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STATEMENT OF ADDITIONAL INFORMATION
VAN KAMPEN STRATEGIC INCOME FUND
Van Kampen Strategic Income Fund (the "Fund") is a separate, non-diversified
series of Van Kampen Trust (the "Trust"), an open end investment company. The
Fund's primary investment objective is to seek to provide its shareholders with
high current income. The Fund has a secondary investment objective of seeking
capital appreciation. The Fund will seek to achieve its investment objectives by
investing primarily in a portfolio of income securities selected by Van Kampen
Investment Advisory Corp., the Fund's investment adviser (the "Adviser"), from
the following market sectors: U.S. government securities; domestic investment
grade income securities; domestic lower grade income securities; foreign
investment grade income securities; and foreign lower grade income securities.
The Adviser will allocate the Fund's investments among these market sectors
based on its evaluation of the relative investment opportunities and investment
risks presented by such sectors from time to time. Under normal market
conditions, at least 65% of the Fund's total assets will be invested in U.S.
dollar-denominated income securities and at least 40% of the Fund's total assets
will be invested in U.S. government securities and investment grade rated income
securities. A substantial portion of the Fund's assets may be invested in lower
grade income securities, including securities of issuers in emerging market
countries and securities rated in the lowest rating category. Investment in
lower grade income securities involves significant risks. Lower grade securities
commonly are referred to as "junk bonds." The Fund borrows money for investment
purposes which will create the opportunity for increased return but also
involves special risks. The Fund is allowed to invest in derivative mortgage
back securities without limitation. In addition, the Fund may invest up to 20%
in defaulted bank loans. There can be no assurance that the Fund will achieve
its investment objectives.
This Statement of Additional Information is not a prospectus, but should be
read in conjunction with the current Prospectus for the Fund (the "Prospectus")
dated as of the date hereof. This Statement of Additional Information does not
include all information that a prospective investor should consider before
purchasing shares of the Fund, and investors should obtain and read the
Prospectus prior to purchasing shares. A copy of the Prospectus may be obtained
without charge by writing or calling Van Kampen Fund, Inc. at One Parkview
Plaza, Oakbrook Terrace, Illinois 60181 at (800) 421-5666 ((800) 421-2833 for
the hearing impaired). This Statement of Additional Information incorporates by
reference the entire Prospectus.
The Prospectus and this Statement of Additional Information omit certain of
the information contained in the registration statement filed with the
Securities and Exchange Commission, Washington, D.C. (the "SEC"). These items
may be obtained from the SEC upon payment of the fee prescribed, or inspected at
the SEC's office at no charge.
TABLE OF CONTENTS
<TABLE>
<S> <C>
The Fund and the Trust...................................... B-2
Investment Policies and Restrictions........................ B-3
Additional Investment Considerations........................ B-4
Description of Securities Ratings........................... B-26
Trustees and Officers....................................... B-33
Legal Counsel............................................... B-42
Transfer Agency............................................. B-42
Investment Advisory and Other Services...................... B-42
Custodian and Independent Accountants....................... B-44
Portfolio Transactions and Brokerage Allocation............. B-44
Tax Status of the Fund...................................... B-45
The Distributor............................................. B-48
Distribution and Service Plans.............................. B-49
Performance Information..................................... B-50
Report of Independent Accountants........................... B-53
Financial Statements........................................ B-54
Notes to Financial Statements............................... B-65
</TABLE>
THIS STATEMENT OF ADDITIONAL INFORMATION IS DATED OCTOBER 28, 1997, AS
SUPPLEMENTED UNDER SEPARATE COVER ON JULY 14, 1998 AND HEREWITH ON OCTOBER 1,
1998.
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THE FUND AND THE TRUST
Van Kampen American Capital Strategic Income Fund (the "Fund") is a separate,
non-diversified series of Van Kampen American Capital Trust (the "Trust"), an
open-end management investment company. The Fund was established pursuant to a
designation of series dated May 10, 1995. At present, the Fund, Van Kampen
American Capital High Yield Fund, Van Kampen American Capital Short-Term Global
Income Fund, are the only series of the Trust, although other series may be
organized and offered in the future. Each series of the Trust will be treated as
a separate corporation for Federal income tax purposes.
The Trust is an unincorporated business trust established under the laws of
the State of Delaware by an Agreement and Declaration of Trust dated as of May
10, 1995 (the "Declaration of Trust"). The Declaration of Trust permits the
Trustees to create one or more separate investment portfolios and issue a series
of shares for each portfolio. The Trustees can further sub-divide each series of
shares into one or more classes of shares. The Trust can issue an unlimited
number of full and fractional shares, par value $0.01 per share (prior to July
31, 1995, the shares had no par value). Each share represents an equal
proportionate interest in the assets of the series with each other share in such
series and no interest in any other series. No series is subject to the
liabilities of any other series. The Declaration of Trust provides that
shareholders are not liable for any liabilities of the Trust or any of its
series, requires inclusion of a clause to that effect in every agreement entered
into by the Trust or any of its series and indemnifies shareholders against any
such liability.
Shares of the Trust entitle their holders to one vote per share; however,
separate votes are taken by each series on matters affecting an individual
series. For example, a change in investment policy for a series would be voted
upon by shareholders of only the series involved. Except as described in the
Prospectus, shares do not have cumulative voting rights, preemptive rights or
any conversion or exchange rights. The Trust does not contemplate holding
regular meetings of shareholders to elect Trustees or otherwise. However, the
holders of 10% or more of the outstanding shares may by written request require
a meeting to consider the removal of Trustees by a vote of two-thirds of the
shares then outstanding cast in person or by proxy at such meeting. The Trust
will assist such holders in communicating with other shareholders of the Fund to
the extent required by the Investment Company Act of 1940, as amended (the "1940
Act").
The Trustees may amend the Declaration of Trust (including with respect to any
series) in any manner without shareholder approval, except that the Trustees may
not adopt any amendment adversely affecting the rights of shareholders of any
series without approval by a majority of the shares of each affected series
present at a meeting of shareholders (or such higher vote as may be required by
the 1940 Act or other applicable law) and except that the Trustees cannot amend
the Declaration of Trust to impose any liability on shareholders, make any
assessment on shares or impose liabilities on the Trustees without approval from
each affected shareholder or Trustee, as the case may be.
The Trust originally was organized as Van Kampen Merritt Trust, a
Massachusetts business trust created by a Declaration of Trust dated March 14,
1986 (the "Massachusetts Trust"). The Massachusetts Trust was reorganized into
the Trust and adopted its present name on July 31, 1995 pursuant to an Agreement
and Plan of Reorganization and Liquidation. The Trust was formed pursuant to an
Agreement and Declaration of Trust dated May 10, 1995 for the purpose of
facilitating the Massachusetts Trust's reorganization into a Delaware business
Trust. The Trust filed a Certificate of Trust with the Delaware Secretary of
State on July 28, 1995.
The Fund originally was organized under the name Van Kampen Merritt Strategic
Income Fund, as a sub-trust of the Massachusetts Trust. In connection with the
Massachusetts Trust's reorganization into a Delaware business trust, the Fund
was reorganized into a series of the Trust and renamed Van Kampen American
Capital Strategic Income Fund.
Statements contained in this Statement of Additional Information as to the
contents of any contract or other document referred to are not necessarily
complete, and, in each instance, reference is made to the copy of such contract
or other document filed as an exhibit to the Registration Statement of which
this Statement of Additional Information forms a part, each such statement being
qualified in all respects by such reference.
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INVESTMENT POLICIES AND RESTRICTIONS
The investment objectives of the Fund are set forth in the Prospectus under
the caption "Investment Objectives and Policies." There can be no assurance that
the Fund will achieve its investment objectives.
Fundamental investment restrictions limiting the investments of the Fund
provide that the Fund may not:
1. Invest 25% or more of the value of its total assets in any single industry.
(Neither the U.S. government nor any of its agencies or instrumentalities
will be considered an industry for purposes of this restriction.)
2. Issue senior securities, borrow money or enter into reverse repurchase
agreements or dollar rolls in the aggregate in excess of 33 1/3% of the
Fund's total assets (after giving effect to any such borrowing); provided
that the Fund may, with respect to up to an additional 5% of its total
assets, borrow from and enter into reverse repurchase agreements and dollar
rolls with, any entity for temporary purposes. The Fund will not mortgage,
pledge or hypothecate any assets other than in connection with borrowings,
reverse repurchase agreements, dollar rolls, and Strategic Transactions.
3. Make loans of money or property to any person, except (i) to the extent the
securities in which the Fund may invest are considered to be loans, (ii)
through the loan of portfolio securities or the acquisition of securities
subject to repurchase agreements, and (iii) to the extent that the Fund may
lend money or property in connection with maintenance of the value of, or
the Fund's interest with respect to, the securities owned by the Fund.
4. Buy securities "on margin." Neither the deposit of initial or maintenance
margin in connection with Strategic Transactions, short term credits as may
be necessary for the clearance of transactions nor borrowing, entering into
reverse repurchase agreements or dollar rolls consistent with investment
restriction 2. above is considered the purchase of a security on margin.
5. Act as an underwriter of securities, except to the extent the Fund may be
deemed to be an underwriter in connection with the sale of securities held
in its portfolio.
6. Make investments for the purpose of exercising control or participation in
management of any company other than a CMO issuer, except to the extent
that exercise by the Fund of its rights under agreements related to
portfolio securities would be deemed to constitute such control or
participation, and except that the Fund may purchase securities of other
investment companies to the extent permitted by (i) the 1940 Act, as
amended from time to time, (ii) the rules and regulations promulgated by
the SEC under the 1940 Act, as amended from time to time, or (iii) an
exemption or other relief from the provisions of the 1940 Act.
7. Invest in securities issued by other investment companies except as part of
a merger, reorganization or other acquisition and extent permitted by (i)
the 1940 Act, as amended from time to time, (ii) the rules and regulations
promulgated by the SEC under the 1940 Act, as amended from time to time, or
(iii) an exemption or other relief from the provisions of the 1940 Act.
8. Invest in oil, gas or mineral leases or in equity interests in oil, gas, or
other mineral exploration or development programs except pursuant to the
exercise by the Fund of its rights under agreements relating to portfolio
securities.
9. Purchase or sell real estate, commodities or commodity contracts, except to
the extent that the securities that the Fund may invest in are considered
to be interests in real estate, commodities or commodity contracts or to
the extent the Fund exercises its rights under agreements relating to
portfolio securities (in which case the Fund may liquidate real estate
acquired as a result of a default on a mortgage), and except to the extent
that Strategic Transactions the Fund may engage in are considered to be
commodities or commodities contracts.
The Fund may not change any of these investment restrictions as they apply to
the Fund or the Fund's fundamental investment objectives without the approval of
the lesser of (i) more than 50% of the Fund's outstanding shares or (ii) 67% of
the Fund's outstanding Shares present at a meeting at which the holders of more
than 50% of the outstanding shares are present in person or by proxy. As long as
the percentage restrictions described above are satisfied at the time of the
investment or borrowing, the Fund will be
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considered to have abided by those restrictions even if, at a later time, a
change in values or net assets causes an increase or decrease in percentage
beyond that allowed.
In addition, to comply with federal tax requirements for qualifications as a
"regulated investment company," the Fund's investments will be limited in a
manner such that at the close of each quarter of each fiscal year, (a) no more
than 25% of the Fund's total assets are invested in the securities of a single
issuer, and (b) with regard to at least 50% of the Fund's total assets, no more
than 5% of its total assets are invested in the securities of a single issuer.
These tax-related limitations may be changed by the Trustees to the extent
necessary to comply with changes to applicable tax requirements.
The Fund generally will not engage in the trading of securities for the
purpose of realizing short-term profits, but it will adjust its portfolio as
deemed advisable in view of prevailing or anticipated market conditions to
accomplish the Fund's investment objectives. For example, the Fund may sell
portfolio securities in anticipation of a movement in interest rates. Other than
for tax purposes, frequency of portfolio turnover will not be a limiting factor
if the Fund considers it advantageous to purchase or sell securities. The Fund
anticipates that its annual portfolio turnover rate will normally be less than
200%. Portfolio turnover will be calculated by dividing the lesser of purchases
or sales of portfolio securities by the monthly average value of the securities
in the portfolio during the year. Securities, including options, whose maturity
or expiration date at the time of acquisition were one year or less will be
excluded from such calculation. A high rate of portfolio turnover involves
correspondingly higher brokerage commissions and transaction expenses than a
lower rate, which expenses must be borne by the Fund and its Shareholders. A
high portfolio turnover rate may result in the realization of more short-term
capital gains than if the Fund had a lower portfolio turnover rate.
ADDITIONAL INVESTMENT CONSIDERATIONS
The following information supplements the information provided in the
Prospectus under the headings "Investment Objectives and Policies" and "Other
Investment Practices."
PORTFOLIO SECURITIES
U.S. GOVERNMENT SECURITIES. U.S. government securities include securities
issued by the U.S. government, such as U.S. Treasury securities, and securities
issued or guaranteed by agencies of the U.S. government. U.S. Treasury
securities are generally fixed rate securities. The Fund may invest in both
adjustable rate and fixed rate securities issued or guaranteed by agencies of
the U.S. government, including, but not limited to, Government National Mortgage
Association (GNMA), Federal National Mortgage Association (FNMA) and Federal
Home Loan Mortgage Corporation (FHLMC) securities. In the case of securities not
backed by the full faith and credit of the United States, the Fund must look
principally to the agency issuing or guaranteeing the obligation for ultimate
repayment.
U.S. government securities are considered among the most creditworthy of fixed
income investments. The yields available from U.S. government securities are
generally lower than the yields available from corporate debt securities. The
values of U.S. government securities will change as interest rates fluctuate. To
the extent U.S. government securities are not adjustable rate securities, these
changes in value in response to changes in interest rates generally will be more
pronounced. During periods of falling interest rates, the values of outstanding
long-term fixed rate U.S. government securities generally rise. Conversely,
during periods of rising interest rates, the values of such securities generally
decline. The magnitude of these fluctuations will generally be greater for
securities with longer maturities. Although changes in the value of U.S.
government securities will not affect investment income from those securities,
they may affect the net asset value of the Fund.
MORTGAGE-BACKED SECURITIES. "Mortgage-Backed Securities" are securities that
directly or indirectly represent a participation in, or are secured by and
payable from, mortgage loans secured by real property. There are currently three
basic types of Mortgage-Backed Securities: (i) those issued or guaranteed by the
U.S. government or one of its agencies or instrumentalities, such as GNMA, FNMA
and FHLMC; (ii) those issued by private issuers that represent an interest in or
are collateralized by Mortgage-Backed Securities issued or guaranteed by the
U.S. government or one of its agencies or instrumentalities; and (iii) those
issued
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by private issuers that represent an interest in or are collateralized by whole
mortgage loans or Mortgage-Backed Securities without a government guarantee but
usually having some form of private credit enhancement.
Mortgage-Backed Securities may represent an undivided ownership interests in
pools of mortgages. The mortgages backing these securities may include
conventional 30-year fixed rate mortgages, 15-year fixed rate mortgages,
graduated payment mortgages and adjustable rate mortgages. The U.S. Government
or the issuing agency guarantees the payment of the interest on and principal of
these securities. However, the guarantees do not extend to the securities' yield
or value, which are likely to vary inversely with fluctuations in interest
rates, nor do the guarantees extend to the yield or value of the Fund's shares.
These securities are in most cases "pass-through" instruments, through which the
holders receive a share of all interest and principal payments from the
mortgages underlying the securities, net of certain fees. Because the principal
amounts of such underlying mortgages may generally be prepaid in whole or in
part by the mortgagees at any time without penalty and the prepayment
characteristics of the underlying mortgages vary, it is not possible to predict
accurately the average life of a particular issue of pass-through securities.
Mortgage-Backed Securities are subject to more rapid repayment than their stated
maturity date would indicate as a result of the pass-through of prepayments of
principal on the underlying mortgage obligations. The remaining maturity of a
Mortgage-Backed Security will be deemed to be equal to the average maturity of
the mortgages underlying such security determined by the Adviser on the basis of
assumed prepayment rates with respect to such mortgages. The remaining expected
average life of a pool of mortgages underlying a Mortgage-Backed Security is a
prediction of when the mortgages will be repaid and is based upon a variety of
factors such as the demographic and geographic characteristics of the borrowers
and the mortgaged properties, the length of time that each of the mortgages has
been outstanding, the interest rates payable on the mortgages and the current
interest rate environment. While the timing of prepayments of graduated payment
mortgages differs somewhat from that of conventional mortgages, the prepayment
experience of graduated payment mortgages is basically the same as that of the
conventional mortgages of the same maturity dates over the life of the pool.
The yield characteristics of Mortgage-Backed Securities differ from
traditional debt securities. Among the major differences are that interest and
principal prepayments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other assets generally may be prepaid at any time. As a result, if the Fund
purchases such a security at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing yield to maturity.
Conversely, if the Fund purchases these securities at a discount, faster than
expected prepayments will increase, while slower than expected prepayments will
reduce, yield to maturity. Stripped Mortgage-Backed Securities (defined herein)
which are highly sensitive to changes in prepayment and interest rates.
Prepayments on a pool of mortgage loans are influenced by a variety of
economic, geographic, social and other factors, including changes in mortgagors'
housing needs, job transfers, unemployment, mortgagors' net equity in the
mortgaged properties and servicing decisions. Generally, however, prepayments on
mortgage loans will increase during a period of falling interest rates and
decrease during a period of rising interest rates. Accordingly, amounts
available for reinvestment by the Fund are likely to be greater during a period
of declining interest rates and, as a result, likely to be reinvested at lower
interest rates than during a period of rising interest rates. Mortgage-Backed
Securities may decrease in value as a result of increases in interest rates and
may benefit less than other fixed income securities from declining interest
rates because of the risk of prepayment.
The Fund's yield may also be affected by the yields on instruments in which
the Fund is able to reinvest the proceeds of payments and prepayments.
Accelerated prepayments on securities purchased by the Fund at a premium also
impose a risk of loss of principal because the premium may not have been fully
amortized at the time the principal is repaid in full.
During periods of declining interest rates, prepayment of mortgages underlying
Mortgage-Backed Securities can be expected to accelerate. When the mortgage
obligations are prepaid, the Fund reinvests the prepaid amounts in other income
producing securities, the yields of which reflect interest rates prevailing at
the time. Therefore, the Fund's ability to maintain a portfolio of high-yielding
Mortgage-Backed Securities will be adversely affected to the extent that
prepayments of mortgages must be reinvested in securities which have
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lower yields than the prepaid Mortgage-Backed Securities. Moreover, prepayments
of mortgages which underlie securities purchased by the Fund at a premium would
result in capital losses.
Guaranteed Mortgage Pass-Through Securities. The Fund may invest in mortgage
pass-through securities representing participation interest in pools of
residential mortgage loans originated by U.S. governmental or private lenders or
guaranteed, to the extent provided in such securities, by the U.S. government or
one of its agencies or instrumentalities. Mortgage pass-through securities
provide for monthly payments that are a "pass-through" of the monthly interest
and principal payments (including any prepayment) 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 that the Fund may invest in
include those issued or guaranteed by GNMA, FNMA and FHLMC. Each of GNMA, FNMA
and FHLMC guarantee timely distributions of interest to security holders. GNMA
and FNMA also guarantee timely distribution of scheduled principal. FHLMC
guarantees only ultimate collection of principal on the underlying loans, which
collection may take up to one year. The Fund may also invest in other agency
securities, including but not limited to securities issued by the Small Business
Administration, Export-Import Bank of the United States, Federal Housing
Administration, Farm Credit Administration, Federal Home Loan Banks, General
Services Administration, U.S. Department of Transportation, U.S. Department of
Housing and Urban Development, and Student Loan Marketing Association. These
securities generally are not backed by the full faith and credit of the United
States.
Private Mortgage Pass-Through Securities. Private mortgage pass-through
securities ("Private Pass-Throughs") are structured similarly to the GNMA, FNMA
and FHLMC mortgage pass-through securities described above and are issued by
originators of and investors in mortgage loans, including savings and loan
associations, mortgage banks, commercial banks, investment banks and special
purpose subsidiaries of the foregoing. Private Pass-Throughs constituting ARMS
are backed by a pool of conventional adjustable rate mortgage loans. Since
Private Pass-Throughs typically are not guaranteed by an entity having the
credit status of GNMA, FNMA or FHLMC, such securities generally are structured
with one or more types of credit enhancement.
GNMA Certificates. GNMA is a wholly-owned corporate instrumentality of the
United States within the Department of Housing and Urban Development. The
National Housing Act of 1934, as amended (the "Housing Act"), authorizes GNMA to
guarantee the timely payment of the principal of and interest on certificates
that are based on and backed by a pool of mortgage loans insured by the Federal
Housing Administration under the Housing Act, or Title V of the Housing Act of
1949 ("FHA Loans"), or guaranteed by the Veteran's Administration under the
Servicemen's Readjustment Act of 1944, as amended ("VA Loans"), or by pools of
other eligible mortgage loans. The Housing Act provides that the full faith and
credit of the U.S. government is pledged to the payment of all amounts that may
be required to be paid under any guarantee. In order to meet its obligations
under such guarantee, GNMA is authorized to borrow from the U.S. Treasury with
no limitations as to amount.
GNMA Certificates will represent a pro rata interest in one or more pools of
the following types of mortgage loans: (i) fixed rate level payment mortgage
loans, (ii) fixed rate graduated payment mortgage loans; (iii) fixed rate
growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multifamily residential
properties under construction; (vi) mortgage loans on completed multifamily
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used to
reduce the borrower's monthly payments during the early years of the mortgage
loans ("buydown" mortgage loans); (viii) mortgage loans that provide for
adjustments in payments based on periodic changes in interest rates or in other
payment terms of the mortgage loans; and (ix) mortgage-backed serial notes. All
of these mortgage loans will be FHA Loans or VA Loans and, except as otherwise
specified above, will be fully-amortizing loans secured by first liens on one-
to four-family housing units.
FNMA Certificates. FNMA is a federally chartered and privately owned
corporation organized and existing under the Federal National Mortgage
Association Charter Act. FNMA was originally established in 1938 as a U.S.
government agency to provide supplemental liquidity to the mortgage market and
was transformed into a stockholder owned and privately managed corporation by
legislation enacted in 1968. FNMA provides funds
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to the mortgage market primarily by purchasing home mortgage loans from local
lenders, thereby replenishing their funds for additional lending. FNMA acquires
funds to purchase home mortgage loans from many capital market investors that
may not ordinarily invest in mortgage loans directly, thereby expanding the
total amount of funds available for housing.
Each FNMA Certificate will entitle the registered holder thereof to receive
amounts representing such holder's pro rata interest in scheduled principal
payments and interest payments (at such FNMA Certificate's pass-through rate,
which is net of any servicing and guarantee fees on the underlying mortgage
loans), and any principal prepayments on the mortgage loans in the pool
represented by such FNMA Certificate and such holder's proportionate interest in
the full principal amount of any foreclosed or otherwise finally liquidated
mortgage loan. The full and timely payment of principal of and interest on each
FNMA Certificate will be guaranteed by FNMA, which guarantee is not backed by
the full faith and credit of the U.S. government.
Each FNMA Certificate will represent a pro rata interest in one or more pools
of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage loans that
are not insured or guaranteed by any governmental agency) of the following
types: (i) fixed rate level payment mortgage loans; (ii) fixed rate growing
equity mortgage loans; (iii) fixed rate graduated payment mortgage loans; (iv)
variable rate California mortgage loans; (v) other adjustable rate mortgage
loans; and (vi) fixed rate loans secured by multifamily projects.
FHLMC Certificates. FHLMC is a corporate instrumentality of the United States
created pursuant to the Emergency Home Finance Act of 1970, as amended (the
"FHLMC Act"). FHLMC was established primarily for the purpose of increasing the
availability of mortgage credit for the financing of needed housing. The
principal activity of FHLMC currently consists of the purchase of first lien,
conventional, residential mortgage loans and participation interests in such
mortgage loans and the resale of the mortgage loans so purchased in the form of
mortgage securities, primarily Freddie Mac Certificates.
FHLMC guarantees to each registered holder of a FHLMC Certificate the timely
payment of interest at the rate provided for by such FHLMC Certificate, whether
or not received. Freddie Mac also guarantees to each registered holder of a
FHLMC Certificate ultimate collection of all principal of the related mortgage
loans, without any offset or deduction, but does not, generally, guarantee the
timely payment of scheduled principal. FHLMC may remit the amount due on account
of its guarantee of collection of principal at any time after default on an
underlying mortgage loan, but not later than 30 days following (i) foreclosure
sale, (ii) payment of a claim by any mortgage insurer, or (iii) the expiration
of any right of redemption, whichever occurs later, but in any event no later
than one year after demand has been made upon the mortgagor for accelerated
payment of principal. The obligation of FHLMC under its guarantee are
obligations solely of FHLMC and are not backed by the full faith and credit of
the U.S. government.
FHLMC Certificates represent a pro rata interest in a group of mortgage loans
(a "FHLMC Certificate group") purchased by FHLMC. The mortgage loans underlying
the FHLMC Certificates will consist of fixed rate or adjustable rate mortgage
loans with original terms to maturity of between ten and thirty years,
substantially all of which are secured by first liens on one- to four-family
residential properties or multifamily projects. Each mortgage loan must meet the
applicable standards set forth in the FHLMC Act. A FHLMC Certificate group may
include whole loans, participation interests in whole loans and undivided
interests in whole loans and participations comprising another FHLMC Certificate
group.
Collateralized Mortgage Obligations and Multiclass Pass-Through Securities.
Collateralized mortgage obligations ("CMOs") are debt obligations which are
secured by mortgage loans or other Mortgage-Backed Securities (such collateral
is collectively hereinafter referred to as "Mortgage Assets"). Multiclass pass-
through securities are equity interests in a trust composed of Mortgage Assets.
Unless the context indicates otherwise, all references herein to CMOs include
multiclass 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 distributions on the multiclass
pass-through securities. CMOs may be issued by agencies or instrumentalities of
the U.S. government, or by private originators of, or investors in, mortgage
loans, including savings and loan associations, mortgage banks, commercial
banks, investment banks and special purpose subsidiaries of the foregoing. The
issuer of a series of CMOs may elect to be treated as a Real Estate Mortgage
Investment Conduit (a "REMIC"). All future references to CMOs shall also be
deemed to include REMICs.The Fund will not invest in REMIC residuals or other
CMO residuals.
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In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," may be issued at a
specific fixed or floating coupon rate and has a stated maturity or final
distribution date. Principal prepayments on the underlying Mortgage Assets may
cause the CMOs to be retired substantially earlier than their stated maturities
or final distribution dates. Interest is paid or accrues on all classes of a CMO
on a monthly, quarterly or semi-annual basis. The principal of and interest on
the Mortgage Assets may be allocated among the several classes of a series of a
CMO in many ways. By investing in particular tranches of a CMO with specified
cash flows, the Fund may gain more predictability of cash flows than if it had
invested in the underlying Mortgage Assets. Generally, the more predictable the
cash flow of a CMO tranche, the lower the anticipated yield will be on that
tranche at the time of issuance relative to prevailing market yields on
Mortgage-Backed Securities. As part of the process of creating more predictable
cash flows on most of the tranches in a series of CMOs, one or more tranches
generally must be created that absorb most of the volatility in the cash flows
on the underlying Mortgage Assets. The yields on these tranches are generally
higher than prevailing market yields on Mortgage-Backed Securities with similar
average lives. Because of the uncertainty of the cash flows on these tranches,
and the sensitivity thereof to changes in prepayment rates on the underlying
Mortgage Assets, the market prices of and yield on these tranches tend to be
more volatile.
One or more tranches of a CMO may have coupon rates which reset periodically
at a specified increment over an index such as LIBOR. These adjustable rate
tranches are known as "floating rate CMOs," "inverse floating CMOs" and
"interest only CMOs". Floating rate CMOs may be backed by fixed rate or
adjustable rate mortgages; to date, fixed rate mortgages have been more commonly
utilized for this purpose. Floating rate CMOs are typically issued with lifetime
caps on the coupon rate thereon. These caps, similar to the caps on adjustable
rate mortgages, represent a ceiling beyond which the coupon rate on a floating
rate CMO may not be increased regardless of increases in the interest rate index
to which the floating rate CMO is geared. Inverse floating rate CMOs pay
interest at rates that vary inversely with changes in market rates of interest
and may pay a rate of interest determined by applying a multiple to the floating
rate. Accordingly, when market rates of interest decrease, the change in value
of inverse floating CMOs owned by the Fund will have a positive effect on the
net asset value of the Fund and when market rates of interest increase, the
change in value of inverse floating rate CMOs owned by the Fund will have a
negative effect on the net asset value of the Fund. In addition, the extent of
increases and decreases in the net asset value of the Fund in response to
changes in market rates of interest generally will be larger than comparable
changes in the net asset value of the Fund if the Fund held an equal principal
amount of a fixed rate CMO security having similar credit quality, redemption
provisions and maturity.
The Fund also may invest in, among other things, parallel pay CMOs and Planned
Amortization Class CMOs (PAC Bonds). Parallel pay CMOs are structured to provide
payments of principal on each payment date to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class, which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC Bonds generally require payments of a
specified amount of principal on each payment date. The Fund will not, however,
invest in CMO residuals.
In reliance on an SEC interpretation, the Fund's investment in certain
qualifying collateralized mortgage obligations (CMOs), including CMOs that have
elected to be treated as Real Estate Mortgage Investment Conduits (REMICs), are
not subject to the 1940 Act's limitation on acquiring interests in other
investment companies. In order to be able to rely on the SEC's interpretation,
the CMOs and REMICs must be unmanaged, fixed-asset issuers that (a) invest
primarily in mortgage-backed securities, (b) do not issue redeemable securities,
(c) operate under general exemptive orders exempting them from all provisions of
the 1940 Act, and (d) are not registered or regulated under the 1940 Act as
investment companies. To the extent that the Fund selects CMOs or REMICs that do
not meet the above requirements, the Fund may not invest more than 10% of its
assets in all such entities and may not acquire more than 3% of the voting
securities of any single such entity.
Stripped Mortgage-Backed Securities. Stripped Mortgage-Backed Securities are
derivative multi-class mortgage securities. Stripped Mortgage-Backed Securities
may be issued by agencies or instrumentalities of the U.S. government, or by
private originators of, or investors in, mortgage loans, including savings and
loan
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associations, mortgage banks, commercial banks, investment banks and special
purpose subsidiaries of the foregoing. Stripped Mortgage-Backed Securities
issued by parties other than agencies or instrumentalities of the U.S.
Government are considered, under current guidelines of the staff of the SEC, to
be illiquid securities.
Stripped Mortgage-Backed Securities are structured with two classes that
receive different proportions of the interest and principal distributions on a
pool of Mortgage Assets. A common type of Stripped Mortgage-Backed Securities
will have one class receiving a small portion of the interest and a larger
portion of the principal from the Mortgage Assets, while the other classes will
receive primarily interest and only a small portion of the principal. In the
most extreme case, one class will receive all of the interest (the interest-only
or "IO" class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yields to maturity on IOs and POs are
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and principal payments may have a material
effect on yield to maturity. If the underlying Mortgage Assets experience
greater than anticipated prepayments of principal, the Fund may not fully recoup
its initial investment in IOs. Conversely, if the underlying mortgage assets
experience less than anticipated prepayments of principal, the yield on POs
could be materially adversely affected. The market value of such Stripped
Mortgage-Backed Securities, including adjustable rate U.S. government IOs, are
subject to greater risk of fluctuation in response to changes in market interest
rates than other adjustable rate securities, and such greater risk of
fluctuation may adversely affect the ability of the Fund to achieve its
investment objective of maintaining a relatively stable net asset value.
Types of Credit Support. To lessen the effect of failures by obligors on
underlying mortgages to make payments, ARMS and other Mortgage-Backed Securities
may contain elements of credit support. Such credit support falls into two
categories: (i) liquidity protection and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to ensure that the pass-through of
payments due on the underlying pool occurs in a timely fashion. Protection
against losses resulting from ultimate default enhances the likelihood of
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit support,
although the existence of credit support may increase the price of a security.
The ratings of securities for which third-party credit enhancement provides
liquidity protection or protection against losses from default are generally
dependent upon the continued creditworthiness of the enhancement provider. The
ratings of such securities could be subject to reduction in the event of
deterioration in the creditworthiness of the credit enhancement provider even in
cases where the delinquency and loss experience on the underlying pool of assets
is better than expected.
Examples of credit support arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of "reserve
funds" (where cash or investments, sometimes funded from a portion of the
payments on the underlying assets, are held in reserve against future losses)
and "over-collateralization" (where the scheduled payments on, or the principal
amount of, the underlying assets exceed those required to make payment on the
securities and pay any servicing or other fees). The degree of credit support
provided for each issue is generally based on historical information with
respect to the level of credit risk associated with the underlying assets. Other
information which may be considered include demographic factors, loan
underwriting practices and general market and economic conditions. Delinquency
or loss in excess of that which is anticipated could adversely affect the return
on an investment in such a security.
Adjustable Rate Mortgage-Backed Securities. Adjustable rate Mortgage-Backed
Securities are debt securities having interest rates which are adjusted or reset
at periodic intervals ranging, in general, from one month to three years, based
on a spread over a specific interest rate or interest rate index. There are
three main categories of indices: (i) those based on U.S. Government Securities,
(ii) those derived from a calculated
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measure such as a cost of funds index and (iii) those based on a moving average
of interest rates, including mortgage rates. Commonly utilized indices include,
for example, the One Year Constant Maturity Treasury Index, the London Interbank
Offered Rate (LIBOR), the Federal Home Loan Bank Cost of Funds, the prime rate
and commercial paper rates.
Adjustable rate securities allow the Fund to participate in increases in
interest rates through periodic upward adjustments of the coupon rates of such
securities, resulting in higher yields. During periods of declining interest
rates, however, coupon rates may readjust downward resulting in lower yields to
the Fund. During periods of rising interest rates, changes in the coupon rate of
adjustable rate securities will lag behind changes in the market interest rate,
which may result in such security having a lower value until the coupon resets
to reflect more closely market interest rates. Investors who redeem shares of
the Fund prior to the time the coupon rates of the Fund's portfolio securities
are adjusted could suffer some loss on their investment in the Fund's shares.
Adjustable rate securities typically limit the maximum amount the coupon rate
may be adjusted during any adjustment period, in any one year and during the
term of the security. During periods of significant fluctuations in market rates
of interest the net asset value of the Fund may fluctuate more significantly
since these limits may prevent the Fund's portfolio securities from fully
adjusting to reflect market rates.
The Fund may invest in adjustable rate securities with interest rates that
adjust or vary inversely to changes in market interest rates. Such securities,
which are referred to as "inverse floating obligations," provide opportunities
for high current income, but the market value of such securities may be more
volatile in response to changes in market interest rates. Certain of such
inverse floating obligations have coupon rates that adjust to changes in market
interest rates to a greater degree than the change in the market rate and
accordingly have investment characteristics similar to investment leverage. As a
result, the market value of such inverse floating obligations are subject to
greater risk of fluctuation than other adjustable rate securities which do not
vary inversely to changes in market interest rates, and such greater risk of
fluctuation may adversely affect the ability of the Fund to achieve its
investment objective of maintaining a relatively stable net asset value.
ASSET-BACKED SECURITIES. "Asset-Backed Securities" have structural
characteristics similar to Mortgage-Backed Securities but have underlying assets
that are not mortgage loans or interests in mortgage loans. Through the use of
trusts and special purpose corporations, various types of assets, primarily
automobile and credit card receivables and home equity loans, have been
securitized in pass-through structures similar to the mortgage pass-through
structures or in a pay-through structure similar to the CMO structure. In
general, these types of loans are of shorter average life than mortgage loans
and are less likely to have substantial prepayments.
Asset-Backed Securities present certain risks that are not presented by
Mortgage-Backed Securities, including the risk that these securities do not have
the benefit of a security interest in the related collateral. Credit card
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, some of which
give such debtors the right to set off certain amounts owed on the credit cards,
thereby reducing the balance due. Most issues of Asset-Backed Securities backed
by automobile receivables permit the servicers of such receivable to retain
possession of the underlying obligations. If the servicer were to sell these
obligations to another party, there is a risk that the purchaser would acquire
an interest superior to that of the holders of the related Asset-Backed
Securities. In addition, because of the large number of vehicles involved in a
typical issuance and technical requirement under state laws, the trustee for the
holders of Asset-Backed Securities backed by automobile receivables may not have
a proper security interest in the obligations backing such receivables.
Therefore, there is the possibility that recoveries on repossessed collateral
may not, in some cases, be available to support payments on these securities.
FLOATING AND VARIABLE RATE INCOME SECURITIES. Income securities may provide
for floating or variable rate interest or dividend payments. The floating or
variable rate may be determined by reference to a known lending rate, such as a
bank's prime rate, a certificate of deposit rate or the London Inter Bank
Offered Rate (LIBOR). Alternatively, the rate may be determined through an
auction or remarketing process. The rate may also be indexed to changes in the
values of interest rate or securities indexes, currency exchange rates or other
commodities. The amount by which the rate paid on an income security may
increase or decrease may
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be subject to periodic or lifetime caps. Floating and variable rate income
securities include derivative securities whose rates vary inversely with changes
in market rates of interest. Such securities may also pay a rate of interest
determined by applying a multiple to the variable rate. The extent of increases
and decreases in the value of securities whose rates vary inversely with changes
in market rates of interest generally will be larger than comparable changes in
the value of an equal principal amount of a fixed rate security having similar
credit quality, redemption provisions and maturity.
DISCOUNT, ZERO COUPON SECURITIES AND PAYMENT-IN-KIND SECURITIES. The Fund may
invest in securities sold at a substantial discount from their value at
maturity. Such securities include "zero coupon" and payment-in-kind securities
of governmental or private issuers. Zero coupon securities generally pay no cash
interest (or dividends in the case of preferred stock) to their holders prior to
maturity. Payment-in-kind securities allow the issuer, at its option, to make
current interest payments on such securities either in cash or additional
securities. Accordingly, such securities usually are issued and traded at a deep
discount from their face or par value and generally are subject to greater
fluctuations of market value in response to changing interest rates than
securities of comparable maturities and credit quality that pay cash interest
(or dividends in the case of preferred stock) on a current basis.
Federal tax law requires that a holder of a zero coupon security accrue a
portion of the original issue discount on the security and to include the
"interest" on payment-in-kind securities as income each year, even though the
holder receives no interest payment on the security during the year. Federal tax
law also requires that entities such as the Fund which seek to qualify for
pass-through federal income tax treatment as regulated investment companies
distribute substantially all of their net investment income each year, including
non-cash income. Accordingly, although the Fund will receive no payments on its
zero coupon or payment-in-kind securities prior to their maturity or
disposition, it will have income attributable to such securities, and it will be
required, in order to maintain the desired tax treatment, to include in its
dividends an amount equal to the income attributable to its zero coupon and
payment-in-kind securities. Such dividends will be paid from the cash assets of
the Fund, from borrowings or by liquidation of portfolio securities, if
necessary, at a time that the Fund otherwise might not have done so. To the
extent the proceeds from any such dispositions are used by the Fund to pay
distributions, the Fund will not be able to purchase additional income-producing
securities with such proceeds, and as a result the Fund's current income
ultimately may be reduced. See "Taxation."
PREMIUM SECURITIES. The fund may invest in income securities bearing coupon
rates higher than prevailing market rates. Such "premium" securities are
typically purchased at prices greater than the principal amounts payable on
maturity. The Fund will not amortize the premium paid for such securities in
calculating its net investment income. As a result, in such cases the purchase
of such securities provides the Fund a higher level of investment income
distributable to shareholders on a current basis than if the Fund purchased
securities bearing current market rates of interest. Although such securities
bear coupon rates higher than prevailing market rates, because they are
purchased at a price in excess of par value, the yield earned by the Fund on
such investments may not exceed prevailing market yields. If an issuer were to
redeem securities held by a Fund during a time of declining interest rates, the
Fund may not be able to reinvest the proceeds in securities providing the same
investment return as the securities redeemed. If securities purchased by a Fund
at a premium are called or sold prior to maturity, the Fund will recognize a
capital loss to the extent the call or sale price is less than the purchase
price. Additionally, the Fund will recognize a capital loss if it holds such
securities to maturity.
CONVERTIBLE SECURITIES. Convertible securities are bonds, debentures, notes,
preferred stocks or other securities that may be converted into or exchanged for
a specified amount of common stock of the same or a different issuer within a
particular period of time and at a specified price or formula. A convertible
security entitles the holder to receive interest generally paid or accrued on
debt or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Convertible securities have
unique investment characteristics in that they generally (i) have higher yields
than common stocks, but lower yields than comparable non-convertible income
securities, (ii) are less subject to fluctuation in value than the underlying
stock since they have fixed income characteristics, and (iii) provide the
potential for capital appreciation if the market price of the underlying common
stock increases. Most convertible securities currently are issued by domestic
companies, although a substantial Eurodollar convertible securities market has
developed, and the markets for convertible securities denominated in local
currencies are increasing.
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The value of a convertible security is a function of its "investment value"
(determined by its yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and its
"conversion value" (the security's worth, at market value, if converted into the
underlying common stock). The investment value of a convertible security is
influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline. The credit
standing of the issuer and other factors also may have an effect on the
convertible security's investment value. The conversion value of a convertible
security is determined by the market price of the underlying common stock. If
the conversion value is low relative to the investment value, the price of the
convertible security is governed principally by its investment value. Generally
the conversion value decreases as the convertible security approaches maturity.
To the extent the market price of the underlying common stock approaches or
exceeds the conversion price, the price of the convertible security will be
increasingly influenced by its conversion value. A convertible security
generally will sell at a premium over its conversion value by the extent to
which investors place value on the right to acquire the underlying common stock
while holding a fixed income security.
EQUITY FEATURES. Income securities may involve equity features, such as
contingent interest or participations based on revenues, sales or profits (i.e.,
interest of other payments, often in addition to a fixed rate of return, that
are based on the borrower's attainment of specified levels of revenues, sales or
profits). At times, the Fund may also acquire warrants and other equity
securities in connection with the purchase of income securities. Warrants are
securities permitting, but not obligating, their holder to subscribe for other
securities or commodities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments.
PREFERRED STOCK. Preferred stock generally has a preference as to dividends
and upon liquidation over an issuer's common stock but ranks junior to debt
securities in an issuer's capital structure. Preferred stock generally pays
dividends in cash (or additional shares of preferred stock) at a defined rate
but, unlike interest payments on debt securities, preferred stock dividends are
payable only if declared by the issuer's board of directors. Dividends on
preferred stock may be cumulative, meaning that, in the event the issuer fails
to make one or more dividend payments on the preferred stock, no dividends may
be paid on the issuer's common stock until all unpaid preferred stock dividends
have been paid. Preferred stock also may provide that, in the event the issuer
fails to make a specified number of dividend payments, the holders of the
preferred stock will have the right to elect a specified number of directors to
the issuer's board. Preferred stock also may be subject to optional or mandatory
redemption provisions.
COMMON STOCK. Common stocks are shares of a corporation or other entity that
entitle the holder to a pro rata share of the profits of the corporation, if
any, without preference over any other shareholder or class of shareholders,
after making required payments to holders of such entity's preferred stock and
other senior equity. Common stock usually carries with it the right to vote and
frequently an exclusive right to do so. In selecting common stocks for
investment, the Fund will focus both on the security's dividend paying capacity
and on its potential for appreciation.
BRADY BONDS. The Fund may invest in Brady Bonds and other sovereign debt of
countries that have restructured or are in the process of restructuring
sovereign debt pursuant to the Brady Plan. "Brady Bonds" are debt securities
issuer under the framework of the Brady Plan, an initiative announced by former
U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for debtor
nations to restructure their outstanding external commercial bank indebtedness.
The Brady Plan framework contemplates the exchange of commercial bank debt for
newly issued Brady Bonds. Brady Bonds may also be issued in respect of new money
being advanced by existing lenders in connection with the debt restructuring.
Certain Brady Bonds have been collateralized as to principal due at maturity by
U.S. Treasury zero coupon bonds with a maturity equal to the final maturity of
such Brady Bonds.
Brady Plan debt restructurings have been implemented to date in countries
including Mexico, Costa Rica, Venezuela, Uruguay, Nigeria, Argentina and the
Philippines. Brady Bonds have been issued only recently, and accordingly do not
have a long payment history. Agreements implemented under the Brady Plan to date
are designed to achieve debt and debt-service reduction through specific options
negotiated by a debtor nation
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with its creditors. As a result, the financial packages offered by each country
differ. Brady Bonds issued to date include bonds issued at 100% of face value of
such debt, which carry a below-market stated rate of interest (generally known
as par bonds), bonds issued at a discount from the face value of such debt
(generally known as discount bonds), bonds bearing an interest rate which
increases over time and bonds issued in exchange for the advancement of new
money by existing lenders.
In light of the risk of Brady Bonds including, among other factors, the
history of defaults with respect to commercial bank loans by public and private
entities of countries issuing Brady Bonds, investments in Brady Bonds are to be
viewed as speculative. The Fund may purchase Brady Bonds with no or limited
collateralization, and will be relying for payment of interest and (except in
the case of principal collateralized Brady Bonds) principal primarily on the
willingness and ability of the foreign government to make payment in accordance
with terms of the Brady Bonds. Many of the Brady Bonds and other income
securities in which the Fund invests are likely to be acquired at a discount.
See "Taxation."
The Salomon Brothers Brady Bond Index provides a benchmark that can be used to
compare returns of Brady Bonds with returns in other bond markets.
OTHER SOVEREIGN-RELATED DEBT. In addition to Brady Bonds, the Fund may invest
in sovereign or sovereign-related income securities. Such obligations may
include, but are limited to, participations and assignments in sovereign bank
loans, restructured external debt that has not undergone a Brady-style debt
exchange, and internal government debt such as Mexican Treasury Bills known as
Certificados de la Tesoreira ("CETES"), Argentine Bonos del Tesoro ("BOTE"),
Bonos de Inversion y Crecimiento-Quinta Serie ("BIC V") and Venezuelan zero
coupon notes.
The sovereign related income securities in which the Fund may invest generally
consist of obligations issued or backed by national, state or provincial
governments or similar political subdivisions or central banks in foreign
countries. Sovereign related income securities also include debt obligations of
supranational entities, which include international organizations designated or
backed by governmental entities to promote economic reconstruction or
development, international banking institutions and related government agencies.
Examples include the International Bank for Reconstruction and Development (the
World Bank), the European Coal and Steel Community, the Asian Development Bank
and the InterAmerican Development Bank.
Sovereign related income securities also include income securities of
"quasi-governmental agencies" and income securities denominated in multinational
currency units of an issuer (including supranational issuers). An example of a
multinational currency unit is the European Currency Unit ("ECU"). An ECU
represents specified amounts of the currencies of certain member states of the
European Economic Community. The specific amounts of currencies comprising the
ECU may be adjusted by the Council of Ministers of the European Community to
reflect changes in relative values of the underlying currencies. European
supranational entities, in particular, issue ECU-denominated obligations. Income
securities of quasi-governmental agencies are issued by entities owned by either
a national, state or equivalent government or are obligations of a political
unit that is not backed by the national government's full faith and credit and
general taxing powers.
DEPOSITORY RECEIPTS. Some of the securities in the Fund may be in the form of
depository receipts. Depository receipts usually represent common stock or other
equity securities of non-domestic issuers deposited with a custodian in a
depository. The underlying securities are usually withdrawable at any time by
surrendering the depository receipt. Depository receipts are usually denominated
in U.S. dollars and dividends and other payments from the issuer are converted
by the custodian into U.S. dollars before payment to receipt holders. In other
respects depository receipts for foreign securities have the same
characteristics as the underlying securities. Depository receipts that are not
sponsored by the issuer may be less liquid and there may be less readily
available public information about the issuer.
STRUCTURED INVESTMENTS. The Fund may invest a portion of its assets in
interests in entities organized and operated solely for the purpose of
restructuring the investment characteristics of other income securities,
including income securities issued by foreign governments. This type of
restructuring involves the deposit with or purchase by an entity, such as a
corporation or trust, of specified instruments (such as commercial bank loans or
Brady Bonds) and the issuance by that entity of one or more classes of
securities ("Structured Investments") backed by, or representing interests in,
the underlying instruments. The cash flow on the
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underlying instruments may be apportioned among the newly issued Structured
Investments to create securities with different investment characteristics such
as varying maturities, payment priorities and interest rate provisions, and the
extent of the payments made with respect to Structured Investments is dependent
on the extent of the cash flow on the underlying instruments. The Fund may
invest in a class of Structured Investments that is subordinated to the right of
payment of another class. Subordinated Structured Investments typically have
higher yields and present greater risks than unsubordinated Structured
Investments.
PRIVATE PLACEMENTS. The Fund may invest in income securities that are sold in
private placement transactions between their issuers and their purchasers and
that are neither listed on an exchange nor traded in the OTC secondary market.
In many cases, privately placed securities will be subject to contractual or
legal restrictions on transfer. As a result of the absence of a public trading
market, privately placed securities may in turn be less liquid and more
difficult to value than publicly traded securities. In addition, issuers whose
securities are not publicly traded may not be subject to the disclosure and
other investor protection requirements that may be applicable if their
securities were publicly traded. Certain of the Fund's direct investments,
particularly in emerging foreign markets, may include investments in smaller,
less seasoned companies, which may involve greater risks. These companies may
have limited product lines, markets or financial resources, or they may be
dependent on a limited management group. If any privately placed securities held
by the Fund were required to be registered under the securities laws of any
jurisdiction prior to being resold, the Fund may be required to bear the
expenses of registration.
INDEXED INCOME SECURITIES. The Fund may invest in income securities issued by
banks and other business entities that are indexed to certain specific foreign
currency exchange rates, interest rates or other reference rates. The terms of
such securities provide that their principal amount is adjusted upwards or
downwards (but ordinarily not below zero) at maturity to reflect changes in the
exchange rate between two currencies (or other rates) while the obligations are
outstanding. While such securities offer the potential for an attractive rate of
return, they also entail the risk of loss of principal.
INVESTMENT IN OTHER INVESTMENT COMPANIES. The Fund may invest in other
investment companies whose investment objectives and policies are consistent
with those of the Fund. In accordance with the 1940 Act, the Fund may invest up
to 10% of its total assets in securities of other investment companies. In
addition, under the 1940 Act the Fund may not own more than 3% of the total
outstanding voting stock of any investment company and not more than 5% of the
value of the Fund's total assets may be invested in the securities of any
investment company. If the Fund acquires shares in investment companies,
stockholders would bear both their proportionate share of expenses in the Fund
(including investment advisory and administrative fees) and, indirectly, the
expenses of such investment companies (including investment advisory and
administrative fees).
SPECIAL RISK FACTORS
INVESTMENT IN LOWER GRADE INCOME SECURITIES. A substantial portion of the
Fund's assets may be invested in lower grade securities, commonly referred to as
"junk bonds." Debt securities rated BB or lower by S&P or Ba or lower by Moody's
are deemed by S&P and Moody's to be predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal and may involve major
risk exposure to adverse conditions. The lower grade income securities in which
the Fund may invest may include securities having the lowest ratings assigned by
S&P or Moody's and, together with comparable unrated securities, may include
securities in default or that face the risk of default with respect to the
payment of principal or interest. The Fund may invest in income securities rated
in the lowest rating categories. These securities are considered to have
extremely poor prospects of ever attaining any real investment standing.
Lower grade income securities generally offer a higher yield than that
available from higher grade income securities. However, lower grade income
securities involve higher risks, in that they are especially subject to adverse
changes in general economic conditions, the industries in which the issuers are
engaged, the financial condition of the issuers and prevailing interest rates.
Issuers of lower grade securities are often highly
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leveraged and may not have available to them more traditional methods of
financing. During periods of economic downturn or rising interest rates, highly
leveraged issuers may experience financial stress which could adversely affect
their ability to make payments of principal and interest and increase the
possibility of default. The issuer's ability to service its debt obligations may
also be adversely affected by specific developments affecting the issuer, such
as the issuer's inability to meet specific projected business or revenue
forecasts. Similarly, certain emerging market governments that issue lower grade
income securities are among the largest debtors to commercial banks, foreign
governments and supranational organizations and may not be able or willing to
obtain additional financing.
Lower grade income securities frequently have call or buy-back features which
permit an issuer to call or repurchase the security prior to maturity. If an
issuer exercises these provisions in a declining interest rate environment, the
Fund may have to reinvest in lower yielding securities, resulting in a decrease
in income earned by the Fund. The risk of loss due to default by the issuer is
also significantly greater for the holders of lower grade securities because
such securities are generally unsecured and are often subordinated to other
income securities of the issuer. To the extent the Fund is required to seek
recovery upon a default in the payment of principal or interest on its portfolio
holdings, the Fund may incur additional expenses and, with respect to foreign
lower grade income securities, may have limited legal recourse in the event of a
default.
INVESTMENTS IN FOREIGN INCOME SECURITIES. Investment in foreign income
securities involves certain special risks not usually associated with investment
in domestic income securities. The magnitude of such risks is generally greater
with respect to investment in emerging market countries. Investments in foreign
income securities involve risks relating to political and economic developments
abroad. The economies of individual foreign emerging market countries may differ
unfavorably from the U.S. economy in such respects as growth of gross domestic
product, rate of inflation, currency depreciation, capital reinvestment,
resource self-sufficiency and balance of payments position. Further, the
economies of developing countries generally are heavily dependent upon
international trade and, accordingly, have been and may continue to be adversely
affected by trade barriers, exchange controls, managed adjustments in relative
currency values and other protectionist measures imposed or negotiated by the
countries with which they trade. These economies also have been and may continue
to be adversely affected by changes in the economic conditions in the countries
with which they trade.
With respect to many foreign countries, there is the possibility of
nationalization, expropriation or confiscatory taxation, political instability,
increased governmental regulation, social instability or diplomatic developments
(including armed conflict) which could adversely affect the economies of such
countries or the value of the Fund's investments in those countries.
Foreign investment in certain countries is restricted or controlled to varying
degrees. These restrictions or controls may at times limit or preclude foreign
investment in certain emerging income securities and increase the costs and
expenses of the Fund. Certain countries require governmental approval prior to
investments by foreign persons, limit the amount of investment by foreign
persons in a particular issuer, limit the investment by foreign persons only to
a specific class of securities of an issuer that may have less advantageous
rights than the classes available for purchase by domiciliaries of the countries
and/or impose additional taxes on foreign investors. Certain countries may also
restrict investment opportunities in industries deemed important to national
interests. In addition, certain countries may require governmental approval for
the repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. If a deterioration occurs in an emerging market
country's balance of payments, the country might impose temporary restrictions
on foreign capital remittances. Investing in local markets in certain countries
may require the Fund to adopt special procedures, seek local government
approvals or take other actions, each of which may involve additional costs to
the Fund.
Disclosure and regulatory standards in many respects are less stringent in
many countries than in the U.S. There also may be a lower level of monitoring
and regulation of securities markets and the activities of investors in such
markets, and enforcement of existing regulations has in many instances been
limited. Many of the foreign income securities held by the Fund will not be
registered with the SEC, nor will the issuers thereof be subject to SEC
reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers than is available concerning domestic
companies. Foreign companies,
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and in particular, companies in emerging market countries are not generally
subject to uniform accounting, auditing and financial reporting standards or to
other regulatory requirements comparable to those applicable to domestic
companies.
Because the Fund may invest in non-U.S. dollars-denominated securities,
changes in foreign currency exchange rates will affect the Fund's net asset
value, the value of dividends and interest earned, gains and losses realized on
the sale of securities and net investment income to be distributed to
shareholders. If the value of a foreign currency rises against the U.S. dollar,
the value of Fund assets denominated in such currency will increase;
correspondingly, if the value of a foreign currency declines against the U.S.
dollar, the value of Fund assets denominated in such currency will decrease. The
exchange rates between the U.S. dollar and other currencies can be volatile. In
addition, there may be less timely and accurate information with respect to
general economic conditions and trends in countries in which issuers of foreign
income securities are located, particularly in emerging market countries.
The costs associated with investing in foreign income securities frequently
are higher than those attributable to domestic investing. Investment income on
certain foreign securities in which the Fund may invest may be subject to
foreign, income withholding or other government taxes.
Foreign markets also have different clearance and settlement procedures, and
in certain markets settlement may fail to keep pace with the volume of
securities transactions, making it difficult to conduct such transactions.
Delays in settlement could result in temporary periods when assets of the Fund
are uninvested and no return is earned thereon. The inability of the Fund to
make intended security purchases due to settlement problems could cause the Fund
to miss attractive investment opportunities. Inability to dispose of a portfolio
security due to settlement problems could result in losses to the Fund due to
subsequent declines in the value of such portfolio security.
SOVEREIGN DEBT. Certain countries have historically experienced, and may
continue to experience, high rates of inflation, high interest rates, exchange
rate fluctuations, large amounts of external debt, balance of payment and trade
difficulties and extreme poverty and unemployment. The issuer of sovereign debt
or the governmental authorities that control the repayment of sovereign debt may
be unable or unwilling to repay principal or interest when due in accordance
with the terms of such debt. Sovereign debt differs from debt obligations issued
by private entities in that, generally, remedies for defaults must be pursued in
the courts of the defaulting party. Legal recourse is therefore limited.
Certain emerging market countries are among the largest debtors to commercial
banks and foreign governments. At times certain emerging market countries have
declared moratoria on the payment of principal and interest on external debt.
Since 1982, certain emerging market countries have experienced difficulty in
servicing their sovereign debt on a timely basis which led to defaults on
certain obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds, and
obtaining new credit to finance interest payments. Holders of sovereign debt,
including the Fund, may be requested to participate in the rescheduling of such
debt and to extend further loans to sovereign debtors. The interests of holders
of sovereign debt could be adversely affected in the course of restructuring
arrangements. Furthermore, some of the participants in the secondary market for
sovereign debt may also be directly involved in negotiating the terms of these
arrangements and may therefore have access to information not available to other
market participants.
INVESTMENT PRACTICES
STRATEGIC TRANSACTIONS. The Fund may, but is not required to, utilize various
other investment strategies as described below to hedge various market risks
(such as interest rates, currency exchange rates and broad or specific market
movements) or to manage the effective maturity or duration of the Fund's income
securities or to enhance potential gain. Such strategies are generally accepted
by modern portfolio managers and are regularly utilized by many mutual funds and
other institutional investors. Techniques and instruments may change over time
as new instruments and strategies are developed or regulatory changes occur.
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<PAGE> 17
In the course of pursuing these investment strategies, the Fund may purchase
and sell derivative instruments such as exchange-listed and over-the-counter put
and call options on securities, equity and income indices and other financial
instruments, purchase and sell financial futures contracts and options thereon,
enter into various interest rate transactions such as swaps, caps, floors or
collars and enter into various currency transactions such as currency forward
contracts, currency futures contracts, currency swaps or options on currencies
or currency futures (collectively, all the above are called "Strategic
Transactions"). Strategic Transactions may be used to attempt to protect against
possible changes in the market value of securities held in or to be purchased
for the Fund's portfolio resulting from securities markets or exchange rate
fluctuations, to protect the Fund's unrealized gains in the value of its
portfolio securities, to facilitate the sale of such securities for investment
purposes, to manage the effective maturity or duration of the Fund's portfolio,
or to establish a position in the derivatives markets as a temporary substitute
for purchasing or selling particular securities.
Any or all of these investment techniques may be used at any time and there is
no particular strategy that dictates the use of one technique rather than
another, as use of any Strategic Transaction is a function of numerous variables
including market conditions. The ability of the Fund to utilize these Strategic
Transactions successfully will depend on the Adviser's ability to predict
pertinent market movements, which cannot be assured. The Fund will comply with
applicable regulatory requirements when implementing these strategies,
techniques and instruments.
Strategic Transactions have risks associated with them including possible
default by the other party to the transaction, illiquidity and, to the extent
the Adviser's view as to certain market movements is incorrect, the risk that
the use of such Strategic Transactions could result in losses greater than if
they had not been used. Use of put and call options may result in losses to the
Fund, force the sale or purchase of portfolio securities at inopportune times or
for prices other than current market values, limit the amount of appreciation
the Fund can realize on its investments or cause the Fund to hold a security it
might otherwise sell. The use of currency transactions can result in the Fund
incurring losses as a result of a number of factors including the imposition of
exchange controls, suspension of settlements or the inability to deliver or
receive a specified currency. The use of options and futures transactions
entails certain other risks. In particular, the variable degree of correlation
between price movements of futures contracts and price movements in the related
portfolio position of the Fund creates the possibility that losses on the
hedging instrument may be greater than gains in the value of the Fund's
position. In addition, futures and options markets may not be liquid in all
circumstances and certain over-the-counter options may have no markets. As a
result, in certain markets, the Fund might not be able to close out a
transaction without incurring substantial losses, if at all. Although the use of
futures and options transactions for hedging should tend to minimize the risk of
loss due to a decline in the value of the hedged position, at the same time they
tend to limit any potential gain which might result from an increase in value of
such position. Finally, the daily variation margin requirements for futures
contracts would create a greater ongoing potential financial risk than would
purchases of options, where the exposure is limited to the cost of the initial
premium. Losses resulting from the use of Strategic Transactions would reduce
net asset value, and possibly income, and such losses can be greater than if the
Strategic Transactions had not been utilized. Income earned or deemed to be
earned, if any, by the Fund from its Strategic Transactions will generally be
taxable income of the Fund. See "Tax Status" in the Prospectus.
GENERAL CHARACTERISTICS OF OPTIONS. Put options and call options typically
have similar structural characteristics and operational mechanics regardless of
the underlying instrument on which they are purchased or sold. Thus, the
following general discussion relates to each of the particular types of options
discussed in greater detail below. In addition, many Strategic Transactions
involving options require segregation of Fund assets in special accounts, as
described below under "Use of Segregated and Other Special Accounts."
A put option gives the purchaser of the option, upon payment of a premium, the
right to sell, and the writer the obligation to buy, the underlying security,
commodity, index, currency or other instrument at the exercise price. For
instance, the Fund's purchase of a put option on a security might be designed to
protect its holdings in the underlying instrument (or, in some cases, a similar
instrument) against a substantial decline in the market value by giving the Fund
the right to sell such instrument at the option exercise price. A call option,
upon payment of a premium, gives the purchaser of the option the right to buy,
and the seller the obligation to sell, the underlying instrument at the exercise
price. The Fund's purchase of a call option on a security,
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<PAGE> 18
financial future, index, currency or other instrument might be intended to
protect the Fund against an increase in the price of the underlying instrument
that it intends to purchase in the future by fixing the price at which it may
purchase such instrument. An American style put or call option may be exercised
at any time during the option period while a European style put or call option
may be exercised only upon expiration or during a fixed period prior thereto.
The Fund is authorized to purchase and sell exchange listed options and
over-the-counter options ("OTC options"). Exchange listed options are issued by
a regulated intermediary such as the Options Clearing Corporation ("OCC"), which
guarantees the performance of the obligations of the parties to such options.
The discussion below uses the OCC as a paradigm, but is also applicable to other
financial intermediaries.
With certain exceptions, OCC issued and exchange listed options generally
settle by physical delivery of the underlying security or currency, although in
the future cash settlement may become available. Index options and Eurodollar
instruments are cash settled for the net amount, if any, by which the option is
"in-the-money" (i.e., where the value of the underlying instrument exceeds, in
the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting purchase or sale transactions that do not result in ownership of the
new option.
The Fund's ability to close out its position as a purchaser or seller of an
OCC or exchange listed put or call option is dependent, in part, upon the
liquidity of the option market. Among the possible reasons for the absence of a
liquid option market on an exchange are: (i) insufficient trading interest in
certain options; (ii) restrictions on transactions imposed by an exchange; (iii)
trading halts, suspensions or other restrictions imposed with respect to
particular classes or series of options or underlying securities including
reaching daily price limits; (iv) interruption of the normal operations of the
OCC or an exchange; (v) inadequacy of the facilities of an exchange or OCC to
handle current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the relevant market for that option on that exchange would cease
to exist, although outstanding options on that exchange would generally continue
to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours during
which the underlying financial instruments are traded. To the extent that the
option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of an
OTC option, including such terms as method of settlement, term, exercise price,
premium, guarantees and security, are set by negotiation of the parties. The
Fund will only sell OTC options (other than OTC currency options) that are
subject to a buy-back provision permitting the Fund to require the Counterparty
to sell the option back to the Fund at a formula price within seven days. The
Fund expects generally to enter into OTC options that have cash settlement
provisions, although it is not required to do so.
Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC option. As a result, if the Counterparty fails to make or
take delivery of the security, currency or other instrument underlying an OTC
option it has entered into with the Fund or fails to make a cash settlement
payment due in accordance with the terms of that option, the Fund will lose any
premium it paid for the option as well as any anticipated benefit of the
transaction. Accordingly, the Adviser must assess the creditworthiness of each
such Counterparty or any guarantor or credit enhancement of the Counterparty's
credit to determine the likelihood that the terms of the OTC option will be
satisfied. The Fund will engage in OTC option transactions only with United
States government securities dealers recognized by the Federal Reserve Bank of
New York as "primary dealers", or broker dealers, domestic or foreign banks or
other financial institutions which have received (or the guarantors of the
obligation of which have received) a short-term credit rating of "A-1" from S&P
or "P-1" from Moody's or an equivalent rating from any other nationally
recognized statistical rating organization ("NRSRO"). The staff of the SEC
currently takes the position that, in general, OTC options on
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<PAGE> 19
securities other than U.S. Government securities purchased by the Fund, and
portfolio securities "covering" the amount of the Fund's obligation pursuant to
an OTC option sold by it (the cost of the sell-back plus the in-the-money
amount, if any) are illiquid, and are subject to the Fund's limitation on
investing no more than 15% of its assets in illiquid securities.
If the Fund sells a call option, the premium that it receives may serve as a
partial hedge, to the extent of the option premium, against a decrease in the
value of the underlying securities or instruments in its portfolio or will
increase the Fund's income. The sale of put options can also provide income.
The Fund may purchase and sell call options on securities, including U.S.
Treasury and agency securities, municipal obligations, mortgage-backed
securities corporate debt securities, equity securities (including convertible
securities) and Eurodollar instruments that are traded on domestic and foreign
securities exchanges and in the over-the-counter markets and on securities
indices, currencies and futures contracts. All calls sold by the Fund must be
"covered" (i.e., the Fund must own the securities or futures contract subject to
the call) or must meet the asset segregation requirements described below as
long as the call is outstanding. Even though the Fund will receive the option
premium to help protect it against loss, a call sold by the Fund exposes the
Fund during the term of the option to possible loss of opportunity to realize
appreciation in the market price of the underlying security or instrument and
may require the Fund to hold a security or instrument which it might otherwise
have sold. In selling calls on securities not owned by the Fund, the Fund may be
required to acquire the underlying security at a disadvantageous price in order
to satisfy its obligations with respect to the call.
The Fund may purchase and sell put options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, municipal
obligations corporate debt securities, equity securities (including convertible
securities) and Eurodollar instruments (whether or not it holds the above
securities in its portfolio) and on securities indices, currencies and futures
contracts other than futures or individual corporate debt and individual equity
securities. The Fund will not sell put options if, as a result, more than 50% of
the Fund's assets would be required to be segregated to cover its potential
obligations under such put options other than those with respect to futures and
options thereon. In selling put options, there is a risk that the Fund may be
required to buy the underlying security at a disadvantageous price above the
market price.
GENERAL CHARACTERISTICS OF FUTURES. The Fund may enter into financial futures
contracts or purchase or sell put and call options on such futures as a hedge
against anticipated interest rate, currency, equity or income market changes,
for duration management and for risk management purposes. Futures are generally
bought and sold on the commodities exchanges where they are listed with payment
of initial and variation margin as described below. The purchase of a futures
contract creates a firm obligation by the Fund, as purchaser, to take delivery
from the seller the specific type of financial instrument called for in the
contract at a specific future time for a specified price (or, with respect to
index futures and Eurodollar instruments, the net cash amount). The sale of a
futures contract creates a firm obligation by the Fund, as seller, to deliver to
the buyer the specific type of financial instrument called for in the contract
at a specific future time for a specified price (or, with respect to index
futures and Eurodollar instruments, the net cash amount). Options on futures
contracts are similar to options on securities except that an option on a
futures contract gives the purchaser the right in return for the premium paid,
to assume a position in a futures contract and obligates the seller to deliver
such option.
The Fund's use of financial futures and options thereon will in all cases be
consistent with applicable regulatory requirements and in particular the rules
and regulations of the Commodity Futures Trading Commission. Typically,
maintaining a futures contract or selling an option thereon requires the Fund to
deposit with a financial intermediary as security for its obligations an amount
of cash or other specified assets (initial margin) which initially is typically
1% to 10% of the face amount of the contract (but may be higher in some
circumstances). Additional cash or assets (variation margin) may be required to
be deposited thereafter on a daily basis as the mark to market value of the
contract fluctuates. The purchase of options on financial futures involves
payment of a premium for the option without any further obligation on the part
of the Fund. If the Fund exercises an option on a futures contract it will be
obligated to post initial margin (and potential subsequent variation margin) for
the resulting futures position just as it would for any position. Futures
contracts and options thereon are generally settled by entering into an
offsetting transaction but there can be
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<PAGE> 20
no assurance that the position can be offset prior to settlement at an
advantageous price nor that delivery will occur.
The Fund will not enter into a futures contract or related option (except for
closing transactions) for other than for bona fide hedging purposes if,
immediately thereafter, the sum of the amount of its initial margin and premiums
on open futures contracts and options thereon would exceed 5% of the Fund's
total assets (taken at current value); however, in the case of an option that is
in-the-money at the time of the purchase, the in-the-money amount may be
excluded in calculating the 5% limitation. Certain state securities laws to
which the Fund may be subject may further restrict the Fund's ability to engage
in transactions in futures contracts and related options. The segregation
requirements with respect to futures contracts and options thereon are described
below.
OPTIONS ON SECURITIES INDICES AND OTHER FINANCIAL INDICES. The Fund also may
purchase and sell call and put options on securities indices and other financial
indices and in so doing can achieve many of the same objectives it would achieve
through the sale or purchase of options on individual securities or other
instruments. Options on securities indices and other financial indices are
similar to options on a security or other instrument except that, rather than
settling by physical delivery of the underlying instrument, they settle by cash
settlement, i.e., an option on an index gives the holder the right to receive,
upon exercise of the option, an amount of cash if the closing level of the index
upon which the option is based exceeds, in the case of a call, or is less than,
in the case of a put, the exercise price of the option (except if, in the case
of an OTC option, physical delivery is specified). This amount of cash is equal
to the excess of the closing price of the index over the exercise price of the
option, which also may be multiplied by a formula value. The seller of the
option is obligated, in return for the premium received, to make delivery of
this amount. The gain or loss on an option on an index depends on price
movements in the instruments making up the market, market segment, industry or
other composite on which the underlying index is based, rather than price
movements in individual securities, as is the case with respect to options on
securities.
CURRENCY TRANSACTIONS. The Fund may engage in currency transactions with
Counterparties in order to hedge the value of portfolio holding denominated in
particular currencies against fluctuations in relative value. Currency
transactions include forward currency contracts, exchange listed currency
futures, exchange listed and OTC options on currencies, and currency swaps. A
forward currency contract involves a privately negotiated obligation to purchase
or sell (with delivery generally required) a specific currency at a future date,
which may be any fixed number of days from the date of the contract agreed upon
by the parties, at a price set at the time of the contract. A currency swap is
an agreement to exchange cash flows based on the notional difference among two
or more currencies and operates similarly to an interest rate swap, which is
described below. The Fund may enter into currency transactions with
Counterparties which have received (or the guarantors of the obligations of such
Counterparties have received) a credit rating of A-1 or P-1 by S&P or Moody's,
respectively, or that have an equivalent rating from an NRSRO or (except for OTC
currency options) are determined to be of equivalent credit quality by the
Adviser.
The Fund's dealings in forward currency contracts and other currency
transactions such as futures, options, options on futures and swaps will be
limited to hedging involving either specific transactions or portfolio
positions. Transaction hedging is entering into a currency transaction with
respect to specific assets or liabilities of the Fund, which will generally
arise in connection with the purchase or sale of its portfolio securities or the
receipt of income therefrom. Position hedging is entering into a currency
transaction with respect to portfolio security positions denominated or
generally quoted in that currency.
The Fund will not enter into a transaction to hedge currency exposure to an
extent greater, after netting all transactions intended to wholly or partially
offset other transactions, than the aggregate market value (at the time of
entering into the transaction) of the securities held in its portfolio that are
denominated or generally quoted in or currently convertible into such currency
other than with respect to cross hedging and proxy hedging as described below.
The Fund may cross-hedge currencies by entering into transactions to purchase
or sell one or more currencies that are expected to decline in value relative to
other currencies to which the Fund has or in which the Fund expects to have
portfolio exposure.
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<PAGE> 21
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, the Fund may also engage in proxy
hedging. Proxy hedging is often used when the currency to which the Fund's
portfolio is exposed is difficult to hedge or to hedge against the dollar. Proxy
hedging entails entering into a forward contract to sell a currency whose
changes in value are generally considered to be linked to a currency or
currencies in which some or all of the Fund's portfolio securities are or are
expected to be denominated, and to buy U.S. dollars. For example, if the Adviser
considers the Austrian schilling is linked to the German deutschemark (the
"D-mark"), the Fund holds securities denominated in schillings and the Adviser
believes that that the value of schillings will decline against the U.S. dollar,
the Adviser may enter into a contract to sell D-marks and buy dollars. Currency
hedging involves some of the same risks and considerations as other transactions
with similar instruments. Currency transactions can result in losses to the Fund
if the currency being hedged fluctuates in value to a degree or in a direction
that is not anticipated. Further, there is the risk that the perceived linkage
between various currencies may not be present or may not be present during the
particular time that the Fund is engaging in proxy hedging. If the Fund enters
into a currency hedging transaction, the Fund will comply with the asset
segregation requirements described below.
RISKS OF CURRENCY TRANSACTIONS. Currency transactions are subject to risks
different from those of other portfolio transactions. Because currency control
is of great importance to the issuing governments and influences economic
planning and policy, purchases and sales of currency and related instruments can
be negatively affected by government exchange controls, blockages, and
manipulations or exchange restrictions imposed by governments. These can result
in losses to the Fund if it is unable to deliver or receive currency or funds in
settlement of obligations and could also cause hedges it has entered into to be
rendered useless, resulting in full currency exposure as well as incurring
transaction costs. Buyers and sellers of currency futures are subject to the
same risks that apply to the use of futures generally. Further, settlement of a
currency futures contract for the purchase of most currencies must occur at a
bank based in the issuing nation. Trading options on currency futures is
relatively new, and the ability to establish and close out positions on such
options is subject to the maintenance of a liquid market which may not always be
available. Currency exchange rates may fluctuate based on factors extrinsic to
that country's economy.
COMBINED TRANSACTIONS. The Fund may enter into multiple transactions,
including multiple options transactions, multiple futures transactions, multiple
currency transactions (including forward currency contracts), multiple interest
rate transactions and any combination of futures, options, currency and interest
rate transactions ("component" transactions), instead of a single Strategic
Transaction, as part of a single or combined strategy when, in the opinion of
the Adviser, it is in the best interest of the Fund to do so. A combined
transaction will usually contain elements of risk that are present in each of
its component transactions. Although combined transactions are normally entered
into based on the Adviser's judgment that the combined strategies will reduce
risk or otherwise more effectively achieve the desired portfolio management
goal, it is possible that the combination will instead increase such risks or
hinder achievement of the portfolio management objective.
SWAPS, CAPS, FLOORS AND COLLARS. Among the Strategic Transactions into which
the Fund may enter are interest rate, currency and index swaps and the purchase
or sale of related caps, floors and collars. The Fund expects 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. The 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 the
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. 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 cap to the
extent that a specified index exceeds a predetermined interest rate or amount.
The purchase of a floor 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.
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<PAGE> 22
A collar is a combination of a cap and a floor that preserves a certain return
within a predetermined range of interest rates or values.
The 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. Inasmuch as these swaps, caps,
floors and collars are entered into for good faith hedging purposes, the Adviser
and the Fund believe such obligations do not constitute senior securities under
the 1940 Act and, accordingly, will not treat them as being subject to its
borrowing restrictions. The Fund will not enter into any swap, cap, floor or
collar 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 S&P or Moody's or has an equivalent
equity rating from an 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 years with a large number of banks
and investment banking firms acting both as principals and agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid. Caps, floors and collars are more recent innovations for
which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than swaps.
EURODOLLAR INSTRUMENTS. The Fund may make investments in Eurodollar
instruments. Eurodollar instruments are U.S. dollar-denominated futures
contracts or options thereon which are linked to the London Interbank Offered
Rate ("LIBOR"), although foreign currency-denominated instruments are available
from time to time. Eurodollar futures contracts enable purchasers to obtain a
fixed rate for the lending of funds and sellers to obtain a fixed rate for
borrowings. The Fund might use Eurodollar futures contracts and options thereon
to hedge against changes in LIBOR, to which many interest rate swaps and income
instruments are linked.
RISKS OF STRATEGIC TRANSACTIONS OUTSIDE THE UNITED STATES. When conducted
outside the United States, Strategic Transactions may not be regulated as
rigorously as in the United States, may not involve a clearing mechanism and
related guarantee, and are subject to the risk of governmental actions affecting
trading in, or the prices of, foreign securities, currencies and other
instruments. The value of such positions also could be adversely affected by:
(i) other complex foreign political, legal and economic factors, (ii) lesser
availability than in the United States of data on which to make trading
decisions, (iii) delays in the Fund's ability to act upon economic events
occurring in foreign markets during non-business hours in the United States,
(iv) the imposition of different exercise and settlement terms and procedures
and margin requirements than in the United States, and (v) lower trading volume
and liquidity.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS. Many Strategic Transactions, in
addition to other requirements, require that the Fund segregate cash or liquid
securities with its custodian to the extent Fund obligations are not otherwise
"covered" through ownership of the underlying security, financial instrument or
currency. In general, either the full amount of any obligation by the Fund to
pay or deliver securities or assets must be covered at all times by the
securities, instruments or currency required to be delivered, or, subject to any
regulatory restrictions, an amount of cash or liquid securities at least equal
to the current amount of the obligation must be segregated with the custodian.
The segregated assets cannot be sold or transferred unless equivalent assets are
substituted in their place or it is no longer necessary to segregate them. For
example, a call option written by the Fund will require the Fund to hold the
securities subject to the call (or securities convertible into the needed
securities without additional consideration) or to segregate cash or liquid
securities sufficient to purchase and deliver the securities if the call is
exercised. A call option sold by the Fund on an index will require the Fund to
own portfolio securities which correlate with the index or to segregate cash or
liquid securities equal to the excess of the index value over the exercise price
on a current basis. A put option written by the Fund requires the Fund to
segregate cash or liquid securities equal to the exercise price.
Except when the Fund enters into a forward contract for the purchase or sale
of a security denominated in a particular currency, which requires no
segregation, a currency contract which obligates the Fund to buy or sell
currency will generally require the Fund to hold an amount of that currency or
liquid securities denominated in that currency equal to the Fund's obligations
or to segregate cash or liquid securities equal to the amount of the Fund's
obligation.
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<PAGE> 23
OTC options entered into by the Fund, including those on securities,
currencies, financial instruments or indices and OCC issued and exchange listed
index options, will generally provide for cash settlement. As a result, when the
Fund sells these instruments it will only segregate an amount of assets equal to
its accrued net obligations, as there is no requirement for payment or delivery
of amounts in excess of the net amount. These amounts will equal 100% of the
exercise price in the case of a non cash-settled put, the same as an OCC
guaranteed listed option sold by the Fund, or the in-the-money amount plus any
sell-back formula amount in the case of a cash-settled put or call. In addition,
when the Fund sells a call option on an index at a time when the in-the-money
amount exceeds the exercise price, the Fund will segregate, until the option
expires or is closed out, cash or liquid securities equal in value to such
excess. OCC issued and exchange listed options sold by the Fund other than those
above generally settle with physical delivery or with an election of either
physical delivery or cash settlement, and the Fund will segregate an amount of
assets equal to the full value of the option. OTC options settling with physical
delivery, or with an election of either physical delivery or cash settlement,
will be treated the same as other options settling with physical delivery.
In the case of a futures contract or an option thereon, the Fund must deposit
initial margin and possible daily variation margin in addition to segregating
assets sufficient to meet its obligation to purchase or provide securities or
currencies, or to pay the amount owed at the expiration of an index-based
futures contract. Such assets may consist of cash, cash equivalents, liquid debt
or equity securities or other acceptable assets.
With respect to swaps, the 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 securities having a
value equal to the accrued excess. Caps, floors and collars require segregation
of assets with a value equal to the Fund's net obligation, if any.
Strategic Transactions may be covered by other means when consistent with
applicable regulatory policies. The Fund may also enter into offsetting
transactions so that its combined position, coupled with any segregated assets,
equals its net outstanding obligation in related options and Strategic
Transactions. For example, the Fund could purchase a put option if the strike
price of that option is the same or higher than the strike price of a put option
sold by the Fund. Moreover, instead of segregating assets if the Fund held a
futures or forward contract, it could purchase a put option on the same futures
or forward contract with a strike price as high or higher than the price of the
contract held. Other Strategic Transactions may also be offset in combinations.
If the offsetting transaction terminates at the time of or after the primary
transaction no segregation is required, but if it terminates prior to such time,
assets equal to any remaining obligation would need to be segregated.
The Fund's activities involving Strategic Transactions may be limited by the
requirements of the Code for qualification as a regulated investment company.
See "Tax Status of the Fund."
REPURCHASE AGREEMENTS. The Fund may use up to 20% of its assets to enter into
repurchase agreements with selected commercial banks and broker-dealers, under
which the Fund acquires securities and agrees to resell the securities at an
agreed upon time and at an agreed upon price. The Fund accrues as interest the
difference between the amount it pays for the securities and the amount it
receives upon resale. At the time the Fund enters into a repurchase agreement,
the value of the underlying security including accrued interest will be equal to
or exceed the value of the repurchase agreement and, for repurchase agreements
that mature in more than one day, the seller will agree that the value of the
underlying security including accrued interest will continue to be at least
equal to the value of the repurchase agreement. The Adviser will monitor the
value of the underlying security in this regard. The Fund will enter into
repurchase agreements only with commercial banks whose deposits are insured by
the Federal Deposit Insurance Corporation and whose assets exceed $500 million
or broker-dealers who are registered with the SEC. In determining whether to
enter into a repurchase agreement with a bank or broker-dealer, the Fund will
take into account the credit-worthiness of such party and will monitor its
credit-worthiness on an ongoing basis. In the event of default by such party,
the delays and expenses potentially involved in establishing the Fund's rights
to, and in liquidating, the security may result in loss to the Fund. The Fund's
ability to invest in repurchase agreements that mature in more than seven days
is subject to an investment policy that limits the Fund's investments in
"illiquid" securities, including such repurchase agreements, to 15% of the
Fund's net assets.
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<PAGE> 24
"WHEN ISSUED" AND "DELAYED DELIVERY" TRANSACTIONS. The Fund may also purchase
and sell portfolio securities on a "when issued" and "delayed delivery" basis.
No income accrues to or is earned by the Fund on portfolio securities in
connection with such purchase transactions prior to the date the Fund actually
takes delivery of such securities. These transactions are subject to market
fluctuation; the value of such securities at delivery may be more or less than
their purchase price, and yields generally available on such securities when
delivery occurs may be higher or lower than yields on the such securities
obtained pursuant to such transactions. Because the Fund relies on the buyer or
seller, as the case may be, to consummate the transaction, failure by the other
party to complete the transaction may result in the Fund missing the opportunity
of obtaining a price or yield considered to be advantageous. When the Fund is
the buyer in such a transaction, however, it will maintain, in a segregated
account with its custodian, cash or liquid securities having an aggregate value
equal to the amount of such purchase commitments until payment is made. The Fund
will make commitments to purchase securities on such basis only with the
intention of actually acquiring these securities, but the Fund may sell such
securities prior to the settlement date if such sale is considered to be
advisable. To the extent the Fund engages in "when issued" and "delayed
delivery" transactions, it will do so for the purpose of acquiring securities
for the Fund's portfolio consistent with the Fund's investment objectives and
policies and not for the purposes of investment leverage. No specific limitation
exists as to the percentage of the Fund's assets which may be used to acquire
securities on a "when issued" or "delayed delivery" basis.
SHORT SALES. The Fund may make short sales of securities. A short sale is a
transaction in which the Fund sells a security it does not own in anticipation
that the market price of that security will decline. The Fund expects to make
short sales both to obtain capital gains from anticipated declines in securities
and as a form of hedging to offset potential declines in long positions in the
same or similar securities. The short sale of a security is considered a
speculative investment technique.
When the Fund makes a short sale, it must borrow the security sold short and
deliver it to the broker-dealer through which it made the short sale in order to
satisfy its obligation to deliver the security upon conclusion of the sale. The
Fund may have to pay a fee to borrow particular securities and is often
obligated to pay over any payments received on such borrowed securities.
The Fund's obligation to replace the borrowed security will be secured by
collateral deposited with the broker-dealer of cash or liquid securities. The
Fund will also be required to deposit similar collateral with its Custodian to
the extent, if any, necessary so that the value of both collateral deposits in
the aggregate is at all times equal to the greater of the price at which the
security is sold short or 100% of the current market value of the security sold
short. Depending on arrangements made with the broker-dealer from which it
borrowed the security regarding payment over of any payments received by the
Fund on such security, the Fund may not receive any payments (including
interest) on its collateral deposited with such broker-dealer. If the price of
the security sold short increases between the time of the short sale and the
time the Fund replaces the borrowed security, the Fund will incur a loss;
conversely, if the price declines, the Fund will realize a capital gain. Any
gain will be decreased, and any loss increased, by the transaction costs
described above. Although the Fund's gain is limited to the price at which it
sold the security short, its potential loss is theoretically unlimited.
The market value of the securities sold short of any one issuer will not
exceed either 5% of the Fund's total assets or 5% of such issuer's voting
securities. The Fund will not make a short sale, if, after giving effect to such
sale, the market value of all securities sold short exceeds 25% of the value of
its assets or the Fund's aggregate short sales of a particular class of
securities exceeds 25% of the outstanding securities of that class. The Fund may
also make short sales "against the box" without respect to such limitations. In
this type of short sale, at the time of the sale, the Fund owns or has the
immediate and unconditional right to acquire at no additional cost the identical
security.
LOANS OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, the Fund may lend its portfolio securities to selected commercial
banks or broker-dealers up to a maximum of 50% of the assets of the Fund. Such
loans must be callable at any time and be continuously secured by collateral
deposited by the borrower in a segregated account with the Fund's custodian
consisting of cash or of securities issued or guaranteed by the U.S. government
or its agencies, which collateral is equal at all times to at least 100% of the
B-24
<PAGE> 25
value of the securities loaned, including accrued interest. The Fund will
receive amounts equal to earned income for having made the loan. Any cash
collateral pursuant to these loans will be invested in short-term instruments.
The Fund is the beneficial owner of the loaned securities in that any gain or
loss in the market price during the loan inures to the Fund and its
shareholders. Thus, when the loan is terminated, the value of the securities may
be more or less than their value at the beginning of the loan. In determining
whether to lend its portfolio securities to a bank or broker-dealer, the Fund
will take into account the credit-worthiness of such borrower and will monitor
such credit-worthiness on an ongoing basis in as much as default by the other
party may cause delays or other collection difficulties. The Fund may pay
finders' fees in connection with loans of its portfolio securities.
BORROWINGS AND OTHER TECHNIQUES. The Fund may enter into reverse repurchase
agreements with respect to securities which could otherwise be sold by the Fund.
Reverse repurchase agreements involve sales by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price which is greater than the sales price. During the
reverse repurchase agreement period, the Fund continues to receive principal and
interest payments on these securities. Reverse repurchase agreements involve the
risk that the market value of the securities retained by the Fund may decline
below the price of the securities the Fund has sold but is obligated to
repurchase under the agreement. In the event the buyer of securities under a
reverse repurchase agreement files for bankruptcy or becomes insolvent, the
Fund's use of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to enforce
the Fund's obligation to repurchase the securities. Reverse repurchase
agreements will be treated as borrowings for the purposes of the Fund's
investment restriction on borrowings.
In order to seek high current income, the Fund may enter into dollar rolls in
which the Fund sells securities for delivery in the current month and
simultaneously contracts to repurchase, typically in 30 or 60 days,
substantially similar (same type and coupon) securities on a specified future
date from the same party at an agreed upon price which is less than the sales
price. During the roll period, the Fund forgoes principal and interest paid on
the securities. The Fund is compensated by the difference between the current
sales price and the forward price for the future purchase (often referred to as
the "drop") as well as by the interest earned on the cash proceeds of the
initial sale. The cash proceeds from the sale will be maintained by the Fund in
a segregated account with its custodian in which cash or liquid securities will
be equal in value to its obligations. Because such assets are maintained in a
segregated account, the Fund will not treat such obligations as senior
securities for purposes of the 1940 Act. A "covered roll" is a specific type of
dollar roll for which there is an offsetting cash position or cash equivalent
security position which matures on or before the forward settlement date of the
dollar roll transaction. "Covered rolls" are not subject to these segregation
requirements. Dollar rolls will be treated as borrowings for purposes of the
Fund's investment restriction on borrowings.
Borrowing by the Fund creates an opportunity for increased net income but, at
the same time, creates special risk considerations such as changes in the net
asset value of the Shares and in the yield on the Fund's portfolio. Although the
principal of such borrowings will be fixed, the Fund's assets may change in
value during the time the borrowing is outstanding. Borrowing will create
interest expenses for the Fund which can exceed the income from the assets
retained. To the extent the income derived from securities purchased with
borrowed funds exceeds the interest the Fund will have to pay, the Fund's net
income will be greater than if borrowing were not used. Conversely, if the
income from the assets retained with borrowed funds is not sufficient to cover
the cost of borrowing, the net income of the Fund will be less than if borrowing
were not used, and therefore the amount available for distribution to
shareholders as dividends will be reduced.
DEFENSIVE STRATEGIES. At times conditions in the markets may, in the Adviser's
judgment, make pursuing the Fund's basic investment strategy inconsistent with
the best interests of its shareholders. At such times, the Adviser may use
alternative strategies primarily designed to reduce fluctuations in the value of
the Fund's assets. In implementing these "defensive" strategies, the Fund may
invest a portion or all of the Fund's assets in high-quality, short-term
obligations. Such obligations may include: obligations of the U.S. Government,
its agencies or instrumentalities; other debt securities rated within the four
highest grades by either S&P or Moody's (or comparably rated by any other
NRSROs); commercial paper rated in the highest grade by either rating service
(or comparably rated by any other nationally recognized statistical rating
organization); certificates of deposit and bankers' acceptances; repurchase
agreements with respect to any of the foregoing investments; or any other income
securities that the Adviser considers consistent with such strategy. The yield
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<PAGE> 26
on these securities generally is lower than the yield on the types of income
securities in which the Fund will invest in normal market conditions.
CREDIT QUALITY. The Fund's policies with respect to credit quality of
portfolio investments will apply only at the time of purchase of a security, and
the Fund will not be required to dispose of a security in the event that S&P or
Moody's (or any other nationally recognized statistical rating organization) or,
in the case of unrated income securities, the Adviser, downgrades its assessment
of the credit characteristics of a particular issuer. In determining whether the
Fund will retain or sell such a security, the Adviser may consider such factors
as the Adviser's assessment of the credit quality of the issuer of such
security, the price at which such security could be sold and the rating, if any,
assigned to such security by other NRSROs.
LIQUIDITY. The Fund may invest up to 15% of its total assets in illiquid
securities, including securities the disposition of which is subject to
substantial legal or contractual restrictions on resale and securities that are
not readily marketable. The sale of such securities often requires more time and
results in higher brokerage charges or dealer discounts and other selling
expenses than does the sale of securities eligible for trading on national
securities exchanges or in the over-the-counter markets. Restricted securities
may sell at a price lower than similar securities that are not subject to
restrictions on resale. The Fund may, from time to time, adopt a more
restrictive limitation with respect to investment in illiquid and restricted
securities in order to comply with the most restrictive state securities law.
The Fund may invest in income securities not registered under the Securities Act
of 1933 (the "Securities Act"), but eligible for resale pursuant to Rule 144A
under the Securities Act. Rule 144A establishes a "safe harbor" from the
registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers. Institutional markets for
restricted securities have developed as a result of Rule 144A, providing both
readily ascertainable values for restricted securities and the ability to
liquidate an investment. Such markets include automated systems for the trading,
clearance and settlement of unregistered securities of domestic and foreign
issuers, such as the PORTAL System sponsored by the National Association of
Securities Dealers, Inc. ("NASD"). An insufficient number of qualified buyers
interested in purchasing Rule 144A-eligible restricted securities held by the
Fund, however, could affect adversely the marketability of such portfolio
securities and the Fund might be unable to dispose of such securities promptly
or at favorable prices. The Fund's limitations with respect to investment in
illiquid and restricted securities does not include restricted securities
eligible for resale pursuant to Rule 144A under the Securities Act of 1933, as
amended, which the Board of Trustees or the Fund's investment adviser has
determined under Board-approved guidelines to be liquid. The Fund's policy with
respect to investment in illiquid and restricted securities is not a fundamental
policy and may be changed by the Board of Trustees, in consultation with the
Adviser, without obtaining shareholder approval. Also excluded from this
limitation set forth above are the Fund's purchases of securities issued by
investment companies to the extent permitted by (i) the 1940 Act, as amended
from time to time, (ii) the rules and regulations promulgated by the SEC under
the 1940 Act, as amended from time to time, or (iii) an exemption or other
relief from the provision of the 1940 Act.
DESCRIPTION OF SECURITIES RATINGS
STANDARD & POOR'S RATINGS GROUP--A brief description of the applicable
Standard & Poor's Ratings Group (S&P) rating symbols and their meanings (as
published by S&P follows):
1. DEBT
A S&P corporate or municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors,
insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability
for a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not
perform an audit in connection with any rating and may, on occasion, rely
on unaudited financial information. The ratings may be changed, suspended,
or withdrawn as a result of changes in, or unavailability of, such
information, or based on other circumstances.
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<PAGE> 27
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of payment--capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms
of the obligation:
2. Nature of and provisions of the obligation:
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization, or other arrangement under the
laws of bankruptcy and other laws affecting creditor's rights.
LONG-TERM DEBT--INVESTMENT GRADE
AAA: Debt rated "AAA" has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA: Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A: Debt rated "A" has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in the higher rated categories.
BBB: Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
BB, B, CCC, CC, C: Debt rated "BB", "B", "CCC", "CC" and "C" is regarded as
having significantly speculative characteristics with respect to capacity to pay
interest and repay principal. "BB" indicates the least degree of speculation and
"C" the highest. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or large exposures
to adverse conditions.
BB: Debt rated "BB" is less vulnerable to default than other speculative
issues. However, it faces major ongoing uncertainties or exposure to adverse
business, financial, or economic conditions which could lead to inadequate
capacity to meet timely interest and principal payments. The "BB" rating
category is also used for debt subordinated to senior debt that is assigned an
actual or implied "BBB-" rating.
B: Debt rated "B" is more vulnerable to default but currently has the capacity
to meet interest payments and principal repayments. Adverse business, financial,
or economic conditions will likely impair capacity or willingness to pay
interest and repay principal. The "B" rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied "BB" or "BB-"
rating.
CCC: Debt rated "CCC" is currently vulnerable to default, and is dependent
upon favorable business, financial, and economic conditions to meet timely
payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
CC: Debt rated "CC" is currently highly vulnerable to nonpayment. The rating
"CC" is also used for debt subordinated to senior debt that is assigned an
actual or implied "CCC" rating.
C: The "C" rating may be used to cover a situation where a bankruptcy petition
has been filed, but debt service payments are continued. The rating "C"
typically is applied to debt subordinated to senior debt which is assigned an
actual or implied "CCC-" debt rating.
D: Debt rated "D" is in payment default. The "D" rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless
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<PAGE> 28
S&P believes that such payments will be made during such grace period. The 'D'
rating also will be used upon the filing of a bankruptcy petition if debt
service payments are jeopardized.
PLUS (+) OR MINUS (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
NR: Not rated.
R: This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe payment risk -- such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
DEBT OBLIGATIONS OF ISSUERS OUTSIDE THE UNITED STATES AND ITS TERRITORIES are
rated on the same basis as domestic corporate and municipal issues. The ratings
measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
BOND INVESTMENT QUALITY STANDARDS: Under present commercial bank regulations
issued by the Comptroller of the Currency, bonds rated in the top four
categories ("AAA", "AA", "A," "BBB", commonly known as "investment grade"
ratings) are generally regarded as eligible for bank investment. In addition,
the laws of various states governing legal investments impose certain rating or
other standards for obligations eligible for investment by savings banks, trust
companies, insurance companies and fiduciaries generally.
2. COMMERCIAL PAPER
A S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
Ratings are graded into several categories, ranging from "A-1" for the highest
quality obligations to "D" for the lowest. These categories are as follows:
A-1 This highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to
possess extremely strong safety characteristics are denoted with a
plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high
as for issues designated "A-1".
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects
of changes in circumstances than obligations carrying the higher
designations.
B Issues rated "B" are regarded as having significant speculative
characteristics.
C This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
D Debt rated "D" is in payment default. The "D" rating category is
used when interest payments or principal payments are not made on
the date due, even if the applicable grace period has not expired,
unless S&P believes that such payments will be made during such
grace period.
A commercial paper rating is not a recommendation to purchase, sell or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained from other sources it considers reliable. S&P does
not perform an audit in connection with any rating and may, on occasion, rely on
unaudited financial information. The ratings may be changed, suspended or
withdrawn as a result of changes in, or unavailability of, such information, or
based on other circumstances.
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<PAGE> 29
3. VARIABLE RATE DEMAND BONDS
S&P assigns "dual" ratings to all debt issues that have a put or demand
feature as part of their structure.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols for the put option (for
example, "AAA/A-"). With short-term demand debt, S&P's note rating symbols are
used with the commercial paper rating symbols (for example, "SP-1+/A-1+").
4. NOTES
An S&P note rating reflects the liquidity factors and market access risks
unique to notes. Notes maturing in 3 years or less will likely receive a note
rating. Notes maturing beyond 3 years will most likely receive a long-term debt
rating. The following criteria will be used in making that assignment:
-- Amortization schedule (the longer the final maturity relative to other
maturities, the more likely the issue is to be treated as a note).
-- Source of payment (the more the issue depends on the market for its
refinancing, the more likely it is to be treated as a note).
Note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues determined
to possess very strong safety characteristics will be given a
plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest with some
vulnerability to adverse financial and economic changes over the
term of the notes.
SP-3 Speculative capacity to pay principal and interest.
5. PREFERRED STOCK
A S&P preferred stock rating is an assessment of the capacity and willingness
of an issuer to pay preferred stock dividends and any applicable sinking fund
obligations. A preferred stock rating differs from a bond rating inasmuch as it
is assigned to an equity issue, which issue is intrinsically different from, and
subordinated to, a debt issue. Therefore, to reflect this difference, the
preferred stock rating symbol will normally not be higher than the bond rating
symbol assigned to, or that would be assigned to, the senior debt of the same
issuer.
The preferred stock ratings are based on the following considerations:
1. Likelihood of payment-capacity and willingness of the issuer to meet the
timely payment of preferred stock dividends and any applicable sinking fund
requirements in accordance with the terms of the obligation.
2. Nature of, and provisions of, the issuer.
3. Relative position of the issue in the event of bankruptcy, reorganization,
or other arrangements under the laws of bankruptcy and other laws affecting
creditors' rights.
AAA This is the highest rating that may be assigned by S&P to a
preferred stock issue and indicates an extremely strong
capacity to pay the preferred stock obligations.
AA A preferred stock issue rated "AA" also qualifies as a
high-quality, fixed income security. The capacity to pay
preferred stock obligations is very strong, although not as
overwhelming as for issues rated "AAA".
A An issue rated "A" is backed by a sound capacity to pay the
preferred stock obligations, although it is somewhat more
susceptible to the adverse effects of changes in
circumstances and economic conditions.
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<PAGE> 30
BBB An issue rated "BBB" is regarded as backed by an adequate
capacity to pay the preferred stock obligations. Whereas it
normally exhibits adequate protection parameters, adverse
economic conditions or changing circumstances are more
likely to lead to a weakened capacity to make payments for a
preferred stock in this category than for issues in the "A"
category.
BB Preferred stock rated "BB", "B", and "CCC" are regarded, on
B balance, as predominantly speculative with respect to the
CCC issuer's capacity to pay preferred stock obligations. "BB"
indicates the lowest degree of speculation and "CCC" the
highest. While such issues will likely have some quality and
protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
CC The rating "CC" is reserved for a preferred stock issue in
arrears on dividends or sinking fund payments, but that is
currently paying.
C A preferred stock rated "C" is a nonpaying issue.
D A preferred stock rated "D" is a nonpaying issue with the
issuer in default on debt instruments.
NR: This indicates that no rating has been requested, that there
is insufficient information on which to base a rating, or
that S&P does not rate a particular type of obligation as a
matter of policy.
PLUS (+) or MINUS (-): To provide more detailed indications
of preferred stock quality, ratings from "AA" to "CCC" may
be modified by the addition of a plus or minus sign to show
relative standing within the major rating categories.
A preferred stock rating is not a recommendation to purchase, sell, or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in, or unavailability of, such
information, or based on other circumstances.
MOODY'S INVESTORS SERVICE -- A brief description of the applicable Moody's
Investors Service (Moody's) rating symbols and their meanings (as published by
Moody's Investor Service) follows:
1. LONG-TERM DEBT
AAA: Bonds which are rated AAA are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt 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 which are rated AA are judged to be of high quality by all
standards. Together with the AAA group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than AAA securities.
A: Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
BAA: Bonds which are rated BAA are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payment and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA: Bonds which are rated BA are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B-30
<PAGE> 31
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA: Bonds which are rated CAA are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
CA: Bonds which are rated CA represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: Moody's applies the numerical modifiers 1, 2, and 3 in each generic
rating classification from AA to B. The modifier 1 indicates that the security
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates that the issue ranks in the
lower end of its generic rating category.
ABSENCE OF RATING: Where no rating has been assigned or where a rating has
been suspended or withdrawn, it may be for reasons unrelated to the quality of
the issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities or companies
that are not rated as a matter of policy.
3. There is a lack of essential data pertaining to the issue or
issuer.
4. The issue was privately placed, in which case the rating is not
published in Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise,
the effects of which preclude satisfactory analysis; if there is no longer
available reasonable up-to-date data to permit a judgment to be formed; if a
bond is called for redemption; or for other reasons.
2. SHORT-TERM DEBT
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations. These obligations have an original
maturity not exceeding one year unless explicitly noted.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issues:
Issuers rated Prime-1 (or supporting institutions) have a superior ability for
repayment of senior short-term debt obligations. Prime-1 repayment ability will
often be evidenced by many of the following characteristics:
--Leading market positions in well-established industries.
--High rates of return on funds employed.
--Conservative capitalization structure with moderate reliance on debt
and ample asset protection.
--Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
--Well-established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated Prime-2 (or supporting institutions) have a strong ability for
repayment or senior short-term debt obligations. This will normally be evidenced
by many of the characteristics cited above but to a lesser degree. Earnings
trends and coverage ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable ability
for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced.
B-31
<PAGE> 32
Variability in earnings and profitability may result in changes of the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
Issuers rated Not Prime do not fall within any of the Prime rating categories.
3. PREFERRED STOCK
Preferred stock rating symbols and their definitions are as follows:
AAA: An issue which is rated "AAA" is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least
risk of dividend impairment within the universe of preferred stocks.
AA: An issue which is rated "AA" is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance the
earnings and asset protection will remain relatively well maintained in the
foreseeable future.
A: An issue which is rated "A" is considered to be an
upper-medium-grade preferred stock. While risks are judged to be somewhat
greater than in the "AAA" and "AA" classifications, earnings and asset
protections are, nevertheless, expected to be maintained at adequate
levels.
BAA: An issue which is rated "BAA" is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and
asset protection appear adequate at present but may be questionable over
any great length of time.
BA: An issue which is rated "BA" is considered to have speculative
elements and its future cannot be considered well assured. Earnings and
asset protection may be very moderate and not well safeguarded during
adverse periods. Uncertainty of position characterizes preferred stocks in
this class.
B: An issue which is rated "B" generally lacks the characteristics of
a desirable investment. Assurance of dividend payments and maintenance of
other terms of the issue over any long period of time may be small.
CAA: An issue which is rated "CAA" is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payments.
CA: An issue which is rated "CA" is speculative in a high degree and
is likely to be in arrears on dividends with little likelihood of eventual
payment.
C: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from "AA" through "B" in its preferred stock rating system.
The modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and
the modifier 3 indicates that the issue ranks in the lower end of its
generic rating category.
B-32
<PAGE> 33
TRUSTEES AND OFFICERS
The tables below list the trustees and officers of the Trust (of which the
Fund is a separate series) and other executive officers of the Fund's investment
adviser and their principal occupations for the last five years and their
affiliations, if any, with VK/AC Holding, Inc. ("VKAC Holding"), Van Kampen
American Capital, Inc. ("Van Kampen American Capital" or "VKAC"), Van Kampen
American Capital Investment Advisory Corp. ("Advisory Corp."), Van Kampen
American Capital Asset Management, Inc. ("Asset Management"), Van Kampen
American Capital Distributors, Inc., the distributor of the Fund's shares (the
"Distributor") and ACCESS Investors Services Inc., the Fund's transfer agent
("ACCESS"). Advisory Corp. and Asset Management sometimes are referred to herein
collectively as the "Advisers". For purposes hereof, the term "Fund Complex"
includes each of the open-end investment companies advised by the Advisers
(excluding the Van Kampen American Capital Exchange Fund and the Common Sense
Trust).
TRUSTEES
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS OR
NAME, ADDRESS AND AGE EMPLOYMENT IN PAST 5 YEARS
--------------------- --------------------------
<S> <C>
J. Miles Branagan......................... Private investor. Co-founder, and prior to August 1996,
1632 Morning Mountain Road Chairman, Chief Executive Officer and President, MDT
Raleigh, NC 27614 Corporation (now known as Getinge/Castle, Inc., a
Date of Birth: 07/14/32 subsidiary of Getinge Industrier AB), a company which
develops, manufactures, markets and services medical and
scientific equipment. Trustee/Director of each of the
funds in the Fund Complex.
Richard M. DeMartini*..................... President and Chief Operating Officer, Individual Asset
Two World Trade Center Management Group, a division of Morgan Stanley, Dean
66th Floor Witter, Discover & Co. Mr. DeMartini is a Director of
New York, NY 10048 InterCapital Funds, Dean Witter Distributors, Inc. and
Date of Birth: 10/12/52 Dean Witter Trust Company. Trustee of the TCW/DW Funds.
Director of the National Healthcare Resources, Inc.
Formerly Vice Chairman of the Board of the National
Association of Securities Dealers, Inc. and Chairman of
the Board of the Nasdaq Stock Market, Inc.
Trustee/Director of each of the funds in the Fund
Complex.
Linda Hutton Heagy........................ Co-Managing Partner of Heidrick & Stuggles, an executive
Sears Tower search firm. Prior to 1997, Partner, Ray & Berndtson,
233 South Wacker Drive Inc., an executive recruiting and management consulting
Suite 7000 firm. Formerly, Executive Vice President of ABN AMRO,
Chicago, IL 60606 N.A., a Dutch bank holding company. Prior to 1992,
Date of Birth: 06/03/48 Executive Vice President of La Salle National Bank.
Trustee on the University of Chicago Hospitals Board, The
International House Board and the Women's Board of the
University of Chicago. Trustee/Director of each of the
funds in the Fund Complex.
R. Craig Kennedy.......................... President and Director, German Marshall Fund of the
11 DuPont Circle, N.W. United States. Formerly, advisor to the Dennis Trading
Washington, D.C. 20036 Group Inc. Prior to 1992, President and Chief Executive
Date of Birth: 02/29/52 Officer, Director and Member of the Investment Committee
of the Joyce Foundation, a private foundation.
Trustee/Director of each of the funds in the Fund
Complex.
Jack E. Nelson............................ President, Nelson Investment Planning Services, Inc., a
423 Country Club Drive financial planning company and registered investment
Winter Park, FL 32789 adviser. President, Nelson Ivest Brokerage Services Inc.,
Date of Birth: 02/13/36 a member of the National Association of Securities
Dealers, Inc. ("NASD") and Securities Investors
Protection Corp. ("SIPC"). Trustee/Director of each of
the funds in the Fund Complex.
</TABLE>
B-33
<PAGE> 34
<TABLE>
<S> <C>
Don G. Powell*............................ Chairman, President, Chief Executive Officer and a Director of VKAC.
2800 Post Oak Blvd. Chairman, Chief Executive Officer and a Director of the Advisers and
Houston, TX 77056 the Distributor. Chairman and a Director of ACCESS. Director or officer
Date of Birth: 10/19/39 of certain other subsidiaries of VKAC. Chairman of the Board of
Governors and the Executive Committee of the Investment Company
Institute. Prior to November, 1996, President, Chief Executive Officer
and a Director of VKAC Holding. Trustee/Director of funds in the Fund
Complex advised by Advisory Corp. and prior to July 1996, President,
Chief Executive Officer and a Trustee of the funds in the Fund Complex.
Jerome L. Robinson........................ President, Robinson Technical Products Corporation, a manufacturer and
115 River Road processor of welding alloys, supplies and equipment. Director,
Edgewater, NJ 07020 Pacesetter Software, a software programming company specializing in
Date of Birth: 10/10/22 white collar productivity. Director, Panasia Bank. Trustee/Director of
each of the funds in the Fund Complex.
Phillip B. Rooney......................... Vice Chairman and Director of The ServiceMaster Company, a business and
One ServiceMaster Way consumer services. Director of Illinois Tool Works, Inc., a
Downers Grove, IL 60515 manufacturing company; the Urban Shopping Centers Inc., a retail mall
Date of Birth: 07/08/44 management company; and Stone Container Corp., a paper manufacturing
company. Trustee, University of Notre Dame. Formerly, President and
Chief Executive Officer, Waste Management Inc., an environmental
services company, and prior to that President and Chief Operating
Officer, Waste Management Inc. Trustee/Director of each of the funds in
the Fund Complex.
Fernando Sisto............................ Professor Emeritus and, prior to 1995, Dean of the Graduate School,
155 Hickory Lane Stevens Institute of Technology. Director, Dynalysis of Princeton, a
Closter, NJ 07624 firm engaged in engineering research. Trustee/Director of each of the
Date of Birth: 08/02/24 funds in the Fund Complex.
Wayne W. Whalen*.......................... Partner in the law firm of Skadden, Arps, Slate, Meagher & Flom
333 West Wacker Drive (Illinois), legal counsel to the funds in the Fund Complex, open-end
Chicago, IL 60606 funds advised by Van Kampen American Capital Management, Inc. and
Date of Birth: 08/22/39 closed-end funds advised by Advisory Corp. Trustee/Director of each of
the funds in the Fund Complex, open-end funds advised by Van Kampen
American Capital Management, Inc. and closed-end funds advised by
Advisory Corp.
</TABLE>
- ---------------
* Such trustee is an "interested person" (within the meaning of Section 2(a)(19)
of the 1940 Act). Mr. Whalen is an interested person of the Fund by reason of
his firm currently acting as legal counsel to the Fund and is an interested
person of Asset Management with respect to certain funds advised by Asset
Management by reason of his firm in the past acting as legal counsel to Asset
Management. Messrs. DeMartini and Powell are interested persons of the Fund
and the Advisers by reason of their positions with the Adviser or its
affiliates.
B-34
<PAGE> 35
OFFICERS
Messrs. McDonnell, Hegel, Nyberg, Wood, Sullivan, Dalmaso, Martin, Wetherell
and Hill are located at One Parkview Plaza, Oakbrook Terrace, IL 60181. The
Fund's other officers are located at 2800 Post Oak Blvd., Houston, TX 77056.
<TABLE>
<CAPTION>
POSITIONS AND PRINCIPAL OCCUPATIONS
NAME AND AGE OFFICES WITH FUND DURING PAST 5 YEARS
------------ ----------------- ---------------------
<S> <C> <C>
Dennis J. McDonnell......... President President and a Director of VKAC.
Date of Birth: 05/20/42 President, Chief Operating Officer and a
Director of the Advisers. Director or
officer of certain other subsidiaries of
VKAC. Prior to November 1996, Executive
Vice President and a Director of VKAC
Holding. President of each of the funds in
the Fund Complex. President, Chairman of
the Board and Trustee of other investment
companies advised by the Advisers or their
affiliates.
Peter W. Hegel.............. Vice President Executive Vice President of the Advisers.
Date of Birth: 06/25/56 Director of Asset Management. Officer of
certain other subsidiaries of VKAC. Vice
President of each of the funds in the Fund
Complex and certain other investment
companies advised by the Advisers or their
affiliates.
Curtis W. Morell............ Vice President and Chief Senior Vice President of the Advisers, Vice
Date of Birth: 08/04/46 Accounting Officer President and Chief Accounting Officer of
each of the funds in the Fund Complex and
certain other investment companies advised
by the Advisers or their affiliates.
Ronald A. Nyberg............ Vice President and Secretary Executive Vice President, General Counsel
Date of Birth: 07/29/53 and Secretary of VKAC. Executive Vice
President, General Counsel, Assistant
Secretary and a Director of the Advisers
and the Distributor. Executive Vice
President, General Counsel and Assistant
Secretary of ACCESS. Director or officer of
certain other subsidiaries of VKAC.
Director of ICI Mutual Insurance Co., a
provider of insurance to members of the
Investment Company Institute. Prior to
November 1996, Executive Vice President,
General Counsel and Secretary of VKAC
Holding. Vice President and Secretary of
each of the funds in the Fund Complex and
certain other investment companies advised
by the Advisers or their affiliates.
Alan T. Sachtleben.......... Vice President Executive Vice President of the Advisers.
Date of Birth: 04/20/42 Director of Asset Management. Director or
officer of certain other subsidiaries of
VKAC. Vice President of each of the funds
in the Fund Complex and certain other
investment companies advised by the
Advisers or their affiliates.
</TABLE>
B-35
<PAGE> 36
<TABLE>
<CAPTION>
POSITIONS AND PRINCIPAL OCCUPATIONS
NAME AND AGE OFFICES WITH FUND DURING PAST 5 YEARS
------------ ----------------- ---------------------
<S> <C> <C>
Paul R. Wolkenberg.......... Vice President Executive Vice President of VKAC, the
Date of Birth: 11/10/44 Advisers and the Distributor. President,
Chief Executive Officer and a Director of
ACCESS. Director or officer of certain
other subsidiaries of VKAC. Vice President
of each of the funds in the Fund Complex
and certain other investment companies
advised by the Advisers or their
affiliates.
Edward C. Wood III.......... Vice President and Chief Senior Vice President of the Advisers. Vice
Date of Birth: 01/11/56 Financial Officer President and Chief Financial Officer of
each of the funds in the Fund Complex and
certain other investment companies advised
by the Advisers or their affiliates.
John L. Sullivan............ Treasurer First Vice President of the Advisers.
Date of Birth: 08/20/55 Treasurer of each of the funds in the Fund
Complex and certain other investment
companies advised by the Advisers or their
affiliates.
Tanya M. Loden.............. Controller Vice President of the Advisers. Controller
Date of Birth: 11/19/59 of each of the funds in the Fund Complex
and other investment companies advised by
the Advisers or the affiliates.
Nicholas Dalmaso............ Assistant Secretary Vice President and Assistant Secretary of
Date of Birth: 03/01/65 VKAC. Vice President and Assistant
Secretary of the Advisers and the
Distributor. Officer of certain other
subsidiaries of VKAC. Assistant Secretary
of each of the funds in the Fund Complex
and other investment companies advised by
the Advisers or the affiliates.
Huey P. Falgout, Jr......... Assistant Secretary Assistant Vice President and Senior
Date of Birth: 11/15/63 Attorney of VKAC. Assistant Vice President
and Assistant Secretary of the Advisers,
the Distributor and ACCESS. Officer of
certain other subsidiaries of VKAC.
Assistant Secretary of each of the funds in
the Fund Complex and other investment
companies advised by the Advisers or the
affiliates.
Scott E. Martin............. Assistant Secretary Senior Vice President, Deputy General
Date of Birth: 08/20/56 Counsel and Assistant Secretary of VKAC.
Senior Vice President, Deputy General
Counsel and Secretary of the Advisers, the
Distributor and ACCESS. Officer of certain
other subsidiaries of VKAC. Prior to
November 1996, Senior Vice President,
Deputy General Counsel and Assistant
Secretary of VKAC Holding. Assistant
Secretary of each of the funds in the Fund
Complex and other investment companies
advised by the Advisers or the affiliates.
</TABLE>
B-36
<PAGE> 37
<TABLE>
<CAPTION>
POSITIONS AND PRINCIPAL OCCUPATIONS
NAME AND AGE OFFICES WITH FUND DURING PAST 5 YEARS
------------ ----------------- ---------------------
<S> <C> <C>
Weston B. Wetherell......... Assistant Secretary Vice President, Associate General Counsel
Date of Birth: 06/15/56 and Assistant Secretary of VKAC, the
Advisers and the Distributor. Officer of
certain other subsidiaries of VKAC.
Assistant Secretary of each of the funds in
the Fund Complex and other investment
companies advised by the Advisers or the
affiliates.
Steven M. Hill.............. Assistant Treasurer Assistant Vice President of the Advisers.
Date of Birth: 10/16/64 Assistant Treasurer of each of the funds in
the Fund Complex and other investment
companies advised by the Advisers or the
affiliates.
M. Robert Sullivan.......... Assistant Controller Assistant Vice President of the Advisers.
Date of Birth: 03/30/33 Assistant Controller of each of the funds
in the Fund Complex and other investment
companies advised by the Advisers or the
affiliates.
</TABLE>
Each trustee/director holds the same position with each of the funds in the
Fund Complex. As of the date of this Statement of Additional Information, there
are 65 operating funds in the Fund Complex. For purposes of the following
compensation and benefits discussion, the Fund Complex is divided into the
following three groups: the funds advised by Asset Management (the "AC Funds"),
the funds advised by Advisory Corp. excluding funds organized as series of the
Morgan Stanley Fund, Inc. (the "VK Funds") and the funds advised by Advisory
Corp. organized as series of the Morgan Stanley Fund, Inc. (the "MS Funds").
Each trustee/director who is not an affiliated person of VKAC, the Advisers, the
Distributor, ACCESS or Morgan Stanley (each a "Non-Affiliated Trustee") is
compensated by an annual retainer and meeting fees for services to the funds in
the Fund Complex. Each fund in the Fund Complex provides a deferred compensation
plan to its Non-Affiliated Trustees that allows trustees/directors to defer
receipt of their compensation and earn a return on such deferred amounts.
Deferring compensation has the economic effect as if the Non-Affiliated Trustee
reinvested his or her compensation into the funds. As of the date hereof, each
AC Fund and VK Fund provides a retirement plan to its Non-Affiliated Trustees
that provides Non-Affiliated Trustees with compensation after retirement,
provided that certain eligibility requirements are met as more fully described
below. As of January 1, 1998, it is anticipated that each fund in the Fund
Complex, except the money market series of the MS Funds, will provide such a
retirement plan to its Non-Affiliated Trustees.
The trustees recently reviewed and adopted a standardized compensation and
benefits program for each fund in the Fund Complex. Effective January 1, 1998,
the compensation of each Non-Affiliated Trustee includes an annual retainer in
an amount equal to $50,000 per calendar year, due in four quarterly installments
on the first business day of each quarter. Payment of the annual retainer is
allocated among the funds in the Fund Complex (except the money market series of
the MS Funds) on the basis of the relative net assets of each fund as of the
last business day of the preceding calendar quarter. Effective January 1, 1998,
the compensation of each Non-Affiliated Trustee includes a per meeting fee from
each fund in the Fund Complex (except the money market series of the MS Funds)
in the amount of $200 per quarterly or special meeting attended by the
Non-Affiliated Trustee, due on the date of the meeting, plus reasonable expenses
incurred by the Non-Affiliated Trustee in connection with his or her services as
a trustee, provided that no compensation will be paid in connection with certain
telephonic special meetings.
For each AC Fund's last fiscal year and the period up to and including
December 31, 1997, the compensation of each Non-Affiliated Trustee from the AC
Funds includes an annual retainer in an amount equal to $35,000 per calendar
year, due in four quarterly installments on the first business day of each
calendar quarter. The AC Funds pay each Non-Affiliated Trustee a per meeting fee
in the amount of $2,000 per regular quarterly meeting attended by the
Non-Affiliated Trustee, due on the date of such meeting, plus reasonable
expenses incurred by the Non-Affiliated Trustee in connection with his or her
services as a trustee. Payment of the annual retainer and the regular meeting
fee is allocated among the AC Funds (i) 50% on the basis of the relative net
assets of each AC Fund to the aggregate net assets of all the AC Funds and (ii)
50% equally to
B-37
<PAGE> 38
each AC Fund, in each case as of the last business day of the preceding calendar
quarter. Each AC Fund which is the subject of a special meeting of the trustees
generally pays each Non-Affiliated Trustee a per meeting fee in the amount of
$125 per special meeting attended by the Non-Affiliated Trustee, due on the date
of such meeting, plus reasonable expenses incurred by the Non-Affiliated Trustee
in connection with his or her services as a trustee, provided that no
compensation will be paid in connection with certain telephonic special
meetings.
For each VK Fund's last fiscal year and the period up to and including
December 31, 1997, the compensation of each Non-Affiliated Trustee from each VK
Fund includes an annual retainer in an amount equal to $2,500 per calendar year,
due in four quarterly installments on the first business day of each calendar
quarter. Each Non-Affiliated Trustee receives a per meeting fee from each VK
Fund in the amount of $125 per regular quarterly meeting attended by the
Non-Affiliated Trustee, due on the date of such meeting, plus reasonable
expenses incurred by the Non-Affiliated Trustee in connection with his or her
services as a trustee. Each Non-Affiliated Trustee receives a per meeting fee
from each VK Fund in the amount of $125 per special meeting attended by the
Non-Affiliated Trustee, due on the date of such meeting, plus reasonable
expenses incurred by the Non-Affiliated Trustee in connection with his or her
services as a trustee, provided that no compensation will be paid in connection
with certain telephonic special meetings.
For the period from July 2, 1997 up to and including December 31, 1997, the
compensation of each Non-Affiliated Trustee from the MS Funds is intended to be
based generally on the compensation amounts and methodology used by such funds
prior to their joining the current Fund Complex on July 2, 1997. Each
trustee/director was elected as a director of the MS Funds on July 2, 1997.
Prior to July 2, 1997, the MS Funds were part of another fund complex (the
"Prior Complex") and the former directors of the MS Funds were paid an aggregate
fee allocated among the funds in the Prior Complex that resulted in individual
directors receiving total compensation between approximately $8,000 to $10,000
from the MS Funds during such funds' last fiscal year.
The trustees/directors were subject to a voluntary aggregate compensation cap
with respect to funds in the Fund Complex of $84,000 per Non-Affiliated Trustee
per year (excluding any retirement benefits) for the period July 22, 1995
through December 31, 1996, subject to the net assets and the number of funds in
the Fund Complex as of July 21, 1995 and certain other exceptions. For the
calendar year ended December 31, 1996, certain trustees/directors received
aggregate compensation from the funds in the Fund Complex over $84,000 due to
compensation received but not subject to the cap, including compensation from
new funds added to the Fund Complex after July 22, 1995 and certain special
meetings in 1996. In addition, each of Advisory Corp. or Asset Management, as
the case may be, agreed to reimburse each fund in the Fund Complex through
December 31, 1996 for any increase in the aggregate compensation over the
aggregate compensation paid by such fund in its 1994 fiscal year, provided that
if a fund did not exist for the entire 1994 fiscal year appropriate adjustments
will be made.
Under the deferred compensation plan, each Non-Affiliated Trustee generally
can elect to defer receipt of all or a portion of the compensation earned by
such Non-Affiliated Trustee until retirement. Amounts deferred are retained by
the Fund and earn a rate of return determined by reference to the return on the
common shares of such Fund or other funds in the Fund Complex as selected by the
respective Non-Affiliated Trustee, with the same economic effect as if such
Non-Affiliated Trustee had invested in one or more funds in the Fund Complex. To
the extent permitted by the 1940 Act, the Fund may invest in securities of those
funds selected by the Non-Affiliated Trustees in order to match the deferred
compensation obligation. The deferred compensation plan is not funded and
obligations thereunder represent general unsecured claims against the general
assets of the Fund.
Under the retirement plan, a Non-Affiliated Trustee who is receiving
compensation from such Fund prior to such Non-Affiliated Trustee's retirement,
has at least 10 years of service (including years of service prior to adoption
of the retirement plan) and retires at or after attaining the age of 60, is
eligible to receive a retirement benefit equal to $2,500 per year for each of
the ten years following such retirement from such Fund. Non-Affiliated Trustees
retiring prior to the age of 60 or with fewer than 10 years but more than 5
years of service may receive reduced retirement benefits from such Fund. Each
trustee/director has served as a member of the Board of Trustees of the Fund
since he or she was first appointed or elected in the year set forth below. The
B-38
<PAGE> 39
retirement plan contains a Fund Complex retirement benefit cap of $60,000 per
year. Asset Management had reimbursed each AC Fund for the expenses related to
the retirement plan through December 31, 1996.
Additional information regarding compensation and benefits for trustees is set
forth below. As indicated in the notes accompanying the table, the amounts
relate to either the Fund's most recently completed fiscal year or the Fund
Complex' most recently completed calendar year ended December 31, 1996.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
PENSION OR ESTIMATED MAXIMUM BEFORE DEFERRAL
AGGREGATE COMPENSATION RETIREMENT BENEFITS ANNUAL BENEFITS FROM FUND
BEFORE DEFERRAL FROM THE ACCRUED AS PART OF FROM THE TRUST UPON COMPLEX PAID
NAME(1) TRUST(2) EXPENSES(3) RETIREMENT(4) TO TRUSTEE(5)
------- ------------------------ ------------------- ------------------- ---------------
<S> <C> <C> <C> <C>
J. Miles Branagan* $10,500 $1,861 $7,500 $104,875
Linda Hutton Heagy* 10,500 200 7,500 104,875
Dr. Roger Hilsman 5,250 0 0 103,750
R. Craig Kennedy* 10,500 149 7,500 104,875
Donald C. Miller 5,250 7,059 4,250 104,875
Jack E. Nelson* 9,750 1,038 7,500 97,875
Jerome L. Robinson* 10,500 7,858 4,250 101,625
Phillip B. Rooney* 2,250 0 7,500 0
Dr. Fernando Sisto* 10,500 3,200 5,250 104,875
Wayne W. Whalen* 10,500 770 7,500 104,875
William S. Woodside 5,250 0 0 104,875
</TABLE>
- ---------------
* Currently a member of the Board of Trustees. Mr. Phillip B. Rooney became a
member of the Board of Trustees effective April 14, 1997 and thus does not
have a full fiscal year of information to report.
(1) Persons not designated by an asterisk are not currently members of the Board
of Trustees, but were members of the Board of Trustees during the Fund's
most recently completed fiscal year. Messrs. Hilsman, Miller and Woodside
retired from the Board of Trustees on December 31, 1996. Messrs. DeMartini,
McDonnell and Powell, also trustees of the Fund during all or a portion of
the Fund's last fiscal year, are not included in the compensation table
because they are affiliated persons of the Advisers and are not eligible for
compensation or retirement benefits from the Fund.
(2) The amounts shown in this column represent the Aggregate Compensation before
Deferral from all three series of the Trust, including the Fund, with
respect to the Trust's fiscal year ended June 30, 1997. The detail of
aggregate compensation before deferral for each series, including the Fund,
is shown in Table A below. The following trustees deferred compensation from
the Trust during the fiscal year ended June 30, 1997; the aggregate amount
deferred from all three series of the Trust, including the Fund, is as
follows: Mr. Branagan, $7,125; Ms. Heagy, $8,250; Mr. Kennedy, $2,250; Mr.
Miller, $4,875; Mr. Nelson, $9,375; Mr. Robinson, $9,375; Dr. Sisto, $2,250;
and Mr. Whalen, $9,375. The details of amounts deferred for each series,
including the Fund, is shown in Table B below. Amounts deferred are retained
by the Fund and earn a rate of return determined by reference to either the
return on the common shares of the Fund or other funds in the Fund Complex
as selected by the respective Non-Affiliated Trustee, with the same economic
effect as if such Non-Affiliated Trustee had invested in one or more funds
in the Fund Complex. To the extent permitted by the 1940 Act, each Fund may
invest in securities of those funds selected by the Non-Affiliated Trustees
in order to match the deferred compensation obligation. The cumulative
deferred compensation (including interest) accrued with respect to each
trustee, including former trustees, from all three series of the Trust,
including the Fund, as of June 30, 1997 is as follows: Mr. Branagan, $7,917;
Mr. Gaughan, $11,229; Ms. Heagy, $14,076; Mr. Kennedy, $28,809; Mr. Miller,
$27,966; Mr. Nelson, $37,572; Mr. Rees, $8,071; Mr. Robinson, $35,118; Dr.
Sisto, $2,445; and Mr. Whalen, $32,052. The detail of deferred compensation
(including interest) for each series, including the Fund, is shown in Table
C below. The deferred compensation plan is described above the Compensation
Table.
(3) The amounts shown in this column represent the Retirement Benefits accrued
by all three series of the Trust, including the Fund, for each trustee
during the Trust's fiscal year ended June 30, 1997. The retirement plan is
described above the Compensation Table. The details of retirement benefits
accrued for
B-39
<PAGE> 40
each Series, including the Fund, are shown in Table D below. Amounts accrued
during the Trust's last fiscal year for former trustees not named above was
$3,291.
(4) For Messrs. Hilsman, Miller and Woodside, this is the actual annual benefits
payable from all three series of the Trust, including the Fund, in each year
of the 10-year period since such trustee's retirement. For the remaining
trustees, this is the estimated maximum annual benefits payable from all
three series of the Trust, including the Fund, in each year of the 10-year
period commencing in the year of such trustee's retirement from the Trust
based on the earlier of the trustee's anticipated retirement date or the
trustee having 10 or more years of service on the Board of Trustees
(including years of service prior to the adoption of the retirement plan)
and retiring at or after attaining the age of 60. Trustees retiring prior to
the age of 60 or with fewer than 10 years of service for the Fund may
receive reduced retirement benefits from the Fund. The actual annual benefit
may be less if the trustee is subject to the Fund Complex retirement benefit
cap or if the trustee is not fully vested at the time of retirement. Each
Non-Affiliated Trustee of the Board of Trustees has served as a member of
the Board of Trustees since he or she was first appointed or elected in the
year set forth in Table E below.
(5) The amounts shown in this column represent the aggregate compensation paid
by all 51 operating investment companies in the Fund Complex as of December
31, 1996 before deferral by the trustees under the deferred compensation
plan. Because the funds in the Fund Complex have different fiscal year ends,
the amounts shown in this column are presented on a calendar year basis. As
described in the narrative preceding the table, the Fund Complex has
increased in size since December 31, 1996. It is likely the aggregate
compensation from the Fund Complex for the calendar year ending December 31,
1997 will be higher due to the increased size of the Fund Complex during
1997. The trustees recently reviewed and adopted a standardized compensation
and benefits program to become effective January 1, 1998 which program is
described in more detail in the narrative preceding this table. Certain
trustees deferred all or a portion of their aggregate compensation from the
Fund Complex during the calendar year ended December 31, 1996. The deferred
compensation earns a rate of return determined by reference to the return on
the shares of the funds in the Fund Complex as selected by the respective
Non-Affiliated Trustee, with the same economic effect as if such
Non-Affiliated Trustee had invested in one or more funds in the Fund
Complex. To the extent permitted by the 1940 Act, the Fund may invest in
securities of those investment companies selected by the Non-Affiliated
Trustees in order to match the deferred compensation obligation. The
trustees' Fund Complex compensation cap covered the period July 22, 1995
through December 31, 1996. For the calendar year ended December 31, 1996,
certain trustees received compensation over $84,000 in the aggregate due to
compensation received but not subject to the cap, including compensation
from new funds added to the Fund Complex after July 22, 1995 and certain
special meetings in 1996. The Advisers and their affiliates also serve as
investment adviser for other investment companies; however, with the
exception of Messrs. McDonnell, Powell and Whalen, the trustees were not
trustees of such investment companies. Combining the Fund Complex with other
investment companies advised by the Advisers and their affiliates, Mr.
Whalen received Total Compensation of $243,375 during the calendar year
ended December 31, 1996.
B-40
<PAGE> 41
TABLE A
FISCAL YEAR 1997 AGGREGATE COMPENSATION FROM THE TRUST AND EACH SERIES
<TABLE>
<CAPTION>
TRUSTEE
FISCAL ----------------------------------------------------------------------------
FUND NAME YEAR-END BRANAGAN HEAGY HILSMAN KENNEDY MILLER NELSON ROBINSON ROONEY
--------- -------- -------- ----- ------- ------- ------ ------ -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
High Yield Fund.......................... 06/30 $ 3,500 $ 3,500 $1,750 $ 3,500 $1,750 $3,250 $ 3,500 $ 750
Short-Term Global Income Fund............ 06/30 3,500 3,500 1,750 3,500 1,750 3,250 3,500 750
Strategic Income Fund.................... 06/30 3,500 3,500 1,750 3,500 1,750 3,250 3,500 750
Trust Total............................ $10,500 $10,500 $5,250 $10,500 $5,250 $9,750 $10,500 $2,250
<CAPTION>
TRUSTEE
----------------------------
FUND NAME SISTO WHALEN WOODSIDE
--------- ----- ------ --------
<S> <C> <C> <C>
High Yield Fund.......................... $ 3,500 $ 3,500 $1,750
Short-Term Global Income Fund............ 3,500 3,500 1,750
Strategic Income Fund.................... 3,500 3,500 1,750
Trust Total............................ $10,500 $10,500 $5,250
</TABLE>
TABLE B
FISCAL YEAR 1997 AGGREGATE COMPENSATION DEFERRED FROM
THE TRUST AND EACH SERIES
<TABLE>
<CAPTION>
TRUSTEE
FISCAL ------------------------------------------------------------------
FUND NAME YEAR-END BRANAGAN HEAGY HILSMAN KENNEDY MILLER NELSON ROBINSON
--------- -------- -------- ----- ------- ------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High Yield Fund............................. 06/30 $2,375 $2,750 $0 $ 750 $1,625 $3,125 $3,125
Short-Term Global Income Fund............... 06/30 2,375 2,750 0 750 1,625 3,125 3,125
Strategic Income Fund....................... 06/30 2,375 2,750 0 750 1,625 3,125 3,125
Trust Total............................... $7,125 $8,250 $0 $2,250 $4,875 $9,375 $9,375
<CAPTION>
TRUSTEE
-----------------------------------
FUND NAME ROONEY SISTO WHALEN WOODSIDE
--------- ------ ----- ------ --------
<S> <C> <C> <C> <C>
High Yield Fund............................. $0 $ 750 $3,125 $0
Short-Term Global Income Fund............... 0 750 3,125 0
Strategic Income Fund....................... 0 750 3,125 0
Trust Total............................... $0 $2,250 $9,375 $0
</TABLE>
TABLE C
FISCAL YEAR 1997 CUMULATIVE COMPENSATION DEFERRED (PLUS INTEREST)
FROM THE TRUST AND EACH SERIES
<TABLE>
<CAPTION>
TRUSTEE
FISCAL ------------------------------------------------------------------------------
YEAR-
FUND NAME END BRANAGAN HEAGY HILSMAN KENNEDY MILLER NELSON ROBINSON ROONEY
--------- ------ -------- ----- ------- ------- ------ ------ -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
High Yield Fund......................... 06/30 $2,639 $ 4,692 $0 $ 9,603 $ 9,322 $12,524 $11,706 $0
Short-Term Global Income Fund........... 06/30 2,639 4,692 0 9,603 9,322 12,524 11,706 0
Strategic Income Fund................... 06/30 2,639 4,692 0 9,603 9,322 12,524 11,706 0
Trust Total........................... $7,917 $14,076 $0 $28,809 $27,966 $37,572 $35,118 $0
<CAPTION>
TRUSTEE
---------------------------
FUND NAME SISTO WHALEN WOODSIDE
--------- ----- ------ --------
<S> <C> <C> <C>
High Yield Fund......................... $ 815 $10,684 $0
Short-Term Global Income Fund........... 815 10,684 0
Strategic Income Fund................... 815 10,684 0
Trust Total........................... $2,445 $32,052 $0
</TABLE>
TABLE D
FISCAL YEAR 1997 RETIREMENT BENEFITS ACCRUED AS PART OF EXPENSES
FOR THE TRUST AND EACH SERIES
<TABLE>
<CAPTION>
TRUSTEE
FISCAL -----------------------------------------------------------------
FUND NAME YEAR-END BRANAGAN HEAGY HILSMAN KENNEDY MILLER NELSON ROBINSON
--------- -------- -------- ----- ------- ------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High Yield Fund.............................. 06/30 $ 630 $ 68 $0 $ 52 $3,896 $ 389 $2,812
Short-Term Income Fund....................... 06/30 624 67 0 50 3,163 347 2,719
Strategic Income Fund........................ 06/30 607 65 0 47 0 302 2,327
Trust Total................................ $1,861 $200 $0 $149 $7,059 $1,038 $7,858
<CAPTION>
TRUSTEE
-----------------------------------
FUND NAME ROONEY SISTO WHALEN WOODSIDE
--------- ------ ----- ------ --------
<S> <C> <C> <C> <C>
High Yield Fund.............................. $0 $1,085 $293 $0
Short-Term Income Fund....................... 0 1,072 257 0
Strategic Income Fund........................ 0 1,043 220 0
Trust Total................................ $0 $3,200 $770 $0
</TABLE>
TABLE E
YEAR OF ELECTION OR APPOINTMENT TO EACH SERIES OF THE TRUST
<TABLE>
<CAPTION>
TRUSTEE
--------------------------------------------------------------------------------------------
FUND NAME BRANAGAN HEAGY HILSMAN KENNEDY MILLER NELSON ROBINSON ROONEY SISTO WHALEN
- --------- -------- ----- ------- ------- ------ ------ -------- ------ ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
High Yield Fund.................... 1995 1995 1995 1993 1986 1986 1992 1997 1995 1986
Short-Term Global Income Fund...... 1995 1995 1995 1993 1990 1990 1992 1997 1995 1990
Strategic Income Fund.............. 1995 1995 1995 1993 1993 1993 1993 1997 1995 1993
<CAPTION>
TRUSTEE
--------
FUND NAME WOODSIDE
- --------- --------
<S> <C>
High Yield Fund.................... 1995
Short-Term Global Income Fund...... 1995
Strategic Income Fund.............. 1995
</TABLE>
B-41
<PAGE> 42
As of October 6, 1997, the trustees and officers of the Fund as a group owned
less than 1% of the shares of the Fund. As of October 6, 1997, no trustee or
officer of the Fund owns or would be able to acquire 5% or more of the common
stock of VK/AC Holding, Inc. Mr. McDonnell owns, or has the opportunity to
purchase, an equity interest in VK/AC Holding, Inc., the parent company of Van
Kampen American Capital, and has entered into an employment contract (for a term
until February 17, 1998) with Van Kampen American Capital.
As of October 6, 1997, no person was known by the Fund to own beneficially or
to hold of record as much as 5% of the outstanding Class A Shares, Class B
Shares or Class C Shares of the Fund, except as follows:
<TABLE>
<CAPTION>
AMOUNT OF
OWNERSHIP AT CLASS OF PERCENTAGE
NAME AND ADDRESS OF HOLDER OCTOBER 6, 1997 SHARES OWNERSHIP
- -------------------------- --------------- -------- ----------
<S> <C> <C> <C>
Van Kampen American Capital Trust Company................... 442,224 A 12.22%
2800 Post Oak Blvd. 360,414 B 5.89%
Houston, TX 77056
Van Kampen American Capital TR.............................. 189,586 A 5.24%
IRA R/O Robert J Holuba
2 Hackensack Ave
Kearny, NJ 07032-4511
Edward D. Hones and Co. F/A/O............................... 18,380 C 6.22%
Edward D. Jones & Co. Custodian
FBO Herman L. Dumming IRA
EDJ #271-90019-1-5
P.O. Box 2500
Maryland Hts, MO 63043-8500
MLPF&S For the Sole......................................... 684,335 B 11.18%
Benefit of Its Customers 17,935 C 6.07%
Attn: Fund Administration
4800 Deer Lake Drive E
3rd Floor
Jacksonville, FL 32246-6484
</TABLE>
Van Kampen American Capital Trust Company acts as custodian for certain
employee benefit plans and independent retirement accounts.
LEGAL COUNSEL
Counsel to the Fund is Skadden, Arps, Slate, Meagher & Flom (Illinois).
TRANSFER AGENCY
During the fiscal periods ended June 30, 1997 and 1996, ACCESS, shareholder
service agent and dividend disbursing agent for the Fund, received fees
aggregating $158,700 and $128,300, respectively, for these services. These
services are provided at cost plus a profit.
INVESTMENT ADVISORY AND OTHER SERVICES
INVESTMENT ADVISORY AGREEMENT
Van Kampen American Capital Investment Advisory Corp. (the "Adviser") is the
Fund's investment adviser. The Adviser's principal office is located at One
Parkview Plaza, Oakbrook Terrace, Illinois 60181. The Adviser is a wholly-owned
subsidiary of Van Kampen American Capital, Inc. ("Van Kampen American Capital"),
which is an indirect wholly-owned subsidiary of Morgan Stanley, Dean Witter,
Discover & Co.
The investment advisory agreement provides that the Adviser will supply
investment research and portfolio management, including the selection of
securities for the Fund to purchase. The Adviser also administers the business
affairs of the Fund, furnishes offices, necessary facilities and equipment,
provides administrative
B-42
<PAGE> 43
services, and permits its officers and employees to serve without compensation
as officers of the Fund and trustees of the Trust if duly elected to such
positions.
The investment advisory agreement between the Adviser and the Fund provides
that the Adviser will supply investment research and portfolio management,
including the selection of securities for the Fund to purchase, hold or sell and
the selection of brokers through whom the Fund's portfolio transactions are
executed. The Adviser also administers the business affairs of the Fund,
furnishes offices, necessary facilities and equipment, provides administrative
services, and permits its officers and employees to serve without compensation
as trustees of the Trust and officers of the Fund if duly elected to such
positions.
The agreement provides that the Adviser shall not be liable for any error of
judgment or of law, or for any loss suffered by the Fund in connection with the
matters to which the agreement relates, except a loss resulting from willful
misfeasance, bad faith, or gross negligence on the part of the Adviser in the
performance of its obligations and duties, or by reason of its reckless
disregard of its obligations and duties under the agreement.
The Adviser's activities are subject to the review and supervision of the
Board of Trustees of the Trust, of which the Fund is a series, to whom the
Adviser renders periodic reports of the Fund's investment activities.
The investment advisory agreement for the Fund will continue in effect from
year to year if specifically approved by the trustees of the Trust, of which the
Fund is a separate series (or by the Fund's shareholders), and by the
disinterested trustees in compliance with the requirements of the 1940 Act. The
agreement may be terminated without penalty upon 60 days' written notice by
either party thereto and will automatically terminate in the event of
assignment.
The investment advisory agreement specifies that the Adviser will reimburse
the Fund for annual expenses of the Fund which exceed the most stringent limit
prescribed by any state in which the Fund's shares are offered for sale. In
addition to making any required reimbursements, the Adviser may in its
discretion, but is not obligated to, waive all or any portion of its fee or
assume all or any portion of the expenses of the Fund.
For the fiscal years ended June 30, 1997, 1996 and 1995, the Fund recognized
advisory expenses of $1,132,304, $927,893 and $798,331, respectively.
OTHER AGREEMENTS
ACCOUNTING SERVICES AGREEMENT. The Fund has also entered into an accounting
services agreement pursuant to which the Adviser provides accounting services
supplementary to those provided by the Custodian. Such services are expected to
enable the Fund to more closely monitor and maintain its accounts and records.
The Fund shares equally, together with the other funds advised by the Adviser
and its affiliates and distributed by the Distributor, in 25% of the cost of
providing such services, with the remaining 75% of such cost being paid by the
Fund and such other funds based proportionally on their respective net assets.
For the fiscal years ended June 30, 1997, 1996 and 1995, the Fund recognized
expenses of approximately $6,200, $5,000 and $4,500, respectively, representing
the Adviser's cost of providing accounting services.
LEGAL SERVICES AGREEMENT. The Fund and other funds advised by the Adviser and
distributed by the Distributor have entered into Legal Services Agreements
pursuant to which Van Kampen American Capital provides legal services, including
without limitation: maintenance of the fund's minute books and records,
preparation and oversight of the fund's regulatory reports, and other
information provided to shareholders, as well as responding to day-to-day legal
issues on behalf of the funds. Payment by the Fund for such services is made on
a cost basis for the salary and salary related benefits, including but not
limited to bonuses, group insurances and other regular wages for the employment
of personnel, as well as overhead and the expenses related to the office space
and the equipment necessary to render the legal services. Other funds
distributed by the Distributor also receive legal services from Van Kampen
American Capital. Of the total costs for legal services provided to funds
distributed by the Distributor, one half of such costs are allocated equally to
each fund and the remaining one half of such costs are allocated to specific
funds based on monthly time records.
B-43
<PAGE> 44
For the fiscal years ended June 30, 1997, 1996 and 1995, the Fund recognized
expenses of approximately $13,600, $8,700 and $12,000, respectively,
representing Van Kampen American Capital, Inc.'s cost of providing legal
services.
CUSTODIAN AND INDEPENDENT ACCOUNTANTS
State Street Bank and Trust Company, 225 West Franklin Street, P.O. Box 1713,
Boston, MA 02105-1713, is the custodian of the Fund and has custody of all
securities and cash of the Fund. The custodian, among other things, attends to
the collection of principal and income, and payment for and collection of
proceeds of securities bought and sold by the Fund.
The independent accountants for the Fund are KPMG Peat Marwick LLP, Chicago,
Illinois. The selection of independent accountants will be subject to
ratification by the shareholders of the Fund at any annual meeting of
shareholders.
PORTFOLIO TRANSACTIONS AND BROKERAGE ALLOCATION
The Adviser will place orders for portfolio transactions for the Fund with
broker-dealer firms giving consideration to the quality, quantity and nature of
each firm's professional services. These services include execution, clearance
procedures, wire service quotations and statistical and other research
information provided to the Fund, or the Adviser, including quotations necessary
to determine the value of the Fund's net assets. Any research benefits derived
are available for all clients of the Adviser. Since statistical and other
research information is only supplementary to the research efforts of the
Adviser to the Fund and still must be analyzed and reviewed by its staff, the
receipt of research information is not expected to materially reduce its
expenses.
If it is believed to be in the best interests of the Fund, the Adviser may
place portfolio transactions with brokers who provide the types of research
service described above, even if it means the Fund will have to pay a higher
commission (or, if the broker's profit is part of the cost of the security, will
have to pay a higher price for the security), than would be the case if no
weight were given to the broker's furnishing of those research services. This
will be done, however, only if, in the opinion of the Fund's Adviser, the amount
of additional commission or increased cost is reasonable in relation to the
value of such services.
In selecting among the firms believed to meet the criteria for handling a
particular transaction, the Adviser may take into consideration that certain
firms (i) provide market, statistical or other research information such as that
set forth above to the Fund and the Adviser, (ii) have sold or are selling
shares of the Fund and (iii) may select firms that are affiliated with the Fund,
its investment adviser or its distributor and other principal underwriters. If
purchases or sales of securities of the Fund and of one or more other investment
companies or clients supervised by the Adviser are considered at or about the
same time, transactions in such securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by the
Adviser, taking into account the respective sizes of the Fund and other
investment companies and clients and the amount of securities to be purchased or
sold. Although it is possible that in some cases this procedure could have a
detrimental effect on the price or volume of the security as far as the Fund is
concerned, it is also possible that the ability to participate in volume
transactions and to negotiate lower brokerage commissions will be beneficial to
the Fund.
While the Adviser will be primarily responsible for the placement of the
Fund's business, the policies and practices in this regard must be consistent
with the foregoing and will at all times be subject to review by the trustees of
the Trust, of which the Fund is a separate series.
The trustees have adopted certain policies incorporating the standards of Rule
17e-1 issued by the SEC under the 1940 Act which requires that the commissions
paid to the Distributor and other affiliates of the Fund must be reasonable and
fair compared to the commissions, fees or other remuneration received or to be
received by other brokers in connection with comparable transactions involving
similar securities during a comparable period of time. The rule and procedures
also contain review requirements and require the Adviser to furnish reports to
the trustees and to maintain records in connection with such reviews. After
consideration
B-44
<PAGE> 45
of all factors deemed relevant, the trustees will consider from time to time
whether the advisory fee for the Fund will be reduced by all or a portion of the
brokerage commission given to affiliated brokers.
State securities laws may differ from the interpretations of federal law
expressed herein, and banks and financial institutions may be required to
register as dealers pursuant to state law.
During the year ended June 30, 1997, the Fund paid no brokerage commissions on
transactions to brokers related to research services provided to the Adviser.
Effective October 31, 1996, Morgan Stanley Group Inc. ("Morgan Stanley")
became an affiliate of the Adviser. Effective May 31, 1997, Dean Witter Discover
& Co. ("Dean Witter") became an affiliate of the Adviser.
<TABLE>
<CAPTION>
AFFILIATED BROKERS
----------------------------
BROKERS MORGAN STANLEY DEAN WITTER
------- -------------- -----------
<S> <C> <C> <C>
Commissions paid:
Fiscal year 1995........................................ $ 0 N/A N/A
Fiscal year 1996........................................ $ 0 N/A N/A
Fiscal year 1997........................................ $53,126 $ 0 $ 0
Fiscal year 1997 Percentages:
Commissions with affiliate to total commissions......... 0% 0%
Value of brokerage transactions with affiliate to total
transactions......................................... 0% 0%
</TABLE>
TAX STATUS OF THE FUND
FEDERAL INCOME TAXATION. The Fund has qualified and intends to continue to
qualify each year to be treated as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). To
qualify as a regulated investment company, the Fund must comply with certain
requirements of the Code relating to, among other things, the source of its
income and diversification of its assets. Included among such requirements is
the requirement that the Fund must derive at least 90% of its gross income from
dividends, interest, payments with respect to securities loans and gains from
the sale or other disposition of stocks, securities or foreign currencies or
other income (including but not limited to gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stocks, securities or currencies. For purposes of this requirement, the Treasury
Department is authorized to issue (but has not yet issued) regulations excluding
from qualifying income foreign currency gains that are not directly related to a
regulated investment company's principal business of investing in stocks or
securities (or options and futures with respect to stocks or securities). The
Fund expects that all of its foreign currency gains will be directly related to
its principal business of investing in securities.
If the Fund so qualifies and distributes each year to its Shareholders at
least 90% of its net investment income (which includes tax-exempt income and net
short-term capital gain, but not net capital gains, which are the excess of net
long-term capital gains over net short-term capital losses) in each year, it
will not be required to pay federal income taxes on any income distributed to
Shareholders. The Fund intends to distribute at least the minimum amount of net
investment income necessary to satisfy the 90% distribution requirement. The
Fund will not be subject to federal income tax on any net capital gains
distributed to Shareholders.
In order to avoid a 4% excise tax, the Fund will be required to distribute, by
December 31 of each year, at least 98% of its ordinary income (not including
tax-exempt income) for such year and at least 98% of its capital gain net income
(the latter of which generally is computed on the basis of the one-year period
ending on October 31 of such year), plus any amounts that were not distributed
in previous taxable years. For purposes of the excise tax, any ordinary income
or capital gain net income retained by and subject to federal income tax in the
hands of, the Fund will be treated as having been distributed.
If the Fund failed to qualify as a regulated investment company or failed to
satisfy the 90% distribution requirement in any taxable year, the Fund would be
taxed as an ordinary corporation on its taxable income
B-45
<PAGE> 46
(even if such income were distributed to its Shareholders) and all distributions
out of earnings and profits would be taxed to Shareholders as ordinary income.
To qualify again as a regulated investment company in a subsequent year, the
Fund may be required to pay an interest charge on 50% of its earnings and
profits attributable to non-regulated investment company years and would be
required to distribute such earnings and profits to Shareholders (less any
interest charge). In addition, if the Fund failed to qualify as a regulated
investment company for its first taxable year or, if immediately after
qualifying as a regulated investment company for any taxable year, it failed to
qualify for a period greater than one taxable year, the Fund would be required
to recognize any net built-in gains (the excess of aggregate gains, including
items of income, over aggregate losses that would have been realized if it had
been liquidated) in order to qualify as a regulated investment company in a
subsequent year.
Some of the Fund's investment practices (including those involving certain
risk management transactions and foreign currency transactions) may be subject
to special provisions of the Code that, among other things, defer the use of
certain losses of the Fund and affect the holding period of the securities held
by the Fund and the character of the gains or losses realized by the Fund. These
provisions may also require the Fund to recognize income or gain without
receiving cash with which to make distributions in amounts necessary to satisfy
the 90% distribution requirement and the distribution requirements for avoiding
income and excise taxes. The Fund will monitor its transactions and may make
certain tax elections in order to mitigate the effect of these rules and prevent
disqualification of the Fund as a regulated investment company.
Investments of the Fund in securities issued at a discount or providing for
deferred interest or payment of interest in kind are subject to special tax
rules that will affect the amount, timing and character of distributions to
Shareholders. For example, with respect to securities issued at a discount, the
Fund will be required to accrue as income each year a portion of this discount
and to distribute such income each year in order to maintain its qualification
as a regulated investment company and to avoid income and excise taxes. In order
to generate sufficient cash to make distributions necessary to satisfy the 90%
distribution requirement and to avoid income and excise taxes, the Fund may have
to dispose of securities that it would otherwise have continued to hold.
The Fund's ability to dispose of portfolio securities may be limited by the
requirement for qualification as a regulated investment company that less than
30% of the Fund's annual gross income be derived from the disposition of
securities held for less than three months. Under recently enacted legislation,
this requirement will no longer be applicable to the Fund beginning on July 1,
1998.
PASSIVE FOREIGN INVESTMENT COMPANIES. The Fund may invest in the stock of
"passive foreign investment companies" ("PFICs"). A PFIC is a foreign
corporation that, in general, meets either of the following tests: (1) at least
75% of its gross income is passive income or (2) an average of at least 50% of
its assets produce, or are held for the production of, passive income. Under
certain circumstances, a regulated investment company that holds stock of a PFIC
will be subject to federal income tax on a portion of any "excess distribution"
received on such stock or of any gain on disposition of the stock (collectively
"PFIC income"), plus interest thereon, even if the regulated investment company
distributes the PFIC income as a taxable dividend to its shareholders. The
balance of the PFIC income will be included in the regulated investment
company's investment company taxable income and, accordingly, will not be
taxable to it to the extent that income is distributed to its shareholders. If
the Fund invests in a PFIC and elects to treat the PFIC as a "qualified electing
fund," then in lieu of the foregoing tax and interest obligation, the Fund would
be required to include in income each year its pro rata share of the qualified
electing fund's annual ordinary earnings and net capital gain, which most likely
would have to be distributed to satisfy the 90% distribution requirement and the
distribution requirement for avoiding income and excise taxes. In most instances
it will be very difficult to make this election due to certain requirements
imposed with respect to the election.
Under provisions of the Taxpayer Relief Act of 1997 (the "1997 Tax Act")
generally effective for taxable years ending after 1997, the Fund may make an
election to annually mark-to-market certain publicly traded PFIC stock (a "PFIC
Mark-to-Market Election"). "Marking-to-market," in this context, means
recognizing as ordinary income or loss each year an amount equal to the
difference between the Fund's adjusted tax basis in such PFIC stock and its fair
market value. Losses will be allowed only to the extent of net mark-to-market
gain previously included by the Fund pursuant to the election for prior taxable
years. The Fund may be
B-46
<PAGE> 47
required to include in its taxable income for the first taxable year in which it
makes a PFIC Mark-to-Market Election an amount equal to the interest charge that
would otherwise accrue with respect to distributions on, or dispositions of, the
PFIC stock. This amount would not be deductible from the Fund's taxable income.
The PFIC Mark-to-Market Election applies to the taxable year for which made and
to all subsequent taxable years, unless the PFIC stock ceases to be publicly
traded or the Internal Revenue Service consents to revocation of the election.
By making the PFIC Mark-to-Market Election, the Fund could ameliorate the
adverse tax consequences arising from its ownership of PFIC stock, but in any
particular year may be required to recognize income in excess of the
distributions it receives from the PFIC and proceeds from the dispositions of
PFIC stock.
DISTRIBUTIONS. Distribution of the Fund's net investment income are taxable to
Shareholders as ordinary income to the extent of the Fund's earnings and
profits, whether paid in cash or reinvested in additional Shares. Distributions
of the Fund's net capital gains ("capital gains dividends"), if any, are taxable
to Shareholders at the rates applicable to long-term capital gains regardless of
the length of time Shares of the Fund have been held by such Shareholders.
Distributions in excess of the Fund's earnings and profits will first reduce the
adjusted tax basis of a holder's Shares and, after such adjusted tax basis is
reduced to zero, will constitute capital gains to such holder (assuming such
Shares are held as a capital asset). For a summary of the tax rates applicable
to capital gains (including capital gains dividends), see "Capital Gains Rates
Under the 1997 Tax Act" below. The Fund will inform Shareholders of the source
and tax status of all distributions promptly after the close of each calendar
year. A portion of the distributions from the Fund will be eligible for the
dividends received deduction for corporations if the Fund receives qualifying
dividends during the year and if certain other requirements of the Code are
satisfied.
Shareholders receiving distributions in the form of additional Shares issued
by the Fund will be treated for federal income tax purposes as receiving a
distribution in an amount equal to the fair market value of the Shares received,
determined as of the distribution date. The basis of such Shares will equal the
fair market value on the distribution date.
Although dividends generally will be treated as distributed when paid,
dividends declared in October, November, or December, payable to Shareholders of
record on a specified date in such a month and paid during January of the
following year will be treated as having been distributed by the Fund and
received by the Shareholders on the December 31 prior to the date of payment. In
addition, certain other distributions made after the close of a taxable year of
the Fund may be "spilled back" and treated as paid by the Fund (except for
purposes of the 4% excise tax) during such taxable year. In such case,
Shareholders will be treated as having received such dividends in the taxable
year in which the distribution was actually made.
The Fund is required, is certain circumstances, to withhold 31% of taxable
dividends and certain other payments, including redemptions, paid to
Shareholders who do not furnish to the Fund their correct taxpayer
identification number (in the case of individuals, their social security number)
and certain required certifications or who are otherwise subject to backup
withholding.
FOREIGN TAXES. It is expected that a portion of the interest earned by the
Fund from non-U.S. resident issuers and in certain circumstances gains realized
by the Fund will be subject to foreign withholding taxes. The tax rate to which
such interest and gains will be subject will vary depending on the country or
countries having taxing jurisdiction over a particular non-U.S. resident issuer
and may be affected by the existence of an income tax treaty with the United
States. If more than 50% of the value of the Fund's total assets at the close of
any taxable year consists of stocks or securities of "foreign corporations," the
Fund may elect and currently intends to elect, for United States federal income
tax purposes, to treat any foreign taxes paid by the Fund that can be treated as
foreign income taxes under United States federal income tax principles as paid
by its Shareholders. The Fund expects that it will be able to treat some, but
not necessarily all, of the foreign taxes it will have to pay as foreign income
taxes for United States federal income tax purposes. In addition, the Fund
currently intends to treat investments in securities that are issued by, or that
are treated under relevant United States federal income tax principles as issued
by, foreign governments as not constituting securities of "foreign corporations"
for purposes of meeting the 50% test described above. Accordingly, the Fund may
not qualify for this election in all of its taxable years. For any year that the
Fund so qualifies and makes such an election, the amount of foreign taxes paid
by the Fund that can be treated as foreign income taxes for United States
federal
B-47
<PAGE> 48
income tax purposes would be included in the income of its Shareholders (in
addition to other taxable dividends received) and (subject to certain
limitations) Shareholders would be entitled to credit their portions of these
amounts against their United States federal income tax due, if any, or to deduct
their portions from their United States taxable income, if any. A Shareholder
who does not itemize deductions may not claim a deduction for foreign taxes. The
Fund will notify each Shareholder within 60 days after the close of the Fund's
taxable year as to whether the foreign income taxes paid by the Fund will
qualify for "pass-through" treatment for that year and, if so, such notification
will designate (i) each Shareholder's pro rata portion of the foreign income
taxes paid and (ii) the portion of distributions that represents income derived
from foreign sources.
Generally, a foreign tax credit is subject to the limitation that it may not
exceed the Shareholder's United States tax (before the credit) attributable to
the Shareholder's total taxable income from foreign sources. For this purpose,
the Shareholder's proportionate share of dividends paid by the Fund that
represent income derived from foreign sources will be treated as foreign source
income. The Fund's gains and losses from the sale of securities and certain
currency gains and losses generally will be treated as derived from United
States sources. The limitation on the foreign tax credit applies separately to
specific categories of foreign source income, including "passive income," a
category that includes the portion of dividends received from the Fund that
qualifies as foreign source income. The foregoing limitation may prevent a
Shareholder from claiming a credit for the full amount of his proportionate
share of the foreign income taxes paid by the Fund.
SALES OF SHARES. The sale of Shares (including transfers in connection with a
redemption or repurchase of Shares) will be a taxable transaction for federal
income tax purposes. Selling Shareholders will generally recognize gain or loss
in an amount equal to the difference between their adjusted tax basis in the
Shares and the amount received. If such Shares are held as a capital asset, the
gain or loss will be a capital gain or loss. For a summary of the tax rates
applicable to capital gains, see "Capital Gains Rates Under the 1997 Tax Act"
below. Any loss recognized upon a taxable disposition of Shares held for six
months or less will be treated as a long-term capital loss to the extent of any
capital gains dividends received with respect to such Shares. For purposes of
determining whether Shares have been held for six months or less, the holding
period is suspended for any periods during which the Shareholder's risk of loss
is diminished as a result of holding one or more other positions in
substantially similar or related property or through certain options or short
sales.
CAPITAL GAINS RATES UNDER THE 1997 TAX ACT. Under the 1997 Tax Act, the
maximum tax rates applicable to net capital gains recognized by individuals and
other non-corporate taxpayers are (i) the same as ordinary income rates for
capital assets held for one year or less, (ii) 28% for capital assets held for
more than one year but not more than 18 months and (iii) 20% for capital assets
held for more than 18 months. Under the 1997 Tax Act, the Treasury is authorized
to issue regulations that address the application of the new capital gains rates
to sales and exchanges by regulated investment companies and to sales and
exchanges of interests in regulated investment companies, but no such
regulations have been issued as of the date hereof. It is expected that the new
tax rates for capital gains under the 1997 Tax Act described above will apply to
distributions of capital gains dividends by regulated investment companies such
as the Fund as well as to sales and exchanges of shares in regulated investment
companies such as the Fund. With respect to capital losses recognized on
dispositions of shares held six months or less where such losses are treated as
long-term capital losses to the extent of prior capital gains dividends received
on such shares (see "Sale of Shares" above), it is unclear how such capital
losses offset the capital gains referred to above. Shareholders should consult
their own tax advisors as to the application of the new capital gains rates to
their particular circumstances.
GENERAL. The federal income tax discussion set forth above is for general
information only. Prospective investors should consult their advisors regarding
the specific federal tax consequences of purchasing, holding and disposing of
Shares, as well as the effects of state, local and foreign tax law and any
proposed tax law changes.
THE DISTRIBUTOR
The Distributor offers one of the industry's broadest lines of investments --
encompassing mutual funds, closed-end funds and unit investment trusts -- assets
which have been entrusted to Van Kampen American Capital in more than 2 million
investor accounts. Van Kampen American Capital has one of the largest research
teams (outside of the rating agencies) in the country.
B-48
<PAGE> 49
The Distributor acts as the principal underwriter of the Fund's shares
pursuant to a written agreement (the "Distribution and Service Agreement"). The
Distributor has the exclusive right to distribute shares of the Fund through
dealers. The Distributor's obligation is an agency or "best efforts" arrangement
under which the Distributor is required to take and pay for only such shares of
the Fund as may be sold to the public. The Distributor is not obligated to sell
any stated number of shares. The Distributor bears the cost of printing (but not
typesetting) prospectuses used in connection with this offering and certain
other costs, including the cost of supplemental sales literature and
advertising. The Distribution and Service Agreement is renewable from year to
year if approved (a) by the Fund's Trustees or by a vote of a majority of the
Fund's outstanding voting securities and (b) by the affirmative vote of a
majority of Trustees who are not parties to the Distribution and Service
Agreement or interested persons of any party, by votes cast in person at a
meeting called for such purpose. The Distribution and Service Agreement provides
that it will terminate if assigned, and that it may be terminated without
penalty by either party on 90 days' written notice. Total underwriting
commissions on the sale of shares of the Fund for the fiscal periods indicated
are as follows:
<TABLE>
<CAPTION>
AMOUNTS
TOTAL UNDERWRITING RETAINED
COMMISSIONS BY DISTRIBUTOR
------------------ --------------
<S> <C> <C>
Fiscal Year Ended June 30, 1997............................. $214,184 $26,483
Fiscal Year Ended June 30, 1996............................. $195,066 $28,532
</TABLE>
DISTRIBUTION AND SERVICE PLANS
The Fund has adopted a distribution plan (the "Distribution Plan") with
respect to each class of its shares pursuant to Rule 12b-1 under the 1940 Act.
The Fund also has adopted a service plan (the "Service Plan") with respect to
each class of its shares. The Distribution Plan and the Service Plan sometimes
are referred to herein as the "Plans." The Plans provide that the Fund may spend
a portion of the Fund's average daily net assets attributable to each class of
shares in connection with distribution of the respective class of shares and in
connection with the provision of ongoing services to shareholders of such class,
respectively. The Plans are being implemented through the Distribution and
Service Agreement with the Distributor, sub-agreements between the Distributor
and members of the NASD acting as securities dealers and NASD members or
eligible non-members who are acting as brokers or agents and similar agreements
between the Fund and financial intermediaries acting as brokers (collectively,
"Selling Agreements") that may provide for their customers or clients certain
services or assistance, which may include, but not be limited to, processing
purchase and redemption transactions, establishing and maintaining shareholder
accounts regarding the Fund, and such other services as may be agreed to from
time to time and as may be permitted by applicable statute, rule or regulation.
Brokers, dealers and financial intermediaries that have entered into
sub-agreements with the Distributor and sell shares of the Fund are referred to
herein as "financial intermediaries."
The Distributor must submit quarterly reports to the Board of Trustees of the
Trust, of which the Fund is a series, setting forth separately by class of
shares all amounts paid under the Plans and the purposes for which such
expenditures were made, together with such other information as from time to
time is reasonably requested by the Trustees. The Plans provide that it will
continue in full force and effect from year to year so long as such continuance
is specifically approved by a vote of the Trustees, and also by a vote of the
disinterested Trustees, cast in person at a meeting called for the purpose of
voting on the Plans. The Plans may not be amended to increase materially the
amount to be spent for the services described therein with respect to either
class of shares without approval by a vote of a majority of the outstanding
voting shares of such class, and all material amendments of the Plans must be
approved by the Trustees and also by the disinterested Trustees. The Plans may
be terminated with respect to either class of shares at any time by a vote of a
majority of the disinterested Trustees or by a vote of a majority of the
outstanding voting shares of such class.
For the year ended June 30, 1995, the Fund has recognized expenses under the
Plans of $74,777, $487,064 and $20,370 for the Class A Shares, Class B Shares
and Class C Shares, respectively, of which $64,495, $119,407 and $2,755
represent payments to financial intermediaries under the Selling Agreements for
Class A Shares, Class B Shares and Class C Shares, respectively. For the year
ended June 30, 1995, the Fund has reimbursed the Distributor $5,464, $15,985 and
$0 for advertising expenses, and $7,717, $10,727 and $0 for
B-49
<PAGE> 50
compensation of the Distributor's sales personnel for the Class A Shares, Class
B Shares and Class C Shares, respectively.
For the year ended June 30, 1996, the Fund has recognized expenses under the
Plans of $79,707, $569,681 and $25,454 for the Class A Shares, Class B Shares
and Class C Shares, respectively, of which $65,647, $115,828 and $9,418
represent payments to financial intermediaries under the Selling Agreements for
Class A Shares, Class B Shares and Class C Shares, respectively.
For the period ended June 30, 1997, the Fund has recognized expenses under the
Plans of $92,954, $693,534 and $34,770 for the Class A Shares, Class B Shares
and Class C Shares, respectively, of which $92,954, $168,821 and $16,770
represent payments to financial intermediaries under the Selling Agreements for
Class A Shares, Class B Shares and Class C Shares, respectively.
For the fiscal year ended June 30, 1997, the Fund's aggregate expenses under
the Class B Plan were $693,534 or 1.00% of the Class B shares' average net
assets. Such expenses were paid to reimburse the Distributor for the following
payments: $524,713 for commissions and transaction fees paid to financial
intermediaries in respect of sales of Class B shares of the Fund and $168,821
for fees paid to financial intermediaries for servicing Class B shareholders and
administering the Plans. For the fiscal year ended June 30, 1997, the Fund's
aggregate expenses under the Plans for Class C shares were $34,770 or 1.00% of
the Class C shares' average net assets. Such expenses were paid to reimburse the
Distributor for the following payments: $18,000 for commissions and transaction
fees paid to financial intermediaries in respect of sales of Class C shares of
the Fund and $16,770 for fees paid to financial intermediaries for servicing
Class C shareholders and administering the Class C Plan.
PERFORMANCE INFORMATION
The Fund's yield quotation is determined on a daily basis with respect to the
immediately preceding 30 day period, and yield is computed by dividing the
Fund's net investment income per share of a given class earned during such
period by the Fund's maximum offering price (including, with respect to the
Class A Shares, the maximum initial sales charge) per share of such class on the
last day of such period. The Fund's net investment income per share is
determined by taking the interest attributable to a given class of shares earned
by the Fund during the period, subtracting the expenses attributable to a given
class of shares accrued for the period (net of any reimbursements), and dividing
the result by the average daily number of the shares of each class outstanding
during the period that were entitled to receive dividends. The yield calculation
formula assumes net investment income is earned and reinvested at a constant
rate and annualized at the end of a six month period. Yield will be computed
separately for each class of shares. Class B Shares redeemed during the first
five years after their issuance and Class C Shares redeemed during the first
year after their issuance may be subject to a CDSC of the lesser of the then
current net asset value of the shares redeemed or their initial purchase price
from the Fund. Yield quotations do not reflect the imposition of a CDSC, and if
any such CDSC imposed at the time of redemption were reflected, it would reduce
the performance quoted.
The Fund calculates average compounded total return by determining the
redemption value (less any applicable CDSC) at the end of specified periods
(after adding back all dividends and other distributions made during the period)
of a $1,000 investment in a given class of shares of the Fund (less the maximum
sales charge, if any) at the beginning of the period, annualizing the increase
or decrease over the specified period with respect to such initial investment
and expressing the result as a percentage. Average compounded total return will
be computed separately for each class of shares.
Total return figures utilized by the Fund are based on historical performance
and are not intended to indicate future performance. Total return and net asset
value per share of a given class can be expected to fluctuate over time, and
accordingly upon redemption a shareholder's shares may be worth more or less
than their original cost.
The Fund may, in supplemental sales literature, advertise non-standardized
total return figures representing the cumulative, non-annualized total return of
each class of shares of the Fund from a given date to a subsequent given date.
Cumulative non-standardized total return is calculated by measuring the value of
an initial investment in a given class of shares of the Fund at a given time,
deducting the maximum initial sales
B-50
<PAGE> 51
charge, if any, determining the value of all subsequent reinvested
distributions, and dividing the net change in the value of the investment as of
the end of the period by the amount of the initial investment and expressing the
result as a percentage. Non-standardized total return will be calculated
separately for each class of shares. Non-standardized total return calculations
do not reflect the imposition of a CDSC, and if any such contingent deferred
sales charge with respect to the CDSC Shares imposed at the time of redemption
were reflected, it would reduce the performance quoted.
From time to time the Fund may compare its performance to certain indices or
utilize such indices to illustrate market trends in U.S. interest rates,
including indices with respect to interest rates on 90 day U.S. Treasury bills
and 30 year Treasury bonds. In addition, the Fund may include in advertisements,
charts, graphs or drawings which illustrate the potential risks and rewards of
investment in various investment vehicles, including but not limited to, foreign
securities, stocks, bonds, treasury bills and shares of the Fund.
From time to time marketing materials may provide a portfolio manager update,
an adviser update and discuss general economic conditions and outlooks. The
Fund's marketing materials may also show the Fund's asset class diversification,
top five sector holdings and ten largest holdings. Materials may also mention
how Van Kampen American Capital believes the Fund compares relative to other
funds advised by the Adviser or its affiliates. Materials may also discuss the
Dalbar Financial Services study from 1984 to 1994 which examined investor cash
flow into and out of all types of mutual funds. The ten year study found that
investors who bought mutual fund shares and held such shares outperformed
investors who bought and sold. The Dalbar study conclusions were consistent
regardless if shareholders purchased their funds in direct or sales force
distribution channels. The study showed that investors working with a
professional representative have tended over time to earn higher returns than
those who invested directly. The Fund will also be marketed on the Internet.
CLASS A SHARES
The Fund's yield for the 30-day period ending June 30, 1997 (calculated in the
manner described in the Prospectus under the heading "Fund Performance") for
Class A Shares was 6.81%. In determining the Fund's net investment income for a
stated 30-day period, the Fund calculates yield to maturity on each portfolio
security on a daily basis. The Fund's distribution rate for the 30-day period
ending June 30, 1997 (calculated in the manner described in the Prospectus under
the heading "Fund Performance") for Class A Shares was 7.38%.
The Fund's average total return, including payment of the maximum sales
charge, for (i) the one year ended June 30, 1997 was 9.47% and (ii) the three
year, six month period from December 31, 1993, the commencement of investment
operations for Class A Shares of the Fund, through June 30, 1997 was 4.56%.
The Fund's cumulative non-standardized total return, excluding the payment of
the maximum sales charge, for Class A Shares from inception through June 30,
1997 (as calculated in the manner described in the Prospectus under the heading
"Fund Performance") was 22.69%.
The Fund's cumulative non-standardized total return, including the payment of
the maximum sales charge, for Class A Shares from inception through June 30,
1997 (as calculated in the manner described in the Prospectus under the heading
"Fund Performance") was 16.89%.
CLASS B SHARES
The Fund's yield for the 30-day period ending June 30, 1997 (calculated in the
manner described in the Prospectus under the heading "Fund Performance") for
Class B Shares was 6.38%. In determining the Fund's net investment income for a
stated 30-day period, the Fund calculates yield to maturity on each portfolio
security on a daily basis. The Fund's distribution rate for the 30-day period
ending June 30, 1997 (calculated in the manner described in the Prospectus under
the heading "Fund Performance") for Class B Shares was 7.00%.
The Fund's average total return, including the payment of the CDSC, for (i)
the one year ended June 30, 1997 was 9.98% and (ii) the three year, six month
period from December 31, 1993, the commencement of investment operations for
Class B Shares of the Fund, through June 30, 1997 was 4.60%.
B-51
<PAGE> 52
The Fund's cumulative non-standardized total return, excluding the payment of
the CDSC, for Class B Shares from inception through June 30, 1997 (as calculated
in the manner described in the Prospectus under the heading "Fund Performance")
was 19.30%.
The Fund's cumulative non-standardized total return, including the payment of
the CDSC, for Class B Shares from inception through June 30, 1997 (as calculated
in the manner described in the Prospectus under the heading "Fund Performance")
was 17.07%.
CLASS C SHARES
The Fund's yield for the 30-day period ending June 30, 1997 (calculated in the
manner described in the Prospectus under the heading "Fund Performance") for
Class C Shares was 6.38%. In determining the Fund's net investment income for a
stated 30-day period, the Fund calculates yield to maturity on each portfolio
security on a daily basis. The Fund's distribution rate for the 30-day period
ending June 30, 1997 (calculated in the manner described in the Prospectus under
the heading "Fund Performance") for Class C Shares was 7.00%.
The Fund's average total return, including the payment of the CDSC, for (i)
the one year ended June 30, 1997 was 12.99% and (ii) the three year, six month
period from December 31, 1993, the commencement of investment operations for
Class C Shares of the Fund, through June 30, 1997 was 5.15%.
The Fund's cumulative non-standardized total return, excluding the payment of
the CDSC, for Class C Shares from inception through June 30, 1997 (as calculated
in the manner described in the Prospectus under the heading "Fund Performance")
was 19.22%.
The Fund's cumulative non-standardized total return, including the payment of
the CDSC, for Class C Shares from inception through June 30, 1997 (as calculated
in the manner described in the Prospectus under the heading "Fund Performance")
was 19.22%.
B-52
<PAGE> 53
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Trustees and Shareholders of
Van Kampen American Capital Strategic Income Fund:
We have audited the accompanying statement of assets and liabilities of Van
Kampen American Capital Strategic Income Fund (the "Fund"), including the
portfolio of investments, as of June 30, 1997, and the related statement of
operations for the year then ended, the statement of changes in net assets for
each of the two years in the period then ended, and the financial highlights for
each of the periods presented. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of June
30, 1997, by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of Van
Kampen American Capital Strategic Income Fund as of June 30, 1997, the results
of its operations for the year then ended, the changes in its net assets for
each of the two years in the period then ended, and the financial highlights for
each of the periods presented, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Chicago, Illinois
August 13, 1997
B-53
<PAGE> 54
PORTFOLIO OF INVESTMENTS
June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Par Amount
in Local
Currency Maturity U.S.$
(000) Description Coupon Date Market Value
- ---------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
CORPORATE BONDS 93.4%
BANKING 9.6%
2,000 Banco Bansud - US$....................... 9.250% 12/01/99 $ 2,075,000
2,000 Banco Credito Argentino 144A - US$ (e)... 9.500 04/24/20 2,070,000
1,500 Bank United Corp. - US$.................. 8.875 05/01/07 1,541,715
2,000 Hubco Capital Trust I 144A - US$ (e)..... 8.980 02/01/27 2,046,000
4,100 Western Financial Savings - US$ (b)...... 8.500 07/01/03 4,175,416
------------
11,908,131
------------
BEVERAGE, FOOD & TOBACCO 2.5%
500 Azteca Holdings 144A - US$ (e)........... 11.000 06/15/02 505,005
2,500 Pepsi - Gemex 144A - US$ (b)(e).......... 9.750 03/01/04 2,581,250
------------
3,086,255
------------
BUILDINGS AND REAL ESTATE 0.2%
200 Clark Material - US$..................... 10.750 05/15/06 210,500
------------
DIVERSIFIED/CONGLOMERATE
MANUFACTURING 0.9%
1,000 Aetna Industries - US$................... 11.875 10/01/06 1,092,500
------------
ELECTRONICS 1.1%
500 Bell & Howell Co. - US$ (b)(c)........... 0/11.500 03/01/05 400,000
1,000 Philippine Long Distance Telephone Co. -
US$...................................... 8.350 03/06/17 947,600
------------
1,347,600
------------
FINANCE 26.0%
1,500 Advanta Capital Trust I 144A - US$
(b)(e)................................... 8.990 12/17/26 1,462,128
3,000 Advanta Corp. - US$ (b).................. 7.000 05/01/01 2,929,140
5,000 Banco Bilbao Vizcaya International Fin -
US$ (b).................................. 6.875 10/27/05 4,867,500
2,500 Contifinancial Corp. 144A - US$ (e)...... 7.500 03/15/02 2,475,325
2,000 Financiera Energetica Nacional - US$..... 9.375 06/15/06 2,140,000
2,000 Guangdong Enterprises 144A - US$ (e)..... 8.875 05/22/07 2,054,540
4,000 Lehman Brothers, Inc. - US$ (b).......... 7.250 04/15/03 4,023,952
5,000 Paine Webber Group MTN - US$ (b)......... 7.740 01/30/12 4,993,750
3,000 Rolls-Royce Cap - US$ (b)................ 7.125 07/29/03 3,013,500
3,945 Westinghouse Credit Corp - US$ (b)....... 8.875 06/14/14 4,272,475
------------
32,232,310
------------
HEALTHCARE 0.5%
500 Tenet Healthcare - US$................... 10.125 03/01/05 547,500
------------
INSURANCE 4.1%
1,000 American Annuity 144A - US$ (e).......... 7.250 09/28/01 1,006,520
4,000 Orion Capital Trust - US$ (b)............ 8.730 01/01/37 4,076,500
------------
5,083,020
------------
</TABLE>
See Notes to Financial Statements
B-54
<PAGE> 55
PORTFOLIO OF INVESTMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Par Amount
in Local
Currency Maturity U.S.$
(000) Description Coupon Date Market Value
- ---------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
LEISURE AND AMUSEMENT 1.5%
2,000 Viacom, Inc. - US$ (b)................... 7.625% 01/15/16 $ 1,886,138
------------
MINING 0.8%
500 Algoma Steel - US$....................... 12.375 07/15/05 556,250
400 Carbide/Graphite Group, Inc. - US$ (b)... 11.500 09/01/03 438,000
------------
994,250
------------
OIL & GAS 13.8%
1,500 Camuzzi Gas - US$ (b).................... 9.250 12/01/01 1,571,250
2,000 Chesapeake Energy - US$ (b).............. 8.500 03/15/12 1,890,000
500 Dawson Product Services - US$............ 9.375 02/01/07 510,000
500 Global Marine - US$ (b).................. 12.750 12/15/99 525,000
450 KCS Energy - US$......................... 11.000 01/15/03 487,125
1,500 Oleoducto Central S.A. 144A - US$ (e).... 9.350 09/01/05 1,550,625
500 Pacalta Resources Ltd. 144A - US$ (e).... 10.750 06/15/04 507,500
2,000 Perez Companc - US$...................... 9.000 01/30/04 2,072,840
2,500 Soc Comercial De Plata - US$............. 11.500 05/09/00 2,690,625
5,000 Triton Energy - US$ (b).................. 9.250 04/15/05 5,322,100
------------
17,127,065
------------
PAPER 1.7%
1,000 Doman Industries Ltd. - US$ (b).......... 8.750 03/15/04 970,000
1,000 Tjiwi Kimia International BV - US$....... 13.250 08/01/01 1,140,000
------------
2,110,000
------------
PERSONAL AND NON DURABLE CONSUMER GOODS 0.4%
500 Cole National Group - US$................ 9.875 12/31/06 526,250
------------
PRINTING, PUBLISHING & BROADCASTING 1.1%
500 International Cabletel - US$............. * 02/01/06 345,000
1,000 SCI Television - US$..................... 11.000 06/30/05 1,052,500
------------
1,397,500
------------
RETAIL 4.8%
3,500 Grupo Elektra sa de CV - US$............. 12.750 05/15/01 3,858,750
2,000 Shopko Stores - US$ (b).................. 8.500 03/15/02 2,102,580
------------
5,961,330
------------
</TABLE>
See Notes to Financial Statements
B-55
<PAGE> 56
PORTFOLIO OF INVESTMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Par Amount
in Local
Currency Maturity U.S.$
(000) Description Coupon Date Market Value
- ---------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
TELECOMMUNICATIONS 11.3%
1,000 Cablevision Systems - US$................ 9.875% 05/15/06 $ 1,065,000
5,000 Comcast Cablevision 144A - US$ (e)....... 8.500 05/01/27 5,398,950
5,000 MFS Communications - US$ (b)............. * 01/15/06 3,975,000
750 Millicom International - US$............. * 06/01/06 541,875
1,000 Panamsat L.P. - US$ (b).................. 9.750 08/01/00 1,050,000
600 Pricellular Wireless Corp. - US$ (c)..... 0/12.250 10/01/03 562,500
2,000 Viatel, Inc. - US$ (b)................... * 01/15/05 1,350,000
------------
13,943,325
------------
TEXTILES 0.4%
500 Anvil Knitware 144A - US$ (b)(e)......... 10.875 03/15/07 506,250
------------
UTILITIES 12.7%
500 AES Corp. - US$.......................... 10.250 07/15/06 547,500
1,000 Bridas Corp. - US$ (b)................... 12.500 11/15/99 1,098,750
500 Central Puerto S.A. 144A - US$ (e)....... 10.700 08/01/01 537,240
1,000 Central Termica Guemes S.A. 144A - US$
(e)...................................... 12.000 11/26/01 1,050,000
3,500 Companhia Energetica Sao Paul 144A - US$
(e)...................................... 9.125 06/26/07 3,447,500
1,250 Companhia Paranaense De Energ 144A - US$
(e)...................................... 9.750 05/01/05 1,293,750
2,000 Enersis S.A. - US$....................... 6.600 12/01/26 1,956,052
1,500 Midland Funding Corp II - US$ (b)........ 11.750 07/23/05 1,747,500
300 National Energy Group - US$ (b).......... 10.750 11/01/06 310,500
1,000 Sodigas - US$............................ 10.500 07/06/99 1,045,000
1,000 Sodigas 144A - US$ (e)................... 10.500 07/06/99 1,045,000
1,586 Subic Power Corp. 144A - US$ (e)......... 9.500 12/28/08 1,649,877
------------
15,728,669
------------
Total Corporate Bonds............................................ 115,688,593
------------
FOREIGN GOVERNMENT AND AGENCY SECURITIES 31.4%
ARGENTINA 3.2%
2,000 Argentina Par Bond - US$ (d)............. 5.500 03/31/23 1,387,500
2,000 Bonos del Tesoro - US$................... 8.750 05/09/02 2,000,000
500 Republic of Argentina - ARS.............. 11.750 02/12/07 554,486
------------
3,941,986
------------
AUSTRALIA 1.2%
2,000 Australian Government - AU$.............. 6.750 11/15/06 1,487,709
------------
BRAZIL 2.5%
1,980 Republic of Brazil - US$ (d)............. 7.250 04/15/06 1,827,778
1,380 Republic of Brazil - US$................. 10.125 05/15/27 1,328,250
------------
3,156,028
------------
CANADA 0.8%
1,250 Canadian Government - CA$................ 7.500 03/01/01 964,372
------------
</TABLE>
See Notes to Financial Statements
B-56
<PAGE> 57
PORTFOLIO OF INVESTMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Par Amount
in Local
Currency Maturity U.S.$
(000) Description Coupon Date Market Value
- ---------------------------------------------------------------------------------------------
<C> <S> <C> <C> <C>
COLOMBIA 2.1%
1,000 Republic of Colombia - US$............... 7.625% 02/15/07 $ 974,690
1,500 Republic of Colombia - US$............... 8.660 10/07/16 1,588,050
------------
2,562,740
------------
COSTA RICA 0.7%
1,000 Banco Central Costa Rica - US$ (d)....... 6.250 05/21/10 850,000
------------
CROATIA 4.0%
5,000 Republic of Croatia 144A - US$ (b)(e).... 7.000 02/27/02 4,918,750
------------
ITALY 0.8%
1,500,000 Republic of Italy BTPS - ITL............. 9.500 05/01/01 977,629
------------
MEXICO 1.4%
1,500 Mexico Global Bond - US$................. 11.500 05/15/26 1,713,750
------------
NEW ZEALAND 1.2%
2,000 New Zealand Government - NZ$............. 8.000 11/15/06 1,454,274
------------
PANAMA 4.0%
5,000 Republic of Panama 144A - US$ (e)........ 7.875 02/13/02 4,975,000
------------
RUSSIA 4.3%
5,000 DLJ Emerging Markets LDC - US$........... 5.500 12/30/97 5,363,000
------------
SLOVAKIA 2.7%
3,500 New Slovakia Euro Bond 144A - US$ (e).... 7.250 12/19/06 3,405,500
------------
UNITED KINGDOM 1.8%
1,000 UK Treasury Bonds - GBP (b).............. 7.000 11/06/01 1,658,536
350 UK Treasury Bonds - GBP.................. 6.750 11/26/04 571,745
------------
2,230,281
------------
URUGUAY 0.7%
1,000 Banco Central del Uruguay Ser B - US$
(d)...................................... 6.750 02/19/21 897,500
------------
Total Foreign Government and Agency Securities................... 38,898,519
------------
MORTGAGE BACKED SECURITIES (U.S.) 9.4%
2,337 DLJ Mortgage Acceptance Corp 1996-E1..... 8.517 09/28/25 2,381,275
75 FNMA REMIC #93-55 M PAC (Interest
Only).................................... 727.220 09/25/06 1,449,633
3,541 FNMA REMIC #93-175 S..................... 8.142 05/25/07 3,394,682
3,256 FNMA REMIC #93-180 SB (Inverse Fltg)
(b)...................................... 3.883 09/25/00 2,950,309
23,985 FNMA REMIC #97-20 IB (Interest Only)..... 1.840 03/25/27 1,460,689
------------
Total Mortgage Backed Securities (U.S.).......................... 11,636,588
------------
</TABLE>
See Notes to Financial Statements
B-57
<PAGE> 58
PORTFOLIO OF INVESTMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Description Shares Market Value
- -----------------------------------------------------------------------------------
<S> <C> <C>
COMMON AND PREFERRED STOCKS 5.1%
Avalon Properties - Preferred - US$......................... 50,000 $ 1,287,500
Grupo Casa Autrey - ADR (Mexico) - US$...................... 8,500 172,656
MEPC International Capital L.P. - Preferred - US$ (b)....... 100,000 2,587,500
Time Warner, Inc. - Preferred - US$ (a)..................... 2,000 2,266,620
Thai Military Bank - THB.................................... 15,000 16,792
------------
Total Common and Preferred Stocks................................ 6,331,068
------------
SWAP TRANSACTIONS 0.0%
Goldman Sachs, 40.0 million US$ notional amount, maturing 01/23/00,
payment based upon the spread between the 6 year French Franc fixed
swap interest rate versus the 6 year German Mark fixed swap interest
rate................................................................. (65,217)
------------
TOTAL LONG-TERM INVESTMENTS 139.3%
(Cost $169,602,085)................................................ 172,489,551
LIABILITIES IN EXCESS OF OTHER ASSETS (39.3%)....................... (48,622,679)
------------
NET ASSETS 100.0%................................................... $123,866,872
============
</TABLE>
* Zero coupon bond
(a) Securities purchased on a when issued or delayed delivery basis.
(b) Assets segregated as collateral for when issued or delayed delivery purchase
commitments, open option, futures, forwards or swaps transactions or
borrowings of the Fund.
(c) Security is a "Step-up" bond where the coupon increases, or steps up, at a
predetermined date.
(d) Item represents a "Brady Bond" which is a product of the "Brady Plan" under
which various Latin American, African and southeast Asian nations have
converted their outstanding external defaulted commercial bank loans into
bonds. Certain Brady Bonds have been collateralized, as to principal due at
maturity, by U.S. Treasury zero coupon bonds with a maturity date equal to
the final maturity date of such Brady Bonds.
(e) 144A securities are those which are exempt from registration under Rule 144A
of the Securities Act of 1933. These securities may only be resold in
transactions exempt from registration which are normally those transactions
with qualified institutional buyers.
PORTFOLIO COMPOSITION BY CREDIT QUALITY
The following table summarizes the portfolio composition at June 30, 1997,
based upon the highest credit quality ratings as determined by Standard & Poor's
or Moody's.
<TABLE>
<S> <C>
U.S. Government and
Government Agency
Obligations................ 6.8%
AAA.......................... 4.1
AA........................... 2.8
A............................ 6.7
BBB.......................... 22.7
BB........................... 23.4
B............................ 11.7
Non-Rated.................... 21.8
-----
100.0%
=====
</TABLE>
See Notes to Financial Statements
B-58
<PAGE> 59
STATEMENT OF ASSETS AND LIABILITIES
June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
ASSETS:
Total Investments (Cost $169,602,085)....................... $172,489,551
Receivables:
Interest.................................................. 3,481,239
Fund Shares Sold.......................................... 310,467
Variation Margin on Futures............................... 148,489
Options at Market Value (Net premiums paid of $246,766)..... 253,950
Unamortized Organizational Costs............................ 51,018
Other....................................................... 1,068
------------
Total Assets............................................ 176,735,782
------------
LIABILITIES:
Payables:
Bank Borrowings........................................... 50,983,397
Income Distributions...................................... 430,721
Investments Purchased..................................... 371,264
Distributor and Affiliates................................ 169,090
Investment Advisory Fee................................... 105,874
Fund Shares Repurchased................................... 82,595
Forward Currency Contracts.................................. 201,614
Accrued Expenses............................................ 444,074
Deferred Compensation and Retirement Plans.................. 80,281
------------
Total Liabilities....................................... 52,868,910
------------
NET ASSETS.................................................. $123,866,872
============
NET ASSETS CONSIST OF:
Capital..................................................... $126,195,708
Net Unrealized Appreciation................................. 2,587,120
Accumulated Undistributed Net Investment Income............. 150,395
Accumulated Net Realized Loss............................... (5,066,351)
------------
NET ASSETS.................................................. $123,866,872
============
MAXIMUM OFFERING PRICE PER SHARE:
Class A Shares:
Net asset value and redemption price per share (Based on
net assets of $43,810,221 and 3,428,615 shares of
beneficial interest issued and outstanding)............. $ 12.78
Maximum sales charge (4.75%* of offering price)......... .64
------------
Maximum offering price to public........................ $ 13.42
============
Class B Shares:
Net asset value and offering price per share (Based on
net assets of $76,222,552 and 5,964,656 shares of
beneficial interest issued and outstanding)............. $ 12.78
============
Class C Shares:
Net asset value and offering price per share (Based on
net assets of $3,834,099 and 300,301 shares of
beneficial interest issued and outstanding)............. $ 12.77
============
</TABLE>
*On sales of $100,000 or more, the sales charge will be reduced.
See Notes to Financial Statements
B-59
<PAGE> 60
STATEMENT OF OPERATIONS
For the Year Ended June 30, 1997
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest (Net of foreign withholding taxes of $20,787)...... $12,861,325
Dividends (Net of foreign withholding taxes of $568)........ 560,482
-----------
Total Income.......................................... 13,421,807
-----------
EXPENSES:
Investment Advisory Fee..................................... 1,132,304
Distribution (12b-1) and Service Fees (Attributed to Classes
A, B and C of $97,970, $699,251 and $35,618,
respectively)............................................. 832,839
Shareholder Services........................................ 208,244
Custody..................................................... 163,379
Trustees Fees and Expenses.................................. 38,650
Amortization of Organizational Costs........................ 33,982
Legal....................................................... 18,250
Other....................................................... 222,781
-----------
Total Operating Expenses.............................. 2,650,429
Less Expenses Reimbursed.............................. 49,624
-----------
Net Operating Expenses................................ 2,600,805
Interest Expense...................................... 2,239,645
-----------
NET INVESTMENT INCOME....................................... $ 8,581,357
===========
NET REALIZED AND UNREALIZED GAIN/LOSS:
Realized Gain/Loss:
Investments............................................... $ 5,129,577
Options................................................... (483,643)
Futures................................................... (1,998,211)
Forwards.................................................. 603,111
Foreign Currency Transactions............................. (251,444)
-----------
Net Realized Gain........................................... 2,999,390
-----------
Net Unrealized Appreciation/Depreciation:
Beginning of the Period..................................... (794,446)
-----------
End of the Period:
Investments............................................... 2,887,466
Options................................................... 7,184
Futures................................................... (105,472)
Forwards.................................................. (209,912)
Foreign Currency Translation.............................. 7,854
-----------
2,587,120
-----------
Net Unrealized Appreciation During the Period............... 3,381,566
-----------
NET REALIZED AND UNREALIZED GAIN............................ $ 6,380,956
---------
NET INCREASE IN NET ASSETS FROM OPERATIONS.................. $14,962,313
===========
</TABLE>
See Notes to Financial Statements
B-60
<PAGE> 61
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended June 30, 1997 and 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended Year Ended
June 30, 1997 June 30, 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Operations:
Net Investment Income.................................... $ 8,581,357 $ 7,166,242
Net Realized Gain........................................ 2,999,390 2,088,097
Net Unrealized Appreciation During the Period............ 3,381,566 1,185,450
------------ ------------
Change in Net Assets from Operations..................... 14,962,313 10,439,789
------------ ------------
Distributions from Net Investment Income................. (8,604,269) (7,166,242)
Distributions in Excess of Net Investment Income......... (27,347) (721,843)
------------ ------------
Distributions from and in Excess of Net Investment
Income*................................................. (8,631,616) (7,888,085)
------------ ------------
NET CHANGE IN NET ASSETS FROM INVESTMENT ACTIVITIES...... 6,330,697 2,551,704
------------ ------------
FROM CAPITAL TRANSACTIONS:
Proceeds from Shares Sold................................ 40,557,345 29,338,222
Net Asset Value of Shares Issued Through Dividend
Reinvestment............................................ 3,498,095 3,220,366
Cost of Shares Repurchased............................... (25,388,033) (20,206,493)
------------ ------------
NET CHANGE IN NET ASSETS FROM CAPITAL TRANSACTIONS....... 18,667,407 12,352,095
------------ ------------
TOTAL INCREASE IN NET ASSETS............................. 24,998,104 14,903,799
NET ASSETS:
Beginning of the Period.................................. 98,868,768 83,964,969
------------ ------------
End of the Period (Including accumulated undistributed
net investment income of $150,395 and $22,912,
respectively)........................................... $123,866,872 $ 98,868,768
============ ============
</TABLE>
<TABLE>
<CAPTION>
Year Ended Year Ended
*Distributions by Class June 30, 1997 June 30, 1996
- ---------------------------------------------------------------------------------
<S> <C> <C>
Distributions from and in Excess of
Net Investment Income:
Class A Shares....................... $(3,189,748) $(2,908,823)
Class B Shares....................... (5,177,891) (4,768,060)
Class C Shares....................... (263,977) (211,202)
----------- -----------
$(8,631,616) $(7,888,085)
=========== ===========
</TABLE>
See Notes to Financial Statements
B-61
<PAGE> 62
FINANCIAL HIGHLIGHTS
The following schedule presents financial highlights for one share of
the Fund outstanding throughout the periods indicated.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, 1993
(Commencement
Year Ended June 30, of Investment
--------------------------- Operations) to
Class A Shares 1997 1996 1995 June 30, 1994
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of the Period.... $12.065 $11.704 $11.975 $14.300
------- ------- ------- -------
Net Investment Income....................... 1.019 1.013 .657 .566
Net Realized and Unrealized Gain/Loss....... .714 .446 .272 (2.391)
------- ------- ------- -------
Total from Investment Operations............ 1.733 1.459 .929 (1.825)
------- ------- ------- -------
Less:
Distributions from and in Excess of Net
Investment Income....................... 1.020 1.098 .793 .500
Return of Capital Distribution............ -0- -0- .407 -0-
------- ------- ------- -------
Total Distributions......................... 1.020 1.098 1.200 .500
------- ------- ------- -------
Net Asset Value, End of the Period.......... $12.778 $12.065 $11.704 $11.975
======= ======= ======= =======
Total Return* (a)........................... 14.92% 12.92% 8.46% (12.83%)**
Net Assets at End of the Period (In
millions)................................. $ 43.8 $ 33.8 $ 29.6 $ 24.5
Ratio of Operating Expenses to Average Net
Assets*................................... 1.81% 1.84% 1.98% 1.88%
Ratio of Interest Expense to Average Net
Assets.................................... 1.99% 2.27% 2.38% .96%
Ratio of Net Investment Income to Average
Net Assets*............................... 8.12% 8.34% 5.88% 9.27%
Portfolio Turnover.......................... 474% 343% 253% 114%**
* If certain expenses had not been reimbursed by VKAC, Total Return would have been lower and
the ratios would have been as follows:
Ratio of Operating Expenses to Average Net
Assets.................................... 1.86% 1.92% N/A N/A
Ratio of Net Investment Income to Average
Net Assets................................ 8.07% 8.26% N/A N/A
</TABLE>
** Non-Annualized
(a) Total Return is based upon net asset value which does not include payment of
the maximum sales charge or contingent deferred sales charge.
N/A = Not Applicable
See Notes to Financial Statements
B-62
<PAGE> 63
FINANCIAL HIGHLIGHTS (CONTINUED)
The following schedule presents financial highlights for one share of
the Fund outstanding throughout the periods indicated.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, 1993
(Commencement
Year Ended June 30, of Investment
--------------------------- Operations) to
Class B Shares 1997 1996 1995 June 30, 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of the Period.... $12.069 $11.706 $11.968 $14.300
------- ------- ------- -------
Net Investment Income....................... .920 .926 .585 .515
Net Realized and Unrealized Gain/Loss....... .717 .443 .245 (2.392)
------- ------- ------- -------
Total from Investment Operations............ 1.637 1.369 .830 (1.877)
------- ------- ------- -------
Less:
Distributions from and in Excess of Net
Investment Income....................... .927 1.006 .722 .455
Return of Capital Distribution............ -0- -0- .370 -0-
------- ------- ------- -------
Total Distributions......................... .927 1.006 1.092 .455
------- ------- ------- -------
Net Asset Value, End of the Period.......... $12.779 $12.069 $11.706 $11.968
======= ======= ======= =======
Total Return* (a)........................... 13.98% 12.06% 7.62% (13.21%)**
Net Assets at End of the Period (In
millions)................................. $ 76.2 $ 61.9 $ 52.6 $ 46.4
Ratio of Operating Expenses to Average Net
Assets*................................... 2.57% 2.59% 2.68% 2.63%
Ratio of Interest Expense to Average Net
Assets.................................... 1.98% 2.26% 2.38% .96%
Ratio of Net Investment Income to Average
Net Assets*............................... 7.33% 7.58% 5.30% 8.48%
Portfolio Turnover.......................... 474% 343% 253% 114%**
* If certain expenses had not been reimbursed by VKAC, Total Return would have been lower
and the ratios would have been as follows:
Ratio of Operating Expenses to Average Net
Assets.................................... 2.61% 2.67% N/A N/A
Ratio of Net Investment Income to Average
Net Assets................................ 7.28% 7.50% N/A N/A
</TABLE>
** Non-Annualized
(a) Total Return is based upon net asset value which does not include payment of
the maximum sales charge or contingent deferred sales charge.
N/A = Not Applicable
See Notes to Financial Statements
B-63
<PAGE> 64
FINANCIAL HIGHLIGHTS (CONTINUED)
The following schedule presents financial highlights for one share of
the Fund outstanding throughout the periods indicated.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, 1993
(Commencement
Year Ended June 30, of Investment
--------------------------- Operations) to
Class C Shares 1997 1996 1995 June 30, 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of the Period.... $12.059 $11.699 $11.966 $14.300
------- ------- ------- -------
Net Investment Income....................... .913 .944 .598 .509
Net Realized and Unrealized Gain/Loss....... .723 .422 .227 (2.388)
------- ------- ------- -------
Total from Investment Operations............ 1.636 1.366 .825 (1.879)
------- ------- ------- -------
Less:
Distributions from and in Excess of Net
Investment Income....................... .927 1.006 .722 .455
Return of Capital Distribution............ -0- -0- .370 -0-
------- ------- ------- -------
Total Distributions......................... .927 1.006 1.092 .455
------- ------- ------- -------
Net Asset Value, End of the Period.......... $12.768 $12.059 $11.699 $11.966
======= ======= ======= =======
Total Return* (a)........................... 13.99% 12.07% 7.53% (13.21%)**
Net Assets at End of the Period (In
millions)................................. $ 3.8 $ 3.1 $ 1.7 $ 2.1
Ratio of Operating Expenses to Average Net
Assets*................................... 2.56% 2.58% 2.69% 2.65%
Ratio of Interest Expense to Average Net
Assets.................................... 1.98% 2.22% 2.38% .95%
Ratio of Net Investment Income to Average
Net Assets*............................... 7.31% 7.49% 5.92% 8.36%
Portfolio Turnover.......................... 474% 343% 253% 114%**
* If certain expenses had not been reimbursed by VKAC, Total Return would have been lower
and the ratios would have been as follows:
Ratio of Operating Expenses to Average Net
Assets.................................... 2.61% 2.66% N/A N/A
Ratio of Net Investment Income to Average
Net Assets................................ 7.27% 7.41% N/A N/A
</TABLE>
** Non-Annualized
(a) Total Return is based upon net asset value which does not include payment of
the maximum sales charge or contingent deferred sales charge.
N/A = Not Applicable
See Notes to Financial Statements
B-64
<PAGE> 65
NOTES TO FINANCIAL STATEMENTS
June 30, 1997
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES
Van Kampen American Capital Strategic Income Fund (the "Fund") is organized as a
series of Van Kampen American Capital Trust (the "Trust"), a Delaware business
trust, and is registered as a non-diversified open-end management investment
company under the Investment Company Act of 1940, as amended. The Fund's primary
investment objective is to seek to provide shareholders with high current
income, while its' secondary investment objective is to seek capital
appreciation. The Fund will allocate its investments among the following market
sectors: U.S. government securities, domestic investment grade income
securities, domestic lower grade income securities, foreign investment grade
income securities and foreign lower grade income securities. The Fund borrows
money for investment purposes which will create the opportunity for enhanced
return, but also should be considered a speculative technique and may increase
the Fund's volatility. The Fund commenced investment operations on December 31,
1993, with three classes of common shares, Class A, Class B and Class C shares.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from these estimates.
A. SECURITY VALUATION--Investments are stated at value using market quotations,
prices provided by market makers or, if such valuations are not available,
estimates obtained from yield data relating to instruments or securities with
similar characteristics in accordance with procedures established in good faith
by the Board of Trustees. Foreign investments are stated at value using the last
available bid price or yield equivalents obtained from dealers in the
over-the-counter (OTC) or interbank market. Short-term securities with remaining
maturities of 60 days or less are valued at amortized cost.
B. SECURITY TRANSACTIONS--Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis. The
Fund may purchase and sell securities on a "when issued" or "delayed delivery"
basis, with settlement to occur at a later date. The value of the security so
purchased is subject to market fluctuations during this period. The Fund will
maintain, in a segregated account
B-65
<PAGE> 66
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
with its custodian, assets having an aggregate value at least equal to the
amount of the when issued or delayed delivery purchase commitments until payment
is made.
C. INVESTMENT INCOME--Interest income is recorded on an accrual basis and
dividend income is recorded on the ex-dividend date. Original issue discount is
amortized over the expected life of each applicable security.
D. CURRENCY TRANSLATION--Assets and liabilities denominated in foreign
currencies and commitments under forward currency contracts are translated into
U.S. dollars at the mean of the quoted bid and ask prices of such currencies
against the U.S. dollar. Purchases and sales of portfolio securities are
translated at the rate of exchange prevailing when such securities were acquired
or sold. Income and expenses are translated at rates prevailing when accrued.
E. ORGANIZATIONAL COSTS--The Fund has reimbursed Van Kampen American Capital
Distributors, Inc. or its affiliates (collectively "VKAC") for costs incurred in
connection with the Fund's organization in the amount of $170,000. These costs
are being amortized on a straight line basis over the 60 month period ending
December 31, 1998. Van Kampen American Capital Investment Advisory Corp. (the
"Adviser") has agreed that in the event any of the initial shares of the Fund
originally purchased by VKAC are redeemed during the amortization period, the
Fund will be reimbursed for any unamortized organizational costs in the same
proportion as the number of shares redeemed bears to the number of initial
shares held at the time of redemption.
F. FEDERAL INCOME TAXES--It is the Fund's policy to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no provision for federal income taxes is required.
The Fund intends to utilize provisions of the federal income tax laws which
allow it to carry a realized capital loss forward for eight years following the
year of the loss and offset such losses against any future realized capital
gains. At June 30, 1997, the Fund had an accumulated capital loss carryforward
for tax purposes of $5,050,946 which will expire between June 30, 2003 and June
30, 2004. Net realized gains or losses may differ for financial and tax
reporting purposes primarily as a result of post October 31 losses which are not
recognized for tax purposes until the first day of the following fiscal year and
as a result of gains or losses recognized for tax purposes on the mark to market
of open options, futures and forward transactions at June 30, 1997.
B-66
<PAGE> 67
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
At June 30, 1997, for federal income tax purposes, cost of long-term
investments is $169,602,085; the aggregate gross unrealized appreciation is
$3,907,013 and the aggregate gross unrealized depreciation is $1,114,313,
resulting in net unrealized appreciation on investments, swap, option and
futures transactions of $2,792,700.
G. DISTRIBUTION OF INCOME AND GAINS--The Fund declares daily and pays monthly
dividends from net investment income. Net investment income for federal income
tax purposes includes gains and losses realized on transactions in foreign
currencies and options and futures on foreign currencies. These realized gains
and losses are included as net realized gains or losses for financial reporting
purposes. Permanent book and tax basis differences relating to net currency
gains totaling $177,742 were reclassified from accumulated net realized
gain/loss to accumulated undistributed net investment income.
Net realized gains, if any, are distributed annually.
2. INVESTMENT ADVISORY AGREEMENT AND OTHER TRANSACTIONS WITH AFFILIATES
Under the terms of the Fund's Investment Advisory Agreement, the Adviser will
provide investment advice and facilities to the Fund for an annual fee payable
monthly as follows:
<TABLE>
<CAPTION>
AVERAGE MANAGED ASSETS % PER ANNUM
- ------------------------------------------------------------------------
<S> <C>
First $500 million...................................... .75 of 1%
Next $500 million....................................... .70 of 1%
Over $1 billion......................................... .65 of 1%
</TABLE>
For the year ended June 30, 1997, VKAC has agreed to assume a portion of the
Fund's registration and filing fees. This waiver is voluntary and may be
discontinued at any time.
For the year ended June 30, 1997, the Fund recognized expenses of
approximately $6,200 representing legal services provided by Skadden, Arps,
Slate, Meagher & Flom (Illinois), counsel to the Fund, of which a trustee of the
Fund is an affiliated person.
For the year ended June 30, 1997, the Fund recognized expenses of
approximately $25,300 representing VKAC's cost of providing accounting, cash
management and legal services to the Fund. Of this amount, approximately $800
has been assumed by VKAC.
ACCESS Investor Services, Inc. ("ACCESS"), an affiliate of the Adviser,
serves as the shareholder servicing agent for the Fund. For the year ended June
30, 1997, the Fund recognized expenses of approximately $158,700, representing
ACCESS' cost of providing transfer agency and shareholder services plus a
profit.
B-67
<PAGE> 68
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
Certain officers and trustees of the Fund are also officers and directors of
VKAC. The Fund does not compensate its officers or trustees who are officers of
VKAC. During the year ended June 30, 1997, the Adviser reimbursed the Fund for
certain trustees' compensation in connection with the July 1995 increase in the
number of trustees of the Fund.
The Fund provides deferred compensation and retirement plans for its
trustees who are not officers of VKAC. Under the deferred compensation plan,
trustees may elect to defer all or a portion of their compensation to a later
date. Benefits under the retirement plan are payable for a ten-year period and
are based upon each trustee's years of service to the Fund. The maximum annual
benefit per trustee under the plan is equal to $2,500.
At June 30, 1997, VKAC owned 100 shares each of Classes A, B and C.
3. CAPITAL TRANSACTIONS
The Fund has outstanding three classes of shares of beneficial interest, Classes
A, B and C, each with a par value of $.01 per share. There are an unlimited
number of shares of each class authorized.
At June 30, 1997, capital aggregated $44,483,168, $77,747,304 and $3,965,236
for Classes A, B and C, respectively. For the year ended June 30, 1997,
transactions were as follows:
<TABLE>
<CAPTION>
SHARES VALUE
- ---------------------------------------------------------------------------
<S> <C> <C>
Sales:
Class A.................................... 1,136,784 $ 14,246,123
Class B.................................... 1,951,416 24,358,899
Class C.................................... 156,283 1,952,323
---------- ------------
Total Sales.................................. 3,244,483 $ 40,557,345
========== ============
Dividend Reinvestment:
Class A.................................... 102,757 $ 1,289,971
Class B.................................... 163,577 2,052,790
Class C.................................... 12,383 155,334
---------- ------------
Total Dividend Reinvestment.................. 278,717 $ 3,498,095
========== ============
Repurchases:
Class A.................................... (614,505) $ (7,723,135)
Class B.................................... (1,282,624) (16,096,646)
Class C.................................... (125,528) (1,568,252)
---------- ------------
Total Repurchases............................ (2,022,657) $(25,388,033)
========== ============
</TABLE>
B-68
<PAGE> 69
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
At June 30, 1996, capital aggregated $36,670,209, $67,432,261 and $3,425,831
for Classes A, B and C, respectively. For the year ended June 30, 1996,
transactions were as follows:
<TABLE>
<CAPTION>
SHARES VALUE
- ---------------------------------------------------------------------------
<S> <C> <C>
Sales:
Class A.................................... 751,977 $ 9,046,110
Class B.................................... 1,498,860 18,147,281
Class C.................................... 178,450 2,144,831
---------- ------------
Total Sales.................................. 2,429,287 $ 29,338,222
========== ============
Dividend Reinvestment:
Class A.................................... 94,962 $ 1,139,581
Class B.................................... 163,856 1,965,307
Class C.................................... 9,612 115,478
---------- ------------
Total Dividend Reinvestment.................. 268,430 $ 3,220,366
========== ============
Repurchases:
Class A.................................... (575,267) $ (6,903,393)
Class B.................................... (1,024,433) (12,352,105)
Class C.................................... (78,275) (950,995)
---------- ------------
Total Repurchases............................ (1,677,975) $(20,206,493)
========== ============
</TABLE>
Class B and C shares are offered without a front end sales charge, but are
subject to a contingent deferred sales charge (CDSC). The CDSC will be imposed
on most redemptions made within six years of the purchase for Class B and one
year of the purchase for Class C as detailed in the following schedule. The
Class B and C shares bear the expense of their respective deferred sales
arrangements, including higher distribution and service fees and incremental
transfer agency costs.
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE
YEAR OF REDEMPTION CLASS B CLASS C
- ------------------------------------------------------------------------------
<S> <C> <C>
First.............................................. 4.00% 1.00%
Second............................................. 3.75% None
Third.............................................. 3.50% None
Fourth............................................. 2.50% None
Fifth.............................................. 1.50% None
Sixth.............................................. 1.00% None
Seventh and Thereafter............................. None None
</TABLE>
B-69
<PAGE> 70
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
For the year ended June 30, 1997, VKAC, as Distributor for the Fund,
received commissions on sales of the Fund's Class A shares of approximately
$26,500 and CDSC on redeemed shares of approximately $296,300. Sales charges do
not represent expenses of the Fund.
4. INVESTMENT TRANSACTIONS
During the period, the cost of purchases and proceeds from sales of investments,
excluding short-term investments, were $745,551,022 and $715,779,945,
respectively.
5. DERIVATIVE FINANCIAL INSTRUMENTS
A derivative financial instrument in very general terms refers to a security
whose value is "derived" from the value of an underlying asset, reference rate
or index.
The Fund has a variety of reasons to use derivative instruments, such as to
attempt to protect the Fund against possible changes in the market value of its
portfolio, manage the portfolio's effective yield, foreign currency exposure,
maturity and duration or generate potential gain. All of the Fund's portfolio
holdings, including derivative instruments, are marked to market each day with
the change in value reflected in unrealized appreciation/depreciation. Upon
disposition, a realized gain or loss is recognized accordingly, except when
exercising an option contract or taking delivery of a security underlying a
futures or forward contract. In these instances, the recognition of gain or loss
is postponed until the disposal of the security underlying the option, futures
or forward contract. Risks may arise as a result of the potential inability of
the counterparties to meet the terms of their contracts.
Summarized below are the specific types of derivative financial instruments
used by the Fund.
A. OPTION CONTRACTS--An option contract gives the buyer the right, but not the
obligation to buy (call) or sell (put) an underlying item at a fixed exercise
price during a specified period. These contracts are generally used by the Fund
to manage the portfolio's effective maturity and duration.
B-70
<PAGE> 71
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
Transactions in options for the year ended June 30, 1997, were as follows:
<TABLE>
<CAPTION>
CONTRACTS PREMIUM
- ---------------------------------------------------------------------------
<S> <C> <C>
Outstanding at June 30, 1996................... 3 $ (458,000)
Options Written and Purchased (Net)............ 9,182 (2,797,571)
Options Terminated in Closing
Transactions (Net)........................... (6,742) 2,225,052
Options Exercised.............................. (303) 226,532
Options Expired (Net).......................... (513) 557,221
------ -----------
Outstanding at June 30, 1997................... 1,627 $ (246,766)
====== ===========
</TABLE>
The descriptions and market values of the option contracts outstanding as of
June 30, 1997, are as follows:
<TABLE>
<CAPTION>
STRIKE
EXPIRATION PRICE/ MARKET
DESCRIPTION CONTRACTS DATE YIELD VALUE
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
EURO $ FUTURES
Dec. 1997 - Purchased
Call...................... 600 12/15/97 94 $157,500
Dec. 1997 - Written
Call...................... 900 12/15/97 94.25 (67,500)
J.P. MORGAN EMERGING
MARKETS INDEX
Purchased Put............. 1 08/11/97 329.37 119,700
Written Put............... 1 08/11/97 321.14 (49,500)
U.S. TREASURY BOND FUTURES
Aug. 1997 - Purchased
Put....................... 125 07/19/97 111 93,750
----- --------
1,627 $253,950
===== ========
</TABLE>
B. FUTURES CONTRACTS--A futures contract is an agreement involving the delivery
of a particular asset on a specified future date at an agreed upon price. The
Fund generally invests in futures on U.S. Treasury Bonds and typically closes
the contract prior to the delivery date. These contracts are generally used to
manage the portfolio's effective maturity and duration.
Upon entering into futures contracts, the Fund maintains, in a segregated
account with its custodian, securities with a value equal to its obligation
under the futures contracts. During the period the futures contract is open,
payments are received from or made to the broker based upon changes in the value
of the contract (the variation margin). The cost of securities acquired through
delivery under a contract is adjusted by the unrealized gain or loss on the
contract.
B-71
<PAGE> 72
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
Transactions in futures contracts for the year ended June 30, 1997, were as
follows:
<TABLE>
<CAPTION>
CONTRACTS
- ------------------------------------------------------------------------
<S> <C>
Outstanding at June 30, 1996............................... 231
Futures Opened............................................. 8,160
Futures Closed............................................. (7,702)
------
Outstanding at June 30, 1997............................... 689
======
</TABLE>
The futures contracts outstanding as of June 30, 1997, and the descriptions
and unrealized appreciation/depreciation are as follows:
<TABLE>
<CAPTION>
UNREALIZED
APPRECIATION/
CONTRACTS DEPRECIATION
- ---------------------------------------------------------------------------
<S> <C> <C>
LONG CONTRACTS:
U.S. Treasury Bond Future Dec 1997
(Current notional value $110,656 per
contract)................................... 200 $ 487,500
SHORT CONTRACTS:
10-Year British Gilt Future Sept 1997
(Current notional value $94,870 per
contract)................................... 10 (25,134)
10-Year German Mark Future Sept 1997
(Current notional value $145,476 per
contract)................................... 10 (18,928)
10-Year Japanese Bond Future Sept 1997
(Current notional value $1,082,708 per
contract)................................... 3 (30,832)
U.S. Treasury Bond Future Sept 1997
(Current notional value $111,063 per
contract)................................... 300 (355,156)
2-Year U.S. Treasury Note Future Sept 1997
(Current notional value $206,016 per
contract)................................... 41 (39,250)
5-Year U.S. Treasury Note Future Sept 1997
(Current notional value $105,891 per
contract)................................... 125 (123,672)
--- ---------
689 $(105,472)
=== =========
</TABLE>
C. FORWARD CURRENCY CONTRACTS--These instruments are commitments to purchase or
sell a foreign currency at a future date at a negotiated forward rate. The gain
or loss arising from the difference between the original value of the contract
and the closing value of such contract is included as a component of realized
gain/loss on forwards.
B-72
<PAGE> 73
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
At June 30, 1997, the Fund has outstanding forward currency contracts as
follows:
<TABLE>
<CAPTION>
UNREALIZED
FORWARD CURRENT APPRECIATION/
CURRENCY VALUE DEPRECIATION
- ------------------------------------------------------------------------
<S> <C> <C>
LONG CONTRACTS:
Canadian Dollar,
2,751,100 expiring 09/30/97.............. $ 2,003,277 $ (1,752)
French Franc,
57,760,000 expiring 08/01/97............. 9,850,285 (321,953)
German Mark,
29,954,750 expiring 08/04/97-12/30/97.... 17,331,744 (534,622)
Japanese Yen,
1,142,000,000 expiring 08/27/97.......... 10,046,845 46,845
----------- ---------
$39,232,151 $(811,482)
=========== ---------
SHORT CONTRACTS:
British Pound Sterling,
1,536,731 expiring 08/28/97.............. $ 2,554,657 $ (54,657)
French Franc,
85,979,900 expiring 08/04/97-12/30/97.... 14,762,058 416,786
German Mark,
15,000,000 expiring 07/30/97............. 8,619,942 286,205
Japanese Yen,
1,071,700,000 expiring 11/27/98.......... 10,046,764 (46,764)
----------- ---------
$35,983,421 601,570
=========== ---------
$(209,912)
=========
</TABLE>
At June 30, 1997, the Fund has realized gains on closed but unsettled
forward currency contracts of $8,298 scheduled to settle between July 1, 1997
and March 16, 1998.
D. SWAP TRANSACTIONS--These securities, which are identified in the portfolio of
investments, represent an agreement between two parties to exchange a series of
cash flows based upon various indices at specified intervals.
E. INVERSE FLOATING SECURITY--These instruments, which are identified in the
portfolio of investments, have a coupon which is inversely indexed to a
short-term floating interest rate multiplied by a specified factor. As the
floating rate rises, the coupon is reduced. Conversely, as the floating rate
declines, the coupon is increased. The price of these
B-73
<PAGE> 74
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
securities may be more volatile than the price of a comparable fixed rate
security. These instruments are typically used by the Fund to enhance the yield
of the portfolio.
6. MORTGAGE-BACKED SECURITIES
A Mortgage-Backed Security (MBS) is a pass-through security created by pooling
mortgages and selling participations in the principal and interest payments
received from borrowers. Most of these securities are guaranteed by federally
sponsored agencies such as Federal National Mortgage Association (FNMA).
A REMIC (Real Estate Mortgage Investment Conduit) is a bond which is
collateralized by a pool of MBS's. These MBS pools are divided into classes or
tranches with each class having its own characteristics.
A MBS may also be stripped to create an Interest Only (IO) security. An IO
represents ownership in the cash flows of the interest payments made from a
specific pool of MBS. The cash flow on this instrument decreases as the mortgage
principal balance is repaid by the borrower. IO's are typically used to manage
interest rate exposure in the Fund's portfolio.
7. DISTRIBUTION AND SERVICE PLANS
The Fund and its shareholders have adopted a distribution plan pursuant to Rule
12b-1 under the Investment Company Act of 1940 and a service plan (collectively
the "Plans"). The Plans govern payments for the distribution of the Fund's
shares, ongoing shareholder services and maintenance of shareholder accounts.
Annual fees under the Plans of up to .25% of Class A net assets and 1.00%
each of Class B and Class C net assets are accrued daily. Included in these fees
for the year ended June 30, 1997, are payments to VKAC of approximately
$547,100.
8. BORROWINGS
In accordance with its investment policies, the Fund may borrow money from banks
or enter into reverse repurchase agreements or dollar rolls for investment
purposes in an amount up to 33.3% of its total assets.
The Fund has entered into a $60,000,000 revolving credit agreement which
expires on March 31, 1998. Interest is charged under the agreement at a rate of
.425% above the federal funds rate. The interest rate in effect at June 30,
1997, was 6.675%. An annual commitment fee of .075% is charged on the unused
portion of the credit line.
B-74
<PAGE> 75
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
June 30, 1997
- --------------------------------------------------------------------------------
The Fund has entered into reverse repurchase agreements under which the Fund
sells securities and agrees to repurchase them at a mutually agreed upon date
and price. At June 30, 1997, there were no open reverse repurchase agreements.
The average daily balance of bank borrowings and reverse repurchase
agreements for the year ended June 30, 1997, was approximately $38,213,200 with
an average interest rate of 5.78%.
At June 30, 1997, these agreements represented 28.8% of the Fund's total
assets.
B-75
