PAINEWEBBER FINANCIAL SERVICES GROWTH FUND INC.
51 WEST 52ND STREET
NEW YORK, NEW YORK 10019-6114
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber Financial Services Growth Fund Inc. is a diversified,
professionally managed, open-end management investment company organized as a
Maryland corporation ("Corporation").
The fund's investment adviser, administrator and distributor is Mitchell
Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned asset
management subsidiary of PaineWebber Incorporated ("PaineWebber"). As
distributor for the fund, Mitchell Hutchins has appointed PaineWebber to serve
as dealer for the sale of fund shares.
Portions of the fund's Annual Report to Shareholders are incorporated by
reference into this Statement of Additional Information ("SAI"). The Annual
Report accompanies this SAI. You may obtain an additional copy of the Annual
Report without charge by calling toll-free 1-800-647-1568.
This SAI is not a prospectus and should be read only in conjunction with
the fund's current Prospectus, dated July 26, 2000 (as revised August 3, 2000).
A copy of the Prospectus may be obtained by calling any PaineWebber Financial
Advisor or correspondent firm or by calling toll-free 1-800-647-1568. This SAI
is dated July 26, 2000 (as revised August 3, 2000).
TABLE OF CONTENTS
PAGE
The Fund and Its Investment Policies.........................................2
The Fund's Investments, Related Risks and Limitations........................2
Strategies Using Derivative Instruments......................................12
Organization of the Corporation; Directors and Officers; Principal
Holders and Management Ownership of Securities...............................20
Investment Advisory, Administration and Distribution Arrangements............27
Portfolio Transactions.......................................................32
Reduced Sales Charges, Additional Exchange and Redemption
Information and Other Services............................................34
Conversion of Class B Shares.................................................39
Valuation of Shares..........................................................40
Performance Information......................................................40
Taxes........................................................................43
Other Information............................................................46
Financial Statements.........................................................47
Appendix....................................................................A-1
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THE FUND AND ITS INVESTMENT POLICIES
The fund's investment objective may not be changed without shareholder
approval. Except where noted, the other investment policies of the fund may be
changed by its board without shareholder approval. As with other mutual funds,
there is no assurance that the fund will achieve its investment objective.
The fund's investment objective is long-term capital appreciation. The
fund seeks to achieve this objective by investing primarily in equity securities
of companies in the financial services industries. These companies include
banks, savings and loan institutions ("thrifts"), insurance companies,
commercial finance companies, consumer finance companies, brokerage companies,
investment management companies, companies that provide specialized services
closely allied to financial services (such as transaction processing and
financial printing) and their holding companies.
The fund normally invests at least 65% of its total assets in equity
securities of financial services companies. To be considered a financial
services company, the company must: (1) derive at least 50% of either its
revenues or earnings from financial services activities or devote at least 50%
of its assets to these activities; or (2) be engaged in "securities-related
businesses," meaning it derives more than 15% of its gross revenues from
securities brokerage or investment management activities. The fund may invest up
to 35% of its total assets in equity securities of companies outside the
financial services industries and in investment grade bonds of all issuers. The
fund may also invest up to 20% of its total assets in equity securities and
investment grade bonds of foreign issuers. The fund may invest in securities
other than equity securities when, in Mitchell Hutchins' opinion, their
potential for capital appreciation is equal to or greater than that of equity
securities or when such holdings might reduce volatility in the fund. The fund
may not invest more than 5% of its total assets in the equity securities of any
one company engaged in securities-related businesses. The fund may invest in
banks and thrifts (and their holding companies) only if their deposits are
insured by the Federal Deposit Insurance Corporation ("FDIC"). However, neither
the securities of these companies nor the fund's shares are insured by the FDIC
or any other federal or governmental agency.
The fund may invest up to 10% of its net assets in illiquid securities.
The fund may purchase securities on a when-issued basis and may purchase or sell
securities for delayed delivery. The fund may lend its portfolio securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. The fund may also borrow from banks or through reverse
repurchase agreements for temporary or emergency purposes, but not in excess of
10% of its total assets. The fund also may invest in securities of other
investment companies and may sell securities short "against the box."
THE FUND'S INVESTMENTS, RELATED RISKS AND LIMITATIONS
The following supplements the information contained in the Prospectus and
above concerning the fund's investments, related risks and limitations. Except
as otherwise indicated in the Prospectus or this SAI, the fund has established
no policy limitations on its ability to use the investments or techniques
discussed in these documents.
EQUITY SECURITIES. Equity securities include common stocks, most preferred
stocks and securities that are convertible into them, including common stock
purchase warrants and rights, equity interests in trusts, partnerships, joint
ventures or similar enterprises and receipts. Common stocks, the most familiar
type, represent an equity (ownership) interest in a corporation.
Preferred stock has certain fixed income features, like a bond, but
actually it is equity that is senior to a company's common stock. Convertible
bonds may be converted into or exchanged for a prescribed amount of common stock
of the same or a different issuer within a particular period of time at a
specified price or formula. Depositary receipts typically are issued by banks or
trust companies and evidence ownership of underlying equity securities.
While past performance does not guarantee future results, equity
securities historically have provided the greatest long-term growth potential in
a company. However, their prices generally fluctuate more than other securities
and reflect changes in a company's financial condition and in overall market and
economic conditions. Common stocks generally represent the riskiest investment
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in a company. It is possible that the fund may experience a substantial or
complete loss on an individual equity investment. While this is possible with
bonds, it is less likely.
BONDS. Bonds are fixed or variable rate debt obligations, including bills,
notes, debentures, money market instruments and similar instruments and
securities. Mortgage- and asset-backed securities are types of bonds, and
certain types of income-producing, non-convertible preferred stocks may be
treated as bonds for investment purposes. Bonds generally are used by
corporations, governments and other issuers to borrow money from investors. The
issuer pays the investor a fixed or variable rate of interest and normally must
repay the amount borrowed on or before maturity. Many preferred stocks and some
bonds are "perpetual" in that they have no maturity date.
Bonds are subject to interest rate risk and credit risk. Interest rate
risk is the risk that interest rates will rise and that, as a result, bond
prices will fall, lowering the value of the fund's investments in bonds. In
general, bonds having longer durations are more sensitive to interest rate
changes than are bonds with shorter durations. Credit risk is the risk that an
issuer may be unable or unwilling to pay interest and/or principal on the bond.
Credit risk can be affected by many factors, including adverse changes in the
issuer's own financial condition or in economic conditions.
CONVERTIBLE SECURITIES. A convertible security is a bond, preferred stock
or other security that may be converted into or exchanged for a prescribed
amount of common stock of the same or a different issuer within a particular
period of time at a specified price or formula. A convertible security entitles
the holder to receive interest or dividends until the convertible security
matures or is redeemed, converted or exchanged. Convertible securities have
unique investment characteristics in that they generally (1) have higher yields
than common stocks, but lower yields than comparable non-convertible securities,
(2) are less subject to fluctuation in value than the underlying stock because
they have fixed income characteristics and (3) provide the potential for capital
appreciation if the market price of the underlying common stock increases. While
no securities investment is without some risk, investments in convertible
securities generally entail less risk than the issuer's common stock. However,
the extent to which such risk is reduced depends in large measure upon the
degree to which the convertible security sells above its value as a fixed income
security.
WARRANTS. Warrants are securities permitting, but not obligating, holders
to subscribe for other securities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date.
CREDIT RATINGS; NON-INVESTMENT GRADE BONDS. Moody's Investors Service,
Inc. ("Moody's"), Standard & Poor's, a division of The McGraw-Hill Companies,
Inc. ("S&P"), and other nationally recognized statistical rating agencies
("rating agencies") are private services that provide ratings of the credit
quality of bonds and certain other securities. A description of the ratings
assigned to corporate bonds by Moody's and S&P is included in the Appendix to
this SAI. Credit ratings attempt to evaluate the safety of principal and
interest payments, but they do not evaluate the volatility of a debt security's
value or its liquidity and do not guarantee the performance of the issuer.
Rating agencies may fail to make timely changes in credit ratings in response to
subsequent events, so that an issuer's current financial condition may be better
or worse than the rating indicates. There is a risk that rating agencies may
downgrade a bond's rating. Subsequent to a bond's purchase by the fund, it may
cease to be rated or its rating may be reduced below the minimum rating required
for purchase by the fund. The fund 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.
In addition to ratings assigned to individual bond issues, Mitchell
Hutchins will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and asset
quality. The yields on bonds are dependent on a variety of factors, including
general money market conditions, general conditions in the bond market, the
financial condition of the issuer, the size of the offering, the maturity of the
obligation and its rating. There is a wide variation in the quality of bonds,
both within a particular classification and between classifications. An issuer's
obligations under its bonds are subject to the provisions of bankruptcy,
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insolvency and other laws affecting the rights and remedies of bond holders or
other creditors of an issuer; litigation or other conditions may also adversely
affect the power or ability of issuers to meet their obligations for the payment
of interest and principal on their bonds.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another rating agency or, if
unrated, determined by Mitchell Hutchins to be of comparable quality. Moody's
considers bonds rated Baa (its lowest investment grade rating) to have
speculative characteristics. This means that changes in economic conditions or
other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case for higher rated bonds.
Non-investment grade bonds (commonly known as "junk bonds" and sometimes
referred to as "high yield" bonds) are rated Ba or lower by Moody's, BB or lower
by S&P, comparably rated by another rating agency or determined by Mitchell
Hutchins to be of comparable quality. The fund's investments in non-investment
grade bonds entail greater risk than its investments in higher rated bonds.
Non-investment grade bonds are considered predominantly speculative with respect
to the issuer's ability to pay interest and repay principal and may involve
significant risk exposure to adverse conditions. Non-investment grade bonds
generally offer a higher current yield than that available for investment grade
issues; however, they involve greater risks, in that they are especially
sensitive to adverse changes in general economic conditions and in the
industries in which the issuers are engaged, to changes in the financial
condition of the issuers and to price fluctuations in response to changes in
interest rates. During periods of economic downturn or rising interest rates,
highly leveraged issuers may experience financial stress which could adversely
affect their ability to make payments of interest and principal and 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. The risk of loss due to default by such issuers is
significantly greater because such securities frequently are unsecured by
collateral and will not receive payment until more senior claims are paid in
full.
The market for non-investment grade bonds, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. This has been reflected in recent years
by volatility in emerging market securities. In the past, many lower rated bonds
experienced substantial price declines 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, those higher yields
did not reflect the value of the income stream that holders of such securities
expected. Rather they reflected the risk that holders of such securities could
lose a substantial portion of their value due to financial restructurings or
defaults by the issuers. There can be no assurance that such declines will not
recur.
The market for non-investment grade bonds generally is thinner and less
active than that for higher quality securities, which may limit the fund's
ability to sell such securities 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 non-investment grade securities, especially in a thinly traded
market.
U.S. GOVERNMENT SECURITIES. U.S. government securities include direct
obligations of the U.S. Treasury (such as Treasury bills, notes or bonds) and
obligations issued or guaranteed as to principal and interest (but not as to
market value) by the U.S. government, its agencies or its instrumentalities.
U.S. government securities include mortgage-backed securities issued or
guaranteed by government agencies or government-sponsored enterprises. Other
U.S. government securities may be backed by the full faith and credit of the
U.S. government or supported primarily or solely by the creditworthiness of the
government-related issuer or, in the case of mortgage-backed securities, by
pools of assets.
U.S. government securities also include separately traded principal and
interest components of securities issued or guaranteed by the U.S. Treasury,
which are traded independently under the Separate Trading of Registered Interest
and Principal of Securities ("STRIPS") program. Under the STRIPS programs, the
principal and interest components are individually numbered and separately
issued by the U.S. Treasury.
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Treasury inflation-indexed securities (also known as "Treasury
inflation-protection securities" or "TIPS") are Treasury bonds on which the
principal value is adjusted periodically in accordance with changes in the
Consumer Price Index. Interest on TIPS is payable semi-annually on the adjusted
principal value. The principal value of TIPS will decline during periods of
deflation, but the principal amount payable at maturity will not be less than
the original par amount. If inflation is lower than expected while the fund
holds TIPS, it may earn less on the TIPS than it would on conventional Treasury
bonds. Any increase in the principal value of TIPS is taxable in the year the
increase occurs, even though holders do not receive cash representing the
increase at that time. See "Taxes -- Other Information," below.
INVESTING IN FOREIGN SECURITIES. Investing in foreign securities involves
more risks than investing in U.S. securities. The value of foreign securities is
subject to economic and political developments in the countries where the
issuers operate and to changes in foreign currency values. Investments in
foreign securities involve risks relating to political, social and economic
developments abroad, as well as risks resulting from the differences between the
regulations to which U.S. and foreign issuers and markets are subject. These
risks may include expropriation, confiscatory taxation, withholding taxes on
interest and/or dividends, limitations on the use of or transfer of fund assets
and political or social instability or diplomatic developments. Moreover,
individual foreign economies may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position. In those European countries that are using the Euro as a common
currency unit, individual national economies may be adversely affected by the
inability of national governments to use monetary policy to address their own
economic or political concerns.
Securities of many foreign companies may be less liquid and their prices
more volatile than securities of comparable U.S. companies. Transactions in
foreign securities may be subject to less efficient settlement practices.
Foreign securities trading practices, including those involving securities
settlement where fund assets may be released prior to receipt of payment, may
expose the fund to increased risk in the event of a failed trade or the
insolvency of a foreign broker-dealer. Legal remedies for defaults and disputes
may have to be pursued in foreign courts, whose procedures differ substantially
from those of U.S. courts. Additionally, the costs of investing outside the
United States frequently are higher than those in the United States. These costs
include relatively higher brokerage commissions and foreign custody expenses.
Securities of foreign issuers may not be registered with the Securities
and Exchange Commission ("SEC"), and the issuers thereof may not be subject to
its reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by the fund 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 fund may invest in foreign securities by purchasing depositary
receipts, including American Receipts ("ADRs"), European Receipts ("EDRs") and
Global 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. ADRs are receipts typically issued by a U.S. bank or trust company
evidencing ownership of the underlying securities. They generally are in
registered form, are denominated in U.S. dollars and are designed for use in the
U.S. securities markets. EDRs are European receipts evidencing a similar
arrangement, 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 financial markets. For purposes of the fund's
investment policies, receipts generally are deemed to have the same
classification as the underlying securities they represent. Thus, a receipt
representing ownership of common stock will be treated as common stock.
ADRs are publicly traded on exchanges or over-the-counter in the United
States and are issued through "sponsored" or "unsponsored" arrangements. In a
sponsored ADR arrangement, the foreign issuer assumes the obligation to pay some
or all of the 's transaction fees, whereas under an unsponsored arrangement, the
foreign issuer assumes no obligations and the 's transaction fees are paid
directly by the ADR holders. In addition, less information is available in the
United States about an unsponsored ADR than about a sponsored ADR.
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The fund anticipates that its 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.
However, from time to time foreign securities may be difficult to liquidate
rapidly without significantly depressing the price of such securities. Although
the fund will endeavor to achieve the best net results in effecting its
portfolio transactions, transactions on foreign exchanges are usually subject to
fixed commissions that are generally higher than negotiated commissions on U.S.
transactions. There is generally less government supervision and regulation of
exchanges and brokers in foreign countries than in the United States.
Investments in foreign sovereign debt involves special risks. Foreign
sovereign debt includes bonds issued by foreign governments or their agencies,
instrumentalities or political subdivisions or by foreign central banks.
Sovereign debt also may be issued by quasi-governmental entities that are owned
by foreign governments but are not backed by their full faith and credit or
general taxing powers. 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 fund may have limited legal recourse in the event of a default. Foreign
sovereign debt differs from bonds 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 diminished. 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 debt issued by the same sovereign entity may
not contest payments to the holders of foreign government bonds in the event of
default under commercial bank loan agreements.
Investment income on certain foreign securities in which the fund may
invest may be subject to foreign withholding or other taxes that could reduce
the return on these securities. Tax treaties between the United States and
foreign countries, however, may reduce or eliminate the amount of foreign taxes
to which the fund would be subject. In addition, substantial limitations may
exist in certain countries with respect to the fund's ability to repatriate
investment capital or the proceeds of sales of securities.
FOREIGN CURRENCY TRANSACTIONS. Currency risk is the risk that changes in
foreign exchange rates may reduce the U.S. dollar value of the fund's foreign
investments. The fund's share value may change significantly when its
investments are denominated in foreign currencies. Generally, currency exchange
rates are determined by supply and demand in the foreign exchange markets and
the relative merits of investments in different countries. Currency exchange
rates also can be affected by the intervention of the U.S. and foreign
governments or central banks, the imposition of currency controls, speculation,
devaluation or other political or economic developments inside and outside the
United States.
The fund values its assets daily in U.S. dollars and does not intend to
convert its holdings of foreign currencies to U.S. dollars on a daily basis.
From time to time the fund's foreign currencies may 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 fund could suffer a loss of some or all
of the amounts deposited. The fund may convert foreign currency to U.S. dollars
from time to time.
The value of the fund's assets as measured in U.S. dollars may be affected
favorably or unfavorably by fluctuations in currency rates and exchange control
regulations. Further, the fund may incur costs in connection with conversions
between various currencies. Currency exchange dealers realize a profit based on
the difference between the prices at which they are buying and selling various
currencies. Thus, a dealer normally will offer to sell a foreign currency to the
fund at one rate, while offering a lesser rate of exchange should the fund
desire immediately to resell that currency to the dealer. The fund conducts its
currency exchange transactions either on a spot (I.E., cash) basis at the spot
rate prevailing in the foreign currency exchange market, or through entering
into forward, futures or options contracts to purchase or sell foreign
currencies.
ZERO COUPON AND OTHER OID SECURITIES. Zero coupon securities are
securities on which no periodic interest payments are made and are issued at a
deep discount from their maturity value. The buyer of these securities receives
a rate of return by the gradual appreciation of the security, which results from
the fact that it will be paid at face value on a specified maturity date. There
are many types of zero coupon securities. Some are issued in zero coupon form,
including Treasury bills, notes and bonds that have been stripped of (separated
from) their unmatured interest coupons (unmatured interest payments) and
receipts or certificates representing interests in such stripped debt
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obligations and coupons. Others are created by brokerage firms that strip the
coupons from interest-paying bonds and sell the principal and the coupons
separately.
The fund may invest in other securities with original issue discount
("OID"), a term that means the securities are issued at a price that is lower
than their value at maturity, even though the securities also may make cash
payments of interest prior to maturity. These OID securities usually trade at a
discount from their face value.
Zero coupon securities are generally more sensitive to changes in interest
rates than debt obligations of comparable maturities that make current interest
payments. This means that when interest rates fall, the value of zero coupon
securities rises more rapidly than securities paying interest on a current
basis. However, when interest rates rise, their value falls more dramatically.
Other OID securities also are subject to greater fluctuations in market value in
response to changing interest rates than bonds of comparable maturities that
make current distributions of interest in cash.
Federal tax law requires that the holder of a zero coupon security or
other OID security include in gross income each year the original issue discount
that accrues on the security for the year, even though the holder receives no
interest payment on the security during the year. Accordingly, to continue to
qualify for treatment as a regulated investment company for federal tax
purposes, and to avoid imposition of federal income and excise taxes, the fund
may be required in a particular year to distribute as dividends amounts that are
greater than the total amount of cash it actually receives during that year.
These distributions must be made from the fund's cash assets or, if necessary,
from the proceeds of sales of portfolio securities. The fund will not be able to
purchase additional securities with cash used to make such distributions, and
its current income and the value of its shares may ultimately be reduced as a
result.
ILLIQUID SECURITIES. The term "illiquid securities" 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, purchased over-the-counter 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 the fund's board. The assets used as cover for over-the-counter
options written by the fund will be considered illiquid unless the options are
sold to qualified dealers who agree that the fund may repurchase the options at
a maximum price to be calculated by a formula set forth in the option
agreements. The cover for an over-the-counter 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.
The fund may not be able to readily liquidate its investments in illiquid
securities and may have to sell other investments if necessary to raise cash to
meet its obligations. The lack of a liquid secondary market for illiquid
securities may make it more difficult for the fund to assign a value to those
securities for purposes of valuing its portfolio and calculating its net asset
value.
Restricted securities are not registered under the Securities Act of 1933,
as amended ("Securities Act"), and may be sold only in privately negotiated or
other exempted transactions or after a Securities Act registration statement has
become effective. Where registration is required, the 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 the fund may be
permitted to sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop, the fund might
obtain a less favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. If the fund holds foreign
securities are freely tradable in the country in which they are principally
traded, they generally are not considered illiquid, even if they are restricted
in the United States. A large institutional market has developed for many U.S.
and foreign securities that are not registered under the Securities 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.
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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 Securities 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
the 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.
The 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 bids are solicited and
the mechanics of transfer). Mitchell Hutchins monitors the liquidity of
restricted securities in the fund's portfolio and reports periodically on such
decisions to the board.
Mitchell Hutchins also monitors the fund's overall holdings of illiquid
securities. If the fund's holdings of illiquid securities exceed its limitation
on investments in illiquid securities for any reason (such as a particular
security becoming illiquid, changes in the relative market values of liquid and
illiquid portfolio securities or shareholder redemptions), Mitchell Hutchins
will consider what action would be in the best interests of the fund and its
shareholders. Such action may include engaging in an orderly disposition of
securities to reduce the fund's holdings of illiquid securities. However, the
fund is not required to dispose of illiquid securities under these
circumstances.
TEMPORARY AND DEFENSIVE INVESTMENTS; MONEY MARKET INVESTMENTS. The fund
may invest in money market investments for temporary or defensive purposes, to
reinvest cash collateral from its securities lending activities or as part of
its normal investment program. Such investments include, among other things, (1)
securities issued or guaranteed by the U.S. government or one of its agencies or
instrumentalities, (2) debt obligations of banks, savings and loan institutions,
insurance companies and mortgage bankers, (3) commercial paper and notes,
including those with variable and floating rates of interest, (4) debt
obligations of foreign branches of U.S. banks, U.S. branches of foreign banks
and foreign branches of foreign banks, (5) debt obligations issued or guaranteed
by one or more foreign governments or any of their political subdivisions,
agencies or instrumentalities, including obligations of supranational entities,
(6) bonds issued by foreign issuers, (7) repurchase agreements and (8) other
investment companies that invest exclusively in money market instruments and
similar private investment vehicles.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which the
fund purchases securities or other obligations from a bank or securities dealer
(or its affiliate) and simultaneously commits to resell them to the counterparty
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 obligations.
The fund maintains custody of the underlying obligations prior to their
repurchase, either through its regular custodian or through a special
"tri-party" custodian or sub-custodian that maintains separate accounts for both
the fund and its counterparty. Thus, the obligation of the counterparty to pay
the repurchase price on the date agreed to or upon demand is, in effect, secured
by such obligations.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including a possible decline in the market value of
the underlying obligations. If their value becomes less than the repurchase
price, plus any agreed-upon additional amount, the counterparty 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 obligations and
the price that was paid by the fund upon acquisition is accrued as interest and
included in its net investment income. Repurchase agreements involving
obligations other than U.S. government securities (such as commercial paper and
corporate bonds) may be subject to special risks and may not have the benefit of
certain protections in the event of the counterparty's insolvency. If the seller
or guarantor becomes insolvent, the fund may suffer delays, costs and possible
losses in connection with the disposition of collateral. The fund intends to
enter into repurchase agreements only with counterparties in transactions
believed by Mitchell Hutchins to present minimum credit risks.
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REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve the
sale of securities held by the fund subject to the 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. Reverse repurchase agreements are subject
to the fund's limitation on borrowings and may be entered into only with banks
and securities dealers or their affiliates. While a reverse repurchase agreement
is outstanding, the fund will maintain, in a segregated account with its
custodian, cash or liquid securities, marked to market daily, in an amount at
least equal to its obligations under the reverse repurchase agreement. See "The
Fund's Investments, Related Risks and Limitations -- Segregated Accounts."
Reverse repurchase agreements involve the risk that the buyer of the
securities sold by the fund might be unable to deliver them when the fund seeks
to repurchase. In the event that the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, such buyer or
trustee or receiver may receive an extension of time to determine whether to
enforce the fund's obligation to repurchase the securities, and the fund's use
of the proceeds of the reverse repurchase agreement may effectively be
restricted pending such decision.
LENDING OF PORTFOLIO SECURITIES. The fund is authorized to lend its
portfolio securities to broker-dealers or institutional investors that Mitchell
Hutchins deems qualified. Lending securities enables the fund to earn additional
income, but could result in a loss or delay in recovering these securities. The
borrower of the fund's portfolio securities must maintain acceptable collateral
with the fund's custodian in an amount, marked to market daily, 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. The fund may reinvest any cash collateral in money market
investments or other short-term liquid investments including other investment
companies. The fund also may reinvest cash collateral in private investment
vehicles similar to money market funds, including one managed by Mitchell
Hutchins. 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. The fund will
retain authority to terminate any of its loans at any time. The 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 reinvestment of cash
held as collateral. The fund will receive amounts equivalent to any dividends,
interest or other distributions on the securities loaned. The fund will regain
record ownership of loaned securities to exercise beneficial rights, such as
voting and subscription rights, when regaining such rights is considered to be
in the fund's interest.
Pursuant to procedures adopted by the board governing the fund's
securities lending program, PaineWebber has been retained to serve as lending
agent for the fund. The board also has authorized the payment of fees (including
fees calculated as a percentage of invested cash collateral) to PaineWebber for
these services. The board periodically reviews all portfolio securities loan
transactions for which PaineWebber acted as lending agent. PaineWebber also has
been approved as a borrower under the fund's securities lending program.
SHORT SALES "AGAINST THE BOX." The 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 the fund, and the fund is
obligated to replace the securities borrowed at a date in the future. When the
fund sells short, it establishes a margin account with the broker effecting the
short sale and deposits collateral with the broker. In addition, the fund
maintains with its custodian, in a segregated account, the securities that could
be used to cover the short sale. The fund incurs transaction costs, including
interest expense, in connection with opening, maintaining and closing short
sales "against the box."
The 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 the fund or a
security convertible into or exchangeable for a security owned by the fund. In
such case, any loss in the 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 securities the fund owns,
either directly or indirectly, and in the case where the fund owns convertible
securities, changes in the investment value or conversion premiums of such
securities.
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WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The fund may purchase
securities on a "when-issued" basis or may purchase or sell securities for
delayed delivery, I.E., for issuance or delivery to or by the fund later than a
normal settlement date for such securities at a stated price and yield. The fund
generally would not pay for such securities or start earning interest on them
until they are received. However, when the fund undertakes a when-issued or
delayed delivery obligation, it immediately assumes the risks of ownership,
including the risks of price fluctuation. Failure of the issuer to deliver a
security purchased by the fund on a when-issued or delayed delivery basis may
result in the fund's incurring or missing an opportunity to make an alternative
investment.
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 the fund's net asset value. When the fund commits to purchase
securities on a when-issued or delayed delivery basis, its custodian segregates
assets to cover the amount of the commitment. See "The Fund's Investments,
Related Risks and Limitations--Segregated Accounts." The fund's when-issued and
delayed delivery purchase commitments could cause its net asset value per share
to be more volatile.
INVESTMENTS IN OTHER INVESTMENT COMPANIES. The fund may invest in
securities of other investment companies, subject to limitations imposed by the
Investment Company Act of 1940, as amended ("Investment Company Act"). Among
other things, these limitations currently restrict the fund's aggregate
investments in other investment companies to no more than 10% of its total
assets. The fund's investment in certain private investment vehicles are not
subject to this restriction. The shares of other investment companies are
subject to the management fees and other expenses of those companies, and the
purchase of shares of some investment companies requires the payment of sales
loads and (in the case of closed-end investment companies) sometimes substantial
premiums above the value of such companies' portfolio securities. At the same
time, the fund would continue to pay its own management fees and expenses with
respect to all its investments, including shares of other investment companies.
The fund may invest in the shares of other investment companies when, in the
judgment of Mitchell Hutchins, the potential benefits of the investment outweigh
the payment of any management fees and expenses and, where applicable, premium
or sales load.
SEGREGATED ACCOUNTS. When the fund enters into certain transactions that
involve obligations to make future payments to third parties, including the
purchase of securities on a when-issued or delayed delivery basis and reverse
repurchase agreements, 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 "Strategies Using Derivative
Instruments," segregated accounts may also be required in connection with
certain transactions involving options, futures, forward currency contracts and
swaps.
INVESTMENT LIMITATIONS OF THE FUND
FUNDAMENTAL LIMITATIONS. The following investment limitations cannot be
changed for the fund without the affirmative vote of the lesser of (a) more than
50% of its outstanding shares or (b) 67% or more of the shares present at a
shareholders' meeting if more than 50% of its 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, a later increase or decrease in
percentage resulting from changing values of portfolio securities or amount of
total assets will not be considered a violation of any of the following
limitations. With regard to the borrowings limitation in fundamental limitation
(3), the fund will comply with the applicable restrictions of Section 18 of the
Investment Company Act.
The 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.
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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 the
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.
(3) issue senior securities or borrow money, except as permitted under the
Investment Company 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 are
non-fundamental and may be changed by the vote of the appropriate board without
shareholder approval. If a percentage restriction is adhered to at the time of
an investment or transaction, a later increase or decrease in percentage
resulting from changing values of portfolio securities or amount of total assets
will not be considered a violation of any of the following limitations.
The fund will not:
(1) invest more than 10% of its net assets in illiquid securities.
(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.
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(4) purchase securities of other investment companies, except to the
extent permitted by the Investment Company 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.
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
STRATEGIES USING DERIVATIVE INSTRUMENTS
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"), options on
futures contracts, forward currency contracts and swap transactions. The fund
may enter into transactions involving one or more types of Derivative
Instruments under which the full value of its portfolio is at risk. Under normal
circumstances, however, the 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 fund are described below.
The fund might not use any Derivative Instruments or derivative
strategies, and there can be no assurance that using any strategy will succeed.
If Mitchell Hutchins is incorrect in its judgment on market values, interest
rates or other economic factors in using a Derivative Instrument or strategy,
the fund may have lower net income and a net loss on the investment.
OPTIONS ON 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 or at specified
times or at the expiration of the option, depending on the type of option
involved. 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 or at specified times or at the expiration of the option,
depending on the type of option involved. 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 SECURITIES INDICES -- A securities index assigns relative
values to the securities included in the index and fluctuates with changes in
the market values of those securities. A securities index option operates in the
same way as a more traditional securities option, except that exercise of a
securities index option is effected with cash payment and does not involve
delivery of securities. Thus, upon exercise of a securities 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 securities
index.
SECURITIES INDEX FUTURES CONTRACTS -- A securities 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 securities 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 securities 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 bonds 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 will be accompanied by delivery of the accumulated balance that
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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 STRATEGIES USING DERIVATIVE INSTRUMENTS. The fund
may use Derivative Instruments to attempt to hedge its portfolio and also to
attempt to enhance income or return or realize gains and to manage the duration
of its bond portfolio. The fund may use Derivative Instruments to maintain
exposure to stocks or bonds while maintaining a cash balance for fund management
purposes (such as to provide liquidity to meet anticipated shareholder sales of
fund shares and for fund operating expenses), to facilitate trading or to adjust
its exposure to different asset classes. The fund may use Derivative Instruments
on currencies, including forward currency contracts, to hedge against price
changes of securities that the fund owns or intends to acquire that are
attributable to changes in the value of the currencies in which the securities
are denominated. In addition, the fund may use Derivative Instruments on
currencies to shift exposure from one currency to another or to attempt to
realize gains from favorable changes in exchange rates.
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 the fund's portfolio. Thus, in a short hedge the 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, the
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, the 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, the 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 the fund intends to acquire. Thus, in a
long hedge, the 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, the 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, the fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, the fund might be able to offset the price increase by
closing out an appreciated call option and realizing a gain.
The fund may purchase and write (sell) 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. The fund
might enter into a long straddle when Mitchell Hutchins believes it 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. The 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 the fund
owns or intends to acquire. Derivative Instruments on stock indices, in
contrast, generally are used to hedge against price movements in broad stock
market sectors in which the fund has invested or expects to invest. Derivative
Instruments on bonds may be used to hedge either individual securities or broad
fixed income market sectors.
Income strategies using Derivative Instruments may include the writing of
covered options to obtain the related option premiums. Return or gain strategies
may include using Derivative Instruments to increase or decrease the fund's
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exposure to different asset classes without buying or selling the underlying
instruments. The fund also may use derivatives to simulate full investment by
the fund while maintaining a cash balance for fund management purposes (such as
to provide liquidity to meet anticipated shareholder sales of fund shares and
for fund operating expenses).
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, the fund's
ability to use Derivative Instruments may be limited by tax considerations. See
"Taxes."
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins may discover additional opportunities in
connection with Derivative Instruments and with hedging, income, return and gain
strategies. These new opportunities may become available as regulatory
authorities broaden the range of permitted transactions and as new Derivative
Instruments and techniques are developed. Mitchell Hutchins may utilize these
opportunities for the fund to the extent that they are consistent with the
fund's investment objective and permitted by its investment limitations and
applicable regulatory authorities. The fund's Prospectus or this SAI 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 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 that are 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 the 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, the 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, the 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 the
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. The 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 counterparty to enter into a transaction
closing out the position. Therefore, there is no assurance that any hedging
position can be closed out at a time and price that is favorable to the fund.
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COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose the fund to an
obligation to another party. The fund will not enter into any such transactions
unless it owns either (1) an offsetting ("covered") position in securities,
currencies or other options or futures contracts or (2) cash or liquid
securities with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. The fund will
comply with SEC guidelines regarding cover for such 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, committing a large portion of the
fund's assets to cover positions or to segregated accounts could impede
portfolio management or the fund's ability to meet redemption requests or other
current obligations.
OPTIONS. The fund may purchase put and call options, and write (sell)
covered put or call options on securities in which it invests and related
indices and on 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. The fund
may also use options to attempt to enhance return or realize gains by increasing
or reducing its exposure to an asset class without purchasing or selling the
underlying securities. Writing covered put or call options can enable the fund
to enhance income by reason of the premiums paid by the purchasers of such
options. 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 fund will be obligated to
sell the security at less than its market value. Writing covered put options
serves 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. The securities or other assets used as cover for
over-the-counter options written by the fund would be considered illiquid to the
extent described under "The Fund's Investments, Related Risks and
Limitations--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. Generally, over-the-counter options on bonds are
European-style options. This means that the option can only be exercised
immediately prior to its expiration. This is in contract to American-style
options that may be exercised at any time. There are also other types of options
that may be exercised on certain specified dates before expiration. Options that
expire unexercised have no value.
The fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the 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, the 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 the fund to realize profits or
limit losses on an option position prior to its exercise or expiration.
The fund may purchase and write both exchange-traded and over-the-counter
options. Currently, many options on equity securities (stocks) are
exchange-traded. Exchange markets for options on bonds exist but are relatively
new, and these instruments are primarily traded on the over-the-counter 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, over-the-counter options are contracts between the fund and its
counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the fund purchases or writes an
over-the-counter option, it relies on the counterparty to make or take delivery
of the underlying investment upon exercise of the option. Failure by the
counterparty 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.
15
<PAGE>
The fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The fund intends 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
over-the-counter options only by negotiating directly with the counterparty, or
by a transaction in the secondary market if any such market exists. Although the
fund will enter into over-the-counter options only with counterparties that are
expected to be capable of entering into closing transactions with the fund there
is no assurance that the fund will in fact be able to close out an
over-the-counter option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, the fund might be unable to close
out an over-the-counter option position at any time prior to its expiration.
If the 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.
The fund may purchase and write put and call options on 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 a securities
market (or market sector) rather than anticipated increases or decreases in the
value of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. The fund's use of options is governed
by the following guidelines, which can be changed by its board without
shareholder vote:
(1) The fund may purchase a put or call option, including any straddle or
spread, only if the value of its premium, when aggregated with the premiums on
all other options held by the fund, does not exceed 5% of its total assets.
(2) The aggregate value of securities underlying put options written by
the fund, determined as of the date the put options are written, will not exceed
50% of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by the fund that are held at any time will not exceed 20%
of its net assets.
FUTURES. The fund may purchase and sell securities index futures
contracts, interest rate future contracts and foreign currency future contracts.
The fund may 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. In addition, the fund may purchase or sell futures contracts or
purchase options thereon to increase or reduce its exposure to an asset class
without purchasing or selling the underlying securities, either as a hedge or to
enhance return or realize gains.
Futures strategies also can be used to manage the average duration of the
fund's bond portfolio. If Mitchell Hutchins wishes to shorten the average
duration of the fund's bond portfolio, the fund may sell a futures contract or a
call option thereon, or purchase a put option on that futures contract. If
Mitchell Hutchins wishes to lengthen the average duration of the fund's bond
portfolio, the fund may buy a futures contract or a call option thereon, or sell
a put option thereon.
The fund may also write put options on futures contracts while at the same
time purchasing call options on the same futures contracts in order
synthetically to create a long futures contract position. Such options would
have the same strike prices and expiration dates. The fund will engage in this
strategy only when it is more advantageous to the fund than is purchasing the
futures contract.
16
<PAGE>
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract the 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 United States 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 the fund at the termination of the transaction if
all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, the 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 the fund's obligations to or from a futures
broker. When the fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the 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 the 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 fund intends 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 the 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. The fund would continue to be subject
to market risk with respect to the position. In addition, except in the case of
purchased options, the 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 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 fund's use of
futures and related options is governed by the following guidelines, which can
be changed by its board without shareholder vote:
(1) To the extent the 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.
17
<PAGE>
(2) The aggregate premiums paid on all options (including options on
securities, foreign currencies and securities indices and options on futures
contracts) purchased by the 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 the fund will not exceed 5% of its total assets.
FOREIGN CURRENCY HEDGING STRATEGIES -- SPECIAL CONSIDERATIONS. The fund
may use options and futures on foreign currencies, as described above, and
forward currency contracts, as described below, to hedge against movements in
the values of the foreign currencies in which the fund's securities are
denominated. Such currency hedges can protect against price movements in a
security the 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 fund 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 considered expensive. In such cases, the fund 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. In addition, the fund may use forward
currency contracts to shift 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 Derivative Instrument will
not correlate or will correlate unfavorably with the foreign currency being
hedged.
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, the 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.
Settlement of Derivative Instruments involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
the fund 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. The 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.
The cost to the 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
18
<PAGE>
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
counterparty to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterparty to do so would result in the loss
of any expected benefit of the transaction.
As is the case with futures contracts, parties to forward currency
contracts can enter into offsetting closing transactions, similar to closing
transactions on futures, by entering into an instrument identical to the
instrument purchased or sold, but in the opposite direction. 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 counterparty. Thus, there can be no assurance
that the 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 counterparty, 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, the fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not 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. The 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.
SWAP TRANSACTIONS. The fund may enter into swap transactions, which
include swaps, caps, floors and collars relating to interest rates, currencies,
securities or other instruments. Interest rate swaps 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 and 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. Currency swaps, caps, floors and collars are similar to interest rate
swaps, caps, floors and collars, but they are based on currency exchange rates
rather than interest rates. Equity swaps or other swaps relating to securities
or other instruments are also similar, but they are based on changes in the
value of the underlying securities or instruments. For example, an equity swap
might involve an exchange of the value of a particular security or securities
index in a certain notional amount for the value of another security or index or
for the value of interest on that notional amount at a specified fixed or
variable rate.
The fund may enter into interest rate swap transactions to preserve a
return or spread on a particular investment or portion of its bond portfolio or
to protect against any increase in the price of securities it anticipates
purchasing at a later date. The fund may use interest rate swaps, caps, floors
and collars as a hedge on either an asset-based or liability-based basis,
depending on whether it is hedging its assets or its liabilities. Interest rate
swap transactions are subject to risks comparable to those described above with
respect to other derivatives strategies.
The fund will usually enter into 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. Since 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
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<PAGE>
of the excess, if any, of the fund's obligations over its entitlements with
respect to each 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 swaps that are not entered into on a net basis.
The fund will enter into interest rate swap transactions only with banks
and recognized securities dealers or their respective affiliates believed by
Mitchell Hutchins to present minimal credit risk in accordance with guidelines
established by the fund's 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.
ORGANIZATION OF THE CORPORATION; DIRECTORS AND OFFICERS;
PRINCIPAL HOLDERS AND MANAGEMENT OWNERSHIP OF SECURITIES
The Corporation was organized on February 13, 1986, as a Maryland
corporation, and has one operating series. The Corporation has authority to
issue 300 million shares of common stock of separate series, par value $0.001
per share.
The Corporation is governed by a board of directors, which oversees its
operations and which is authorized to establish additional series. The directors
("board members") and executive officers of the Corporation, their ages,
business addresses and principal occupations during the past five years are:
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
Margo N. Alexander*+; 53 Director and Mrs. Alexander is Chairman
President (since March 1999), chief
executive officer and a director
of Mitchell Hutchins (since
January 1995), and an executive
vice president and director of
PaineWebber (since March 1984).
Mrs. Alexander is president and a
director or trustee of 30
investment companies for which
Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
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<PAGE>
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
Richard Q. Armstrong; 65 Director Mr. Armstrong is chairman and
R.Q.A. Enterprises principal of R.Q.A. Enterprises
One Old Church Road (management consulting firm)
Unit #6 (since April 1991 and principal
Greenwich, CT 06830 occupation since March 1995).
Mr. Armstrong was chairman of the
board, chief executive officer
and co-owner of Adirondack
Beverages (producer and
distributor of soft drinks and
sparkling/still waters) (October
1993-March 1995). He was a
partner of The New England
Consulting Group (management
consulting firm) (December
1992-September 1993). He was
managing director of LVMH U.S.
Corporation (U.S. subsidiary of
the French luxury goods
conglomerate, Louis Vuitton Moet
Hennessey Corporation)
(1987-1991) and chairman of its
wine and spirits subsidiary,
Schieffelin & Somerset Company
(1987-1991). Mr. Armstrong is a
director or trustee of 29
investment companies for which
Mitchell Hutchins, PaineWebber or
one of their affiliates serves as
investment adviser.
E. Garrett Bewkes, Director and Mr. Bewkes is a director of
Jr.**+; 73 Chairman of the Paine Webber Group Inc. ("PW
Board of Directors Group") (holding company of
PaineWebber and Mitchell
Hutchins). Prior to 1996, he was
a consultant to PW Group. He
serves as a consultant to
PaineWebber (since May 1999).
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.
Mr. Bewkes is a director or
trustee of 40 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
21
<PAGE>
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
Richard R. Burt; 53 Director Mr. Burt is chairman of IEP
1275 Pennsylvania Ave., Advisors, LLP (international
N.W. investments and consulting firm)
Washington, D.C. 20004 (since March 1994) and a partner
of McKinsey & Company
(management consulting firm)
(since 1991). He is also a
director of
Archer-Daniels-Midland Co.
(agricultural commod-ities),
Hollinger International Co.
(publishing), Homestake Mining
Corp., (gold mining), six
investment companies in the
Deutsche Bank family of funds,
nine investment companies in the
Flag Investors family of funds,
The Central European Fund, Inc.
and The Germany Fund, Inc., vice
chairman of Anchor Gaming
(provides technology to gaming
and wagering industry) (since
July 1999) and chairman of
Weirton Steel Corp. (makes and
finishes steel products) (since
April 1996). 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 29 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
Mary C. Farrell**+; 50 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 appears 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
Business. Ms. Farrell is a
director or trustee of 28
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
Meyer Feldberg; 58 Director Mr. Feldberg is Dean and
Columbia University Professor of Management of the
101 Uris Hall Graduate School of Business,
New York, NY 10027 Columbia University. Prior to
1989, he was president of the
Illinois Institute of
Technology. Dean Feldberg is
also a director of Primedia,
Inc. (publishing), Federated
Department Stores, Inc.
(operator of department stores)
and Revlon, Inc. (cosmetics).
Dean Feldberg is a director or
trustee of 37 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
22
<PAGE>
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
George W. Gowen; 70 Director Mr. Gowen is a partner in the
666 Third Avenue law firm of Dunnington,
New York, NY 10017 Bartholow & Miller. Prior to May
1994, he was a partner in the
law firm of Fryer, Ross & Gowen.
Mr. Gowen is a director or
trustee of 37 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
Frederic V. Malek; 63 Director Mr. Malek is chairman of Thayer
1455 Pennsylvania Ave., Capital Partners (merchant bank)
N.W. and chairman of Thayer Hotel
Suite 350 Investors II and Lodging
Washington, D.C. 20004 Opportunities Fund (hotel
investment partnerships). From
January 1992 to November 1992,
he was campaign manager of
Bush-Quayle `92. From 1990 to
1992, he was vice chairman and,
from 1989 to 1990, he was
president of Northwest Airlines
Inc. and NWA Inc. (holding
company of Northwest Airlines
Inc.). Prior to 1989, he was
employed by the Marriott
Corporation (hotels,
restaurants, airline catering
and contract feeding), where he
most recently was an executive
vice president and president of
Marriott Hotels and Resorts. Mr.
Malek is also a director of
Aegis Communications, Inc.
(tele-services), American
Management Systems, Inc.
(management consulting and
computer related services),
Automatic Data Processing, Inc.
(computing services), CB Richard
Ellis, Inc. (real estate
services), FPL Group, Inc.
(electric services), Global
Vacation Group (packaged
vacations), HCR/Manor Care, Inc.
(health care), SAGA Systems,
Inc. (software company) and
Northwest Airlines Inc. Mr.
Malek is a director or trustee
of 29 investment companies for
which Mitchell Hutchins,
PaineWebber or one of their
affiliates serves as investment
adviser.
23
<PAGE>
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
Carl W. Schafer; 64 Director Mr. Schafer is president of the
66 Witherspoon Street, Atlantic Foundation (charitable
#1100 foundation supporting mainly
Princeton, NJ 08542 oceanographic exploration and
research). He is a director of
Labor Ready, Inc. (temporary
employment), Roadway Express,
Inc. (trucking), The Guardian
Group of Mutual Funds, the
Harding, Loevner Funds, E.I.I.
Realty Trust (investment
company), Evans Systems, Inc.
(motor fuels, convenience store
and diversified company),
Electronic Clearing House, Inc.
(financial transactions
processing), Frontier Oil
Corporation and Nutraceutix,
Inc. (bio-technology company).
Prior to January 1993, he was
chairman of the Investment
Advisory Committee of the Howard
Hughes Medical Institute. Mr.
Schafer is a director or trustee
of 29 investment companies for
which Mitchell Hutchins,
PaineWebber or one of their
affiliates serves as investment
adviser.
Brian M. Storms*+; 45 Director Mr. Storms is president and
chief operating officer of
Mitchell Hutchins (since March
1999). Mr. Storms was president
of Prudential Investments
(1996-1999). Prior to joining
Prudential, he was a managing
director at Fidelity
Investments. Mr. Storms is a
director or trustee of 29
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
Thomas Disbrow***; 34 Vice President and Mr. Disbrow is a first vice
Assistant Treasurer president and a senior manager
of the mutual fund finance
department of Mitchell
Hutchins. Prior to November
1999, he was a vice president of
Zweig/Glaser Advisers. Mr.
Disbrow is a vice president and
assistant treasurer of 30
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
John J. Holmgren****; 61 Vice President Mr. Holmgren is a Managing
Director of Mitchell Hutchins
(since August 2000). Mr.
Holmgren is also president,
chief executive officer and a
director of DSI International
Management, Inc. ("DSI"). He is
a vice president of two
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
24
<PAGE>
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
John J. Holmgren****; 38 Vice President Mr. Holmgren is a Managing
Director of Mitchell Hutchins
(since August 2000). Mr.
Holmgren is also executive vice
president, chief operating
officer, a portfolio manager and
a director of DSI. Prior to
January 1997, he was president
of DSC Data Services, Inc., a
consulting firm. Mr. Holmgren
is a vice president of two
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
John J. Lee***; 31 Vice President and Mr. Lee is a vice president and
Assistant Treasurer a 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 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
Kevin J. Mahoney***; 34 Vice President Mr. Mahoney is a first vice
and Assistant president and senior manager of
Treasurer the mutual fund finance
department of Mitchell Hutchins.
From August 1996 through March
1999, he was the manager of the
mutual fund internal control
group of Salomon Smith Barney.
Prior to August 1996, he was an
associate and assistant
treasurer for BlackRock
Financial Management L.P.
Mr. Mahoney is a vice president
and assistant treasurer of 30
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
Ann E. Moran***; 43 Vice President and Ms. Moran is a vice president
Assistant Treasurer and a manager of the mutual fund
finance department of Mitchell
Hutchins. Ms. Moran is a vice
president and assistant
treasurer of 30 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
Dianne E. O'Donnell**; 48 Vice President and Ms. O'Donnell is a senior vice
Secretary president and deputy general
counsel of Mitchell Hutchins.
Ms. O'Donnell is a vice
president and secretary of 30
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
Paul H. Schubert***; 37 Vice President and Mr. Schubert is a senior vice
Treasurer president and the director of
the mutual fund finance
department of Mitchell Hutchins.
Mr. Schubert is a vice president
and treasurer of 30 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
25
<PAGE>
POSITION WITH BUSINESS EXPERIENCE; OTHER
NAME AND ADDRESS; AGE CORPORATION DIRECTORSHIPS
--------------------- ----------- -------------
Barney A. Vice President and Mr. Taglialatela is a vice
Taglialatela***; 39 Assistant Treasurer president and a manager of the
mutual fund finance department
of Mitchell Hutchins. Mr.
Taglialatela is a vice president
and assistant treasurer of 30
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
Mark A. Tincher*; 44 Vice President Mr. Tincher is a managing
director and chief investment
officer--equities of Mitchell
Hutchins. Mr. Tincher is a vice
president of 10 investment
companies for which Mitchell
Hutchins, PaineWebber or one of
their affiliates serves as
investment adviser.
Keith A. Weller**; 38 Vice President and Mr. Weller is a first vice
Assistant Secretary president and associate general
counsel of Mitchell Hutchins.
Mr. Weller is a vice president
and assistant secretary of 29
investment companies for which
Mitchell Hutchins, PaineWebber
or one of their affiliates
serves as investment adviser.
-------------
* This person's business address is 51 West 52nd Street, New York, New York
10019-6114.
** This person's business address is 1285 Avenue of the Americas, New York,
New York 10019-6028.
*** This person's business address is Newport Center III, 499 Washington Blvd.,
14th Floor, Jersey City, New Jersey 07310-1998.
**** This person's business address is 301 Merritt 7, Norwalk, Connecticut
06851.
+ Mrs. Alexander, Mr. Bewkes, Ms. Farrell and Mr. Storms are "interested
persons" of the fund as defined in the Investment Company Act by virtue of
their positions with Mitchell Hutchins, PaineWebber, and/or PW Group.
The Corporation pays each director who is not an "interested person" of
the Corporation $1,500 annually and up to $150 per series for attending each
board meeting and each separate meeting of a board committee. Each chairman of
the audit and contract review committees of individual funds within the
PaineWebber fund complex receives additional compensation aggregating $15,000
annually from the relevant funds. All board members are reimbursed for any
expenses incurred in attending meetings. Because Mitchell Hutchins and
PaineWebber perform substantially all of the services necessary for the
operation of the Corporation and the fund, the Corporation requires no
employees. No officer, director or employee of Mitchell Hutchins or PaineWebber
presently receives any compensation from the 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 Corporation or with other
PaineWebber funds during the periods indicated.
26
<PAGE>
<TABLE>
COMPENSATION TABLE+
<CAPTION>
TOTAL COMPENSATION FROM
AGGREGATE THE CORPORATION
COMPENSATION FROM THE AND THE FUND
NAME OF PERSON, POSITION CORPORATION* COMPLEX**
------------------------ ------------ ---------
<S> <C> <C>
Richard Q. Armstrong,
Director................................. $ 2,280 $ 104,650
Richard R. Burt,
Director................................. 2,280 102,850
Meyer Feldberg,
Director................................. 2,932 143,650
George W. Gowen,
Director................................. 2,280 138,400
Frederic V. Malek,
Director................................. 2,280 104,650
Carl W. Schafer,
Director................................. 2,250 104,650
</TABLE>
--------------------
+ Only independent board members are compensated by the PaineWebber funds and
identified above; board members who are "interested persons," as defined by
the Investment Company Act, do not receive compensation from the PaineWebber
funds.
* Represents fees paid to each board member from the Corporation for the fiscal
year ended March 31, 2000.
** Represents total compensation paid during the calendar year ended December
31, 1999, to each board member by 31 investment companies (34 in the case of
Messrs. Feldberg and Gowen) for which Mitchell Hutchins, PaineWebber or one
of their affiliates served as investment adviser. No fund within the
PaineWebber fund complex has a bonus, pension, profit sharing or retirement
plan.
PRINCIPAL HOLDERS AND MANAGEMENT OWNERSHIP OF SECURITIES
As of June 30, 2000, directors and officers owned in the aggregate less
than 1% of the outstanding shares of any class of the fund.
As of June 30, 2000, the following shareholder was shown in the fund's
records as owning 5% or more of any class of the fund's shares:
PERCENTAGE OF SHARES
BENEFICIALLY OWNED AS
NAME AND ADDRESS* OF JUNE 30, 2000
----------------- ----------------
James Holtman
PW Rollover IRA 6.65%
----------------
* The shareholder listed may be contacted c/o Mitchell Hutchins Asset
Management Inc., 51 West 52nd Street, New York, NY 10019-6114.
INVESTMENT ADVISORY, ADMINISTRATION AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY AND ADMINISTRATION ARRANGEMENTS. Mitchell Hutchins
acts as the investment adviser and administrator to the fund pursuant to a
contract ("Advisory Contract") with the Corporation. Under the Advisory
Contract, the fund pays Mitchell Hutchins a fee, computed daily and paid
monthly, at the annual rate of 0.70% of its average daily net assets.
27
<PAGE>
During the fiscal years ended March 31, 2000, March 31, 1999 and March 31,
1998, the fund paid (or accrued) investment advisory and administrative fees of
$2,541,366, $3,553,490 and $1,912,197, respectively. For the fiscal year ended
March 31, 2000, Mitchell Hutchins voluntarily waived $4,398 of its fee under the
Advisory Contract in connection with the fund's investment of cash collateral
from securities lending in a private investment vehicle managed by Mitchell
Hutchins.
Under the terms of the Advisory Contract, the fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. Expenses borne by the fund include the following: (1) the cost
(including brokerage commissions, if any) 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 who are not interested persons of the 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 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 and supplements thereto, statements of
additional information and supplements thereto, reports and proxy materials for
existing shareholders and costs of mailing such materials to existing
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 trustees and
officers; and (18) costs of mailing, stationery and communications equipment.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the 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. The Advisory Contract terminates
automatically upon its assignment and is terminable at any time without penalty
by the 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 Corporation.
TRANSFER AGENCY-RELATED SERVICES. PFPC Inc. ("PFPC"), the fund's transfer
agent, (not the fund) pays PaineWebber for certain transfer agency-related
services that PFPC has delegated to PaineWebber. Prior to August 1, 1997,
PaineWebber provided certain services to the fund not otherwise provided by
PFPC. Pursuant to a separate agreement between PaineWebber and the Corporation
relating to those services, PaineWebber earned (or accrued) $14,088 for the four
months ended July 31, 1997.
SECURITIES LENDING. During the fiscal years ended March 31, 2000, March
31, 1999 and March 31, 1998, the fund paid (or accrued) $13,851, $14,067 and
$24,841, respectively, to PaineWebber for its services as securities lending
agent.
NET ASSETS. The following table shows the approximate net assets as of
June 30, 2000, sorted by category of investment objective, of the investment
companies as to which Mitchell Hutchins serves as adviser or sub-adviser. An
investment company may fall into more than one of the categories below.
28
<PAGE>
NET ASSETS
INVESTMENT CATEGORY ($MIL)
------------------- ------
Domestic (excluding Money Market)............... $ 9,266.8
Global.......................................... 4,753.1
Equity/Balanced................................. 9,728.1
Fixed Income (excluding Money Market)........... 4,291.8
Taxable Fixed Income..................... 2,881.0
Tax-Free Fixed Income.................... 1,410.8
Money Market Funds.............................. 38,725.6
PERSONAL TRADING POLICIES. The fund, its investment adviser and its
principal underwriter each have adopted a code of ethics under rule 17j-1 of the
Investment Company Act, which permits personnel covered by the rule to invest in
securities that may be purchased or held by the fund but prohibits fraudulent,
deceptive or manipulative conduct in connection with that personal investing.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of
each class of shares of the fund under separate distribution contracts with the
Corporation (collectively, "Distribution Contracts"). The Distribution Contract
requires Mitchell Hutchins to use its best efforts, consistent with its other
businesses, to sell shares of the fund. Shares of the fund are offered
continuously. Under separate dealer agreements between Mitchell Hutchins and
PaineWebber relating to each class of shares of the fund (collectively, "PW
Dealer Agreements"), PaineWebber and its correspondent firms sell the fund's
shares. Mitchell Hutchins is located at 51 West 52nd Street, New York, New York
10019-6114 and PaineWebber is located at 1285 Avenue of the Americas, New York,
New York 10019-6028.
Under separate plans of distribution pertaining to the Class A, Class B
and Class C shares of the fund adopted by the Corporation in the manner
prescribed under Rule 12b-1 under the Investment Company Act (each,
respectively, a "Class A Plan," "Class B Plan" and "Class C Plan," and
collectively, "Plans"), the 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. Under the Class B Plan and the Class C Plan, the
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. There is no distribution plan with respect to the fund's Class Y
shares and the fund pays no service or distribution fees with respect to its
Class Y shares.
Mitchell Hutchins uses the service fees under the Plans for Class A, Class
B and Class C shares primarily to pay PaineWebber for shareholder servicing,
currently at the annual rate of 0.25% of the aggregate investment amounts
maintained in the fund by PaineWebber clients. PaineWebber then compensates its
Financial Advisors for shareholder servicing that they perform and offsets its
own expenses in servicing and maintaining shareholder accounts.
Mitchell Hutchins uses the distribution fees under the Class B and Class C
Plans to:
o Offset the commissions it pays to PaineWebber for selling the fund's
Class B and Class C shares, respectively.
o Offset the fund's marketing costs attributable to such classes, such
as preparation, printing and distribution of sales literature,
advertising and prospectuses to prospective investors and related
overhead expenses, such as employee salaries and bonuses.
PaineWebber compensates Financial Advisors when Class B and Class C shares
are bought by investors, as well as on an ongoing basis. Mitchell Hutchins
receives no special compensation from the fund or investors at the time Class B
or C shares are bought.
Mitchell Hutchins receives the proceeds of the initial sales charge paid
when Class A shares are bought and of the contingent deferred sales charge paid
upon sales of shares. These proceeds may be used to cover distribution expenses.
29
<PAGE>
The Plans and the related Distribution Contracts for Class A, Class B and
Class C shares specify that the fund must pay service and distribution fees to
Mitchell Hutchins for its service- and distribution-related activities, not as
reimbursement for specific expenses incurred. Therefore, even if Mitchell
Hutchins' expenses exceed the service or distribution fees it receives, the fund
will not be obligated to pay more than those fees. On the other hand, if
Mitchell Hutchins' expenses are less than such fees, it will retain its full
fees and realize a profit. Expenses in excess of service and distribution fees
received or accrued through the termination date of any Plan will be Mitchell
Hutchins' sole responsibility and not that of the fund. Annually, the board of
the fund reviews the Plans and Mitchell Hutchins' corresponding expenses for
each class separately from the Plans and expenses of the other classes.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the applicable 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 applicable board, including those board members who are not
"interested persons" of the Corporation 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 the
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 fund and (4) while the Plan remains in effect, the selection and
nomination of board members who are not "interested persons" of the Corporation
shall be committed to the discretion of the board members who are not
"interested persons" of the Corporation.
In reporting amounts expended under the Plans to the board members,
Mitchell Hutchins allocates expenses attributable to the sale of each class of
the 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
the fund's shares will not be used to subsidize the sale of any other class of
fund shares.
The fund paid (or accrued) the following service and/or distribution fees
to Mitchell Hutchins under the Class A, Class B and Class C Plans during the
fiscal year ended March 31, 2000:
Class A.................................... $ 407,951
Class B.................................... 1,398,523
Class ..................................... 561,488
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to the fund during the fiscal year
ended March 31, 2000:
CLASS A
Marketing and advertising............. $ 959,351
Amortization of commissions........... 0
Printing of prospectuses and SAIs..... 1,154
Branch network costs allocated and
interest expense........... 653,327
Service fees paid to PaineWebber
Financial Advisors......... 159,101
CLASS B
Marketing and advertising............. $ 807,990
Amortization of commissions........... 510,650
Printing of prospectuses and SAIs..... 837
Branch network costs allocated and
interest expense........... 637,724
Service fees paid to PaineWebber
Financial Advisors......... 136,356
30
<PAGE>
CLASS C
Marketing and advertising............. $ 325,319
Amortization of commissions........... 164,235
Printing of prospectuses and SAIs..... 349
Branch network costs allocated and
interest expense...................... 223,677
Service fees paid to PaineWebber
Financial Advisors.................... 54,745
"Marketing and advertising" includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing the fund's 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 fund's shares, including the PaineWebber retail branch system.
In approving the fund's overall Flexible Pricing(SERVICEMARK) system of
distribution, the 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 the fund and attracting
new investors and assets to the fund to the benefit of the fund and its
shareholders, (2) facilitate distribution of the fund's shares and (3) maintain
the competitive position of the fund in relation to other funds that have
implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan, the 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 Financial Advisors 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 the PW Dealer Agreement with Mitchell Hutchins and (6)
Mitchell Hutchins' shareholder service-related expenses and costs.
In approving the Class B Plan, the 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 PW Financial Advisors 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 Financial Advisors 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 the PW 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 Financial
Advisors, 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, the board considered all the features of
the distribution system, including (1) 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, (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 Financial Advisors 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 Financial Advisors 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,
31
<PAGE>
(6) the services provided by PaineWebber pursuant to the PW 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 Financial
Advisors after Class C shares have been held more than one year, without the
concomitant receipt by Mitchell Hutchins of initial sales charges or contingent
deferred sales charges upon redemption after one year following purchase was
conditioned upon its expectation of being compensated under the Class C Plan.
With respect to each Plan, the board 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 also considered the
benefits that would accrue to Mitchell Hutchins under each Plan in that Mitchell
Hutchins would receive service, distribution and advisory fees that are
calculated based upon a percentage of the average net assets of the fund, which
fees would increase if the Plan were successful and the fund attained and
maintained significant asset levels.
Under the Distribution Contract between the fund and Mitchell Hutchins for
the 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 dealer.
FISCAL YEARS ENDED MARCH 31,
----------------------------
2000 1999 1998
---- ---- ----
Earned.............................$ 200,908 $ 1,505,641 $ 2,006,218
Retained........................... 13,756 103,282 143,106
Mitchell Hutchins earned and retained the following contingent deferred
sales charges paid upon certain redemptions of shares for the fiscal year ended
March 31, 2000:
Class A................ $ 0
Class B................ 1,437,342
Class C................ 34,831
PORTFOLIO TRANSACTIONS
Subject to policies established by the board, Mitchell Hutchins is
responsible for the execution of the fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins seeks to obtain the best net results for the 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 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 fund may invest in securities traded
in the over-the-counter 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 years
ended March 31, 2000, March 31, 1999 and March 31, 1998, the fund paid
$1,800,513, $791,116 and $317,283, respectively, in brokerage commissions.
The fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The fund contemplates that, consistent
with the policy of obtaining the best net results, brokerage transactions may be
conducted through Mitchell Hutchins or its affiliates, including PaineWebber.
The board has adopted procedures in conformity with Rule 17e-1 under the
Investment Company Act to ensure that all brokerage commissions paid to
PaineWebber are reasonable and fair. Specific provisions in the Advisory
Contract authorizes Mitchell Hutchins and any of its affiliates that is a member
of a national securities exchange to effect portfolio transactions for the fund
32
<PAGE>
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 fiscal years ended March 31, 2000, March 31, 1999 and March 31,
1998, the fund paid $66,672, $66,432 and $17,497, respectively, in brokerage
commissions to PaineWebber. The brokerage commissions paid by the fund for the
fiscal year ended March 31, 2000 represented 3.70% of the total commissions paid
by that fund and 4.45% of the aggregate dollar amount of the fund's transactions
involving commission payments.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs"), who receive brokerage commissions for their services. The
fund's procedures in selecting FCMs to execute its 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.
In selecting brokers, Mitchell Hutchins will consider the full range and
quality of a broker's services. Consistent with the interests of the fund and
subject to the review of the board, Mitchell Hutchins may cause the fund to
purchase and sell portfolio securities through brokers who provide Mitchell
Hutchins with brokerage or research services. The fund may pay those brokers a
higher commission than may be charged by other brokers, provided that Mitchell
Hutchins determines in good faith that the commission is reasonable in terms
either of that particular transaction or of the overall responsibility of
Mitchell Hutchins to the fund and its other clients.
Research services obtained from brokers may include written reports,
pricing and appraisal services, analysis of issues raised in proxy statements,
educational seminars, subscriptions, portfolio attribution and monitoring
services, and computer hardware, software and access charges which are directly
related to investment research. Research services may be received in the form of
written reports, online services, telephone contacts and personal meetings with
securities analysts, economists, corporate and industry spokespersons and
government representatives.
During the fiscal year ended March 31, 2000, the fund directed $98,258,229
in portfolio transactions to brokers chosen because they provide brokerage or
research services, for which the fund paid $132,232 in brokerage commissions.
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, it
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. Mitchell Hutchins may engage in agency
transactions in over-the-counter equity and debt securities in return for
research and execution services. These transactions are entered into only
pursuant to procedures that are designed to ensure 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.
Research services and information received from brokers or dealers are
supplemental to Mitchell Hutchins' own research efforts and, when utilized, are
subject to internal analysis before being incorporated into their investment
processes. Information and research services furnished by brokers or dealers
through which or with which the fund effects 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 fund.
Investment decisions for the 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 the fund and one or more accounts. In
those cases, simultaneous transactions are inevitable. Purchases or sales are
then averaged as to price and allocated between that fund and the other
account(s) as to amount in a manner deemed equitable to the fund and the other
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 fund is concerned, or upon
its ability to complete its entire order, in other cases it is believed that
simultaneous transactions and the ability to participate in volume transactions
will benefit the fund.
33
<PAGE>
The fund 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 the board pursuant to Rule 10f-3 under the
Investment Company 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 fund.
As of March 31, 2000, the fund owned securities issued by the following
companies which are regular broker-dealers for the fund:
<TABLE>
<CAPTION>
ISSUER TYPE OF SECURITY VALUE
------ ---------------- -----
<S> <C> <C>
Citigroup, Inc. common stock $ 10,083,125
American Express Co. common stock 4,468,125
Charles Schwab Corp. common stock 7,385,625
Donaldson, Lufkin & Jenrette Inc. common stock 5,175,000
Legg Mason common stock 1,297,500
Lehman Brothers Holdings Inc. common stock 11,640,000
Merrill Lynch & Co. Inc. common stock 8,400,000
Morgan Stanley, Dean Witter & Co. common stock 4,893,750
T. Rowe Price & Associates, Inc. common stock 5,332,500
Dresdner Bank repurchase agreement 10,000,000
Merrill Lynch & Co. Inc. common stock 2,636,000
</TABLE>
PORTFOLIO TURNOVER. The fund's 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 the 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. During the fiscal
years ended March 31, 2000 and March 31, 1999, the fund's portfolio turnover
rates were 122% and 59%, respectively. The higher turnover rate in the most
recent fiscal year was primarily due to ongoing portfolio restructuring as a
result largely of increased industry consolidation and market sector volatility.
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
WAIVERS OF SALES CHARGES/CONTINGENT DEFERRED SALES CHARGES -- CLASS A
SHARES. The following additional sales charge waivers are available for Class A
shares if you:
o Purchase shares through a variable annuity offered only to qualified
plans. For investments made pursuant to this waiver, Mitchell
Hutchins may make payments out of its own resources to PaineWebber
and to the variable annuity's sponsor, adviser or distributor in a
total amount not to exceed l% of the amount invested;
o Acquire shares through an investment program that is not sponsored
by PaineWebber or its affiliates and that charges participants a fee
for program services, provided that the program sponsor has entered
into a written agreement with PaineWebber permitting the sale of
shares at net asset value to that program. For investments made
pursuant to this waiver, Mitchell Hutchins may make a payment to
PaineWebber out of its own resources in an amount not to exceed 1%
of the amount invested. For subsequent investments or exchanges made
to implement a rebalancing feature of such an investment program,
the minimum subsequent investment requirement is also waived;
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o Acquire shares in connection with a reorganization pursuant to which
the fund acquires substantially all of the assets and liabilities of
another fund in exchange solely for shares of the acquiring fund; or
o Acquire shares in connection with the disposition of proceeds from
the sale of shares of Managed High Yield Plus Fund Inc. that were
acquired during that fund's initial public offering of shares and
that meet certain other conditions described in its prospectus.
In addition, reduced sales charges on Class A shares are available through
the combined purchase plan or through rights of accumulation described below.
Class A share purchases of $1 million or more are not subject to an initial
sales charge; however, if a shareholder sells these shares within one year after
purchase, a contingent deferred sales charge of 1% of the offering price or the
net asset value of the shares at the time of sale by the shareholder, whichever
is less, is imposed.
COMBINED PURCHASE PRIVILEGE -- CLASS A SHARES. Investors and eligible
groups of related fund investors may combine purchases of Class A shares of the
fund 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
tables of sales charges for Class A shares in the Prospectus. The sales charge
payable on the purchase of Class A shares of the fund and Class A shares of such
other funds will be at the rates applicable to the total amount of the combined
concurrent purchases.
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 the 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 UniformTransfers to Minors Act/Uniform Gifts 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 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.
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REINSTATEMENT PRIVILEGE -- CLASS A SHARES. Shareholders who have redeemed
Class A shares may reinstate their account without a sales charge 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 will be taxable regardless of whether the reinstatement
privilege is exercised, although a loss arising out of a redemption will not be
deductible to the extent the reinstatement privilege is exercised within 30 days
after redemption, in which event 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 readjusted 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 "Taxes -- Special Rule for Class A Shareholders,"
below.
WAIVERS OF CONTINGENT DEFERRED SALES CHARGES -- CLASS B SHARES. The
maximum 5% contingent deferred sales charge applies to sales of shares during
the first year after purchase. The charge generally declines by 1% annually,
reaching zero after six years. 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 sole 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.
PURCHASES OF CLASS Y SHARES THROUGH THE PACE(SERVICEMARK) MULTI ADVISOR
PROGRAM. An investor who participates in the PACE(SERVICEMARK) Multi Advisor
Program is eligible to purchase Class Y shares. The PACE(SERVICEMARK) Multi
Advisor Program is an advisory program sponsored by PaineWebber that provides
comprehensive investment services, including investor profiling, a personalized
asset allocation strategy using an appropriate combination of funds, and a
quarterly investment performance review. Participation in the PACE(SERVICEMARK)
Multi Advisor Program is subject to payment of an advisory fee at the effective
maximum annual rate of 1.5% of assets. Employees of PaineWebber and its
affiliates are entitled to a waiver of this fee. Please contact your PaineWebber
Financial Advisor or PaineWebber's correspondent firms for more information
concerning mutual funds that are available through the PACE(SERVICEMARK) Multi
Advisor Program.
PURCHASES OF CLASS A SHARES THROUGH THE PAINEWEBBER
INSIGHTONE(SERVICEMARK) PROGRAM. Investors who purchase shares through the
PaineWebber InsightOne(SERVICEMARK) Program are eligible to purchase Class A
shares without a sales load. The PaineWebber InsightOne(SERVICEMARK) Program
offers a nondiscretionary brokerage account to investors for an asset-based fee
at an annual rate of up to 1.50% of the assets in the account. Account holders
may purchase or sell certain investment products without paying commissions or
other markups/markdowns.
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the fund may be exchanged for shares of the
corresponding class of most other PaineWebber mutual funds. Class Y shares are
not eligible for exchange. Shareholders will receive at least 60 days' notice of
any termination or material modification of the exchange offer, except no notice
need be given if, under extraordinary circumstances, either redemptions are
suspended under the circumstances described below or the 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.
If conditions exist that make cash payments undesirable, the fund reserves
the right to honor any request for redemption by making payment in whole or in
part in securities chosen by the fund and valued in the same way as they would
be valued for purposes of computing the fund's 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. The fund has
elected, however, to be governed by Rule 18f-1 under the Investment Company Act,
under which it is obligated to redeem shares solely in cash up to the lesser of
$250,000 or 1% of its net asset value during any 90-day period for one
shareholder. This election is irrevocable unless the SEC permits its withdrawal.
The fund may suspend redemption privileges or postpone the date of payment
during any period (1) when the New York Stock Exchange is closed or trading on
the New York Stock Exchange is restricted as determined by the SEC, (2) when an
emergency exists, as defined by the SEC, that makes it not reasonably
practicable for the fund to dispose of securities owned by it or fairly to
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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 the fund's portfolio at the time.
SERVICE ORGANIZATIONS. The fund may authorize service organizations, and
their agents, to accept on its behalf purchase and redemption orders that are in
"good form" in accordance with the policies of those service organizations. The
fund will be deemed to have received these purchase and redemption orders when a
service organization or its agent accepts them. Like all customer orders, these
orders will be priced based on the fund's net asset value next computed after
receipt of the order by the service organizations or their agents. Service
organizations may include retirement plan service providers who aggregate
purchase and redemption instructions received from numerous retirement plans or
plan participants.
AUTOMATIC INVESTMENT PLAN. PaineWebber offers an automatic investment plan
with a minimum initial investment of $1,000 through which the fund will deduct
$50 or more on a monthly, quarterly, semi-annual or annual basis from the
investor's bank account to invest directly in the fund. Participation in the
automatic investment plan enables an investor to use the technique of "dollar
cost averaging." When an investor invests the same dollar amount each month
under the plan, the investor will purchase more shares when the 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 both low and
high price levels. An investor should also consider whether a large, single
investment would qualify for sales load reductions.
SYSTEMATIC WITHDRAWAL PLAN. The systematic withdrawal plan allows
investors to set up monthly, quarterly (March, June, September and December),
semi-annual (June and December) or annual (December) withdrawals from their
PaineWebber mutual fund accounts. Minimum balances and withdrawals vary
according to the class of shares:
o Class A and Class C shares. Minimum value of fund shares is $5,000;
minimum withdrawals of $100.
o Class B shares. Minimum value of fund shares is $10,000; minimum
monthly, quarterly, and semi-annual and annual withdrawals of $100,
$200, $300 and $400, respectively.
Withdrawals under the systematic withdrawal plan will not be subject to a
contingent deferred sales charge if the investor withdraws no more than 12% of
the value of the fund account when the investor signed up for the Plan (for
Class B shares, annually; for Class A and Class C shares, during the first year
under the Plan). Shareholders who elect to receive dividends or other
distributions in cash may not participate in this 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 the minimum values specified
above. Purchases of additional shares of the 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 a month for
monthly, quarterly, semi-annual and annual plans, PaineWebber will arrange for
redemption by the fund of sufficient fund shares to provide the withdrawal
payments specified by participants in the fund's systematic withdrawal plan. The
payments generally are mailed approximately five Business Days (defined under
"Valuation of Shares") after the redemption date. Withdrawal payments should not
be considered dividends, but redemption proceeds. 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. 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 PFPC. Shareholders may request the
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forms needed to establish a systematic withdrawal plan from their PaineWebber
Financial Advisors, correspondent firms or PFPC at 1-800-647-1568.
INDIVIDUAL RETIREMENT ACCOUNTS. Self-directed IRAs are available through
PaineWebber in which purchases of PaineWebber mutual funds and other investments
may be made. Investors considering establishing an IRA should review applicable
tax laws and should consult their tax advisers.
TRANSFER OF ACCOUNTS. If investors holding shares of the fund in a
PaineWebber brokerage account transfer their brokerage accounts to another firm,
the fund shares will be moved to an account with PFPC. However, if the other
firm has entered into a selected dealer agreement with Mitchell Hutchins
relating to the fund, the shareholder may be able to hold fund shares in an
account with the other firm.
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN(SERVICEMARK);
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(REGISTERED) (RMA)(REGISTERED)
Shares of PaineWebber mutual funds (each a "PW fund" and, collectively,
the "PW funds") are available for purchase through the RMA Resource Accumulation
Plan ("Plan") by customers of PaineWebber and its correspondent firms who
maintain Resource Management Accounts ("RMA accountholders"). 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 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 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 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 in connection with enrolling in
the Plan. Information about mutual fund positions and outstanding instructions
under the Plan are noted on the RMA accountholder's account statement.
Instructions under the Plan may be changed at any time, but may take up to two
weeks to become effective.
The terms of the Plan, or an RMA accountholder's participation in the
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 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 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 may result in a
lower average original investment cost per share than if an investor invested a
larger dollar amount in a mutual fund at one time. In deciding whether to use
dollar cost averaging, an investor should also consider whether a large, single
investment would qualify for sales load reductions.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the 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:
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o monthly Premier account statements that itemize all account
activity, including investment transactions, checking activity and
Platinum MasterCard(REGISTERED) transactions during the period, and
provide unrealized and realized gain and loss estimates for most
securities held in the account;
o comprehensive year-end summary statements that provide information
on account activity for use in tax planning and tax return
preparation;
o 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. AN INVESTMENT IN A MONEY
MARKET FUND IS NOT INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT
INSURANCE CORPORATION OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH A
MONEY MARKET FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT
$1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN A
MONEY MARKET FUND;
o 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;
o Platinum 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 Platinum MasterCard are debited to the RMA account once monthly,
permitting accountholders to remain invested for a longer period of
time;
o 24-hour access to account information through toll-free numbers, and
more detailed personal assistance during business hours from the RMA
Service Center;
o unlimited electronic funds transfers and bill payment service for an
additional fee;
o expanded account protection for the net equity securities balance in
the event of the liquidation of PaineWebber. This protection does
not apply to shares of funds that are held at PFPC and not through
PaineWebber; and
o 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
Platinum MasterCard, with an additional fee of $40 if the investor selects an
optional line of credit with the Platinum MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares will automatically convert to Class A shares, 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 the 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 (i) the
date on which the Class B shares were issued or (ii) 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 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 that the conversion of shares does not constitute
a taxable event. If the conversion feature ceased to be available, the Class B
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shares 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 will
not continue to be met.
VALUATION OF SHARES
The fund determines its net asset value per share separately for each
class of shares, normally as of the close of regular trading (usually 4:00 p.m.,
Eastern time) on the New York Stock Exchange on each Business Day, which is
defined as each Monday through Friday when the New York Stock Exchange is open.
Prices will be calculated earlier when the New York Stock Exchange closes early
because trading has been halted for the day. Currently the New York Stock
Exchange 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 exchanges normally 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
over-the-counter market and listed on the Nasdaq Stock Market ("Nasdaq")
normally are valued at the last available sale price on Nasdaq prior to
valuation; other over-the-counter securities are valued at the last bid price
available prior to valuation. Where market quotations are readily available,
portfolio securities are valued based upon market quotations, provided those
quotations adequately reflect, in the judgment of Mitchell Hutchins, the fair
value of the security. Where those market quotations are not readily available,
securities are valued based upon appraisals received from a pricing service
using a computerized matrix system or based upon appraisals derived from
information concerning the security or similar securities received from
recognized dealers in those securities. All other securities and other assets
are valued at fair value as determined in good faith by or under the direction
of the board. It should be recognized that judgment often plays a greater role
in valuing thinly traded securities, including many lower rated bonds, than is
the case with respect to securities for which a broader range of dealer
quotations and last-sale information is available. The amortized cost method of
valuation generally is used to value debt obligations with 60 days or less
remaining until maturity, unless the board determines that this does not
represent fair value.
PERFORMANCE INFORMATION
The fund's performance data quoted in advertising and other promotional
materials ("Performance Advertisements") represent past performance and are 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 the fund's Performance Advertisements are
calculated according to the following formula:
P(1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares
of a 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.
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.
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The fund 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 fund calculates 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.
The following table shows performance information for each class of the
fund's shares outstanding for the periods indicated. All returns for periods of
more than one year are expressed as an average annual return.
<TABLE>
<CAPTION>
CLASS CLASS A CLASS B CLASS C CLASS Y
----- ------- ------- ------- -------
(INCEPTION DATE) (5/22/86) (7/1/91) (7/2/92) (3/30/98)
---------------- --------- -------- -------- ---------
<S> <C> <C> <C> <C>
Year ended March 31, 2000:
Standardized Return*............ (12.97)% (14.01)% (10.46)% (8.76)%
Non-Standardized Return......... (8.88)% (9.63)% (9.59)% (8.76)%
Five Years ended March 31, 2000:
Standardized Return*............ 16.87% 16.84% 17.05% N/A
Non-Standardized Return......... 17.96% 17.05% 17.05% N/A
Ten Years ended March 31, 2000:
Standardized Return*............ 18.61% N/A N/A N/A
Non-Standardized Return......... 19.16% N/A N/A N/A
Inception to March 31, 2000:
Standardized Return*............ 13.62% 18.68% 15.55% (7.67)%
Non-Standardized Return......... 14.00% 18.68% 15.55% (7.67)%
</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 charge imposed on a redemption of shares held for the period.
Class Y shares do not impose an initial or contingent deferred sales charge;
therefore, the performance information is the same for both standardized
return and non-standardized return for the periods indicated.
OTHER INFORMATION. In Performance Advertisements, the fund may compare its
Standardized Return and/or their Non-Standardized Return with data published by
Lipper Inc. ("Lipper") for U.S. government funds, corporate bond (BBB) funds and
high yield funds, CDA Investment Technologies, Inc. ("CDA"), Wiesenberger
Investment Companies Service ("Wiesenberger"), Investment Company Data, Inc.
("ICD") or Morningstar Mutual Funds ("Morningstar"), or with the performance of
recognized stock, bond and other indices, including the Municipal Bond Buyers
Indices, Lehman Bond Index, the Standard & Poor's 500 Composite Stock Price
Index ("S&P 500"), the Dow Jones Industrial Average, Merrill Lynch Municipal
Bond Indices, the Morgan Stanley Capital International World Index, the Lehman
Brothers Treasury Bond Index, Lehman Brothers Government/Corporate Bond Index,
the Salomon Smith Barney World Government Bond Index and changes in the Consumer
Price Index as published by the U.S. Department of Commerce. The fund also may
refer in these 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 fund 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 fund 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 the fund investment are reinvested
in additional fund shares, any future income or capital appreciation of the 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
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of the fund investment would increase more quickly than if dividends or other
distributions had been paid in cash.
The fund may also compare its 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(REGISTERED) Money Markets. In comparing the
fund's 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 fund are not insured or guaranteed by
the U.S. government and returns and net asset values will fluctuate. The debt
securities held by the fund generally have longer maturities than most CDs and
may reflect interest rate fluctuations for longer term debt securities. An
investment in the fund involves greater risks than an investment in either a
money market fund or a CD.
The fund may also compare its performance to general trends in the stock
and bond markets, as illustrated by the following graph prepared by Ibbotson
Associates, Chicago.
The chart below contains the following plot points:
Common Long-Term Treasury
YEAR Stocks Gov't Bonds Inflation/CPI Bills
1925 $10,000 $10,000 $10,000 $10,000
1926 $11,162 $10,777 $9,851 $10,327
1927 $15,347 $11,739 $9,646 $10,649
1928 $22,039 $11,751 $9,553 $11,028
1929 $20,184 $12,153 $9,572 $11,552
1930 $15,158 $12,719 $8,994 $11,831
1931 $8,588 $12,044 $8,138 $11,957
1932 $7,885 $14,072 $7,300 $12,072
1933 $12,142 $14,062 $7,337 $12,108
1934 $11,967 $15,473 $7,486 $12,128
1935 $17,672 $16,243 $7,710 $12,148
1936 $23,667 $17,465 $7,803 $12,170
1937 $15,376 $17,505 $8,045 $12,208
1938 $20,161 $18,473 $7,822 $12,205
1939 $20,079 $19,570 $7,784 $12,208
1940 $18,115 $20,762 $7,859 $12,208
1941 $16,015 $20,955 $8,623 $12,215
1942 $19,273 $21,630 $9,424 $12,248
1943 $24,265 $22,080 $9,721 $12,291
1944 $29,057 $22,700 $9,926 $12,331
1945 $39,645 $25,136 $10,150 $12,372
1946 $36,446 $25,111 $11,993 $12,415
1947 $38,527 $24,453 $13,074 $12,478
1948 $40,646 $25,284 $13,428 $12,579
1949 $48,283 $26,915 $13,186 $12,717
1950 $63,594 $26,931 $13,950 $12,870
1951 $78,869 $25,873 $14,769 $13,061
1952 $93,357 $26,173 $14,899 $13,278
1953 $92,433 $27,126 $14,991 $13,520
1954 $141,071 $29,076 $14,916 $13,636
1955 $185,594 $28,701 $14,971 $13,850
1956 $197,768 $27,097 $15,399 $14,191
1957 $176,449 $29,118 $15,864 $14,636
1958 $252,957 $27,345 $16,144 $14,862
1959 $283,211 $26,727 $16,386 $15,300
1960 $284,542 $30,410 $16,628 $15,707
1961 $361,055 $30,705 $16,740 $16,042
1962 $329,535 $32,820 $16,944 $16,480
1963 $404,669 $33,271 $17,223 $16,994
1964 $471,359 $34,383 $17,428 $17,596
1965 $530,043 $34,627 $17,763 $18,287
1966 $476,721 $35,891 $18,358 $19,158
1967 $591,038 $32,597 $18,916 $19,964
1968 $656,407 $32,512 $19,809 $21,004
1969 $600,613 $30,863 $21,019 $22,386
1970 $624,697 $34,601 $22,173 $23,846
1971 $714,091 $39,179 $22,918 $24,893
1972 $849,626 $41,408 $23,700 $25,849
1973 $725,071 $40,948 $25,785 $27,640
1974 $533,144 $42,730 $28,931 $29,851
1975 $731,474 $46,661 $30,956 $31,582
1976 $905,565 $54,500 $32,442 $33,193
1977 $840,364 $54,118 $34,648 $34,886
1978 $895,828 $53,469 $37,767 $37,398
1979 $1,060,661 $52,827 $42,790 $41,287
1980 $1,404,315 $50,767 $48,096 $45,911
1981 $1,335,504 $51,732 $52,376 $52,660
1982 $1,621,301 $72,631 $54,419 $58,190
1983 $1,986,094 $73,139 $56,487 $63,310
1984 $2,111,218 $84,476 $58,746 $69,515
1985 $2,791,030 $110,664 $60,979 $74,867
1986 $3,307,371 $137,776 $61,649 $79,509
1987 $3,479,354 $134,056 $64,362 $83,882
1988 $4,063,885 $147,060 $67,194 $89,167
1989 $5,344,009 $173,678 $70,285 $96,657
1990 $5,173,001 $184,446 $74,572 $104,196
1991 $6,750,766 $220,044 $76,884 $110,031
1992 $7,270,575 $237,867 $79,114 $113,882
1993 $7,996,906 $281,159 $81,250 $117,185
1994 $8,101,665 $259,229 $83,443 $121,755
1995 $10,507,050 $313,511 $85,404 $126,856
1996 $13,710,736 $337,286 $88,451 $135,380
1997 $18,274,382 $363,828 $90,067 $142,494
1998 $23,495,420 $441,777 $91,513 $149,416
1999 $28,456,286 $402,177 $93,998 $156,414
The chart is shown for illustrative purposes only and does not represent the
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 Index, 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 1999 Yearbook((TRADEMARK) )Ibbotson
Assoc., Chi. (annual updates work by Roger G. Ibbotson & Rex A. Sinquefield).
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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 1999, stocks beat all other traditional asset
classes. A $10,000 investment in the stocks comprising the S&P 500 Index grew to
$28,456,286, significantly more than any other investment.
TAXES
BACKUP WITHHOLDING. The fund is required to withhold 31% of all dividends,
capital gain distributions and redemption proceeds payable to individuals and
certain other non-corporate shareholders who do not provide the fund or
PaineWebber with a correct taxpayer identification number. Withholding at that
rate also is required from dividends and capital gain distributions payable to
those shareholders who otherwise are subject to backup withholding.
SALE OR EXCHANGE OF FUND SHARES. A shareholder's sale (redemption) of
shares may result in a taxable gain or loss, depending on whether the
shareholder receives more or less than his or her adjusted basis in the shares
(which normally includes any initial sales charge paid on Class A shares). An
exchange of the fund's shares for shares of another PaineWebber mutual fund
generally will have similar tax consequences. In addition, if the fund's shares
are bought within 30 days before or after selling other fund shares (regardless
of class) at a loss, all or a portion of that loss will not be deductible and
will increase the basis in the newly purchased shares.
SPECIAL RULE FOR CLASS A SHAREHOLDERS. A special tax rule applies when a
shareholder sells or exchanges Class A shares within 90 days of purchase and
subsequently acquires Class A shares of the same or another PaineWebber mutual
fund without paying a sales charge due to the 365-day reinstatement privilege or
the exchange privilege. In these cases, any gain on the sale or exchange of the
original Class A shares would be increased, or any loss would be decreased, by
the amount of the sales charge paid when those shares were bought, and that
amount would increase the basis in the PaineWebber mutual fund shares
subsequently acquired.
CONVERSION OF CLASS B SHARES. A shareholder will recognize no gain or loss
as a result of a conversion from Class B shares to Class A shares.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY. The fund intends to
continue to qualify for treatment as a regulated investment company ("RIC")
under the Internal Revenue Code. To so qualify, the 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.
These additional 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 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
that are 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. If the fund
failed to qualify for treatment as a RIC for any taxable year, (1) it would be
taxed as an ordinary corporation on its taxable income for that year without
being able to deduct the distributions it makes to its shareholders and (2) the
shareholders would treat all those distributions, including distributions of net
capital gain (the excess of net long-term capital gain over net short-term
capital loss), as dividends (that is, ordinary income) to the extent of the
fund's earnings and profits. In addition, the fund could be required to
recognize unrealized gains, pay substantial taxes and interest, and make
substantial distributions before requalifying for RIC treatment.
OTHER INFORMATION. Dividends and other distributions the fund declares in
October, November or December of any year that are 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 fund
pays the distributions during the following January.
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A portion of the dividends from the 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 the fund receives 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 thereon. Investors also
should be aware that if shares are purchased shortly before the record date for
a 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, and gains realized, by the fund on
foreign securities may be subject to income, withholding or other taxes imposed
by foreign countries and U.S. possessions (collectively "foreign taxes") that
would reduce the return on its securities. Tax conventions between certain
countries and the United States, however, may reduce or eliminate foreign taxes,
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 the 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 will enable its shareholders, in effect, to
receive the benefit of the foreign tax credit with respect to any foreign taxes
it paid. Pursuant to the election, the fund would treat those taxes as dividends
paid to its shareholders and each shareholder (1) would be required to include
in gross income, and treat as paid by him or her, his or her proportionate share
of those taxes, (2) would be required to 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) could
either deduct the foreign 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. The
fund will report to its shareholders shortly after each taxable year their
respective shares of foreign taxes paid to, and the income from sources within,
foreign countries and U.S. possessions if it 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, in which event they would
be able to claim a foreign tax credit without having to file the detailed Form
1116 that otherwise is required. The fund does not expect to be able to make
this election during the coming year.
The 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 the calendar year and capital gain
net income for the one-year period ending on October 31 of that year, plus
certain other amounts.
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 determine for income tax purposes the amount,
character and timing of recognition of the gains and losses the 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 the fund with respect
to its business of investing in securities or foreign currencies, qualify as
permissible income under the Income Requirement.
The fund may invest in the stock of "passive foreign investment companies"
("PFICs") if that stock is a permissible investment. A PFIC is a foreign
corporation (with certain exceptions) 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, the 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 such 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 it distributes that income
to its shareholders.
If the 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 -- which
it may have to distribute to satisfy the Distribution Requirement and avoid
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imposition of the Excise Tax -- even if the QEF does not distribute those
earnings and gain to the fund. In most instances it will be very difficult, if
not impossible, to make this election because of certain of its requirements.
The 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 a PFIC's stock over
the fund's adjusted basis therein as of the end of that year. Pursuant to the
election, the fund also would be allowed to 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 by the fund for
prior taxable years under the election (and under regulations proposed in 1992
that provided a similar election with respect to the stock of certain PFICs).
The fund's adjusted basis in each PFIC's stock with respect to which it has made
this election will be adjusted to reflect the amounts of income included and
deductions taken thereunder.
Certain futures and foreign currency contracts in which the fund may
invest may be subject to section 1256 of the Code ("section 1256 contracts").
Any section 1256 contracts the fund holds at the end of its taxable year
generally must be "marked-to-market" (that is, treated as having been sold at
that time for their fair market value) for federal income tax purposes, with the
result that unrealized gains or losses will be treated as though they were
realized. Sixty percent of any net gain or loss recognized on these deemed
sales, and 60% of any net realized gain or loss from any actual sales of section
1256 contracts, will be treated as long-term capital gain or loss, and the
balance will be treated as short-term capital gain or loss. These rules may
operate to increase the amount that the fund must distribute to satisfy the
Distribution Requirement (i.e., with respect to the portion treated as
short-term capital gain), which will be taxable to the shareholders as ordinary
income, and to increase the net capital gain the fund recognizes, without in
either case increasing the cash available to the fund. The fund may elect not to
have the foregoing rules apply to any "mixed straddle" (that is, a straddle,
clearly identified by the fund in accordance with the applicable regulations, at
least one (but not all) of the positions of which are section 1256 contracts),
although doing so may have the effect of increasing the relative proportion of
net short-term capital gain (taxable as ordinary income) and thus increasing the
amount of dividends that must be distributed.
Gains or losses (1) from the disposition of foreign currencies , including
forward currency contracts, (2) on the disposition of each
foreign-currency-denominated debt security that are attributable to fluctuations
in the value of the foreign currency between the dates of acquisition and
disposition of the security and (3) that are attributable to exchange rate
fluctuations between the time the fund accrues interest, dividends or other
receivables, or expenses or other liabilities, denominated in a foreign currency
and the time the fund actually collects the receivables or pays the liabilities,
generally are treated as ordinary income or loss. These gains, referred to under
the Code as "section 988" gains or losses, increase or decrease the amount of
the fund's investment company taxable income available to be distributed to its
shareholders as ordinary income, rather than increasing or decreasing the amount
of its net capital gain. If section 988 losses exceed other investment company
taxable income during a taxable year, the fund would not be able to distribute
any dividends, and any distributions made during that year before the losses
were realized would be recharacterized as a return of capital to shareholders,
rather than as a dividend, thereby reducing each shareholder's basis in his or
her fund shares.
Offsetting positions the fund enters into or holds in any actively traded
security, option, futures or forward contract may constitute a "straddle" for
federal income tax purposes. Straddles are subject to certain rules that may
affect the amount, character and timing of the fund's gains and losses with
respect to positions of the straddle by requiring, among other things, that (1)
loss realized on disposition of one position of a straddle be deferred to the
extent of any unrealized gain in an offsetting position until the latter
position is disposed of, (2) the fund's holding period in certain straddle
positions not begin until the straddle is terminated (possibly resulting in gain
being treated as short-term rather than long-term capital gain) and (3) losses
recognized with respect to certain straddle positions, that otherwise would
constitute short-term capital losses, be treated as long-term capital losses.
Applicable regulations also provide certain "wash sale" rules, which apply to
transactions where a position is sold at a loss and a new offsetting position is
acquired within a prescribed period, and "short sale" rules applicable to
straddles. Different elections are available to the fund, which may mitigate the
effects of the straddle rules, particularly with respect to "mixed straddles"
(i.e., a straddle of which at least one, but not all, positions are section 1256
contracts).
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When a covered call option written (sold) by the fund expires, it realizes
a short-term capital gain equal to the amount of the premium it received for
writing the option. When the fund terminates its obligations under such an
option by entering into a closing transaction, it realizes a short-term capital
gain (or loss), depending on whether the cost of the closing transaction is less
(or more) than the premium it received when it wrote the option. When a covered
call option written by the fund is exercised, the fund is treated as having sold
the underlying security, producing long-term or short-term capital gain or loss,
depending on the holding period of the underlying security and whether the sum
of the option price received on the exercise plus the premium received when it
wrote the option is more or less than the basis of the underlying security.
If the 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 position, 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 the fund or a related person with respect to
the same or substantially identical property. In addition, if the appreciated
financial position is itself a short sale or such a contract, acquisition of the
underlying property or substantially identical property will be deemed a
constructive sale. The foregoing will not apply, however, to a 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 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 identical 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).
The fund may acquire zero coupon or other securities issued with original
issue discount ("OID") and/or Treasury inflation-protected securities ("TIPS"),
on which principal is adjusted based on changes in the Consumer Price Index. The
fund must include in its gross income the OID that accrues on those securities,
and the amount of any principal increases on TIPS, during the taxable year, even
if it receives no corresponding payment on them during the year. The fund has
elected similar treatment with respect to securities purchased at a discount
from their face value ("market discount"). Because the fund annually must
distribute substantially all of its investment company taxable income, including
any accrued OID, market discount and other non-cash income, to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax, it may be
required in a particular year to distribute as a dividend an amount that is
greater than the total amount of cash it actually receives. Those distributions
would have to be made from the fund's cash assets or from the proceeds of sales
of portfolio securities, if necessary. The fund might realize capital gains or
losses from those sales, which would increase or decrease its investment company
taxable income and/or net capital gain.
The foregoing is only a general summary of some of the important federal
tax considerations generally affecting the fund and its shareholders. No attempt
is made to present a complete explanation of the federal tax treatment of the
fund's activities, and this discussion is not intended as a substitute for
careful tax planning. Accordingly, potential investors are urged to consult
their own tax advisers for more detailed information and for information
regarding any state, local or foreign taxes applicable to the fund and to
dividends and other distributions therefrom.
OTHER INFORMATION
CLASSES OF SHARES. A share of each class of the fund represents an
identical interest in the fund's investment portfolio and has the same rights,
privileges and preferences. However, each class may differ with respect to sales
charges, if any, distribution and/or service fees, if any, other expenses
allocable exclusively to each class, voting rights on matters exclusively
affecting that class, and its exchange privilege, if any. The different sales
charges and other expenses applicable to the different classes of shares of the
fund will affect the performance of those classes. Each share of the fund is
entitled to participate equally in dividends, other distributions and the
proceeds of any liquidation of the fund. However, due to the differing expenses
of the classes, dividends and liquidation proceeds on Class A, B, C and Y shares
will differ.
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VOTING RIGHTS. Shareholders of the fund are entitled to one vote for each
full share held and fractional votes for fractional shares held. Voting rights
are not cumulative and, as a result, the holders of more than 50% of all the
shares of the fund may elect all of the board members of the Corporation. The
shares of the fund will be voted together, except that only the shareholders of
a particular class of the fund may vote on matters affecting only that class,
such as the terms of a Rule 12b-1 Plan as it relates to the class.
The fund does not hold annual meetings. Shareholders of record of no less
than two-thirds of the outstanding shares of the fund may remove a board member
through a declaration in writing or by vote cast in person or by proxy at a
meeting called for that purpose. A meeting will be called to vote on the removal
of a board member at the written request of holders of 10% of the outstanding
shares of the fund.
CLASS-SPECIFIC EXPENSES. The fund may determine to allocate certain of its
expenses (in addition to service and distribution fees) to the specific classes
of its shares to which those expenses are attributable. For example, 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.
PRIOR NAMES. Prior to December 14, 1995, the fund was known as
"PaineWebber Regional Financial Growth Fund Inc." Prior to November 10, 1995,
the fund's Class C shares were known as "Class D" shares.
CUSTODIAN AND RECORDKEEPING AGENT; TRANSFER AND DIVIDEND AGENT. State
Street Bank and Trust Company, located at One Heritage Drive, North Quincy,
Massachusetts 02171, serves as custodian and recordkeeping agent for the fund.
PFPC Inc., a subsidiary of PNC Bank, N.A., located at 400 Bellevue Parkway,
Wilmington, DE 19809, serves as the fund's transfer and dividend disbursing
agent.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the fund.
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 fund.
FINANCIAL STATEMENTS
The fund's Annual Report to Shareholders for its last fiscal year ended
March 31, 2000 is a separate document supplied with this SAI, and the financial
statements, accompanying notes and report of independent auditors appearing
therein are incorporated herein by this reference.
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APPENDIX
RATINGS INFORMATION
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
"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 risk 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 payment 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 applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
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 meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
obligations 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 obligations 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.
However, 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 exposures to adverse conditions; BB. An
obligation rated BB is less vulnerable to nonpayment than other speculative
issues. However, it faces major ongoing certainties 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
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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 this
obligation are not 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 even if the applicable grace period has not expired, unless
S&P believes that such payments will be made during such grace period. The D
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on a obligation are jeopardized.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
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.
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YOU SHOULD RELY ONLY ON THE INFORMATION PaineWebber
CONTAINED OR REFERRED TO IN THE Financial Services Growth
PROSPECTUS AND THIS STATEMENT OF Fund
ADDITIONAL INFORMATION. THE FUND AND ITS
DISTRIBUTOR HAVE NOT AUTHORIZED ANYONE
TO PROVIDE YOU WITH INFORMATION THAT IS
DIFFERENT. THE PROSPECTUS AND THIS
STATEMENT OF ADDITIONAL INFORMATION ARE
NOT AN OFFER TO SELL SHARES OF THE FUND
IN ANY JURISDICTION WHERE THE FUND OR
ITS DISTRIBUTOR MAY NOT LAWFULLY SELL
THOSE SHARES.
------------
-----------------------------------
Statement of Additional Information
July 26, 2000
(as revised August 3, 2000)
-----------------------------------
PAINEWEBBER
(C)2000 PaineWebber Incorporated. All rights reserved.
