NATIONS FUND, INC.
Statement of Additional Information
NATIONS PRIME FUND
NATIONS TREASURY FUND
NATIONS EQUITY INCOME FUND
NATIONS GOVERNMENT SECURITIES FUND
NATIONS INTERNATIONAL EQUITY FUND
Investor Shares and Primary Shares
April 1, 1996, as supplemented on
June 14, 1996
This Statement of Additional Information ("SAI") provides supplementary
information pertaining to the classes of shares representing interests in the
above listed five investment portfolios of Nations Fund, Inc. (individually, a
"Fund" and collectively, the "Funds"). This SAI is not a prospectus, and should
be read only in conjunction with the current Prospectuses for the aforementioned
Funds related to the class or series of shares in which one is interested, dated
April 1, 1996 (each a "Prospectus"). All terms used in this SAI that are
defined in the Prospectuses will have the same meanings assigned in the
Prospectuses. Copies of these Prospectuses may be obtained by writing
Nations Fund c/o Stephens Inc., One NationsBank Plaza, 33rd Floor, Charlotte,
North Carolina 28255, or by calling Nations Fund at (800) 321-7854.
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TABLE OF CONTENTS
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INTRODUCTION ................................................................................ 1
FUND TRANSACTIONS AND BROKERAGE.............................................................. 1
General Brokerage Policy............................................................. 1
Prime, Treasury and Government Securities Funds...................................... 2
Equity Income and International Equity Funds......................................... 2
Section 28(e) Standards.............................................................. 4
ADDITIONAL INFORMATION ON FUND INVESTMENTS .................................................. 5
General.............................................................................. 5
When-Issued Securities .............................................................. 5
Delayed Delivery Transactions ....................................................... 6
Foreign Currency Transactions ....................................................... 6
Futures, Options and Other Derivative
Instruments ................................................................... 7
Interest Rate Transactions .......................................................... 15
Asset-Backed Securities.............................................................. 16
Special Situations................................................................... 19
Reverse Repurchase Agreements ....................................................... 19
Securities Lending................................................................... 19
Short Sales.......................................................................... 19
Guaranteed Investment Contracts ..................................................... 20
Illiquid Securities.................................................................. 20
Commercial Instruments............................................................... 20
Municipal Securities................................................................. 21
Real Estate Investment Trusts........................................................ 22
Additional Investment Limitations ................................................... 23
NET ASSET VALUE.............................................................................. 25
Purchases and Redemptions............................................................ 25
Net Asset Value Determination........................................................ 25
Exchanges............................................................................ 26
DESCRIPTION OF SHARES........................................................................ 26
Dividends and Distributions.......................................................... 26
ADDITIONAL INFORMATION CONCERNING TAXES...................................................... 27
Qualification as a Regulated Investment
Company........................................................................ 27
Excise Tax on Regulated Investment Companies......................................... 29
Distributions........................................................................ 30
Sale or Redemption of Shares ........................................................ 32
Foreign Shareholders ................................................................ 32
Effect of Future Legislation: Local Tax Considerations............................... 33
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DIRECTORS AND OFFICERS....................................................................... 33
Compensation Table................................................................... 37
Nations Funds Retirement Plan........................................................ 38
Nations Funds Deferred Compensation Plan ............................................ 39
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY, SHAREHOLDER SERVICING AND
DISTRIBUTION AGREEMENTS ..................................................................... 39
The Company and Its Common Stock..................................................... 39
Investment Adviser................................................................... 40
Investment Styles.................................................................... 43
Administrator and Co-Administrator................................................... 44
Distribution Plans and Shareholder Servicing
Arrangements for Investor Shares................................................. 46
Shareholder Servicing Agreements-Money Market Funds
(Primary B Shares)............................................................... 53
Shareholder Administration Plan-Non-Money Market Funds
(Primary B Shares)............................................................... 53
Expenses............................................................................. 54
Transfer Agents and Custodians....................................................... 55
DISTRIBUTOR ................................................................................. 56
INDEPENDENT ACCOUNTANT AND REPORTS........................................................... 56
COUNSEL...................................................................................... 56
ADDITIONAL INFORMATION ON PERFORMANCE........................................................ 56
Yield Calculations................................................................... 57
Total Return Calculations............................................................ 58
MISCELLANEOUS ............................................................................... 61
Certain Record Holders............................................................... 61
SUITABILITY OF NATIONS TREASURY FUND FOR
INVESTMENT BY MUNICIPAL INVESTORS............................................................ 65
SCHEDULE A - Description of Ratings........................................................... A-1
SCHEDULE B - Additional Information Concerning Options &
Futures...................................................................................... B-1
SCHEDULE C - Additional Information Concerning Mortgage
Backed Securities............................................................................ C-1
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INTRODUCTION
Nations Fund, Inc. (the "Company") is a mutual fund. The rules and
regulations of the United States Securities and Exchange Commission (the "SEC")
require all mutual funds to furnish prospective investors certain information
concerning the activities of the mutual fund being considered for investment.
This information about the Company is included in various Prospectuses. The
Prospectuses relate to the Primary A (formerly called Trust A), Primary B
(formerly called the Trust B), Investor A, Investor B, Investor C and Investor D
Shares of Nations Prime Fund (the "Prime Fund") and Nations Treasury Fund (the
"Treasury Fund") (hereinafter the Prime or Treasury Funds, collectively referred
to as the "Money Market Funds"), and the Primary A, Primary B, Investor A,
Investor C and Investor N Shares of Nations Equity Income Fund (the "Equity
Income Fund"), Nations Government Securities Fund (the "Government Securities
Fund") and Nations International Equity Fund (the "International Equity Fund")
(hereinafter the Equity Income, Government Securities and International Equity
Funds, collectively referred to as the "Non-Money Market Funds"). The Primary A
and Primary B Shares are collectively referred to herein as "Primary Shares" and
the Investor A, Investor B, Investor C, Investor D and Investor N Shares are
referred to as "Investor Shares." Prospectuses relating to these Funds may be
obtained without charge by written request to Nations Fund, c/o Stephens, Inc.,
One NationsBank Plaza, 33rd Floor, Charlotte, NC 28255. Investors also may call
toll-free at (800) 321-7854.
NationsBanc Advisors, Inc. ("NBAI") is the investment adviser to the Funds.
TradeStreet Investment Associates, Inc. ("TradeStreet") is sub-investment
adviser to all of the Funds except Nations International Equity Fund. Nations
Gartmore Investment Management ("Nations Gartmore") serves as sub-investment
adviser to Nations International Equity Fund. As used herein, "Adviser" shall
mean NBAI, TradeStreet and/or Nations Gartmore as the context may require.
This SAI is intended to furnish prospective investors with additional
information concerning the Company and the Funds. Some of the information
required to be in this SAI is also included in the Funds' current Prospectuses,
and, in order to avoid repetition, reference will be made to sections of the
Prospectuses. Additionally, the Prospectuses and this SAI omit certain
information contained in the registration statement filed with the SEC. Copies
of the registration statement, including items omitted from the Prospectuses and
this SAI, may be obtained from the SEC by paying the charges prescribed under
its rules and regulations.
FUND TRANSACTIONS AND BROKERAGE
General Brokerage Policy
Subject to policies established by the Board of Directors of the Company,
the Adviser is responsible for decisions to buy and sell securities for each
Fund, for the selection of broker/dealers, for the execution of such Fund's
securities transactions, and for the allocation of brokerage fees in connection
with such transactions. The Adviser's primary consideration in effecting a
security transaction is to obtain the best net price and the most favorable
execution of the order. While the Adviser generally seeks reasonably competitive
commission rates, a Fund does not necessarily pay the lowest commission or
spread available.
During the fiscal years ended May 31, 1993, 1994 and 1995, the Equity
Income Fund paid Shearson Lehman Brothers Inc. $10, $0 and $0, respectively in
brokerage commissions. During the fiscal years ended May 31, 1993, 1994 and
1995, the percentage of the Company's aggregate brokerage commissions paid to
Shearson Lehman Brothers Inc. were 0%, 0% and 0%, respectively, and the
percentage of the Company's aggregate dollar amount of transactions involving
the payment of commissions effected through Shearson Lehman Brothers Inc. was
0%, 0% and 0%, respectively.
During the fiscal year ended May 31, 1994, the Equity Income Fund and the
International Equity Fund paid $56,184 and $4,500, respectively, in brokerage
commissions to Dean Witter and during the fiscal year ended May 31, 1995, the
Equity Income Fund paid $71,240 in brokerage commissions to Dean Witter. During
the fiscal year ended May 31, 1995 the percentage of the Equity Income Fund's
aggregate brokerage commissions paid to Dean
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Witter was 3.43% and the percentage of the Company's aggregate dollar amount of
transactions involving the payment of commissions effected through Dean Witter
was .37%.
During the fiscal years ended May 31, 1993, 1994 and 1995, the Company did
not pay brokerage commissions to NationsBanc Securities, Inc., NationsBanc
Capital Markets, Inc., Nations Securities or Stephens.
As of May 31, 1995, the Equity Income Fund and International Equity Fund
did not hold any securities of the Company's regular brokers or dealers.
Prime, Treasury and Government Securities Funds
Since purchases and sales of fund securities by the Prime, Treasury, and
Government Securities Funds are usually principal transactions, these Funds
incur little or no brokerage commissions. Fund securities are normally purchased
directly from the issuer or from a market maker for the securities. The purchase
price paid to dealers serving as market makers may include a spread between the
bid and asked prices. These Funds may also purchase securities from underwriters
at prices which include a commission paid by the issuer to the underwriter.
The Company does not generally seek to profit from short-term trading, and
will generally (although not always) hold fund securities to maturity, but the
Adviser may seek to enhance the yield of the Money Market Funds by taking
advantage of yield disparities or other factors that occur in the money market.
For example, market conditions frequently result in similar securities trading
at different prices. The Adviser may dispose of any portfolio security prior to
its maturity if such disposition and reinvestment of proceeds are expected to
enhance yield consistent with the Adviser's judgment as to desirable fund
maturity structure or if such disposition is believed to be advisable due to
other circumstances or conditions. The fundamental policies of each of the Funds
require that investments mature within one year or less. The amortized cost
method of valuing fund securities requires that each Fund maintain an average
weighted portfolio maturity of 90 days or less. Thus, there is likely to be
relatively high fund turnover, but since brokerage commissions are not normally
paid on money market instruments, the high rate of portfolio turnover is not
expected to have a material effect on the net income or expenses of the Money
Market Funds.
Equity Income and International Equity Funds
During the fiscal years ended May 31, 1993, 1994 and 1995, the Equity
Income Fund paid aggregate brokerage commissions of $257,775, $1,268,685 and
$2,076,553, respectively. A portion of the securities in which the Equity Income
Fund invests are traded in over-the-counter markets, and in such transactions
such Fund deals directly with the dealers who make markets in the securities
involved, except in those circumstances where better prices and executions are
available elsewhere. Equity Income Fund transactions placed through dealers
serving as primary market makers are effected at net prices, without commissions
as such, but which include compensation in the form of a mark up or mark down.
During the fiscal years ended May 31, 1993, 1994 and 1995, the
International Equity Fund paid aggregate brokerage commissions of $235,475,
$1,200,255 and $2,108,611, respectively. Subject to policies established by the
Board of Directors of the Company, the Adviser is responsible for decisions to
buy and sell securities for the Fund, for the selection of broker/dealers, for
the execution of the Fund's securities transactions, and for the allocation of
brokerage fees in connection with such transactions. The primary consideration
in effecting a security transaction is to obtain the best net price and the most
favorable execution of the order. While the Adviser generally seeks reasonably
competitive commission rates, the Fund does not necessarily pay the lowest
commission or spread available.
The Adviser anticipates that most brokerage services will be provided by
brokerage companies located in London. A portion of the securities in which the
Funds invest are traded in over-the-counter markets, and in such transactions
each such Fund deals directly with the dealers who make markets in the
securities involved, except in
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those circumstances where better prices and executions are available elsewhere.
Portfolio transactions placed through dealers serving as primary market makers
are effected at net prices, without commissions as such, but which include
compensation in the form of a mark up or mark down.
The Adviser may from time to time determine target levels of commission
business to transact with various brokers on behalf of its clients (including
the Company) over a certain time period. The target levels will be determined
based upon the following factors, among others: (1) the execution services
provided by the broker; (2) the research services provided by the broker; and
(3) the broker's attitude toward and interest in mutual funds in general and in
the Company and other mutual funds advised by the Adviser in particular. No
specific formula will be used in connection with any of the foregoing
considerations in determining the target levels. However, if a broker has
indicated a certain level of desired commissions in return for certain research
services provided by the broker, this factor will be taken into consideration by
the Adviser.
Subject to the overall objective of obtaining best price and execution for
a Fund, the Adviser may also consider sales of shares of such Fund and of the
other mutual funds managed or advised by the Adviser as a factor in the
selection of broker/dealers to execute portfolio transactions for the Funds.
The Adviser will seek, whenever possible, to recapture for the benefit of
a Fund any commission, fees, brokerage or similar payments paid by such Fund on
portfolio transactions. Normally, the only fees which may be recaptured are the
soliciting dealer fees on the tender of an account's portfolio securities in a
tender or exchange offer.
The Funds are not under any obligation to deal with any broker or group of
brokers in the execution of transactions in portfolio securities. Brokers who
provide supplemental investment research to the Adviser may receive orders for
transactions by a Fund. Information so received will be in addition to and not
in lieu of the services required to be performed by the Adviser under its
agreements with each Fund and the expenses of the Adviser will not necessarily
be reduced as a result of the receipt of such supplemental information. Certain
research services furnished by broker/dealers may be useful to the Adviser in
connection with its services to other advisory clients, including the investment
companies which it advises. Also, the Fund may pay a higher price for securities
or higher commissions in recognition of research services furnished by
broker/dealers.
The Adviser and its affiliates manage several other investment accounts,
some of which may have investment objectives similar to those of one or more of
the Funds. It is possible that, at times, identical securities will be
appropriate for investment by one or more of the Funds and by one or more of
such investment accounts. The position of each account, however, in the
securities of the same issuer may vary and the length of time that each account
may choose to hold its investment in the securities of the same issuer may
likewise vary. The timing and amount of purchase by each account will also be
determined by its cash position. If the purchase or sale of securities
consistent with the investment policies of a Fund and one or more of these
accounts is considered at or about the same time, transactions in such
securities will be allocated among the accounts in a manner deemed equitable by
the Adviser. The Adviser may combine such transactions, in accordance with
applicable laws and regulations, in order to obtain the best net price and most
favorable execution. Simultaneous transactions could, however, adversely affect
the ability of a Fund to obtain or dispose of the full amount of a security
which it seeks to purchase or sell.
In some cases the procedure for allocating securities transactions among
the various investment accounts advised by the Adviser and its affiliates could
have an adverse effect on the price or amount of securities available to a Fund.
In making such allocations, the main factors considered by the Adviser are the
respective investment objectives and policies of such advisory clients, the
relative size of holdings of the same or comparable securities, the availability
of cash for investment, the size of investment commitments generally held and
the judgments of the persons responsible for recommending the investment.
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Section 28(e) Standards
Under Section 28(e) of the Securities Exchange Act of 1934, the Adviser
shall not be "deemed to have acted unlawfully or to have breached its fiduciary
duty" solely because under certain circumstances it has caused the account to
pay a higher commission than the lowest available. To obtain the benefit of
Section 28(e), an adviser must make a good faith determination that the
commissions paid are "reasonable in relation to the value of the brokerage and
research services provided ...viewed in terms of either that particular
transaction or its overall responsibilities with respect to the accounts as to
which it exercises investment discretion and that the services provided by a
broker provide an adviser with lawful and appropriate assistance in the
performance of its investment decision making responsibilities." Accordingly,
the price to a Fund in any transaction may be less favorable than that available
from another broker/dealer if the difference is reasonably justified by other
aspects of the portfolio execution services offered.
Broker/dealers utilized by the Adviser may furnish statistical, research
and other information or services which are deemed by the Adviser to be
beneficial to the Funds' investment programs. Research services received from
brokers supplement the Adviser's own research and may include the following
types of information: statistical and background information on industry groups
and individual companies; forecasts and interpretations with respect to U.S and
foreign economies, securities, markets, specific industry groups and individual
companies; information on political developments; fund management strategies;
performance information on securities and information concerning prices of
securities; and information supplied by specialized services to the Adviser and
to the Company's directors with respect to the performance, investment
activities and fees and expenses of other mutual funds. Such information may be
communicated electronically, orally or in written form. Research services may
also include the providing of equipment used to communicate research
information, the arranging of meetings with management of companies and the
providing of access to consultants who supply research information.
The outside research assistance is useful to the Adviser since the brokers
utilized by the Adviser as a group tend to follow a broader universe of
securities and other matters than the Adviser's staff can follow. In addition,
this research provides the Adviser with a diverse perspective on financial
markets. Research services which are provided to the Adviser by brokers are
available for the benefit of all accounts managed or advised by the Adviser. In
some cases, the research services are available only from the broker providing
such services. In other cases, the research services may be obtainable from
alternative sources in return for cash payments. The Adviser is of the opinion
that because the broker research supplements rather than replaces its research,
the receipt of such research does not tend to decrease its expenses, but tends
to improve the quality of its investment advice. However, to the extent that the
Adviser would have purchased any such research services had such services not
been provided by brokers, the expenses of such services to the Adviser could be
considered to have been reduced accordingly. Certain research services furnished
by broker/dealers may be useful to the Adviser with clients other than the
Funds. Similarly, any research services received by the Adviser through the
placement of fund transactions of other clients may be of value to the Adviser
in fulfilling its obligations to the Funds. The Adviser is of the opinion that
this material is beneficial in supplementing its research and analysis; and,
therefore, it may benefit the Company by improving the quality of the Adviser's
investment advice. The advisory fees paid by the Company are not reduced because
the Adviser receives such services.
Some broker/dealers may indicate that the provision of research services
is dependent upon the generation of certain specified levels of commissions and
underwriting concessions by the Adviser's clients, including the Funds.
For the period ended May 31, 1995, Nations Prime Fund acquired stock in the
following broker dealers in the indicated amounts: Lehman Brothers Holdings,
Inc. -- $20,000,000; Lehman Brothers PLC -$150,000,000 and Goldman Sachs Group,
L.P. - $155,010,413.
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ADDITIONAL INFORMATION ON FUND INVESTMENTS
General
Information concerning each Fund's investment objective is set forth in
each of the Prospectuses under the headings "Investment Objectives And
Policies," and "Appendix A." There can be no assurance that the Funds will
achieve their objectives. The principal features of the Funds' investment
programs and the primary risks associated with those investment programs are
discussed in the Prospectuses under the heading "Investment Objectives And
Policies" and "Appendix A." The securities in which the Money Market Funds
invest may not yield as high a level of current income as longer term or lower
grade securities, which generally have less liquidity and greater fluctuation in
value. The values of the securities in which the Funds invest fluctuate based
upon interest rates, foreign currency rates, the financial stability of the
issuer and market factors.
Pursuant to one of the Company's fundamental investment restrictions (see
"Investment Limitations" in the Company's Prospectuses), the Company does not
have authority to purchase any securities which would cause more than 25% of the
value of any Fund's total assets at the time of such purchase to be invested in
the securities of one or more issuers conducting their principal business
activities in the same industry, provided that, there is no limitation with
respect to investments in obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities and further provided that with
respect to the Money Market Funds only, there is no limitation with respect to
investments in obligations by banks. The position of the staff of the SEC is
that the exclusion with respect to banks may only be applied to domestic banks.
For this purpose, the staff also takes the position that United States branches
of foreign banks and foreign branches of domestic banks may, if certain
conditions are met, be treated as "domestic banks." The Company currently
intends to consider only obligations of "domestic banks" to be within the
exclusion with respect to banks. For this purpose, "domestic banks" will be
construed by the Company to include: (a) United States branches of foreign
banks, to the extent they are subject to the same regulation as United States
banks; and (b) foreign branches of domestic banks with respect to which the
domestic bank would be unconditionally liable in the event that the foreign
branch failed to pay on its instruments for any reason.
When-Issued Securities
Each Fund may purchase securities on a "when-issued" basis, that is, the
date for delivery of the payment for the securities is not fixed at the date of
purchase, but is set after the securities are issued (normally within 45 days
after the date of the transaction). Each Fund may also purchase or sell
securities on a delayed delivery basis. The payment obligation and the interest
rate that will be received on the when-issued securities are fixed at the time
the buyer enters into the commitment. Each Fund will only make commitments to
purchase when-issued or delayed delivery securities with the intention of
actually acquiring such securities, but each Fund may sell these securities
before the settlement date if it is deemed advisable.
If a Fund purchases a when-issued security, the Fund will direct its
custodian bank to place cash or high grade securities in a separate account of
the Fund in an amount equal to the when-issued commitment. If a separate account
must be maintained because a Fund enters into when-issued commitments, the
deposited securities will be valued at market for the purpose of determining the
adequacy of the securities in the account. If the market value of such
securities declines, additional cash or securities will be placed in the account
on a daily basis so that the market value of the account will equal the amount
of the Fund's when-issued commitments. To the extent funds are in a separate
account, they will not be available for new investment or to meet redemptions.
Securities purchased on a when-issued basis and the securities held in the
Funds are subject to changes in market value based upon the public's perception
of the creditworthiness of the issuer and changes in the level of interest rates
(which will generally result in all of those securities changing in value in the
same way, i.e., experiencing appreciation when interest rates fall). Therefore,
if in order to achieve higher interest income a Fund remains substantially fully
invested at the same time that it has purchased securities on a when-issued
basis, there is a possibility that the Fund will experience greater fluctuation
in the market value of its assets.
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Furthermore, when the time comes for a Fund to meet its obligations under
when-issued commitments, the Fund will do so by use of its then available cash,
by the sale of securities held in the separate account, by the sale of other
securities or, although it would not normally expect to do so, by directing the
sale of the when-issued securities themselves (which may have a market value
greater or less than the Fund's payment obligation thereunder). The sale of
securities to meet such obligations carries with it a greater potential for the
realization of net short-term capital gains, which are not exempt from federal
income tax. The value of when-issued securities on the settlement date may be
more or less than the purchase price.
Delayed Delivery Transactions
In a delayed delivery transaction, the Fund relies on the other party to
complete the transaction. If the transaction is not completed, the Fund may miss
a price or yield considered to be advantageous.
Foreign Currency Transactions
As described in the Prospectuses, certain Funds may invest in foreign
currency transactions. Foreign securities involve currency risks. The U.S.
dollar value of a foreign security tends to decrease when the value of the U.S.
dollar rises against the foreign currency in which the security is denominated,
and tends to increase when the value of the U.S. dollar falls against such
currency. A Fund may purchase or sell forward foreign currency exchange
contracts ("forward contracts") to attempt to minimize the risk to the Fund from
adverse changes in the relationship between the U.S. dollar and foreign
currencies. A Fund may also purchase and sell foreign currency futures contracts
and related options (see "Purchase and Sale of Currency Futures Contracts and
Related Options"). A forward contract is an obligation to purchase or sell a
specific currency for an agreed price at a future date that is individually
negotiated and privately traded by currency traders and their customers.
Forward foreign currency exchange contracts establish an exchange rate at
a future date. These contracts are transferable in the interbank market
conducted directly between currency traders (usually large commercial banks) and
their customers. A forward foreign currency exchange contract generally has no
deposit requirement, and is traded at a net price without commission. A Fund
maintains with its custodian a segregated account of high grade liquid assets in
an amount at least equal to its obligations under each forward foreign currency
exchange contract. Neither spot transactions nor forward foreign currency
exchange contracts eliminate fluctuations in the prices of a Fund's portfolio
securities or in foreign exchange rates, or prevent loss if the prices of these
securities should decline.
A Fund may enter into a forward contract, for example, when it enters into
a contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of the security (a
"transaction hedge"). In addition, when the Adviser believes that a foreign
currency may suffer a substantial decline against the U.S. dollar, it may enter
into a forward sale contract to sell an amount of that foreign currency
approximating the value of some or all of the Fund's securities denominated in
such foreign currency, or when the Adviser believes that the U.S. dollar may
suffer a substantial decline against the foreign currency, it may enter into a
forward purchase contract to buy that foreign currency for a fixed dollar amount
(a "position hedge").
A Fund may, however, enter into a forward contract to sell a different
foreign currency for a fixed U.S. dollar amount where the Adviser believes that
the U.S. dollar value of the currency to be sold pursuant to the forward
contract will fall whenever there is a decline in the U.S. dollar value of the
currency in which the fund securities are denominated (a "cross-hedge").
Foreign currency hedging transactions are an attempt to protect a Fund
against changes in foreign currency exchange rates between the trade and
settlement dates of specific securities transactions or changes in foreign
currency exchange rates that would adversely affect a portfolio position or an
anticipated portfolio position. Although these transactions tend to minimize the
risk of loss due to a decline in the value of the hedged currency, at the same
time they tend to limit any potential gain that might be realized should the
value of the hedged currency increase. The precise matching of the forward
contract amount and the value of the securities involved will not generally be
possible because the future value of these securities in foreign currencies will
change as a
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consequence of market movements in the value of those securities between the
date the forward contract is entered into and date it matures.
The Fund's custodian will place cash not available for investment or U.S.
Government securities or other high-quality debt securities in a separate
account of the Fund having a value equal to the aggregate amount of the Fund's
commitments under forward contracts entered into with respect to position hedges
and cross-hedges. If the value of the securities placed in a separate account
declines, additional cash or securities will be placed in the account on a daily
basis so that the value of the account will equal the amount of the Fund's
commitments with respect to such contracts. As an alternative to maintaining all
or part of the separate account, the Fund may purchase a call option permitting
the Fund to purchase the amount of foreign currency being hedged by a forward
sale contract at a price no higher than the forward contract price or the Fund
may purchase a put option permitting the Fund to sell the amount of foreign
currency subject to a forward purchase contract at a price as high or higher
than the forward contract price.
Futures, Options and Other Derivative Instruments
A futures contract is an agreement between two parties for the future
delivery of fixed income securities or for the payment or acceptance of a cash
settlement in the case of futures contracts on an index of fixed income
securities or stock index futures contracts. A "sale" of a futures contract
means the contractual obligation to deliver the securities at a specified price
on a specified date, or to make the cash settlement called for by the contract.
Futures contracts have been designed by exchanges which have been designated
"contract markets" by the Commodity Futures Trading Commission ("CFTC") and must
be executed through a brokerage firm, known as a futures commission merchant,
which is a member of the relevant contract market. Futures contracts trade on
these markets, and the exchanges, through their clearing organizations,
guarantee that the contracts will be performed as between the clearing members
of the exchange. Presently, futures contracts are based on such debt securities
as long-term U.S. Treasury Bonds, Treasury Notes, Government National Mortgage
Association modified pass-through mortgage-backed securities, three-month U.S.
Treasury Bills, bank certificates of deposit, and on indices of municipal,
corporate and government bonds.
While futures contracts based on securities do provide for the delivery
and acceptance of securities, such deliveries and acceptances are very seldom
made. Generally, a futures contract is terminated by entering into an offsetting
transaction. A Fund will incur brokerage fees when it purchases and sells
futures contracts. At the time such a purchase or sale is made, a Fund must
provide cash or money market securities as a deposit known as "margin." The
initial deposit required will vary, but may be as low as 2% or less of a
contract's face value. Daily thereafter, the futures contract is valued through
a process known as "marking to market," and a Fund that engages in futures
transactions may receive or be required to pay "variation margin" as the futures
contract becomes more or less valuable. At the time of delivery of securities
pursuant to a futures contract based on securities, adjustments are made to
recognize differences in value arising from the delivery of securities with a
different interest rate than the specific security that provides the standard
for the contract. In some (but not many) cases, securities called for by a
futures contract may not have been issued when the contract was written.
Futures contracts on indices of securities are settled through the making
and acceptance of cash settlements based on changes in value of the underlying
rate or index between the time the contract is entered into and the time it is
liquidated.
Futures Contracts on Fixed Income Securities and Related Indices. As noted
in their respective Prospectuses, certain Funds may enter into transactions in
futures contracts for the purpose of hedging a relevant portion of their
portfolios. A Fund may enter into transactions in futures contracts that are
based on U.S. Government obligations, including any index of government
obligations that may be available for trading. Such transactions will be entered
into where movements in the value of the securities or index underlying a
futures contract can be expected to correlate closely with movements in the
value of securities held in a Fund. For example, a Fund may sell futures
contracts in anticipation of a general rise in the level of interest rates,
which would result in a decline in the value of its fixed income securities. If
the expected rise in interest rates occurs, the
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Fund may realize gains on its futures position, which should offset all or part
of the decline in value of fixed income fund securities. A Fund could protect
against such decline by selling fixed income securities, but such a strategy
would involve higher transaction costs than the sale of futures contracts and,
if interest rates again declined, the Fund would be unable to take advantage of
the resulting market advance without purchases of additional securities.
The purpose of the purchase or sale of a futures contract on government
securities and indices of government securities, in the case of the
above-referenced Funds, which hold or intend to acquire long-term debt
securities, is to protect a Fund from fluctuations in interest rates without
actually buying or selling long-term debt securities. For example, if long-term
bonds are held by a Fund, and interest rates were expected to increase, the Fund
might enter into futures contracts for the sale of debt securities. Such a sale
would have much the same effect as selling an equivalent value of the long-term
bonds held by the Fund. If interest rates did increase, the value of the debt
securities in the Fund would decline, but the value of the futures contracts to
the Fund would increase at approximately the same rate thereby keeping the net
asset value of the Fund from declining as much as it otherwise would have. When
a Fund is not fully invested and a decline in interest rates is anticipated,
which would increase the cost of fixed income securities that the Fund intends
to acquire, it may purchase futures contracts. In the event that the projected
decline in interest rates occurs, the increased cost of the securities acquired
by the Fund should be offset, in whole or part, by gains on the futures
contracts by entering into offsetting transactions on the contract market on
which the initial purchase was effected. In a substantial majority of these
transactions, a Fund will purchase fixed income securities upon termination of
the long futures positions, but under unusual market conditions, a long futures
position may be terminated without a corresponding purchase of securities.
Similarly, when it is expected that interest rates may decline, futures
contracts on fixed income securities and indices of government securities may be
purchased for the purpose of hedging against anticipated purchases of long-term
bonds at higher prices. Since the fluctuations in the value of such futures
contracts should be similar to that of long-term bonds, a Fund could take
advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Fund's cash reserves could then be used to
buy long-term bonds in the cash market. Similar results could be accomplished by
selling bonds with long maturities and investing in bonds with short maturities
when interest rates are expected to increase. However, since the futures market
is more liquid than the cash market, the use of these futures contracts as an
investment technique allows a Fund to act in anticipation of such an interest
rate decline without having to sell its portfolio securities. To the extent a
Fund enters into futures contracts for this purpose, the assets in the
segregated asset accounts maintained by a Fund will consist of cash, cash
equivalents or high quality debt securities of the Fund in an amount equal to
the difference between the fluctuating market value of such futures contract and
the aggregate value of the initial deposit and variation margin payments made by
the Fund with respect to such futures contracts.
Stock Index Futures Contracts. As described in the Prospectuses, certain
Funds may sell stock index futures contracts in order to offset a decrease in
market value of its securities that might otherwise result from a market
decline. A Fund may do so either to hedge the value of its portfolio as a whole,
or to protect against declines, occurring prior to sales of securities, in the
value of securities to be sold. Conversely, a Fund may purchase stock index
futures contracts in order to protect against anticipated increases in the cost
of securities to be acquired. As also described above with respect to futures
contracts on fixed income securities and related indices, in a substantial
majority of these transactions, the Fund would purchase such securities upon
termination of the long futures position, but under unusual market conditions, a
long futures position may be terminated without a corresponding purchase of
securities.
In addition, a Fund may utilize stock index futures contracts in
anticipation of changes in the composition of its portfolio. For example, in the
event that a Fund expects to narrow the range of industry groups represented in
its portfolio, it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. As such securities
are acquired, a Fund's futures positions would be closed out. A Fund may also
sell futures contracts in connection with this strategy, in order to protect
against the possibility that the value of the securities to be sold as part of
the restructuring of its portfolio will decline prior to the time of sale.
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Options on Futures Contracts. An option on a futures contract gives the
purchaser (the "holder") the right, but not the obligation, to enter into a
"long" position in the underlying futures contract (i.e., a purchase of such
futures contract) in the case of an option to purchase (a "call" option), or a
"short" position in the underlying futures contract (i.e., a sale of such
futures contract) in the case of an option to sell (a "put" option), at a fixed
price (the "strike price") up to a stated expiration date. The holder pays a
non-refundable purchase price for the option, known as the "premium." The
maximum amount of risk the purchase of the option assumes is equal to the
premium plus related transaction costs, although this entire amount may be lost.
Upon exercise of the option by the holder, the exchange clearing corporation
establishes a corresponding long position in the case of a put option. In the
event that an option is exercised, the parties will be subject to all the risks
associated with the trading of futures contracts, such as payment of variation
margin deposits. In addition, the writer of an option on a futures contract,
unlike the holder, is subject to initial and variation margin requirements on
the option position.
Options on Futures Contracts on Fixed Income Securities and Related
Indices. As described in the Prospectuses, certain Funds may purchase put
options on futures contracts in which such Funds are permitted to invest for the
purpose of hedging a relevant portion of their portfolios against an anticipated
decline in the values of portfolio securities resulting from increases in
interest rates, and may purchase call options on such futures contracts as a
hedge against an interest rate decline when they are not fully invested. A Fund
would write options on these futures contracts primarily for the purpose of
terminating existing positions.
Options on Stock Index Futures Contracts, Options on Stock Indices and
Options on Equity Securities. As described in the Prospectuses, certain Funds
may purchase put options on stock index futures contracts, stock indices or
equity securities for the purpose of hedging the relevant portion of their
portfolio securities against an anticipated market-wide decline or against
declines in the values of individual portfolio securities, and they may purchase
call options on such futures contracts as a hedge against a market advance when
they are not fully invested. A Fund would write options on such futures
contracts primarily for the purpose of terminating existing positions. In
general, options on stock indices will be employed in lieu of options on stock
index futures contracts only where they present an opportunity to hedge at lower
cost. With respect to options on equity securities, a Fund may, under certain
circumstances, purchase a combination of call options on such securities and
U.S. Treasury bills. The Adviser believes that such a combination may more
closely parallel movements in the value of the security underlying the call
option than would the option itself.
Further, while a Fund generally would not write options on individual
portfolio securities, it may do so under limited circumstances known as
"targeted sales" and "targeted buys," which involve the writing of call or put
options in an attempt to purchase or sell portfolio securities at specific
desired prices. A Fund would receive a fee, or a "premium," for the writing of
the option. For example, where the Fund seeks to sell portfolio securities at a
"targeted" price, it may write a call option at that price. In the event that
the market rises above the exercise price, it would receive its "targeted"
price, upon the exercise of the option, as well as the premium income. Also,
where it seeks to buy portfolio securities at a "targeted" price, it may write a
put option at that price for which it will receive the premium income. In the
event that the market declines below the exercise price, a Fund would pay its
"targeted" price upon the exercise of the option. In the event that the market
does not move in the direction or to the extent anticipated, however, the
targeted sale or buy might not be successful and a Fund could sustain a loss on
the transaction that may not be offset by the premium received. In addition, a
Fund may be required to forego the benefit of an intervening increase or decline
in value of the underlying security.
Options and Futures Strategies. The Adviser may seek to increase the
current return of the Fund by writing covered call or put options. In addition,
through the writing and purchase of options and the purchase and sale of U.S.
and certain foreign stock index futures contracts, interest rate futures
contracts, foreign currency futures contracts and related options on such
futures contracts, the Adviser may at times seek to hedge against a decline in
the value of securities included in the Fund or an increase in the price of
securities that it plans to purchase for the Fund. Expenses and losses incurred
as a result of such hedging strategies will reduce the Fund's current return. A
Fund's investment in foreign stock index futures contracts and foreign interest
rate futures contracts, and related options on such futures contracts, are
limited to only those contracts and related options that have been approved by
the CFTC for investment by U.S. investors. Additionally, with respect to a
Fund's investment in foreign
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options, unless such options are specifically authorized for investment by order
of the CFTC or meet the definition of trade options as set forth in CFTC rule
32.4, a Fund will not make these investments.
The ability of a Fund to engage in the options and futures strategies
described below will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to stock indices,
foreign government securities and foreign currencies are relatively new and
still developing. It is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore, no assurance
can be given that a Fund will be able to utilize these instruments effectively
for the purposes stated below. Furthermore, a Fund's ability to engage in
options and futures transactions may be limited by tax considerations. Although
a Fund will only engage in options and futures transactions for limited
purposes, these activities will involve certain risks which are described below
under "Risk Factors Associated with Futures and Options Transactions." A Fund
will not engage in options and futures transactions leveraging purposes.
Writing Covered Options on Securities. A Fund may write covered call
options and covered put options on optionable securities of the types in which
it is permitted to invest from time to time as the Adviser determines is
appropriate in seeking to attain its objective. Call options written by a Fund
give the holder the right to buy the underlying securities from a Fund at a
stated exercise price; put options give the holder the right to sell the
underlying security to the Fund at a stated price.
A Fund may write only covered options, which means that, so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option (or comparable securities satisfying the cover
requirements of securities exchanges). In the case of put options, a Fund will
maintain in a separate account cash or short-term U.S. Government securities
with a value equal to or greater than the exercise price of the underlying
securities. A Fund may also write combinations of covered puts and calls on the
same underlying security.
A Fund will receive a premium from writing a put or call option, which
increases the Fund's return in the event the option expires unexercised or is
closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price of the underlying security to the
exercise price of the option, the term of the option and the volatility of the
market price of the underlying security. By writing a call option, a Fund limits
its opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option. By writing a put
option, the Fund assumes the risk that it may be required to purchase the
underlying security for an exercise price higher than its then current market
value, resulting in a potential capital loss if the purchase price exceeds the
market value plus the amount of the premium received, unless the security
subsequently appreciates in value.
A Fund may terminate an option that it has written prior to its expiration
by entering into a closing purchase transaction in which it purchases an option
having the same terms as the option written. A Fund will realize a profit or
loss from such transaction if the cost of such transaction is less or more than
the premium received from the writing of the option. In the case of a put
option, any loss so incurred may be partially or entirely offset by the premium
received from a simultaneous or subsequent sale of a different put option.
Because increases in the market price of a call option will generally reflect
increases in the market price of the underlying security, any loss resulting
from the repurchase of a call option is likely to be offset in whole or in part
by unrealized appreciation of the underlying security owned by a Fund.
Purchasing Put and Call Options on Securities. A Fund may purchase put
options to protect its portfolio holdings in an underlying security against a
decline in market value. Such hedge protection is provided during the life of
the put option since a Fund, as holder of the put option, is able to sell the
underlying security at the put exercise price regardless of any decline in the
underlying security's market price. In order for a put option to be profitable,
the market price of the underlying security must decline sufficiently below the
exercise price to cover the premium and transaction costs. By using put options
in this manner, a Fund will reduce any profit it might otherwise have realized
in its underlying security by the premium paid for the put option and by
transaction costs.
A Fund may also purchase call options to hedge against an increase in
prices of securities that it wants ultimately to buy. Such hedge protection is
provided during the life of the call option since the Fund, as holder of
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the call option, is able to buy the underlying security at the exercise price
regardless of any increase in the underlying security's market price. In order
for a call option to be profitable, the market price of the underlying security
must rise sufficiently above the exercise price to cover the premium and
transaction costs. By using call options in this manner, a Fund will reduce any
profit it might have realized had it bought the underlying security at the time
it purchased the call option by the premium paid for the call option and by
transaction costs.
Purchase and Sale of Options and Futures on Stock Indices. A Fund may
purchase and sell options on non-U.S. stock indices and stock index futures as a
hedge against movements in the equity markets.
Options on stock indices are similar to options on specific securities
except that, rather than the right to take or make delivery of the specific
security at a specific price, an option on a stock index gives the holder the
right to receive, upon exercise of the option, an amount of cash if the closing
level of that stock index is greater than, in the case of a call, or less than,
in the case of a put, the exercise price of the option. This amount of cash is
equal to such difference between the closing price of the index and the exercise
price of the option expressed in dollars multiplied by a specified multiple. The
writer of the option is obligated, in return for the premium received, to make
delivery of this amount. Unlike options on specific securities, all settlements
of options on stock indices are in cash and gain or loss depends on general
movements in the stocks included in the index rather than price movements in
particular stocks. A stock index futures contract is an agreement in which one
party agrees to deliver to the other an amount of cash equal to a specific
amount multiplied by the difference between the value of a specific stock index
at the close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of securities is made.
If the Adviser expects general stock market prices to rise, a Fund might
purchase a call option on a stock index or a futures contract on that index as a
hedge against an increase in prices of particular equity securities it wants
ultimately to buy. If in fact the stock index does rise, the price of the
particular equity securities intended to be purchased may also increase, but
that increase would be offset in part by the increase in the value of a Fund's
index option or futures contract resulting from the increase in the index. If,
on the other hand, the Adviser expects general stock market prices to decline, a
Fund might purchase a put option or sell a futures contract on the index. If
that index does in fact decline, the value of some or all of the equity
securities in a Fund may also be expected to decline, but that decrease would be
offset in part by the increase in the value of the Fund's position in such put
option or futures contract.
Purchase and Sale of Interest Rate Futures. A Fund may purchase and sell
interest rate futures contracts on foreign government securities including, but
not limited to, debt securities of the governments and central banks of France,
Germany, Denmark and Japan for the purpose of hedging fixed income and interest
sensitive securities against the adverse effects of anticipated movements in
interest rates.
A Fund may sell interest rate futures contracts in anticipation of an
increase in the general level of interest rates. Generally, as interest rates
rise, the market value of the fixed income securities held by a Fund will fall,
thus reducing the net asset value of the Fund. This interest rate risk can be
reduced without employing futures as a hedge by selling long-term fixed income
securities and either reinvesting the proceeds in securities with shorter
maturities or by holding assets in cash. This strategy, however, entails
increased transaction costs to a Fund in the form of dealer spreads and
brokerage commissions.
The sale of interest rate futures contracts provides an alternative means
of hedging against rising interest rates. As rates increase, the value of a
Fund's short position in the futures contracts will also tend to increase, thus
offsetting all or a portion of the depreciation in the market value of a Fund's
investments that are being hedged. While a Fund will incur commission expenses
in selling and closing out futures positions (which is done by taking an
opposite position which operates to terminate the position in the futures
contract), commissions on futures transactions are lower than transaction costs
incurred in the purchase and sale of portfolio securities.
Options on Stock Index Futures Contracts and Interest Rate Futures
Contracts. A Fund may purchase and write call and put options on non-U.S. stock
index and interest rate futures contracts. A Fund may use such options on
futures contracts in connection with its hedging strategies in lieu of
purchasing and writing options directly on
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the underlying securities or stock indices or purchasing and selling the
underlying futures. For example, a Fund may purchase put options or write call
options on stock index futures, or interest rate futures, rather than selling
futures contracts, in anticipation of a decline in general stock market prices
or rise in interest rates, respectively, or purchase call options or write put
options on stock index or interest rate futures, rather than purchasing such
futures, to hedge against possible increases in the price of equity securities
or debt securities, respectively, which the Fund intends to purchase.
Purchase and Sale of Currency Futures Contracts and Related Options. In
order to hedge its portfolio and to protect it against possible variations in
foreign exchange rates pending the settlement of securities transactions, a Fund
may buy or sell currency futures contracts and related options. If a fall in
exchange rates for a particular currency is anticipated, a Fund may sell a
currency futures contract or a call option thereon or purchase a put option on
such futures contract as a hedge. If it is anticipated that exchange rates will
rise, a Fund may purchase a currency futures contract or a call option thereon
or sell (write) a put option to protect against an increase in the price of
securities denominated in a particular currency a Fund intends to purchase.
These futures contracts and related options thereon will be used only as a hedge
against anticipated currency rate changes, and all options on currency futures
written by a Fund will be covered.
A currency futures contract sale creates an obligation by a Fund, as
seller, to deliver the amount of currency called for in the contract at a
specified future time for a special price. A currency futures contract purchase
creates an obligation by a Fund, as purchaser, to take delivery of an amount of
currency at a specified future time at a specified price. Although the terms of
currency futures contracts specify actual delivery or receipt, in most instances
the contracts are closed out before the settlement date without the making or
taking of delivery of the currency. Closing out of a currency futures contract
is effected by entering into an offsetting purchase or sale transaction. Unlike
a currency futures contract, which requires the parties to buy and sell currency
on a set date, an option on a currency futures contract entitles its holder to
decide on or before a future date whether to enter into such a contract. If the
holder decides not to enter into the contract, the premium paid for the option
is fixed at the point of sale.
The Fund will write (sell) only covered put and call options on currency
futures. This means that a Fund will provide for its obligations upon exercise
of the option by segregating sufficient cash or short-term obligations or by
holding an offsetting position in the option or underlying currency future, or a
combination of the foregoing. A Fund will, so long as it is obligated as the
writer of a call option on currency futures, own on a contract-for-contract
basis an equal long position in currency futures with the same delivery date or
a call option on stock index futures with the difference, if any, between the
market value of the call written and the market value of the call or long
currency futures purchased maintained by a Fund in cash, Treasury bills, or
other high grade short-term obligations in a segregated account with its
custodian. If at the close of business on any day the market value of the call
purchased by a Fund falls below 100% of the market value of the call written by
the Fund, a Fund will so segregate an amount of cash, Treasury bills or other
high grade short-term obligations equal in value to the difference.
Alternatively, a Fund may cover the call option through segregating with the
custodian an amount of the particular foreign currency equal to the amount of
foreign currency per futures contract option times the number of options written
by a Fund. In the case of put options on currency futures written by the Fund,
the Fund will hold the aggregate exercise price in cash, Treasury bills, or
other high grade short-term obligations in a segregated account with its
custodian, or own put options on currency futures or short currency futures,
with the difference, if any, between the market value of the put written and the
market value of the puts purchased or the currency futures sold maintained by a
Fund in cash, Treasury bills or other high grade short-term obligations in a
segregated account with its custodian. If at the close of business on any day
the market value of the put options purchased or the currency futures by a Fund
falls below 100% of the market value of the put options written by the Fund, a
Fund will so segregate an amount of cash, Treasury bills or other high grade
short-term obligations equal in value to the difference.
If other methods of providing appropriate cover are developed, a Fund
reserves the right to employ them to the extent consistent with applicable
regulatory and exchange requirements. In connection with transactions in stock
index options, stock index futures, interest rate futures, foreign currency
futures and related options on such futures, a Fund will be required to deposit
as "initial margin" an amount of cash or short-term government securities equal
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to from 5% to 8% of the contract amount. Thereafter, subsequent payments
(referred to as "variation margin") are made to and from the broker to reflect
changes in the value of the futures contract.
Limitations on Purchase of Options. The staff of the SEC has taken the
position that purchased over-the-counter options and assets used to cover
written over-the-counter options are illiquid and, therefore, together with
other illiquid securities, cannot exceed 15% of a Fund's assets. The Adviser
intends to limit a Fund's writing of over-the-counter options in accordance with
the following procedure. Each Fund intends to write over-the-counter options
only with primary U.S. Government securities dealers recognized by the Federal
Reserve Bank of New York. Also, the contracts which a Fund has in place with
such primary dealers will provide that the Fund has the absolute right to
repurchase an option it writes at any time at a price which represents the fair
market value, as determined in good faith through negotiation between the
parties, but which in no event will exceed a price determined pursuant to a
formula in the contract. Although the specific formula may vary between
contracts with different primary dealers, the formula will generally be based on
a multiple of the premium received by a Fund for writing the option, plus the
amount, if any, of the option's intrinsic value (i.e., the amount that the
option is in-the-money). The formula also may include a factor to account for
the difference between the price of the security and the strike price of the
option if the option is written out-of-the-money. A Fund will treat all or a
part of the formula price as illiquid for purposes of the 15% test imposed by
the SEC staff.
Risk Factors Associated with Futures and Options Transactions. The
effective use of options and futures strategies depends on, among other things,
a Fund's ability to terminate options and futures positions at times when the
Adviser deems it desirable to do so. Although a Fund will not enter into an
option or futures position unless the Adviser believes that a liquid secondary
market exists for such option or future, there is no assurance that a Fund will
be able to effect closing transactions at any particular time or at an
acceptable price. A Fund generally expects that its options and futures
transactions will be conducted on recognized U.S. and foreign securities and
commodity exchanges. In certain instances, however, a Fund may purchase and sell
options in the over-the-counter market. A Fund's ability to terminate option
positions established in the over-the-counter market may be more limited than in
the case of exchange-traded options and may also involve the risk that
securities dealers participating in such transactions would fail to meet their
obligations to the Fund.
Options and futures markets can be highly volatile and transactions of
this type carry a high risk of loss. Moreover, a relatively small adverse market
movement with respect to these types of transactions may result not only in loss
of the original investment but also in unquantifiable further loss exceeding any
margin deposited.
The use of options and futures involves the risk of imperfect correlation
between movements in options and futures prices and movements in the price of
securities which are the subject of the hedge. Such correlation, particularly
with respect to options on stock indices and stock index futures, is imperfect,
and such risk increases as the composition of a Fund diverges from the
composition of the relevant index. The successful use of these strategies also
depends on the ability of the Adviser to correctly forecast interest rate
movements, currency rate movements and general stock market price movements.
In addition to certain risk factors described above, the following sets
forth certain information regarding the potential risks associated with the
Funds' futures and options transactions.
Risk of Imperfect Correlation. A Fund's ability effectively to hedge all
or a portion of its portfolio through transactions in futures, options on
futures or options on stock indices depends on the degree to which movements in
the value of the securities or index underlying such hedging instrument
correlate with movements in the value of the relevant portion of the Fund's
securities. If the values of the securities being hedged do not move in the same
amount or direction as the underlying security or index, the hedging strategy
for a Fund might not be successful and the Fund could sustain losses on its
hedging transactions which would not be offset by gains on its portfolio. It is
also possible that there may be a negative correlation between the security or
index underlying a futures or option contract and the portfolio securities being
hedged, which could result in losses both on the hedging transaction and the
Fund securities. In such instances, a Fund's overall return could be less than
if the hedging transactions had not been undertaken. Stock index futures or
options based on a narrower index of securities may present greater risk than
options or futures based on a broad market index, as a narrower index is more
susceptible to rapid and extreme
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fluctuations resulting from changes in the value of a small number of
securities. A Fund would, however, effect transactions in such futures or
options only for hedging purposes.
The trading of futures and options on indices involves the additional risk
of imperfect correlation between movements in the futures or option price and
the value of the underlying index. The anticipated spread between the prices may
be distorted due to differences in the nature of the markets, such as
differences in margin requirements, the liquidity of such markets and the
participation of speculators in the futures and options market. The purchase of
an option on a futures contract also involves the risk that changes in the value
of underlying futures contract will not be fully reflected in the value of the
option purchased. The risk of imperfect correlation, however, generally tends to
diminish as the maturity date of the futures contract or termination date of the
option approaches. The risk incurred in purchasing an option on a futures
contract is limited to the amount of the premium plus related transaction costs,
although it may be necessary under certain circumstances to exercise the option
and enter into the underlying futures contract in order to realize a profit.
Under certain extreme market conditions, it is possible that a Fund will not be
able to establish hedging positions, or that any hedging strategy adopted will
be insufficient to completely protect the Fund.
A Fund will purchase or sell futures contracts or options only if, in the
Adviser's judgment, there is expected to be a sufficient degree of correlation
between movements in the value of such instruments and changes in the value of
the relevant portion of the Fund's portfolio for the hedge to be effective.
There can be no assurance that the Adviser's judgment will be accurate.
Potential Lack of a Liquid Secondary Market. The ordinary spreads between
prices in the cash and futures markets, due to differences in the natures of
those markets, are subject to distortions. First, all participants in the
futures market are subject to initial deposit and variation margin requirements.
This could require a Fund to post additional cash or cash equivalents as the
value of the position fluctuates. Further, rather than meeting additional
variation margin requirements, investors may close futures contracts through
offsetting transactions which could distort the normal relationship between the
cash and futures markets. Second, the liquidity of the futures or options market
may be lacking. Prior to exercise or expiration, a futures or option position
may be terminated only by entering into a closing purchase or sale transaction,
which requires a secondary market on the exchange on which the position was
originally established. While a Fund will establish a futures or option position
only if there appears to be a liquid secondary market therefor, there can be no
assurance that such a market will exist for any particular futures or option
contract at any specific time. In such event, it may not be possible to close
out a position held by a Fund, which could require the Fund to purchase or sell
the instrument underlying the position, make or receive a cash settlement, or
meet ongoing variation margin requirements. The inability to close out futures
or option positions also could have an adverse impact on a Fund's ability
effectively to hedge its securities or the relevant portion thereof.
The liquidity of a secondary market in a futures contract or an option on
a futures contract may be adversely affected by "daily price fluctuation limits"
established by the exchanges, which limit the amount of fluctuation in the price
of a contract during a single trading day and prohibit trading beyond such
limits once they have been reached. The trading of futures and options contracts
also is subject to the risk of trading halts/suspensions, exchange or clearing
house equipment failures, government intervention, insolvency of the brokerage
firm or clearing house or other disruptions of normal trading activity, which
could at times make it difficult or impossible to liquidate existing positions
or to recover excess variation margin payments.
Risk of Predicting Interest Rate Movements. Investments in futures
contracts on fixed-income securities and related indices involve the risk that
if the Adviser's investment judgment concerning the general direction of
interest rates is incorrect, a Fund's overall performance may be poorer than if
it had not entered into any such contract. For example, if a Fund has been
hedged against the possibility of an increase in interest rates which would
adversely affect the price of bonds held in its portfolio and interest rates
decrease instead, the Fund will lose part or all of the benefit of the increased
value of its bonds which have been hedged because it will have offsetting losses
in its futures positions. In addition, in such situations, if a Fund has
insufficient cash, it may have to sell bonds from its portfolio to meet daily
variation margin requirements, possibly at a time when it may be disadvantageous
to do so. Such sale of bonds may be, but will not necessarily be, at increased
prices which reflect the rising market.
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Trading and Position Limits. Each contract market on which futures and
option contracts are traded has established a number of limitations governing
the maximum number of positions which may be held by a trader, whether acting
alone or in concert with others. The Adviser does not believe that these trading
and position limits will have an adverse impact on the hedging strategies
regarding the Funds' investments.
Regulations on the Use of Futures and Options Contracts. Regulations of
the CFTC require that the Funds enter into transactions in futures contracts and
options thereon for hedging purposes only, in order to assure that they are not
deemed to be a "commodity pool" under such regulations. In particular, CFTC
regulations require that all short futures positions be entered into for the
purpose of hedging the value of investment securities held by a Fund, and that
all long futures positions either constitute bona fide hedging transactions, as
defined in such regulations, or have a total value not in excess of an amount
determined by reference to certain cash and securities positions maintained for
the Fund, and accrued profits on such positions. In addition, a Fund may not
purchase or sell such instruments if, immediately thereafter, the sum of the
amount of initial margin deposits on its existing futures positions and premiums
paid for options on futures contracts would exceed 5% of the market value of the
Fund's total assets.
When a Fund purchases a futures contract, an amount of cash or cash
equivalents or high debt securities will be deposited in a segregated account
with the Fund's custodian so that the amount so segregated, plus the initial
deposit and variation margin held in the account of its broker, will at all
equal the value of the futures contract, thereby insuring that the use of such
futures is unleveraged.
The Funds' ability to engage in the hedging transactions described herein
may be limited by the current federal income tax requirement that a Fund derive
less than 30% of its gross income from the sale or other disposition of stock or
securities held for less than three months. The Funds may also further their
ability to engage in such transactions in response to the policies and concerns
of various federal and state regulatory agencies. Such policies may be changed
by vote of the Board of Directors.
Interest Rate Transactions
Among the strategic transactions into which a Fund may enter are interest
rate swaps and the purchase or sale of related caps and floors. The Funds expect
to enter into these transactions primarily to preserve a return or spread on a
particular investment or portion of its portfolio, to protect against currency
fluctuations, as a duration management technique or to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date. A Fund intends to use these transactions as hedges and not as speculative
investments and will not sell interest rate caps or floors where it does not own
securities or other instruments providing the income stream the Fund may be
obligated to pay. Interest rate swaps involve the exchange by a Fund with
another party of their respective commitments to pay or receive interest, e.g.
an exchange of floating rate payments for fixed rate payments with respect to a
notional amount of principal. A currency swap is an agreement to exchange cash
flows on a notional amount of two or more currencies based on the relative value
differential among them and an index swap is an agreement to swap cash flows on
a notional amount based on changes in the values of the reference indices. The
purchase of a cap entitles the purchaser to receive payments on a notional
principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount.
A Fund will usually enter into swaps on a net basis, i.e., the two payment
streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. In as much as these swaps, caps and
floors are entered into for good faith hedging purposes, the Adviser and the
Fund believe such obligations do not constitute senior securities under the
Investment Company Act of 1940 (the "1940 Act") and, accordingly, will not treat
them as being subject to its borrowing restrictions. A Fund will not enter into
any swap, cap and floor transaction unless, at the time of entering into such
transaction, the unsecured long-term debt of the counterparty, combined with any
credit enhancements, is rated at least "A" by Standard & Poor's Corporation or
Moody's Investors Service, Inc. or has an equivalent rating from a Nationally
Recognized Statistical Rating Organization ("NRSRO") or is determined to be of
equivalent credit quality by the Adviser. If there is a default by the
counterparty, the Fund may have contractual remedies pursuant to the agreements
related to the transaction. The swap market has grown substantially in recent
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years with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a result,
the swap market has become relatively liquid. Caps and floors are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
With respect to swaps, a Fund will accrue the net amount of the excess, if
any, of its obligations over its entitlements with respect to each swap on a
daily basis and will segregate an amount of cash or liquid high grade securities
having a value equal to the accrued excess. Caps and floors require segregation
of assets with a value equal to the Fund's net obligation, if any.
Asset-Backed Securities
In General. Asset-backed securities arise through the grouping by
governmental, government-related, and private organizations of loans,
receivables, or other assets originated by various lenders. Asset-backed
securities consist of both mortgage- and non-mortgage-backed securities.
Interests in pools of these assets differ from other forms of debt securities,
which normally provide for periodic payment of interest in fixed amounts with
principal paid at maturity or specified call dates. Instead, asset-backed
securities provide periodic payments which generally consist of both interest
and principal payments.
The life of an asset-backed security varies depending upon rate of the
prepayment of the underlying debt instruments. The rate of such prepayments will
be primarily a function of current market interest rates, although other
economic and demographic factors may be involved. For example, falling interest
rates generally result in an increase in the rate of prepayments of mortgage
loans while rising interest rates generally decrease the rate of prepayments. An
acceleration in prepayments in response to sharply falling interest rates will
shorten the security's average maturity and limit the potential appreciation in
the security's value relative to a conventional debt security. Consequently,
asset-backed securities are not as effective in locking in high, long-term
yields. Conversely, in periods of sharply rising rates, prepayments are
generally slow, increasing the security's average life and its potential for
price depreciation.
Mortgage-Backed Securities. Mortgage-backed securities represent an
ownership interest in a pool of residential mortgage loans, the interest in
which is in most cases issued and guaranteed by an agency or instrumentality of
the U.S. Government, though not necessarily by the U.S. Government itself.
Mortgage pass-through securities may represent participation interests in
pools of residential mortgage loans originated by U.S. governmental or private
lenders and guaranteed, to the extent provided in such securities, by the U.S.
Government or one of its agencies, authorities or instrumentalities. Such
securities, which are ownership interests in the underlying mortgage loans,
differ from conventional debt securities, which provide for periodic payment of
interest in fixed amounts (usually semi-annually) and principal payments at
maturity or on specified call dates. Mortgage pass-through securities provide
for monthly payments that are a "pass-through" of the monthly interest and
principal payments (including any prepayments) made by the individual borrowers
on the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which a Fund may invest
may include those issued or guaranteed by GNMA, FNMA and FHLMC. Such
Certificates are mortgage-backed securities which represent a partial ownership
interest in a pool of mortgage loans issued by lenders such as mortgage bankers,
commercial banks and savings and loan associations. Such mortgage loans may have
fixed or adjustable rates of interest. Each mortgage loan included in the pool
is either insured by the Federal Housing Administration ("FHA") or guaranteed by
the Veterans Administration ("VA").
The average life of a GNMA Certificate is likely to be substantially less
than the original maturity of the mortgage pools underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures will usually
result in the return on the greater part of principal invested far in advance of
the maturity of the mortgages in the pool. Foreclosures impose no risk to
principal investment because of the GNMA guarantee.
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As the prepayment rates of individual mortgage pools will vary widely, it
is not possible to accurately predict the average life of a particular issue of
GNMA Certificates. However, statistics published by the FHA indicate that the
average life of a single-family dwelling mortgage with a 25- to 30-year
maturity, the type of mortgage which backs most GNMA Certificates, is
approximately 12 years. It is therefore customary practice to treat GNMA
Certificates as 30-year mortgage-backed securities which prepay fully in the
twelfth year.
As a consequence of the fees paid to GNMA and the issuer of GNMA
Certificates, the coupon rate of interest of GNMA Certificates is lower than the
interest paid on the VA-guaranteed or FHA-insured mortgages underlying the
Certificates.
The yield which will be earned on GNMA Certificates may vary from their
coupon rates for the following reasons: (i) Certificates may be issued at a
premium or discount, rather than at par; (ii) Certificates may trade in the
secondary market at a premium or discount after issuance; (iii) interest is
earned and compounded monthly, which has the effect of raising the effective
yield earned on the Certificates; and (iv) the actual yield of each Certificate
is affected by the prepayment of mortgages included in the mortgage pool
underlying the Certificates and the rate at which principal so prepaid is
reinvested. In addition, prepayment of mortgages included in the mortgage pool
underlying a GNMA Certificate purchased at a premium may result in a loss to the
Fund.
Due to the large numbers of GNMA Certificates outstanding and active
participation in the secondary market by securities dealers and investors, GNMA
Certificates are highly liquid instruments.
Mortgage-backed securities issued by private issuers, whether or not such
obligations are subject to guarantees by the private issuer, may entail greater
risk than obligations directly or indirectly guaranteed by the U.S. Government.
Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities (collateral
collectively hereinafter referred to as "Mortgage Assets"). Multi-class
pass-through securities are interests in a trust composed of Mortgage Assets and
all references herein to CMOs will include multi-class pass-through securities.
Payments of principal of and interest on the Mortgage Assets, and any
reinvestment income thereon, provide the funds to pay debt service on the CMOs
or make scheduled distribution on the multi-class pass-through securities.
Moreover, principal prepayments on the Mortgage Assets may cause the CMOs
to be retired substantially earlier than their stated maturities or final
distribution dates, resulting in a loss of all or part of the premium if any has
been paid. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semiannual basis.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. Planned Amortization Class CMOs ("PAC
Bonds") generally require payments of a specified amount of principal on each
payment date. PAC Bonds are always parallel pay CMOs with the required principal
payment on such securities having the highest priority after interest has been
paid to all classes.
Stripped mortgage-backed securities ("SMBS") are derivative multi-class
mortgage securities. A Fund will only invest in SMBS that are obligations backed
by the full faith and credit of the U.S. Government. SMBS are usually structured
with two classes that receive different proportions of the interest and
principal distributions from a pool of mortgage assets. A Fund will only invest
in SMBS whose mortgage assets are U.S. Government obligations.
A common type of SMBS will be structured so that one class receives some
of the interest and most of the principal from the mortgage assets, while the
other class receives most of the interest and the remainder of the principal. If
the underlying mortgage assets experience greater than anticipated prepayments
of principal, a Fund may fail to fully recoup its initial investment in these
securities. The market value of any class which consists primarily or entirely
of principal payments generally is unusually volatile in response to changes in
interest rates. Because SMBS were only recently introduced, established trading
markets for these securities have not yet been developed.
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The average life of mortgage-backed securities varies with the maturities
of the underlying mortgage instruments, which have maximum maturities of 40
years. The average life is likely to be substantially less than the original
maturity of the mortgage pools underlying the securities as the result of
mortgage prepayments, mortgage refinancings, or foreclosures. The rate of
mortgage prepayments, and hence the average life of the certificates, will be a
function of the level of interest rates, general economic conditions, the
location and age of the mortgage and other social and demographic conditions.
Such prepayments are passed through to the registered holder with the regular
monthly payments of principal and interest and have the effect of reducing
future payments. Estimated average life will be determined by the Adviser and
used for the purpose of determining the average weighted maturity of the Funds.
Non-Mortgage Asset-backed Securities. Non-mortgage asset-backed securities
include interests in pools of receivables, such as motor vehicle installment
purchase obligations and credit card receivables. Such securities are generally
issued as pass-through certificates, which represent undivided fractional
ownership interests in the underlying pools of assets. Such securities also may
be debt instruments, which are also known as collateralized obligations and are
generally issued as the debt of a special purpose entity organized solely for
the purpose of owning such assets and issuing such debt.
Non-mortgage-backed securities are not issued or guaranteed by the U.S.
Government or its agencies or instrumentalities; however, the payment of
principal and interest on such obligations may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution (such as a bank or insurance company) unaffiliated with
the issuers of such securities. In addition, such securities generally will have
remaining estimated lives at the time of purchase of five years or less.
The purchase of non-mortgage-backed securities raises considerations
peculiar to the financing of the instruments underlying such securities. For
example, most organizations that issue asset-backed securities relating to motor
vehicle installment purchase obligations perfect their interests in their
respective obligations only by filing a financing statement and by having the
servicer of the obligations, which is usually the originator, take custody
thereof. In such circumstances, if the servicer were to sell the same
obligations to another party, in violation of its duty not to do so, there is a
risk that such party could acquire an interest in the obligations superior to
that of the holders of the Asset-backed Securities. Also, although most such
obligations grant a security interest in the motor vehicle being financed, in
most states the security interest in a motor vehicle must be noted on the
certificate of title to perfect such security interest against competing claims
of other parties. Due to the larger number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the obligations
underlying the Asset-backed Securities, usually is not amended to reflect the
assignment of the seller's security interest for the benefit of the holders of
the Asset-backed Securities. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on those securities. In addition, various state and Federal laws give
the motor vehicle owner the right to assert against the holder of the owner's
obligation certain defenses such owner would have against the seller of the
motor vehicle. The assertion of such defenses could reduce payments on the
related Asset-backed Securities. Insofar as credit card receivables are
concerned, credit card holders are entitled to the protection of a number of
state and Federal consumer credit laws, many of which give such holders the
right to set off certain amounts against balances owed on the credit card,
thereby reducing the amounts paid on such receivables. In addition, unlike most
other Asset-backed Securities, credit card receivables are unsecured obligations
of the card holder.
The development of non-mortgage-backed securities is at an early stage
compared to mortgage-backed securities. While the market for Asset-backed
Securities is becoming increasingly liquid, the market for mortgage-backed
securities issued by certain private organizations and non-mortgage-backed
securities is not as well developed. As stated above, the Adviser, as adviser to
each Fund, intends to limit its purchases of mortgage-backed securities issued
by certain private organizations and non-mortgage-backed securities to
securities that are readily marketable at the time of purchase.
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Special Situations
As described in the Prospectuses, certain Funds may invest in "special
situations." A special situation arises when, in the opinion of the Adviser, the
securities of a particular company will, within a reasonably estimable period of
time, be accorded market recognition at an appreciated value solely by reason of
a development applicable to that company, and regardless of general business
conditions or movements of the market as a whole. Developments creating special
situations might include, among others: liquidations, reorganizations,
recapitalizations, mergers, material litigation, technical breakthroughs and new
management or management policies. Although large and well known companies may
be involved, special situations more often involve comparatively small or
unseasoned companies. Investments in unseasoned companies and special situations
often involve much greater risk than is inherent in ordinary investment
securities.
Reverse Repurchase Agreements
At the time a Fund enters into a reverse repurchase agreement, it may
establish a segregated account with its custodian bank in which it will maintain
cash, U.S. Government securities or other liquid high grade debt obligations
equal in value to its obligations in respect of reverse repurchase agreements.
Reverse repurchase agreements involve the risk that the market value of the
securities the Funds are obligated to repurchase under the agreement may decline
below the repurchase price. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Funds' use
of proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, whether to enforce the Funds'
obligation to repurchase the securities. Reverse repurchase agreements are
speculative techniques involving leverage, and are subject to asset coverage
requirements if the Funds do not establish and maintain a segregated account (as
described above). In addition, some or all of the proceeds received by a Fund
from the sale of a portfolio instrument may be applied to the purchase of a
repurchase agreement. To the extent the proceeds are used in this fashion and a
common broker/dealer is the counterparty on both the reverse repurchase
agreement and the repurchase agreement, the arrangement might be recharacterized
as a swap transaction. Under the requirements of the 1940 Act, the Funds are
required to maintain an asset coverage (including the proceeds of the
borrowings) of at least 300% of all borrowings. Depending on market conditions,
the Funds' asset coverage and other factors at the time of a reverse repurchase,
the Funds may not establish a segregated account when the Adviser believes it is
not in the best interests of the Funds to do so. In this case, such reverse
repurchase agreements will be considered borrowings subject to the asset
coverage described above.
Securities Lending
To increase return on portfolio securities, certain of the Funds may lend
their portfolio securities to broker/dealers and other institutional investors
pursuant to agreements requiring that the loans be continuously secured by
collateral equal at all times in value to at least the market value of the
securities loaned. Collateral for such loans may include cash, securities of the
U.S. Government, its agencies or instrumentalities, an irrevocable letter of
credit issued by (i) a U.S. bank that has total assets exceeding $1 billion and
that is a member of the Federal Deposit Insurance Corporation, or (ii) a foreign
bank that is one of the 75 largest foreign commercial banks in terms of total
assets, or any combination thereof. Such loans will not be made if, as a result,
the aggregate of all outstanding loans of the Fund involved exceeds 30% of the
value of its total assets. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even a loss of rights in
the collateral should the borrower of the securities fail financially. However,
loans are made only to borrowers deemed by the Adviser to be of good standing
and when, in its judgment, the income to be earned from the loan justifies the
attendant risks. Pursuant to the securities loan agreement a Fund is able to
terminate the securities loan upon notice of not more than five business days
and thereby secure the return to the Fund of securities identical to the
transferred securities upon termination of the loan.
Short Sales
As described in the Prospectuses, certain Funds may from time to time
enter into short sales transactions. A Fund will not make short sales of
securities nor maintain a short position unless at all times when a short
position is
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open, such Fund owns an equal amount of such securities or securities
convertible into or exchangeable, without payment of any further consideration,
for securities of the same issue as, and equal in amount to, the securities sold
short. This is a technique known as selling short "against the box." Such short
sales will be used by a Fund for the purpose of deferring recognition of gain or
loss for federal income tax purposes.
Guaranteed Investment Contracts
Guaranteed Investment Contracts ("GICs") are issued by highly rated
insurance companies. Pursuant to such contracts, a Fund makes cash contributions
to a deposit fund of the insurance company's general or separate accounts. The
insurance company then credits to the Fund guaranteed interest. The insurance
company may assess periodic charges against a GIC for expense and service costs
allocable to it, and the charges will be deducted from the value of the deposit
fund. The purchase price paid for a GIC becomes part of the general assets of
the issuer, and the contract is paid from the general assets of the issuer.
A Fund will only purchase GlCs from issuers which, at the time of purchase,
meet quality and credit standards established by the Adviser. Generally, GlCs
are not assignable or transferable without the permission of the issuing
insurance companies, and an active secondary market in GlCs does not currently
exist. Also, a Fund may not receive the principal amount of a GIC from the
insurance company on seven days' notice or less. Therefore, GlCs are generally
considered to be illiquid investments.
A Money Market Fund will acquire GlCs so that they, together with other
instruments in such Fund's portfolio which are not readily marketable, will not
exceed 10% of such Fund's total assets. A Money Market Fund will restrict its
investments in GlCs to those having a term of 397 days or less. In determining
average weighted portfolio maturity, a GIC will be deemed to have a maturity
equal to the period of time remaining under the next readjustment of the
guaranteed interest rate.
Illiquid Securities
Certain of the Non-Money Market Funds may invest up to 15% of their net
assets, and certain of the Money Market Funds may invest up to 10% of their net
assets, in securities that are considered illiquid because of the absence of a
readily available market or due to legal or contractual restrictions. Certain
restricted securities that are not registered for sale to the general public but
that can be resold to institutional investors may not be considered illiquid,
provided that a dealer or institutional trading market exists. The institutional
trading market is relatively new, and liquidity of a Fund's investments could be
impaired if trading does not develop or declines.
Commercial Instruments
Commercial Instruments consist of short-term U.S. dollar-denominated
obligations issued by domestic corporations or issued in the U.S. by foreign
corporations and foreign commercial banks. The Nations Prime Fund will limit
purchases of commercial instruments to instruments which: (a) if rated by at
least two Nationally Rated Statistical Rating Organizations ("NRSROs"), are
rated in the highest rating category for short-term debt obligations given by
such organizations, or if only rated by one such organization, are rated in the
highest rating category for short-term debt obligations given by such
organization; or (b) if not rated, are (i) comparable in priority and security
to a class of short-term instruments of the same issuer that has such rating(s),
or (ii) of comparable quality to such instruments as determined by Nations Fund,
Inc.'s Board of Directors on the advice of the Adviser.
Investments by a Fund in commercial paper will consist of issues rated in
a manner consistent with such Fund's investment policies and objectives. In
addition, the Funds may acquire unrated commercial paper and corporate bonds
that are determined by the Adviser at the time of purchase to be of comparable
quality to rated instruments that may be acquired by such Funds as previously
described.
Variable-rate master demand notes are unsecured instruments that permit
the indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate. While some of these notes are not rated by credit rating
agencies, issuers of variable rate master demand notes must satisfy the Adviser
that similar criteria to that set forth
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above with respect to the issuers of commercial paper purchasable by the Nations
Prime Fund are met. Variable-rate instruments acquired by a Fund will be rated
at a level consistent with such Fund's investment objective and policies of high
quality as determined by a major rating agency or, if not rated, will be of
comparable quality as determined by the Adviser. Substantial holdings of
variable-rate instruments could reduce portfolio liquidity.
Variable- and floating-rate instruments are unsecured instruments that
permit the indebtedness thereunder to vary. While there may be no active
secondary market with respect to a particular variable or floating rate
instrument purchased by a Fund, a Fund may, from time to time as specified in
the instrument, demand payment of the principal or may resell the instrument to
a third party. The absence of an active secondary market, however, could make it
difficult for a Fund to dispose of an instrument if the issuer defaulted on its
payment obligation or during periods when a Fund is not entitled to exercise its
demand rights, and a Fund could, for these or other reasons, suffer a loss. The
instruments are not typically rated by credit rating agencies, but issuers of
variable and floating rate instruments must satisfy similar criteria to that set
forth above for issuers of commercial paper. A Fund may invest in variable and
floating rate instruments only when the Adviser deems the investment to involve
minimal credit risk. If such instruments are not rated, the Adviser will
consider the earning power, cash flows, and other liquidity ratios of the
issuers of such instruments and will continuously monitor their financial status
to meet payment on demand. In determining average weighted portfolio maturity,
an instrument will be deemed to have a maturity equal to the longer of the
period remaining to the next interest rate adjustment or the demand notice
period specified in the instrument.
The Nations Prime Fund also may purchase short-term participation
interests in loans extended by banks to companies, provided that both such banks
and such companies meet the quality standards set forth above.
Municipal Securities
The two principal classifications of municipal securities are "general
obligation" securities and "revenue" securities. General obligation securities
are secured by the issuer's pledge of its full faith, credit, and taxing power
for the payment of principal and interest. Revenue securities are payable only
from the revenues derived from a particular facility or class of facilities or,
in some cases, from the proceeds of a special excise tax or other specific
revenue source such as the user of the facility being financed. Private activity
bonds held by a Fund are in most cases revenue securities and are not payable
from the unrestricted revenues of the issuer. Consequently, the credit quality
of private activity bonds is usually directly related to the credit standing of
the corporate user of the facility involved.
Municipal securities may include "moral obligation" bonds, which are
normally issued by special purpose public authorities. If the issuer of moral
obligation bonds is unable to meet its debt service obligations from current
revenues, it may draw on a reserve fund, the restoration of which is a moral
commitment but not a legal obligation of the state or municipality which created
the issuer.
Municipal securities may include variable or floating rate instruments
issued by industrial development authorities and other governmental entities.
While there may not be an active secondary market with respect to a particular
instrument purchased by a Fund, a Fund may demand payment of the principal and
accrued interest on the instrument or may resell it to a third party as
specified in the instruments. The absence of an active secondary market,
however, could make it difficult for a Fund to dispose of the instrument if the
issuer defaulted on its payment obligation or during periods the Fund is not
entitled to exercise its demand rights, and the Fund could, for these or other
reasons, suffer a loss.
Some of these instruments may be unrated, but unrated instruments
purchased by a Fund will be determined by the Adviser to be of comparable
quality at the time of purchase to instruments rated "high quality" by any major
rating service. Where necessary to ensure that an instrument is of comparable
"high quality," a Fund will require that an issuer's obligation to pay the
principal of the note may be backed by an unconditional bank letter or line of
credit, guarantee, or commitment to lend.
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Municipal securities may include participations in privately arranged
loans to municipal borrowers, some of which may be referred to as "municipal
leases." Generally such loans are unrated, in which case they will be determined
by the Adviser to be of comparable quality at the time of purchase to rated
instruments that may be acquired by a Fund. Frequently, privately arranged loans
have variable interest rates and may be backed by a bank letter of credit. In
other cases, they may be unsecured or may be secured by assets not easily
liquidated. Moreover, such loans in most cases are not backed by the taxing
authority of the issuers and may have limited marketability or may be marketable
only by virtue of a provision requiring repayment following demand by the
lender. Such loans made by a Fund may have a demand provision permitting the
Fund to require payment within seven days. Participations in such loans,
however, may not have such a demand provision and may not be otherwise
marketable. To the extent these securities are illiquid, they will be subject to
each Fund's limitation on investments in illiquid securities. Recovery of an
investment in any such loan that is illiquid and payable on demand may depend on
the ability of the municipal borrower to meet an obligation for full repayment
of principal and payment of accrued interest within the demand period, normally
seven days or less (unless a Fund determines that a particular loan issue,
unlike most such loans, has a readily available market). As it deems
appropriate, the Adviser will establish procedures to monitor the credit
standing of each such municipal borrower, including its ability to meet
contractual payment obligations.
Municipal securities may include units of participation in trusts holding
pools of tax-exempt leases. Municipal participation interests may be purchased
from financial institutions, and give the purchaser an undivided interest in one
or more underlying municipal security. To the extent that municipal
participation interests are considered to be "illiquid securities," such
instruments are subject to each Fund's limitation on the purchase of illiquid
securities. Municipal leases and participating interests therein which may take
the form of a lease or an installment sales contract, are issued by state and
local governments and authorities to acquire a wide variety of equipment and
facilities. Interest payments on qualifying leases are exempt from Federal
income taxes.
In addition, certain of the Funds may acquire "stand-by commitments" from
banks or broker/dealers with respect to municipal securities held in their
portfolios. Under a stand-by commitment, a dealer would agree to purchase at a
Fund's option specified Municipal Securities at a specified price. A Fund will
acquire stand-by commitments solely to facilitate portfolio liquidity and do not
intend to exercise their rights thereunder for trading purposes.
Although the Funds do not presently intend to do so on a regular basis,
each may invest more than 25% of its total assets in municipal securities the
interest on which is paid solely from revenues of similar projects if such
investment is deemed necessary or appropriate by the Adviser. To the extent that
more than 25% of a Fund's total assets are invested in Municipal Securities that
are payable from the revenues of similar projects, a Fund will be subject to the
peculiar risks presented by such projects to a greater extent than it would be
if its assets were not so concentrated.
Real Estate Investment Trusts
A real estate investment trust ("REIT") is a managed portfolio of real
estate investments which may include office buildings, apartment complexes,
hotels and shopping malls. An Equity REIT holds equity positions in real estate,
and it seeks to provide its shareholders with income from the leasing of its
properties, and with capital gains from any sales of properties. A Mortgage REIT
specializes in lending money to developers of properties, and passes any
interest income it may earn to its shareholders.
REITs may be affected by changes in the value of the underlying property
owned or financed by the REIT, while Mortgage REITs also may be affected by the
quality of credit extended. Both Equity and Mortgage REITs are dependent upon
management skill and may not be diversified. REITs also may be subject to heavy
cash flow dependency, defaults by borrowers, self-liquidation, and the
possibility of failing to qualify for tax-free pass-through of income under the
Internal Revenue Code or 1986, as amended.
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Additional Investment Limitations
The most significant investment restrictions applicable to the Funds'
investment programs are set forth in the Prospectuses under the heading
"Investment Limitations." Additionally, as a matter of fundamental policy which
may not be changed without a majority vote of a Fund's shareholders (as that
term is defined under the heading "Investment Advisory, Administration, Custody,
Transfer Agency, Shareholder Servicing and Distribution Agreements -- The
Company and Its Common Stock" in this SAI), each Fund will not:
1. Borrow money or issue senior securities as defined in the 1940 Act except
that (a) a Fund may borrow money from banks for temporary purposes in
amounts up to one-third of the value of such Fund's total assets at the
time of borrowing, provided that borrowings in excess of 5% of the value of
such Fund's total assets will be repaid prior to the purchase of additional
portfolio securities by such Fund, (b) a Fund may enter into commitments to
purchase securities in accordance with the Fund's investment program,
including delayed delivery and when-issued securities, which commitments
may be considered the issuance of senior securities, and (c) a Fund may
issue multiple classes of shares in accordance with SEC regulations or
exemptions under the 1940 Act. The purchase or sale of futures contracts
and related options shall not be considered to involve the borrowing of
money or issuance of senior securities.
2. Purchase any securities on margin (except for such short-term credits as
are necessary for the clearance of purchases and sales of portfolio
securities) or sell any securities short (except against the box.) For
purposes of this restriction, the deposit or payment by the Fund of initial
or maintenance margin connection with futures contracts and related options
and options on securities is not considered to be the purchase of a
security on margin.
3. Underwrite securities issued by any other person, except to the extent that
the purchase of securities and the later disposition of such securities in
accordance with the Fund's investment program may be deemed an
underwriting. This restriction shall not limit a Fund's ability to invest
in securities issued by other registered investment companies.
4. Invest in real estate or real estate limited partnership interests. (The
Fund may, however, purchase and sell securities secured by real estate or
interests therein or issued by issuers which invest in real estate or
interests therein.) This restriction does not apply to real estate limited
partnerships listed on a national stock exchange (e.g., the New York Stock
Exchange).
5. Purchase or sell commodity contracts except that each Fund may, to the
extent appropriate under its investment policies, purchase publicly traded
securities of companies engaging in whole or in part in such activities,
may enter into futures contracts and related options, may engage in
transactions on a when-issued or forward commitment basis, and may enter
into forward currency contracts in accordance with its investment policies.
In addition, certain non-fundamental investment restrictions are also
applicable to various investment portfolios, including the following:
1. The Company will not purchase or retain the securities of any issuer if the
officers, or directors of the Company, its advisers, or managers owning
beneficially more than one half of one percent of the securities of each
issuer together own beneficially more than five percent of such securities.
2. No Fund of the Company will purchase securities of unseasoned issuers,
including their predecessors, that have been in operation for less than
three years, if by reason thereof the value of such Fund's investment in
such classes of securities would exceed 5% of such Fund's total assets. For
purposes of this limitation, issuers include predecessors, sponsors,
controlling persons, general partners, guarantors and originators of
underlying assets which have less than three years of continuous operation
or relevant business experience.
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3. No Fund will purchase puts, calls, straddles, spreads and any combination
thereof if by reason thereof the value of its aggregate investment in such
classes of securities will exceed 5% of its total assets except that: (a)
this restriction shall not apply to standby commitments, (b) this
restriction shall not apply to a Fund's transactions in futures contracts
and related options, and (c) a Fund may obtain short-term credit as may be
necessary for the clearance of purchases and sales of portfolio securities.
4. No Fund will invest in warrants, valued at the lower of cost or market, in
excess of 5% of the value of such Fund's assets, and no more than 2% of the
value of the Fund's net assets may be invested in warrants that are not
listed on the New York or American Stock Exchange (for purposes of this
undertaking, warrants acquired by a Fund in units or attached to securities
will be deemed to have no value).
5. Nations Prime Fund and Nations Treasury Fund may not purchase securities of
any one issuer (other than obligations issued or guaranteed by the U.S.
government, its agencies, authorities or instrumentalities and repurchase
agreements fully collateralized by such obligations) if, immediately after
such purchase, more than 5% of the value of the Fund's assets would be
invested in the securities of such issuer. Notwithstanding the foregoing,
up to 25% of each Fund's total assets may be invested for a period of three
business days in the securities of a single issuer without regard to such
5% limitation.
6. No Fund of the Company will purchase securities of companies for the
purpose of exercising control.
7. No Money Market Fund of the Company will invest more than 10% of the value
of its net assets in illiquid securities, including repurchase agreements
with remaining maturities in excess of seven days, time deposits with
maturities in excess of seven days, restricted securities, and other
securities which are not readily marketable. For purposes of this
restriction, illiquid securities shall not include securities which may be
resold under Rule 144A under the Securities Act of 1933 that the Board of
Directors, or its delegate, determines to be liquid, based upon the trading
markets for the specific security.
8. No Non-Money Market Fund of the Company will invest more than 15% of the
value of its net assets in illiquid securities, including repurchase
agreements with remaining maturities in excess of seven days, time deposits
with maturities in excess of seven days, restricted securities, and other
securities which are not readily marketable. For purposes of this
restriction, illiquid securities shall not include securities which may be
resold under Rule 144A under the Securities Act of 1933 that the Board of
Directors, or its delegate, determines to be liquid, based upon the trading
markets for the specific security.
9. No Fund of the Company will mortgage, pledge or hypothecate any assets
except to secure permitted borrowings and then only in an amount up to
one-third of the value of the Fund's total assets at the time of borrowing.
For purposes of this limitation, collateral arrangements with respect to
the writing of options, futures contracts, options on futures contracts,
and collateral arrangements with respect to initial and variation margin
are not considered to be a mortgage, pledge or hypothecation of assets.
10. No Fund of the Company will invest in securities of other investment
companies, except as they may be acquired as part of a merger,
consolidation or acquisition of assets and except to the extent otherwise
permitted by the 1940 Act.
No Fund of the Company will purchase oil, gas or mineral leases or other
interests (a Fund may, however, purchase and sell the securities of companies
engaged in the exploration, development, production,refining,transporting
and marketing of oil, gas or minerals).
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NET ASSET VALUE
Purchases and Redemptions
See "How To Buy Shares" and "How To Redeem Shares" in the Prospectuses for
a complete description of the manner in which shares of the various classes of
the Funds may be purchased and redeemed.
The Funds also are available for a variety of retirement plans, including
IRAs, that allow investors to shelter some of their income from taxes. Investors
should contact their Selling Agents for details concerning retirement plans.
The right of redemption may be suspended or the date of payment postponed
when (a) trading on the New York Stock Exchange is restricted, as determined by
applicable rules and regulations of the SEC, (b) the New York Stock Exchange is
closed for other than customary weekend and holiday closings, (c) the SEC has by
order permitted such suspension, or (d) an emergency as determined by the SEC
exists making disposal of portfolio securities or the valuation of the net
assets of a Fund of the Company not reasonably practicable.
Net Asset Value Determination
Shares of the common stock of each class of shares of each Fund that are
offered by the Prospectuses are sold at their respective net asset value next
determined after the receipt of the purchase order, plus any applicable sales
charge. Shareholders may at any time redeem all or a portion of their shares at
net asset value next determined following receipt of a redemption order, less
any contingent deferred sales charge applicable to Investor Shares.
The net asset value per share of each of the Funds is determined at the
times and in the manner described in the Prospectuses.
The securities of the Money Market Funds are valued on the basis of
amortized cost, as are short-term obligations (with maturities of 60 days or
less) held by any Fund. This method values a security at its cost on the date of
purchase and thereafter assumes a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates on
the market value of the security. While this method provides certainty in
valuation, it may result in periods during which value, as determined by
amortized cost, is higher or lower than the price a Fund would receive if the
security were sold. During such periods, the daily yield on shares of a Fund's
class computed as described under "Yield Information" may differ somewhat from
an identical computation made by another investment company with identical
investments utilizing available indications as to the market value of its
portfolio securities.
The valuation of the portfolio instruments based upon their amortized cost
and the concomitant attempt to maintain the net asset value per share of $1.00
for the Money Market Funds is permitted in accordance with applicable rules and
regulations of the SEC which require each such Fund to adhere to certain
conditions, which are more fully described in the Prospectuses for the Money
Market Funds.
With respect to the Equity Income and International Equity Funds, a
security listed or traded on an exchange is valued at its last sales price on
the exchange where the security is principally traded or, lacking any sales on a
particular day, the security is valued at the mean between the closing bid and
asked prices on that day. Each security traded in the over-the-counter market
(but not including securities reported on the NASDAQ National Market System) is
valued at the mean between the last bid and asked prices based upon quotes
furnished by market makers for such securities. Each security reported on the
NASDAQ National Market System is valued at the last sales price on the valuation
date. With respect to the Government Securities Fund, securities may be valued
on the basis of prices provided by an independent pricing service. Prices
provided by the pricing service may be determined without exclusive reliance on
quoted prices, and may reflect appropriate factors such as yield, type of issue,
coupon rate maturity and seasoning differential. Securities for which prices are
not provided by the pricing
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<PAGE>
service are valued at the mean between the last bid and asked prices based upon
quotes furnished by market makers for such securities.
With respect to the Equity Income, Government Securities and International
Equity Funds, securities for which market quotations are not readily available
are valued at fair value as determined in good faith by or under the supervision
of the Company's officers in a manner specifically authorized by the Board of
Directors of the Company. Short-term obligations having 60 days or less to
maturity are valued at amortized cost, which approximates market value.
Generally, trading in foreign securities, as well as U.S. Government
securities, money market instruments and repurchase agreements, is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of such securities used in computing the net asset value of
the shares of the Fund are determined as of such times. Foreign currency
exchange rates are also generally determined prior to the close of the New York
Stock Exchange. Occasionally, events affecting the value of such securities and
such exchange rates may occur between the times at which they are determined and
the close of the New York Stock Exchange, which will not be reflected in the
computation of net asset value. If during such periods events occur which
materially affect the value of such securities, the securities will be valued at
their fair market value as determined in good faith by the directors.
For purposes of determining the net asset value per Share of the
International Equity Fund, all assets and liabilities of the International
Equity Fund initially expressed in foreign currencies will be converted into
U.S. dollars at the mean between the bid and offer prices of such currencies
against U.S. dollars quoted by a major bank that is a regular participant in the
foreign exchange market or on the basis of a pricing service that takes into
account the quotes provided by a number of such major banks.
Exchanges
By use of the exchange privilege, the holder of Investor Shares and/or
Primary B Shares authorizes the transfer agent or the shareholder's financial
institution to rely on telephonic instructions from any person representing
himself to be the investor and reasonably believed to be genuine. The transfer
agent's or a financial institution's records of such instructions are binding.
Exchanges are taxable transactions for Federal income tax purposes; therefore, a
shareholder will realize a capital gain or loss depending on whether the
Investor Shares and/or Primary B Shares being exchanged have a value which is
more or less than their adjusted cost basis.
The Company may limit the number of times the exchange privilege may be
exercised by a shareholder within a specified period of time. Also, the exchange
privilege may be terminated or revised at any time by Nations Fund, Inc. upon
such notice as may be required by applicable regulatory agencies (presently
sixty days for termination or material revision), provided that the exchange
privilege may be terminated or materially revised without notice under certain
unusual circumstances.
The Prospectuses for the Investor Shares and Primary B Shares of each Fund
describe the exchange privileges available to holders of such Investor Shares
and Primary B Shares, respectively.
DESCRIPTION OF SHARES
Dividends and Distributions
Nations Prime and Treasury Funds. All of the net investment income earned
by each of the Money Market Funds is declared daily as a dividend to the
shareholders of record of each class of shares of each Fund. The Investor A,
Investor B, Investor C and Primary B Shares of each such Fund shall accrue an
additional expense not borne by the Primary A Shares as a result of the Rule
12b-1 Plans and/or the Shareholder Servicing Plans or Shareholder Administration
Plan and/or Shareholder Administration Agreements applicable to each such class
of shares. Consequently, a separate calculation shall be made to arrive at the
dividends of each class of shares.
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Dividends normally accrue on the first day that a purchase order is effective
but not on the date that a redemption order is effective. Thus, if a purchase
order is accepted prior to 12:00 noon Eastern Standard Time, the shareholder
will receive dividends beginning that day. All dividends declared during a month
will be paid in cash within five business days after the end of the month. If a
shareholder of record redeems all of the shares in its account at any time
during the month, all dividends declared through the date of redemption are paid
to the shareholder along with the proceeds of the redemption within five
business days of the redemption.
Equity Income Fund and International Equity Fund. Dividends and
distributions from net investment income, if any, are declared and paid
quarterly, and capital gains distributions are declared and paid annually. The
Investor A, Investor C, Investor N and Primary B Shares of the Funds shall
accrue an additional expense not borne by the Primary A Shares as a result of
the applicable Rule 12b-1 Plan and/or Shareholder Servicing Plan or Shareholder
Administration Plan and/or Shareholder Administration Agreements. Consequently,
a separate calculation shall be made to arrive at the net asset value per share
and dividends of each class of shares of the Funds.
Government Securities Fund. Dividends and distributions from net
investment income are declared daily and paid monthly, and capital gains
distributions are declared and paid annually. The Investor A, Investor C,
Investor N and Primary B Shares of the Fund shall accrue an additional expense
not borne by the Primary A Shares as a result of the 12b-1 Plans and the
Shareholder Servicing Plan or Shareholder Administration Plan and/or Shareholder
Administration Agreements. Consequently, a separate calculation shall be made to
arrive at the net asset value per share and dividends of each class of shares of
the Fund.
With respect to the Money Market Funds, net investment income for dividend
purposes consists of (i) interest accrued and original issue discount earned on
a Fund's assets, (ii) plus the amortization of market discount and minus the
amortization of market premium on such assets, (iii) less accrued expenses
directly attributable to the Fund and the general expenses of Nations Fund
prorated to a Fund on the basis of its relative net assets. With respect to the
Non-Money Market Funds, net income for dividend purposes consists of (i), (ii)
and (iii) above, plus dividend or distribution income on the Fund's assets.
ADDITIONAL INFORMATION CONCERNING TAXES
The following is only a summary of certain additional tax considerations
generally affecting the Funds and their shareholders that are not described in
the Prospectuses. No attempt is made to present a detailed explanation of the
tax treatment of each Fund or its shareholders, and the discussion here and in
the Prospectuses is not intended as a substitute for careful tax planning.
The Company has received a private letter ruling from the Internal Revenue
Service to the effect that: (i) the differing fees imposed on Primary A, Primary
B, Investor A, Investor C, Investor D and Investor N Shares with respect to
servicing, distribution and administrative support services, and transfer agency
arrangements; the differing sales charges on purchases and redemptions of such
shares; and the Investor C Shares of the Non-Money Market Funds conversion
feature, applicable to shares purchased prior to April 1, 1994, does not result
in the Company's dividends or distributions constituting "preferential
dividends" under the Internal Revenue Code of 1986, as amended (the "Code"); and
(ii) the Investor C Shares conversion feature does not constitute a taxable
event under the federal income tax law.
Qualification as a Regulated Investment Company
Each Fund expects to qualify as a regulated investment company under
Subchapter M of the Code. As a regulated investment company, each Fund is not
subject to federal income tax on the portion of its net investment income (i.e.,
taxable interest, dividends and other taxable ordinary income, net of expenses)
and capital gain net income (i.e., the excess of capital gains over capital
losses) that it distributes to shareholders, provided that it distributes at
least 90% of its investment company taxable income (i.e., net investment income
and the excess of it short-term capital gain over net long-term capital loss)
and at least 90% of its tax-exempt income (net of expenses
27
<PAGE>
allocable thereto) for the taxable year (the "Distribution Requirement"), and
satisfies certain other requirements of the Code that are described below.
Distributions by a Fund made during the taxable year or, under specified
circumstances, within twelve months after the close of the taxable year, will be
considered distributions of income and gains of the taxable year and can
therefore satisfy the Distribution Requirement.
In addition to satisfying the Distribution Requirement, a regulated
investment company must (i) derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, gains
from the sale or other disposition of stock or securities or foreign currencies
(to the extent such currency gains are directly related to the regulated
investment company's principal business of investing in stock or securities) and
other income (including but not limited to gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies (the "Income Requirement"); and (ii) derive less
than 30% of its gross income (exclusive of certain gains on designated hedging
transactions that are offset by realized or unrealized losses on offsetting
positions) from the sale or other disposition of stock, securities or foreign
currencies (or options, futures or forward contracts thereon) held for less than
three months (the "Short-Short Gain Test"). However, foreign currency gains,
including those derived from options, futures and forwards, will not be
characterized as Short-Short Gain if they are directly related to the regulated
investment company's investments in stock or securities (or options or futures
thereon). Because of the Short-Short Gain Test, a Fund may have to limit the
sale of appreciated securities that it has held for less than three months.
However, the Short-Short Gain Test will not prevent a Fund from disposing of
investments at a loss, since the recognition of a loss before the expiration of
the three-month holding period is disregarded. Interest (including original
issue discount) received by a Fund at maturity or upon the disposition of a
security held for less than three months will not be treated as gross income
derived from the sale or other disposition of such security within the meaning
of the Short-Short Gain Test. However, income that is attributable to realized
market appreciation will be treated as gross income from the sale or other
disposition of securities for this purpose.
In general, gain or loss recognized by a Fund on the disposition of an
asset will be a capital gain or loss. However, gain recognized on the
disposition of a debt obligation (including tax-exempt obligations purchased
after April 30, 1993) purchased by a Fund at a market discount (generally, at a
price less than its principal amount) will be treated as ordinary income to the
extent of the portion of the market discount which accrued during the period of
time the Fund held the debt obligation. In addition, under the rules of Code
Section 988, gain or loss recognized on the disposition of a debt obligation
denominated in a foreign currency or an option with respect thereto (but only to
the extent attributable to changes in foreign currency exchange rates), and gain
or loss recognized on the disposition of a foreign currency forward contract,
futures contract, option or similar financial instrument, or of foreign currency
itself, will generally be treated as ordinary income or loss.
In general, for purposes of determining whether capital gain or loss
recognized by a Fund on the disposition of an asset is long-term or short-term,
the holding period of the asset may be affected if (i) the asset is used to
close a "short sale" (which includes for certain purposes the acquisition of a
put option) or is substantially identical to another asset so used, (ii) the
asset is otherwise held by the Fund as part of a "straddle" (which term
generally excludes a situation where the asset is stock and the Fund grants a
qualified covered call option (which, among other things, must not be
deep-in-the-money) with respect thereto) or (iii) the asset is stock and the
Fund grants an in-the-money qualified covered call option with respect thereto.
However, for purposes of the Short-Short Gain Test, the holding period of the
asset disposed of may be reduced only in the case of clause (i) above. In
addition, a Fund may be required to defer the recognition of a loss on the
disposition of an asset held as part of a straddle to the extent of any
unrecognized gain on the offsetting position.
Any gain recognized by a Fund on the lapse of, or any gain or loss
recognized by a Fund from a closing transaction with respect to, an option
written by the Fund will be treated as a short-term capital gain or loss. For
purposes of the Short-Short Gain Test, the holding period of an option written
by a Fund will commence on the date it is written and end on the date it lapses
or the date a closing transaction is entered into. Accordingly, a Fund may be
limited in its ability to write options which expire within three months and to
enter into closing transactions at a gain within three months of the writing of
options.
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Transactions that may be engaged in by certain of the Funds (such as
futures contracts and options on stock indices and futures contracts) will be
subject to special tax treatment as "Section 1256 contracts." Section 1256
contracts are treated as if they are sold for their fair market value on the
last business day of the taxable year, regardless of whether a taxpayer's
obligations (or rights) under such contracts have terminated (by delivery,
exercise, entering into a closing transaction or otherwise) as of such date. The
net amount of such gain or loss for the entire taxable year (including gain or
loss arising as a consequence of the year-end deemed sale of such contracts) is
treated as 60% long-term capital gain or loss and 40% short-term capital gain or
loss. The Internal Revenue Service has held in several private rulings that
gains arising from Section 1256 contracts will be treated for purposes of the
Short-Short Gain Test as being derived from securities held for not less than
three months if the gains arise as a result of a constructive sale under Code
Section 1256. A Fund may elect not to have this special tax treatment apply to
Section 1256 contracts that are part of a "mixed straddle" with other
investments of the Fund that are not Section 1256 contracts.
Treasury regulations permit a regulated investment company, in determining
its investment company taxable income and net capital gain (i.e., the excess of
net long-term capital gain over net short-term capital loss) for any taxable
year, to elect (unless it has made a taxable year election for excise tax
purposes as discussed below) to treat all or part of any net capital loss, any
net long-term capital loss or any net foreign currency loss incurred after
October 31 as if they had been incurred in the succeeding year.
In addition to satisfying the requirement described above, each Fund must
satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of each Fund's
taxable year, at least 50% of the value of the Fund's assets must consist of
cash and cash items, Government securities, securities of other regulated
investment companies, and securities of other issuers (as to which the Fund has
not invested more than 5% of the value of the Fund's total assets in securities
of such issuer and as to which the Fund does not hold more than 10% of the
outstanding voting securities of such issuer), and no more than 25% of the value
of its total assets may be invested in the securities of any one issuer (other
than U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses.
If for any taxable year a Fund does not qualify as a regulated investment
company, all of its taxable income (including its net capital gain) will be
subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable as
ordinary dividends to the extent of such Fund's current and accumulated earnings
and profits. With respect to the Equity Income Fund, such distributions
generally will be eligible for the dividends-received deduction in the case of
corporate shareholders.
Excise Tax on Regulated Investment Companies
A 4% non-deductible excise tax is imposed on a regulated investment
company that fails to distribute in each calendar year an amount equal to 98% of
ordinary taxable income for the calendar year and 98% of capital gain net income
for the one-year period ended on October 31 of such calendar year (or, at the
election of a regulated investment company having a taxable year ending November
30 or December 31, for its taxable year (a "taxable year election"). Tax-exempt
interest on Municipal Obligations is not subject to the excise tax. The balance
of such income must be distributed during the next calendar year. For the
foregoing purposes, a regulated investment company is treated as having
distributed any amount on which it is subject to income tax for any taxable year
ending in such calendar year.
For purposes of the excise tax, a regulated investment company may (1)
reduce its capital gain net income (but not below its net capital gain) by the
amount of any net ordinary loss for the calendar year and (2) exclude foreign
currency gains and losses incurred after October 31 of any year (or after the
end of its taxable year if it has made a taxable year election) in determining
the amount of ordinary taxable income for the current calendar year
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(and, instead, include such gains and losses in determining ordinary taxable
income for the succeeding calendar year).
Each Fund intends to make sufficient distributions or deemed distributions
of its ordinary taxable income and capital gain net income to avoid liability
for the excise tax. However, investors should note that a Fund may in certain
circumstances be required to liquidate Fund investments to make sufficient
distributions to avoid excise tax liability.
Distributions
Each Fund anticipates distributing substantially all of its investment
company taxable income for each taxable year. Such distributions will be taxable
to shareholders as ordinary income and treated as dividends for federal income
tax purposes, but they may qualify for the 70% dividends-received deduction only
to the extent discussed below with respect to the corporate shareholders of the
Equity Income Fund.
A Fund may either retain or distribute to shareholders its net capital
gain for each taxable year. Each Fund currently intends to distribute any such
amounts. If net capital gain is distributed and designated as a capital gain
dividend, it will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his/her shares or
whether such gain was recognized by the Fund prior to the date on which the
shareholder acquired his/her shares. Conversely, if a Fund elects to retain its
net capital gain, the Fund will be taxed thereon (except to the extent of any
available capital loss carryovers) at the applicable corporate tax rate. If a
Fund elects to retain its net capital gain, it is expected that the Fund also
will elect to have shareholders treated as if each received a distribution of
its pro rata share of such gain, with the result that each shareholder will be
required to report its pro rata share of such gain on its tax return as
long-term capital gain, will receive a refundable tax credit for its share of
tax paid by the Fund on the gain, and will increase the basis for its shares by
an amount equal to the deemed distribution less the tax credit.
Ordinary income dividends paid by the Equity Income Fund with respect to a
taxable year will qualify for the 70% dividends received deduction generally
available to corporate shareholders (other than corporate shareholders, such as
"S" corporations, which are not eligible for the deduction because of their
special characteristics and other than for purposes of special taxes such as the
accumulated earnings tax and the personal holding company tax) to the extent of
the amount of qualifying dividends received by the Fund from domestic
corporations for the taxable year. A dividend received by the Equity Income Fund
will not be treated as a qualifying dividend (1) if it has been received with
respect to any share of stock that the Fund has held for less than 46 days (91
days in the case of certain preferred stock), excluding for this purpose under
the rules of Code Section 246(c)(3) and (4) (i) any day more than 45 days (or 90
days in the case of certain preferred stock) after the date on which the stock
becomes ex-dividend and (ii) any period during which the Fund has an option to
sell, is under a contractual obligation to sell, has made and not closed a short
sale of, is the grantor of a deep-in-the money or otherwise nonqualified option
to buy or has otherwise diminished its risk of loss by holding other positions
with respect to, such (or substantially identical) stock; (2) to the extent that
the Fund is under an obligation (pursuant to a short sale or otherwise) to make
related payments with respect to positions in substantially similar or related
property; or (3) to the extent the stock on which the dividend is paid is
treated as debt financed under the rules of Code Section 246A. Moreover, the
dividends-received deduction for a corporate shareholder may be disallowed or
reduced (i) if the corporate shareholder fails to satisfy the foregoing
requirements with respect to its shares of the Fund or (ii) by application of
Code Section 246(b) which in general limits the dividends-received deduction to
70% of the shareholder's taxable income (determined without regard to the
dividends-received deduction and certain other items).
For purposes of the corporate alternative minimum tax (the "AMT") and the
environmental supervened tax the corporate dividends received deduction is not
itself an item of tax preference that must be added back to taxable income or is
otherwise disallowed in determining a corporation's alternative minimum taxable
income ("AMTI"). However, corporate shareholders will generally be required to
take the full amount of any dividend received from the Equity Income Fund into
account (without a dividends-received deduction) in determining its adjusted
current earnings.
30
<PAGE>
Investment income that may be received by certain of the Funds (in
particular the International Equity Fund) from sources within foreign countries
may be subject to foreign taxes withheld at the source. The United States has
entered into tax treaties with many foreign countries which entitle any such
Fund to a reduced rate of, or exemption from, taxes on such income. It is
impossible to determine the effective rate of foreign tax in advance since the
amount of any such Fund's assets to be invested in various countries is not
known. If more than 50% of the value of the Fund's total assets at the close of
its taxable year consists of the stock or securities of foreign corporations,
the Fund may elect to "pass through" to the Fund's shareholders the amount of
foreign taxes paid by the Fund. If the Fund so elects, each shareholder would be
required to include in gross income, even though not actually received, its pro
rata share of the foreign taxes paid by the Fund, but would be treated as having
paid its pro rata share of such foreign taxes and would, therefore, be allowed
to either deduct such amount in computing taxable income or use such amount
(subject to various Code limitations) as a foreign tax credit against federal
income tax (but not both). For purposes of the foreign tax credit limitation
rules of the Code, each shareholder would treat as foreign source income its pro
rata share of such foreign taxes plus the portion of dividends received from the
Fund representing income derived from foreign sources. No deduction for foreign
taxes could be claimed by an individual shareholder who does not itemize
deductions.
The International Equity Fund may purchase the securities of certain
foreign investment funds or trusts called passive foreign investment companies
("PFICs"). If this Fund invests in PFICs, it may be subject to U.S. federal
income tax on a portion of any "excess distribution" or gain from the
disposition of such shares even if such income is distributed as a taxable
dividend to shareholders. In addition to bearing their proportionate share of
the International Equity Fund's expenses (management fees and operating
expenses), shareholders will also bear indirectly similar expenses of PFICs in
which the Fund has invested. Additional charges in the nature of interest may be
imposed on either the International Equity Fund or its shareholders in respect
of deferred taxes arising from such distributions or gains. Capital gains on the
sale of such holdings will be deemed to be ordinary income regardless of how
long such PFICs are held. If the International Equity Fund were to invest in a
PFIC and elect to treat the PFIC as a "qualified electing fund" under the Code,
in lieu of the foregoing requirements, the Fund might be required to include in
income each year a portion of the ordinary earnings and net capital gains of the
qualified electing fund, even if not distributed to the Fund, and such amounts
would be subject to the 90% and calendar year distribution requirements
described above.
Distributions by a Fund that do not constitute ordinary income dividends,
exempt-interest dividends or capital gain dividends will be treated as a return
of capital to the extent of (and in reduction of) the shareholder's tax basis in
his/her shares; any excess will be treated as gain from the sale of his/her
shares, as discussed below.
Prior to purchasing shares in one of the Non-Money Market Funds, the
impact of dividends or distributions which are expected to be or have been
declared, but not paid, should be carefully considered. Any dividend or
distribution declared shortly after a purchase of such shares prior to the
record date will have the effect of reducing the per share net asset value by
the per share amount of the dividend or distribution. All or a portion of such
dividend or distribution, although in effect a return of capital, may be subject
to tax.
Distributions by a Fund will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Fund (or of another Fund). Shareholders receiving a
distribution in the form of additional shares will be treated as receiving a
distribution in an amount equal to the fair market value of the shares received,
determined as of the reinvestment date. In addition, if the net asset value at
the time a shareholder purchases shares of a Fund reflects undistributed net
investment income or recognized capital gain net income, or unrealized
appreciation in the value of the assets of the Fund, distributions of such
amounts will be taxable to the shareholder in the manner described above,
although such distributions economically constitute a return of capital to the
shareholder.
Ordinarily, shareholders are required to take distributions by a Fund into
account in the year in which the distributions are made. However, distributions
declared in October, November or December of any year and payable to
shareholders of record on a specified date in such a month will be deemed to
have been received by the shareholders (and made by the Fund) on December 31 of
such calendar year if such distributions are actually paid
31
<PAGE>
in January of the following year. Shareholders will be advised annually as to
the U.S. federal income tax consequences of distributions made (or deemed made)
during the year.
The Funds will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and
the proceeds of redemption of shares, paid to any shareholder (1) who has
provided either an incorrect Taxpayer Identification Number or no number at all,
(2) who is subject to backup withholding by the Internal Revenue Service for
failure to report the receipt of interest or dividend income properly, or (3)
who has failed to certify to a Fund that it is not subject to backup withholding
or that it is a corporation or other "exempt recipient."
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or redemption of
shares of a Fund in an amount equal to the difference between the proceeds of
the sale or redemption and the shareholder's adjusted tax basis in the shares.
All or a portion of any loss so recognized may be disallowed if the shareholder
purchases other shares of the Fund (or substantially identical shares) within 30
days before or after the sale or redemption. In general, any gain or loss
arising from (or treated as arising from) the sale or redemption of shares of a
Fund will be considered capital gain or loss and will be long-term capital gain
or loss if the shares were held for longer than one year. However, any capital
loss arising from the sale or redemption of shares held for six months or less
will be disallowed to the extent of the amount of exempt-interest dividends
received on such shares and (to the extent not disallowed) will be treated as a
long-term capital loss to the extent of the amount of capital gain dividends
received on such shares. For this purpose, the special holding period rules of
Code Section 246(c)(3) and (4) (discussed above in connection with the
dividends-received deduction for corporations) generally will apply in
determining the holding period of shares. Capital losses in any year are
deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $3,000 of ordinary income.
If a shareholder (i) incurs a sales load in acquiring shares of a Fund,
(ii) disposes of such shares less than 91 days after they are acquired and (iii)
subsequently acquires shares of the Fund or another fund at a reduced sales load
pursuant to a right to reinvest at such reduced sales load acquired in
connection with the acquisition of the shares disposed of, then the sales load
on the shares disposed of (to the extent of the reduction in the sales load on
the shares subsequently acquired) shall not be taken into account in determining
gain or loss on the shares disposed of, but shall be treated as incurred on the
acquisition of the shares subsequently acquired.
Nations Fund, Inc. may make payment for redemptions in readily marketable
securities or other property if it is appropriate to do so in light of Nations
Fund, Inc.'s responsibilities under the 1940 Act.
Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a nonresident
alien individual, foreign trust or estate, foreign corporation, or foreign
partnership ("foreign shareholder"), depends on whether the income from a Fund
is "effectively connected" with a U.S. trade or business carried on by such
shareholder.
If the income from a Fund is not effectively connected with a U.S. trade
or business carried on by a foreign shareholder, ordinary income dividends will
be subject to U.S. withholding tax at the rate of 30% (or lower applicable
treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign
shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower
applicable treaty rate) on the gross income resulting from the Fund's election
to treat any foreign taxes paid by its shareholders, but may not be allowed a
deduction against this gross income or a credit against this U.S. withholding
tax for the foreign shareholder's pro rata share of such foreign taxes which it
is treated as having paid. Such a foreign shareholder would generally be exempt
from U.S. federal income tax on gains realized on the sale of shares of a Fund,
capital gain dividends and exempt-interest dividends and amounts retained by a
Fund that are designated as undistributed capital gains.
If the income from a Fund is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income dividends,
capital gain dividends and any gains realized upon the sale of shares
32
<PAGE>
of the Fund will be subject to U.S. federal income tax at the rates applicable
to U.S. citizens, U.S. residents or domestic corporations.
In the case of foreign noncorporate shareholders, a Fund may be required
to withhold U.S. federal income tax at a rate of 31% on distributions that are
otherwise exempt from withholding tax (or taxable at a reduced treaty rate)
unless such shareholders furnish the Fund with proper notification of their
foreign status.
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisors with
respect to the particular tax consequences to them of an investment in a Fund,
including the applicability of foreign taxes.
Effect of Future Legislation: Local Tax Considerations
The foregoing general discussion of U.S. federal income tax consequences
is based on the Code and the regulations issued thereunder as in effect on the
date of this SAI. Future legislative or administrative changes or court
decisions may significantly change the conclusions expressed herein, and any
such changes or decisions may have a retroactive effect with respect to the
transactions contemplated herein.
Rules of state and local taxation for ordinary income dividends,
exempt-interest dividends and capital gain dividends from regulated investment
companies often differ from the rules for U.S. federal income taxation described
above. Distributions of net investment income may be taxable to shareholders as
dividend income under state or local law even though a substantial portion of
such distributions may be derived from interest on U.S. Government obligations,
which, if realized directly, would be exempt from such taxes. Shareholders are
urged to consult their tax advisors as to the consequences of these and other
state and local tax rules affecting investment in the Funds.
DIRECTORS AND OFFICERS
The directors and executive officers of the Company and their principal
occupations during the last five years are set forth below. The address of each,
unless otherwise indicated, is 111 Center Street, Little Rock, Arkansas 72201.
Those directors who are "interested persons" of the Company (as defined in the
1940 Act) are indicated by an asterisk(*).
</TABLE>
<TABLE>
<CAPTION>
Principal Occupations
During Past 5 Years
Position with and Current
Name Address and Age the Company Directorships
<S> <C> <C>
Edmund L. Benson, III, 59 Director Director, President and
Saunders & Benson, Inc. Treasurer, Saunders & Benson,
728 East Main Street Inc. (Insurance); Trustee,
Suite 400 Nations Institutional Reserves
Richmond, VA 23219 and Nations Fund Trust, Director,
Nations Fund, Inc. and Nations
Fund Portfolios, Inc.
James Ermer, 53 Director Senior Vice President- Finance,
CSX Corporation CSX Corporation (transportation
One James Center and natural resources); Director,
901 East Cary Street National Mine Service; Director,
33
<PAGE>
Richmond. VA 23219 Lawyers Title Corporation;
Trustee, Nations Institutional
Reserves and Nations Fund Trust;
Director, Nations Fund, Inc. and
Nations Fund Portfolios, Inc.
William H. Grigg, 63 Director Since April 1994, Chairman and
Duke Power Co. Chief Executive Officer; November
422 South Church Street 1991 to April 1994, Vice
PB04G Chairman, Duke Power Co.; from
Charlotte, NC 28242-0001 April 1988 to November 1991,
Executive Vice President Customer
Group, Duke Power Co.; Director,
Hatteras Income Securities, Inc.,
Nations Government Income Term
Trust 2003, Inc., Nations
Government Income Term Trust 2004,
Inc., Nations Balanced Target
Maturity Fund, Inc., Nations Fund,
Inc. and Nations Fund Portfolios,
Inc.; Trustee, Nations
Institutional Reserves and Nations
Fund Trust.
Thomas F. Keller, 64 Director R.J. Reynolds Industries
Fuqua School of Business Professor of Business
Duke University Administration and Dean, Fuqua
Durham, NC 27706 School of Business, Duke
University; Director, LADD
Furniture, Inc.; Director, Wendy's
International Mentor Growth Fund,
and Cambridge Trust; Director,
Hatteras Income Securities, Inc.,
Nations Government Income Term
Trust 2003, Inc., Nations
Government Income Term Trust 2004,
Inc., Nations Balanced Target
Maturity Fund, Inc., Nations Fund,
Inc. and Nations Fund Portfolios,
Inc.; Trustee, Nations
Institutional Reserves and Nations
Fund Trust.
Carl E. Mundy, Jr., 60 Director Commandant, United States Marine
9308 Ludgate Drive Corps, from July 1991 to July
Alexandria, VA 23309 1995; Commanding General, Marine
Forces Atlantic, from June 1990
to June 1991; Director, Nations
Fund, Inc. and Nations Fund
Portfolios, Inc.; Trustee,
Nations Institutional Reserves
and Nations Fund Trust.
34
<PAGE>
A. Max Walker*, 74 President, Director and Financial consultant; Formerly,
6215 Riverwood Drive, N.W. Chairman of the Board President, A. Max Walker, Inc.;
Atlanta, GA 30328 Director and Chairman of the
Board, Hatteras Income Securities,
Inc., Nations Government Income
Term Trust 2003, Inc., Nations
Government Income Term Trust 2004,
Inc., Nations Balanced Target
Maturity Fund, Inc., Nations Fund,
Inc. and Nations Fund Portfolios.
Inc.; President and Chairman of
the Board of Trustees, Nations
Institutional Reserves and Nations
Fund Trust.
Charles B. Walker, 57 Director Since 1989, Director, Executive
Ethyl Corporation Vice President, Chief Financial
P.O. Box 2189 Officer and Treasurer, Ethyl
330 South Fourth Street Corporation (chemicals, plastics,
Richmond, VA 23217 and aluminum manufacturing);
since 1994, Vice Chairman, Ethyl
Corporation and Vice Chairman,
Chief Financial Officer and
Treasurer, Albemarle Corporation,
Director, Nations Fund, Inc. and
Nations Fund Portfolios, Inc.;
Trustee, Nations Institutional
Reserves and Nations Fund Trust.
Thomas S. Word, Jr.*, 57 Director Partner, McGuire Woods Battle &
McGuire, Woods, Battle & Boothe Boothe (law); Director, Vaughan
One James Center Bassett Furniture Company,
Richmond, VA 23219 Director VB Williams Furniture
Company, Inc.; Director, Nations
Fund, Inc. and Nations Fund
Portfolios, Inc.; Trustee,
Nations Institutional Reserves
and Nations Fund Trust.
Richard H. Blank, Jr., 39 Secretary Since 1994, Vice President of
Stephens Inc. Mutual Fund Services, Stephens
Inc. 1990 to 1994, Manager Mutual
Fund Services, Stephens Inc. 1983
to 1990, Associate in Corporate
Finance Department, Stephens
Inc.; Secretary, Nations
Institutional Reserves, Nations
Fund Trust, Nations Fund, Inc.
and Nations Fund Portfolios, Inc.
Michael W. Nolte, 35 Assistant Secretary Associate, Financial Services
Stephens Inc. Group of Stephens Inc.
35
<PAGE>
Louise P. Newcomb, 43 Assistant Secretary Corporate Syndicate Associate,
Stephens Inc. Stephens Inc.
James E. Banks, 39 Assistant Secretary Since 1993, Attorney, Stephens
Stephens Inc. Inc.; Associate Corporate
Counsel, Federated Investors; from
1991 to 1993, Staff Attorney,
Securities and Exchange Commission
from 1988 to 1991
Richard H. Rose, 40 Treasurer Since 1994, Vice President,
First Data Investors Services Group, Inc. Division Manager, First Data
(formerly, The Shareholder Services Group, Investors Services Group, Inc.
Inc.) (formerly, The Shareholder
One Exchange Place Services Group, Inc.) since 1988,
Boston, MA 02109 Senior Vice President, The Boston
Company Advisors. Inc.;
Treasurer, Nations Institutional
Reserves, Nations Fund Trust,
Nations Fund, Inc. and Nations
Fund Portfolios, Inc.
Joseph C. Viselli, 32 Assistant Treasurer Director, The Shareholder Service
First Data Investors Services Group Group, Inc. since 1995 and
(formerly, The Shareholder Services Group, Assistant Vice President, The
Inc.) Boston Company Advisors, Inc.
One Exchange Place Since April 1992.
Boston, MA 02109
</TABLE>
36
<PAGE>
COMPENSATION TABLE
<TABLE>
<CAPTION>
Total Compensation from Nations Fund
Aggregate Registrant and Fund Nations Fund Deferred
Name of Person Compensation Complex Paid Retirement Compensation
Position (1) from Registrant to Directors (3) Plan Plan
- ----------------- --------------- ---------------------- -------------- -------------
<S> <C> <C> <C> <C>
Edmund L. Benson, III $7,000 $36,500 N/A $4,606.14
Director
James Ermer $7,000 $36,500 N/A N/A
Director
William H. Grigg $7,000 $36,500 N/A $9,212.28
Director
Thomas F. Keller $7,000 $36,500 N/A $9,212.28
Director
A. Max Walker $9,000 $42,500 N/A N/A
Chairman of the Board
Charles B. Walker $7,000 $36,500 N/A N/A
Director
Thomas S. Word $7,000 $36,500 N/A $9,212.28
Director
Carl E. Mundy, Jr., Trustee $7,000 N/A N/A N/A
</TABLE>
(1) All directors receive reimbursements for expenses related to their
attendance at meetings of the Board of Directors. Officers of the Company
receive no direct remuneration in such capacity from the Company.
(2) For current fiscal year and includes estimated future payments. Each
Director receives (i) an annual retainer of $1,000 ($3,000 for the Chairman
of the Board) plus $500 for each Fund of the Company, plus (ii) a fee of
$1,000 for attendance at each "in-person" meeting of the Board of Directors
(or committee thereof) and $500 for attendance at each other meeting of the
Board of Directors (or Committee thereof).
(3) Messrs. Grigg, Keller and A.M. Walker receive compensation from eight
investment companies, including the Company, that are deemed to be part of
the Nations Fund "fund complex," as that term is defined under Rule 14a-101
of the Securities Exchange Act of 1934, as amended. Messrs. Benson, Ermer,
C. Walker, Mundy and Word receive compensation from four investment
companies, including the Company, deemed to be part of the Nations Fund
complex.
37
<PAGE>
Mr. Rose serves as Treasurer to certain other investment companies for
which First Data Investors Services Group, Inc.(formerly, The Shareholder
Services Group, Inc.) (the "Co-Administrator") or its affiliates serve as
sponsor, distributor, administrator and/or investment adviser.
Each Director of the Company is also a Trustee of Nations Fund Trust and
Nations Institutional Reserves and a Director of Nations Fund Portfolios, Inc.,
each a registered investment company that is part of the Nations Fund Family.
Richard H. Blank, Jr., Richard H. Rose, Joseph C. Viselli, Michael W. Nolte,
Louise P. Newcomb and James E. Banks. Jr. also are officers of Nations Fund
Trust, Nations Institutional Reserves and Nations Fund, Portfolios, Inc.
Each Director receives (i) an annual retainer of $1,000 ($3,000 for the
Chairman of the Board) plus $500 for each Fund of the Company, plus (ii) a fee
of $1,000 for attendance at each "in-person" meeting of the Board of Directors
(or committee thereof). All Directors receive reimbursements for expenses
related to their attendance at meetings of the Board of Directors. During the
fiscal year ended May 31, 1995 the Company paid a total of $51,000 in directors'
fees and expenses. Mr. Mundy was not a Director of the Company during the fiscal
year ended May 31, 1995 and therefore received no compensation. Officers receive
no direct remuneration in such capacity from the Company.
As of the date of this SAI, the directors and officers of the Company as a
group owned less than 1% of the outstanding shares of each of the Funds.
The Company has adopted a Code of Ethics which, among other things,
prohibits each access person of the Company from purchasing or selling
securities when such person knows or should have known that, at the time of the
transaction, the security (i) was being considered for purchase or sale by a
Fund, or (ii) was being purchased or sold by a Fund. For purposes of the Code of
Ethics, an access person means (i) a director or officer of the Company, (ii)
any employee of the Company (or any company in a control relationship with the
Company) who, in the course of his/her regular duties, obtains information
about, or makes recommendations with respect to, the purchase or sale of
securities by the Company, and (iii) any natural person in a control
relationship with the Company who obtains information concerning recommendations
made to the Company regarding the purchase or sale of securities. Portfolio
managers and other persons who assist in the investment process are subject to
additional restrictions, including a requirement that they disgorge to the
Company any profits realized on short-term trading (i.e., the purchase/sale or
sale/purchase of securities within any 60-day period). The above restrictions do
not apply to purchases or sales of certain types of securities, including money
market instruments and certain U.S. Government securities. To facilitate
enforcement, the Code of Ethics generally requires that the Company's access
persons, other than its "disinterested" directors, submit reports to the
Company's designated compliance person regarding transactions involving
securities which are eligible for purchase by a Fund.
Nations Funds Retirement Plan
Under the terms of the Nations Funds Retirement Plan for Eligible
Directors (the "Retirement Plan"), each director may be entitled to certain
benefits upon retirement from the Board of Directors. Pursuant to the Retirement
Plan, the normal retirement date is the date on which the eligible director has
attained age 65 and has completed at least five years of continuous service with
one or more of the open-end investment companies ("Funds") advised by the
Adviser. If a director retires before reaching age 65, no benefits are payable.
Each eligible director is entitled to receive an annual benefit from the Funds
commencing on the first day of the calendar quarter coincident with or next
following his date of retirement equal to 5% of the aggregate director's fees
payable by the Funds during the calendar year in which the director's retirement
occurs multiplied by the number of years of service (not in excess of ten years
of service) completed with respect to any of the Funds. Such benefit is payable
to each eligible director in quarterly installments for a period of no more than
five years. If an eligible director dies after attaining age 65, the director's
surviving spouse (if any) will be entitled to receive 50% of the benefits that
would have been paid (or would have continued to have been paid) to the director
if he had not died. The Retirement Plan is unfunded. The benefits owed to each
director are unsecured and subject to the general creditors of the Funds. At
present the Plan is not in effect and therefore there are no fees to disclose.
38
<PAGE>
Nations Funds Deferred Compensation Plan
Under the terms of the Nations Funds Deferred Compensation Plan for
Eligible Directors (the "Deferred Compensation Plan"), each director may elect,
on an annual basis, to defer all or any portion of the annual board fees
(including the annual retainer and all attendance fees) payable to the director
for that calendar year. An application was submitted to and approved by the SEC
to permit deferring directors to elect to tie the rate of return on fees
deferred pursuant to the Deferred Compensation Plan to one or more of certain
investment portfolios of certain Funds. Distributions from the deferring
directors' deferral accounts will be paid in cash, in generally equal quarterly
installments over a period of five years beginning on the date the deferring
director's retirement benefits commence under the Retirement Plan. The Board of
Directors, in its sole discretion, may accelerate or extend such payments after
a director's termination of service. If a deferring director dies prior to the
commencement of the distribution of amounts in his deferral account, the balance
of the deferral account will be distributed to his designated beneficiary in a
lump sum as soon as practicable after the director's death. If a deferring
director dies after the commencement of such distribution, but prior to the
complete distribution of his deferral account, the balance of the amounts
credited to his deferral account will be distributed to his designated
beneficiary over the remaining period during which such amounts were
distributable to the director. Amounts payable under the Deferred Compensation
Plan are not funded or secured in any way and deferring directors have the
status of unsecured creditors of the Funds from which they are deferring
compensation.
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY, SHAREHOLDER SERVICING AND DISTRIBUTION AGREEMENTS
The Company and Its Common Stock
The Company is an open-end diversified management investment company
organized as a corporation under the laws of the State of Maryland on December
13, 1983. The Company had no operations prior to December 15, 1986. Effective
October 2, 1989, the Company changed its name from Silver Star Fund, Inc. to
Hatteras Funds, Inc., effective May 1, 1992 the Company began doing business
under the name Nations Fund Portfolios and effective September 24, 1992 the
Company changed its name to Nations Fund, Inc. The Company offers shares of
common stock which represent interests in one of five separate Funds. This SAI
relates to the following Funds of the Company: the Nations Prime Fund, the
Nations Treasury Fund, the Nations Equity Income Fund, the Nations Government
Securities Fund and the Nations International Equity Fund (collectively, the
"Funds"). Each Fund offers the following separate classes of shares (Primary A
Shares, Primary B Shares, Investor A Shares, Investor B, Investor C and Investor
D Shares) of the Money Market Funds and (Primary A Shares, Primary B Shares,
Investor A Shares, Investor C Shares and Investor N Shares) of the Non-Money
Market Funds. Certain classes of the Company are offered on a no load basis, and
others are offered at the public offering price plus a sales charge. shares of
each Fund of the Company are redeemable at the net asset value (less any
applicable contingent deferred sales charge ("CDSC") thereof at the option of
the holders thereof or in certain circumstances at the option of the Company.
For information concerning the methods of redemption and the rights of share
ownership, consult the Prospectuses under the captions "How To Buy Shares," "How
To Redeem Shares" and "Organization And History."
Primary Shares are sold exclusively through banks and certain other
financial institutions primarily to their fiduciary clients and similar
customers. Investor Shares are available to non-fiduciary customers of certain
broker/dealers and other financial institutions. Certain charges that apply to
one class of shares of a Fund may not be charged to the other class of shares of
the same Fund. Consequently, the yield earned on one class of shares of a Fund
may be different from that of the other class of shares of the same Fund, and
the net asset value per share of the classes of shares of each of the Equity
Income Fund, the Government Securities Fund and the International Equity Fund
will differ.
As used in this SAI and in the Prospectuses, the term "majority of the
outstanding shares" of the Company, a particular Fund or a particular class of
shares of a Fund means, respectively, the vote of the lesser of (i) 67% or more
of the shares of the Company, Fund or class (as appropriate) present at a
meeting of shareholders, if the
39
<PAGE>
holders of more than 50% of the outstanding shares entitled to vote, are present
or represented by proxy, or (ii) more than 50% of the outstanding shares of the
Company, Fund or class.
The Board of Directors may classify or reclassify any unissued shares of
the Company into shares of any class, classes or Fund in addition to those
already authorized by setting or changing in any one or more respects, from time
to time, prior to the issuance of such shares, the preferences, conversion or
other rights, voting powers, restrictions, limitations as to dividends,
qualifications, or terms or conditions of redemption, of such shares and,
pursuant to such classification or reclassification to increase or decrease the
number of authorized shares of any Fund or class. Any such classification or
reclassification will comply with the provisions of the 1940 Act. Fractional
shares shall have the same rights as full shares to the extent of their
proportionate interest.
Because certain of the Prospectuses combine disclosure on two separate
open-end management investment companies, there is a possibility that one
investment company might become liable for a misstatement, inaccuracy or
incomplete disclosure in such Prospectuses concerning the other investment
company. Nations Fund Trust and Nations Fund, Inc. have entered into an
indemnification agreement that creates a right of indemnification from the
investment company responsible for any such misstatement, inaccuracy or
incomplete disclosure that may appear in such Prospectuses.
Investment Adviser
Effective January 1, 1996, NBAI began serving as investment adviser to the
Funds, pursuant to an Investment Advisory Agreement dated January 1, 1996.
Effective January 1, 1996, TradeStreet began serving as sub-investment adviser
to the Prime Fund, the Treasury Fund, the Equity Income Fund and the Government
Securities Fund pursuant to a Sub-Advisory Agreement dated January 1, 1996.
Nations Gartmore serves as sub-investment adviser to the International Equity
Fund pursuant to a Sub-Advisory Agreement dated January 1, 1996.
NBAI also serves as the investment adviser to Nations Fund Trust, Nations
Institutional Reserves and Nations Fund Portfolios, Inc., each a registered
investment company that is part of the Nations Fund Family. In addition, NBAI
serves as the investment advisor to Hatteras Income Securities, Inc., Nations
Government Income Term Trust 2003, Inc., Nations Government Income Term Trust
2004, Inc. and Managed Balanced Target Maturity Fund, Inc., each a closed-end
diversified management investment company traded on the New York Stock Exchange.
TradeStreet also serves as the sub-investment adviser to Nations Fund Trust,
Nations Institutional Reserves, Hatteras Income Securities, Inc., Nations
Government Income Term Trust 2003, Inc., Nations Government Income Term Trust
2004, Inc. and Managed Balanced Target Maturity Fund, Inc. Nations Gartmore also
serves as sub-investment adviser to Nations Fund Portfolios, Inc.
NBAI and TradeStreet are each wholly owned subsidiaries of Nations Bank,
N.A. ("NationsBank"), which in turn is a wholly owned banking subsidiary of
NationsBank Corporation, a bank holding company organized as a North Carolina
corporation. Nations Gartmore is a joint venture structured as a Delaware
general partnership between NB Partner Corp., a wholly owned subsidiary of
NationsBank and Gartmore U.S. Limited, an indirect wholly owned subsidiary of
Gartmore plc, a publicly listed U.K. company. Banque Indosuez, S.A., a French
bank, indirectly owns 75% of Gartmore plc's outstanding voting shares, and the
remaining 25% are owned by the public and by Gartmore plc's employees. Banque
Indosuez, a wholly owned subsidiary of Companie de Suez, S.A., acquired Gartmore
plc in 1990. Nations Gartmore is a registered investment adviser in the United
States and a member of the Investment Management Regulatory Organization
Limited, a U.K. regulatory authority. The respective principal offices of NBAI,
TradeStreet and Nations Gartmore are located at One NationsBank Plaza,
Charlotte, N.C. 28255.
On February 19, 1996, it was announced that National Westminster Bank
plc ("NatWest"), one of the world's largest commercial and investment banking
firms, had agreed to acquire, subject to the satisfaction or waiver of certain
conditions, control of Gartmore plc from Compagnie de Suez, S.A. and affiliated
entities (collectively, "Compagnie de Suez") through a two-part transaction
involving (1) the direct purchase from Compagnie de Suez of its subsidiary that
holds 75% of the outstanding voting shares of Gartmore plc; and (2) a tender
offer for the remaining portion of Gartmore plc shares held by public
shareholders (collectively, the
40
<PAGE>
"Acquisition"). The Acquisition, if completed, will result in a change in
ownership of Nations Gartmore and will probably result in a change in the name
of Nations Gartmore. Based on representations made by Nations Gartmore, it is
not anticipated that the change in ownership will affect the level of service
provided to the Funds or result in a change to the personnel assigned to handle
advisory responsibilities. As of February 19, 1996, NatWest had assets under
management of approximately $47,000,000,000.
Prior to January 1, 1996, NationsBank served as investment adviser to the
Funds. Since 1874, NationsBank and its predecessors have been managing money for
foundations, universities, corporations, institutions and individuals. It is a
company dedicated to a goal of providing responsible investment management and
superior service. NationsBank is recognized for its sound investment approaches,
which place it among the nation's foremost financial institutions. NationsBank
and its affiliated organizations make available a wide range of financial
services to its over 6 million customers through over 1700 banking and
investment centers. Approximately 12 of NationsBank personnel are involved in
stock and bond research.
NationsBank restructured its investment management division as of January
1, 1996 by reorganizing the division into two separate, wholly owned advisory
subsidiaries, NBAI and TradeStreet. The restructuring resulted in the transfer
of the division's investment management and advisory functions to NBAI, and the
its day to day investment company portfolio management functions to TradeStreet.
The investment professionals who performed investment company management
functions and who managed the companies portfolios as employees of NationsBank
continue to perform such services as employees of NBAI and TradeStreet,
respectively. The restructuring did not change the scope and nature of
investment advisory services provided to the relevant Funds. The restructuring,
and related Investment Advisory Agreements and Sub-Advisory Agreements, were
approved by the Board of Directors of the Company at the October 12-13, 1995
Board Meeting.
Pursuant to the terms of the Investment Advisory Agreement and
Sub-Advisory Agreements (at times, the "Advisory Agreements") with NBAI,
TradeStreet and Nations Gartmore, respectively, subject at all times to the
control of the Company's Board of Directors and in conformance with the stated
policies of the Company, NBAI, TradeStreet and Nations Gartmore each selects and
manages the investments of the Funds. Each such advisory entity obtains and
evaluates economic, statistical and financial information to formulate and
implement investment policies for the Funds.
The Advisory Agreements for NBAI and TradeStreet each provides that in the
absence of willful misfeasance, bad faith, negligence or reckless disregard of
obligations or duties thereunder on the part of NBAI or Trade Street,
respectively, or any of their respective officers, directors, employees or
agents, NBAI or TradeStreet shall not be subject to liability to the Company or
to any shareholder of the Company for any act or omission in the course of, or
connected with, rendering services under thereunder or for any losses that may
be sustained in the purchase, holding or sale of any security.
The Investment Advisory Agreement with NBAI shall become effective with
respect to a Fund if and when approved by the Directors of the Company, and if
so approved, shall thereafter continue from year to year, provided that such
continuation of the Agreement is specifically approved at least annually by (a)
(i) the Company's Board of Directors or (ii) the vote of "a majority of the
outstanding voting securities" of a Fund (as defined in Section 2(a)(42) of the
1940 Act), and (b) the affirmative vote of a majority of the Company's Directors
who are not parties to such Agreement or "interested persons" (as defined in the
1940 Act) of a party to such Agreement (other than as Directors of the Company),
by votes cast in person at a meeting specifically called for such purpose. The
Investment Advisory Agreement will terminate automatically in the event of its
assignment, and is terminable with respect to a Fund at any time without penalty
by the Company (by vote of the Board of Directors or by vote of a majority of
the outstanding voting securities of the Fund) or by NBAI on 60 days' written
notice.
The Sub-Advisory Agreement with TradeStreet shall become effective with
respect to each Fund as of its execution date and, unless sooner terminated,
shall continue in full force and effect for one year, and may be continued with
respect to each Fund thereafter, provided that the continuation of the Agreement
is specifically approved at least annually by (a) (i) the Company's Board of
Directors (ii) the vote of "a majority of the
41
<PAGE>
outstanding voting securities" of a Fund (as defined in Section 2(a)(42) of the
1940 Act), and (b) the affirmative vote of a majority of the Company's Directors
who are not parties to such Agreement or "interested persons" (as defined in the
1940 Act) of a party to such Agreement (other than as Directors of the Company),
by votes cast in person at a meeting specifically called for such purpose. The
Sub-Advisory Agreement will terminate automatically in the event of its
assignment, and is terminable with respect to a Fund at any time without penalty
by the Company (by vote of the Board of Directors or by vote of a majority of
the outstanding voting securities of the Fund), or by NBAI, or by TradeStreet on
60 days' written notice.
The Sub-Advisory Agreement with Nations Gartmore provides that Nations
Gartmore shall not be liable to the Company or to its shareholders for any act
or omission by Nations Gartmore or for any loss sustained by the Company or by
its shareholders except in the case of Nations Gartmore's willful misfeasance,
bad faith, gross negligence or reckless disregard of duty on the part of Nations
Gartmore, as the case may be.
NBAI, TradeStreet and Nations Gartmore may waive a portion of their fees;
however, any such waiver may be discontinued at any time. As discussed under the
caption "Expenses," NBAI, TradeStreet and Nations Gartmore will be required to
reduce their fees from the Funds, in direct proportion to the fees payable by
the Funds to NBAI, TradeStreet, Nations Gartmore and the Administrator, if the
expenses of the Funds exceed the applicable expense limitation of any state in
which the Funds' shares are registered or qualified for sale.
Prior to January 1, 1996, NationsBank served as investment adviser to the
Funds pursuant to Investment Advisory Agreements approved by the Company's Board
of Directors on August 3, 1988 with respect to the Prime and Treasury Funds and
by the shareholders on September 30, 1988 with respect to the Prime and Treasury
Funds. The Advisory Agreements with respect to the Equity Income Fund and the
Government Securities Fund were approved by the Company's Board of Directors on
March 22, 1991, and by the shareholders of those Funds on September 6, 1991. The
Advisory and Sub-Advisory Agreements with respect to the International Equity
Fund were approved by the Company's Board of Directors on January 26, 1995 and
by the public shareholders of the International Equity Fund on March 31, 1995.
Subject to reduction in accordance with the expense limitation provisions
which may be imposed by states in which the Funds' shares are qualified for
sale, NationsBank received fees from the Funds for its services as outlined in
the following chart:
<TABLE>
<CAPTION>
ADVISORY FEES
FY 1995 FY 1994 FY 1993
Net Amt. Amount Reimbsd. Net Amt. Amount Reimbsd. Net Amt. Amount Reimbsd
Paid Waived by Advsr. Paid Waived by Advsr. Paid Waived by Advsr.
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Nations Prime Fund $4,608,731 $2,649,510 $ 191,636 $3,986,063 $1,836,579 $120,041 $2,352,512 $ 588,823 $ 0
Nations Treasury Fund 4,709,550 1,285,177 0 4,161,589 1,354,486 N/A 4,252,606 1,087,695 0
Nations Equity Income
Fund 2,482,606 0 0 1,882,223 26,454 N/A 1,001,388 151,189 0
Nations International
Equity Fund 2,158,263 0 0 1,034,049 6,809 N/A 759,553 0 0
Nations Government
Securities Fund 519,421 196,944 0 453,581 167,200 36,928 360,657 79,866 0
</TABLE>
42
<PAGE>
Investment Styles
The Adviser uses various investment strategies during the process of
constructing and managing the Company's portfolios. These strategies have been
categorized into investment styles which consist of (i) the Nations Equity
Income Style, and (ii) the Nations International Equity Style. The Investment
Styles described below relate to the Equity Income Fund and International Equity
Fund.
Nations Equity Income Style. The Equity Income Fund is managed by the
Adviser using the Nations Equity Income Style. The Nations Equity Income Style
investment philosophy is premised on the belief that a diversified portfolio of
stocks with an above average yield can provide long-term returns, higher than
that of the S&P 500 Index (the "S&P 500") and with less volatility.
This style utilizes a "low volatility" approach to stock selection,
focusing on tested factors of fundamental stock valuation. Volatility is reduced
through selecting stocks with Beta Coefficient ("Beta") of less than 1.0 (Beta
is a measurement of volatility relative to the stock market as a whole, which
has a Beta of 1.0). The Equity Income Style seeks to maintain a yield on the
portfolio of at least 50% higher than the dividend yield for the S&P 500. The
Adviser reduces risk by investing in both common stocks and convertible
securities.
The Equity Income Style stock selection process begins with a team of
in-house research specialists aided by a computerized screening process.
Starting with a 2000 company universe, stocks must first pass a rigorous
screening process that selects companies with a yield only one-third less than
the S&P 500 and market capitalization greater than $500 million. Often stocks
with below average yields grow faster than those with average yields. Therefore,
over time, a portfolio may earn more income by purchasing stocks with below
average yields. Stocks are then ranked relative to other stocks within their
industry.
A more sophisticated screening process is then applied to the universe.
Each company is ranked based on the following factor weightings: (i) market
style analyzes correlations between crucial stock characteristics (price/book
ratios, dividends yields, and return on assets) and price performance; (ii)
Insider Trading looks at filings with the SEC and evaluates them by title, date,
transaction size and historical performance; (iii) Earnings Expectations
evaluates changes in annual earnings estimates and quarterly earnings surprises,
and (iv) Price Momentum monitors relative price strength with short term under
performance. The final portfolio of approximately 70 issues is constructed by
the Equity Income Style Group senior portfolio managers working closely with
in-house industry specialists, as well as expert Wall Street sources.
Nations International Equity Income Style. The International Equity Fund
is managed by the Adviser using the International Equity Style. The Nations
International Equity Income Style investment philosophy is premised on the
belief that a diversified portfolio of equity securities of established,
non-United States issuers can provide long-term growth of capital and income.
This style focuses on the country selection process by utilizing
macroeconomic forecasts to identify areas of the world which will exhibit
relatively strong growth within the context of a modest inflation and low
interest rate environment. The political factors and market liquidity
constraints which can affect stock market valuations are also taken into
consideration by the Adviser prior to making stock selections.
The stock selection process begins with the elimination of equity
securities with a market capitalization of less than $250 million. The next step
in the process is the ranking of each country and industry sector by relative
price/earnings ratio using an historical range of not less than ten years from
an universe of approximately 1000 stocks. In addition to the relative historical
price/earnings ratio the portfolio managers also employ a fundamental analysis
of growth opportunities, management and future direction of these stocks.
The International Equity Fund is a dollar-denominated mutual fund and
therefore, consideration is given to hedging part or all of the portfolio back
to U.S. dollars from international currencies. All decisions to hedge are based
upon an analysis of the relative value of the U.S. dollar on an international
purchasing power parity basis (purchasing power parity is a method for
determining the relative purchasing power of different currencies by
43
<PAGE>
comparing the amount of each currency required to purchase a typical bundle of
goods and services to domestic markets) and an estimation of short-term interest
rate differentials (which affect both the direction of currency movements and
also the cost of hedging).
Administrator and Co-Administrator
Effective September 1, 1993 (the "Transition Date"), Stephens Inc. (the
"Administrator") began serving as administrator of the Company and First Data
Investors Services Group, Inc.(formerly, The Shareholder Services Group, Inc.)
(the "Co-Administrator") (formerly The Boston Company Advisors, Inc.) began
serving as the co-administrator of the Company. From February 19, 1992 to the
Transition Date, the Co-Administrator served as the administrator of the
Company.
The Administrator and Co-Administrator serve under an administration
agreement ("Administration Agreement") and co-administration agreement
("Co-Administration Agreement"), respectively, each of which was approved by the
Board of Directors on August 4, 1993. The Administrator receives, as
compensation for its services rendered under the Administration Agreement and as
agent for the Co-Administrator for the services it provides under the
Co-Administration Agreement, an administrative fee, computed daily and paid
monthly, at the annual rate of 0.10% of the average daily net assets of each
Fund.
Pursuant to the Administration Agreement, the Administrator has agreed to,
among other things, (i) maintain office facilities for the Funds, (ii) furnish
statistical and research data, data processing, clerical, and internal executive
and administrative services to the Company, (iii) furnish corporate secretarial
services to the Company, including coordinating the preparation and distribution
of materials for Board of Directors meetings, (iv) coordinate the provision of
legal advice to the Company with respect to regulatory matters, (v) coordinate
the preparation of reports to the Company's shareholders and the SEC, including
annual and semi-annual reports, (vi) coordinating the provision of services to
the Company by the Co-Administrator, the Transfer Agents and the Custodians, and
(vii) generally assist in all aspects of the Company's operations. Additionally,
the Administrator is authorized to receive, as agent for the Co-Administrator,
the fees payable to the Co-Administrator by the Company for its services
rendered under the Co-Administration Agreement. The Administrator bears all
expenses incurred in connection with the performance of its services.
Pursuant to the Co-Administration Agreement, the Co-Administrator has
agreed to, among other things, (i) provide accounting and bookkeeping services
for the Funds, (ii) compute each Fund's net asset value and net income, (iii)
accumulate information required for the Company's reports to shareholders and
the SEC, (iv) prepare and file the Company's federal and state tax returns, (v)
perform monthly compliance testing for the Company, and (vi) prepare and furnish
the Company monthly broker security transaction summaries and transaction
listings and performance information. The Co-Administrator bears all expenses
incurred in connection with the performance of its services.
The Administration Agreement and the Co-Administration Agreement may be
terminated by a vote of a majority of the Board of Directors, or by the
Administrator or Co-Administrator, respectively, on 60 days' written notice
without penalty. The Administration Agreement and Co-Administration Agreement
are not assignable without the written consent of the other party. Furthermore,
the Administration Agreement and the Co-Administration Agreement provide that
the Administrator and Co-Administrator, respectively, shall not be liable to the
Funds or to their shareholders except in the case of the Administrator's or
Co-Administrator's, respectively, willful misfeasance, bad faith, gross
negligence or reckless disregard of duty.
The table set forth below states the net Administration fees paid and
waived for the fiscal years ending May 31, 1995, 1994 and 1993.
44
<PAGE>
<TABLE>
<CAPTION>
ADMINISTRATION FEES
FY 1995 FY 1994 FY 1993
Net Administration Net Administration Net Administration
Admin. Fees Admin. Fees Admin. Fees
Fees Waived Fees Waived Fees Waived
<S> <C> <C> <C> <C> <C> <C>
Nations Prime Fund $3,510,935 $190,996 $2,745,870 $225,471 $1,057,382 $ 77,941
Nations Treasury Fund 2,670,833 307,92 2,533,388 224,650 1,902,420 137,388
Nations Equity Income
Fund 344,917 18,677 247,799 21,548 129,222 10,910
Nations International
Equity Fund 511,883 27,683 240,675 19,540 81,777 17,875
Nations Government
Securities Fund 106,071 6,098 94,826 8,540 49,970 3,092
</TABLE>
As discussed under the caption "Expenses," the Administrator and
Co-Administrator will be required to reduce their fee from the Company, in
direct proportion to the fees payable to the Administrator and Co-Administrator
by the Company, if the expenses of the Company exceed the applicable expense
limitation of any state in which the Funds' shares are registered or qualified
for sale.
45
<PAGE>
Distribution Plans and Shareholder Servicing Arrangements for Investor Shares
Investor A Shares. The Company has adopted an Amended and Restated
Shareholder Servicing and Distribution Plan (the "Investor A Plan") pursuant to
Rule 12b-1 under the 1940 Act with respect to each Fund's Investor A Shares. The
Investor A Plan provides that each Fund may pay the Distributor or banks,
broker/dealers or other financial institutions that offer shares of the Fund and
that have entered into a Sales Support Agreement with the Distributor ("Selling
Agents") or a Shareholder Servicing Agreement with the Company, ("Servicing
Agents"), up to 0.10% (on an annualized basis) of the average daily net asset
value of Investor A Shares of the Money Market Funds and up to 0.25% (on an
annualized basis) of the average daily net asset value of the Non-Money Market
Funds.
With respect to the Money Market Funds, such payments may be made to (i)
the Distributor for reimbursements of distribution-related expenses actually
incurred by the Distributor, including, but not limited to, expenses of
organizing and conducting sales seminars, printing of prospectuses and
statements of additional information (and supplements thereto) and reports for
other than existing shareholders, preparation and distribution of advertising
material and sales literature and costs of administering the Investor A Plan, or
(ii) Selling Agents that have entered into a Sales Support Agreement with the
Distributor for providing sales support assistance in connection with the sale
of Investor A Shares of the Money Market Funds. The sales support assistance
provided by a Selling Agent under a Sales Support Agreement may include
forwarding sales literature and advertising provided by Nations Fund Trust or
the Distributor to their customers and providing such other sales support
assistance as may be requested by the Distributor from time to time. Currently,
substantially all fees paid by the Money Market Funds pursuant to the Investor A
Plan are paid to compensate Selling Agents for providing sales support services,
with any remaining amounts being used by the Distributor to partially defray
other expenses incurred by the Distributor in distributing Investor A Shares.
Fees received by the Distributor pursuant to the Investor A Plan will not be
used to pay any interest expenses, carrying charges or other financing costs
(except to the extent permitted by the SEC) and will not be used to pay any
general and administrative expenses of the Distributor.
With respect to the Non-Money Market Funds, payments under the Investor A
Plan may be made to the Distributor for providing the distribution-related
services described in (i) above or to Servicing Agents that have entered into a
Shareholder Servicing Agreement with the Company for providing shareholder
support services to their Customers which hold of record or beneficially
Investor A Shares of a Non-Money Market Fund. Such shareholder support services
provided by Servicing Agents to holders of Investor A Shares of the Non-Money
Market Funds may include (i) aggregating and processing purchase and redemption
requests for Investor A Shares from their Customers and transmitting promptly
net purchase and redemption orders to our distributor or transfer agent; (ii)
providing their Customers with a service that invests the assets of their
accounts in Investor A Shares pursuant to specific or pre-authorized
instructions; (iii) processing dividend and distribution payments from the
Company on behalf of their Customers; (iv) providing information periodically to
their Customers showing their positions in Investor A Shares; (v) arranging for
bank wires; (vi) responding to their Customers' inquiries concerning their
investment in Investor A Shares; (vii) providing sub-accounting with respect to
Investor A Shares beneficially owned by their Customers or the information
necessary to us for sub-accounting; (viii) if required by law, forwarding
shareholder communications from the Company (such as proxies, shareholder
reports, annual and semi-annual financial statements and dividend, distribution
and tax notices) to their Customers (ix) forwarding to their Customers proxy
statements and proxies containing any proposals regarding the Shareholder
Servicing Agreement; (x) providing general shareholder liaison services; and
(xi) providing such other similar services as the Company may reasonably request
to the extent the Selling Agent is permitted to do so under applicable statutes,
rules or regulations.
Expenses incurred by the Distributor pursuant to the Investor A Plan in
any given year may exceed the sum of the fees received under the Investor A
Plan. Any such excess may be recovered by the Distributor in future years so
long as the Investor A Plan is in effect. If the Investor A Plan were terminated
or not continued, a Fund would not be contractually obligated to pay the
Distributor for any expenses not previously reimbursed by the Fund.
46
<PAGE>
In addition, the Company has adopted an Amended and Restated Shareholder
Servicing Plan for the Investor A Shares of the Money Market Funds (the "Money
Market Investor A Servicing Plan"). Pursuant to the Money Market Investor A
Servicing Plan, which became effective on March 28, 1993, each Money Market Fund
may pay banks, broker/dealers or other financial institutions that have entered
into a Shareholder Servicing Agreement with the Company ("Servicing Agents") up
to 0.25% (on an annualized basis) of the average daily net asset value of the
Investor A Shares of each Money Market Fund for providing shareholder support
services. Such shareholder support services provided by Servicing Agents may
include those shareholder support services discussed above with respect to the
Investor A Shares of the Non-Money Market Funds. Fees paid pursuant to the Money
Market Investor A Servicing Plan are calculated daily and paid monthly.
For the fiscal year ending May 31, 1993, the following Funds paid the
indicated fees pursuant to the Investor A Plan: Prime Fund -- $925,943; Treasury
Fund $328,737; Equity Income Fund -- $42,188; International Equity Fund -- $605;
and Government Securities Fund -- $10,180, after taking into effect waivers of
$6,973.
For the fiscal year ending May 31, 1993, the Prime Fund and the Treasury
Fund paid $130,357 and $45,212, respectively, in shareholder servicing fees
pursuant to the Investor A Plan.
For the fiscal year ended May 31, 1993, in connection with the sale of
Investor A Shares, the prior distributor received $757,418 in front end sales
charges; the Prior distributor retained $94,181 of this amount and paid the
balance to selling dealers. During the same period, the prior distributor
received $1,307,653 in Rule 12b-1 fees with respect to Investor A Shares; the
prior distributor retained $0 of this amount.
For the fiscal year ended May 31, 1994 the following funds paid the
indicated fees pursuant to the Investor A Plan: Prime Fund -- $1,728,199;
Treasury Fund -- $291,291; Equity Income Fund -- $86,960; International Equity
Fund - $4,309; and Government Securities Fund -- $25,830.
For the fiscal year ended May 31, 1995 the following Funds paid the
indicated fees pursuant to the Investor A Plan: Prime Fund -- $616,364; Treasury
Fund -- $96,210; Equity Income Fund--$83,892; International Equity Fund --
$10,492 and Government Securities Fund -- $28,881.
For the fiscal year ended May 31, 1995 the Funds paid $57,270 in front end
sales loads and $835,839 in 12b-1 fees, of which $0 was retained by the
distributor.
Investor B Shares of the Money Market Funds and Investor C Shares of the
Non-Money Market Funds. The Directors of the Company have approved an Amended
and Restated Distribution Plan in accordance with Rule 12b-1 under the 1940 Act
for the Investor B Shares of Money Market Funds and Investor C Shares of the
Non-Money Market Funds (the "Investor B/C Plan"). Pursuant to the Investor B/C
Plan, each Fund may pay the Distributor for certain expenses that are incurred
in connection with the distribution of shares. Payments under the Investor B/C
Plan will be calculated daily and paid monthly at a rate set from time to time
by the Board of Directors provided that the annual rate may not exceed 0.75% of
the average daily net asset value of Investor C Shares of a Non-Money Market
Fund and 0.10% of the average daily net asset value of Investor B Shares of a
Money Market Fund. Payments to the Distributor pursuant to the Investor B/C Plan
will be used (i) to compensate banks, other financial institutions or a
securities broker/dealer that have entered into a Sales Support Agreement with
the Distributor ("Selling Agents") for providing sales support assistance
relating to Investor B or Investor C Shares, ( for promotional activities
intended to result in the sale of Investor B or Investor C Shares such as to pay
for the preparation, printing and distribution of prospectuses to other than
current shareholders, and (iii) to compensate Selling Agents for providing sales
support services with respect to their Customers who are, from time to time,
beneficial and record holders of Investor B or Investor C Shares. Currently,
substantially all fees paid pursuant to the Investor B/C Plan are paid to
compensate Selling Agents for providing the services described in (i) and (iii)
above, with any remaining amounts being used by the Distributor to partially
defray other expenses incurred by the Distributor in distributing Investor B or
Investor C Shares. Fees received by the Distributor pursuant to the Investor B/C
Plan will not be used to pay any interest expenses, carrying charges or other
financing costs (except to the extent permitted by the SEC) and will not be used
to pay any general and administrative expenses of the Distributor.
47
<PAGE>
Pursuant to the Investor B/C Plan, the Distributor may enter into Sales
Support Agreements with Selling Agents for providing sales support services to
their Customers who are the record or beneficial owners of Investor B Shares of
the Money Market Funds and Investor C Shares of the non-Money Market Funds. Such
Selling Agents will be compensated at the annual rate of up to 0.75% of the
average daily net asset value of the Investor C Shares of the Non-Money Market
Funds, and up to 0.10% of the average daily net asset value of the Investor B
Shares of the Money Market Funds held of record or beneficially by such
Customers. The sales support services provided by Setting Agents may include
providing distribution assistance and promotional activities intended to result
in the sales of shares such as paying for the preparation, printing and
distribution of prospectuses to other than current shareholders.
Fees paid pursuant to the Investor B/C Plan are accrued daily and paid
monthly, and are charged as expenses of the relevant shares of a Fund as
accrued. Expenses incurred by the Distributor pursuant to the Investor B/C Plan
in any given year may exceed the sum of the fees received under the Investor B/C
Plan and payments received pursuant to contingent deferred sales charges. Any
such excess may be recovered by the Distributor in future years so long as the
Investor B/C Plan is in effect. If the Investor B/C Plan were terminated or not
continued, a Fund would not be contractually obligated to pay the Distributor
for any expenses not previously reimbursed by the Fund or recovered through
contingent deferred sales charges.
In addition, the Directors have approved an Amended and Restated
Shareholder Servicing Plan ("Servicing Plan") with respect to the Investor B
Shares of the Money Market Funds and Investor C Shares of the Non-Money Market
Funds (the "Investor B/C Servicing Plan"). Pursuant to the Investor B/C
Servicing Plan, each Fund may pay banks, broker/dealers or other financial
institutions that have entered into a Shareholder Servicing Agreement with
Nations Fund ("Servicing Agents") for certain expenses that are incurred by the
Servicing Agents in connection with shareholder support services that are
provided by the Servicing Agents. Payments under the Investor B/C Servicing Plan
will be calculated daily and paid monthly at a rate set from time to time by the
Board of Directors, provided that the annual rate may not exceed 0.25% of the
average daily net asset value of the Money Market Funds' Investor B Shares and
the Non-Money Market Funds' Investor C Shares. The shareholder services provided
by the Servicing Agents may include (i) aggregating and processing purchase and
redemption requests for such Investor B or Investor C Shares from Customers and
transmitting promptly net purchase and redemption orders to our distributor or
transfer agent; (ii) providing Customers with a service that invests the assets
of their accounts in such Investor B or Investor C Shares pursuant to specific
or pre-authorized instructions; (iii) dividend and distribution payments from
the Company on behalf of Customers; (iv) providing information periodically to
Customers showing their positions in such Investor B or Investor C Shares; (v)
arranging for bank wires; (vi) responding to Customers' inquiries concerning
their investment in such Investor B or Investor C Shares; (vii) providing
sub-accounting with respect to such Investor B or Investor C Shares beneficially
owned by Customers or providing the information to us necessary for
sub-accounting; (viii) if required by law, forwarding shareholder communications
from the Company (such as proxies, shareholder reports, annual and semi-annual
financial statements and dividend, distribution and tax notices) to Customers;
(ix) forwarding to Customers proxy statements and proxies containing any
proposals regarding the Shareholder Servicing Agreement; (x) providing general
shareholder liaison services; and (xi) providing such other similar services as
the Company may reasonably request to the extent the Servicing Agent is
permitted to do so under applicable statutes, rules or regulations.
For the fiscal year ending May 31, 1993, the following Funds paid the
indicated fees pursuant to the Investor B/C Plan: Equity Income Fund -- $15,796;
International Equity Fund -- $885; and Government Securities Fund -- $13,496,
after taking into effect waivers of $5,217. During the same fiscal year, the
following Funds paid the indicated fees pursuant to the Investor B/C Servicing
Plan: Equity Income Fund -- $1,554; International Equity Fund -- $75; and
Government Securities Fund -- $2,000. The Prime Fund and Treasury Fund did not
offer Investor B Shares during the fiscal year ended May 31, 1993.
During the fiscal year ended May 31,1993, the prior distributor received
the following amounts from front end sales charges, Rule 12b-1 fees and CDSC
fees in connection with Investor B Shares of the Money Market Funds and Investor
C Shares of the Non-Money Market Funds: $37,339; $30,177; and $4,020,
respectively. Of these amounts, the prior distributor retained $5,104, $0, and
$4,020, respectively, and paid the balance to selling dealers.
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For the fiscal year ended May 31,1994 the following funds paid the
indicated fees pursuant to the Investor B/C Plan: Equity Income Fund -- $44,852;
International Equity Fund -- $2,539 and Government Securities Fund -- $47,436.
For the fiscal year ended May 31, 1995, the following funds paid the
indicated fees pursuant to the Investor B/C Plan: Equity Income Fund -- $31,136;
International Equity Fund -- $3,087 and Government Securities Fund -- $29,739.
For the fiscal year ended May 31, 1995 the Funds paid $63,962 in 12b-1
fees.
Investor C Shares of the Money Market funds and Investor N Shares of the
Non-Money Market Funds. The Directors have approved a Distribution Plan (the
"Investor N Distribution Plan") with respect to Investor N Shares of the
Non-Money Market Funds. Pursuant to the Investor N Distribution Plan, a
Non-Money Market Fund may compensate or reimburse the Distributor for any
activities or expenses primarily intended to result in the sale of the Fund's
Investor N Shares, including for sales related services provided by banks,
broker/dealers or other financial institutions that have entered into a Sales
Support Agreement relating to the Investor N Shares with the Distributor
("Selling Agents"). Payments under a Fund's Investor N Distribution Plan will be
calculated daily and paid monthly at a rate or rates set from time to time by
the Board of Directors provided that the annual rate may not exceed 0.75% of the
average daily net asset value of each Non-Money Market Fund's Investor N Shares.
The fees payable under the Investor N Distribution Plan are used primarily
to compensate or reimburse the Distributor for distribution services provided by
it, and related expenses incurred, including payments by the Distributor to
compensate or reimburse Selling Agents, for sales support services provided, and
related expenses incurred, by such Selling Agents. Payments under the Investor N
Distribution Plan may be made with respect to preparation, printing and
distribution of prospectuses, sales literature and advertising materials by the
Distributor or, as applicable, Selling Agents, attributable to distribution or
sales support activities, respectively, commissions, incentive compensation or
other compensation to, and expenses of, account executives or other employees of
the Distributor or Selling Agents, attributable to distribution or sales support
activities, respectively; overhead and other office expenses of the Distributor
relating to the foregoing (which may be calculated as a carrying charge in the
Distributor's or Selling Agents' unreimbursed expenses), incurred in connection
with distribution or sales support activities. The overhead and other office
expenses referenced above may include, without limitation, (i) the expenses of
operating the Distributor's or Selling Agents' offices in connection with the
sale of Fund shares, including lease costs, the salaries and employee benefit
costs of administrative, operations and support personnel, utility costs,
communication costs and the costs of stationery and supplies, (i) the costs of
client sales seminars and travel related to distribution and sales support
activities, and (ii) other expenses relating to distribution and sales support
activities.
In addition, the Directors have approved a Shareholder Servicing Plan with
respect to Investor C Shares of the Money Market Funds and Investor N Shares of
the Non-Money Market Funds ( "Investor C/N Servicing Plan"). Pursuant to the
Investor C/N Servicing Plan, a Fund may compensate or reimburse banks,
broker/dealers or other financial institutions that have entered into a
Shareholder Servicing Agreement with the Company ("Servicing Agents") for
certain activities or expenses of the Servicing Agents in connection with
shareholder services that are provided by the Servicing Agents. Payments under
the Investor C/N Servicing Plan will be calculated daily and paid monthly at a
rate or rates set from time to time by the Board of Directors, provided that the
annual rate may not exceed 0.25% of the average daily net asset value of the
Investor C Shares of the Money Market Funds and Investor N Shares of the
Non-Money Market Funds.
The fees payable under the Investor C/N Servicing Plan are used primarily
to compensate or reimburse Servicing Agents for shareholder services provided,
and related expenses incurred, by such Servicing Agents. The shareholder
services provided by Servicing Agents may include: (i) aggregating and
processing purchase and redemption requests for such Investor C or Investor N
Shares from Customers and transmitting promptly net purchase and redemption
orders to the Distributor or Transfer Agent; (ii) providing Customers with a
service that invests the assets of their accounts in such Investor C or Investor
N Shares pursuant to specific or pre-authorized instructions; (iii) processing
dividend and distribution payments from the Company on behalf of Customers; (iv)
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providing information periodically to Customers showing their positions in such
Investor C or Investor N Shares; (v) arranging for bank wires; (vi) responding
to Customers' inquiries concerning their investment in such Investor C or
Investor N Shares; (vii) providing sub-accounting with respect to such Investor
C or Investor N Shares beneficially owned by Customers or providing the
information to us necessary for sub-accounting; (viii) if required by law,
forwarding shareholder communications from the Company (such as proxies,
shareholder reports, annual and semi-annual financial statements and dividend,
distribution and tax notices) to Customers; (ix) forwarding to Customers proxy
statements and proxies containing any proposals regarding the Investor C
Servicing Plan or related agreements; (x) providing general shareholder liaison
Services; and (xi) providing such other similar services as the Company may
reasonably request to the extent such Servicing Agent is permitted to do so
under applicable statutes, rules or regulations.
The fees payable under the Investor N Distribution Plan and Investor C/N
Servicing Plan (together, the "Investor C/N Plans") are treated by the Funds as
an expense in the year they are accrued. At any given time, a Selling Agent
and/or Servicing Agent may incur expenses in connection with services provided
pursuant to its agreements with the Distributor under the Investor C/N Plans
which exceed the total of (i) the payments made to the Selling Agents and
Servicing Agents by the Distributor or the Company and reimbursed by the Fund
pursuant to the Investor C/N Plans, and (ii) the proceeds of contingent deferred
sales charges paid to the Distributor and reallowed to the Selling Agent, upon
the redemption of their Customers' Investor C Shares. Any such excess expenses
may be recovered in future years, so long as the Investor C/N Plans are in
effect. Because there is no requirement under the Investor C/N Plans that the
Distributor be paid or the Selling Agents and Servicing Agents be compensated or
reimbursed for all their expenses or any requirement that the Investor C/N Plans
be continued from year to year, such excess amount, if any, does not constitute
a liability to a Fund or the Distributor. Although there is no legal obligation
for the Fund to pay expenses incurred by the Distributor, a Selling Agent or a
Servicing Agent in excess of payments previously made to the Distributor under
the Investor C/N Plans or in connection with contingent deferred sales charges,
if for any reason the Investor C/N Plans are terminated, the Directors will
consider at that time the manner in which to treat such expenses.
For the fiscal year ended May 31, 1994, the Prime Fund and the Treasury
Fund paid $514 and $19, respectively, in shareholder servicing fees pursuant to
the Money Market Investor C Plan. For the fiscal year ended May 31, 1994, the
following funds paid the indicated fees pursuant to the Investor N Plan: Equity
Income Fund -- $187,452; International Equity Fund -- $50,880 and Government
Securities Fund -- $215.493.
For the fiscal year ended May 31, 1995, the following funds paid the
indicated fees pursuant to the Investor N Plan: Equity Income Fund -- $289,973;
International Equity Fund -- $197,156 and Government Securities Fund --
$224,710.
For the fiscal year ended May 31, 1995 the Funds paid $0 in front-end
sales loads, $506,013 in contingent deferred sales charges on the Non-Money
Market Funds, of which $0 was retained by the distributor and $711,839 in 12b-1
fees of which $5,085.17 was retained by the distributor for the Investor N
Shares and $0 in front-end sales loads and $0 in 12b-1 fees for the Investor C
Money Market Funds.
Investor D Shares of the Money Market Funds. The Directors have approved a
Distribution Plan (the "Investor D Distribution Plan") with respect to Investor
D Shares of the Money Market Funds. Pursuant to the Investor D Distribution
Plan, a Money Market Fund may compensate or reimburse the Distributor for any
activities or expenses primarily intended to result in the sale of the Fund's
Investor D Shares, including for sales related services provided by banks,
broker/dealers or other financial institutions that have entered into a Sales
Support Agreement relating to the Investor D Shares with the Distributor
("Selling Agents"). Payments under a Fund's Investor D Distribution Plan will be
calculated daily and paid monthly at a rate or rates set from time to time by
the Board of Directors provided that the annual rate may not exceed 0.45 % of
the average daily net asset value of each Money Market Fund's Investor D Shares.
The fees payable under the Investor D Distribution Plan are used primarily
to compensate or reimburse the Distributor for distribution services provided by
it, and related expenses
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incurred, including payments by the Distributor to compensate or reimburse
Selling Agents, for sales support services provided, and related expenses
incurred, by such Selling Agents. Payments under the Investor D Distribution
Plan may be made with respect to preparation, printing and distribution of
prospectuses, sales literature and advertising materials by the Distributor or,
as applicable, Selling Agents, attributable to distribution or sales support
activities, respectively, commissions, incentive compensation or other
compensation to, and expenses of, account executives or other employees of the
Distributor or Selling Agents, attributable to distribution or sales support
activities, respectively; overhead and other office expenses of the Distributor
relating to the foregoing (which may be calculated as a carrying charge in the
Distributor's or Selling Agents' unreimbursed expenses), incurred in connection
with distribution or sales support activities. The overhead and other office
expenses referenced above may include, without limitation, (i) the expenses of
operating the Distributor's or Selling Agents' offices in connection with the
sale of Fund shares, including lease costs, the salaries and employee benefit
costs of administrative operations and support personnel, utility costs,
communication costs and the costs of stationery and supplies, (ii) the costs of
client sales seminars and travel related to distribution and sales support
activities, and (iii) other expenses relating to distribution and sales support
activities.
In addition, the Directors have approved a Shareholder Servicing Plan with
respect to Investor D Shares of the Money Market Funds (the "Investor D
Servicing Plan"). Pursuant to the Investor D Servicing Plan, a Fund may
compensate or reimburse banks, broker/dealers or other financial institutions
that have entered into a Shareholder Servicing Agreement with the Company
("Servicing Agents") for certain activities or expenses of the Servicing Agents
in connection with shareholder services that are provided by the Servicing
Agents. Payments under the Investor D Servicing Plan will be calculated daily
and paid monthly at a rate or rates set from time to time by the Board of
Directors, provided that the annual rate may not exceed 0.25% of the average
daily net asset value of the Investor D Shares of the Money Market Funds.
The fees payable under the Investor D Servicing Plan are used primarily to
compensate or reimburse Servicing Agents for shareholder services provided, and
related expenses incurred, by such Servicing Agents. The shareholder services
provided by Servicing Agents may include: (i) aggregating and processing
purchase and redemption requests for such Investor D Shares from Customers and
transmitting promptly net purchase and redemption orders to the Distributor or
Transfer Agent; (ii) providing Customers with a service that invests the assets
of their accounts in such Investor D Shares pursuant to specific or
pre-authorized instructions; (iii) processing dividend and distribution payments
from the Company on behalf of Customers; (iv) providing information periodically
to Customers showing their positions in such Investor D Shares; (v) arranging
for bank wires; (vi) responding to Customers' inquiries concerning their
investment in such Investor D Shares; (vii) providing sub-accounting with
respect to such Investor D Shares beneficially owned by Customers or providing
the information to us necessary for sub-accounting; (viii) if required by law,
forwarding shareholder communications from the Company (such as proxies,
shareholder reports, annual and semi-annual financial statements and dividend,
distribution and tax notices) to Customers; (ix) forwarding to Customers proxy
statements and proxies containing any proposals regarding the Investor D
Servicing Plan or related agreements; (x) providing general shareholder liaison
services; and (xi) providing such other similar services as the Company may
reasonably request to the extent such Servicing Agent is permitted to do so
under applicable statutes, rules or regulations.
The fees payable under the Investor D Distribution Plan and Investor D
Servicing Plan (together, the "Investor D Plans") are treated by the Funds as an
expense in the year they are accrued. At any given time, a Selling Agent and/or
Servicing Agent may incur expenses in connection with services provided pursuant
to its agreements with the Distributor under the Investor D Plans which exceed
the total of (i) the payments made to the Selling Agents and Servicing Agents by
the Distributor or the Company and reimbursed by the Fund pursuant to the
Investor D Plans, and (ii) the proceeds of contingent deferred sales charges
paid to the Distributor and reallowed to the Selling Agent, upon the redemption
of their Customers' Investor D Shares. Any such excess expenses may be recovered
in future years, so long as the Investor D Plans are in effect. Because there is
no requirement under the Investor D Plans that the Distributor be paid or the
Selling Agents and Servicing Agents be compensated or reimbursed for all their
expenses or any requirement that the Investor D Plans be continued from year to
year, such excess amount, if any, does not constitute a liability to a Fund or
the Distributor. Although there is no legal obligation for the Fund to pay
expenses incurred by the Distributor, a Selling Agent or a Servicing Agent in
excess of payments previously made to the Distributor under the Investor D Plans
or in connection with
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contingent deferred sales charges, if for any reason the Investor D Plans are
terminated, the Directors will consider at that time the manner in which to
treat such expenses.
For the fiscal year ended May 31, 1995, the Prime Fund and the Treasury
Fund paid nothing in shareholder servicing fees pursuant to the Money Market
Investor D Plan.
Information Applicable to Investor A, Investor B, Investor C and Investor
D Shares and Investor N Shares. The Investor A Plan, the Money Market Investor A
Servicing Plan, the Investor B/C Plan, the Investor B/C Servicing Plan, the
Investor C Plan, the Investor D Distribution Plan, the Investor D Servicing Plan
and the Investor C/N Servicing Plan (each a "Plan" and collectively the "Plans")
may only be used for the purposes specified above and as stated in each such
Plan. Compensation payable to Selling Agents or Servicing Agents for shareholder
support services under the Investor A Plan, the Money Market Investor A
Servicing Plan, the Investor B/C Servicing Plan, Investor D Servicing Plan and
the Investor C/N Servicing Plan is subject to, among other things, the National
Association of Securities Dealers, Inc. ("NASD") Rules of Fair Practice
governing receipt by NASD members of shareholder servicing plan fees from
registered investment companies (the "NASD Servicing Plan Rule"), which became
effective on July 7, 1993. Such compensation shall only be paid for services
determined to be permissible under the NASD Servicing Plan Rule.
Each Plan requires the officers of the Company or the Distributor to
provide the Board of Directors at least quarterly with a written report of the
amounts expended pursuant to the Plan and the purposes for which such
expenditures were made. The Board of Directors reviews these reports in
connection with their decisions with respect to the Plans.
As required by Rule 12b-1 under the 1940 Act, each Plan was approved by
the Board of Directors, including a majority of the directors who are not
"interested persons" (as defined in the 1940 Act) of the Company and who have no
direct or indirect financial interest in the operation of the Plan or in any
agreements related to the Plan ("Qualified Directors") on September 27, 1989,
with respect to the Investor C Shares of the Money Market Funds, on March 22,
1991, with respect to the Investor A Shares of the Equity Income and Government
Securities Funds, on June 24, 1992 with respect to the Investor A Shares of the
International Equity Fund, and on March 19, 1992, with respect to the Investor C
Shares of the Non-Money Market Funds. Additionally, each Plan with respect to
the Investor B Shares of the Money Market Funds and with respect to the Investor
N Shares of all the Non-Money Market Funds was approved by the Board of
Directors, including a majority of the Qualified Directors, on February 3, 1993.
The Plan with respect to the Investor C Shares of the Money Market Funds was
initially approved on August 4, 1993. The Plan with respect to the Investor D
Shares of the Money Market Funds was initially approved on August 4, 1993. The
Plans continue in effect as long as such continuance is specifically approved at
least annually by the Board of Directors, including a majority of the Qualified
Directors. On November 6, 1994, the Board of Directors (including a majority of
the Qualified Directors) voted to continue each Plan for an additional one year
period.
In approving the Plans in accordance with the requirements of Rule 12b-1,
the directors considered various factors and determined that there is a
reasonable likelihood that each Plan will benefit the respective Investor A,
Investor B, Investor C Shares or Investor N Shares and the holders of such
shares. The Investor A Plan was approved by the Shareholders of the Investor A
Shares of each of the Funds except the International Equity Fund on September 6,
1991, and the Investor B/C Plan applicable to Investor C Shares of the
International Equity and Equity Income Funds and the Investor A Plan applicable
to Investor A Shares of the International Equity Fund were approved on September
22, 1992 by the Investor C Shareholders of the respective International Equity
and Equity Income Funds with respect to the Investor B/C Plan and by the
Investor A Shareholders of the International Equity Fund with respect to the
Investor A Plan. The Plans applicable to the Investor B Shares of the Money
Market Funds and Investor N Shares of the Non-Money Market Funds were approved
by such Funds' initial shareholder of Investor B and Investor N Shares.
The Investor A Shares' Plans with respect to the Money Market Funds
originally became effective on December 4, 1989, and were amended February
12,1990, March 19, 1992 and February 3, 1993. The Investor A Shares' Plan with
respect to the Equity Income and Government Securities Funds became effective on
March 22,
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1991, and was amended March 19, 1992. The Investor A Shares' Plan with respect
to the International Equity Fund became effective September 6, 1991 and was
amended March 19, 1992 and February 3, 1993.
The Investor A Plan, Investor B/C Plan and Investor C/N Plan may be
terminated with respect to their respective shares by vote of a majority of the
Qualified Directors, or by vote of a majority of the holders of the outstanding
voting securities of the Investor A, Investor B, Investor C or Investor N
Shares, as appropriate. Any change in such a Plan that would increase materially
the distribution expenses paid by the Investor A, Investor B, Investor C or
Investor N Shares requires shareholder approval; otherwise, each Plan may be
amended by the directors, including a majority of the Qualified Directors, by
vote cast in person at a meeting called for the purpose of voting upon such
amendment. The Money Market Investor A Servicing Plan, the Investor B/C
Servicing Plan and the Investor C/N Servicing Plan may be terminated by a vote
of a majority of the Qualified Directors. As long as a Plan is in effect, the
selection or nomination of the Qualified Directors is committed to the
discretion of the Qualified Directors.
Conflict of interest restrictions may apply to the receipt by Selling
and/or Servicing Agents of compensation from the Company in connection with the
investment of fiduciary assets in Investor Shares. Selling and/or Servicing
Agents, including banks regulated by the Comptroller of the Currency, the
Federal Reserve Board, or the Federal Deposit Insurance Corporation, and
investment advisers and other money managers subject to the jurisdiction of the
SEC, the Department of Labor, or state securities commissions, are urged to
consult their legal advisers before investing such assets in Investor Shares.
Shareholder Servicing Agreements (Primary B Shares) - Money Market Funds
As stated in the Prospectuses for the Money Market Funds' Primary Shares,
the Company has a separate Shareholder Servicing Plan with respect to the
Non-Money Market Funds' Primary B Shares. Pursuant to the Shareholder Servicing
Plans, the Company has entered into agreements with certain banks pertaining to
the provision of administrative services to their customers who may from time to
time own of record or beneficially Primary B Shares ("Customers") in
consideration for the payment of up to 0.25% (on an annualized basis) of the net
asset value of such shares. Such services may include: (i) aggregating and
processing purchase, exchange and redemption requests for Primary B Shares from
Customers and transmitting promptly net purchase and redemption orders with the
Distributor or the transfer agents; (ii) providing Customers with a service that
invests the assets of their accounts in Primary B Shares pursuant to specific or
pre-authorized instructions; (iii) processing dividend and distribution payments
from the Company on behalf of Customers; (iv) providing information periodically
to Customers showing their positions in Primary B Shares; (v) arranging for bank
wires; (vi) responding to Customer inquiries concerning their investment in
Primary B Shares; (vii) providing sub-accounting with respect to Primary B
Shares beneficially owned by Customers or the information necessary for
sub-accounting; (viii) if required by law, forwarding shareholder communications
(such as proxies, shareholder reports annual and semi-annual financial
statements and dividend, distribution and tax notices) to Customers; (ix)
forwarding to Customers proxy statements and proxies containing any proposals
regarding the Shareholder Servicing Agreements or Shareholder Serving Plan; and
(x) providing such other similar services as may reasonably be requested to the
extent permitted under applicable statutes, rules, or regulations.
Such plan shall continue in effect as long as the Board of Directors,
including a majority of the Qualified Directors, specifically approves the plan
at least annually.
Shareholder Administration Plan (Primary B Shares) - Non-Money Market Funds
As stated in the Prospectus for the Non-Money Market Funds' Primary B
Shares, the Company has a separate Shareholder Administration Plan (the
"Administration Plan") with respect to such shares. Pursuant to the
Administration Plan, the Company may enter into agreements ("Administration
Agreements") with broker/dealers, banks and other financial institutions that
are dealers of record or holders of record or which have a servicing
relationship with the beneficial owners of Non-Money Market Fund Primary B
Shares ("Servicing Agents"). The Administration Plan provides that pursuant to
the Administration Agreements, Servicing Agents shall provide the shareholder
support services as set forth therein to their customers who may from time to
time own of record or
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beneficially Primary B Shares ("Customers") in consideration for the payment of
up to 0.60% (on an annualized basis) of the net asset value of such shares. Such
services may include: (i) aggregating and processing purchase, exchange and
redemption requests for Primary B Shares from Customers and transmitting
promptly net purchase and redemption orders with the Distributor or the transfer
agents; (ii) providing Customers with a service that invests the assets of their
accounts in Primary B Shares pursuant to specific or pre-authorized
instructions; (iii) processing dividend and distribution payments from the
Company on behalf of Customers; (iv) providing information periodically to
Customers showing their positions in Primary B Shares; (v) arranging for bank
wires; (vi) responding to Customer inquiries concerning their investment in
Primary B Shares; (vii) providing sub-accounting with respect to Primary B
Shares beneficially owned by Customers or the information necessary for
sub-accounting; (viii) if required by law, forwarding shareholder communications
(such as proxies, shareholder reports annual and semi-annual financial
statements and dividend, distribution and tax notices) to Customers; (ix)
forwarding to Customers proxy statements and proxies containing any proposals
regarding an Administration Agreement; (x) employee benefit plan recordkeeping,
administration, custody and trustee services; (xi) general shareholder liaison
services and (xii) providing such other similar services as may reasonably be
requested to the extent permitted under applicable statutes, rules, or
regulations.
The Administration Plan also provides that in no event may the portion of
the shareholder administration fee that constitutes a "service fee," as the term
is defined in NASD Servicing Plan Rule, exceed 0.25% of the average daily net
asset value of the Primary B Shares of a Non-Money Market Fund. In addition, to
the extent any portion of the fees payable under the Plan is deemed to be for
services primarily intended to result in the sale of Fund Shares, such fees are
deemed approved and may be paid under the Administration Plan. Accordingly, the
Administration Plan has been approved and will be operated pursuant to Rule
12b-1 under the 1940 Act. Such plan shall continue in effect as long as the
Board of Directors, including a majority of the Qualified Directors,
specifically approves the plan at least annually.
Expenses
The Administrator furnishes, without additional cost to the Company, the
services of the Treasurer and Secretary of the Company and such other personnel
(other than the personnel of the Adviser) as are required for the proper conduct
of the Company's affairs. The Distributor bears the incremental expenses of
printing and distributing prospectuses used by the Distributor or furnished by
the Distributor to investors in connection with the public offering of the
Company's shares and the costs of any other promotional or sales literature,
except that to the extent permitted under the Plans relating to the Investor A,
Investor B, Investor C and Investor N Shares of each Fund, sales-related
expenses incurred by the Distributor may be reimbursed by the Company.
The Company pays or causes to be paid all other expenses of the Company,
including, without limitation: the fees of the Adviser, the Administrator and
Co-Administrator; the charges and expenses of any registrar, any custodian or
depository appointed by the Company for the safekeeping of its cash, fund
securities and other property, and any stock transfer, dividend or accounting
agent or agents appointed by the Company; brokerage commissions chargeable to
the Company in connection with fund securities transactions to which the Company
is a party; all taxes, including securities issuance and transfer taxes;
corporate fees payable by the Company to federal, state or other governmental
agencies; all costs and expenses in connection with the registration and
maintenance of registration of the Company and its shares with the SEC and
various states and other jurisdictions (including filing fees, legal fees and
disbursements of counsel); the costs and expenses of typesetting prospectuses
and statements of additional information of the Company (including supplements
thereto) and periodic reports and of printing and distributing such prospectuses
and statements of additional information (including supplements thereto) to the
Company's shareholders; all expenses of shareholders' and directors' meetings
and of preparing, printing and mailing proxy statements and reports to
shareholders; fees and travel expenses of directors or director members of any
advisory board or committee; all expenses incident to the payment of any
dividend or distribution, whether in shares or cash; charges and expenses of any
outside service used for pricing of the Company's shares; fees and expenses of
legal counsel and of independent auditors in connection with any matter relating
to the Company; membership dues of industry associations; interest payable on
Company borrowings; postage and long-distance telephone charges; insurance
premiums on property or personnel (including officers and directors) of the
Company which inure to its benefit; extraordinary expenses (including, but not
limited to, legal claims and liabilities and
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litigation costs and any indemnification related thereto); and all other charges
and costs of the Company's operation unless otherwise explicitly assumed by the
Adviser), the Administrator or Co-Administrator.
Expenses of the Company which are not directly attributable to the
operations of any class of shares or Fund are pro-rated among all classes of
shares or Fund of the Company based upon the relative net assets of each class
or Fund. Expenses of the Company which are not directly attributable to a
specific class of shares but are directly attributable to a specific Fund are
prorated among all the classes of shares of such Fund based upon the relative
net assets of each such class of shares. Expenses of the Company which are
directly attributable to a class of shares are charged against the income
available for distribution as dividends to such class of shares.
The Advisory Agreement, the Sub-Advisory Agreements, and the
Administration Agreement require NBAI, TradeStreet, Nations Gartmore, and the
Administrator to reduce their fees to the extent required to satisfy any expense
limitations which may be imposed by the securities laws or regulations
thereunder of any state in which a Fund's shares are registered or qualified for
sale, as such limitations may be raised or lowered from time to time, and the
aggregate of all such investment advisory, sub-advisory, and administration fees
shall be reduced by the amount of such excess. The amount of any such reduction
to be borne by NBAI, TradeStreet, Nations Gartmore or the Administrator shall be
deducted from the monthly investment advisory and administration fees otherwise
payable to NBAI, TradeStreet, Nations Gartmore and the Administrator during such
fiscal year. If required pursuant to such state securities regulations, NBAI,
TradeStreet, Nations Gartmore and the Administrator will reimburse the Company
no later than the last day of the first month of the next succeeding fiscal
year, for any such annual operating expenses (after reduction of all investment
advisory and administration fees in excess of such limitation).
Transfer Agents and Custodians
First Data Investors Services Group, Inc. (formerly, The Shareholder
Services Group, Inc.) is located at One Exchange Place, 53 State Street, Boston,
Massachusetts 02109, and acts as transfer agent for the Company's Primary Shares
and Investor Shares. Under the transfer agency agreements, the transfer agent
maintains shareholder account records for the Company, handles certain
communications between shareholders and the Company, and distributes dividends
and distributions payable by the Company to shareholders, and produces
statements with respect to account activity for the Company and its shareholders
for these services. The transfer agent receives a monthly fee computed on the
basis of the number of shareholder accounts that it maintains for the Company
during the month and is reimbursed for out-of-pocket expenses.
NationsBank of Texas, N.A., 901 Main Street, Dallas, Texas 75201, serves
as sub-transfer agent for each Fund's Primary Shares. NationsBank of Texas,
N.A., also serves as custodian for the portfolio securities and cash of the
Money Market Funds, the Equity Income Fund and the Government Securities Fund.
As such custodian, NationsBank of Texas, N.A., maintains custody of such Funds'
securities cash and other property, delivers securities against payment upon
sale and pays for securities against delivery upon purchase, makes payments on
behalf of such Funds for payments of dividends, distributions and redemptions,
endorses and collects on behalf of such Funds all checks, and receives all
dividends and other distributions made on securities owned by such Funds.
Boston Safe Deposit and Trust Company, One Boston Place, Boston,
Massachusetts, 02108, serves as custodian for the portfolio securities and cash
of the International Equity Fund. Boston Safe Deposit and Trust Company receives
compensation from the Fund for its services in such capacity based on a
percentage of the market value of the Fund's securities and a charge for fund
transactions.
55
<PAGE>
DISTRIBUTOR
On the Transition Date, Stephens Inc. (the "Distributor") began serving as
the principal underwriter and distributor of the shares of the Funds, replacing
Funds Distributor, Inc. which had served in this capacity from February 19, 1992
to the Transition Date. Prior to February 19, 1992, Fund Management Company
served as distributor for the Company.
At a meeting held on August 4, 1993, the Board of Directors selected
Stephens Inc. as Distributor, effective on the Transition Date, and approved a
distribution agreement ("Distribution Agreement") with the Distributor. Pursuant
to the Distribution Agreement, the Distributor, as agent, sells shares of the
Funds on a continuous basis and transmits purchase and redemption orders that
its receives to the Company or the Transfer Agent. Additionally, the Distributor
has agreed to use appropriate efforts to solicit orders for the sale of shares
and to undertake such advertising and promotion as it believes appropriate in
connection with such solicitation. Pursuant to the Distribution Agreement, the
Distributor, at its own expense, finances those activities which are primarily
intended to result in the sale of shares of the Funds, including, but not
limited to, advertising, compensation of underwriters, dealers and sales
personnel, the printing of prospectuses to other than existing shareholders, and
the printing and mailing of sales literature. The Distributor, however, may be
reimbursed for all or a portion of such expenses to the extent permitted by a
distribution plan adopted by the Company pursuant to Rule 12b-1 under the 1940
Act.
The Distribution Agreement will continue year to year as long as such
continuance is approved at least annually by (i) the Board of Directors or a
vote of the majority (as defined in the 1940 Act) of the outstanding voting
securities of the Fund and (ii) a majority of the directors who are not parties
to the Distribution Agreement or "interested persons" of any such party by a
vote cast in person at a meeting called for such purpose. The Distribution
Agreement is not assignable and is terminable with respect to a Fund, without
penalty, on 60 days' notice by the Board of Directors, the vote of a majority
(as defined in the 1940 Act) of the outstanding voting securities of the Fund,
or by the Distributor.
INDEPENDENT ACCOUNTANT AND REPORTS
At least semi-annually, the Company will furnish shareholders of the Funds
with a list of the investments held in the Funds and financial statements for
the Funds. The annual financial statements will be audited by the Company's
independent accountant. The Board of Directors has selected Price Waterhouse,
LLP, 160 Federal Street, Boston, Massachusetts, 02110 as the Company's
independent accountant to audit the Company's books and review the Company's tax
returns for the Funds' fiscal years ending on and after May 31, 1993. KPMG Peat
Marwick, One Boston Place, Boston, Massachusetts 02108, were the Company's
independent auditors for the fiscal years ended on and before May 31, 1992.
The audited financial statements and portfolio of investments contained in
the Annual Reports for the fiscal period ended March 31, 1996 are hereby
incorporated herein by reference in this SAI. The Annual Reports will be sent
free of charge with this SAI to any shareholder who requests this SAI.
COUNSEL
Morrison & Foerster LLP serves as legal counsel to the Company. Their
address is 2000 Pennsylvania Avenue, N.W., Washington, D.C. 20006.
ADDITIONAL INFORMATION ON PERFORMANCE
Yield information and other performance information for the Company's
Funds may be obtained by calling the Company at (800) 321-7854.
56
<PAGE>
From time to time, the yield and total return of a Fund's Investor Shares
and Primary Shares may be quoted in advertisements, shareholder reports, and
other communications to shareholders. Each Fund of the Company also may quote
information obtained from the Investment Company Institute in its advertising
materials and sales literature. In addition, certain potential benefits of
investing in world securities markets may be discussed in promotional materials.
Such benefits include, but are not limited to: a) the expanded opportunities for
investment in securities markets outside the U.S.; b) the growth of securities
markets outside the U.S. vis-a-vis U.S. markets; c) the relative return
associated with foreign securities markets vis-a-vis U.S. markets; and d) a
reduced risk of portfolio volatility resulting from a diversified securities
portfolio consisting of both U.S. and foreign securities. Performance
information is available by calling 1-800-321-7854 with respect to Investor
Shares and 1-800-621-2192 with respect to Primary Shares.
Yield Calculations
The current yield quotations for the Primary A, Primary B, Investor A,
Investor B, Investor C and Investor D Shares of the Money Market Funds are
computed by determining the net change, exclusive of capital changes, over a
seven-day base period in the value of a hypothetical pre-existing account having
a balance of one share at the beginning of the period. The net change in account
value is divided by the value of the account at the beginning of the base period
to obtain the base period return. The base period return is then multiplied by
(5/7), with the resulting annualized yield figure carried to the nearest 1/100
of 1%. For purposes of calculating current yield, net change in account value
reflects: (i) the value of additional shares purchased with dividends from the
original shares and dividends declared on both the original shares and any such
additional shares, and (ii) all fees (other than non-recurring account charges)
that are charged to all shareholder accounts in proportion to the length of the
base period and the average account size of the Primary A, Primary B, Investor
A, Investor B, Investor C and Investor D Shares of the Money Market Funds. The
capital changes excluded from the calculation of current yield are realized
gains and losses from the sale of securities and unrealized appreciation and
depreciation.
The effective yield quotations for the Primary Shares and Investor Shares
of the Money Market Funds are computed by compounding the unannualized seven-day
base period return as follows: 1 is added to the base period return and this sum
is then raised to a power equal to (5/7), and 1 is then subtracted from the
result. Based on the seven-day period ended May 31, 1995, (the "base period"),
the current and effective yields of the various shares of the Money Market Funds
were as follows:
Seven Day Yield
Effective Yield
Yield Without Without Fee
Yield Fee Waivers Effective Yield Waivers
Nations Prime Fund
Primary A Shares 5.99% 5.93% 6.16% 6.10%
Primary B Shares 5.74% 5.68% 5.89% 5.83%
Investor A Shares 5.52% 5.46% 5.64% 5.60%
Investor B Shares 5.73% 5.67% 5.89% 5.83%
Investor C Shares 5.71% 5.65% 5.86% 5.80%
Investor D Shares 5.29% 5.23% 5.42% 5.36%
Nations Treasury Fund
Primary A Shares 5.78% 5.75% 5.94% 5.91%
Primary B Shares 5.52% 5.49% 5.67% 5.64%
Investor A Shares 5.41% 5.38% 5.55% 5.52%
Investor B Shares 5.52% 5.49% 5.67% 5.64%
Investor C Shares 5.31% 5.48% 5.66% 5.63%
Investor D Shares 5.52% 5.49% 5.67% 5.64%
57
<PAGE>
The yield of the Primary Shares and Investor Shares of the Non-Money
Market Funds is a measure of the net investment income per share (as defined)
earned over a 30-day period expressed as a percentage of the maximum offering
price of a share of such classes at the end of the period. Based upon the 30-day
period ended May 31, 1995, the yields of the various shares of the Government
Securities Fund were as follows:
Thirty Day Yield
Yield Without Fee
Nations Government Securities Fund Yield Waivers
----- -------
Primary A Shares 6.15% 6.05%
Investor A Shares 5.62% 5.48%
Investor C Shares 5.40% 5.01%
Investor N Shares 5.50% 5.01%
During the period for which certain yield quotations are given above,
NationsBank and the Administrator voluntarily waived fees or reimbursed certain
expenses of such shares, thereby increasing yield figures. Such waivers or
expense reimbursements may be discontinued at any time. Primary B Shares were
not offered during the period ended May 31, 1995.
Such yield figures were determined by dividing the net investment income
per share earned during the specified 30-day period by the maximum offering
price per share on the last day of the period, according to the following
formula:
Yield = 2[(a-b + 1)6-1]
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = average daily number of shares outstanding during the period that
were entitled to receive dividends
d = maximum offering price per share on the last day of the period
For purposes of yield quotation, income is calculated in accordance with
standardized methods applicable to all stock and bond mutual funds. In general,
interest income is reduced with respect to bonds trading at a premium over their
par value by subtracting a portion of the premium from income on a daily basis,
and is increased with respect to bonds trading at a discount by adding a portion
of the discount to daily income.
Capital gains and losses are excluded from the calculation.
Income calculated for the purposes of calculating a Fund's yield differs
from income as determined for other accounting purposes. Because of the
different accounting methods used, and because of the compounding assumed in
yield calculations, the yield quoted for a Fund may differ from the rate of
distributions a Fund paid over the same period or the rate of income reported in
the Funds' financial statements.
Total Return Calculations
Total return measures both the net investment income generated by, and the
effect of any realized or unrealized appreciation or depreciation of the
underlying investments in a Non-Money Market Fund. The Non-Money Market Funds'
average annual and cumulative total return figures are computed in accordance
with the standardized methods prescribed by the SEC.
58
<PAGE>
Average annual total return figures are computed by determining the
average annual compounded rates of return over the periods indicated in the
advertisement, sales literature or shareholders' report that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value at the end of the period of
a hypothetical $1,000 payment made at the beginning
of such period.
This calculation (i) assumes all dividends and distributions are reinvested at
net asset value on the appropriate reinvestment dates as described in the
Prospectuses, and (ii) deducts (a) the maximum sales charge from the
hypothetical initial $1,000 investment, and (b) all recurring fees, such as
advisory and administrative fees, charged as expenses to all shareholder
accounts.
The Non-Money Market Funds did not offer Primary B Shares during the
period ended May 31, 1995. The following figures, for the period ended May 31,
1995, reflect the deduction of sales charges, if any, that would have been
deducted from a sale of shares.
Average Annual Total Return
Period Ended
3/31/95 Inception to 5/31/95
Equity Income Fund
Primary A Shares 14.79% 12.25%
Investor A 7.95% 10.26%
Investor C 12.49% 10.99%
Investor N 9.03% 7.60%
International Equity Fund
Primary A (0.46%) 6.01%
Investor A (6.40%) 3.18%
Investor C (2.52%) 5.46%
Investor N (6.14%) 4.37%
Government Securities Fund
Primary A 7.55% 6.85%
Investor A 2.19% 5.38%
Investor C 5.76% 3.91%
Investor N 1.86% 0.97%
Cumulative total return is computed by finding the cumulative compounded
rate of return over the period indicated in the advertisement that would equate
the initial amount invested to the ending redeemable value, according to the
following formula:
CTR = (ERV-P) 100
P
59
<PAGE>
Where: CTR = Cumulative total return
ERV = ending redeemable value at the end of the period of
a hypothetical $1,000 payment made at the beginning
of such period
P = initial payment of $1,000.
This calculation (i) assumes all dividends and distributions are reinvested at
net asset value on the appropriate reinvestment dates as described in the
Prospectuses, and (ii) deducts (a) the maximum sales charge from the
hypothetical initial $1,000 investment, and (b) all recurring fees, such as
advisory and administrative fees, charged as expenses to all shareholder
accounts.
<TABLE>
<CAPTION>
Cumulative Total Return
Period Ended 5/31/95 Inception to 5/31/95
Total Return Total Return
Total Without Sales Without Sales
Return Charge Total Return Charge
<S> <C> <C> <C> <C>
Equity Income Fund
Primary A Shares N/A 14.79% N/A 61.28%
Investor A 7.95% 14.53% 49.59% 58.72%
Investor C 12.49% 13.49% 36.04% 36.04%
Investor N 9.03% 14.03% 15.62% 19.55%
International Equity Fund
Primary A N/A (0.46%) N/A 22.62%
Investor A (6.40%) (0.69%) 9.81% 16.51%
Investor C (2.52%) (1.56%) 16.99% 16.99%
Investor N (6.14%) (1.30%) 8.48% 12.84%
Government Securities Fund
Primary A N/A 7.55% N/A 31.51%
Investor A 2.19% 7.29% 24.09% 30.28%
Investor C 5.76% 6.76% 11.77% 11.77%
Investor N 1.86% 6.86% 1.93% 5.69%
</TABLE>
* Primary A Shares of the Company do not carry a sales charge.
The Primary Shares and Investor Shares of the Equity Income Fund, Government
Securities Fund and International Equity Fund may also quote their distribution
rates, which express the historical amount of income dividends paid to their
shareholders during a one-month (in the case of the Government Securities Fund)
or a three-month (in the case of the Equity Income Fund and International Equity
Fund) period as a percentage of the maximum offering price per share on the last
day of such period. The performance figures of the Funds as described above will
vary from time to time depending upon market and economic conditions, the
composition of their portfolios and operating expenses. These factors should be
considered when comparing the performance figures of the Funds with those of
other investment companies and investment vehicles.
The "yield" and "effective yield" of each class of shares of a Money
Market Fund may be compared to the respective averages compiled by Donoghue's
Money Fund Report, a widely recognized independent publication that monitors the
performance of money market funds, or to the average yields reported by the Bank
Rate Monitor for money market deposit accounts offered by the 50 leading banks
and thrift institutions in the top five
60
<PAGE>
metropolitan statistical areas. The Funds also may compare the performance and
yield of a class or series of shares to those of other mutual funds with similar
investment objectives and to other relevant indices or to rankings prepared by
independent services or other financial or industry publications that monitor
the performance of mutual funds. For example, the performance and yield of a
class of shares in a Fund may be compared to data prepared by Lipper Analytical
Services, Inc. Performance and yield data as reported in national financial
publications such as Money Magazine, Forbes, Barron's, The Wall Street Journal,
and The New York Times, or in publications of a local or regional nature, also
may be used in comparing the performance of a class of shares in a Fund.
In addition, the performance and yield of a class of shares in Nations
Equity Income Fund and Nations International Equity Fund may be compared to the
Standard & Poor's 500 Stock Index, an unmanaged index of a group of common
stocks, the Consumer Price Index, or the Dow Jones Industrial Average, a
recognized unmanaged index of common stocks of 30 industrial companies listed on
the New York Stock Exchange. The performance and yield of a class of shares in
the Nations International Equity Fund may be compared to the Europe, Far East
and Australia Index, a recognized unmanaged index of international stocks. Any
given performance comparison should not be considered representative of a Fund's
performance for any future period.
MISCELLANEOUS
Certain Record Holders
The following indicates those persons who owned 5% or more of the
indicated class of shares as of May 24, 1996. Unless otherwise indicated, the
address for each recordholder of Primary Shares is 1401 Elm Street, 11th Floor,
Dallas, Texas 75202.
Percentage of Shares
Name and Address Held of Record Only
Nations Prime Fund
Primary A Shares
NationsBank of Texas, N.A. 99.60%
Attn. Adrian Castillo
1405 Elm Street, 11th Floor
Dallas, TX 75202-2911
Investor A Shares
Stephens Inc. Omnibus Account 6.64%
Attn: Jean Geiger
P.O. Box 3507
Little Rock, AR 72203
Investor B Shares
Hare & Co., Bank of New York 19.26%
Attn. STIF/Master Note
One Wall Street, 5th Fl.
New York, NY 10286
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<PAGE>
Investor D Shares
Dean Witter Reynolds Cust. for 52.89%
William O. Kirker, MD
IRA Standard Dated 06/14/93
6130 Moss Spring Road
Columbia, SC 29209
Dean Witter Reynolds Cust. for 20.14%
William Emory Nessmith
IRA Standard Dated 06/14/93
2638 Langland Court
Atlanta, GA 30345-1507
Dean Witter Reynolds Cust. for 18.62%
Barbara Jean A. Kirker
IRA Standard Dated 06/14/93
6130 Moss Spring Road
Columbia, SC 29209
Stephens Inc. for the Exclusive 5.07%
Benefit of our Customers
111 Center Street
Little Rock, AR 72201
Nations Treasury Fund
Investor A Shares
Florida Auto Dealers 6.90%
Self Insurance Fund
Attn. Steve Grierson
P. O. Box 531124
Orlando, FL 32853
BTA Oil Producers 6.23%
104 S. Pecos
Midland, TX 79601
62
<PAGE>
Stephens Inc. Omnibus Account 6.13%
Attn. Jean Geiger
P.O. Box 3507
Little Rock, AR 72203
Investor B Shares
Hare & Co., Bank of New York 94.11%
Attn. STIF/MasterNote
One Wall Street, 5th Fl.
New York, NY 10286
Investor C Shares
Lois H. Bohler 23.29%
6 Bransford Place
Augusta, GA 30904-6131
David S. Hungerford and 15.10%
UTA-Heide Hungerford Ten Enty
10715 Potspring Road
Cockeysville, MD 21030
Donald S. Pratt 12.64%
4911 Sentinel Post Road
Charlotte, NC 28226-7444
Robert L. Hancock 7.62%
460 McLaws Circle
Williamsburg, VA 23185
Nations Equity Income Fund
Investor C Shares
Dean Witter Reynolds Cust for 7.69%
Dale Morris
IRA Standard Dated 6/14/93
818 19th Avenue South
Nashville, TN 37203-3202
Phillip P. Brown and 6.78%
Sue N. Brown, JTWROS
518 Park Center Drive
Nashville, TN 37205
Nations Government Securities Fund
Investor A Shares
Southside Bank TTEE 20.21%
East Texas Regional
Health Facilities Trust
U/A DTD 10/20/89
P. O. Box 8444
Tyler, TX 75711
63
<PAGE>
Dodson Brothers 12.40%
Exterminating Co. Inc.
Attn: H.P. Dawson
P.O. Box 10249
Lynchburg, VA 24506
Investor C Shares
Dean Witter Reynolds 7.44%
CUST FOR Gene H. Sloan
IRA Standard Dated 06/14/93
412 Lillard Rd.
Murfreesboro, TN 37130-3130
Nations International Equity Fund
Investor C Shares
Janet C. Howard 18.82%
for The Tidewater Heart Specialists
Profit Sharing Plan DTD 1/1/94
2112-B Hartford Road
Hampton, VA 23666
Nations Securities Margin Acct. FBO 14.84%
Diana Rhodes
3980 Ridgeway
San Antonio, TX 78259-1756
As of May 24, 1996, NationsBank and its affiliates owned of record more
than 25% of the outstanding shares of the Company acting as agent, fiduciary, or
custodian for its customers and may be deemed a controlling person of the
Company under the 1940 Act.
<PAGE>
SUITABILITY OF NATIONS TREASURY FUND
FOR INVESTMENT BY MUNICIPAL INVESTORS
The Public Funds Investments Act (the "Act"), enacted by the Texas
legislature in 1987, as amended on June 14, 1989, and effective on August 28,
1989, permits Texas municipalities and certain other similar entities that hold
public funds to invest in certain types of financial instruments. These entities
include an incorporated city or town, a county, a public school district, a
district or authority created under Article III, Section 52(b) (i) or (2), or
Article XVI, Section 59 of the Texas Constitution, an institution of higher
education as defined by Section 61.003 of the Texas Education Code, a hospital
district, a fresh water supply district, or any nonprofit corporation or public
funds investment pool created under Chapter 791, Texas Government Code, acting
on behalf of any of such entities (the "Entities"). The Act permits Entities to
invest in U.S. Treasury securities, certain repurchase agreements related
thereto, and in certain mutual funds that invest in such securities. Special
counsel to the Company with respect to the Treasury Fund has rendered an opinion
to the effect that, assuming that an Entity complies with applicable law, and
that limitations in the Act with respect to the amount of funds in the control
of the Entity that can be invested in the Company are met, the Entity may invest
in the Treasury Fund of the Company when duly authorized by its governing body.
65
<PAGE>
SCHEDULE A
DESCRIPTION OF RATINGS
The following summarizes the highest six ratings used by Standard & Poor's
Corporation ("S&P") for corporate and municipal bonds. The first four ratings
denote investment-grade securities.
AAA - This is the highest rating assigned by S&P to a debt
obligation and indicates an extremely strong capacity to pay interest and
repay principal.
AA - Debt rated AA is considered to have a very strong capacity to
pay interest and repay principal and differs from AAA issues only in a
small degree.
A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in
higher-rated categories.
BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for those in
higher-rated categories.
BB, B - Bonds rated BB and B are regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. BB
represents the lowest degree of speculation and B a higher degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposure to adverse conditions.
To provide more detailed indications of credit quality, the AA, A and BBB
ratings may be modified by the addition of a plus or minus sign to show relative
standing within these major rating categories.
The following summarizes the highest six ratings used by Moody's Investors
Service, Inc. ("Moody's") for corporate and municipal bonds. The first four
denote investment grade securities.
Aaa - Bonds that 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 edge." 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 that are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the best
bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-term
risks appear somewhat larger than in Aaa securities.
A - Bonds that are rated A possess many favorable investment
attributes and are to be considered 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 that are rated Baa are considered medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of
A-1
<PAGE>
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 as well safeguarded during both good times and bad times over
the future. Uncertainty of position characterizes bonds in this class.
B - Bond 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.
Moody's applies numerical modifiers (1, 2 and 3) with respect to corporate
bonds rated Aa through B. The modifier 1 indicates that the bond being rated
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates that the bond ranks in the
lower end of its generic rating category. With regard to municipal bonds, those
bonds in the Aa, A and Baa groups which Moody's believes possess the strongest
investment attributes are designated by the symbols Aal, A1 or Baal,
respectively.
The following summarizes the highest four ratings used by Duff & Phelps
Credit Rating Co. ("D&P") for bonds, each of which denotes that the securities
are investment grade.
AAA - Bonds that are rated AAA are of the highest credit quality.
The risk factors are considered to be negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA - Bonds that are rated AA are of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
A - Bonds that are rated A have protection factors which are
average but adequate. However risk factors are more variable and greater
in periods of economic stress.
BBB - Bonds that are rated BBB have below average protection
factors but still are considered sufficient for prudent investment.
Considerable variability in risk exists during economic cycles.
To provide more detailed indications of credit quality, the AA, A and BBB
ratings may modified by the addition of a plus or minus sign to show relative
standing within these major categories.
The following summarizes the highest four ratings used by Fitch Investors
Service, Inc. ("Fitch") for bonds, each of which denotes that the securities are
investment grade:
AAA - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA - Bonds considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly vulnerable
to foreseeable future developments, short-term debt of these issuers is
generally rated F-1+.
A - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic conditions and
A-2
<PAGE>
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
To provide more detailed indications of credit quality, the AA, A and BBB
ratings may be modified by the addition of a plus or minus sign to show relative
standing within these major rating categories.
The following summarizes the two highest ratings used by Moody's for
short-term municipal notes and variable-rate demand obligations:
MIG-1/VMIG-1 -- Obligations bearing these designations are of the best
quality, enjoying strong protection from established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
MIG-2/VMIG-2 -- Obligations bearing these designations are of high
quality, with ample margins of protection although not so large as in the
preceding group.
The following summarizes the two highest ratings used by S&P for
short-term municipal notes:
SP-1 - Very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics are given a
"plus" (+) designation.
SP-2 - Satisfactory capacity to pay principal and interest.
The three highest rating categories of D&P for short-term debt, each of
which denotes that the securities are investment grade, are D-1, D-2, and D-3.
D&P employs three designations, D-1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is judged to be "outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations." D-1 indicates very high
certainty of timely payment. Liquidity factors are excellent and supported by
good fundamental protection factors. Risk factors are considered to be minor.
D-1 indicates high certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
D-2 indicates good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small. D-3 indicates satisfactory liquidity and other protection factors which
qualify the issue as investment grade. Risk factors are larger and subject to
more variation. Nevertheless, timely payment is expected.
The following summarizes the three highest rating categories used by Fitch
for short-term obligations each of which denotes that the securities are
investment grade:
F-1+ securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
F-1 securities possess very strong credit quality. Issues assigned this
rating reflect an assurance of timely payment only slightly less in degree than
issues rated F-1+.
F-2 securities possess good credit quality. Issues carrying this rating
have a satisfactory degree of assurance for timely payment, but the margin of
safety is not as great as for issues assigned the F-1+ and F-1 ratings.
Commercial paper rated A-1 by S&P indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted A-1+. Capacity for timely payment on
commercial paper rated A-2 is satisfactory, but the relative degree of safety is
not as high as for issues designated A-1.
A-3
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The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of senior short-term
promissory obligations. Issuers rated Prime-2 (or related supporting
institutions) are considered to have a strong capacity for repayment of senior
short-term promissory obligations. This will normally be evidenced by many of
the characteristics of issuers rated Prime-1, but to a lesser degree. Earnings
trends and coverage ratios, while sound, will be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
For commercial paper, D&P uses the short-term debt ratings described
above.
For commercial paper, Fitch uses the short-term debt ratings described
above.
Thomson BankWatch, Inc. ("BankWatch") ratings are based upon a qualitative
and quantitative analysis of all segments of the organization including, where
applicable, holding company and operating subsidiaries. BankWatch ratings do not
constitute a recommendation to buy or sell securities of any of these companies.
Further, BankWatch does not suggest specific investment criteria for individual
clients.
BankWatch long-term ratings apply to specific issues of long-term debt and
preferred stock. The long-term ratings specifically assess the likelihood of
untimely payment of principal or interest over the term to maturity of the rated
instrument. The following are the four investment grade ratings used by
BankWatch for long-term debt:
AAA - The highest category; indicates ability to repay principal
and interest on a timely basis is extremely high.
AA - The second highest category; indicates a very strong ability
to repay principal and interest on a timely basis with limited incremental
risk versus issues rated in the highest category.
A - The third highest category; indicates the ability to repay
principal and interest is strong. Issues rated "A" could be more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
BBB - The lowest investment grade category; indicates an acceptable
capacity to repay principal and interest. Issues rated "BBB" are, however,
more vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
The BankWatch short-term ratings apply to commercial paper, other senior
short-term obligations and deposit obligations of the entities to which the
rating has been assigned. The BankWatch short-term ratings specifically assess
the likelihood of an untimely payment of principal or interest.
TBW-1 The highest category; indicates a very high
likelihood that principal and interest will be paid
on a timely basis.
TBW-2 The second highest category; while the degree of
safety regarding timely repayment of principal and
interest is strong, the relative degree of safety is
not as high as for issues rated "TBW-1".
TBW-3 The lowest investment grade category; indicates that
while more susceptible to adverse developments (both
internal and external) than obligations with higher
ratings, capacity to service principal and interest
in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded
as non-investment grade and therefore speculative.
A-4
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The following summarizes the four highest long-term debt ratings used by
IBCA Limited and its affiliate, IBCA Inc. (collectively "IBCA"):
AAA - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest
is substantial such that adverse changes in business, economic or
financial conditions are unlikely to increase investment risk
significantly.
AA - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest
is substantial. Adverse changes in business, economic or financial
conditions may increase investment risk albeit not very significantly.
A - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may
lead to increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest
is adequate, although adverse changes in business, economic or financial
conditions are more likely to lead to increased investment risk than for
obligations in other categories.
A plus or minus sign may be appended to a rating below AAA to denote
relative status within major rating categories.
The following summarizes the three highest short-term debt ratings used by
IBCA:
A1 - Obligations supported by the highest capacity for timely
repayment. Where issues possess a particularly strong credit
feature, a rating of A1+ is assigned.
A2 - Obligations supported by a good capacity for timely repayment.
A-5
<PAGE>
SCHEDULE B
ADDITIONAL INFORMATION CONCERNING
OPTIONS & FUTURES
As stated in the Prospectus, each Non-Money Market Fund, may enter into
futures contracts and options for hedging purposes. Such transactions are
described in this Schedule. During the current fiscal year, each of these Funds
intends to limit its transactions in futures contracts and options so that not
more than 5% of the Fund's net assets are at risk. Furthermore, in no event
would any Fund purchase or sell futures contracts, or related options thereon,
for hedging purposes if, immediately thereafter, the aggregate initial margin
that is required to be posted by the Fund under the rules of the exchange on
which the futures contract (or futures option) is traded, plus any premiums paid
by the Fund on its open futures options positions, exceeds 5% of the Fund's
total assets, after taking into account any unrealized profits and unrealized
losses on the Fund's open contracts and excluding the amount that a futures
option is "in-the-money" at the time of purchase. (An option to buy a futures
contract is "in-the-money" if the value of the contract that is subject to the
option exceeds the exercise price; an option to sell a futures contract is
"in-the-money" if the exercise Price exceeds the value of the contract that is
subject of the option.)
I. Interest Rate Futures Contracts.
Use of Interest Rate Futures Contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures market have tended to move generally in the aggregate
in concert with the cash market prices and have maintained fairly predictable
relationships. Accordingly, a Fund may use interest rate futures as a defense,
or hedge, against anticipated interest rate changes and not for speculation. As
described below, this would include the use of futures contract sales to protect
against expected increases in interest rates and futures contract purchases to
offset the impact of interest rate declines.
A Fund presently could accomplish a similar result to that which it hopes
to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by the Fund, through using futures contracts.
Description of Interest Rates Futures Contracts. An interest rate futures
contract sale would create an obligation by a Fund, as seller, to deliver the
specific type of financial instrument called for in the contract at a specific
future time for a specified price. A futures contract purchase would create an
obligation by the Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until at or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Fund's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund's entering
into a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
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Interest rate futures contracts are traded in an auction environment on
the floors of several exchanges principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. A Fund would deal
only in standardized contracts on recognized changes. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various financial
instruments including long-term United States Treasury Bonds and Notes;
Government National Mortgage Association ("GNMA") modified pass-through
mortgage-backed securities; three-month United States Treasury Bills; and
ninety-day commercial paper. The Funds may trade in any futures contract for
which there exists a public market, including, without limitation, the foregoing
instruments.
Examples of Futures Contract Sale. A Fund would engage in an interest rate
futures contract sale to maintain the income advantage from continued holding of
a long-term bond while endeavoring to avoid part or all of the loss in market
value that would otherwise accompany a decline in long-term securities prices.
Assume that the market value of a certain security in a Fund tends to move in
concert with the futures market prices of long-term United States Treasury bonds
("Treasury Bonds"). The Adviser wishes to fix the current market value of this
portfolio security until some point in the future. Assume the portfolio security
has a market value of 100, and the Adviser believes that, because of an
anticipated rise in interest rates, the value will decline to 95. The Fund might
enter into futures contract sales of Treasury bonds for an equivalent of 98. If
the market value of the portfolio securities does indeed decline from 100 to 95,
the equivalent futures market price for the Treasury bonds might also decline
from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The Adviser could be wrong in its forecast of interest rates and the
equivalent futures market price could rise above 98. In this case, the market
value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Fund in the above example
might incur a loss of 2 points (which might be reduced by an offsetting
transaction prior to the settlement date). In each transaction, transaction
expenses would also be incurred.
Examples of Future Contract Purchase. A Fund would engage in an interest
rate futures contract purchase when it is not fully invested in long-term bonds
but wishes to defer for a time the purchase of long-term bonds in light of the
availability of advantageous interim investments, e.g., shorter-term securities
whose yields are greater than those available on long-term bonds. The Fund's
basic motivation would be to maintain for a time the income advantage from
investing in the short-term securities; the Fund would be endeavoring at the
same time to eliminate the effect of all or part of an expected increase in
market price of the long-term bonds that the Fund may purchase.
For example, assume that the market price of a long-term bond that the
Fund may purchase, currently yielding 10%, tends to move in concert with futures
market prices of Treasury bonds. The Adviser wishes to fix the current market
price (and thus 10% yield) of the long-term bond until the time (four months
away in this example) when it may purchase the bond. Assume the long-term bond
has a market price of 100, and the Adviser believes that, because of an
anticipated fall in interest rates, the price will have risen to 105 (and the
yield will have dropped to about 9-1/2%) in four months. The Fund might enter
into futures contracts purchases of Treasury bonds for an equivalent price of
98. At the same time, the Fund would assign a pool of investments in short-term
securities that are either maturing in four months or earmarked for sale in four
months, for purchase of the long-term bond at an assumed market price of 100.
Assume these short-term securities are yielding 15%. If the market price of the
long-term bond does indeed rise from 100 to 105, the equivalent futures market
price for Treasury
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bonds might also rise from 98 to 103. In that case, the 5-point increase in the
price that the Fund pays for the long-term bond would be offset by the 5-point
gain realized by closing out the futures contract Purchase.
The Adviser could be wrong in its forecast of interest rates; long-term
interest rates might rise to above 10%; and the equivalent futures market price
could fall below 98. If short-term rates at the same time fall to 10% or below,
it is possible that the Fund would continue with its purchase program for
long-term bonds. The market price of available long-term bonds would have
decreased. The benefit of this price decrease, and thus yield increase, will be
reduced by the loss realized on closing out the futures contract purchase.
If, however, short-term rates remained above available long-term rates, it
is possible that the Fund would discontinue its purchase program for long-term
bonds. The yield on short-term securities in the portfolio, including those
originally in the pool assigned to the particular long-term bond, would remain
higher than yields on long-term bonds. The benefit of this continued incremental
income will be reduced by the loss realized on closing out the futures contract
purchase.
In each transaction, expenses also would be incurred.
II. Index Futures Contracts.
A stock or bond index assigns relative values to the stocks or bonds
included in the index, and the index fluctuates with changes in the market
values of the stocks or bonds included. Some stock index futures contracts are
based on broad market indices, such as the Standard & Poor's 500 or the New York
Stock Exchange Composite Index. In contract, certain exchanges offer futures
contracts on narrower market indices, such as the Standard & Poor's 100, the
Bond Buyer Municipal Bond Index, an index composed of 40 term revenue and
general obligation bonds, or indices based on an industry or market segment,
such as oil and gas stocks. Futures contracts are traded on organized exchanges
regulated by the Commodity Futures Trading Commission. Transactions on such
exchanges are cleared through a clearing corporation, which guarantees the
performance of the parties to each contract.
A Fund will sell index futures contracts in order to offset a decrease in
market value of its portfolio securities that might otherwise result from a
market decline. The Fund may do so either to hedge the value of its portfolio as
a whole, or to protect against declines, occurring prior to sales of securities,
in the value of the securities to be sold. Conversely, a Fund will purchase
index futures contracts in anticipation of purchases of securities. In a
substantial majority of these transactions, the Fund will purchase such
securities upon termination of the long futures position, but a long futures
position may be terminated without a corresponding purchase of securities.
In addition, a Fund may utilize index futures contracts in anticipation of
changes in the composition of its portfolio holdings. For example, in the event
that a Fund expects to narrow the range of industry groups represented in its
holdings it may, prior to making purchases of the actual securities, establish a
long futures position based on a more restricted index, such as an index
comprised of securities of a particular industry group. A Fund also may sell
futures contracts in connection with this strategy, in order to protect against
the possibility that the value of the securities to be sold as part of the
restructuring of the portfolio will decline prior to the time of sale.
The following are examples of transactions in stock index futures (net of
commissions and premiums, if any).
B-3
<PAGE>
ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objection Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/
Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/
Increase in Purchase Contract
Price = $2,500 Gain on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future Hedge
Objective Protect Against Declining (Value of the Portfolio)
Factors
Value of Stock Portfolio = $1,000,000 Value of Futures Contract = 125 x $500 =
$62,500 Portfolio Beta Relative to the Index - 1 0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Portfolio Gain on Futures = $40,000
Value = $40 000
If, however, the market moved in the opposite direction, that is, market
value decreased and the Fund had entered into an anticipatory purchase hedge, or
market value increased and the Fund had hedged its stock portfolio, the results
of the Fund's transactions in stock index futures would be as set forth below.
B-4
<PAGE>
ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objection: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/
Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 120
Actual Cost = $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Loss on Futures = $2,500
Price = $2,500 Contract
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors
Value of Stock Portfolio = $1,000,000 Value of Futures Contract = 125 x $500 =
$62,500 Portfolio Beta Relative to the Index - 1 0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Portfolio = $40,000 Loss of Futures = $40,000
Value = $40 000
III. Margin Payments
Unlike when a Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Initially,
the Fund will be required to deposit with the broker or in a segregated account
with the Fund's Custodian an amount of cash or cash equivalents, the value, of
which may vary but is generally equal to 10% or less of the value of the
contract. This amount is known as initial margin. The nature of initial margin
in futures transactions is different from that of margin in security
transactions in that futures contract margin does not involve the borrowing of
funds by the customer to finance the transactions. Rather, the initial margin is
in the nature of a performance bond or good faith deposit on the contract which
is returned to the Fund upon termination of the futures contract assuming all
contractual obligations have been satisfied. Subsequent
B-5
<PAGE>
payments, called variation margin, to and from the broker, will be made on a
daily basis as the price of the underlying security or index fluctuates making
the long and short positions in the futures contract more or less valuable, a
process known as marking to the market. For example, when a Fund has purchased a
futures contract and the price of the contract has risen in response to a rise
in the underlying instruments, that position will have increased in value and
the Fund will be entitled to receive from the broker a variation margin payment
equal to that increase in value. Conversely, where a Fund has purchased a
futures contract and the price of the futures contract has declined in response
to a decrease in the underlying instruments, the position would be less
valuable, the Fund would be required to make a variation margin payment to the
broker. At any time prior to expiration of the futures contract, the Adviser may
elect to close the position by taking an opposite position, subject to the
availability of a secondary market, which will operate to terminate the Fund's
position in the futures contract. A final determination of variation margin is
then made, additional cash is required to be paid by or released to the Fund,
and the Fund realizes a loss or gain.
IV. Risks of Transactions in Futures Contracts
There are several risks in connection with the use of futures by a Fund as
a hedging device. One risk arises because of the imperfect correlation between
movements in the price of the future and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price of
the future moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of securities
being hedged has moved in an unfavorable direction, the Fund would be in a
better position than if it had not hedged at ail. If the price of the securities
being hedged has moved in a favorable direction, this advance will be partially
offset by the loss on the future. If the price of the future moves more than the
price of the hedged securities, the Fund involved will experience either a loss
or gain on the future which will not be completely offset by movements in the
price of the securities which are the subject of the hedge.
To compensate for the imperfect correlation of movements in the price of
securities being hedged and movements in the price of futures contracts, a Fund
may buy or sell futures contracts in a greater dollar amount than the dollar
amount of securities being hedged if the volatility over a particular time
period of the prices of such securities has been greater than the volatility
over such time period of the future, or if otherwise deemed to be appropriate by
the Adviser. Conversely, a Fund may buy or sell fewer futures contracts if the
volatility over a particular time period of the prices of the securities being
hedged is less than the volatility over such time period of the futures contract
being used, or if otherwise deemed to be appropriate by the Adviser. It also is
possible that, where a Fund has sold futures to hedge its portfolio against a
decline in the market, the market may advance, and the value of securities held
by the Fund may decline. If this occurred, the Fund would lose money on the
future and also experience a decline in value in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, the Fund will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's Custodian
and/or in a margin account with a broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the securities
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. Rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking
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delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced thus producing distortions. Third, from
the point of view of speculators, the deposit requirements in the futures market
are less onerous than margin requirements in the securities market. Therefore,
increased participation by speculators in the futures market may also cause
temporary price distortions. Due to the possibility of Price distortion in the
futures market, and because of the imperfect correlation between the movements
in the cash market and movements in the price of futures, a correct forecast of
general market trends or interest rate movements by the Adviser still may not
result in a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Funds
intend to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to
close a futures investment position, and in the event of adverse price
movements, a Fund would continue to be required to make daily cash payments of
variation margin. However, in the event futures contracts have been used to
hedge portfolio securities, such securities will not be sold until the futures
contract can be terminated. In such circumstances, an increase in the price of
the securities, if any, may partially or completely offset losses on the futures
contract. However, as described above, there is no guarantee that the price of
the securities will in fact correlate with the price movements in the futures
contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Fund also is subject to the Adviser's
ability to predict correctly movements in the direction of the market. For
example, if a Fund has hedged against the possibility of a decline in the market
adversely affecting securities held in its portfolio and securities prices
increase instead, the Fund will lose part or all of the benefit to the increased
value of its securities which it has hedged because it will have offsetting
losses in its futures positions. In addition, in such situations, if the Fund
has insufficient cash, it may have to sell securities to meet daily variation
margin requirements. Such sales of securities may be, but will not necessarily
be, at increased prices which reflect the rising market. A Fund may have to sell
securities at a time when it may be disadvantageous to do so.
V. Options on Futures Contracts.
The Funds may purchase options on the futures contracts described above. A
futures option gives the holder, in return for the premium paid, the right to
buy (call) from or sell (put) to the writer of the option a futures contract at
a specified price at any time during the period of the option. Upon exercise,
the writer of the option is obligated to pay the difference between the cash
value of the futures contract and the exercise price. Like the buyer or seller
of a futures contract, the holder, or writer, of an option has the right to
terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the futures
contract upon which it is based, or upon the price of the securities being
hedged, an option may or may not be less risky than ownership of the futures
contract or such securities. In general, the market prices of options can be
expected to be more volatile than the market prices on the underlying futures
contract. Compared to the purchase or sale of futures contracts, however, the
purchase of call or put options on futures contracts may frequently involve less
potential risk to a Fund because the maximum amount at risk is the premium paid
for the
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options (plus transaction costs). Although permitted by their fundamental
investment policies, the Funds do not currently intend to write future options,
and will not do so in the future absent any necessary regulatory approvals.
Accounting and Tax Treatment.
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles.
Generally, futures contracts and options on futures contracts held by a
Fund at the close of the Fund's taxable year will be treated for Federal income
tax purposes as sold for their fair market value on the last business day of
such year, a process known as "marking-to-market." Forty percent (40%) of any
gains or loss resulting from such constructive sale will be treated as
short-term capital gain or loss and sixty percent (60%) of such gain or loss
will be treated as long-term capital gain or loss without regard to the length
of time the Fund holds the futures contract or option (the "40%-60% rule"). The
amount of any capital gain or loss actually realized by a Fund in a subsequent
sale or other disposition of those futures contracts will be adjusted to reflect
any capital gain or loss taken into account by the Fund in a prior year as a
result of the constructive sale of the contracts and options. With respect to
futures contracts to sell or options which will be regarded as parts of a "mixed
straddle" because their values fluctuate inversely to the values of specific
securities held by the Fund, losses as to such contracts to sell or options will
be subject to certain loss deferral rules which limit the amount of loss
currently deductible on either part of the straddle to the amount thereof which
exceeds the unrecognized gain (if any) with respect to the other part of the
straddle, and to certain wash sales regulations. Under short sales rules, which
also will be applicable, the holding period of the securities forming part of
the straddle will (if they have not been held for the long-term holding period)
be deemed not to begin prior to termination of the straddle. With respect to
certain futures contracts and options, deductions for interest and carrying
charges will not be allowed. Notwithstanding the rules described above, with
respect to futures contracts to sell which are properly identified as such and
certain options, a Fund may make an election which will except (in whole or in
part) those identified futures contracts or options from being treated for
Federal income tax purposes as sold on the last business day of the Fund's
taxable year, but gains and losses will be subject to such short sales, wash
sales, loss deferral rules and the requirement to capitalize interest and
carrying charges. Under temporary regulations, a Fund would be allowed (in lieu
of the foregoing) to elect to either (1) offset gains or losses from portions
which are part of a mixed straddle by separately identifying each mixed straddle
to which such treatment applies, or (2) establish a mixed straddle account for
which gains and losses would be recognized and offset on a periodic basis during
the taxable year. Under either election, the 40%-60% rule will apply to the net
gain or loss attributable to the futures contracts, but in the case of a mixed
straddle account election, not more than 50% of any net gain may be treated as
long-term and not more than 40% of any net loss may be treated as short-term.
Certain foreign currency contracts entered into by a Fund may be subject
to the "marking-to-market" process and the 40%-60% rule in a manner similar to
that described in the preceding paragraph for futures contracts and options on
futures contracts. To receive such Federal income tax treatment, a foreign
currency contract must meet the following conditions: (1) the contract must
require delivery of a foreign currency of a type in which regulated futures
contracts are traded or upon which the settlement value of the contract depends;
(2) the contract must be entered into at arm's length at a price determined by
reference to the price in the interbank market; and (3) the contract must be
traded in the interbank market. The Treasury Department has broad authority to
issue regulations under the provisions respecting foreign currency contracts.
Other foreign currency contracts entered into by a Fund may result in the
creation of one or more straddles for Federal income tax purposes, in which case
certain loss deferral, short sales, and wash sales rules and the requirement to
capitalize interest and carrying charges may apply.
As described more fully in the section of the SAI entitled "Additional
Information Concerning Taxes," in order to qualify as a regulated investment
company under the Code a Fund must derive less than 30% of its gross income from
investments held for less than three months. With respect to futures contracts
and other financial instruments subject to the marking-to-market rules, the
Internal Revenue Service has ruled in private letter rulings that a gain
realized from such a futures contract or financial instrument will be treated as
being derived from a security held for three months or more (regardless of the
actual period for which the contract or instrument is held)
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if the gain arises as a result of a constructive sale under the
marking-to-market rules, and will be treated as being derived from a security
held for less than three months only if the contract or instrument is terminated
(or transferred) during taxable year (other than by reason of marking-to-market)
and less than three months have elapsed between the date the contract or
instrument is acquired and the termination date. In determining whether the 30%
test is met for a taxable year, increases and decreases in the value of each
Fund's futures contracts and other investments that qualify as part of a
"designated hedge," as defined in the Code, may be netted.
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SCHEDULE C
ADDITIONAL INFORMATION CONCERNING
MORTGAGE-BACKED SECURITIES
Mortgage-Backed Securities
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to an investor.
Most issuers or poolers provide guarantees of payments, regardless of whether or
not the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are supported by various forms of credit collateral, guarantees or
insurance, including individual loan, title, pool and hazard insurance purchased
by the issuer. There can be no assurance that the private issuers or poolers can
meet their obligations under the policies. Mortgage-backed securities issued by
private issuers or poolers, whether or not such securities are subject to
guarantees, may entail greater risk than securities directly or indirectly
guaranteed by the U.S. Government.
Interests in pools of mortgage-backed securities differ from other forms
of debt securities, which normally provide for periodic payment of interest in
fixed amounts with principal payments at maturity or specified call dates.
Instead, these securities provide a monthly payment which consists of both
interest and principal payments. In effect, these payments are a "pass-through"
of the monthly payments made by the individual borrowers on their residential
mortgage loans, net of any fees paid. Additional payments are caused by
repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure net of fees or costs which may be incurred. Some
mortgage-backed securities are described as "modified pass-through." These
securities entitle the holders to receive all interest and principal payments
owed on the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation (FHLMC). FHLMC is a corporate instrumentality of the U.S. Government
and was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. Its stock is owned by
the twelve Federal Home Loan Banks. FHLMC issues Participation Certificates
("PC's"), which represent interests in mortgages from FHLMC's national
portfolio. FHLMC guarantees the timely payment of interest and ultimate
collection of principal.
The Federal National Mortgage Association (FNMA) is a Government sponsored
corporation owned entirely by private stockholders. It is subject to general
regulation by the Secretary of Housing and Urban Development. FNMA purchases
residential mortgages from a list of approved sellers/servicers which include
state and federally-chartered savings and loan associations, mutual savings
banks, commercial banks and credit unions and mortgage bankers. Pass-through
securities issued by FNMA are guaranteed as to timely payment of principal and
interest by FNMA.
The principal Government guarantor of mortgage-backed securities is the
Government National Mortgage Association (GNMA). GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
approved institutions and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than Government and Government-related pools because there are no
direct or indirect Government guarantees of payments in the former
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pools. However, timely payment of interest and principal of these pools is
supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance purchased by the issuer. The insurance
and guarantees are issued by Governmental entities, private insurers, and the
mortgage poolers. There can be no assurance that the private insurers or
mortgage poolers can meet their obligations under the policies.
The Fund expects that Governmental or private entities may create mortgage
loan pools offering pass-through investments in addition to those described
above. The mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payment
may vary or whose terms to maturity may be shorter than previously customary. As
new types of mortgage-backed securities are developed and offered to investors,
certain Funds will, consistent with their investment objective and policies,
consider making investments in such new types of securities.
Underlying Mortgages
Pools consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of 1-4 family homes. The terms
and characteristics of the mortgage instruments are generally uniform within a
pool but may vary among pools. For example, in addition to fixed-rate,
fixed-term mortgages, a Fund may purchase pools of variable-rate mortgages
(VRM), growing equity mortgages (GEM), graduated payment mortgages (GPM) and
other types where the principal and interest payment procedures vary. VRM's are
mortgages which reset the mortgage's interest rate periodically with changes in
open market interest rates. To the extent that the Fund is actually invested in
VRM's, the Fund's interest income will vary with changes in the applicable
interest rate on pools of VRM's. GPM and GEM pools maintain constant interest
rates, with varying levels of principal repayment over the life of the mortgage.
These different interest and principal payment procedures should not impact the
Fund's net asset value since the prices at which these securities are valued
will reflect the payment procedures.
All poolers apply standards for qualification to local lending
institutions which originate mortgages for the pools. Poolers also establish
credit standards and underwriting criteria for individual mortgages included in
the pools. In addition, some mortgages included in pools are insured through
private mortgage insurance companies.
Average Life
The average life of pass-through pools varies with the maturities of the
underlying mortgage instruments. In addition, a pool's term may be shortened by
unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayments is affected by factors
including the level of interest rates, general economic conditions, the location
and age of the mortgage, and other social and demographic conditions.
As prepayment rates of individual pools vary widely, it is not possible to
accurately predict the average life of a particular pool. For pools of
fixed-rated 30-year mortgages, common industry practice is to assume that
prepayments will result in a 12-year average life. Pools of mortgages with other
maturities or different characteristics will have varying assumptions for
average life.
Returns on Mortgage-Backed Securities
Yields on mortgage-backed pass-through securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield.
Reinvestment of prepayments may occur at higher or lower interest rates than the
original investment, thus affecting the yields of the Fund. The compounding
effect from reinvestments of monthly payments received by the Fund will increase
its yield to shareholders, compared to bonds that pay interest semi-annually.
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