
decreases in the value of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. A Fund's use of options is governed by
the following guidelines, which can be changed by its board without
shareholder vote:
(1) Each Fund may purchase a put or call option, including any straddles or
spreads, only if the value of its premium, when aggregated with the premiums
on all other options held by that Fund, does not exceed 5% of its total
assets.
(2) The aggregate value of securities underlying put options written by a
Fund determined as of the date the put options are written will not exceed 50%
of a Fund's net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock and bond indices and options on
futures contracts) purchased by each Fund that are held at any time will not
exceed 20% of that Fund's net assets.
FUTURES. The Funds may purchase and sell stock index futures contracts,
interest rate futures contracts and foreign currency futures contracts. A Fund
may also purchase put and call options, and write covered put and call
options, on futures in which it is allowed to invest. The purchase of futures
or call options thereon can serve as a long hedge, and the sale of futures or
the purchase of put options thereon can serve as a short hedge. Writing
covered call options on futures contracts can serve as a limited short hedge,
and writing covered put options on futures contracts can serve as a limited
long hedge, using a strategy similar to that used for writing covered options
on securities or indices.
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No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, "initial margin" consisting of cash, obligations of
the U.S. government or obligations fully guaranteed as to principal and
interest by the United States, in an amount generally equal to 10% or less of
the contract value. Margin must also be deposited when writing a call option
on a futures contract, in accordance with applicable exchange rules. Unlike
margin in securities transactions, initial margin on futures contracts does
not represent a borrowing, but rather is in the nature of a performance bond
or good-faith deposit that is returned to a Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, a Fund may be required by
an exchange to increase the level of its initial margin payment, and initial
margin requirements might be increased generally in the future by regulatory
action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of each Fund's obligations to or from a futures
broker. When a Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when a Fund purchases
or sells a futures contract or writes a call option thereon, it is subject to
daily variation margin calls that could be substantial in the event of adverse
price movements. If a Fund has insufficient cash to meet daily variation
margin requirements, it might need to sell securities at a time when such
sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to
the instrument held or written. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. The Funds intend to enter into futures transactions only on exchanges
or boards of trade where there appears to be a liquid secondary market.
However, there can be no assurance that such a market will exist for a
particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If a Fund were unable to liquidate a futures or related options position due
to the absence of a liquid secondary market or the imposition of price limits,
it could incur substantial losses. A Fund would continue to be subject to
market risk with respect to the position. In addition, except in the case of
purchased options, a Fund would continue to be required to make daily
variation margin payments and might be required to maintain the position being
hedged by the future or option or to maintain cash or securities in a
segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less
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onerous than margin requirements in the securities markets, there might be
increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. The use of futures
and related options is governed by the following guidelines, which can be
changed by each board without shareholder vote:
(1) If a Fund enters into futures contracts and options on futures positions
that are not for bona fide hedging purposes (as defined by the CFTC), the
aggregate initial margin and premiums on those positions (excluding the amount
by which options are "in-the-money") may not exceed 5% of its net assets.
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock or bond indices and options on
futures contracts) purchased by a Fund that are held at any time will not
exceed 20% of its net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by a Fund will not exceed 5% of its total assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS. Each Fund may
use options and futures on foreign currencies, as described above, and Utility
Income Fund may use forward currency contracts, as described below, to hedge
against movements in the values of the foreign currencies in which their
securities are denominated. Such currency hedges can protect against price
movements in a security a Fund owns or intends to acquire that are
attributable to changes in the value of the currency in which it is
denominated. Such hedges do not, however, protect against price movements in
the securities that are attributable to other causes.
The Funds might seek to hedge against changes in the value of a particular
currency when no Derivative Instruments on that currency are available or such
Derivative Instruments are more expensive than certain other Derivative
Instruments. In such cases, the Funds may hedge against price movements in
that currency by entering into transactions using Derivative Instruments on
another currency or a basket of currencies, the value of which Mitchell
Hutchins believes will have a positive correlation to the value of the
currency being hedged. The risk that movements in the price of the Derivative
Instrument will not correlate perfectly with movements in the price of the
currency being hedged is magnified when this strategy is used.
The value of Derivative Instruments on foreign currencies depends on the
value of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Derivative
Instruments, a Fund could be disadvantaged by having to deal in the odd lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions
in the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain
open, significant price and rate movements might take place in the underlying
markets that cannot be reflected in the markets for the Derivative Instruments
until they reopen.
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Settlement of hedging transactions involving foreign currencies might be
required to take place within the country issuing the underlying currency.
Thus, the Funds might be required to accept or make delivery of the underlying
foreign currency in accordance with any U.S. or foreign regulations regarding
the maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
FORWARD CURRENCY CONTRACTS. Utility Income Fund may enter into forward
currency contracts to purchase or sell foreign currencies for a fixed amount
of U.S. dollars or another foreign currency. Such transactions may serve as
long hedges--for example, the Fund may purchase a forward currency contract to
lock in the U.S. dollar price of a security denominated in a foreign currency
that the Fund intends to acquire. Forward currency contract transactions may
also serve as short hedges--for example, the Fund may sell a forward currency
contract to lock in the U.S. dollar equivalent of the proceeds from the
anticipated sale of a security denominated in a foreign currency.
As noted above, Utility Income Fund also may seek to hedge against changes
in the value of a particular currency by using forward contracts on another
foreign currency or a basket of currencies, the value of which Mitchell
Hutchins believes will have a positive correlation to the values of the
currency being hedged. In addition, the Fund may use forward currency
contracts to shift its exposure to foreign currency fluctuations from one
country to another. For example, if the Fund owned securities denominated in a
foreign currency and Mitchell Hutchins believed that currency would decline
relative to another currency, it might enter into a forward contract to sell
an appropriate amount of the first foreign currency, with payment to be made
in the second foreign currency. Transactions that use two foreign currencies
are sometimes referred to as "cross hedging." Use of a different foreign
currency magnifies the risk that movements in the price of the Hedging
Instrument will not correlate or will correlate unfavorably with the foreign
currency being hedged.
The cost to Utility Income Fund of engaging in forward currency contracts
varies with factors such as the currency involved, the length of the contract
period and the market conditions then prevailing. Because forward currency
contracts are usually entered into on a principal basis, no fees or
commissions are involved. When the Fund enters into a forward currency
contract, it relies on the contra party to make or take delivery of the
underlying currency at the maturity of the contract. Failure by the contra
party to do so would result in the loss of any expected benefit of the
transaction.
As is the case with futures contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that Utility Income Fund will in fact be able to close out a forward currency
contract at a favorable price prior to maturity. In addition, in the event of
insolvency of the contra party, the Fund might be unable to close out a
forward currency contract at any time prior to maturity. In either event, the
Fund would continue to be subject to market risk with respect to the position
and would continue to be required to maintain a position in the securities or
currencies that are the subject of the hedge or to maintain cash or securities
in a segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of
such securities, measured in the foreign currency, will change after the
foreign currency contract has been established. Thus, Utility Income Fund
might need to purchase or sell foreign currencies in the spot (cash) market to
the extent such foreign currencies are not
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covered by forward contracts. The projection of short-term currency market
movements is extremely difficult, and the successful execution of a short-term
hedging strategy is highly uncertain.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS. Utility Income Fund
may enter into forward currency contracts or maintain a net exposure to such
contracts only if (1) the consummation of the contracts would not obligate the
Fund to deliver an amount of foreign currency in excess of the value of the
position being hedged by such contracts or (2) the Fund segregates with its
custodian cash or liquid securities in an amount not less than the value of
its total assets committed to the consummation of the contract and not covered
as provided in (1) above, as marked to market daily.
INTEREST RATE PROTECTION TRANSACTIONS. Utility Income Fund may enter into
interest rate protection transactions, including interest rate swaps and
interest rate caps, floors and collars. Interest rate swap transactions
involve an agreement between two parties to exchange payments that are based,
for example, on variable and fixed rates of interest and that are calculated
on the basis of a specified amount of principal (the "notional principal
amount") for a specified period of time. Interest rate cap or floor
transactions involve an agreement between two parties in which the first party
agrees to make payments to the counterparty when a designated market interest
rate goes above (in the case of a cap) or below (in the case of a floor) a
designated level on predetermined dates or during a specified time period.
Interest rate collar transactions involve an agreement between two parties in
which payments are made when a designated market interest rate either goes
above a designated ceiling level or goes below a designated floor level on
predetermined dates or during a specified time period. The Fund intends to use
these transactions as a hedge and not as a speculative investment. Interest
rate protection transactions are subject to risks comparable to those
described above with respect to other hedging strategies.
Utility Income Fund may enter into interest rate swaps, caps, floors and
collars on either an asset-based or liability-based basis, depending on
whether it is hedging its assets or its liabilities, and will usually enter
into interest rate swaps on a net basis, i.e., the two payment streams are
netted out, with the Fund receiving or paying, as the case may be, only the
net amount of the two payments. Inasmuch as these interest rate protection
transactions are entered into for good faith hedging purposes, and inasmuch as
segregated accounts will be established with respect to such transactions,
Mitchell Hutchins believes such obligations do not constitute senior
securities and, accordingly, will not treat them as being subject to the
Fund's borrowing restrictions. The net amount of the excess, if any, of the
Fund's obligations over its entitlements with respect to each interest rate
swap will be accrued on a daily basis, and appropriate Fund assets having an
aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account as described above in "Investment Policies
and Restrictions--Segregated Accounts." The Fund also will establish and
maintain such segregated accounts with respect to its total obligations under
any interest rate swaps that are not entered into on a net basis and with
respect to any interest rate caps, floors and collars it writes.
Utility Income Fund will enter into interest rate protection transactions
only with banks and recognized securities dealers believed by Mitchell
Hutchins to present minimal credit risk in accordance with guidelines
established by its board. If there is a default by the other party to such a
transaction, the Fund will have to rely on its contractual remedies (which may
be limited by bankruptcy, insolvency or similar laws) pursuant to the
agreements related to the transaction.
The swap market has grown substantially in recent years with a large number
of banks and investment banking firms acting both as principals and as agents
utilizing standardized swap documentation. Caps, collars and floors are more
recent innovations for which documentation is less standardized, and
accordingly, they are less liquid than swaps.
18
<PAGE>
TRUSTEES, DIRECTORS AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees or directors and executive officers of the Trust and the
Corporation, their ages, business addresses and principal occupations during
the past five years are:
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
---------------------- ----------------- --------------------
<C> <C> <S>
Margo N. Alexander**; 51 Trustee/Director and Mrs. Alexander is president, chief
President executive officer and a director of
Mitchell Hutchins (since January
1995) and an executive vice
president and a director of
PaineWebber (since March 1984).
Mrs. Alexander is president and a
director or trustee of 31
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Richard Q. Armstrong; 63 Trustee/Director Mr. Armstrong is chairman and prin-
78 West Brother Drive cipal of RQA Enterprises (manage-
Greenwich, CT 06830 ment consulting firm) (since April
1991 and principal occupation since
March 1995). Mr. Armstrong was
chairman of the board, chief exec-
utive officer and co-owner of Adi-
rondack Beverages (producer and
distributor of soft drinks and
sparkling/still waters) (October
1993-March 1995). Mr. Armstrong was
a partner of the New England Con-
sulting Group (management consult-
ing firm) (December 1992-September
1993). He was managing director of
LVMH U.S. Corporation (U.S. subs-
idiary of the French luxury goods
conglomerate, Louis Vuitton Moet
Hennessey Corporation) (1987-1991)
and chairman of its wine and spir-
its subsidiary, Schieffelin & Som-
erset Company (1987-1991). Mr.
Armstrong is a director or trustee
of 30 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
---------------------- ----------------- --------------------
<C> <C> <S>
E. Garrett Bewkes, Jr.**; 71 Trustee/Director and Mr. Bewkes is a director of Paine
Chairman of the Webber Group Inc. ("PW Group")
Board of (holding company of PaineWebber and
Trustees/Directors Mitchell Hutchins). Prior to De-
cember 1995, he was a consultant to
PW Group. Prior to 1988, he was
chairman of the board, president
and chief executive officer of
American Bakeries Company. Mr.
Bewkes is a director of Interstate
Bakeries Corporation and NaPro
BioTherapeutics, Inc. Mr. Bewkes is
a director or trustee of 31 in-
vestment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Richard R. Burt; 51 Trustee/Director Mr. Burt is chairman of IEP Advi-
1275 Pennsylvania Ave., N.W. sors, Inc. (international invest-
Washington, D.C. 20004 ments and consulting firm) (since
March 1994) and a partner of
McKinsey & Company (management
consulting firm) (since 1991). He
is also a director of Archer-Dan-
iels-Midland Co. (agricultural
commodities), Hollinger Interna-
tional Co. (publishing), Homestake
Mining Corp., Powerhouse Technolo-
gies Inc. and Wierton Steel Corp.
He was the chief negotiator in the
Strategic Arms Reduction Talks with
the former Soviet Union (1989-1991)
and the U.S. Ambassador to the
Federal Republic of Germany (1985-
1989). Mr. Burt is a director or
trustee of 30 investment companies
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
---------------------- ----------------- --------------------
<S> <C> <C>
Mary C. Farrell**; 48 Trustee/Director Ms. Farrell is a managing director,
senior investment strategist and
member of the Investment Policy
Committee of PaineWebber. Ms.
Farrell joined PaineWebber in 1982.
She is a member of the Financial
Women's Association and Women's
Economic Roundtable, and is em-
ployed as a regular panelist on
Wall $treet Week with Louis
Rukeyser. She also serves on the
Board of Overseers of New York
University's Stern School of Busi-
ness. Ms. Farrell is a director
or trustee of 30 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Meyer Feldberg; 56 Trustee/Director Mr. Feldberg is Dean and Professor
Columbia University of Management of the Graduate
101 Uris Hall School of Business, Columbia Uni-
New York, New York 10027 versity. Prior to 1989, he was
president of the Illinois Institute
of Technology. Dean Feldberg is
also a director of Primedia Inc.,
Federated Department Stores, Inc.
and Revlon, Inc. Dean Feldberg is a
director or trustee of 30 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
George W. Gowen; 68 Trustee/Director Mr. Gowen is a partner in the law
666 Third Avenue firm of Dunnington, Bartholow &
New York, New York 10017 Miller. Prior to May 1994, he was a
partner in the law firm of Fryer,
Ross & Gowen. Mr. Gowen is a direc-
tor of Columbia Real Estate Invest-
ments, Inc. Mr. Gowen is a director
or trustee of 30 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
- ---------------------- ----------------- --------------------
<S> <C> <C>
Frederic V. Malek; 61 Trustee/Director Mr. Malek is chairman of Thayer Cap-
1455 Pennsylvania Ave- ital Partners (merchant bank). From
nue, N.W. January 1992 to November 1992, he
Suite 350 was campaign manager of Bush-Quayle
Washington, D.C. 20004 '92. From 1990 to 1992, he was vice
chairman and, from 1989 to 1990, he
was president of Northwest Airlines
Inc., NWA Inc. (holding company of
Northwest Airlines Inc.) and Wings
Holdings Inc. (holding company of
NWA Inc.). Prior to 1989, he was
employed by the Marriott Corpora-
tion (hotels, restaurants, airline
catering and contract feeding),
where he most recently was an exec-
utive vice president and president
of Marriott Hotels and Resorts. Mr.
Malek is also a director of Ameri-
can Management Systems, Inc. (man-
agement consulting and computer-re-
lated services), Automatic Data
Processing, Inc., CB Commercial
Group, Inc. (real estate services),
Choice Hotels International (hotel
and hotel franchising), FPL Group,
Inc. (electric services), Manor
Care, Inc. (health care) and North-
west Airlines Inc. Mr. Malek is a
director or trustee of 30 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
NAME AND ADDRESS*; POSITION WITH BUSINESS EXPERIENCE;
AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
------------------ ----------------- --------------------
<S> <C> <C>
Carl W. Schafer; 62 Trustee/Director Mr. Schafer is president of the At-
66 Witherspoon Street lantic Foundation (charitable foun-
#1100 dation supporting mainly oceano-
Princeton, NJ 08542 graphic exploration and research).
He also is a director of Base Ten
Systems, Inc. (software), Roadway
Express, Inc. (trucking), The
Guardian Group of Mutual Funds, The
Harding Loevner Funds, Evans Sys-
tems, Inc. (motor fuels, conve-
nience store and diversified compa-
ny), Electronic Clearing House,
Inc. (financial transactions
processing), Frontier Oil Corpora-
tion and Nutraceutix, Inc. (bio-
technology company). Prior to Janu-
ary 1993, Mr. Schafer was chairman
of the Investment Advisory Commit-
tee of the Howard Hughes Medical
Institute. Mr. Schafer is a direc-
tor or trustee of 30 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Julieanna Berry; 35 Vice President Ms. Berry is a first vice president
(Trust only) and a portfolio manager of Mitchell
Hutchins. Ms. Berry is a vice pres-
ident of two investment companies
for which Mitchell Hutchins serves
as investment adviser.
Karen L. Finkel; 40 Vice President Mrs. Finkel is a senior vice presi-
dent and a portfolio manager of
Mitchell Hutchins. Mrs. Finkel is a
vice president of two investment
companies for which Mitchell
Hutchins serves as investment ad-
viser.
James F. Keegan; 37 Vice President Mr. Keegan is a senior vice presi-
(Trust only) dent and a portfolio manager of
Mitchell Hutchins. Prior to March
1996, he was director of fixed in-
come strategy and research of
Merrion Group, L.P. From 1987 to
1994, he was a vice president of
global investment management of
Bankers Trust Company. Mr. Keegan
is a vice president of three in-
vestment companies for which Mitch-
ell Hutchins serves as investment
adviser.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
---------------------- ----------------- --------------------
<S> <C> <C>
John J. Lee; 29 Vice President and Mr. Lee is a vice president and a
Assistant Treasurer manager of the mutual fund finance
department of Mitchell Hutchins.
Prior to September 1997, he was an
audit manager in the financial
services practice of Ernst & Young
LLP. Mr. Lee is a vice president
and assistant treasurer of 30 in-
vestment companies for which Mitch-
ell Hutchins or PaineWebber serves
as investment adviser.
Thomas J. Libassi; 39 Vice President Mr. Libassi is a senior vice presi-
(Trust only) dent and a portfolio manager of
Mitchell Hutchins. Prior to May
1994, he was a vice president of
Keystone Custodian Funds Inc. with
portfolio management responsibili-
ty. Mr. Libassi is a vice president
of six investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Dennis McCauley; 51 Vice President Mr. McCauley is a managing director
(Trust only) and chief investment officer--fixed
income of Mitchell Hutchins. Prior
to December 1994, he was director
of fixed income investments of IBM
Corporation. Mr. McCauley is a vice
president of 21 investment compa-
nies for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Ann E. Moran; 40 Vice President and Ms. Moran is a vice president and a
Assistant Treasurer manager of the mutual fund finance
department of Mitchell Hutchins.
Ms. Moran is a vice president and
assistant treasurer of 31 invest-
ment companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Dianne E. O'Donnell; 46 Vice President and Ms. O'Donnell is a senior vice pres-
Secretary ident and deputy general counsel of
Mitchell Hutchins. Ms. O'Donnell is
a vice president and secretary of
30 investment companies and vice
president and assistant secretary
for one investment company for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
- ---------------------- ----------------- --------------------
<S> <C> <C>
Emil Polito; 37 Vice President Mr. Polito is a senior vice presi-
dent and director of operations and
control for Mitchell Hutchins. From
March 1991 to September 1993 he was
director of the mutual funds sales
support and service center for
Mitchell Hutchins and Paine-Webber.
Mr. Polito is vice president of 31
investment companies for which
Mitchell Hutchins or PaineWebber
serves as investment adviser.
Victoria E. Schonfeld; Vice President Ms. Schonfeld is a managing director
47 and general counsel of Mitchell
Hutchins. Prior to May 1994, she
was a partner in the law firm of
Arnold & Porter. Ms. Schonfeld is a
vice president of 30 investment
companies and vice president and
secretary of one investment company
for which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
Paul H. Schubert; 35 Vice President and Mr. Schubert is a senior vice presi-
Treasurer dent and the director of the mutual
fund finance department of Mitchell
Hutchins. From August 1992 to Au-
gust 1994, he was a vice president
of BlackRock Financial Management
Inc. Mr. Schubert is a vice presi-
dent and treasurer of 31 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Nirmal Singh; 42 Vice President Mr. Singh is a senior vice president
(Trust only) and a portfolio manager of Mitchell
Hutchins. Prior to September 1993,
he was a member of the portfolio
management team at Merrill Lynch
Asset Management, Inc. Mr. Singh is
a vice president of four investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE TRUST/CORPORATION OTHER DIRECTORSHIPS
---------------------- ----------------- --------------------
<S> <C> <C>
Barney A. Taglialatela; Vice President and Mr. Taglialatela is a vice president
37 Assistant Treasurer and a manager of the mutual fund
finance department of Mitchell
Hutchins. Prior to February 1995,
he was a manager of the mutual fund
finance division of Kidder Peabody
Asset Management, Inc. Mr.
Taglialetela is a vice president
and assistant treasurer of 31 in-
vestment companies for which Mitch-
ell Hutchins or PaineWebber serves
as investment adviser.
Mark A. Tincher; 42 Vice President Mr. Tincher is a managing director
and chief investment officer--U.S.
equity investments of Mitchell
Hutchins. Prior to March 1995, he
was a vice president and directed
the U.S. funds management and eq-
uity research areas of Chase Man-
hattan Private Bank. Mr. Tincher is
a vice president of 13 investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Craig M. Varrelman; 39 Vice President Mr. Varrelman is a senior vice pres-
(Trust only) ident and a portfolio manager of
Mitchell Hutchins. Mr. Varrelman is
a vice president of four investment
companies for which Mitchell
Hutchins or PaineWebber serves as
investment adviser.
Keith A. Weller; 36 Vice President and Mr. Weller is a first vice president
Assistant Secretary and associate general counsel of
Mitchell Hutchins. Prior to May
1995, he was an attorney in private
practice. Mr. Weller is a vice
president and assistant secretary
of 30 investment companies for
which Mitchell Hutchins or
PaineWebber serves as investment
adviser.
</TABLE>
- --------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of each
Fund as defined in the 1940 Act by virtue of their positions with PW Group,
PaineWebber and/or Mitchell Hutchins.
26
<PAGE>
The Trust pays board members who are not "interested persons" of the Trust
$1,000 annually for each series and the Corporation (which has only one
series) pays board members who are not "interested persons" of the Corporation
$1,500 annually. The Trust and the Corporation each pays such board members
$150 per series for each separate board meeting and each meeting of a board
committee (other than committee meetings held on the same day as a board
meeting). The Trust presently has six operating series and thus pays each such
trustee $6,000 annually, plus any additional amounts due for board or
committee meetings. The Corporation pays each such board member $1,500
annually, plus any additional amounts due for board or committee meetings.
Each chairman of the audit and contract review committees of individual funds
within the PaineWebber fund complex receives additional compensation
aggregating $15,000 annually. All board members are reimbursed for any
expenses incurred in attending meetings. Board members and officers of the
Trust and Corporation own in the aggregate less than 1% of the outstanding
shares of each Fund. Because PaineWebber and Mitchell Hutchins perform
substantially all the services necessary for the operation of the Trust, the
Corporation and each Fund, the Trust and Corporation require no employees. No
officer, director or employee of Mitchell Hutchins or PaineWebber presently
receives any compensation from the Trust or Corporation for acting as a board
member or officer.
The table below includes certain information relating to the compensation of
the current board members who held office with the Trust and the Corporation
or with other PaineWebber funds during the years indicated.
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE TOTAL
AGGREGATE COMPENSATION COMPENSATION
COMPENSATION FROM PW FROM THE
FROM PW FINANCIAL TRUST/CORPORATION
MANAGED SERVICES AND
INVESTMENTS GROWTH THE FUND
NAME OF PERSON, POSITION TRUST FUND, INC.* COMPLEX**
- ------------------------ ------------ ------------ -----------------
<S> <C> <C> <C>
Richard Q. Armstrong,
Trustee/Director................. $11,900 $2,550 $ 94,885
Richard R. Burt,
Trustee/Director................. 11,000 2,400 87,085
Meyer Feldberg, Trustee/Director.. 11,900 3,922 117,853
George W. Gowen,
Trustee/Director................. 13,676 2,550 101,567
Frederic V. Malek,
Trustee/Director................. 11,900 2,550 95,844
Carl W. Schafer,
Trustee/Director................. 11,900 2,550 94,885
</TABLE>
- --------
Only independent members of the board are compensated by the Trust or the
Corporation and identified above; board members who are "interested persons,"
as defined by the 1940 Act, do not receive compensation.
* Represents fees paid to each board member during the year ended March 31,
1998.
** Represents total compensation paid to each board member during the calendar
year ended December 31, 1997; no fund within the fund complex has a pension
or retirement plan.
PRINCIPAL HOLDERS OF SECURITIES
As of July 1, 1998, the records of the Trust and Corporation indicate that
no shareholder owned 5% or more of a Fund's shares. The Trust and Corporation
are not aware of any shareholder who is the beneficial owner of 5% or more of
a Fund's shares.
27
<PAGE>
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator to each Fund pursuant to separate contracts (each an
"Advisory Contract") with the Trust and the Corporation. Under the Advisory
Contracts, each Fund pays Mitchell Hutchins a fee, computed daily and paid
monthly, at the annual rate specified in the Prospectus.
Under the terms of the Advisory Contracts, each Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. Expenses borne by each Fund include the following: (1) the cost
(including brokerage commissions) of securities purchased or sold by the Fund
and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3)
organizational expenses; (4) filing fees and expenses relating to the
registration and qualification of the Fund's shares under federal and state
securities laws and maintenance of such registrations and qualifications; (5)
fees and salaries payable to board members and officers who are not
"interested persons" (as defined in the 1940 Act) of the Trust/Corporation or
Mitchell Hutchins; (6) all expenses incurred in connection with the board
members' services, including travel expenses; (7) taxes (including any income
or franchise taxes) and governmental fees; (8) costs of any liability,
uncollectible items of deposit and other insurance or fidelity bonds; (9) any
costs, expenses or losses arising out of a liability of or claim for damages
or other relief asserted against the Trust/Corporation or Fund for violation
of any law; (10) legal, accounting and auditing expenses, including legal fees
of special counsel for the independent board members; (11) charges of
custodians, transfer agents and other agents; (12) costs of preparing share
certificates; (13) expenses of setting in type and printing prospectuses,
statements of additional information and supplements thereto, reports and
proxy materials for existing shareholders, and costs of mailing such materials
to shareholders; (14) any extraordinary expenses (including fees and
disbursements of counsel) incurred by the Fund; (15) fees, voluntary
assessments and other expenses incurred in connection with membership in
investment company organizations; (16) costs of mailing and tabulating proxies
and costs of meetings of shareholders, the board and any committees thereof;
(17) the cost of investment company literature and other publications provided
to board members and officers; and (18) costs of mailing, stationery and
communications equipment.
Under each Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by a Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. Each Advisory Contract
terminates automatically upon assignment and is terminable at any time without
penalty by the Fund's board or by vote of the holders of a majority of the
Fund's outstanding voting securities on 60 days' written notice to Mitchell
Hutchins, or by Mitchell Hutchins on 60 days' written notice to the Fund.
FINANCIAL SERVICES GROWTH FUND. Mitchell Hutchins acts as the investment
adviser and administrator of Financial Services Growth Fund pursuant to an
Advisory Contract with the Fund dated April 1, 1990. Under the Advisory
Contract, the Fund pays Mitchell Hutchins a fee, computed daily and paid
monthly, at the annual rate of 0.70% of the Fund's average daily net assets.
For the fiscal years ended March 31, 1998, March 31, 1997, and March 31, 1996,
the Fund paid (or accrued) to Mitchell Hutchins investment advisory and
administration fees totalling 1,912,197, $771,491 and $625,307, respectively.
UTILITY INCOME FUND. Mitchell Hutchins acts as the investment adviser and
administrator of Utility Income Fund pursuant to an Advisory Contract with
Managed Investments Trust dated April 21, 1988, as supplemented by a separate
Fee Agreement dated May 1, 1992. Under the Advisory Contract, the Trust pays
Mitchell Hutchins an annual fee of 0.70% of the Fund's average net assets,
computed daily and paid monthly.
28
<PAGE>
For the fiscal year ended March 31, 1998, March 31, 1997, and during the four
months ended March 31, 1996, the Trust paid (or accrued) to Mitchell Hutchins
investment advisory and administration fees of $235,331, $314,323 (of which
$30,480 was waived) and $139,394 (of which $69,697 was waived), respectively.
Prior to August 1, 1997, under a service agreement ("Service Agreement")
with the Trust and the Corporation that was reviewed by the applicable boards
annually, PaineWebber provided certain services to the Funds not otherwise
provided by the Funds' transfer agent. Pursuant to the Service Agreement, for
the four month period ended July 31, 1997 and the fiscal years ended March 31,
1997, and March 31, 1996, Financial Services Growth Fund paid (or accrued) to
PaineWebber $14,088, $26,881 and $25,258, respectively. Pursuant to the
Service Agreement for the four month period ended July 31, 1997, March 31,
1997, during the four months ended March 31, 1996 and for the fiscal year
ended November 30, 1995 and November 30, 1994, Utility Income Fund paid (or
accrued) to PaineWebber $4,244, $17,118, $7,119 and $24,449, respectively. For
both Funds, subsequent to July 31, 1997, PFPC (not the Funds) pays PaineWebber
for certain transfer agency related services that PFPC has delegated to
PaineWebber.
NET ASSETS. The following table shows the approximate net assets as of June
30, 1998, sorted by category of investment objective, of the investment
companies as to which Mitchell Hutchins serves as adviser or sub-adviser. An
investment company may fall into more than one of the categories below.
<TABLE>
<CAPTION>
NET ASSETS
($ MIL)
INVESTMENT CATEGORY ----------
<S> <C>
Domestic (excluding Money Market).............................. $ 7,856.5
Global......................................................... 3,875.8
Equity/Balanced................................................ 6,513.8
Fixed Income (excluding Money Market).......................... 5,218.7
Taxable Fixed Income......................................... 3,641.0
Tax-Free Fixed Income........................................ 1,577.7
Money Market Funds............................................. 28,628.1
</TABLE>
PERSONNEL TRADING POLICIES. Mitchell Hutchins personnel may invest in
securities for their own accounts pursuant to a code of ethics that describes
the fiduciary duty owed to shareholders of PaineWebber mutual funds and other
Mitchell Hutchins' advisory accounts by all Mitchell Hutchins' directors,
officers and employees, establishes procedures for personal investing and
restricts certain transactions. For example, employee accounts generally must
be maintained at PaineWebber, personal trades in most securities require pre-
clearance and short-term trading and participation in initial public offerings
generally are prohibited. In addition, the code of ethics puts restrictions on
the timing of personal investing in relation to trades by PaineWebber funds
and other Mitchell Hutchins' advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Funds' Class A, Class B, Class C and Class Y shares under separate
distribution contracts with each Fund (collectively, "Distribution
Contracts"). Each Distribution Contract requires Mitchell Hutchins to use its
best efforts, consistent with its other businesses, to sell shares of each
Fund. Shares of each Fund are offered continuously. Under separate exclusive
dealer agreements between Mitchell Hutchins and PaineWebber relating to the
Class A, Class B, Class C and Class Y shares (collectively, "Exclusive Dealer
Agreements"), PaineWebber and its correspondent firms sell the Funds' shares.
29
<PAGE>
Under separate plans of distribution pertaining to the Class A, Class B and
Class C shares adopted by each Trust or Corporation in the manner prescribed
under Rule 12b-1 under the 1940 Act ("Class A Plan," "Class B Plan" and "Class
C Plan," collectively, "Plans"), each Fund pays Mitchell Hutchins a service
fee, accrued daily and payable monthly, at the annual rate of 0.25% of the
average daily net assets of each Class of shares for each respective Fund.
Under the Class B Plan and the Class C Plan, each Fund pays Mitchell Hutchins
a distribution fee, accrued daily and payable monthly, at the annual rate of
0.75% of the average daily net assets of the Class B shares and Class C shares
of each respective Fund. There is no distribution plan with respect to any
Fund's Class Y shares.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the board at least quarterly, and the board members will review,
reports regarding all amounts expended under the Plan and the purposes for
which such expenditures were made, (2) the Plan will continue in effect only
so long as it is approved at least annually, and any material amendment
thereto is approved, by the board, including those board members who are not
"interested persons" of their respective Funds and who have no direct or
indirect financial interest in the operation of the Plan or any agreement
related to the Plan, acting in person at a meeting called for that purpose,
(3) payments by a Fund under the Plan shall not be materially increased
without the affirmative vote of the holders of a majority of the outstanding
shares of the relevant class of the respective Fund and (4) while the Plan
remains in effect, the selection and nomination of board members who are not
"interested persons" of the Funds shall be committed to the discretion of the
board members who are not "interested persons" of their respective Funds.
In reporting amounts expended under the Plans to the board members, Mitchell
Hutchins allocates expenses attributable to the sale of each class of each
Fund's shares to such class based on the ratio of sales of shares of such
class to the sales of all three classes of shares. The fees paid by one class
of a Fund's shares will not be used to subsidize the sale of any other class
of Fund shares.
The Funds paid (or accrued) the following fees to Mitchell Hutchins under
the Class A, Class B and Class C Plans during the fiscal year ended March 31,
1998:
<TABLE>
<CAPTION>
FINANCIAL
SERVICES UTILITY
GROWTH INCOME
FUND FUND
---------- --------
<S> <C> <C>
Class A.................................................. $ 344,946 $ 16,318
Class B.................................................. $1,023,922 $202,158
Class C.................................................. $ 328,008 $ 68,760
</TABLE>
30
<PAGE>
Mitchell Hutchins estimates that it and its parent corporation, PaineWebber,
incurred the following shareholder service-related and distribution-related
expenses with respect to each Fund during the fiscal year ended March 31,
1998:
<TABLE>
<CAPTION>
FINANCIAL
SERVICES UTILITY
GROWTH INCOME
FUND FUND
--------- --------
<S> <C> <C>
CLASS A
Marketing and advertising.................................. $ 62,225 $ 19,480
Printing of prospectuses and statement of additional
information............................................... $ 1,878 $ 102
Branch network costs allocated and interest expense........ $206,906 $ 37,810
Service fees paid to PaineWebber investment executives..... $131,080 $ 6,200
CLASS B
Marketing and advertising.................................. $ 43,362 $ 60,487
Amortization of commissions................................ $300,489 $ 55,939
Printing of prospectuses and statement of additional
information............................................... $ 1,308 $ 281
Branch network costs allocated and interest expense........ $144,172 $123,175
Service fees paid to PaineWebber investment executives..... $ 97,273 $ 19,205
CLASS C
Marketing and advertising.................................. $ 13,811 $ 20,549
Amortization of commissions................................ $ 93,481 $ 19,597
Printing of prospectuses and statement of additional
information............................................... $ 417 $ 101
Branch network costs allocated and interest expense........ $ 45,923 $ 40,114
Service fees paid to PaineWebber investment executives..... $ 31,160 $ 6,532
</TABLE>
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing the Funds' shares. These
internal costs encompass office rent, salaries and other overhead expenses of
various departments and areas of operations of Mitchell Hutchins. "Branch
network costs allocated and interest expense" consist of an allocated portion
of the expenses of various PaineWebber departments involved in the
distribution of the Funds' shares, including the PaineWebber retail branch
system.
In approving the Funds' overall Flexible PricingSM system of distribution,
each board considered several factors, including that implementation of
Flexible Pricing would (1) enable investors to choose the purchasing option
best suited to their individual situation, thereby encouraging current
shareholders to make additional investments in each respective Fund and
attracting new investors and assets to the Fund to the benefit of the Fund and
its shareholders, (2) facilitate distribution of the Funds' shares and (3)
maintain the competitive position of the Funds in relation to other funds that
have implemented or are seeking to implement similar distribution
arrangements.
In approving the Class A Plan, each board considered all the features of the
distribution system, including (1) the conditions under which initial sales
charges would be imposed and the amount of such charges, (2) Mitchell
Hutchins' belief that the initial sales charge combined with a service fee
would be attractive to PaineWebber investment executives and correspondent
firms, resulting in greater growth of the Fund than might otherwise be the
case, (3) the advantages to the shareholders of economies of scale resulting
from growth in the Fund's assets and potential continued growth, (4) the
services provided to the Fund and its shareholders by Mitchell Hutchins, (5)
the services provided by PaineWebber pursuant to its Exclusive Dealer
Agreement with Mitchell Hutchins and (6) Mitchell Hutchins' shareholder
service-related expenses and costs.
31
<PAGE>
In approving the Class B Plan, each board considered all the features of the
distribution system, including (1) the conditions under which contingent
deferred sales charges would be imposed and the amount of such charges, (2)
the advantage to investors in having no initial sales charges deducted from
Fund purchase payments and instead having the entire amount of their purchase
payments immediately invested in Fund shares, (3) Mitchell Hutchins' belief
that the ability of PaineWebber investment executives and correspondent firms
to receive sales commissions when Class B shares are sold and continuing
service fees thereafter while their customers invest their entire purchase
payments immediately in Class B shares would prove attractive to the
investment executives and correspondent firms, resulting in greater growth of
the Fund than might otherwise be the case, (4) the advantages to the
shareholders of economies of scale resulting from growth in the Fund's assets
and potential continued growth, (5) the services provided to the Fund and its
shareholders by Mitchell Hutchins, (6) the services provided by PaineWebber
pursuant to its Exclusive Dealer Agreement with Mitchell Hutchins and (7)
Mitchell Hutchins' shareholder service and distribution-related expenses and
costs. The board members also recognized that Mitchell Hutchins' willingness
to compensate PaineWebber and its investment executives, without the
concomitant receipt by Mitchell Hutchins of initial sales charges, was
conditioned upon its expectation of being compensated under the Class B Plan.
In approving the Class C Plan, each board considered all the features of the
distribution system, including (1) the advantage to investors in having no
initial sales charges deducted from the Fund purchase payments and instead
having the entire amount of their purchase payments immediately invested in
Fund shares, (2) the advantage to investors in being free from contingent
deferred sales charges upon redemption for shares held more than one year and
paying for distribution on an ongoing basis, (3) Mitchell Hutchins' belief
that the ability of PaineWebber investment executives and correspondent firms
to receive sales compensation for their sales of Class C shares on an ongoing
basis, along with continuing service fees, while their customers invest their
entire purchase payments immediately in Class C shares and generally do not
face contingent deferred sales charges, would prove attractive to the
investment executives and correspondent firms, resulting in greater growth to
the Fund than might otherwise be the case, (4) the advantages to the
shareholders of economies of scale resulting from growth in the Fund's assets
and potential continued growth, (5) the services provided to the Fund and its
shareholders by Mitchell Hutchins, (6) the services provided by PaineWebber
pursuant to its Exclusive Dealer Agreement with Mitchell Hutchins and (7)
Mitchell Hutchins' shareholder service- and distribution-related expenses and
costs. The board members also recognized that Mitchell Hutchins' willingness
to compensate PaineWebber and its investment executives without the
concomitant receipt by Mitchell Hutchins of initial sales charges or
contingent deferred sales charges upon redemption, was conditioned upon its
expectation of being compensated under the Class C Plan.
With respect to each Plan, the board members considered all compensation
that Mitchell Hutchins would receive under the Plan and the Distribution
Contract, including service fees and, as applicable, initial sales charges,
distribution fees and contingent deferred sales charges. The board members
also considered the benefits that would accrue to Mitchell Hutchins under each
Plan in that Mitchell Hutchins would receive service, distribution and
advisory fees which are calculated based upon a percentage of the average net
assets of each Fund, which fees would increase if the Plan were successful and
the Fund attained and maintained significant asset levels.
32
<PAGE>
Under the Distribution Contracts for Class A shares, for the fiscal years
set forth below, Mitchell Hutchins earned the following approximate amounts of
sales charges and retained the following approximate amounts, net of
concessions to PaineWebber as exclusive dealer.
<TABLE>
<CAPTION>
FOR FISCAL YEARS ENDED MARCH 31,
----------------------------------
1998 1997 1996
------------ ---------- ----------
<S> <C> <C> <C>
FINANCIAL SERVICES GROWTH FUND
Earned....................................... $2,006,218 $318,111 $ 61,563
Retained..................................... $ 143,106 $ 21,364 $ 7,084
</TABLE>
<TABLE>
<CAPTION>
FOR FISCAL FOR FISCAL FOR FOUR FOR FISCAL
YEAR ENDED YEAR ENDED MONTHS ENDED YEAR ENDED
MARCH 31, MARCH 31, MARCH 31, NOVEMBER 30,
1998 1997 1996 1995
---------- ---------- ------------ ------------
<S> <C> <C> <C> <C>
UTILITY INCOME FUND
Earned.......................... $21,396 $5,958 $3,054 $12,015
Retained........................ $ 1,402 $ 340 $ 174 $ 608
</TABLE>
Mitchell Hutchins earned and retained the following contingent deferred
sales charges paid upon certain redemptions of Class A, Class B and Class C
shares for the fiscal year ended March 31, 1998.
<TABLE>
<CAPTION>
FINANCIAL
SERVICES
GROWTH FUND UTILITY INCOME FUND
----------- -------------------
<S> <C> <C>
Class A......................................... $ 0 $ 0
Class B......................................... $184,219 $68,280
Class C......................................... $ 24,887 $ 176
</TABLE>
PORTFOLIO TRANSACTIONS
Subject to policies established by each board, Mitchell Hutchins is
responsible for the execution of each Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins seeks to obtain the best net results for a Fund, taking into
account such factors as the price (including the applicable brokerage
commission or dealer spread), size of order, difficulty of execution and
operational facilities of the firm involved. While Mitchell Hutchins generally
seeks reasonably competitive commission rates, payment of the lowest
commission is not necessarily consistent with obtaining the best net results.
Prices paid to dealers in principal transactions, through which most debt
securities and some equity securities are traded, generally include a
"spread," which is the difference between the prices at which the dealer is
willing to purchase and sell a specific security at the time. The Funds may
invest in securities traded in the OTC market and will engage primarily in
transactions directly with the dealers who make markets in such securities,
unless a better price or execution could be obtained by using a broker. During
the fiscal periods indicated, the Funds paid the brokerage commissions set
forth below:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MARCH
31
------------------------
1998 1997 1996
-------- ------- -------
<S> <C> <C> <C>
Financial Services Growth Fund........................ $317,283 $80,638 $56,121
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEAR FISCAL YEAR
ENDED FISCAL YEAR FOUR MONTHS ENDED
MARCH 31, ENDED MARCH ENDED MARCH NOVEMBER 30,
1998 31, 1997 31, 1996 1995
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Utility Income Fund............ $15,213 $72,018 $26,304 $74,250
</TABLE>
33
<PAGE>
The Funds have no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Funds contemplate that,
consistent with the policy of obtaining the best net results, brokerage
transactions may be conducted through Mitchell Hutchins or its affiliates,
including PaineWebber. Each board has adopted procedures in conformity with
Rule 17e-1 under the 1940 Act to ensure that all brokerage commissions paid to
PaineWebber are reasonable and fair. Specific provisions in the Advisory
Contracts authorize Mitchell Hutchins and any of its affiliates that is a
member of a national securities exchange to effect portfolio transactions for
the Funds on such exchange and to retain compensation in connection with such
transactions. Any such transactions will be effected and related compensation
paid only in accordance with applicable SEC regulations.
For the last three years, Utility Income Fund paid no brokerage commissions
to PaineWebber. For the fiscal years ended March 31, 1997 and March 31, 1998,
Financial Services Growth Fund paid no brokerage commissions to PaineWebber.
For the fiscal year ended March 31, 1998, Financial Services Growth Fund paid
$17,400 in brokerage commissions to PaineWebber, which represented 5.48% of
the total commissions paid by that Fund and 4.14% of the aggregate dollar
amount of transactions involving commission payments.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
Funds' procedures in selecting FCMs to execute their transactions in futures
contracts, including procedures permitting the use of Mitchell Hutchins and
its affiliates, are similar to those in effect with respect to brokerage
transactions in securities.
Consistent with the interests of the Funds and subject to the review of each
board, Mitchell Hutchins may cause a Fund to purchase and sell portfolio
securities through brokers who provide that Fund with research, analysis,
advice and similar services. In return for such services, the Funds may pay to
those brokers a higher commission than may be charged by other brokers,
provided that Mitchell Hutchins determines in good faith that such commission
is reasonable in terms either of that particular transaction or of the overall
responsibility of Mitchell Hutchins to that Fund and its other clients and
that the total commissions paid by the Fund will be reasonable in relation to
the benefits to the Fund over the long term. During the fiscal year ended
March 31, 1998, the Funds directed the portfolio transactions indicated below
to brokers chosen because they provide research and analysis, for which the
Funds paid the brokerage commissions indicated below:
<TABLE>
<CAPTION>
AMOUNT OF PORTFOLIO BROKERAGE COMMISSIONS
TRANSACTIONS PAID
------------------- ---------------------
<S> <C> <C>
Financial Services Growth Fund....... $31,699,519 $35,347
Utility Income Fund.................. $ 831,985 $ 1,530
</TABLE>
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with these transactions,
Mitchell Hutchins will not purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
attributed to the services provided by the executing dealer. Moreover,
Mitchell Hutchins will not enter into any explicit soft dollar arrangements
relating to principal transactions and will not receive in principal
transactions the types of services that could be purchased for hard dollars.
Mitchell Hutchins may engage in agency transactions in OTC equity and debt
securities in return for research and execution services. These transactions
are entered into only in compliance with procedures ensuring that the
transaction (including commissions) is at least as favorable as it would have
been if effected directly with a market-maker that did not provide research or
execution services. These procedures include Mitchell Hutchins receiving
multiple quotes from dealers before executing the transactions on an agency
basis.
34
<PAGE>
Information and research services furnished by brokers or dealers through
which or with which the Funds effect securities transactions may be used by
Mitchell Hutchins in advising other funds or accounts and, conversely,
research services furnished to Mitchell Hutchins by brokers or dealers in
connection with other funds or accounts that either of them advises may be
used in advising the Funds. Information and research received from brokers or
dealers will be in addition to, and not in lieu of, the services required to
be performed by Mitchell Hutchins under the Advisory Contract.
Investment decisions for a Fund and for other investment accounts managed by
Mitchell Hutchins are made independently of each other in light of differing
considerations for the various accounts. However, the same investment decision
may occasionally be made for a Fund and one or more of such accounts. In such
cases, simultaneous transactions are inevitable. Purchases or sales are then
averaged as to price and allocated between that Fund and such other account(s)
as to amount according to a formula deemed equitable to the Fund and such
account(s). While in some cases this practice could have a detrimental effect
upon the price or value of the security as far as the Funds are concerned, or
upon their ability to complete their entire order, in other cases it is
believed that coordination and the ability to participate in volume
transactions will be beneficial to the Funds.
The Funds will not purchase securities that are offered in underwritings in
which PaineWebber is a member of the underwriting or selling group, except
pursuant to procedures adopted by each board pursuant to Rule 10f-3 under the
1940 Act. Among other things, these procedures require that the spread or
commission paid in connection with such a purchase be reasonable and fair, the
purchase be at not more than the public offering price prior to the end of the
first business day after the date of the public offering and that PaineWebber
or any affiliate thereof not participate in or benefit from the sale to the
Funds.
PORTFOLIO TURNOVER. The Funds' annual portfolio turnover rates may vary
greatly from year to year, but they will not be a limiting factor when
management deems portfolio changes appropriate. The portfolio turnover rate is
calculated by dividing the lesser of each Fund's annual sales or purchases of
portfolio securities (exclusive of purchases or sales of securities whose
maturities at the time of acquisition were one year or less) by the monthly
average value of securities in the portfolio during the year.
The Funds' respective portfolio turnover rates for the fiscal periods shown
were:
<TABLE>
<S> <C>
FINANCIAL SERVICES GROWTH FUND
Fiscal year ended March 31, 1998............................................ 23%
Fiscal year ended March 31, 1997............................................ 40%
UTILITY INCOME FUND
Fiscal year ended March 31, 1998............................................ 10%
Fiscal year ended March 31, 1997............................................ 41%
</TABLE>
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
COMBINED PURCHASE PRIVILEGE-CLASS A SHARES. Investors and eligible groups of
related Fund investors may combine purchases of Class A shares of the Funds
with concurrent purchases of Class A shares of any other PaineWebber mutual
fund and thus take advantage of the reduced sales charges indicated in the
table of sales charges for Class A shares in the Prospectus. The sales charge
payable on the purchase of Class A shares of the Funds and Class A shares of
such other funds will be at the rates applicable to the total amount of the
combined concurrent purchases.
35
<PAGE>
An "eligible group of related Fund investors" can consist of any combination
of the following:
(a) an individual, that individual's spouse, parents and children;
(b) an individual and his or her Individual Retirement Account ("IRA");
(c) an individual (or eligible group of individuals) and any company
controlled by the individual(s) (a person, entity or group that holds 25%
or more of the outstanding voting securities of a corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
(d) an individual (or eligible group of individuals) and one or more
employee benefit plans of a company controlled by individual(s);
(e) an individual (or eligible group of individuals) and a trust created
by the individual(s), the beneficiaries of which are the individual and/or
the individual's spouse, parents or children;
(f) an individual and a Uniform Gifts to Minors Act/Uniform Transfers to
Minors Act account created by the individual or the individual's spouse;
(g) an employer (or group of related employers) and one or more qualified
retirement plans of such employer or employers (an employer controlling,
controlled by or under common control with another employer is deemed
related to that other employer); or
(h) individual accounts related together under one registered investment
adviser having full discretion and control over the accounts. The
registered investment adviser must communicate at least quarterly through a
newsletter or investment update establishing a relationship with all of the
accounts.
RIGHTS OF ACCUMULATION-CLASS A SHARES. Reduced sales charges are available
through a right of accumulation, under which investors and eligible groups of
related Fund investors (as defined above) are permitted to purchase Class A
shares of the Funds among related accounts at the offering price applicable to
the total of (1) the dollar amount then being purchased plus (2) an amount
equal to the then-current net asset value of the purchaser's combined holdings
of Class A Fund shares and Class A shares of any other PaineWebber mutual
fund. The purchaser must provide sufficient information to permit confirmation
of his or her holdings, and the acceptance of the purchase order is subject to
such confirmation. The right of accumulation may be amended or terminated at
any time.
WAIVERS OF SALES CHARGES-CLASS B SHARES. Among other circumstances, the
contingent deferred sales charge on Class B shares is waived where a total or
partial redemption is made within one year following the death of the
shareholder. The contingent deferred sales charge waiver is available where
the decedent is either the individual shareholder or owns the shares with his
or her spouse as a joint tenant with right of survivorship. This waiver
applies only to redemption of shares held at the time of death.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the Funds may be exchanged for shares of the
corresponding Class of most other PaineWebber mutual funds. Shareholders will
receive at least 60 days' notice of any termination or material modification
of the exchange offer, except no notice need be given of an amendment whose
only material effect is to reduce the exchange fee and no notice need be given
if, under extraordinary circumstances, either redemptions are suspended under
the circumstances described below or a Fund temporarily delays or ceases the
sales of its shares because it is unable to invest amounts effectively in
accordance with the Fund's investment objective, policies and restrictions.
36
<PAGE>
If conditions exist that make cash payments undesirable, the Funds reserve
the right to honor any request for redemption by making payment in whole or in
part in securities chosen by the Funds and valued in the same way as they
would be valued for purposes of computing the Funds' net asset value. Any such
redemption in kind will be made with readily marketable securities, to the
extent available. If payment is made in securities, a shareholder may incur
brokerage expenses in converting these securities into cash. Each Fund has
elected, however, to be governed by Rule 18f-1 under the 1940 Act, under which
the Funds are obligated to redeem shares solely in cash up to the lesser of
$250,000 or 1% of the net asset value of the Funds during any 90-day period
for one shareholder. This election is irrevocable unless the SEC permits its
withdrawal.
The Funds may suspend redemption privileges or postpone the date of payment
during any period (1) when the New York Stock Exchange ("NYSE") is closed or
trading on the NYSE is restricted as determined by the SEC, (2) when an
emergency exists, as defined by the SEC, that makes it not reasonably
practicable for a Fund to dispose of securities owned by it or fairly to
determine the value of its assets or (3) as the SEC may otherwise permit. The
redemption price may be more or less than the shareholder's cost, depending on
the market value of a Fund's portfolio at the time.
AUTOMATIC INVESTMENT PLAN. Participation in the Automatic Investment Plan
enables an investor to use the technique of "dollar cost averaging." When the
investor invests the same dollar amount each month under the Plan, the
investor will purchase more shares when a Fund's net asset value per share is
low and fewer shares when the net asset value per share is high. Using this
technique, an investor's average purchase price per share over any given
period will be lower than if the investor purchased a fixed number of shares
on a monthly basis during the period. Of course, investing through the
automatic investment plan does not assure a profit or protect against loss in
declining markets. Additionally, because the automatic investment plan
involves continuous investing regardless of price levels, an investor should
consider his or her financial ability to continue purchases through periods of
low price levels.
SYSTEMATIC WITHDRAWAL PLAN. An investor's participation in the systematic
withdrawal plan will terminate automatically if the "Initial Account Balance"
(a term that means the value of the Fund account at the time the investor
elects to participate in the systematic withdrawal plan) less aggregate
redemptions made other than pursuant to the systematic withdrawal plan is less
than $5,000 for Class A and Class C shareholders or $20,000 for Class B
shareholders. Purchases of additional shares of a Fund concurrent with
withdrawals are ordinarily disadvantageous to shareholders because of tax
liabilities and, for Class A shares, initial sales charges. On or about the
20th of each month for monthly, quarterly, semiannual and annual plans,
PaineWebber will arrange for redemption by the Funds of sufficient Fund shares
to provide the withdrawal payment specified by participants in the Funds'
systematic withdrawal plan. The payment generally is mailed approximately five
Business Days (defined under "Valuation of Shares") after the redemption date.
Withdrawal payments should not be considered dividends, but redemption
proceeds, with the tax consequences described under "Dividends & Taxes" in the
Prospectus. If periodic withdrawals continually exceed reinvested dividends
and other distributions, a shareholder's investment may be correspondingly
reduced. A shareholder may change the amount of the systematic withdrawal or
terminate participation in the systematic withdrawal plan at any time without
charge or penalty by written instructions with signatures guaranteed to
PaineWebber or PFPC Inc. ("Transfer Agent"). Instructions to participate in
the plan, change the withdrawal amount or terminate participation in the plan
will not be effective until five days after written instructions with
signatures guaranteed are received by the Transfer Agent. Shareholders may
request the forms needed to establish a systematic withdrawal plan from their
PaineWebber investment executives, correspondent firms or the Transfer Agent
at 1-800-647-1568.
37
<PAGE>
REINSTATEMENT PRIVILEGE-CLASS A SHARES. As described in the Prospectus,
shareholders who have redeemed their Class A shares may reinstate their
account in the Funds without a sales charge. Shareholders may exercise the
reinstatement privilege by notifying the Transfer Agent of such desire and
forwarding a check for the amount to be purchased within 365 days after the
date of redemption. The reinstatement will be made at the net asset value per
share next computed after the notice of reinstatement and check are received.
The amount of a purchase under this reinstatement privilege cannot exceed the
amount of the redemption proceeds. Gain on a redemption is taxable regardless
of whether the reinstatement privilege is exercised; however, a loss arising
out of a redemption will not be deductible to the extent the reinstatement
privilege is exercised within 30 days after redemption, and an adjustment will
be made to the shareholder's tax basis for shares acquired pursuant to the
reinstatement privilege. Gain or loss on a redemption also will be adjusted
for federal income tax purposes by the amount of any sales charge paid on
Class A shares, under the circumstances and to the extent described in
"Dividends & Taxes" in the Prospectus.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLANSM;
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(R) (RMA(R))
Shares of PaineWebber mutual funds (each a "PW Fund" and, collectively, the
"PW Funds") are available for purchase by customers of PaineWebber and its
correspondent firms who maintain Resource Management Accounts ("RMA
accountholders") through the RMA Resource Accumulation Plan ("Accumulation
Plan"). The Plan allows an RMA accountholder to continually invest in one or
more of the PW Funds at regular intervals, with payment for shares purchased
automatically deducted from the client's RMA account. The client may elect to
invest at monthly or quarterly intervals and may elect either to invest a
fixed dollar amount (minimum $100 per period) or to purchase a fixed number of
shares. A client can elect to have Accumulation Plan purchases executed on the
first or fifteenth day of the month. Settlement occurs three Business Days
(defined under "Valuation of Shares") after the trade date, and the purchase
price of the shares is withdrawn from the investor's RMA account on the
settlement date from the following sources and in the following order:
uninvested cash balances, balances in RMA money market funds, or margin
borrowing power, if applicable to the account.
To participate in the Accumulation Plan, an investor must be an RMA
accountholder, must have made an initial purchase of the shares of each PW
Fund selected for investment under the Accumulation Plan (meeting applicable
minimum investment requirements) and must complete and submit the RMA Resource
Accumulation Plan Client Agreement and Instruction Form available from
PaineWebber. The investor must have received a current prospectus for each PW
Fund selected prior to enrolling in the Accumulation Plan. Information about
mutual fund positions and outstanding instructions under the Plan are noted on
the RMA accountholder's account statement. Instructions under the Accumulation
Plan may be changed at any time, but may take up to two weeks to become
effective.
The terms of the Accumulation Plan, or an RMA accountholder's participation
in the Accumulation Plan, may be modified or terminated at any time. It is
anticipated that, in the future, shares of other PW Funds and/or mutual funds
other than the PW Funds may be offered through the Accumulation Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING.
Periodic investing in the PW Funds or other mutual funds, whether through
the Plan or otherwise, helps investors establish and maintain a disciplined
approach to accumulating assets over time, de-emphasizing the importance of
timing the market's highs and lows. Periodic investing also permits an
investor to take advantage
38
<PAGE>
of "dollar cost averaging." By investing a fixed amount in mutual fund shares
at established intervals, an investor purchases more shares when the price is
lower and fewer shares when the price is higher, thereby increasing his or her
earning potential. Of course, dollar cost averaging does not guarantee a
profit or protect against a loss in a declining market, and an investor should
consider his or her financial ability to continue investing through periods of
both low and high share prices. However, over time, dollar cost averaging
generally results in a lower average original investment cost than if an
investor invested a larger dollar amount in a mutual fund at one time.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT.
In order to enroll in the Accumulation Plan, an investor must have opened an
RMA account with PaineWebber or one of its correspondent firms. The RMA
account is PaineWebber's comprehensive asset management account and offers
investors a number of features, including the following:
. monthly Premier account statements that itemize all account activity,
including investment transactions, checking activity and Gold
MasterCard(R) transactions during the period, and provide unrealized and
realized gain and loss estimates for most securities held in the account;
. comprehensive preliminary 9-month and year-end summary statements that
provide information on account activity for use in tax planning and tax
return preparation;
. automatic "sweep" of uninvested cash into the RMA accountholder's choice
of one of the six RMA money market funds-RMA Money Market Portfolio, RMA
U.S. Government Portfolio, RMA Tax-Free Fund, RMA California Municipal
Money Fund, RMA New Jersey Municipal Money Fund and RMA New York
Municipal Money Fund. Each money market fund attempts to maintain a
stable price per share of $1.00, although there can be no assurance that
it will be able to do so. Investments in the money market funds are not
insured or guaranteed by the U.S. government;
. check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
. Gold MasterCard, with or without a line of credit, which provides RMA
accountholders with direct access to their accounts and can be used with
automatic teller machines worldwide. Purchases on the Gold MasterCard are
debited to the RMA account once monthly, permitting accountholders to
remain invested for a longer period of time;
. 24-hour access to account information through toll-free numbers, and more
detailed personal assistance during business hours from the RMA Service
Center;
. expanded account protection to $100 million in the event of the
liquidation of PaineWebber. This protection does not apply to shares of
the RMA money market funds or the PW Funds because those shares are held
at the transfer agent and not through PaineWebber; and
. automatic direct deposit of checks into your RMA account and automatic
withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
39
<PAGE>
CONVERSION OF CLASS B SHARES
Class B shares of a Fund will automatically convert to Class A shares of
that Fund, based on the relative net asset values per share of the two
classes, as of the close of business on the first Business Day (as defined
under "Valuation of Shares") of the month in which the sixth anniversary of
the initial issuance of such Class B shares occurs. For the purpose of
calculating the holding period required for conversion of Class B shares, the
date of initial issuance shall mean (1) the date on which such Class B shares
were issued, or (2) for Class B shares obtained through an exchange, or a
series of exchanges, the date on which the original Class B shares were
issued. For purposes of conversion to Class A shares, Class B shares purchased
through the reinvestment of dividends and other distributions paid in respect
of Class B shares will be held in a separate sub-account. Each time any Class
B shares in the shareholder's regular account (other than those in the sub-
account) convert to Class A shares, a pro rata portion of the Class B shares
in the sub-account will also convert to Class A shares. The portion will be
determined by the ratio that the shareholder's Class B shares converting to
Class A shares bears to the shareholder's total Class B shares not acquired
through dividends and other distributions.
The availability of the conversion feature is subject to the continuing
availability of an opinion of counsel to the effect that the dividends and
other distributions paid on Class A and Class B shares will not result in
"preferential dividends" under the Internal Revenue Code and the conversion of
shares does not constitute a taxable event. If the conversion feature ceased
to be available, the Class B shares of the Funds would not be converted and
would continue to be subject to the higher ongoing expenses of the Class B
shares beyond six years from the date of purchase. Mitchell Hutchins has no
reason to believe that this condition for the availability of the conversion
feature will not continue to be met.
VALUATION OF SHARES
Each Fund determines the net asset values per share separately for each
class of shares as of the close of regular trading (currently 4:00 p.m.,
Eastern time) on the NYSE on each Business Day, which is defined as each
Monday through Friday when the NYSE is open. Currently the NYSE is closed on
the observance of the following holidays: New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
Securities that are listed on U.S. and foreign stock exchanges are valued at
the last sale price on the day the securities are valued or, lacking any sales
on such day, at the last available bid price. In cases where securities are
traded on more than one exchange, the securities are generally valued on the
exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on The Nasdaq Stock Market ("Nasdaq") are
valued at the last trade price on Nasdaq at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation.
Securities and assets for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the direction
of each board. In valuing lower rated corporate debt securities it should be
recognized that judgment often plays a greater role than is the case with
respect to securities for which a broader range of dealer quotations and last-
sale information is available. All investments quoted in foreign currency will
be valued daily in U.S. dollars on the basis of the foreign currency exchange
rate prevailing at the time such valuation is determined by the Funds'
custodian.
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<PAGE>
Foreign currency exchange rates are generally determined prior to the close
of trading on the NYSE. Occasionally events affecting the value of foreign
investments and such exchange rates occur between the time at which they are
determined and the close of trading on the NYSE, which events would not be
reflected in a computation of the Funds' net asset value on that day. If
events materially affecting the value of such investments or currency exchange
rates occur during such time period, the investments will be valued at their
fair value as determined in good faith by or under the direction of each
board. The foreign currency exchange transactions of the Funds conducted on a
spot (that is, cash) basis are valued at the spot rate for purchasing or
selling currency prevailing on the foreign exchange market. This rate under
normal market conditions differs from the prevailing exchange rate in an
amount generally less than one-tenth of one percent due to the costs of
converting from one currency to another.
PERFORMANCE INFORMATION
The Funds' performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represents past performance and is
not intended to indicate future performance. The investment return and
principal value of an investment will fluctuate so that an investor's shares,
when redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes ("Standardized
Return") used in each Fund's Performance Advertisements are calculated
according to the following formula:
<TABLE>
<S> <C> <C> <C>
P(1 + T)n = ERV
a hypothetical initial payment of $1,000 to purchase shares of a
where: P = specified Class
T = average annual total return of shares of that Class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at the
beginning of that period.
</TABLE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or "T" in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over
the period. In calculating the ending redeemable value, for Class A shares,
the maximum 4.5% sales charge is deducted from the initial $1,000 payment and,
for Class B and Class C shares, the applicable contingent deferred sales
charge imposed on a redemption of Class B or Class C shares held for the
period is deducted. All dividends and other distributions are assumed to have
been reinvested at net asset value.
The Funds also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ("Non-Standardized Return"). The Funds calculate Non-Standardized Return
for specified periods of time by assuming an investment of $1,000 in Fund
shares and assuming the reinvestment of all dividends and other distributions.
The rate of return is determined by subtracting the initial value of the
investment from the ending value and by dividing the remainder by the initial
value. Neither initial nor contingent deferred sales charges are taken into
account in calculating Non-Standardized Return; the inclusion of those charges
would reduce the return.
Both Standardized Return and Non-Standardized Return for Class B shares for
periods of over six years reflect conversion of the Class B shares to Class A
shares at the end of the sixth year.
41
<PAGE>
The following table shows performance information for the Class A, Class B
and Class C shares of the Funds for the periods indicated. No Class Y shares
were outstanding for Utility Income Fund during the periods indicated and
Class Y shares were outstanding for only two days for Financial Services
Growth Fund. All returns for periods of more than one year are expressed as an
average return.
FINANCIAL SERVICES GROWTH FUND
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Y
------- ------- ------- -------
<S> <C> <C> <C> <C>
Fiscal year ended March 31, 1998:
Standardized Return*.......................... 45.10% 45.80% 49.76% NA
Non-Standardized Return....................... 51.92% 50.80% 50.76% NA
Five years ended March 31, 1998:
Standardized Return*.......................... 22.61% 22.65% 22.82% NA
Non-Standardized Return....................... 23.75% 22.83% 22.82% NA
Ten years ended March 31, 1998:
Standardized Return*.......................... 23.12% NA NA NA
Non-Standardized Return....................... 23.69% NA NA NA
Inception** to March 31, 1998:
Standardized Return*.......................... 17.81% 28.12% 25.59% 1.02%
Non-Standardized Return....................... 18.27% 28.12% 25.59% 1.02%
</TABLE>
- --------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4.5%. All Standardized Return figures for
Class B and Class C shares reflect deduction of the applicable contingent
deferred sales charges imposed on a redemption of shares held for the
period.
** The inception date for each Class of shares is as follows: Class A--May 22,
1986, Class B--July 1, 1991, Class C--July 2, 1992 and Class Y--March 30,
1998.
UTILITY INCOME FUND
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
Fiscal year ended March 31, 1998:
Standardized Return*.................................. 32.90% 33.13% 37.09%
Non-Standardized Return............................... 39.15% 38.13% 38.09%
Inception** to March 31, 1998:
Standardized Return*.................................. 10.52% 10.47% 10.75%
Non-Standardized Return............................... 11.59% 10.76% 10.75%
</TABLE>
- --------
* All Standardized Return figures for Class A shares reflect deduction of the
current maximum sales charge of 4.5%. All Standardized Return figures for
Class B and Class C shares reflect deduction of the applicable contingent
deferred sales charges imposed on a redemption of shares held for the
period.
** The inception date for each class of shares is July 2, 1993.
OTHER INFORMATION. In Performance Advertisements, the Funds may compare
their Standardized Return and/or their Non-Standardized Return with data
published by Lipper Analytical Services, Inc. ("Lipper"), CDA Investment
Technologies, Inc. ("CDA"), Wiesenberger Investment Companies Service
("Wiesenberger"), Investment Company Data, Inc. ("ICD") or Morningstar Mutual
Funds ("Morningstar"), with the performance of recognized stock and other
indices, including the Standard & Poor's 500 Composite
42
<PAGE>
Stock Price Index ("S&P 500"), the Dow Jones Industrial Average, the Nasdaq
Composite Index, the Russell 2000 Index, the Wilshire 5000 Index, the Lehman
Bond Index, CBOE Real Estate Investment Trust Index, Bloomberg REIT Index,
Keefe Bruyette and Woods Bank Index, Standard & Poor's Bank Composite,
Standard & Poor's Insurance Composite, Standard & Poor's Small Cap Financials
Index, Standard & Poor's Mid Cap Financials Index, Standard & Poor's Super
Composite Financials Index, Standard & Poor's Financials Index, Dow Jones
Utilities Average, NYSE Utilities Index, Standard & Poor's Utilities,
Philadelphia Utility Index, Standard & Poor's Small Utilities, ValueLine
Utilities, Moody's Utility Stocks, 30-year and 10-year U.S. Treasury bonds,
the Morgan Stanley Capital International World Index and changes in the
Consumer Price Index as published by the U.S. Department of Commerce. The
Funds also may refer in such materials to mutual fund performance rankings and
other data, such as comparative asset, expense and fee levels, published by
Lipper, CDA, Wiesenberger, ICD or Morningstar. Performance Advertisements also
may refer to discussions of the Funds and comparative mutual fund data and
ratings reported in independent periodicals, including THE WALL STREET
JOURNAL, MONEY MAGAZINE, FORBES, BUSINESS WEEK, FINANCIAL WORLD, BARRON'S,
FORTUNE, THE NEW YORK TIMES, THE CHICAGO TRIBUNE, THE WASHINGTON POST AND THE
KIPLINGER LETTERS. Comparisons in Performance Advertisements may be in graphic
form.
The Funds may include discussions or illustrations of the effects of
compounding in Performance Advertisements. "Compounding" refers to the fact
that, if dividends or other distributions on a Fund investment are reinvested
in additional Fund shares, any future income or capital appreciation of a Fund
would increase the value, not only of the original Fund investment, but also
of the additional Fund shares received through reinvestment. As a result, the
value of a Fund investment would increase more quickly than if dividends or
other distributions had been paid in cash.
The Funds may also compare their performance with the performance of bank
certificates of deposit (CDs) as measured by the CDA Certificate of Deposit
Index, the Bank Rate Monitor National Index and the averages of yields of CDs
of major banks published by Banxquote(R) Money Markets. In comparing the
Funds' performance to CD performance, investors should keep in mind that bank
CDs are insured in whole or in part by an agency of the U.S. government and
offer fixed principal and fixed or variable rates of interest, and that bank
CD yields may vary depending on the financial institution offering the CD and
prevailing interest rates. Shares of the Funds are not insured or guaranteed
by the U.S. government and returns and net asset value will fluctuate. The
securities held by the Funds generally have longer maturities than most CDs
and may reflect interest rate fluctuations for longer term securities. An
investment in any of the Funds involves greater risks than an investment in
either a money market fund or a CD.
43
<PAGE>
The Funds may also compare their performance to general trends in the stock
and bond markets, as illustrated by the following graph prepared by Ibbotson
Associates, Chicago.
LOGO
The chart is shown for illustrative purposes only and does not represent
either Fund's performance. These returns consist of income and capital
appreciation (or depreciation) and should not be considered an indication or
guarantee of future investment results. Year-to-year fluctuations in certain
markets have been significant and negative returns have been experienced in
certain markets from time to time. Stocks are measured by the S&P 500, an
unmanaged weighted index comprising 500 widely held common stocks and varying
in composition. Unlike investors in bonds and U.S. Treasury bills, common
stock investors do not receive fixed income payments and are not entitled to
repayment of principal. These differences contribute to investment risk.
Returns shown for long-term government bonds are based on U.S. Treasury bonds
with 20-year maturities. Inflation is measured by the Consumer Price Index.
The indexes are unmanaged and are not available for investment.
- --------
Source: Stocks, Bonds, Bills and Inflation 1998 YearbookTM Ibbotson Assoc.,
Chi., (annual updates work by Roger G. Ibbotson & Rex A. Sinquefield).
Over time, although subject to greater risks and higher volatility, stocks
have outperformed all other investments by a wide margin, offering a solid
hedge against inflation. From 1926 to 1997, stocks beat all other traditional
asset classes. A $10,000 investment in the stocks comprising the S&P 500 grew
to $18,272,762, significantly more than any other investment.
TAXES
To continue to qualify for treatment as a regulated investment company
("RIC") under the Internal Revenue Code, each Fund must distribute to its
shareholders for each taxable year at least 90% of its investment company
taxable income (consisting generally of net investment income, net short-term
capital gain and net gains from certain foreign currency transactions)
("Distribution Requirement") and must meet several additional requirements.
For each Fund these requirements include the following: (1) the Fund must
derive at least 90% of its gross income each taxable year from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of securities or foreign currencies, or other income
(including gains from options, futures or forward currency contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) at the close of each quarter of the
44
<PAGE>
Fund's taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs and other securities, with these other securities limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value
of the Fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities; and (3) at the close of each quarter
of the Fund's taxable year, not more than 25% of the value of its total assets
may be invested in securities (other than U.S. government securities or the
securities of other RICs) of any one issuer.
Dividends and other distributions declared by a Fund in October, November or
December of any year and payable to shareholders of record on a date in any of
those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to shareholders for the year in which that December 31 falls.
A portion of the dividends from each Fund's investment company taxable
income (whether paid in cash or in additional shares) may be eligible for the
dividends-received deduction allowed to corporations. The eligible portion may
not exceed the aggregate dividends received by a Fund from U.S. corporations.
However, dividends received by a corporate shareholder and deducted by it
pursuant to the dividends-received deduction are subject indirectly to the
federal alternative minimum tax.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for any dividend or capital gain distribution, the shareholder
will pay full price for the shares and receive some portion of the price back
as a taxable distribution.
Dividends and interest received by a Fund, and gains realized by a Fund, may
be subject to income, withholding or other taxes imposed by foreign countries
and U.S. possessions ("foreign taxes") that would reduce the yield and/or
total return on its securities. Tax conventions between certain countries and
the United States may reduce or eliminate foreign taxes, however, and many
foreign countries do not impose taxes on capital gains in respect of
investments by foreign investors. If more than 50% of the value of a Fund's
total assets at the close of its taxable year consists of securities of
foreign corporations, it will be eligible to, and may, file an election with
the Internal Revenue Service that would enable its shareholders, in effect, to
receive the benefit of the foreign tax credit with respect to any foreign
taxes paid by it. Pursuant to the election, the Fund would treat those taxes
as dividends paid to its shareholders and each shareholder would be required
to (1) include in gross income, and treat as paid by him or her, his or her
proportionate share of those taxes, (2) treat his or her share of those taxes
and of any dividend paid by the Fund that represents income from foreign or
U.S. possessions sources as his or her own income from those sources and (3)
either deduct the taxes deemed paid by him or her in computing his or her
taxable income or, alternatively, use the foregoing information in calculating
the foreign tax credit against his or her federal income tax. A Fund will
report to its shareholders shortly after each taxable year their respective
shares of foreign taxes paid and the income from sources within, and taxes
paid to, foreign countries and U.S. possessions if it makes this election. If
a Fund makes this election, individuals who have no more than $300 ($600 for
married persons filing jointly) of creditable foreign taxes included on Forms
1099 and all of whose foreign source income is "qualified passive income" may
elect each year to be exempt from the extremely complicated foreign tax credit
limitation and will be able to claim a foreign tax credit without having to
file the detailed Form 1116 that otherwise is required. Financial Services
Growth Fund is not expected to be eligible to make this election.
Each Fund will be subject to a nondeductible 4% excise tax ("Excise Tax") to
the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
45
<PAGE>
Each Fund may invest in the stock of "passive foreign investment companies"
("PFICs") if such stock is a permissible investment. A PFIC is a foreign
corporation--other than a "controlled foreign corporation" (i.e., a foreign
corporation in which, on any day during its taxable year, more than 50% of the
total voting power of all voting stock therein or the total value of all stock
therein is owned, directly, indirectly, or constructively, by "U.S.
shareholders," defined as U.S. persons that individually own, directly,
indirectly, or constructively, at least 10% of that voting power) as to which
a Fund is a U.S. shareholder--that, in general, meets either of the following
tests: (1) at least 75% of its gross income is passive or (2) an average of at
least 50% of its assets produce, or are held for the production of, passive
income. Under certain circumstances, a Fund will be subject to federal income
tax on a portion of any "excess distribution" received on the stock of a PFIC
or of any gain from disposition of that stock (collectively "PFIC income"),
plus interest thereon, even if the Fund distributes the PFIC income as a
taxable dividend to its shareholders. The balance of the PFIC income will be
included in the Fund's investment company taxable income and, accordingly,
will not be taxable to it to the extent that income is distributed to its
shareholders. If a Fund invests in a PFIC and elects to treat the PFIC as a
"qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the Fund will be required to include in income each year
its pro rata share of the QEF's annual ordinary earnings and net capital gain
(the excess of net long-term capital gain over net short-term capital loss)--
which may have to be distributed by the Fund to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax--even if those earnings and
gain are not distributed to the Fund by the QEF. In most instances it will be
very difficult, if not impossible, to make this election because of certain
requirements thereof.
Each Fund may elect to "mark to market" its stock in any PFIC. "Marking-to-
market," in this context, means including in ordinary income each taxable year
the excess, if any, of the fair market value of the stock over a Fund's
adjusted basis therein as of the end of that year. Pursuant to the election, a
Fund also may deduct (as an ordinary, not capital, loss) the excess, if any,
of its adjusted basis in PFIC stock over the fair market value thereof as of
the taxable year-end, but only to the extent of any net mark-to-market gains
with respect to that stock included in income by the Fund for prior taxable
years. A Fund's adjusted basis in each PFIC's stock subject to the election
would be adjusted to reflect the amounts of income included and deductions
taken thereunder. Regulations proposed in 1992 provided a similar election
with respect to the stock of certain PFICs.
The use of hedging strategies, such as writing ("selling") and purchasing
options and futures contracts and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character amount, and timing of recognition of the gains and losses a Fund
realizes in connection therewith. Gains from the disposition of foreign
currencies (except certain gains that may be excluded by future regulations),
and gains from options, futures and forward currency contracts derived by a
Fund with respect to its business of investing in securities or foreign
currencies, will qualify as permissible income under the Income Requirement.
If a Fund has an "appreciated financial position"--generally, an interest
(including an interest through an option, futures or forward currency contract
or short sale) with respect to any stock, debt instrument (other than
"straight debt") or partnership interest the fair market value of which
exceeds its adjusted basis--and enters into a "constructive sale" of the same
or substantially similar property, the Fund will be treated as having made an
actual sale thereof, with the result that gain will be recognized at that
time. A constructive sale generally consists of a short sale, an offsetting
notional principal contract or a futures or forward currency contract entered
into by a Fund or a related person with respect to the same or substantially
similar property. In addition, if the appreciated financial position is itself
a short sale or such a contract, acquisition of the underlying property or
substantially similar property will be deemed a constructive sale. The
foregoing will not apply, however, to a Fund's transaction during any taxable
year that otherwise would be treated as a constructive sale if the transaction
is closed within 30 days after the end of that year and the Fund holds the
46
<PAGE>
appreciated financial position unhedged for 60 days after that closing (i.e.,
at no time during that 60-day period is the Fund's risk of loss regarding that
position reduced by reason of certain specified transactions with respect to
substantially similar or related property, such as having an option to sell,
being contractually obligated to sell, making a short sale, or granting an
option to buy substantially identical stock or securities).
OTHER INFORMATION
Prior to December 14, 1995, Financial Services Growth Fund was known as
"PaineWebber Regional Financial Growth Fund Inc." Prior to November 10, 1995,
each Fund's Class C shares were known as "Class D" shares.
The Trust is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders of Utility Income Fund
could, under certain circumstances, be held personally liable for the
obligations of the Trust or Fund. However, the Trust's Declaration of Trust
disclaims shareholder liability for acts or obligations of the Trust or the
Fund and requires that notice of such disclaimer be given in each note, bond,
contract, instrument, certificate or undertaking made or issued by the
trustees or by any officers or officer by or on behalf of the Trust or the
Fund, the trustees or any of them in connection with the Trust. The
Declaration of Trust provides for indemnification from a Fund's property for
all losses and expenses of any shareholder held personally liable for the
obligations of the Fund. Thus, the risk of a shareholder's incurring financial
loss on account of shareholder liability is limited to circumstances in which
the Fund itself would be unable to meet its obligations, a possibility that
Mitchell Hutchins believes is remote and not material. Upon payment of any
liability incurred by a shareholder solely by reason of being or having been a
shareholder of a Fund, the shareholder paying such liability will be entitled
to reimbursement from the general assets of the Fund. The trustees intend to
conduct each Fund's operations in such a way as to avoid, as far as possible,
ultimate liability of the shareholders for liabilities of the Fund.
CLASS-SPECIFIC EXPENSES. Each Fund may determine to allocate certain of its
expenses (in addition to distribution fees) to the specific classes of the
Fund's shares to which those expenses are attributable. For example, a Fund's
Class B and Class C shares bear higher transfer agency fees per shareholder
account than those borne by Class A or Class Y shares. The higher fee is
imposed due to the higher costs incurred by the transfer agent in tracking
shares subject to a contingent deferred sales charge because, upon redemption,
the duration of the shareholder's investment must be determined in order to
determine the applicable charge. Although the transfer agency fee will differ
on a per account basis as stated above, the specific extent to which the
transfer agency fees will differ between the classes as a percentage of net
assets is not certain, because the fee as a percentage of net assets will be
affected by the number of shareholder accounts in each class and the relative
amounts of net assets in each class.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the Funds.
Kirkpatrick & Lockhart LLP also acts as counsel to PaineWebber and Mitchell
Hutchins in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Funds.
FINANCIAL STATEMENTS
Each Fund's Annual Report to Shareholders for the fiscal year ended March
31, 1998 is a separate document supplied with this Statement of Additional
Information and the financial statements, accompanying notes and reports of
independent auditors appearing therein are incorporated herein by this
reference.
47
<PAGE>
APPENDIX
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
a "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues;
Aa. Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities;
A. Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future;
Baa. Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well;
Ba. Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class;
B. Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small;
Caa. Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest;
Ca. Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings;
C. Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: Moody's apply numerical modifiers, 1, 2 and 3 in each generic rating
classification from AA through CAA in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category, the modifier 2 indicates a mid-range ranking, and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
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<PAGE>
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to pay interest and repay principal is extremely strong;
AA. An obligation rated AA differs from the highest rated issues only in small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong; A. An obligation rated A is somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions than debt in higher rated categories, however, the obligor's
capacity to meet its financial commitment on the obligation is still strong;
BBB. An obligation rated BBB exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity of the obligor to meet its financial commitment on the
obligation;
BB, B, CCC, CC, C. Obligations rated BB, B, CCC, CC and C are regarded as
having significant speculative characteristics. BB indicates the least degree
of speculation and C the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major risk exposures to adverse conditions.
BB An obligation rated BB is less vulnerable to nonpayment that other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B. An obligation rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet
its financial commitment on the obligation.
CCC. An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC. An obligation rated CC is currently highly vulnerable to nonpayment.
C. The C rating may be used to cover a situation where a bankruptcy petition
has been filed or similar action has been taken, but payments on the
obligation are being continued.
D. An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due over the
applicable grace period has not expired unless Standard & Poor's believes that
such payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized;
R. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
49
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THE PROSPECTUS OR IN THIS STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE FUNDS OR THEIR DISTRIBUTOR. THE
PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION DO NOT CONSTITUTE AN
OFFERING BY THE FUNDS OR BY THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH
OFFERING MAY NOT LAWFULLY BE MADE.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Policies and Restrictions..................................... 1
Strategies Using Derivative Contracts.................................... 10
Trustees, Directors and Officers; Principal Holders of Securities........ 19
Investment Advisory and Distribution Arrangements........................ 28
Portfolio Transactions................................................... 33
Reduced Sales Charges, Additional Exchange and Redemption Information and
Other Services.......................................................... 35
Conversion of Class B Shares............................................. 40
Valuation of Shares...................................................... 40
Performance Information.................................................. 41
Taxes.................................................................... 44
Other Information........................................................ 47
Financial Statements..................................................... 47
Appendix................................................................. 48
</TABLE>
(C)1998 PaineWebber Incorporated
PaineWebber
Financial Services Growth Fund Inc.
PaineWebber
Utility Income Fund
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Statement of Additional Information
August 1, 1998
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