<PAGE>
As filed with the Securities and Exchange Commission on March 17, 1999
Securities Act File No. 33-6502
Investment Company Act File Act No. 811-4708
============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. [_]
POST-EFFECTIVE AMENDMENT NO. 25 [X]
and/or
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 22
(Check appropriate box or boxes)
SUNAMERICA INCOME FUNDS
(Exact Name of Registrant as Specified in Charter)
The SunAmerica Center
733 Third Avenue - Third Floor
New York, NY 10017 - 3204
(Address of Principal Executive Office)(Zip Code)
Registrant's telephone number, including area code: (800) 858-8850
Robert M. Zakem, Esq.
Senior Vice President and General Counsel
SunAmerica Asset Management Corp.
The SunAmerica Center
733 Third Avenue - Third Floor
New York, NY 10017-3204
(Name and Address for Agent for Service)
Copy to:
Margery K. Neale, Esq.
Swidler Berlin Shereff Friedman, LLP
919 Third Avenue
New York, NY 10022
Approximate Date of Proposed Public Offering: As soon as practicable
after this Registration Statement becomes effective.
It is proposed that this filing will become effective (check appropriate
box)
[_] immediately upon filing pursuant to paragraph (b)
[_] on (date) pursuant to paragraph (b)
[_] 60 days after filing pursuant to paragraph (a)(1)
[X] on June 1, 1999 pursuant to paragraph (a)(1)
[_] 75 days after filing pursuant to paragraph (a)(2)
[_] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[_] This post-effective amendment designates a new effective date
for a previously filed post-effective amendment.
<PAGE>
PROSPECTUS
___________________, 1999
SUNAMERICA INCOME FUNDS
. SUNAMERICA U.S. GOVERNMENT SECURITIES FUND
. SUNAMERICA FEDERAL SECURITIES FUND
. SUNAMERICA DIVERSIFIED INCOME FUND
. SUNAMERICA HIGH INCOME FUND
. SUNAMERICA TAX EXEMPT INSURED FUND
The Securities and Exchange Commission has not
approved or disapproved these securities or passed
upon the adequacy of this prospectus. Any
representation to the contrary is a criminal offense.
[Logo] SUNAMERICA
MUTUAL FUNDS
<PAGE>
TABLE OF CONTENTS
FUND HIGHLIGHTS............................................................. 3
FINANCIAL HIGHLIGHTS....................................................... 10
SHAREHOLDER ACCOUNT INFORMATION............................................ 12
MORE INFORMATION ABOUT THE FUNDS........................................... 26
Fund Investment Strategies............................................. 26
Glossary............................................................... 28
Investment Terminology............................................ 28
Risk Terminology.................................................. 30
FUND MANAGEMENT............................................................ 31
FOR MORE INFORMATION....................................... outside back cover
2
<PAGE>
FUND HIGHLIGHTS
The following questions and answers are designed to give you an overview of the
Trust, and to provide you with information about the Trust's five investment
portfolios, or "Funds," and their investment goals and principal strategies. No
goal may be changed without shareholder approval. There can be no assurance
that any Fund's investment goal will be met or that the net return on an
investment will exceed what could have been obtained through other investment or
savings vehicles. More complete investment information is provided in chart
form, under "More Information About the Funds," which is on page 26, and the
glossary that follows on page 28.
Q: WHAT ARE THE FUNDS' INVESTMENT GOALS, STRATEGIES AND TECHNIQUES?
A:
<TABLE>
<CAPTION>
Principal Investment Principal Investment
Series Investment Goal Strategy Techniques
- ------ --------------- --------------------- -------------------------
<S> <C> <C> <C>
U.S. Government high current income fixed income invests primarily in
Securities Fund consistent with investing securities issued or
relative safety of guaranteed by the
capital U.S. government,
or any agency or
instrumentality
thereof
</TABLE>
[SIDEBAR: The strategy of "FIXED INCOME INVESTING" in which each Fund engages
includes utilizing economic research and analysis of current economic
conditions, potential fluctuations in interest rates, and, where relevant -
particularly with respect to the issuers of high-yield, high-risk bonds - the
strength of the underlying issuer. Each Fund will utilize this strategy to
achieve current income, as consistent with its stated level of risk, as
described in the chart.]
3
<PAGE>
<TABLE>
<CAPTION>
Principal Investment Principal Investment
Series Investment Goal Strategy Techniques
- ------ --------------- --------------------- -------------------------
<S> <C> <C> <C>
Federal Securities current income, with fixed income invests primarily in
Fund capital appreciation as investing securities issued or
a secondary objective guaranteed by the
U.S. government
or any agency or
instrumentality
thereof, with a
significant portion
invested in
mortgage-backed
securities
Diversified Income a high level of current fixed income invests in a
Fund income consistent investing diversified portfolio
with moderate of securities
investment risk, with consisting of: (i) U.S.
preservation of capital government securities;
as a secondary (ii) foreign government and
objective corporate debt securities;
and (iii) fixed income
securities issued by
domestic corporations,
including lower-rated
high-yield securities,
without regard to the
maturities of such
securities
High Income Fund maximum current fixed income invests primarily in
income investing high-yield, high-risk
corporate bonds
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Principal Investment Principal Investment
Series Investment Goal Strategy Techniques
- ------ --------------- --------------------- -------------------------
<S> <C> <C> <C>
Tax Exempt as high a level of fixed income invests, under normal
Insured Fund current income investing market conditions, at
exempt from federal least 80% of its total
income taxes as is assets in Municipal
consistent with Bonds, the income of
preservation of capital which is exempt from
federal income taxes,
and at least 65% of
its total assets in
Municipal Bonds
that, in addition to
having income
exempt from federal
income tax, also are
insured as to the
scheduled payment
of principal and
interest for as long as
such bonds are held
by the Fund, without
regard to the
maturities of such
securities
</TABLE>
[Margin note: The Tax Exempt Insured Fund's policy of investing 80% of its
total assets in Municipal Bonds, the income of which is exempt from federal
income taxes, is a fundamental policy of the Fund, which may not be changed
without the approval of the Fund's shareholders.]
Q: WHAT ARE THE PRINCIPAL RISKS OF INVESTING IN THE FUNDS?
A: The following section describes the principal risks of each Fund, while the
chart on page 26 describes various additional risks.
RISKS OF INVESTING IN BONDS
As interest rates rise, bond prices typically fall; and as interest rates
fall, bond prices typically rise. As with any bond fund, the value of your
investment in these Funds may go up or down in response to changes in
interest rates or defaults (or even the potential for future default) by
bond issuers.
5
<PAGE>
ADDITIONAL PRINCIPAL RISKS
In addition, shares of the Funds are not bank deposits and are not
guaranteed or insured by any bank, government entity or the Federal
Deposit Insurance Corporation. As with any mutual fund, there is no
guarantee that any fund will be able to achieve its investment goals. If
the value of the assets of the Fund goes down, you could lose money.
ADDITIONAL RISKS SPECIFIC TO THE DIVERSIFIED INCOME FUND
The DIVERSIFIED INCOME FUND may invest in "junk bonds," which are
considered speculative. While SunAmerica seeks to diversify the Fund and
to engage in a credit analysis of each junk bond issuer in which it
invests, junk bonds carry a substantial risk of default or they may already
be in default. The market price for junk bonds may fluctuate more than
higher-quality securities and may decline significantly. In addition, it
may be more difficult for a Fund to dispose of junk bonds or to determine
their value. Junk bonds may contain redemption or call provisions that, if
exercised during a period of declining interest rates, may force a Fund to
replace the security with a lower yielding security, which would decrease
the return on such Fund.
ADDITIONAL RISKS SPECIFIC TO THE HIGH INCOME FUND
The HIGH INCOME FUND will invest in "junk bonds," which are considered
speculative. While SunAmerica seeks to diversify the Fund and to engage in
a credit analysis of each junk bond issuer in which it invests, junk bonds
carry a substantial risk of default or they may already be in default. The
market price for junk bonds may fluctuate more than higher-quality
securities and may decline significantly. In addition, it may be more
difficult for a Fund to dispose of junk bonds or to determine their value.
Junk bonds may contain redemption or call provisions that, if exercised
during a period of declining interest rates, may force a Fund to replace
the security with a lower yielding security, which would decrease the
return on such Fund.
ADDITIONAL RISKS SPECIFIC TO THE FEDERAL SECURITIES FUND
The FEDERAL SECURITIES FUND will invest significantly in mortgage-backed
securities, which entails the risk that the underlying principal may be
"prepaid" at any time. As a result of prepayments, in periods of declining
interest rates the Fund may be required to reinvest its assets in
securities with lower interest rates. In periods of increasing interest
rates, prepayments generally may decline, with the effect that the
securities subject to prepayment risk held by the Fund may exhibit price
characteristics of longer-term debt securities.
6
<PAGE>
Q: HOW HAVE THE FUNDS PERFORMED HISTORICALLY?
A: The following Risk/Return Bar Charts and Tables illustrate the risks of
investing in the Funds by showing changes in the Funds' performance from
calendar year to calendar year, and compare the Funds' average annual
returns to those of an appropriate market index. Sales charges are not
reflected in the bar charts. If these amounts were reflected, returns
would be less than those shown. Of course, past performance is not
necessarily an indication of how a Fund will perform in the future.
[TO BE FILED BY AMENDMENT]
Q: WHAT ARE THE FUNDS' EXPENSES?
A: The following table describes the fees and expenses that you may pay if you
buy and hold shares of the Funds.
7
<PAGE>
<TABLE>
<CAPTION>
GOVERNMENT SECURITIES FEDERAL SECURITIES
FUND FUND DIVERSIFIED INCOME FUND
------------------------------------------------------------------------------------
CLASS CLASS CLASS CLASS CLASS CLASS CLASS CLASS CLASS
A B II A B II A B II
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SHAREHOLDER FEES
(fees paid directly
from your investment)
Maximum Sales Charge
(Load) Imposed on Pur-
chases (as a per-
centage of offering
price)/(2)/................. 4.75% None 1.00% 4.75% None 1.00 4.75% None 1.00%
Maximum
Deferred Sales
Charge (Load) (as a
percentage of amount
redeemed)/(3)/.............. None 4.00% 1.00% None 4.00% 1.00% None 4.00% 1.00%
Maximum Sales Charge
(Load) Imposed on
Reinvested
Dividends................... None None None None None None None None None
Redemption Fee/(4)/......... None None None None None None None None None
Exchange Fee................ None None None None None None None None None
Maximum Account Fee
ANNUAL FUND
OPERATING EXPENSES
(expenses that are
deducted from Fund
assets)
Management Fees............. 0.74% 0.74% 0.75% 0.53% 0.53% 0.55% 0.65% 0.65% 0.65%
Distribution
(12b-1) Fees/(5)/............. 0.35% 1.00% 1.00% 0.35% 1.00% 1.00% 0.35% 1.00% 1.00%
Other Expenses................ 0.54% 0.52% 0.59% 0.60% 0.45% 0.41%
------------------------------------------------------------------------------------
Total Annual Fund
Operating
Expenses.................... 1.63% 2.26% /(6)/ 1.47% 2.13% /(6)/ 1.45% 2.06% /(6)/
Expense
Reimbursement/(7)/
Net Expenses
====================================================================================
<CAPTION>
TAX EXEMPT INSURED
HIGH INCOME FUND FUND
-------------------------------------------------------
CLASS CLASS CLASS CLASS CLASS CLASS
A B II/(1)/ A B II
-------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
SHAREHOLDER FEES
(fees paid directly
from your investment)
Maximum Sales Charge
(Load) Imposed on Pur-
chases (as a per-
centage of offering
price)/(2)/................. 4.75% None 1.00% 4.75% None 1.00%
Maximum
Deferred Sales
Charge (Load) (as a
percentage of amount
redeemed)/(3)/.............. None. 4.00% 1.00% None 4.00% 1.00%
Maximum Sales Charge
(Load) Imposed on
Reinvested
Dividends................... None None None None None None
Redemption Fee/(4)/......... None None None None None None
Exchange Fee................ None None None None None None
Maximum Account Fee
ANNUAL FUND
OPERATING EXPENSES
(expenses that are
deducted from Fund
assets)
Management Fees............. 0.75% 0.75% 0.75% 0.50% 0.50% 0.50%
Distribution.................. 1.00% 1.00% 0.35% 1.00% 1.00%
(12b-1) Fees/(5)/............. 0.35%
Other Expenses................ 0.42% 0.38% 0.35% 0.39% 0.40%
-------------------------------------------------------
Total Annual Fund
Operating
Expenses.................... 1.52% 2.13% 2.10% 1.24% 1.90% /(6)/
Expense
Reimbursement/(7)/
Net Expenses
=======================================================
</TABLE>
(1) Previously designated Class C shares.
(2) The front-end sales charge on Class A shares decreases with the size of the
purchase to 0% for purchases of $1 million or more.
(3) Purchases of Class A shares over $1 million will be subject to a contingent
deferred sales charge (CDSC) on redemptions made within one year of
purchase. The CDSC on Class B shares applies only if shares are redeemed
within six years of their purchase. The CDSC on Class II shares applies
only if shares are redeemed within eighteen months of their purchase.
(4) A $15.00 fee may be imposed on wire redemptions.
8
<PAGE>
(5) Because these fees are paid out of a Portfolio's assets on an on-going
basis, over time these fees will increase the cost of your investment and
may cost you more than paying other types of sales charges.
(5) The Board of Directors, including a majority of the Independent Directors,
approved the Investment Advisory and Management Agreement subject to the
net expense ratio set forth above. The Adviser may not increase such
ratios, which are contractually required by agreement with the Board of
Directors, without the approval of the Directors, including a majority of
the Independent Directors. The expense waivers and fee reimbursements will
continue indefinitely, subject to termination by the Directors, including a
majority of the Independent Directors.
(6) The offering of Class II shares commenced for these Funds on December 1,
1998. The amounts shown are estimated based on expenses expected to have
been incurred if Class II shares had been in existence for these Funds
throughout the fiscal year ended March 31, 1999.
EXAMPLE
This Example is intended to help you compare the cost of investing in the Funds
with the cost of investing in other mutual funds.
The Example assumes that you invest $10,000 in a Fund for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Example also assumes that your investment has a 5% return each year and that the
Fund's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions and the net expenses shown in the
fee table your costs would be:
If you redeem your investment at the end of the periods indicated:
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
<S> <C> <C> <C> <C>
GOVERNMENT SECURITIES FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
FEDERAL SECURITIES FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
DIVERSIFIED INCOME FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
HIGH INCOME FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
<S> <C> <C> <C> <C>
TAX EXEMPT INSURED FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
</TABLE>
You would pay the following expenses if you did not redeem your shares:
<TABLE>
<CAPTION>
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
<S> <C> <C> <C> <C>
GOVERNMENT SECURITIES FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
FEDERAL SECURITIES FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
DIVERSIFIED INCOME FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
HIGH INCOME FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
TAX EXEMPT INSURED FUND
(Class A shares).........................
(Class B shares)/*/......................
(Class II shares)........................
</TABLE>
_______________________________
* Class B shares convert to Class A shares approximately seven years after
purchase. Therefore, expense information for years 8, 9 and 10 is the same
for both Class A and B shares.
FINANCIAL HIGHLIGHTS
The Financial Highlights table for each Fund is intended to help you understand
the Fund's financial performance for the past 5 years. Certain information
reflects financial results for a single Fund share. The total returns in each
table represent the rate that an investor would have earned (or lost) on an
investment in a Fund (assuming reinvestment of all dividends and distributions).
This information has
10
<PAGE>
been audited by PricewaterhouseCoopers LLP, whose report, along with each Fund's
financial statements, are included in the Trust's annual report to shareholders,
which is available upon request.
[TO BE FILED BY AMENDMENT]
11
<PAGE>
SHAREHOLDER ACCOUNT INFORMATION
SELECTING A SHARE CLASS
Each Fund offers three classes of shares: Class A, Class B and Class II shares.
Each class of shares has its own cost structure, so you can choose the one best
suited to your investment needs. Your broker or financial advisor can help you
determine which class is right for you.
CLASS A CLASS B CLASS II
. Front-end sales charges, . No front-end sales . Front-end sales
as described below. charge; all your charge, as described
There are several ways money goes to work below.
to reduce these charges, for you right away.
also described below. . Higher annual
. Higher annual expenses than Class
. Lower annual expenses expenses than Class A shares.
than Class B or Class II A shares.
shares. . Deferred sales
. Deferred sales charge charge on shares
on shares you sell you sell within
within six years of eighteen months of
purchase, as described purchase, as
below. described below.
. Automatic conversion . No conversion to
to Class A shares Class A.
after approximately
seven years, thus
reducing future annual
expenses.
12
<PAGE>
CALCULATION OF SALES CHARGES
CLASS A Sales Charges are as follows:
<TABLE>
<CAPTION>
Concession to
Sales Charge Dealers
---------------------------------------------------
% OF % OF NET % OF
OFFERING AMOUNT OFFERING
YOUR INVESTMENT PRICE INVESTED PRICE
---------------------------------------------------
<S> <C> <C> <C>
Less than $50,000.................. 5.75% 6.10% 5.00%
$50,000 but less than $100,000..... 4.75% 4.99% 4.00%
$100,000 but less than $250,000.... 3.75% 3.90% 3.00%
$250,000 but less than $500,000.... 3.00% 3.09% 2.25%
$500,000 but less than $1,000,000.. 2.10% 2.15% 1.35%
$1,000,000 or more................. None None 1.00%
</TABLE>
INVESTMENTS OF $1 MILLION OR MORE Class A shares are available with no front-
end sales charge. However, there is a 1% CDSC on any shares you sell within one
year of purchase.
CLASS B Shares are offered at their net asset value per share, without any
initial sales charge. However, there is a CDSC on shares you sell within six
years of buying them. The longer the time between the purchase and the sale of
shares, the lower the rate of the CDSC:
Class B deferred charges:
Years after purchase CDSC on shares being sold
1st or 2nd year 4.00%
3rd or 4th year 3.00%
5th year 2.00%
6th year 1.00%
7th year and thereafter None
13
<PAGE>
For purposes of the CDSC, we count all purchases you make during a calendar
month as having been made on the FIRST day of that month.
CLASS II Sales Charges are as follows:
Sales Charge Concession to Dealers
- --------------------------------------------------------
% OF % OF NET % OF
OFFERING AMOUNT OFFERING
PRICE INVESTED PRICE
- --------------------------------------------------------
1.00% 1.01% 1.00%
There is also a CDSC of 1% on shares you sell within eighteen months after you
buy them.
DETERMINATION OF CDSC Each CDSC is based on the original purchase cost or the
current market value of the shares being sold, whichever is less. There is no
CDSC on shares you purchase through reinvestment of dividends. To keep your
CDSC as low as possible, each time you place a request to sell shares we will
first sell any shares in your account that are not subject to a CDSC. If there
are not enough of these shares available, we will sell shares that have the
lowest CDSC.
SALES CHARGE REDUCTIONS AND WAIVERS
WAIVERS FOR CERTAIN INVESTORS Various individuals and institutions may purchase
Class A shares without front-end sales charges, including:
. financial planners, institutions, broker-dealer representatives or
registered investment advisers utilizing Fund shares in fee-based
investment products under an agreement with the Distributor (this waiver
may also apply to front-end sales charges of Class II shares)
. participants in certain retirement plans that meet applicable conditions
. Trustees and other individuals who are affiliated with any Fund or other
SunAmerica Mutual Funds and their families
. selling brokers and their employees and sales representatives and their
families
. participants in "Net Asset Value Transfer Program"
We will generally waive the CDSC for CLASS B or CLASS II shares in the following
cases:
. within one year of the shareholder's death or becoming disabled
. taxable distributions or loans to participants made by qualified retirement
plans or retirement accounts (not including rollovers) for which SunAmerica
serves as fiduciary
. Trustees and other individuals who are affiliated with any Fund or other
SunAmerica Mutual Funds and their families
14
<PAGE>
. to make taxable distributions from certain retirement plans
. to make payments through the Systematic Withdrawal Plan (subject to
certain conditions)
REDUCING YOUR CLASS A SALES CHARGES There are several special purchase plans
that allow you to combine multiple purchases of Class A shares of SunAmerica
Mutual Funds to take advantage of the breakpoints in the sales charge schedule.
For information about the "Rights of Accumulation," "Letter of Intent,"
"Combined Purchase Privilege," and "Reduced Sales Charges for Group Purchases,"
contact your broker or financial advisor, or consult the Statement of Additional
Information.
To utilize: if you think you may be eligible for a sales charge reduction or
CDSC waiver, contact your broker or financial advisor.
REINSTATEMENT PRIVILEGE If you sell shares of a Fund, you may invest some or
all of the proceeds in the same share class of the same Fund within one year
without a sales charge. If you paid a CDSC when you sold your shares, we will
credit your account with the dollar amount of the CDSC at the time of sale. All
accounts involved must be registered in the same name(s).
12B-1 FEES
Each class of shares of each Fund has its own 12b-1 plan that provides for
distribution and account maintenance and service fees (payable to the
Distributor) based on a percentage of average daily net assets, as follows:
Account Maintenance and
Class Distribution Fee Service Fee
----- ---------------- -----------
A 0.10% 0.25%
B 0.75% 0.25%
II 0.75% 0.25%
Because 12b-1 fees are paid out of the Fund's assets on an ongoing basis, over
time these fees will increase the cost of your investment and may cost you more
than paying other types of sales charges.
OPENING AN ACCOUNT
Read this prospectus carefully.
Determine how much you want to invest. The minimum initial investments for
the Funds are as follows:
. non-retirement account: $500
. retirement account: $250
. dollar cost averaging: $500 to open; you must invest at least $25 a
month
15
<PAGE>
The minimum subsequent investments for the Funds are as follows:
. non-retirement account: $100
. retirement account: $25
. Complete the appropriate parts of the Account Application, carefully
following the instructions. If you have questions, please contact your
broker or financial advisor or call Shareholder/Dealer Services at
1-800-858-8850.
. Complete the appropriate parts of the Supplemental Account Application.
By applying for additional investor services now, you can avoid the
delay and inconvenience of having to submit an additional application if
you want to add services later.
. Make your initial investment using the chart on the next page. You can
initiate any purchase, exchange or sale of shares through your broker or
financial advisor.
16
<PAGE>
BUYING SHARES
Opening an account Adding to an account
<TABLE>
<CAPTION>
BY CHECK
<S> <C> <C>
. Make out a check for the investment . Make out a check for the investment amount
amount, payable to the specific Fund or payable to the specific Fund or SunAmerica
SunAmerica Funds. Funds.
. Deliver the check and your completed . Include the stub from your Fund statement or
Account Application (and Supplemental a note specifying the Fund name, your share
Account Application, if applicable) to class, your account number and the name(s) in
your broker or financial advisor, or mail which the account is registered.
them to:
. Indicate the Fund and account number in the
SunAmerica Fund Services, Inc. memo section of your check.
Mutual Fund Operations, 3rd Floor
The SunAmerica Center . Deliver the check and your stub or note to
733 Third Avenue your broker or financial advisor, or mail them
New York, New York 10017-3204. to
Non-Retirement Accounts:
-----------------------------------------------
SunAmerica Fund Services, Inc.
c/o NFDS
P.O. Box 419373
Kansas City, Missouri 64141-6373
Retirement Accounts:
-----------------------------------------------
SunAmerica Fund Services, Inc.
Mutual Fund Operations, 3rd Floor
The SunAmerica Center
733 Third Avenue
New York, New York 10017-3204
BY WIRE
. Deliver your completed application to . Instruct your bank to wire the amount of your
your broker or financial advisor or fax it investment to:
to SunAmerica Fund Services, Inc. at
212-551-5585. State Street Bank & Trust Company
Boston, MA
. Obtain your account number by referring ABA #0110-00028
to your statement or by calling your DDA # 99029712
broker or financial advisor or
Shareholder/Dealer Services at 1-800- Specify the Fund name, your share class, your
858-8850, ext. 5125. Fund number, account number and the
name(s) in which the account is registered.
Your bank may charge a fee to wire funds.
</TABLE>
17
<PAGE>
. Instruct your bank to wire the amount of
your investment to:
State Street Bank & Trust Company
Boston, MA
ABA #0110-00028
DDA # 99029712
Specify the Fund name, your choice of
share class, your new Fund number and
account number and the name(s) in which
the account is registered. Your bank may
charge a fee to wire funds.
To open or add to an account using dollar cost averaging, see "Additional
Investor Services."
18
<PAGE>
<TABLE>
<CAPTION>
SELLING SHARES
How Requirements
<S> <C>
THROUGH YOUR BROKER OR FINANCIAL ADVISOR
. Accounts of any type. . Call your broker or financial advisor
. Sales of any amount. to place your order to sell shares.
BY MAIL
. Accounts of any type. . Write a letter of instruction
. Sales of any amount. indicating the Fund name, your share
class, your account number, the
name(s) in which the account is
registered and the dollar value or
number of shares you wish to sell.
. Include all signatures
and any additional documents
that may be required
(see next page).
. Mail the materials to:
SunAmerica Fund Services, Inc.
Mutual Fund Operations, 3rd Floor
The SunAmerica Center
733 Third Avenue
New York, New York 10017-
3204
. A check will normally be mailed on
the next business day to the name(s)
and address in which the account is
registered, or otherwise according to
your letter of instruction.
BY PHONE
. Most accounts.
. Sales of less than $100,000.
</TABLE>
19
<PAGE>
. Call Shareholder/Dealer Services
at 1-800-858-8850 between 8:30
a.m. and 7:00 p.m. (Eastern time)
on most business days. State the
Fund name, the name of the person
requesting the redemption, your
share class, your account number,
the name(s) in which the account
is registered and the dollar value or
number of shares you wish to sell.
. A check will be mailed to the
name(s) and address in which the
account is registered, or to a
different address indicated in a
written authorization previously
provided to the Fund by the
shareholder(s) on the account.
<TABLE>
<CAPTION>
BY WIRE
<S> <C>
. Request by mail to sell any amount . Proceeds will normally be wired on
(accounts of any type). the next business day. A $15 fee will
be deducted from your account.
. Request by phone to sell less than
$100,000.
</TABLE>
To sell shares through a systematic withdrawal plan, see "Additional Investor
Services."
SELLING SHARES IN WRITING In certain circumstances, you will need to make your
request to sell shares in writing. Corporations, executors, administrators,
trustees or guardians may need to include additional items with a request to
sell shares. You may also need to include a signature guarantee, which protects
you against fraudulent orders. You will need a signature guarantee if:
. your address of record has changed within the past 30 days
. you are selling more than $100,000 worth of shares
. you are requesting payment other than by a check mailed to the address
of record and payable to the registered owner(s)
You can generally obtain a signature guarantee from the following sources:
. a broker or securities dealer
. a federal savings, cooperative or other type of bank
. a savings and loan or other thrift institution
20
<PAGE>
. a credit union
. a securities exchange or clearing agency
A notary public CANNOT provide a signature guarantee.
TRANSACTION POLICIES
VALUATION OF SHARES The net asset value per share (NAV) for each Fund and class
is determined each business day at the close of regular trading on the New York
Stock Exchange (generally 4:00 p.m., Eastern time) by dividing the net assets of
each class by the number of such class's outstanding shares. Investments for
which market quotations are readily available are valued at their price as of
the close of regular trading on the New York Stock Exchange for the day. All
other securities and assets for which market quotations are not readily
available are valued at fair value following procedures approved by the
Trustees. Short-term investments that mature in less than 60 days are valued at
amortized cost if their original maturity was 60 days or less, or by amortizing
their value on the 61st day prior to maturity, if their original term exceeds 60
days (unless the Trustees determine that amortized cost value does not represent
fair value, in which case, fair value will be determined as described above).
BUY AND SELL PRICES When you buy shares, you pay the NAV plus any applicable
sales charges, as described earlier. When you sell shares, you receive the NAV
minus any applicable CDSCs.
EXECUTION OF REQUESTS Each Fund is open on those days when the New York Stock
Exchange is open for regular trading. We execute buy and sell requests at the
next NAV to be calculated after the Trust receives your request in good order.
If the Trust or the Distributor receives your order before the Fund's close of
business (generally 4:00 p.m., Eastern time), you will receive that day's
closing price. If the Trust or the Distributor receives your order after that
time, you will receive the next business day's closing price. If you place your
order through a broker or financial advisor, you should make sure the order is
transmitted to the Fund before its close of business. The Trust and the
Distributor reserve the right to reject any order to buy shares.
During periods of extreme volatility or market crisis, a Fund may temporarily
suspend the processing of sell requests, or may postpone payment of proceeds for
up to three business days or longer, as allowed by federal securities laws.
Each of the Diversified Income Fund and High Income Fund may invest to a large
extent in securities that are primarily listed on foreign exchanges that trade
on weekends or other days when such Fund does not price its shares. As a result,
the value of the Fund's shares may change on days when you will not be able to
purchase or redeem your shares.
If the Trust determines that it would be detrimental to the best interests of
the remaining shareholders of the Trust to make payment of redemption proceeds
wholly or partly in cash, the Trust may pay the redemption price by a
distribution in kind of securities from the Trust in lieu of cash. However, the
Trust has made an election that requires it to pay a certain portion of
redemption proceeds in cash.
21
<PAGE>
TELEPHONE TRANSACTIONS For your protection, telephone requests are recorded in
order to verify their accuracy. In addition, Shareholder/Dealer Services will
take measures to verify the identity of the caller, such as asking for name,
account number, social security or other taxpayer ID number and other relevant
information. If appropriate measures are not taken, the Trust is responsible for
any losses that may occur to any account due to an unauthorized telephone call.
Also for your protection, telephone transactions are not permitted on accounts
whose names or addresses have changed within the past 30 days. At times of peak
activity, it may be difficult to place requests by phone. During these times,
consider sending your request in writing.
EXCHANGES You may exchange shares of a Fund for shares of the same class of any
other SunAmerica Mutual Fund. Before making an exchange, you should review a
copy of the prospectus of the fund into which you would like to exchange. All
exchanges are subject to applicable minimum investment requirements. A
Systematic Exchange Program is described under "Additional Investor Services."
If you exchange shares that were purchased subject to a CDSC, the CDSC will
continue to apply following the exchange. In determining the CDSC applicable to
shares being sold after an exchange, we will take into account the length of
time you held those shares prior to the exchange. Your CDSC schedule will not
change if you exchange Class C or Class II shares that you purchased prior to
December 1, 1998 for another portfolio or fund's Class II shares (which
currently have a longer CDSC schedule).
To protect the interests of other shareholders, we may cancel the exchange
privileges of any investors that, in the opinion of the Fund, are using market
timing strategies or making excessive exchanges. A Fund may change or cancel its
exchange privilege at any time, upon 60 days' written notice to its
shareholders. A Fund may also refuse any exchange order.
CERTIFICATED SHARES Most shares are electronically recorded. If you wish to have
certificates for your shares, please call Shareholder/Dealer Services at 1-800-
858-8850 for further information. You may sell or exchange certificated shares
only by returning the certificates to the Funds, along with a letter of
instruction and a signature guarantee. The Funds do not issue certificates for
fractional shares.
MULTI-PARTY CHECKS The Trust may agree to accept a "multi-party check" in
payment for Fund shares. This is a check made payable to the investor by another
party and then endorsed over to the Trust by the investor. If you use a multi-
party check to purchase shares, you may experience processing delays. In
addition, the Trust is not responsible for verifying the authenticity of any
endorsement and assumes no liability for any losses resulting from a fraudulent
endorsement.
ADDITIONAL INVESTOR SERVICES
To select one or more of these additional services, complete the relevant
part(s) of the Supplemental Account Application. To add a service to an
existing account, contact your broker or financial advisor, or call
Shareholder/Dealer Services at 1-800-858-8850.
22
<PAGE>
DOLLAR COST AVERAGING lets you make regular investments from your bank account
to the SunAmerica Mutual Funds of your choice. You determine the frequency and
amount of your investments, and you can terminate your participation at any
time.
SYSTEMATIC WITHDRAWAL PLAN may be used for routine bill payment or periodic
withdrawals from your account. To use:
. Make sure you have at least $5,000 worth of shares in your account.
. Make sure you are not planning to invest more money in this account
(buying shares during a period when you are also selling shares of the
same Fund is not advantageous to you, because of sales charges).
. Specify the payee(s) and amount(s). The payee may be yourself or any
other party, and there is no limit to the number of payees you may
have, as long as they are all on the same payment schedule. Each
withdrawal must be at least $50.
. Determine the schedule: monthly, quarterly, semi-annually, annually or
in certain selected months.
. Make sure your dividends and capital gains are being reinvested.
You cannot elect the systematic withdrawal plan if you have requested
certificates for your shares.
SYSTEMATIC EXCHANGE PROGRAM may be used to exchange shares of a Fund
periodically for the same class of shares of one or more other SunAmerica Mutual
Funds. To use:
. Specify the SunAmerica Mutual Fund(s) from which you would like money
withdrawn and into which you would like money invested.
. Determine the schedule: monthly, quarterly, semi-annually, annually or
in certain selected months.
. Specify the amount(s). Each exchange must be worth at least $25.
. Accounts must be registered identically; otherwise a signature
guarantee will be required.
ASSET PROTECTION PLAN (OPTIONAL) Anchor National Life Insurance Company offers
an Asset Protection Plan to certain investors in the Funds. The benefits of this
optional coverage payable at death will be related to the amounts paid to
purchase Fund shares and to the value of the Fund shares held for the benefit of
the insured persons. However, to the extent the purchased shares are redeemed
prior to death, coverage with respect to these shares will terminate.
Purchasers of the Asset Protection Plan are required to authorize periodic
redemptions of Fund shares to pay the premiums for this coverage. These
redemptions will not be subject to CDSCs but will have the same tax consequences
as any other Fund redemptions.
The Asset Protection Plan will be available to eligible persons who enroll for
the coverage within a limited time period after shares in any Fund are initially
purchased or transferred. In addition, coverage cannot be made available unless
Anchor National knows for whose benefit shares are purchased. For
23
<PAGE>
instance, coverage cannot be made available for shares registered in the name of
your broker unless the broker provides Anchor National with information
regarding the beneficial owners of the shares. In addition, coverage is
available only to shares purchased on behalf of natural persons between 21 and
75 years of age; coverage is not available with respect to shares purchased for
a retirement account. Other restrictions on the coverage apply. This coverage
may not be available in all states and may be subject to additional restrictions
or limitations. Purchasers of shares should also make themselves familiar with
the impact on the Asset Protection Plan coverage of purchasing additional
shares, reinvestment of dividends and capital gains distributions and
redemptions.
Anchor National is a SunAmerica company.
Please call 1-800-858-8850 for more information, including the cost of the Asset
Protection Plan option.
RETIREMENT PLANS SunAmerica Mutual Funds offer a range of qualified retirement
plans, including IRAs, Roth IRAs, Simple IRAs, SARSEPs, 401(k) plans, 403(b)
plans and other pension and profit-sharing plans. Using these plans, you can
invest in any SunAmerica Mutual Fund with a low minimum investment of $250 or,
for some group plans, no minimum investment at all. To find out more, call
Shareholder/Dealer Services at 1-800-858-8850.
TAX, DIVIDEND AND ACCOUNT POLICIES
ACCOUNT STATEMENTS In general, you will receive account statements as follows:
. after every transaction that affects your account balance (except a
dividend reinvestment or automatic purchase from your bank account)
. after any changes of name or address of the registered owner(s)
. in all other circumstances, quarterly or annually, depending upon the
Fund
Every year you should also receive, if applicable, a Form 1099 tax information
statement, mailed by January 31.
DIVIDENDS The Funds generally distribute most or all of their net earnings in
the form of dividends. Income dividends, if any, are declared daily and paid
monthly. Capital gains distributions, if any, are paid annually by the Funds.
DIVIDEND REINVESTMENTS Your dividends and distributions, if any, will be
automatically reinvested in additional shares of the same Fund and share class
on which they were paid, unless the shareholder elects in writing, not less than
five business days prior to the payment date, to receive amounts in excess of
$10 in cash. Alternatively, dividends and distributions may be reinvested in any
other SunAmerica Mutual Fund or paid in cash (if more than $10). You will need
to complete the relevant part of the Account Application to elect one of these
other options. For existing accounts, contact your broker or financial advisor
or call Shareholder/Dealer Services at 1-800-858-8850 to change dividend and
distribution payment options.
24
<PAGE>
TAXABILITY OF DIVIDENDS As long as a Fund meets the requirements for being a
tax-qualified regulated investment company, which each Fund has in the past and
intends to in the future, it pays no federal income tax on the earnings it
distributes to shareholders.
Consequently, dividends you receive from a Fund whether reinvested or taken as
cash, are generally considered taxable. Distributions of a Fund's long-term
capital gains are taxable as capital gains; dividends from other sources are
generally taxable as ordinary income. For an individual, the maximum long-term
capital gains rate is 20%.
Dividends paid by the Tax Exempt Insured Fund generally will be exempt from
federal income taxes, as long as 50% or more of the value of that Fund's assets
at the end of each quarter is invested in state, municipal, and other
obligations, the interest on which is excluded from gross income for federal
income tax purposes. As mentioned, at least 80% of the Tax Exempt Insured Fund's
assets will be invested in such obligations during normal market conditions.
Dividends attributable to the taxable bonds, market discount and to short-term
capital gains, however, will be subject to federal, state and local income tax
at ordinary income tax rates. Some shareholders may be subject to federal
alternative minimum tax liability. Tax-exempt interest from certain bonds is
treated as an item of tax preference, and may be attributed to shareholders. A
portion of all tax-exempt interest is includable as an upward adjustment in
determining a corporation's alternative minimum taxable income. These rules
could make you liable for the alternative minimum income tax (AMT).
The Form 1099 that is mailed to you every January details your dividends and
their federal tax category, although you should verify your tax liability with
your tax professional. Some dividends paid in January may be taxable as if they
had been paid the previous December.
TAXABILITY OF TRANSACTIONS Any time you sell or exchange shares, it is
considered a taxable event for you. Depending on the purchase price and the sale
price of the shares you sell or exchange, you may have a gain or a loss on the
transaction. You are responsible for any tax liabilities generated by your
transactions. If you hold Class B shares, you will not have a taxable event when
they convert into Class A shares.
OTHER TAX CONSIDERATIONS If you are neither a lawful permanent resident nor a
citizen of the U.S. or if you are a foreign entity, ordinary income dividends
paid to you (which include distributions of net short-term capital gains) will
generally be subject to a 30% U.S. withholding tax, unless a lower treaty rate
applies.
By law, each Fund must withhold 31% of your distributions and proceeds if you
have not provided a taxpayer identification number or social security number.
This section summarizes some of the consequences under current federal tax law
of an investment in a Fund. It is not a substitute for professional tax advice.
Consult your tax advisor about the potential tax consequences of an investment
in a Fund under all applicable laws.
SMALL ACCOUNTS If you draw down an account so that its total value is less than
$500 ($250 for retirement plan accounts), you may be asked to purchase more
shares within 60 days. If you do not take action, the Trust may close out your
account and mail you the proceeds. Alternatively, you may be charged a $2.00
monthly charge to maintain your account. Your account will not be closed if its
drop in value is due to Fund performance or the effects of sales charges.
25
<PAGE>
MORE INFORMATION ABOUT THE FUNDS
[SIDEBAR: FUND INVESTMENT STRATEGIES Each Fund has its own investment goal and
a strategy for pursuing it. The chart summarizes information about each Fund's
investment approach. We have included a glossary to define the investment and
risk terminology used in the chart.]
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
GOVERNMENT SECURITIES FUND FEDERAL SECURITIES FUND
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
What is the Fund's high current income consistent with relative current income, with capital appreciation as a
investment goal? safety of capital secondary objective
What are the Fund's fixed income investing fixed income investing
principal investment
strategies?
What are the Fund's invests primarily in securities issued or invests primarily in securities issued or
principal investment guaranteed by the U.S. government, or any guaranteed by the U.S. government or any
techniques? agency or instrumentality thereof agency or instrumentality thereof, with a
significant portion invested in mortgage-backed
securities
What are the Fund 's . bond market volatility . bond market volatility
principal risks? . securities selection . securities selection
. interest rate fluctuations . interest rate fluctuations
. credit quality . credit quality
. prepayment
- -----------------------------------------------------------------------------------------------------------------------------------
What other investment strategies can the Fund use?
. Fixed income securities:
Investment grade Yes Yes
U.S. government securities Yes Yes
Asset-backed securities Yes Yes
(up to 15%) (up to 15%)
Mortgage-backed securities Yes See principal investments above
Junk bonds No No
Short-term money market instruments Yes Yes
(up to 10%) (up to 10%)
Participation interests No No
. Defensive investments Yes Yes
. Foreign securities No No
Foreign debt obligations No No
Emerging markets No No
ADRs/EDRs/GDRs No No
. Illiquid securities Yes Yes
(up to 10%) (up to 10%)
. Options and futures Yes Yes
. Zero-coupon securities Yes Yes
. When-issued /delayed delivery transactions Yes Yes
. Securities lending Yes Yes
(up to 33%) (up to 33%)
- --------------------------------------------------------------------------------------------------------------------------------
. Borrowing for temporary or emergency
purposes Yes (up to 5%) Yes (up to 5%)
. Future developments Yes Yes
- --------------------------------------------------------------------------------------------------------------------------------
What other potential risks . illiquidity . illiquidity
can affect the Fund ? . prepayment . derivatives
. derivatives . hedging
. hedging
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED INCOME FUND HIGH INCOME FUND TAX EXEMPT INSURED FUND
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
What is the Fund's a high level of current income maximum current income as high a level of current
investment goal? consistent with moderate income exempt from federal
investment risk, with income taxes as is consistent
preservation of capital as a with preservation of capital
secondary objective
-----------------------------------------------------------------------------------------------------
What are the Fund's fixed income investing fixed income investing fixed income investing
principal investment
strategies?
-----------------------------------------------------------------------------------------------------
What are the Fund's invests in U.S. government invests in high-yield, invests at least 80% in
principal investment securities; foreign government high-risk corporate bonds tax-exempt Municipal Bonds
techniques? and corporate debt securities; and at least 65% in Municipal
and fixed income securities Bonds that, in addition to
issued by domestic corporations, having income exempt from
including lower-rated high-yield federal income tax, also are
securities, without regard to insured as to the scheduled
the maturities of such securities payment of principal and
interest for as long as such
bonds are held by the Fund,
without regard to the
maturities of such securities
-----------------------------------------------------------------------------------------------------
What are the Fund 's . bond market volatility . bond market volatility . bond market volatility
principal risks? . securities selection . securities selection . securities selection
. interest rate fluctuations . interest rate fluctuations . interest rate fluctuations
. credit quality . credit quality . credit quality
. junk bonds . junk bonds
-----------------------------------------------------------------------------------------------------
Fixed Income Securities:
Investment grade Yes Yes Yes
U.S. government securities Yes Yes Yes
Asset-backed securities Yes Yes Yes
(without limit) (up to 15%) (up to 15%)
Mortgage-backed securities Yes Yes Yes
Junk bonds Yes See principal investments No
above
Short-term money market instruments Yes Yes Yes
(up to 10%) (up to 10%) (up to 10%)
Participation interests Yes Yes No
. Defensive investments Yes Yes Yes
. Foreign securities Yes (up to 25% in any one Yes (up to 25% in any one No
foreign country) foreign country)
Foreign debt obligations Yes Yes No
Emerging markets Yes Yes No
ADRs/EDRs/GDRs Yes Yes No
. Illiquid securities Yes Yes Yes
(up to 10%) (up to 10%) (up to 10%)
. Options and futures Yes Yes Yes
. Zero-coupon securities Yes Yes Yes
. When-issued /delayed
delivery transactions Yes Yes Yes
. Securities lending Yes Yes Yes
(up to 33%) (up to 33%) (up to 33%)
- --------------------------------------------------------------------------------------------------------------------------------
. Borrowing for temporary
or emergency purposes Yes (up to 5%) Yes (up to 5%) Yes (up to 5%)
. Future developments Yes Yes Yes
- --------------------------------------------------------------------------------------------------------------------------------
What other potential risks . foreign exposure . foreign exposure . illiquidity
can affect the Fund ? . emerging markets . emerging markets . prepayment
. euro conversion . euro conversion . derivatives
. illiquidity . illiquidity . hedging
. prepayment . prepayment
. derivatives . derivatives
. hedging . hedging
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
27
<PAGE>
GLOSSARY
INVESTMENT TERMINOLOGY
CAPITAL APPRECIATION is growth of the value of an investment.
PRESERVATION OF CAPITAL means investing in a manner that tries to protect the
value of an investment against market movements and other economic events.
FIXED INCOME SECURITIES provide consistent interest or dividend payments. They
include corporate bonds, notes, debentures, preferred stocks, convertible
securities, U.S. government securities and mortgage-backed and asset-backed
securities. The issuer of a senior fixed income security is obligated to make
payments on this security ahead of other payments to security holders. An
INVESTMENT GRADE fixed income security is rated in one of the top four ratings
categories by a debt rating agency (or is considered of comparable quality by
the Adviser).
A "JUNK BOND" is a high yield, high risk bond that does not meet the credit
quality standards of investment grade securities.
[Margin note: The two best-known debt rating agencies are Standard & Poor's
Ratings Services, a Division of The McGraw-Hill Companies, Inc. and Moody's
Investors Service, Inc. "Investment grade" refers to any security rated "BBB" or
above by Standard & Poor's or "Baa" or above by Moody's.]
U.S. GOVERNMENT SECURITIES are issued or guaranteed by the U.S. government, its
agencies and instrumentalities. Some U.S. government securities are issued or
unconditionally guaranteed by the U.S. Treasury. They are of the highest
possible credit quality. While these securities are subject to variations in
market value due to fluctuations in interest rates, they will be paid in full if
held to maturity. Other U.S. government securities are neither direct
obligations of, nor guaranteed by, the U.S. Treasury. However, they involve
federal sponsorship in one way or another. For example some are backed by
specific types of collateral; some are supported by the issuer's right to borrow
from the Treasury; some are supported by the discretionary authority of the
Treasury to purchase certain obligations of the issuer; and others are supported
only by the credit of the issuing government agency or instrumentality.
A MUNICIPAL BOND is a debt obligation of a state or local government entity,
which may support general governmental needs or special projects.
ASSET-BACKED SECURITIES issued by trusts and special purpose corporations are
backed by a pool of assets, such as credit card or automobile loan receivables
representing the obligations of a number of different parties.
MORTGAGE-BACKED SECURITIES directly or indirectly provide funds for mortgage
loans made to residential home buyers. These include securities that represent
interests in pools of mortgage
28
<PAGE>
loans made by lenders such as commercial banks, savings and loan institutions,
mortgage bankers and others.
SHORT-TERM INVESTMENTS include money market securities such as short-term U.S.
government obligations, repurchase agreements, commercial paper, bankers'
acceptances and certificates of deposit. These securities provide a Fund with
sufficient liquidity to meet redemptions and cover expenses.
PARTICIPATION INTERESTS, which may take the form of interests in or assignments
of loans, are acquired from banks that have made loans or are members of lending
syndicates.
DEFENSIVE INVESTMENTS include high quality fixed income securities, repurchase
agreements and other money market instruments. A Fund will make temporary
defensive investments in response to adverse market, economic, political or
other conditions. When a Fund takes a defensive position, it may miss out on
investment opportunities that could have resulted from investing in accordance
with its principal investment strategy. As a result, a Fund may not achieve its
investment goal.
FOREIGN SECURITIES are issued by companies located outside of the United States
including emerging markets. Foreign securities may include American Depositary
Receipts (ADRS) or other similar securities that convert into foreign securities
such as European Depository Receipts (EDRS) and Global Depository Receipts
(GDRS).
FOREIGN DEBT OBLIGATIONS (which may be denominated in U.S. dollars or in non-
U.S. currencies), include debt obligations issued or guaranteed by foreign
corporations, certain supranational entities (such as the World Bank) and
foreign governments (including political subdivisions having taxing authority),
their agencies or instrumentalities, and debt obligations issued by U.S.
corporations which are either denominated in non-U.S. currencies or traded in
foreign markets (e.g., Eurobonds).
An EMERGING MARKET country is one that the World Bank, the International Finance
Corporation or the United Nations or its authorities has determined to have a
low or middle income economy.
ILLIQUID SECURITIES are subject to legal or contractual restrictions that may
make them difficult to sell. A security that cannot easily be sold within seven
days will generally be considered illiquid. Certain restricted securities (such
as Rule 144A securities) are not generally considered illiquid because of their
established trading market.
A DERIVATIVE instrument is a contract, such as an option or a future, whose
value is based on the performance of an underlying financial instrument.
OPTIONS AND FUTURES are contracts involving the right to receive or obligation
to deliver assets or money depending on the performance of one or more
underlying assets or a market or economic index.
29
<PAGE>
A ZERO-COUPON SECURITY is a security that makes no periodic interest payments
but instead is sold at a deep discount from its face value.
WHEN-ISSUED/DELAYED DELIVERY TRANSACTIONS generally involve the purchase or sale
of a security with payment and delivery at some time in the future--i.e. beyond
normal settlement.
SECURITIES LENDING involves a loan of securities by a Fund in exchange for cash
or collateral. The Fund earns interest on the loan while retaining ownership of
the security.
A Fund may BORROW for temporary or emergency purposes including to meet
redemptions. Borrowing may exaggerate changes in the net asset value of Fund
shares and in the yield on a Fund's portfolio. Borrowing will cost a Fund
interest expense and other fees. The costs of borrowing may reduce a Fund's
return.
FUTURE DEVELOPMENTS refer to securities and other instruments which do not
presently exist but may be developed in the future, provided that each such
investment is consistent with the Fund's investment objectives, policies and
restrictions and is otherwise legally permissible under federal and state laws.
The Prospectus will be amended or supplemented as appropriate to discuss any
such new investments.
RISK TERMINOLOGY
BOND MARKET VOLATILITY: The bond markets as a whole could go up or down
(sometimes dramatically). This could affect the value of the securities in a
Fund's portfolio.
SECURITIES SELECTION: A strategy used by a Fund, or securities selected by its
portfolio manager, may fail to produce the intended return.
INTEREST RATE FLUCTUATIONS: Volatility of the bond market is due principally to
changes in interest rates. As interest rates rise, bond prices typically fall;
and as interest rates fall, bond prices typically rise. Longer-term and lower
coupon bonds tend to be more sensitive to changes in interest rates.
CREDIT QUALITY: The creditworthiness of the issuer is always a factor in
analyzing fixed income securities. An issuer with a lower credit rating will be
more likely than a higher rated issuer to default or otherwise become unable to
honor its financial obligations. This type of issuer will typically issue JUNK
BONDS. In addition to the risk of default, junk bonds may be more volatile, less
liquid, more difficult to value and more susceptible to adverse economic
conditions or investor perceptions than other bonds.
PREPAYMENT: Prepayment risk is the possibility that the principal of the loans
underlying mortgage-backed or other asset-backed securities may be prepaid at
any time. As a general rule, prepayments increase during a period of falling
interest rates and decrease during a period of rising interest rates. As a
result of prepayments, in periods of declining interest rates a Fund may be
required to reinvest its assets in securities with lower interest rates. In
periods of increasing
30
<PAGE>
interest rates, prepayments generally may decline, with the effect that the
securities subject to prepayment risk held by a Fund may exhibit price
characteristics of longer-term debt securities.
FOREIGN EXPOSURE: Investors in foreign countries are subject to a number of
risks. A principal risk is that fluctuations in the exchange rates between the
U.S. dollar and foreign currencies may negatively affect an investment. In
addition, there may be less publicly available information about a foreign
company and it may not be subject to the same uniform accounting, auditing and
financial reporting standards as U.S. companies. Foreign governments may not
regulate securities markets and companies to the same degree as the U.S.
government. Foreign investments will also be affected by local political or
economic developments and governmental actions. Consequently, foreign securities
may be less liquid, more volatile and more difficult to price than U.S.
securities. Historical experience indicates that the markets of EMERGING MARKET
countries have been more volatile than more developed markets; however, such
markets can provide higher rates of return to investors.
EURO CONVERSION: Effective January 1, 1999, several European countries
irrevocably fixed their existing national currencies to a new single European
currency unit, the "euro." Certain European investments may be subject to
additional risks as a result of this conversion. These risks include adverse tax
and accounting consequences, as well as difficulty in processing transactions.
The Adviser is aware of such potential problems and is coordinating efforts to
prevent or alleviate their adverse impact on the Funds. There can be no
assurance that a Fund will not suffer any adverse consequences as a result of
the euro conversion.
ILLIQUIDITY: Certain securities may be difficult or impossible to sell at the
time and the price that the seller would like.
DERIVATIVES: Derivatives are subject to general risks relating to heightened
sensitivity to market volatility, interest rate fluctuations, illiquidity and
creditworthiness of the counterparty to the derivatives transactions.
HEDGING: Hedging is a strategy in which the Adviser uses a derivative security
to reduce certain risk characteristics of an underlying security or portfolio of
securities. While hedging strategies can be very useful and inexpensive ways of
reducing risk, they are sometimes ineffective due to unexpected changes in the
market. Moreover, while hedging can reduce or eliminate losses, it can also
reduce or eliminate gains.
FUND MANAGEMENT
ADVISER SunAmerica Asset Management Corp., which was organized in 1982 under the
laws of Delaware, selects and manages the investments, provides various
administrative services, and supervises the daily business affairs of each Fund.
In addition to managing the Funds, the Adviser serves as adviser, manager and/or
administrator for Anchor Pathway Fund, Anchor Series Trust, Style Select Series,
Seasons Series Trust, SunAmerica Equity Funds, SunAmerica Money Market Funds,
Inc., and SunAmerica Series Trust. The Adviser managed, advised or administered
assets in excess of $15 billion as of October 31, 1998.
31
<PAGE>
For the fiscal year ended March 31, 1999, each Fund paid the Adviser a fee equal
to the following percentage of average daily net assets:
Fund Fee
---- ---
U.S. Government Securities Fund [TO BE FILED BY AMENDMENT]
Federal Securities Fund
Diversified Income Fund
High Income Fund
Tax Exempt Insured Fund
The Fixed Income Investment Team is responsible for the portfolio management of
each of the Funds. The Team is composed of ___ portfolio managers and research
analysts.
DISTRIBUTOR SunAmerica Capital Services, Inc. distributes each Fund's shares.
The Distributor, a SunAmerica company, receives the initial and deferred sales
charges, all or a portion of which may be re-allowed to other broker-dealers. In
addition, the Distributor receives fees under each Fund's 12b-1 plans.
The Distributor, at its expense, may from time to time provide additional
compensation to broker-dealers (including in some instances, affiliates of the
Distributor) in connection with sales of shares of a Fund. This compensation may
include (i) full re-allowance of the front-end sales charge on Class A shares;
(ii) additional compensation with respect to the sale of Class A, Class B or
Class II shares; or (iii) financial assistance to broker-dealers in connection
with conferences, sales or training programs for their employees, seminars for
the public, advertising campaigns regarding one or more of the Funds, and/or
other broker-dealer sponsored special events. In some instances, this
compensation will be made available only to certain broker-dealers whose
representatives have sold a significant number of shares of the Fund.
Compensation may also include payment for travel expenses, including lodging,
incurred in connection with trips taken by invited registered representatives
for meetings or seminars of a business nature. In addition, the following types
of non-cash compensation may be offered through sales contests: (i) travel
mileage on major air carriers; (ii) tickets for entertainment events (such as
concerts or sporting events); or (iii) merchandise (such as clothing, trophies,
clocks, pens or other electronic equipment). Broker-dealers may not use sales of
the Fund's shares to qualify for this compensation to the extent receipt of such
compensation may be prohibited by applicable law or the rules of any self-
regulatory agency, such as the National Association of Securities Dealers, Inc.
Dealers who receive bonuses or other incentives may be deemed to be underwriters
under the Securities Act of 1933.
Certain laws and regulations limit the ability of banks and other depository
institutions to underwrite and distribute securities. However, in the opinion of
the Distributor based upon the advice of counsel, these laws and regulations do
not prohibit such depository institutions from providing other services to
investment companies of the type contemplated by the Funds' 12b-1
32
<PAGE>
plans. Banks and other financial services firms may be subject to various state
laws regarding these services, and may be required to register as dealers
pursuant to state law.
ADMINISTRATOR SunAmerica Fund Services, Inc. assists the Funds' transfer agent
in providing shareholder services. The Administrator, a SunAmerica company, is
paid a monthly fee by each Fund for its services at the annual rate of .22% of
average daily net assets. This fee represents the full cost of providing
shareholder and transfer agency services to the Trust.
The Adviser, Distributor and Administrator are all located in The SunAmerica
Center, 733 Third Avenue, New York, New York 10017.
YEAR 2000 Many computer and computer-based systems cannot distinguish the year
2000 from the year 1900 because of the way they encode and calculate dates. This
is popularly known as the "Year 2000 Issue." The Year 2000 Issue could
potentially have an adverse impact on the handling of security trades, the
payment of interest and dividends, pricing and account services. We recognize
the importance of the Year 2000 Issue and are taking appropriate steps necessary
in preparation for the year 2000. The Trust's management fully anticipates that
their systems will be adapted in time for the year 2000, and to further this
goal they have coordinated a plan to repair, adapt or replace their systems as
necessary. They have also obtained representations from their outside service
providers that they are doing the same. The Trust's management completed their
plan significantly by the end of the 1998 calendar year and expects to perform
appropriate systems testing during the 1999 calendar year. If the problem has
not been fully addressed, however, the Trust could be negatively impacted. The
Year 2000 Issue could also have a negative impact on the companies in which the
Trust invests, which could hurt the Trust's investment returns.
33
<PAGE>
(OUTSIDE BACK COVER)
FOR MORE INFORMATION
The following documents contain more information about the Funds and are
available free of charge upon request:
ANNUAL AND SEMIANNUAL REPORTS. Contain financial statements,
performance data and information on portfolio holdings. The reports
also contain a written analysis of market conditions and investment
strategies that significantly affected a Fund's performance during the
applicable period.
STATEMENT OF ADDITIONAL INFORMATION (SAI). Contains additional
information about the Funds' policies, investment restrictions and
business structure. This prospectus incorporates the SAI by reference.
You may obtain copies of these documents or ask questions about the Funds
by contacting:
SunAmerica Fund Services, Inc.
Mutual Fund Operations
The SunAmerica Center
733 Third Avenue
New York, New York 10017-3204
1-800-858-8850
or by calling your broker or financial advisor.
Information about the Funds (including the SAI) can be reviewed and copied
at the Public Reference Room of the Securities and Exchange Commission,
Washington, D.C. Call (800) SEC-0330 for information on the operation of the
Public Reference Room. Information about the Funds is also available on the
Securities and Exchange Commission's web-site at http://www.sec.gov and copies
may be obtained upon payment of a duplicating fee by writing the Public
Reference Section of the Securities and Exchange Commission, Washington, D.C.
20549-6009.
You should rely only on the information contained in this prospectus. No
one is authorized to provide you with any different information.
[Logo] SUNAMERICA
MUTUAL FUNDS
DISTRIBUTOR: SunAmerica Capital Services
INVESTMENT COMPANY ACT
File No. 811-4708
<PAGE>
SUNAMERICA INCOME FUNDS
STATEMENT OF ADDITIONAL INFORMATION
DATED _______, 1999
The SunAmerica Center General Marketing and
733 Third Avenue Shareholder Information
New York, NY 10017-3204 (800) 858-8850
SunAmerica Income Funds (the "Trust") is a mutual fund consisting of five
different investment funds: SunAmerica U.S. Government Securities Fund,
SunAmerica Federal Securities Fund, SunAmerica Diversified Income Fund,
SunAmerica High Income Fund and SunAmerica Tax Exempt Insured Fund. Each Fund
has distinct investment objectives and strategies.
This Statement of Additional Information is not a Prospectus, but should be
read in conjunction with the Trust's Prospectus dated _______, 1999. The
Prospectus is incorporated by reference into this Statement of Additional
Information and this Statement of Additional Information is incorporated by
reference into the Prospectus. The Trust's audited financial statements are
incorporated into this Statement of Additional Information by reference to its
1998 annual report to shareholders. You may request a copy of the annual report
at no charge by calling (800) 858-8850 or writing the Trust at SunAmerica Fund
Services, Inc., Mutual Fund Operations, The SunAmerica Center, 733 Third Avenue,
New York, New York 10017-3204. Capitalized terms used herein but not defined
have the meanings assigned to them in the Prospectus.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
HISTORY OF THE FUNDS ......................................................... B-2
INVESTMENT OBJECTIVES AND POLICIES ........................................... B-3
INVESTMENT RESTRICTIONS ...................................................... B-42
TRUSTEES AND OFFICERS ........................................................ B-44
ADVISER, PERSONAL SECURITIES TRADING, DISTRIBUTOR AND ADMINISTRATOR .......... B-50
PORTFOLIO TRANSACTIONS AND BROKERAGE ......................................... B-55
ADDITIONAL INFORMATION REGARDING PURCHASE OF SHARES .......................... B-57
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES ........................ B-66
DETERMINATION OF NET ASSET VALUE ............................................. B-67
PERFORMANCE DATA ............................................................. B-68
DIVIDENDS, DISTRIBUTIONS AND TAXES ........................................... B-74
RETIREMENT PLANS ............................................................. B-79
DESCRIPTION OF SHARES ........................................................ B-80
ADDITIONAL INFORMATION ....................................................... B-82
FINANCIAL STATEMENTS ......................................................... B-84
APPENDIX ...............................................................APPENDIX-1
</TABLE>
B-1
<PAGE>
No dealer, salesman or other person has been authorized to give any
information or to make any representations, other than those contained in this
Statement of Additional Information or in the Prospectus, and, if given or made,
such other information or representations must not be relied upon as having been
authorized by the Trust, the Adviser or the Distributor. This Statement of
Additional Information and the Prospectus do not constitute an offer to sell or
a solicitation of an offer to buy any of the securities offered hereby in any
jurisdiction in which such an offer to sell or solicitation of an offer to buy
may not lawfully be made.
This Statement of Additional Information relates to the five different
investment funds of SunAmerica Income Funds, a Massachusetts business trust,
which is registered as an open-end investment company under the Investment
Company Act of 1940, as amended (the "1940 Act"). The five Funds are: SunAmerica
U.S. Government Securities Fund, SunAmerica Federal Securities Fund, SunAmerica
Diversified Income Fund, SunAmerica High Income Fund and SunAmerica Tax Exempt
Insured Fund.
HISTORY OF THE FUNDS
The Trust is a diversified, open-end management investment company. On
October 1, 1993, the Trust, which had been organized in 1986, reorganized with
certain mutual funds in SunAmerica Mutual Funds (the "Reorganization") and was
renamed "SunAmerica Income Funds." In the Reorganization, all outstanding shares
of the two existing series of the Trust, the Government Income Portfolio (the
"Government Income Portfolio") and the High Yield Portfolio (the "High Yield
Portfolio"), were redesignated Class A shares and renamed the Government
Securities Fund and the High Income Fund, respectively. In addition, the
SunAmerica U.S. Government Securities Fund series of SunAmerica Fund Group ("Old
Government Securities") and the SunAmerica High Income Fund series of SunAmerica
Fund Group ("Old High Income") reorganized with, and its shareholders received
Class B shares of, the Government Securities Fund and the High Income Fund,
respectively.
With regard to the three additional series of the Trust, the Federal
Securities Fund, the Diversified Income Fund and the Tax Exempt Insured Fund,
the SunAmerica Federal Securities Fund ("Old Federal Securities") was
reorganized with, and its shareholders received Class B shares of, the Federal
Securities Fund. In addition, the SunAmerica Diversified Income Fund series of
SunAmerica Multi-Asset Portfolios, Inc. ("Old Diversified Income") was
reorganized with, and its shareholders received Class B shares of, the
Diversified Income Fund. Until December 16, 1992, Old Diversified Income had a
different investment objective and was named SunAmerica Global Short-Term Income
Fund. Finally, the SunAmerica Tax Exempt Insured Fund series of SunAmerica Tax
Free Portfolios ("Old Tax Exempt Insured") was reorganized with, and its
shareholders received Class A shares of, the Tax Exempt Insured Fund.
The Reorganization was approved by the shareholders of the Funds or their
predecessors who were entitled to vote with respect thereto, on September 23,
1993. The Trust consists of five Funds; each offers Class A, Class B and Class
II shares. Class C shares of High Income Fund commenced
B-2
<PAGE>
offering March 6, 1997, and were redesignated Class II shares on December 1,
1998. Class II shares of the Government Securities, Federal Securities,
Diversified Income and Tax Exempt Insured Funds commenced offering on December
1, 1998.
INVESTMENT OBJECTIVES AND POLICIES
For a description of the objectives, or "goals," of each of the Funds, see
"More Information About the Funds" in the Prospectus. The following information
is provided for those investors wishing to have more comprehensive information
than that contained in the Prospectus. Unless otherwise specified, each Fund may
invest in the following securities. The stated percentage limitations are
applied to an investment at the time of purchase unless indicated
otherwise.
U.S. GOVERNMENT SECURITIES. Each Fund may invest in U.S. Treasury securities,
including bills, notes, bonds and other debt securities issued by the U.S.
Treasury. These instruments are direct obligations of the U.S. government and,
as such, are backed by the "full faith and credit" of the United States
government. They differ primarily in their interest rates, the lengths of their
maturities and the dates of their issuances. Each Fund may also invest in
securities issued by agencies or instrumentalities of the U.S. government. These
obligations, including those guaranteed by federal agencies or
instrumentalities, may or may not be backed by the "full faith and credit" of
the United States government. All of the foregoing are referred to collectively
as "U.S. government securities." Securities issued or guaranteed by agencies or
instrumentalities are supported by (i) the full faith and credit of the United
States, such as obligations of the Government National Mortgage Association
("GNMA"), the Farmers Home Administration ("FMHA") or the Export-Import Bank;
(ii) the limited authority of the issuer to borrow from the U.S. Treasury, such
as obligations of the Student Loan Marketing Association, the Federal Home Loan
Mortgage Association ("FHLMC"), or the Tennessee Valley Authority; and (iii) the
authority of the U.S. government to purchase certain obligations of the issuer,
such as obligations of the Federal National Mortgage Association ("FNMA"), the
Federal Farm Credit System or the Federal Home Loan Bank. No assurance can be
given that the U.S. government will provide financial support to its agencies
and instrumentalities as described in (ii) and (iii) above, other than as set
forth, since it is not obligated to do so by law. In the case of securities not
backed by the full faith and credit of the United States, a Fund must look
principally to the agency issuing or guaranteeing the obligation for ultimate
repayment and may not be able to assert a claim against the United States if the
agency or instrumentality does not meet its commitments. U.S. government
securities include certain mortgage-backed securities, as described below under
"Mortgage-Backed Securities."
MORTGAGE-BACKED SECURITIES. Each Fund may invest in mortgage-backed securities.
These securities represent participation interests in pools of residential
mortgage loans made by lenders such as commercial banks, savings and loan
institutions, mortgage bankers and others, which may or may not be guaranteed by
agencies or instrumentalities of the U.S. government.
Mortgage-backed securities differ from conventional debt securities, which
provide for periodic payment of interest in fixed amounts (usually semiannually)
with principal payments at
B-3
<PAGE>
maturity or specified call dates. Instead, these securities provide a monthly
payment, which consists of both interest and principal payments. In effect,
these payments are a "pass-through" of the monthly payments made by the
individual borrowers on their residential mortgage loans, net of any fees paid
to the issuer or guarantor of such securities. Additional payments are caused by
prepayments resulting from the sale of the underlying residential property,
refinancing or foreclosure (net of fees or costs that may be incurred). In
addition, prepayment of principal on mortgage-backed securities, which often
occurs when interest rates decline, can significantly change the realized yield
of these securities. Some mortgage-backed securities are described as "modified
pass-through." These securities entitle the holders to receive all interest and
principal payments owed on the mortgages in the pool, net of certain fees,
regardless of whether or not the mortgagors actually make the payments.
The yield on mortgage-backed securities is based on the average expected
life of the underlying pool of mortgage loans. Because 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 certificates.
Mortgage-backed securities are often 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. Thus, the
actual life of any particular pool will be shortened by any unscheduled or early
payments of principal and interest. Principal prepayments generally result from
the sale of the underlying property or the refinancing or foreclosure of
underlying mortgages. The occurrence of prepayments is affected by a wide range
of economic, demographic and social factors and, accordingly, it is not possible
to predict accurately the average life of a particular pool. Yield on such pools
is usually computed by using the historical record of prepayments for that pool,
or, in the case of newly-issued mortgages, the prepayment history of similar
pools. The actual prepayment experience of a pool of mortgage loans may cause
the yield realized by a Fund to differ from the yield calculated on the basis of
the expected average life of the pool.
Prepayments tend to increase during periods of declining interest rates and
will most likely decrease during periods of rising interest rates. When
prevailing interest rates rise, the value of a pass-through security may
decrease as do the value of other debt securities, but, when prevailing interest
rates decline, the value of a pass-through security is not likely to rise on a
comparable basis with other debt securities because of the prepayment feature of
pass-through securities. The reinvestment of scheduled principal payments and
unscheduled prepayments that a Fund receives may occur at higher or lower rates
than the original investment, thus affecting the yield of the Fund. Monthly
interest payments received by a Fund have a compounding effect which may
increase the yield to shareholders more than debt obligations that pay interest
semiannually. Because of those factors, mortgage-backed securities may be less
effective than U.S. Treasury bonds of similar maturity at maintaining yields
during periods of declining interest rates. Accelerated prepayments adversely
affect yields for pass-through securities purchased at a premium (i.e., at a
price in excess of the principal amount) and may involve additional risk of loss
of principal because the premium may not have been fully amortized at the time
the obligation is repaid. The opposite is true for pass-
B-4
<PAGE>
through securities purchased at a discount. Each Fund may purchase mortgage-
backed securities at a premium or at a discount.
The following is a description of GNMA, FNMA and FHLMC certificates, the
most widely available mortgage-backed securities:
GNMA Certificates. GNMA Certificates are mortgage-backed securities that
-----------------
evidence an undivided interest in a pool or pools of mortgages. GNMA
Certificates that each Fund may purchase are the modified pass-through type,
which entitle the holder to receive timely payment of all interest and principal
payments due on the mortgage pool, net of fees paid to the issuer and GNMA,
regardless of whether or not the mortgagor actually makes the payment.
GNMA guarantees the timely payment of principal and interest on securities
backed by a pool of mortgages insured by the FHA or the FMHA, or guaranteed by
the Veteran's Administration ("VA"). The GNMA guarantee is authorized by the
National Housing Act and is backed by the full faith and credit of the United
States. The GNMA is also empowered to borrow without limitation from the U.S.
Treasury if necessary to make any payments required under its guarantee.
The average life of a GNMA Certificate is likely to be substantially
shorter than the original maturity of the mortgages underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosure will usually
result in the return of the greater part of principal investment long before the
maturity of the mortgages in the pool. Foreclosures impose no risk to principal
investment because of the GNMA guarantee, except to the extent that a Fund has
purchased the certificates at a premium in the secondary market. As prepayment
rates of the individual mortgage pools vary widely, it is not possible to
predict accurately the average life of a particular issue of GNMA Certificates.
The coupon rate of interest of GNMA Certificates is lower than the interest
rate paid on the VA-guaranteed or FHA-insured mortgages underlying the GNMA
Certificates by the amount of the fees paid to GNMA and the issuer. The coupon
rate by itself, however, does not indicate the yield which will be earned on
GNMA Certificates. First, GNMA Certificates may trade in the secondary market at
a premium or discount. Second, interest is earned monthly, rather than
semiannually as with traditional bonds; monthly compounding raises the effective
yield earned. Finally, the actual yield of a GNMA Certificate is influenced by
the prepayment experience of the mortgage pool underlying it. For example, if
the higher-yielding mortgages from the pool are prepaid, the yield on the
remaining pool will be reduced.
FHLMC Certificates. FHLMC issues two types of mortgage pass-through
------------------
securities: mortgage participation certificates ("PCs") and guaranteed mortgage
certificates ("GMCs") (collectively, "FHLMC Certificates"). PCs resemble GNMA
Certificates in that each PC represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. Like GNMA Certificates,
PCs are assumed to be prepaid fully in their twelfth year. The FHLMC
B-5
<PAGE>
guarantees timely monthly payment of interest (and, under certain circumstances,
principal) of PCs and the ultimate payment of principal.
GMCs also represent a pro rata interest in a pool of mortgages. However,
these instruments pay interest semiannually and return principal once a year in
guaranteed minimum payments. The expected average life of these securities is
approximately ten years. The FHLMC guarantee is not backed by the full faith and
credit of the U.S. government.
FNMA Certificates. FNMA issues guaranteed mortgage pass-through
-----------------
certificates ("FNMA Certificates"). FNMA Certificates represent a pro rata share
of all interest and principal payments made and owed on the underlying pool.
FNMA guarantees timely payment of interest and principal on FNMA Certificates.
The FNMA guarantee is not backed by the full faith and credit of the U.S.
government. However, FNMA guarantees timely payment of interest on FNMA
Certificates and the full return of principal.
Collateralized Mortgage Obligations. Another type of mortgage-backed
security in which each Fund may invest is a Collateralized Mortgage Obligation
("CMO"). CMOs are fully-collateralized bonds that are the general obligations of
the issuer thereof (e.g., the U.S. government, a U.S. government
instrumentality, or a private issuer). The Government Securities Fund will not
invest in privately issued CMOs except to the extent that they are
collateralized by securities of entities that are instrumentalities of the U.S.
government. CMOs generally are secured by an assignment to a trustee (under the
indenture pursuant to which the bonds are issued) of collateral consisting of a
pool of mortgages. Payments with respect to the underlying mortgages generally
are made to the trustee under the indenture. Payments of principal and interest
on the underlying mortgages are not passed through to the holders of the CMOs as
such (i.e., the character of payments of principal and interest is not passed
through, and therefore payments to holders of CMOs attributable to interest paid
and principal repaid on the underlying mortgages do not necessarily constitute
income and return of capital, respectively, to such holders), but such payments
are dedicated to payment of interest on and repayment of principal of the CMOs.
CMOs often are issued in two or more classes with varying maturities and stated
rates of interest. Because interest and principal payments on the underlying
mortgages are not passed through to holders of CMOs, CMOs of varying maturities
may be secured by the same pool of mortgages, the payments on which are used to
pay interest on each class and to retire successive maturities in sequence.
Unlike other mortgage-backed securities, CMOs are designed to be retired as the
underlying mortgages are repaid. In the event of prepayment on such mortgages,
the class of CMO first to mature generally will be paid down. Therefore,
although in most cases the issuer of CMOs will not supply additional collateral
in the event of such prepayment, there will be sufficient collateral to secure
CMOs that remain outstanding.
Certain CMOs may be deemed to be investment companies under the 1940 Act.
Each Fund intends to conduct operations in a manner consistent with this view,
and therefore generally may not invest more than 10% of its total assets in such
issuers without obtaining appropriate regulatory relief. In reliance on recent
Securities and Exchange Commission ("SEC") staff interpretations, each
B-6
<PAGE>
Fund may invest in those CMOs and other mortgage-backed securities that are not
by definition excluded from the provisions of the 1940 Act, but have obtained
exemptive orders from the SEC from such provisions.
Stripped Mortgage-Backed Securities. The mortgage-backed securities in
which each Fund may invest include stripped mortgage-backed securities. Unlike
U.S. Treasury securities, which are stripped into separate securities for each
interest and principal payment, mortgage securities are generally stripped into
only two parts: a PO (principal only) strip representing all principal payments
and an IO (interest-only) strip representing all interest payments.
The feature that makes mortgage strips most useful in portfolio management
is their interest rate sensitivity. In principle, mortgage strips can be very
useful hedging devices for a variety of investors and portfolio managers.
However, determining the degree of interest sensitivity of mortgage strips in
different interest rate environments is extremely complicated.
The precise sensitivity of mortgage-backed securities and their associated
stripped securities to interest rate changes depends on many factors. First, the
prepayment effect makes the interest rate sensitivity of mortgage-backed
securities different from the interest sensitivity of Treasury securities.
Second, the prepayment effect makes the PO and IO mortgage-backed strips much
more sensitive, on average, to interest rates than the underlying mortgage-
backed security. Third, the prepayment effect is sometimes so strong that an IO
mortgage-backed strip will rise in value when interest rates rise and fall in
value when interest rates fall -- precisely the opposite relationship from other
fixed-income securities. This last feature of stripped mortgage-backed
securities, the positive relationship between the value of some IO strips and
interest rates, is particularly useful to investors who need to hedge a
portfolio of other fixed-income securities.
Mortgage-Backed Security Rolls. The Government Securities Fund, the Federal
Securities Fund and the Diversified Income Fund may enter into "forward roll"
transactions with respect to mortgage-backed securities issued by GNMA, FNMA or
FHLMC. In a forward roll transaction, the Fund will sell a mortgage-backed
security to a U.S. government agency or financial institution and simultaneously
agree to repurchase a similar security from the institution at a later date at
an agreed-upon price. The mortgage-backed securities that are repurchased will
bear the same interest rate as those sold, but generally will be collateralized
by different pools of mortgages with different prepayment histories than those
sold. Risks inherent in mortgage-backed security rolls include: (i) the risk of
prepayment prior to maturity, (ii) the possibility that a Fund may not be
entitled to receive interest and principal payments on the securities sold and
that the proceeds of the sale may have to be invested in money market
instruments (typically repurchase agreements) maturing not later than the
expiration of the roll, and (iii) the risk that the market value of the
securities sold by a Fund may decline below the price at which a Fund is
obligated to purchase the securities. Upon entering into a mortgage-backed
security roll a Fund will be required to place cash or other liquid securities
in a segregated account with its custodian in an amount equal to its obligation
under the roll; that amount is subject to the limitation on borrowing described
below under "Investment Restrictions."
B-7
<PAGE>
ASSET-BACKED SECURITIES. Each Fund except the Diversified Income Fund may invest
up to 15% of its net assets in asset-backed securities meeting such Fund's
credit quality restrictions. With respect to Diversified Income Fund, the Fund
may invest in asset-backed securities without limitation. These securities,
issued by trusts and special purpose corporations, are backed by a pool of
assets, such as credit card and automobile loan receivables, representing the
obligations of a number of different parties. Each Fund may also invest in
privately issued asset-backed securities.
Asset-backed securities present certain risks. For instance, in the case of
credit card receivables, these securities may not have the benefit of any
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, many of which give such debtors the
right to set off certain amounts owed on the credit cards, thereby reducing the
balance due. Most issuers of automobile receivables permit the servicer 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 automobile
receivables. In addition, because of the large number of vehicles involved in a
typical issuance and technical requirements under state laws, the trustee for
the holders of the automobile receivables may not have a proper security
interest in all of 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.
Asset-backed securities are often backed by a pool of assets representing
the obligations of a number of different parties. To lessen the effect of
failures by obligors to make payments on underlying assets, the securities may
contain elements of credit support which fall 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 receipt of payments on the underlying pool occurs in a timely
fashion. Protection against losses resulting from ultimate default ensures
payment through insurance policies or letters of credit obtained by the issuer
or sponsor from third parties. The Fund will not pay any additional or separate
fees for credit support. The degree of credit support provided for each issue is
generally based on historical information respecting the level of credit risk
associated with the underlying assets. Delinquency or loss in excess of that
anticipated or failure of the credit support could adversely affect the return
on an investment in such a security.
ZERO-COUPON SECURITIES. The Government Securities Fund, the Federal Securities
Fund, the Diversified Income Fund, and the High Income Fund may invest in zero-
coupon securities issued by the U.S. Treasury and, in addition, (i) the
Diversified Income Fund and High Income Fund may invest in zero-coupon
securities issued by both domestic and foreign corporations, and (ii) the Tax
Exempt Insured Fund may invest in zero-coupon securities issued by state and
local government entities. Investors earn a return on a zero-coupon bond by
purchasing the bond at a discount, that is, by paying less than the face value
of the bond. Since there are no periodic interest payments to reinvest, there is
no reinvestment risk. The yield of a zero-coupon held to maturity is the
yield
B-8
<PAGE>
quoted when the bond is sold. Because a zero-coupon security pays no interest to
its holder during its life or for a substantial period of time, it usually
trades at a deep discount from its face or par value and will be subject to
greater fluctuations of market value in response to changing interest rates than
debt obligations of comparable maturities which make current distributions of
interest. Because the Funds accrue taxable income from these securities without
receiving cash, the Funds may be required to sell portfolio securities in order
to pay a dividend depending upon the proportion of shareholders who elect to
receive dividends in cash rather than reinvesting dividends in additional shares
of the Funds. The Funds might also sell portfolio securities to maintain
portfolio liquidity. In either case, cash distributed or held by the Funds and
not reinvested will hinder the Funds in seeking a high level of current
income.
Zero-Coupon U.S. Government Securities. Zero-coupon U.S. government
securities are: (i) U.S. Treasury notes and bonds which have been stripped of
their unmatured interest coupons and receipts; or (ii) certificates representing
interest in such stripped debt obligations or coupons.
Corporate Zero-Coupon Securities. Corporate zero-coupon securities are: (i)
notes or debentures that do not pay current interest and are issued at
substantial discounts from par value, or (ii) notes or debentures that pay no
current interest until a stated date one or more years into the future, after
which the issuer is obligated to pay interest until maturity, usually at a
higher rate than if interest were payable from the date of issuance and may also
make interest payments in kind (e.g., with identical zero-coupon securities).
Such corporate zero-coupon securities, in addition to the risks identified
above, are subject to the risk of the issuer's failure to pay interest and repay
principal in accordance with the terms of the obligation. A Fund must accrue the
discount or interest on high-yield bonds structured as zero-coupon securities as
income even though it does not receive a corresponding cash interest payment
until the security's maturity or payment date. See "Foreign Securities" for a
description of the risks involved in investments in foreign corporations.
PARTICIPATION INTERESTS. The Diversified Income Fund and High Income Fund may
invest in loan participation interests, subject to the 10% of net assets
limitation on illiquid investments. These participation interests provide each
such Fund an undivided interest in a loan made by the issuing financial
institution in the proportion that the Fund's participation interest bears to
the total principal amount of the loan. The loan participations in which the
Funds may invest will typically be participating interests in loans made by a
syndicate of banks, represented by an agent bank that has negotiated and
structured the loan, to corporate borrowers to finance internal growth, mergers,
acquisitions, stock repurchases, leveraged buy-outs and other corporate
activities. Such loans may also have been made to governmental borrowers,
especially governments of developing countries (LOC debt). The loans underlying
such participations may be secured or unsecured, and each Fund may invest in
loans collateralized by mortgages on real property or which have no collateral.
The loan participations themselves may extend for the entire term of the loan or
may extend only for short "strips" that correspond to a quarterly or monthly
floating rate interest period on the underlying loan. Thus, a term of revolving
credit that extends for several years may be subdivided into shorter
periods.
B-9
<PAGE>
The Funds may purchase only those participation interests that mature in
one year or less, or, if maturing in more than one year, that have a floating
rate that is automatically adjusted at least once each year according to a
specified rate for such investments, such as the percentage of a bank's prime
rate. Participation interests are primarily dependent upon the creditworthiness
of the borrower for payment of interest and principal. Such borrowers may have
difficulty making payments and may have senior securities rated as low as "C" by
Moody's or "D" by S&P. In the event the borrower fails to pay scheduled interest
or principal payments, a Fund could experience a reduction in its income and
might experience a decline in the net asset value of its shares.
The loan participations in which each Fund will invest will also vary in
legal structure. Occasionally, lenders assign to another institution both the
lender's rights and obligations under a credit agreement. Since this type of
assignment relieves the original lender of its obligations, it is called a
novation. More typically, a lender assigns only its right to receive payments of
principal and interest under a promissory note, credit agreement or similar
document. A true assignment shifts to the assignee the direct debtor-creditor
relationship with the underlying borrower. Alternatively, a lender may assign
only part of its rights to receive payments pursuant to the underlying
instrument or loan agreement. Such partial assignments, which are more
accurately characterized as "participating interests," do not shift the debtor-
creditor relationship to the assignee, who must rely on the original lending
institution to collect sums due and to otherwise enforce its rights against the
agent bank which administers the loan or against the underlying borrower.
No more than 5% of each Fund's net assets can be invested in participation
interests of the same issuing bank. Each Fund must look to the creditworthiness
of the borrowing entity, which is obligated to make payments of principal and
interest on the loan. In the event the borrower fails to pay scheduled interest
or principal payments, the Fund could experience a reduction in its income and
might experience a decline in the net asset value of its shares. In the event of
a failure by the financial institution to perform its obligation in connection
with the participation agreement, the Fund might incur certain costs and delays
in realizing payment or may suffer a loss or principal and/or interest.
FOREIGN SECURITIES. The Diversified Income Fund and High Income Fund may invest
in U.S. dollar denominated fixed-income securities issued by domestic
corporations in any industry. The Funds may also invest in debt obligations
(which may be denominated in U.S. dollars or in non-U.S. currencies) issued or
guaranteed by foreign corporations, certain supranational entities and foreign
governments (including political subdivisions having taxing authority) or their
agencies and instrumentalities, and debt obligations issued by U.S. corporations
which are either denominated in non-U.S. currencies or traded in the foreign
markets (e.g., Eurobonds). The Funds may purchase securities issued by issuers
in any country; provided that a Fund may not invest more than 25% of its
respective total assets in the securities issued by entities domiciled in any
one foreign country. There is no restriction as to the size of the issuer.
The percentage of the Diversified Income Fund's or High Income Fund's total
assets that will be allocated to foreign securities will vary depending on the
relative yields of foreign and U.S.
B-10
<PAGE>
securities, the economies of foreign countries, the condition of such countries'
financial markets, the interest rate climate of such countries and the
relationship of such countries' currency to the U.S. dollar. These factors are
judged on the basis of fundamental economic criteria (e.g., relative inflation
levels and trends, growth rate forecasts, balance of payments status, and
economic policies) as well as technical and political data.
The Adviser may direct the investment of assets of the Diversified Income
Fund and the High Income Fund in securities of foreign issuers in the form of
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs") or
other similar securities convertible into securities of foreign issuers. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs are receipts typically issued
by a U.S. bank or trust company evidencing ownership of the underlying
securities. EDRs are European receipts evidencing a similar arrangement. ADRs
may be sponsored or unsponsored. A sponsored ADR is issued by a depository which
has an exclusive relationship with the issuer of the underlying security. An
unsponsored ADR may be issued by any number of U.S. depositories. Holders of
unsponsored ADRs generally bear all the costs associated with establishing the
unsponsored ADR. The depository of an unsponsored ADR is under no obligation to
distribute shareholder communications received from the underlying issuer or to
pass through to the holders of the unsponsored ADR voting rights with respect to
the deposited securities or pool of securities. The Funds may invest in either
type of ADR. Although the U.S. investor holds a substitute receipt of ownership
rather than direct stock certificates, the use of the depository receipts in the
United States can reduce costs and delays as well as potential currency exchange
and other difficulties. The Funds may purchase securities in local markets and
direct delivery of these ordinary shares to the local depository of an ADR agent
bank in the foreign country. Simultaneously, the ADR agents create a certificate
that settles at the Fund's custodian in five days. The Funds may also execute
trades on the U.S. markets using existing ADRs. A foreign issuer of the security
underlying an ADR is generally not subject to the same reporting requirements in
the United States as a domestic issuer. Accordingly the information available to
a U.S. investor will be limited to the information the foreign issuer is
required to disclose in its own country and the market value of an ADR may not
reflect undisclosed material information concerning the issuer of the underlying
security. For purposes of a Fund's investment policies, the Fund's investments
in these types of securities will be deemed to be investments in the underlying
securities. Securities of foreign issuers that are represented by ADRs or that
are listed on a U.S. securities exchange are nor considered "foreign securities"
for purposes of a Fund's 25% limitation on investments in such securities.
Generally, ADRs, in registered form, are dollar denominated securities designed
for use in the U.S. securities markets and EDRs, in bearer form, are designed
for use in the European securities markets.
The obligations of foreign governmental entities may or may not be
supported by the full faith and credit of a foreign government. Obligations of
supranational entities include those of international organizations designated
or supported by governmental entities to promote economic reconstruction or
development and of 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 Inter-
B-11
<PAGE>
American Development Bank. The governmental members, or "stockholders," usually
make initial capital contributions to the supranational entity and in many cases
are committed to make additional capital contributions if the supranational
entity is unable to repay its borrowings. Each supranational entity's lending
activities are limited to a percentage of its total capital (including "callable
capital" contributed by members at the entity's call), reserves and net income.
There is no assurance that foreign governments will be able or willing to honor
their commitments.
Investments in foreign securities, including securities of emerging market
countries, present special additional investment risks and considerations not
typically associated with investments in domestic securities, including
reduction of income by foreign taxes; fluctuation in value of foreign portfolio
investments due to changes in currency rates and control regulations (e.g.,
currency blockage); transaction charges for currency exchange; lack of public
information about foreign issuers; lack of uniform accounting, auditing and
financial reporting standards comparable to those applicable to domestic
issuers; less volume on foreign exchanges than on U.S. exchanges; greater
volatility and less liquidity on foreign markets than in the U.S.; less
regulation of foreign issuers, stock exchanges and brokers than in the U.S.;
greater difficulties in commencing lawsuits; higher brokerage commission rates
than in the U.S.; increased possibilities in some countries of expropriation,
confiscatory taxation, political, financial or social instability or adverse
diplomatic developments; the imposition of foreign taxes on investment income
derived from such countries; and differences (which may be favorable or
unfavorable) between the U.S. economy and foreign economies. An emerging market
country is one that the World Bank, the International Finance Corporation or the
United Nations or its authorities has determined to have a low or middle income
economy. Historical experience indicates that the markets of emerging market
countries have been more volatile than more developed markets; however, such
markets can provide higher rates of return to investors. The performance of
investments in securities denominated in a foreign currency ("non-dollar
securities") will depend on, among other things, the strength of the foreign
currency against the dollar and the interest rate environment in the country
issuing the foreign currency. Absent other events that could otherwise affect
the value of non-dollar securities (such as a change in the political climate or
an issuer's credit quality), appreciation in the value of the foreign currency
generally can be expected to increase the value of a Fund's non-dollar
securities in terms of U.S. dollars. A rise in foreign interest rates or decline
in the value of foreign currencies relative to the U.S. dollar generally can be
expected to depress the value of the Fund's non-dollar securities. Currencies
are evaluated on the basis of fundamental economic criteria (e.g., relative
inflation levels and trends, growth rate forecasts, balance of payments status
and economic policies) as well as technical and political data. Effective
January 1, 1999, several European countries irrevocably fixed their existing
national currencies to a new single European currency unit, the "euro". Certain
European investments may be subject to additional risks as a result of this
conversion. These risks include adverse tax and accounting consequences, as well
as difficulty in processing transactions. The Adviser is aware of such potential
problems and is coordinating efforts to prevent or alleviate their adverse
impact on the Funds. There can be no assurance that a Fund will not suffer
adverse consequences as a result of the euro conversion.
B-12
<PAGE>
Because the Diversified Income Fund and the High Income Fund may purchase
securities denominated in foreign currencies, a change in the value of any such
currency against the U.S. dollar will result in a change in the U.S. dollar
value of each Fund's assets and income available for distribution. In addition,
although a portion of each Fund's investment income may be received or realized
in foreign currencies, the Fund will be required to compute and distribute its
income in U.S. dollars, and absorb the cost of currency fluctuations. Each Fund
may engage in foreign currency exchange transactions for hedging purposes to
protect against changes in future exchange rates. See "Hedging Strategies."
Costs will be incurred in connection with conversions between various
currencies.
The values of foreign investments and the investment income derived from
them may also be affected unfavorably by changes in currency exchange control
regulations. Although the Funds will invest only in securities denominated in
foreign currencies that at the time of investment do not have significant
government-imposed restrictions on conversion into U.S. dollars, there can be no
assurance against subsequent imposition of currency controls. In addition, the
values of foreign securities will fluctuate in response to changes in U.S. and
foreign interest rates.
Investments in foreign securities offer potential benefits not available
from investments solely in securities of domestic issuers by offering the
opportunity to invest in foreign issuers that appear to offer growth potential,
or in foreign countries with economic policies or business cycles different from
those of the U.S., or to reduce fluctuations in portfolio value by taking
advantage of foreign stock and bond markets that do not move in a manner
parallel to U.S. markets. From time to time, U.S. government policies have
discouraged certain investments abroad by U.S. investors, through taxation or
other restrictions, and it is possible that such restrictions could be
reimposed.
Because the Diversified Income Fund and High Income Fund may invest in
securities that are primarily listed on foreign exchanges that trade on weekends
or other days when the Trust does not price its shares, the value of these
Fund's shares may change on days when a shareholder will not be able to purchase
or redeem shares.
ILLIQUID AND RESTRICTED SECURITIES. Each Fund may invest up to 10% of its net
assets, determined as of the date of purchase, in illiquid securities including
repurchase agreements that have a maturity of longer than seven days or in other
securities that are illiquid by virtue of the absence of a readily available
market or legal or contractual restrictions on resale. Historically, illiquid
securities have included securities subject to contractual or legal restrictions
on resale because they have not been registered under the Securities Act of
1933, as amended ("Securities Act"), securities otherwise not readily marketable
and repurchase agreements having a maturity of longer than seven days.
Repurchase agreements subject to demand are deemed to have a maturity equal to
the notice period. Securities that have not been registered under the Securities
Act are referred to as private placements or restricted securities and are
purchased directly from the issuer or in the secondary market. Mutual funds do
not typically hold a significant amount of these restricted or other illiquid
securities because of the potential for delays on resale and uncertainty in
valuation. Limitations on resale may have an adverse effect on the marketability
of portfolio securities and a mutual fund might be unable to
B-13
<PAGE>
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemptions within
seven days. A mutual fund might also have to register such restricted securities
in order to dispose of them, resulting in additional expense and delay. There
will generally be a lapse of time between a mutual fund's decision to sell an
unregistered security and the registration of such security promoting sale.
Adverse market conditions could impede a public offering of such securities.
When purchasing unregistered securities, each of the Funds will generally seek
to obtain the right of registration at the expense of the issuer (except in the
case of Rule 144A securities, discussed below).
In recent years, a large institutional market has developed for certain
securities that are not registered under the Securities Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments.
For example, restricted securities that the Board of Trustees, or the
Adviser pursuant to guidelines established by the Board of Trustees, has
determined to be marketable, such as securities eligible for resale under Rule
144A promulgated under the Securities Act, or certain private placement of
commercial paper issued in reliance on an exemption from such Act pursuant to
Section 4(2) thereof, may be deemed to be liquid for purposes of this
restriction. This investment practice could have the effect of increasing the
level of illiquidity in a Fund to the extent that qualified institutional buyers
(as defined in Rule 144A) become for a time uninterested in purchasing these
restricted securities. In addition, a repurchase agreement that by its terms can
be liquidated before its nominal fixed-term on seven days or less notice is
regarded as a liquid instrument. The Adviser will monitor the liquidity of such
restricted securities subject to the supervision of the Trustees. In reaching
liquidity decisions the Adviser will consider, inter alia, pursuant to
guidelines and procedures established by the Trustees, the following factors:
(1) the frequency of trades and quotes for the security; (2) the number of
dealers wishing to purchase or sell the security and the number of other
potential purchasers; (3) dealer undertakings to make a market in the security;
and (4) the nature of the security and the nature of the marketplace trades
(i.e., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of the transfer). Subject to the applicable limitation
on illiquid securities investments, a fund may acquire securities issued by the
U.S. government, its agencies or instrumentalities in a private placement. To
the extent that, for a period of time, qualified institutional buyers cease
purchasing such restricted securities pursuant to Rule 144A, the Fund's
investing in such securities may have the effect of increasing the level of
illiquidity in the Fund's portfolio during such period.
Commercial paper issues in which the Funds may invest, include securities
issued by major corporations without registration under the Securities Act in
reliance on the exemption from such registration afforded by Section 3(a)(3)
thereof, and commercial paper issued in reliance on the so-called private
placement exemption from registration which is afforded by Section 4(2) of the
B-14
<PAGE>
Securities Act ("Section 4(2) paper"). Section 4(2) paper is restricted as to
disposition under the Federal securities laws in that any resale must similarly
be made in an exempt transaction. Section 4(2) paper is normally resold to other
institutional investors through or with the assistance of investment dealers who
make a market in Section 4(2) paper, thus providing liquidity. Section 4(2)
paper that is issued by a company that files reports under the Securities
Exchange Act of 1934 is generally eligible to be sold in reliance on the safe
harbor of Rule 144A described above. A Fund's 10% limitation on investments in
illiquid securities includes Section 4(2) paper other than Section 4(2) paper
that the Adviser has determined to be liquid pursuant to guidelines established
by the Trustees. The Trustees delegated to the Adviser the function of making
day-to-day determinations of liquidity with respect to Section 4(2) paper,
pursuant to guidelines approved by the Trustees that require the Adviser to take
into account the same factors described above for other restricted securities
and require the Adviser to perform the same monitoring and reporting functions.
The staff of the SEC has taken the position that purchased over-the-counter
("OTC") options and the assets used as "cover" for written OTC options are
illiquid. The assets used as cover for OTC options written by a Fund will be
considered illiquid unless the OTC options are sold to qualified dealers who
agree that the Fund may repurchase any OTC option it writes at a maximum price
to be calculated by a formula set forth in the option agreement. The cover for
an OTC option written subject to this procedure will be considered illiquid only
to the extent that the maximum repurchase price under the option formula exceeds
the intrinsic value of the option.
SHORT-TERM AND TEMPORARY DEFENSIVE INSTRUMENTS. In addition to its primary
investments, each Fund may also invest up to 10% of its total assets in money
market instruments for liquidity purposes (to meet redemptions and expenses).
For temporary defensive purposes, each Fund may invest up to 100% of its total
assets in short-term fixed-income securities, including corporate debt
obligations and money market instruments rated in one of the two highest
categories by a nationally recognized statistical rating organization (or
determined by the Adviser to be of equivalent quality). A description of
securities ratings is contained in the Appendix to this Statement of Additional
Information.
Subject to the limitations described above, the following is a description
of the types of money market and short-term fixed-income securities in which the
Funds may invest:
U.S. Government Securities: See the section entitled "U.S. Government
Securities" below.
Commercial Paper: Commercial paper consists of short-term (usually from 1
to 270 days) unsecured promissory notes issued by entities in order to finance
their current operations. Each Fund's commercial paper investments may include
variable amount master demand notes and floating rate or variable rate notes.
Variable amount master demand notes and variable amount floating rate notes are
obligations that permit the investment of fluctuating amounts by a Fund at
varying rates of interest pursuant to direct arrangements between a Fund, as
lender, and the borrower. Master demand notes permit daily fluctuations in the
interest rates, while interest rates under variable amount floating rate notes
fluctuate on a weekly basis. These notes permit daily changes in the
B-15
<PAGE>
amounts borrowed. A Fund has the right to increase the amount under these notes
at any time, up to the full amount provided by the note agreement, or to
decrease the amount, and the borrower may repay up to the full amount of the
note without penalty. Because these types of notes are direct lending
arrangements between the lender and the borrower, it is not generally
contemplated that such instruments will be traded and there is no secondary
market for these notes. Master demand notes are redeemable (and, thus,
immediately repayable by the borrower) at face value, plus accrued interest, at
any time. Variable amount floating rate notes are subject to next-day
redemption, 14 days after the initial investment therein. With both types of
notes, a Fund's right to redeem depends on the ability of the borrower to pay
principal and interest on demand. In connection with both types of note
arrangements, a Fund considers earning power, cash flow and other liquidity
ratios of the issuer. These notes, as such, are not typically rated by credit
rating agencies. Unless they are so rated, a Fund may invest in them only if at
the time of an investment the issuer has an outstanding issue of unsecured debt
rated in one of the two highest categories by a nationally recognized
statistical rating organization.
Certificates of Deposit and Bankers' Acceptances: Certificates of deposit
are receipts issued by a bank in exchange for the deposit of funds. The issuer
agrees to pay the amount deposited plus interest to the bearer of the receipt on
the date specified on the certificate. The certificate usually can be traded in
the secondary market prior to maturity.
Bankers' acceptances typically arise from short-term credit arrangements
designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by another bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most maturities are six months or less.
The Funds will generally open interest-bearing accounts only with, or
purchase certificates of deposit or bankers' acceptances only from, banks or
savings and loan associations whose deposits are federally-insured and whose
capital is at least $50 million.
Corporate Obligations: Corporate debt obligations (including master demand
notes). For a further description of variable amount master demand notes, see
the section entitled "Commercial Paper" above.
Repurchase Agreements and Reverse Repurchase Agreements: See the sections
entitled "Repurchase Agreements" and "Reverse Repurchase Agreements" below.
REPURCHASE AGREEMENTS. Each Fund may enter into repurchase agreements only
involving securities in which it could otherwise invest and with selected banks
and securities dealers whose financial condition is monitored by the Adviser,
subject to the guidance of the Trustees in order to
B-16
<PAGE>
generate income while providing liquidity. In such agreements, the seller agrees
to repurchase a security from a Fund at a mutually agreed-upon time and price.
The period of maturity is usually quite short, either overnight or a few days
(and generally within seven days) although it may extend over a number of
months. The repurchase price is in excess of the purchase price, reflecting an
agreed-upon rate of return effective for the period of time a Fund's money is
invested in the security. Whenever a Fund enters into a repurchase agreement, it
obtains collateral having a market value at least equal to 102% of the
repurchase price, including accrued interest. However, a Fund may collateralize
the amount of such transaction at 100% if the collateral is cash. The
instruments held as collateral are valued daily and if the value of the
instruments declines, a Fund will require additional collateral. If the seller
under the repurchase agreement defaults, the Fund may incur a loss if the value
of the collateral securing the repurchase agreement has declined and may incur
disposition costs in connection with liquidating the collateral. In addition, if
bankruptcy proceedings are commenced with respect to the seller of the security,
realization of the collateral by the Fund may be delayed or limited. The
Trustees have established guidelines to be used by the Adviser in connection
with transactions in repurchase agreements and will regularly monitor each
Fund's use of repurchase agreements. A Fund will not invest in repurchase
agreements maturing in more than seven days if the aggregate of such investments
along with other illiquid securities exceeds 10% of the value of its total
assets. However, for temporary defensive purposes, there is no limit on the
amount of a Fund's net assets that may be subject to repurchase agreements
having a maturity of seven days or less.
REVERSE REPURCHASE AGREEMENTS. Each Fund may engage in reverse repurchase
agreements. In a reverse repurchase agreement, the Fund sells a security and
agrees to repurchase it at a mutually agreed upon date and price, reflecting the
interest rate effective for the term of the agreement. The Fund's investment of
the proceeds of a reverse repurchase agreement is the speculative factor known
as leverage. The Funds will enter into a reverse repurchase agreement only if
the interest income from investment of the proceeds is expected to be greater
than the interest expense of the transaction and the proceeds are invested for a
period no longer than the term of the agreement. The Fund will segregate with
the custodian cash or liquid securities in an amount at least equal to 102% of
its purchase obligations under these agreements (including accrued interest). In
the event that the buyer of securities under a reverse repurchase agreement
files for bankruptcy or becomes insolvent, the buyer or its trustee or receiver
may receive an extension of time to determine whether to enforce the Fund's
repurchase obligation, and the Fund's use of proceeds of the agreement may
effectively be restricted pending such decision. Reverse repurchase agreements
are considered to be borrowings and are subject to the percentage limitations on
borrowings. See "Investment Restrictions."
INTEREST-RATE SWAP TRANSACTIONS. The Diversified Income and the High Income
Fund may enter into either asset-based interest-rate swaps or liability-based
interest-rate swaps, depending on whether it is hedging its assets or its
liabilities. A Fund will usually enter into interest-rate swaps on a net basis,
i.e., the two payment streams are netted out, with the Fund receiving or paying,
as the case may be, only the net amount of the two payments. Since these hedging
transactions are entered into for good faith hedging purposes and a segregated
account has been established, the Adviser believes such obligations do not
constitute senior securities and, accordingly, will not treat them as
B-17
<PAGE>
being subject to the borrowing restrictions applicable to each Fund. The net
amount of the excess, if any, of a Fund's obligations over its entitlements with
respect to each interest-rate swap will be accrued on a daily basis and an
amount of cash or liquid securities having an aggregate net asset value at least
equal to the accrued excess will be maintained in a segregated account by a
custodian that satisfies the requirements of the 1940 Act. To the extent that a
Fund enters into interest-rate swaps on other than a net basis, the amount
maintained in a segregated account will be the full amount of the Fund's
obligations, if any, with respect to such interest-rate swaps, accrued on a
daily basis. A Fund may pledge up to 5% of its net assets in connection with
interest-rate swap transactions. A Fund will not enter into any interest-rate
swaps unless the unsecured senior debt or the claims-paying ability of the other
party thereto is rated in the highest rating category of at least one nationally
recognized rating organization at the time of entering into such transaction. If
there is a default by the other party to such transaction, a Fund will have
contractual remedies pursuant to the agreement related to the transaction. The
swap market has grown substantially in recent years with a large number of banks
and investment banking firms acting both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid.
The use of interest-rate swaps is a highly speculative activity that
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If incorrect in its forecast of
market values, interest rates and other applicable factors, the investment
performance of a Fund would diminish compared to what it would have been if this
investment technique was never used.
A Fund may enter into interest-rate swaps only to hedge its portfolio.
Interest-rate swaps do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest-rates swaps is limited to the net amount of interest payments that a
Fund is contractually obligated to make. If the other party to an interest-rate
swap defaults, a Fund's risk of loss consists of the net amount of interest
payments that the Fund is contractually entitled to receive. Since interest-rate
swaps are individually negotiated, a Fund expects to achieve an acceptable
degree of correlation between its rights to receive interest on its portfolio
securities and its rights and obligations to receive and pay interest pursuant
to interest-rate swaps.
WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES. Each Fund may purchase or sell
such securities on a "when-issued" or "delayed-delivery" basis. Although a Fund
will enter into such transactions for the purpose of acquiring securities for
its portfolio or for delivery pursuant to options contracts it has entered into,
the Fund may dispose of a commitment prior to settlement. "When-issued" or
"delayed-delivery" refers to securities whose terms and indenture are available
and for which a market exists, but which are not available for immediate
delivery. While the Fund will purchase securities on a when-issued or delayed-
delivery basis only with the intention of acquiring the securities, the Fund may
sell the securities before the settlement date, if it is deemed advisable. At
the time the Fund makes the commitment to purchase securities on a when-issued
or delayed-delivery basis, the Fund will record the transaction and thereafter
reflect the value, each day, of such security in determining the net asset value
of the Fund. When such transactions are negotiated, the
B-18
<PAGE>
price (which is generally expressed in yield terms) is fixed at the time the
commitment is made, but delivery and payment for the securities take place at a
later date. During the period between commitment by a Fund and settlement
(generally within two months but not to exceed 120 days), no payment is made for
the securities purchased by the purchaser, and no interest accrues to the
purchaser from the transaction. Such securities are subject to market
fluctuation, and the value at delivery may be less than the purchase price. A
Fund will maintain a segregated account with its custodian, consisting of cash
or liquid securities at least equal to the value of purchase commitments until
payment is made. A Fund will likewise segregate liquid assets in respect of
securities sold on a delayed-delivery basis.
A Fund will engage in when-issued transactions in order to secure what is
considered to be an advantageous price and yield at the time of entering into
the obligation. When a Fund engages in when-issued or delayed-delivery
transactions, it relies on the buyer or seller, as the case may be, to
consummate the transaction. Failure to do so may result in a Fund losing the
opportunity to obtain a price and yield considered to be advantageous. If a Fund
chooses (i) to dispose of the right to acquire a when-issued security prior to
its acquisition or (ii) to dispose of its right to deliver or receive against a
forward commitment, it may incur a gain or loss. (At the time a Fund makes a
commitment to purchase or sell a security on a when-issued or forward commitment
basis, it records the transaction and reflects the value of the security
purchased, or if a sale, the proceeds to be received in determining its net
asset value.)
To the extent a Fund engages in when-issued and delayed-delivery
transactions, it will do so for the purpose of acquiring or selling securities
consistent with its investment objectives and policies and not for the purposes
of investment leverage. A Fund enters into such transactions only with the
intention of actually receiving or delivering the securities, although (as noted
above) when-issued securities and forward commitments may be sold prior to the
settlement date. In addition, changes in interest rates in a direction other
than that expected by the Adviser before settlement, will affect the value of
such securities and may cause a loss to a Fund.
When-issued transactions and forward commitments may be used to offset
anticipated changes in interest rates and prices. For instance, in periods of
rising interest rates and falling prices, a Fund might sell securities in its
portfolio on a forward commitment basis to attempt to limit its exposure to
anticipated falling prices. In periods of falling interest rates and rising
prices, a Fund might sell portfolio securities and purchase the same or similar
securities on a when-issued or forward commitment basis, thereby obtaining the
benefit of currently higher cash yields. One form of when-issued or delayed
delivery security that the Government Securities and Federal Securities Funds
may purchase is a "to be announced" or "TBA" mortgage-backed security. A TBA
mortgage-backed security transaction arises when a mortgage-backed security is
purchased or sold with the specific pools to be announced on a future settlement
date.
WHEN, AS AND IF ISSUED SECURITIES. Each Fund may purchase securities on a
"when, as and if issued" basis under which the issuance of the security depends
upon the occurrence of a subsequent event, such as approval of a merger,
corporate reorganization or debt restructuring. The commitment
B-19
<PAGE>
for the purchase of any such security will not be recognized until the Adviser
determines that issuance of the security is probable. At such time, each Fund
will record the transaction, and in determining its net asset value, will
reflect the value of the security daily. At such time, each Fund will also
establish a segregated account with its custodian in which it will maintain cash
or liquid securities equal in value to recognized commitments for such
securities. The value of a Fund's commitments to purchase the securities of any
one issuer, together with the value of all securities of such issuer owned by a
Fund, may not exceed 5% of the value of the Fund's total assets at the time the
initial commitment to purchase such securities is made. Subject to the foregoing
restrictions, each Fund may purchase securities on such basis without limit. An
increase in the percentage of a Fund's assets committed to the purchase of
securities on a when, as and if issued basis, may increase the volatility of its
net asset value. The Adviser does not believe that the net asset value of the
Funds will be adversely affected by its purchase of securities on such basis.
LOANS OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, each Fund may lend portfolio securities in amounts up to 33% of
total assets to brokers, dealers and other financial institutions, provided that
-------- ----
such loans are callable at any time by the Fund and are at all times secured by
cash or equivalent collateral that is equal to at least 102% of the market
value, determined daily, of the loaned securities. In lending its portfolio
securities, a Fund receives income while retaining the securities' potential for
capital appreciation. The advantage of such loans is that a Fund continues to
receive the interest and dividends on the loaned securities while at the same
time earning interest on the collateral, which will generally be invested in
short-term debt securities, including repurchase agreements. A loan may be
terminated by the borrower on one business day's notice or by a Fund at any
time. If the borrower fails to maintain the requisite amount of collateral, the
loan automatically terminates, and the Fund could use the collateral to replace
the securities while holding the borrower liable for any excess of replacement
cost over collateral. As with any extensions of credit, there are risks of delay
in recovery and in some cases, even loss of rights in the collateral should the
borrower of the securities fail financially. However, these loans of portfolio
securities will only be made to firms deemed by the Adviser to be creditworthy.
On termination of the loan, the borrower is required to return the securities to
a Fund; and any gain or loss in the market price of the loaned security during
the loan would inure to the Fund. Each Fund will pay reasonable finders',
administrative and custodial fees in connection with a loan of its securities or
may share the interest earned on collateral with the borrower.
Since voting or consent rights that accompany loaned securities pass to the
borrower, each Fund will follow the policy of calling the loan in whole or in
part, as may be appropriate, to permit the exercise of such rights if the
matters involved would have a material effect on the Fund's investment in the
securities that are the subject of the loan.
PREFERRED STOCKS. The Diversified Income Fund's investment in fixed income
securities issued by domestic corporations may include preferred stocks. In
addition, up to 20% of the High Income Fund's total assets may be invested in
common stocks, preferred stocks, or other equity securities. Dividends on some
preferred stock may be "cumulative" if stated dividends from prior periods have
not been paid. Preferred stock generally has a preference over common stock on
the distribution of
B-20
<PAGE>
a corporation's assets in the event of liquidation of the corporation, and may
be "participating," which means that it may be entitled to a dividend exceeding
the stated dividend in certain cases. The rights of preferred stock are
generally subordinate to rights associated with a corporation's debt securities.
WARRANTS AND RIGHTS. The Diversified Income Fund may invest up to 5% of its
total assets (at the time of purchase) in warrants and rights. The Fund will
invest only in those warrants or rights: (i) acquired as part of a unit or
attached to other securities purchased by the Fund; or (ii) acquired as part of
a distribution from the issuer. Warrants basically are options to purchase
equity securities at specific prices valid for a specific period of time.
Prices of warrants do not necessarily move parallel to the prices of the
underlying securities. Rights are similar to warrants but normally have a short
duration and are distributed by the issuer to its shareholders. Warrants and
rights have no voting rights, pay no dividends and confer no rights, other than
the right to purchase the underlying stock, with respect to the assets of the
issuer.
PAY-IN-KIND BONDS. Investments of the Federal Securities Fund, the Diversified
Income Fund and the High Income Fund in fixed-income securities may include
pay-in-kind bonds. These are securities which pay interest in either cash or
additional securities, at the issuer's option, for a specified period.
Pay-in-kind bonds, like zero-coupon bonds, are designed to give an issuer
flexibility in managing cash flow. Pay-in-kind bonds can be either senior or
subordinated debt and trade flat (i.e., without accrued interest). The price of
pay-in-kind bonds is expected to reflect the market value of the underlying debt
plus an amount representing accrued interest since the last payment. Pay-in-kind
bonds are usually less volatile than zero-coupon bonds, but more volatile than
cash pay securities.
DERIVATIVES STRATEGIES. Each Fund may write (i.e., sell) call options ("calls")
on securities that are traded on U.S. and foreign securities exchanges and
over-the-counter markets to enhance income through the receipt of premiums from
expired calls and any net profits from closing purchase transactions. After any
such sale up to 100% of a Fund's total assets may be subject to calls. All such
calls written by a Fund must be "covered" while the call is outstanding (i.e.,
the Fund must own the securities subject to the call or other securities
acceptable for applicable escrow requirements). Calls on Futures (defined below)
used to enhance income, must be covered by deliverable securities or by liquid
assets segregated to satisfy the Futures contract. If a call written by the
Fund is exercised, the Fund forgoes any profit from any increase in the market
price above the call price of the underlying investment on which the call was
written. In addition, the Fund could experience capital losses, which might
cause previously distributed short-term capital gains to be re-characterized as
a non-taxable return of capital to shareholders.
HEDGING STRATEGIES. For hedging purposes as a temporary defensive maneuver, the
Diversified Income Fund and the High Income Fund may use forward contracts on
forward currencies ("Forward Contracts") and each Fund may use interest-rate
futures contracts, foreign currency futures contracts, and stock and bond index
futures contracts (together, "Futures"), as well as call and put options on
equity and debt securities, Futures, stock and bond indices and foreign
currencies (all the foregoing
B-21
<PAGE>
referred to as "Hedging Instruments"); except that the Government Securities
Fund, the Federal Securities Fund and the Tax Exempt Insured Fund may not engage
in foreign currency Futures and options thereon. All puts and calls on
securities, interest rate Futures or stock and bond index Futures or options on
such Futures purchased or sold by the Fund will be listed on a national
securities or commodities exchange or on U.S. over-the-counter markets. Hedging
Instruments may be used to attempt: (i) to protect against possible declines in
the market value of a Fund's portfolio resulting from downward trends in the
equity and debt securities markets (generally due to a rise in interest rates);
(ii) to protect a Fund's unrealized gains in the value of its equity and debt
securities that have appreciated; (iii) to facilitate selling securities for
investment reasons; (iv) to establish a position in the equity and debt
securities markets as a temporary substitute for purchasing particular equity
and debt securities; or (v) to reduce the risk of adverse currency
fluctuations.
A Fund's strategy of hedging with Futures and options on Futures will be
incidental to its activities in the underlying cash market. When hedging to
attempt to protect against declines in the market value of a Fund's portfolio,
to permit a Fund to retain unrealized gains in the value of portfolio securities
which have appreciated, or to facilitate selling securities for investment
reasons, a Fund could: (i) sell Futures; (ii) purchase puts on such Futures or
securities; or (iii) write calls on securities held by it or on Futures. When
hedging to attempt to protect against the possibility that portfolio securities
are not fully included in a rise in value of the debt securities market, a Fund
could: (i) purchase Futures, or (ii) purchase calls on such Futures or on
securities. When hedging to protect against declines in the dollar value of a
foreign currency-denominated security, the Diversified Income Fund and the High
Income Fund could: (i) purchase puts on that foreign currency and on foreign
currency Futures; (ii) write calls on that currency or on such Futures; or (iii)
enter into Forward Contracts at a lower rate than the spot ("cash") rate.
Additional information about the Hedging Instruments the Funds may use is
provided below.
OPTIONS
- -------
Options on Securities. As noted above, each Fund may write and purchase
call and put options on equity and debt securities.
When a Fund writes a call on a security, it receives a premium and agrees
to sell the underlying security to a purchaser of a corresponding call on the
same security during the call period (usually not more than 9 months) at a fixed
price (which may differ from the market price of the underlying security),
regardless of market price changes during the call period. A Fund has retained
the risk of loss should the price of the underlying security increase during the
call period, which may be offset to some extent by the premium.
To terminate its obligation on a call it has written, a Fund may purchase a
corresponding call in a "closing purchase transaction." A profit or loss will
be realized, depending upon whether the net of the amount of the option
transaction costs and the premium received on the call written was more or less
than the price of the call subsequently purchased. A profit may also be
realized if the call expires unexercised, because a Fund retains the underlying
security and the premium received.
B-22
<PAGE>
Any such profits are considered short-term capital gains for federal income tax
purposes, and when distributed by the Fund, are taxable as ordinary income. If a
Fund could not effect a closing purchase transaction due to lack of a market, it
would hold the callable securities until the call expired or was exercised.
When a Fund purchases a call (other than in a closing purchase
transaction), it pays a premium and has the right to buy the underlying
investment from a seller of a corresponding call on the same investment during
the call period at a fixed exercise price. A Fund benefits only if the call is
sold at a profit or if, during the call period, the market price of the
underlying investment is above the sum of the call price plus the transaction
costs and the premium paid and the call is exercised. If the call is not
exercised or sold (whether or not at a profit), it will become worthless at its
expiration date and a Fund will lose its premium payment and the right to
purchase the underlying investment.
A put option on securities gives the purchaser the right to sell, and the
writer the obligation to buy, the underlying investment at the exercise price
during the option period. Writing a put covered by segregated liquid assets
equal to the exercise price of the put, has the same economic effect to a Fund
as writing a covered call. The premium a Fund receives from writing a put
option represents a profit as long as the price of the underlying investment
remains above the exercise price. However, a Fund has also assumed the
obligation during the option period to buy the underlying investment from the
buyer of the put at the exercise price, even though the value of the investment
may fall below the exercise price. If the put expires unexercised, a Fund (as
the writer of the put) realizes a gain in the amount of the premium. If the put
is exercised, a Fund must fulfill its obligation to purchase the underlying
investment at the exercise price, which will usually exceed the market value of
the investment at that time. In that case, a Fund may incur a loss, equal to
the sum of the sale price of the underlying investment and the premium received
minus the sum of the exercise price and any transaction costs incurred.
A Fund may effect a closing purchase transaction to realize a profit on an
outstanding put option it has written or to prevent an underlying security from
being put. Furthermore, effecting such a closing purchase transaction will
permit a Fund to write another put option to the extent that the exercise price
thereof is secured by the deposited assets, or to utilize the proceeds from the
sale of such assets for other investments by the Fund. A Fund will realize a
profit or loss from a closing purchase transaction if the cost of the
transaction is less or more than the premium received from writing the option.
As described above, for writing covered calls, any and all such profits
described herein from writing puts are considered short-term gains for federal
tax purposes, and when distributed by a Fund, are taxable as ordinary
income.
When a Fund purchases a put, it pays a premium and has the right to sell
the underlying investment to a seller of a corresponding put on the same
investment during the put period at a fixed exercise price. Buying a put on an
investment a Fund owns enables the Fund to protect itself during the put period
against a decline in the value of the underlying investment below the exercise
price by selling such underlying investment at the exercise price to a seller of
a corresponding put. If the
B-23
<PAGE>
market price of the underlying investment is equal to or above the exercise
price and as a result the put is not exercised or resold, the put will become
worthless at its expiration date, and the Fund will lose its premium payment and
the right to sell the underlying investment pursuant to the put. The put may,
however, be sold prior to expiration (whether or not at a profit.)
Buying a put on an investment a Fund does not own permits the Fund either
to resell the put or buy the underlying investment and sell it at the exercise
price. The resale price of the put will vary inversely with the price of the
underlying investment. If the market price of the underlying investment is
above the exercise price and as a result the put is not exercised, the put will
become worthless on its expiration date. In the event of a decline in the stock
market, a Fund could exercise or sell the put at a profit to attempt to offset
some or all of its loss on its portfolio securities.
When writing put options on securities, to secure its obligation to pay for
the underlying security, a Fund will deposit in escrow liquid assets with a
value equal to or greater than the exercise price of the underlying securities.
A Fund therefore forgoes the opportunity of investing the segregated assets or
writing calls against those assets. As long as the obligation of a Fund as the
put writer continues, it may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring a Fund to take delivery of the
underlying security against payment of the exercise price. A Fund has no
control over when it may be required to purchase the underlying security, since
it may be assigned an exercise notice at any time prior to the termination of
its obligation as the writer of the put. This obligation terminates upon
expiration of the put, or such earlier time at which a Fund effects a closing
purchase transaction by purchasing a put of the same series as that previously
sold. Once a Fund has been assigned an exercise notice, it is thereafter not
allowed to effect a closing purchase transaction.
Options on Foreign Currencies. The Diversified Income Fund and the High
Income Fund may write and purchase calls on foreign currencies. A call written
by a Fund on a foreign currency is "covered" if the Fund owns the underlying
foreign currency covered by the call or has an absolute and immediate right to
acquire that foreign currency without additional cash consideration (or for
additional cash consideration held in a segregated account by its custodian)
upon conversion or exchange of other foreign currency held in its portfolio. A
call written by a Fund on a foreign currency is for cross-hedging purposes if it
is not covered, but is designed to provide a hedge against a decline in the U.S.
dollar value of a security which the Fund owns or has the right to acquire and
which is denominated in the currency underlying the option due to an adverse
change in the exchange rate. In such circumstances, a Fund collateralizes the
option by maintaining in a segregated account with the Fund's custodian, cash or
liquid securities in an amount not less than the value of the underlying foreign
currency in U.S. dollars marked-to-market daily. As with other kinds of option
transactions, the writing of an option on currency will constitute only a
partial hedge, up to the amount of the premium received. A Fund could be
required to purchase or sell currencies at disadvantageous exchange rates,
thereby incurring losses. The purchase of an option on currency may constitute
an effective hedge against exchange rate fluctuations; however, in the event of
exchange rate movements adverse to a Fund's position, the Fund may forfeit the
entire amount of the premium plus related transactions costs.
B-24
<PAGE>
Options on Securities Indices. As noted above, each Fund may write and
purchase call and put options on securities indices. Puts and calls on broadly-
based securities indices are similar to puts and calls on securities except that
all settlements are in cash and gain or loss depends on changes in the index in
question (and thus on price movements in the securities market generally) rather
than on price movements in individual securities or Futures. When a Fund buys a
call on a securities index, it pays a premium. During the call period, upon
exercise of a call by a Fund, a seller of a corresponding call on the same
investment will pay the Fund an amount of cash to settle the call if the closing
level of the securities index upon which the call is based is greater than the
exercise price of the call. That cash payment is equal to the difference
between the closing price of the index and the exercise price of the call times
a specified multiple (the "multiplier"), which determines the total dollar value
for each point of difference. When a Fund buys a put on a securities index, it
pays a premium and has the right during the put period to require a seller of a
corresponding put, upon the Fund's exercise of its put, to deliver to the Fund
an amount of cash to settle the put if the closing level of the securities index
upon which the put is based is less than the exercise price of the put. That
cash payment is determined by the multiplier, in the same manner as described
above pertaining to calls.
FUTURES AND OPTIONS ON FUTURES
- ------------------------------
Futures. Upon entering into a Futures transaction, a Fund will be required
to deposit an initial margin payment with the futures commission merchant (the
"futures broker"). The initial margin payment will be deposited with the Fund's
custodian in an account registered in the futures broker's name; however, the
futures broker can gain access to that account only under specified conditions.
As the Future is marked-to-market to reflect changes in its market value,
subsequent margin payments, called variation margin, will be paid to or by the
futures broker on a daily basis. Prior to expiration of the Future, if a Fund
elects to close out its position by taking an opposite position, a final
determination of variation margin is made, additional cash is required to be
paid by or released to the Fund, and any loss or gain is realized for tax
purposes. All Futures transactions are effected through a clearinghouse
associated with the exchange on which the Futures are traded.
Interest-rate futures contracts are purchased or sold for hedging purposes
to attempt to protect against the effects of interest rate changes on a Fund's
current or intended investments in fixed-income securities. For example, if a
Fund owned long-term bonds and interest rates were expected to increase, that
Fund might sell interest-rate futures contracts. Such a sale would have much
the same effect as selling some of the long-term bonds in that Fund's portfolio.
However, since the Futures market is more liquid than the cash market, the use
of interest-rate futures contracts as a hedging technique allows a Fund to hedge
its interest rate risk without having to sell its portfolio securities. If
interest rates did increase, the value of the debt securities in the portfolio
would decline, but the value of that Fund's interest-rate futures contracts
would be expected to increase at approximately the same rate, thereby keeping
the net asset value of that Fund from declining as much as it otherwise would
have. On the other hand, if interest rates were expected to decline,
interest-rate futures contracts may be purchased to hedge in anticipation of
subsequent purchases of long-term bonds at higher prices. Since the fluctuations
in the value of the interest-rate futures
B-25
<PAGE>
contracts should be similar to that of long-term bonds, a Fund could protect
itself against the effects of the anticipated rise in the value of long-term
bonds without actually buying them until the necessary cash became available or
the market had stabilized. At that time, the interest-rate futures contracts
could be liquidated and that Fund's cash reserves could then be used to buy
long-term bonds on the cash market.
Purchases or sales of stock or bond index futures contracts are used for
hedging purposes to attempt to protect a Fund's current or intended investments
from broad fluctuations in stock or bond prices. For example, a Fund may sell
stock or bond index futures contracts in anticipation of or during a market
decline to attempt to offset the decrease in market value of the Fund's
securities portfolio that might otherwise result. If such decline occurs, the
loss in value of portfolio securities may be offset, in whole or part, by gains
on the Futures position. When a Fund is not fully invested in the securities
market and anticipates a significant market advance, it may purchase stock or
bond index futures contracts in order to gain rapid market exposure that may, in
part or entirely, offset increases in the cost of securities that the Fund
intends to purchase. As such purchases are made, the corresponding positions in
stock or bond index futures contracts will be closed out.
As noted above, the Diversified Income Fund and the High Income Fund may
purchase and sell foreign currency futures contracts for hedging to attempt to
protect current or intended investments from fluctuations in currency exchange
rates. Such fluctuations could reduce the dollar value of portfolio securities
denominated in foreign currencies, or increase the cost of foreign-denominated
securities to be acquired, even if the value of such securities in the
currencies in which they are denominated remains constant. A Fund may sell
futures contracts on a foreign currency, for example, when it holds securities
denominated in such currency and it anticipates a decline in the value of such
currency relative to the dollar. In the event such decline occurs, the
resulting adverse effect on the value of foreign-denominated securities may be
offset, in whole or in part, by gains on the Futures contracts. However, if the
value of the foreign currency increases relative to the dollar, a Fund's loss on
the foreign currency futures contract may or may not be offset by an increase in
the value of the securities since a decline in the price of the security stated
in terms of the foreign currency may be greater than the increase in value as a
result of the change in exchange rates.
Conversely, a Fund could protect against a rise in the dollar cost of
foreign-denominated securities to be acquired by purchasing Futures contracts on
the relevant currency, which could offset, in whole or in part, the increased
cost of such securities resulting from a rise in the dollar value of the
underlying currencies. When a Fund purchases futures contracts under such
circumstances, however, and the price of securities to be acquired instead
declines as a result of appreciation of the dollar, the Fund will sustain losses
on its futures position which could reduce or eliminate the benefits of the
reduced cost of portfolio securities to be acquired.
Options on Futures. As noted above, each Fund may purchase and write
options on interest-rate futures contracts and stock and bond index futures
contracts, and the Diversified Income Fund and the High Income Fund may purchase
and write options on foreign currency futures contracts. (Unless otherwise
specified, options on interest-rate futures contracts, options on stock and bond
B-26
<PAGE>
index futures contracts and options on foreign currency futures contracts are
collectively referred to as "Options on Futures.")
The writing of a call option on a Futures contract constitutes a partial
hedge against declining prices of the securities in a Fund's portfolio. If the
Futures price at expiration of the option is below the exercise price, the Fund
will retain the full amount of the option premium, which provides a partial
hedge against any decline that may have occurred in the Fund's portfolio
holdings. The writing of a put option on a Futures contract constitutes a
partial hedge against increasing prices of the securities or other instruments
required to be delivered under the terms of the Futures contract. If the Futures
price at expiration of the put option is higher than the exercise price, a Fund
will retain the full amount of the option premium which provides a partial hedge
against any increase in the price of securities which the Fund intends to
purchase. If a put or call option a Fund has written is exercised, the Fund
will incur a loss which will be reduced by the amount of the premium it
receives. Depending on the degree of correlation between changes in the value of
its portfolio securities and changes in the value of its Options on Futures
positions, a Fund's losses from exercised Options on Futures may to some extent
be reduced or increased by changes in the value of portfolio securities.
A Fund may purchase Options on Futures for hedging purposes, instead of
purchasing or selling the underlying Futures contract. For example, where a
decrease in the value of portfolio securities is anticipated as a result of a
projected market-wide decline or changes in interest or exchange rates, a Fund
could, in lieu of selling a Futures contract, purchase put options thereon. In
the event that such decrease occurs, it may be offset, in whole or part, by a
profit on the option. If the market decline does not occur, the Fund will
suffer a loss equal to the price of the put. Where it is projected that the
value of securities to be acquired by a Fund will increase prior to acquisition,
due to a market advance or changes in interest or exchange rates, a Fund could
purchase call Options on Futures, rather than purchasing the underlying Futures
contract. If the market advances, the increased cost of securities to be
purchased may be offset by a profit on the call. However, if the market
declines, the Fund will suffer a loss equal to the price of the call but the
securities which the Fund intends to purchase may be less expensive.
FORWARD CONTRACTS
- -----------------
The Diversified Income Fund and the High Income Fund may use Forward
Contracts. A Forward Contract involves bilateral obligations of one party to
purchase, and another party to sell, 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 the contract is entered into. These
contracts are traded in the interbank market conducted directly between currency
traders (usually large commercial banks) and their customers. No price is paid
or received upon the purchase or sale of a Forward Contract.
A Fund may use Forward Contracts to protect against uncertainty in the
level of future exchange rates. The use of Forward Contracts does not eliminate
fluctuations in the prices of the underlying securities a Fund owns or intends
to acquire, but it does fix a rate of exchange in advance.
B-27
<PAGE>
In addition, although Forward Contracts limit the risk of loss due to a decline
in the value of the hedged currencies, at the same time they limit any potential
gain that might result should the value of the currencies increase. A Fund will
not speculate with Forward Contracts or foreign currency exchange rates.
A Fund may enter into Forward Contracts with respect to specific
transactions. For example, when a Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when a Fund
anticipates receipt of dividend payments in a foreign currency, the Fund may
desire to "lock-in" the U.S. dollar price of the security or the U.S. dollar
equivalent of such payment by entering into a Forward Contract, for a fixed
amount of U.S. dollars per unit of foreign currency, for the purchase or sale of
the amount of foreign currency involved in the underlying transaction. A Fund
will thereby be able to protect itself against a possible loss resulting from an
adverse change in the relationship between the currency exchange rates during
the period between the date on which the security is purchased or sold, or on
which the payment is declared, and the date on which such payments are made or
received.
A Fund may also use Forward Contracts to lock in the U.S. dollar value of
portfolio positions ("position hedge"). In a position hedge, for example, when
a Fund believes that foreign currency may suffer a substantial decline against
the U.S. dollar, it may enter into a Forward Contract to sell an amount of that
foreign currency approximating the value of some or all of the Fund's portfolio
securities denominated in (or affected by fluctuations in, in the case of ADRs)
such foreign currency, or when a Fund believes that the U.S. dollar may suffer a
substantial decline against a foreign currency, it may enter into a Forward
Contract to buy that foreign currency for a fixed dollar amount. In this
situation a Fund may, in the alternative, enter into a Forward Contract to sell
a different foreign currency for a fixed U.S. dollar amount where the Fund
believes that the U.S. dollar value of the currency to be sold pursuant to the
forward contract will fall whenever there is a decline in the U.S. dollar value
of the currency in which portfolio securities of the Fund are denominated
("cross-hedged").
The Fund's custodian will place cash or liquid securities in a separate
account of the Fund having a value equal to the aggregate amount of the Fund's
commitments under Forward Contracts entered into with respect to position hedges
and cross-hedges to the extent that such positions are not otherwise covered.
If the value of the securities placed in a separate account declines, additional
cash or securities will be placed in the account on a daily basis so that the
value of the account will equal the amount of the Fund's commitments with
respect to such contracts. As an alternative to maintaining all or part of the
separate account, a Fund may purchase a call option permitting the Fund to
purchase the amount of foreign currency being hedged by a forward sale contract
at a price no higher than the Forward Contract price or the Fund may purchase a
put option permitting the Fund to sell the amount of foreign currency subject to
a forward purchase contract at a price as high or higher than the Forward
Contract price. Unanticipated changes in currency prices may result in poorer
overall performance for a Fund than if it had not entered into such
contracts.
B-28
<PAGE>
The precise matching of the Forward Contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of these securities between the date the Forward Contract
is entered into and the date it is sold. Accordingly, it may be necessary for a
Fund to purchase additional foreign currency on the spot (i.e., cash) market
(and bear the expense of such purchase), if the market value of the security is
less than the amount of foreign currency a Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the foreign currency.
Conversely, it may be necessary to sell on the spot market some of the foreign
currency received upon the sale of the portfolio security if its market value
exceeds the amount of foreign currency a Fund is obligated to deliver. The
projection of short-term currency market movements is extremely difficult, and
the successful execution of a short-term hedging strategy is highly uncertain.
Forward Contracts involve the risk that anticipated currency movements will not
be accurately predicted, causing a Fund to sustain losses on these contracts and
transactions costs.
At or before the maturity of a Forward Contract requiring a Fund to sell a
currency, the Fund may either sell a portfolio security and use the sale
proceeds to make delivery of the currency or retain the security and offset its
contractual obligation to deliver the currency by purchasing a second contract
pursuant to which the Fund will obtain, on the same maturity date, the same
amount of the currency that it is obligated to deliver. Similarly, a Fund may
close out a Forward Contract requiring it to purchase a specified currency by
entering into a second contract entitling it to sell the same amount of the same
currency on the maturity date of the first contract. A Fund would realize a
gain or loss as a result of entering into such an offsetting Forward Contract
under either circumstance to the extent the exchange rate or rates between the
currencies involved moved between the execution dates of the first contract and
offsetting contract.
The cost to a Fund of engaging in Forward Contracts varies with factors
such as the currencies involved, the length of the contract period and the
market conditions then prevailing. Because Forward Contracts are usually entered
into on a principal basis, no fees or commissions are involved. Because such
contracts are not traded on an exchange, a Fund must evaluate the credit and
performance risk of each particular counterparty under a Forward Contract.
Although a Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert its holdings of foreign currencies into U.S. dollars on a
daily basis. A Fund may convert foreign currency from time to time, and
investors should be aware of the costs of currency conversion. Foreign exchange
dealers do not charge a fee for conversion, but they do seek to realize a profit
based on the difference between the prices at which they buy and sell various
currencies. Thus, a dealer may offer to sell a foreign currency to a Fund at
one rate, while offering a lesser rate of exchange should the Fund desire to
resell that currency to the dealer.
B-29
<PAGE>
ADDITIONAL INFORMATION ABOUT HEDGING INSTRUMENTS AND THEIR USE
- --------------------------------------------------------------
The Fund's custodian, or a securities depository acting for the custodian,
will act as the Fund's escrow agent through the facilities of the Options
Clearing Corporation ("OCC"), as to the securities on which the Fund has written
options or as to other acceptable escrow securities, so that no margin will be
required for such transaction. OCC will release the securities on the
expiration of the option or upon a Fund's entering into a closing transaction.
An option position may be closed out only on a market which provides
secondary trading for options of the same series and there is no assurance that
a liquid secondary market will exist for any particular option. A Fund's option
activities may affect its turnover rate and brokerage commissions. The exercise
by a Fund of puts on securities will cause the sale of related investments, thus
increasing portfolio turnover. Although such exercise is within a Fund's
control, holding a put might cause the Fund to sell the related investments for
reasons which would not exist in the absence of the put. A Fund will pay a
brokerage commission each time it buys a put or call, sells a call, or buys or
sells an underlying investment in connection with the exercise of a put or call.
Such commissions may be higher than those which would apply to direct purchases
or sales of such underlying investments. Premiums paid for options are small in
relation to the market value of the related investments, and consequently, put
and call options offer large amounts of leverage. The leverage offered by
trading in options could result in a Fund's net asset value being more sensitive
to changes in the value of the underlying investments.
In the future, each Fund may employ Hedging Instruments and strategies that
are not presently contemplated but which may be developed, to the extent such
investment methods are consistent with a Fund's investment objectives, legally
permissible and adequately disclosed.
REGULATORY ASPECTS OF HEDGING INSTRUMENTS
- -----------------------------------------
Each Fund must operate within certain restrictions as to its long and short
positions in Futures and options thereon, under a rule (the "CFTC Rule") adopted
by the Commodity Futures Trading Commission (the "CFTC") under the Commodity
Exchange Act (the "CEA"), which excludes the Fund from registration with the
CFTC as a "commodity pool operator" (as defined in the CEA) if it complies with
the CFTC Rule. In particular, the Fund may (i) purchase and sell Futures and
options thereon for bona fide hedging purposes, as defined under CFTC
regulations, without regard to the percentage of the Fund's assets committed to
margin and option premiums, and (ii) enter into non-hedging transactions,
provided that the Fund may not enter into such non-hedging transactions if,
immediately thereafter, the sum of the amount of initial margin deposits on the
Fund's existing Futures positions and option premiums would exceed 5% of the net
assets of its portfolio, after taking into account unrealized profits and
unrealized losses on any such transactions. However, the Fund intends to engage
in Futures transactions and options thereon only for hedging purposes. Margin
deposits may consist of cash or securities acceptable to the broker and the
relevant contract market.
B-30
<PAGE>
Transactions in options by a Fund are subject to limitations established by
each of the exchanges governing the maximum number of options that may be
written or held by a single investor or group of investors acting in concert,
regardless of whether the options were written or purchased on the same or
different exchanges or are held in one or more accounts or through one or more
exchanges or brokers. Thus, the number of options a Fund may write or hold may
be affected by options written or held by other entities, including other
investment companies having the same or an affiliated investment adviser.
Position limits also apply to Futures. An exchange may order the liquidation of
positions found to be in violation of those limits and may impose certain other
sanctions. Due to requirements under the 1940 Act, when a Fund purchases a
Future, the Fund will maintain, in a segregated account or accounts with its
custodian, cash or liquid securities in an amount equal to the market value of
the securities underlying such Future, less the margin deposit applicable to
it.
POSSIBLE RISK FACTORS IN HEDGING
- --------------------------------
Participation in the options or Futures markets and in currency exchange
transactions involves investment risks and transaction costs to which a Fund
would not be subject absent the use of these strategies. If the Adviser's
predictions of movements in the direction of the securities, foreign currency
and interest rate markets are inaccurate, the adverse consequences to a Fund may
leave the fund in a worse position than if such strategies were not used. In
addition to the risks discussed in the Prospectus and above, there is a risk in
using short hedging by selling Futures to attempt to protect against decline in
value of a Fund's portfolio securities (due to an increase in interest rates)
that the prices of such Futures will correlate imperfectly with the behavior of
the cash (i.e., market value) prices of the Fund's securities. The ordinary
spreads between prices in the cash and Futures markets are subject to
distortions due to differences in the natures of those markets. First, all
participants in the Futures markets are subject to margin deposit and
maintenance requirements. Rather than meeting additional margin deposit
requirements, investors may close Futures contracts through offsetting
transactions that could distort the normal relationship between the cash and
Futures markets. Second, the liquidity of the Futures markets depend on
participants entering into offsetting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the Futures markets could be reduced, thus producing distortion. Third, from
the point of view of speculators, the deposit requirements in the Futures
markets are less onerous than margin requirements in the securities markets.
Therefore, increased participation by speculators in the Futures markets may
cause temporary price distortions.
If a Fund uses Hedging Instruments to establish a position in the debt
securities markets as a temporary substitute for the purchase of individual debt
securities (long hedging) by buying Futures and/or calls on such Futures or on
debt securities, it is possible that the market may decline; if the Adviser then
determines not to invest in such securities at that time because of concerns as
to possible further market decline or for other reasons, the Fund will realize a
loss on the Hedging Instruments that is not offset by a reduction in the price
of the debt securities purchased.
B-31
<PAGE>
LEVERAGE. In seeking to enhance investment performance, the Federal Securities
Fund, Diversified Income Fund and High Income Fund may each increase its
ownership of securities by borrowing at fixed rates of interest and investing
the borrowed funds, subject to the restrictions stated herein. This is the
speculative factor known as leverage. This practice may help a Fund increase
the net asset value of its shares in an amount greater than would otherwise be
the case when the market case when the market values of the securities purchased
through borrowing increase. In the event the return on an investment of borrowed
monies does not fully recover the costs of such borrowing, the net asset value
of a Fund's shares would be reduced by a greater amount than would otherwise be
the case. The effect of leverage will therefore tend to magnify the gains or
losses to a Fund as a result of investing the borrowed monies. During periods of
substantial borrowings, the net asset value of a Fund's shares would be reduced
due to the added expense of interest on borrowed monies. Each Fund is authorized
to borrow and to pledge assets to secure such borrowings, up to the maximum
extent permissible under the 1940 Act (i.e., 50% of its net assets). The time
and extent to which a Fund may employ leverage will be determined by the Adviser
in light of changing facts and circumstances, including general economic and
market conditions, and will be subject to applicable lending regulations of the
Board of Governors of the Federal Reserve Board. Any such borrowing will be
made pursuant to the requirements of the 1940 Act and will be made only to the
extent that the value of the Fund's asset less its liabilities other than
borrowings is equal to at least 300% of all borrowings including the proposed
borrowing. If the value of a Fund's asset so computed should fail to meet the
300% asset coverage requirement, the Fund is required, within three business
days, to reduce its bank debt to the extent necessary to meet such requirement
and may have to sell a portion of its investments at a time when independent
investment judgment would not dictate such sale. Interest on money borrowed is
an expense the Fund would not otherwise incur, so that it may have little or no
net investment income during periods of substantial borrowings. Since
substantially all of the Fund's assets fluctuate in value, but borrowing
obligations are fixed when the Fund has outstanding borrowings, the net asset
value per share of the Fund correspondingly will tend to increase and decrease
more when the Fund's assets increase or decrease in value than would otherwise
be the case. The Fund's policy regarding use of leverage is a fundamental
policy, which may not be changed without approval of the shareholders of the
Fund.
HIGH-YIELD/HIGH-RISK SECURITIES. The Diversified Income Fund may, and the High
Income Fund will, invest in lower-rated bonds commonly referred to as "junk
bonds." These securities are rated "Baa" or lower by Moody's Investors Service,
Inc. ("Moody's") or "BBB" or lower by Standard Poor's Rating Services, a
division of the McGraw-Hill Companies, Inc. ("S&P"). Each Fund may invest in
securities rated as low as "C" by Moody's or "D" by S&P. These ratings indicate
that the obligations are speculative and may be in default. In addition, each
such Fund may invest in unrated securities subject to the restrictions stated in
the Prospectus. The U.S. Government Securities Fund, the Federal Securities
Fund and the Tax Exempt Insured Fund will not invest in junk bonds.
Certain Risk Factors Relating to High-Yield, High-Risk Securities. It
should be noted that lower-rated securities are subject to risk factors such as:
(a) vulnerability to economic downturns and changes in interest rates; (b)
sensitivity to adverse economic changes and corporate developments; (c)
redemption or call provisions which may be exercised at inopportune times; (d)
difficulty in
B-32
<PAGE>
accurately valuing or disposing of such securities; (e) federal legislation
which could affect the market for such securities; and (f) special adverse tax
consequences associated with investments in certain high-yield, high-risk bonds
(e.g., zero-coupon bonds or pay-in-kind bonds).
Ratings assigned by Moody's and S&P to high-yield bonds, like other bonds,
attempt to evaluate the safety of principal and interest payments on those
bonds. However, such ratings do not assess the risk of a decline in the market
value of those bonds. In addition, ratings may fail to reflect recent events in
a timely manner and are subject to change. If a portfolio security's rating is
changed, the Adviser will determine whether the security will be retained based
upon the factors the Adviser considers in acquiring or holding other securities
in the portfolio. Investment in high-yield bonds may make achievement of a
Fund's objective more dependent on the Adviser's own credit analysis than is the
case for higher-rated bonds.
Market prices for high-yield bonds tend to be more sensitive than those for
higher-rated securities due to many of the factors described above, including
the credit-worthiness of the issuer, redemption or call provisions, the
liquidity of the secondary trading market and changes in credit ratings, as well
as interest rate movements and general economic conditions. In addition, yields
on such bonds will fluctuate over time. An economic downturn could severely
disrupt the market for high-yield bonds.
The risk of default in payment of principal and interest on high-yield
bonds is significantly greater than with higher-rated debt securities because
high-yield bonds are generally unsecured and are often subordinated to other
obligations of the issuer. Further, the issuers of high-yield bonds usually
have high levels of indebtedness and are more sensitive to adverse economic
conditions, such as recession or increasing interest rates. Upon a default,
bondholders may incur additional expenses in seeking recovery.
GROWTH OF HIGH-YIELD, HIGH-RISK BOND MARKET. The widespread expansion of
-------------------------------------------
government, consumer and corporate debt within the U.S. economy has made the
corporate sector more vulnerable to economic downturns or increased interest
rates. Further, an economic downturn could severely disrupt the market for
high-yield, high-risk bonds and adversely affect the value of outstanding bonds
and the ability of the issuers to repay principal and interest.
SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. High-yield, high-risk
-------------------------------------------------
bonds are very sensitive to adverse economic changes and corporate developments.
During an economic downturn or substantial period of rising interest rates,
highly leveraged issuers may experience financial stress that would adversely
affect their ability to service their principal and interest payment
obligations, to meet projected business goals, and to obtain additional
financing. If the issuer of a bond defaulted on its obligations to pay interest
or principal or entered into bankruptcy proceedings, a Fund may incur losses or
expenses in seeking recovery of amounts owed to it. In addition, periods of
economic uncertainty and change can be expected to result in increased
volatility of market prices of high-yield, high-risk bonds and a Fund's net
asset value.
B-33
<PAGE>
PAYMENT EXPECTATIONS. High-yield, high-risk bonds may contain redemption
--------------------
or call provisions. If an issuer exercised these provisions in a declining
interest rate market, a Fund would have to replace the security with a lower
yielding security, resulting in a decreased return for investors. Conversely, a
high-yield, high-risk bond's value will decrease in a rising interest rate
market, as will the value of the Fund's assets. If the Fund experiences
significant unexpected net redemptions, this may force it to sell high-yield,
high-risk bonds without regard to their investment merits, thereby decreasing
the asset base upon which expenses can be spread and possibly reducing the
Fund's rate of return.
LIQUIDITY AND VALUATION. There is a thinly traded market for high-yield
-----------------------
bonds, and recent market quotations may not be available for some of these
bonds. Market quotations are generally available only from a limited number of
dealers and may not represent firm bids from such dealers or prices for actual
sales. As a result, the Diversified Income Fund and High Income Fund may have
difficulty valuing the high-yield bonds in their portfolios accurately and
disposing of these bonds at the time or price desired.
LEGISLATION. Federal laws require the divestiture by federally insured
-----------
savings and loan associations of their investments in high yield bonds and limit
the deductibility of interest by certain corporate issuers of high yield bonds.
These laws could adversely affect a Fund's net asset value and investment
practices, the secondary market for high yield securities, the financial
condition of issuers of these securities and the value of outstanding high yield
securities.
TAXES. A Fund may purchase debt securities (such as zero-coupon or pay-
-----
in-kind securities) that contain original issue discount. Original issue
discount that accrues in a taxable year is treated as earned by a Fund and
therefore is subject to the distribution requirements of the Code. Because the
original issue discount earned by the Fund in a taxable year may not be
represented by cash income, the Fund may have to dispose of other securities and
use the proceeds to make distributions to shareholders.
As a result of all these factors, the net asset value of the High Income
Fund and the Diversified Income Fund, to the extent it invests in high-yield
bonds, is expected to be more volatile than the net asset value of funds which
invest solely in higher-rated debt securities. This volatility may result in an
increased number of redemptions from time to time. High levels of redemptions
in turn may cause a fund to sell its portfolio securities at inopportune times
and decrease the asset base upon which expenses can be spread.
MUNICIPAL SECURITIES AND SHORT-TERM TAXABLE SECURITIES. Subject to the
restrictions set forth in the Prospectus, the Tax Exempt Insured Fund seeks to
achieve its investment objective by investing in Municipal Securities and Short-
Term Taxable Securities (defined below).
Municipal Securities. "Municipal Securities" include long-term (i.e.,
maturing in over ten years) and medium-term (i.e., maturing from three to ten
years) municipal bonds ("Municipal Bonds") and short-term (i.e., maturing in one
day to three years) municipal notes and tax-exempt
B-34
<PAGE>
commercial paper ("Municipal Notes"), and in each case refers to debt
obligations issued by or on behalf of states, territories and possessions of the
United States and of the District of Columbia and their political subdivisions,
agencies and instrumentalities, the interest from which is, in the opinion of
bond counsel at the time of issuance, exempt from Federal income tax.
The two principal classifications of Municipal Bonds are general obligation
bonds and revenue or special obligation bonds. General obligation bonds are
secured by the issuer's pledge of its faith, credit and taxing power for the
payment of principal and interest. The term "issuer" means the agency,
authority, instrumentality or other political subdivision whose assets and
revenues are available for the payment of principal and interest on the bonds.
Revenue or special obligation bonds are payable only from the revenue derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special tax or other specific revenue source and generally are not
payable from the unrestricted revenues of the issuer. There are, of course,
variations in the quality of Municipal Bonds, both within a particular
classification and between classifications.
Municipal Housing Bonds are Municipal Bonds issued by state and municipal
authorities established to purchase single family and other residential
mortgages from commercial banks and other lending institutions within the
applicable state or municipality. Such Bonds are typically revenue or special
obligation bonds in that they are secured only by the authority issuing such
bonds. Such authorities are located in or have been established by at least 45
states and generally are intended to facilitate the construction and sales of
housing for low income families. Generally, the authorities are not entitled to
state or municipal appropriations from general tax revenues. As a result, and
because investors in Municipal Housing Bonds receive repayments of principal as
the underlying mortgages are paid prior to maturity, the yields obtainable on
such Bonds exceed those of other similarly rated Municipal Bonds. Municipal
Housing Bonds are used to purchase single family or other residential mortgages
which may or may not be insured by the FHA or guaranteed by the VA. Some
Municipal Housing Bonds, however, are used only to purchase residential
mortgages that are either insured by the FHA or guaranteed by the VA. Under FHA
insurance programs, upon the conveyance of the insured premises and compliance
with certain administrative procedures, the FHA pays to the mortgage insurance
benefits equal to the unpaid principal amount of the defaulted mortgage loan.
Under a VA guaranty, the VA guarantees the payment of a mortgage loan up to a
maximum. The liability of the VA on any such guaranty is reduced or increased
pro rata with any reduction or increase in the amount of indebtedness, but in no
event will the amount payable on the guaranty exceed the amount of the original
guaranty. Notwithstanding the dollar and percentage limitations of the
guaranty, a mortgagee will ordinarily suffer a monetary loss only when the
difference between the unsatisfied indebtedness and the proceeds of a
foreclosure sale of the mortgaged premises is greater than the original guaranty
as adjusted. The VA may, at its option and without regard to the guaranty, make
full payment to a mortgagee of the unsatisfied indebtedness on a mortgage loan
upon its assignment to the VA of the property. As most Municipal Housing Bonds
are secured only by the mortgages purchased, bonds used to purchase mortgages
that are either insured by the FHA or guaranteed by the VA will have less risk
of loss of principal than bonds used to purchase comparable mortgages that are
not insured by the FHA or guaranteed by the VA. Although the Fund will attempt
to diversify its holding of Municipal Housing Bonds geographically
B-35
<PAGE>
there may be similar factors affecting the mortgagor's ability to maintain
payments under the underlying mortgages. Such factors could include changes in
national and state policies relating to transfer payments such as unemployment
insurance and welfare, and adverse economic developments, particularly those
affecting less skilled and low income workers.
The Fund may invest in Municipal Bonds which, on the date of investment,
are within the four highest ratings of Moody's ("Aaa," "Aa," "A," "Baa") or S&P
("AAA," "AA," "A," "BBB") or in Municipal Bonds which are not rated, provided
that in the opinion of the Adviser, such Municipal Bonds are comparable in
quality to those within the four highest ratings. Though bonds rated Baa or BBB
normally exhibit 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 such bonds than for bonds in higher rated
categories. Occasional speculative factors apply to some bonds in this
category.
The ratings of Moody's and S&P represent their respective opinions of the
qualities of the securities they undertake to rate and such ratings are general
and are not absolute standards of quality. In determining suitability of
investment in a particular unrated security, the Adviser will take into
consideration asset and debt coverage, the purpose of the financing, history of
the issuer, existence of other rated securities of the issuer and other general
conditions as may be relevant, including comparability to other issuers.
The Fund has no restrictions on the maturity of Municipal Securities in
which it may invest. The Fund seeks to invest in Municipal Securities of such
maturities that in the judgment of the Adviser will provide a high level of
current income consistent with liquidity requirements and market conditions
after taking into account the cost of any insurance obtainable on such Municipal
Securities. While short-term trading increases the Fund's turnover, the
execution costs for Municipal Securities are substantially less than for
equivalent dollar values of equity securities.
Generally, the value of Municipal Securities will change as the general
level of interest rates fluctuate. During periods of rising interest rates, the
value of outstanding long-term, fixed-income securities generally decline.
Conversely, during periods of falling interest rates, the value of such
securities generally increase. The value of the Fund's shares fluctuates with
the value of its investments. In addition, the individual credit ratings of
issuers' obligations, the ability of such issuers to make payments of interest
and principal on their obligations, and the value of any insurance applicable
thereto, also affects the value of the Fund's investments.
Yields on Municipal Bonds vary depending on a variety of factors, including
the general condition of the financial markets and of the municipal bond market,
the size of a particular offering, the maturity of the obligation and the credit
rating of the issuer. Generally, Municipal Bonds of longer maturities produce
higher current yields but are subject to greater price fluctuation due to
changes in interest rates, tax laws and other general market factors than are
Municipal Bonds with shorter maturities. Similarly, lower-rated Municipal Bonds
generally produce a higher yield than
B-36
<PAGE>
higher-rated Municipal Bonds due to the perception of a greater degree of risk
as to the ability of the issuer to pay principal and interest obligations.
The Fund will not invest more than 25% of its total assets in Municipal
Securities, the issuers of which are located in the same state. On a temporary
defensive basis or due to market conditions, the Fund may invest up to 100% of
its total assets in Municipal Notes and Short-Term Taxable Securities (neither
of which are insured), as well as in repurchase agreements collateralized by
such securities.
Short-Term Taxable Securities. "Short-Term Taxable Securities" mature in
one year or less from the date of purchase and consist of the following
obligations, the income from which is subject to federal income tax:
obligations of the U.S. government, its agencies or instrumentalities, some of
which may be secured by the full faith and credit of the U.S. government and
some of which may be secured only by the credit of the agency or instrumentality
of the U.S. government issuing such obligations; corporate bonds or debentures
rated within the four highest grades by either Moody's or S&P; commercial paper
rated by either of such rating services (Prime-1 through Prime 2- or A-1 through
A-2, respectively) or, if not rated, issued by companies having an outstanding
debt issue rated at least "A" by either of such rating services; certificates of
deposit and bankers' acceptances of banks having assets in excess of $2
billion.
Insurance Feature. The Fund under normal market conditions invests at
least 65% of its total assets in Municipal Bonds that, at the time of purchase,
either (1) are insured under a Mutual Fund Insurance Policy issued to the Trust
for the benefit of the Fund by Financial Guaranty Insurance Company ("Financial
Guaranty") or another insurer (subject to the limitations set forth below); (2)
are insured under an insurance policy obtained by the issuer or underwriter of
such Municipal Bonds at the time of original issuance thereof (a "New Issue
Insurance Policy"); or (3) are without insurance coverage, provided that, an
-------- ----
escrow or trust account has been established pursuant to the documents creating
the Municipal Bonds and containing sufficient U.S. government securities backed
by the U.S. government's full faith and credit pledge in order to ensure payment
of principal and interest on such bonds. (See "Strategies") If a Municipal Bond
is already covered by a New Issue Insurance Policy when acquired by the Fund,
then coverage will not be duplicated by a Mutual Fund Insurance Policy; if a
Municipal Bond, other than that described in (3) above, is not covered by a New
Issue Insurance Policy then it may be covered by a Mutual Fund Insurance Policy
purchased by the Trust for the benefit of the Fund. The Fund may also purchase
Municipal Notes that are insured. However, in general, Municipal Notes are not
presently issued with New Issue Insurance Policies and the Fund does not
generally expect to cover Municipal Notes under its Mutual Fund Insurance
Policy. Accordingly, the Fund does not presently expect that any significant
portion of the Municipal Notes it purchases will be covered by insurance.
Securities other than Municipal Bonds and Notes purchased by the Fund are not
covered by insurance. Although the insurance feature reduces certain financial
risks, the premiums for a Mutual Fund Insurance Policy, which are paid from the
Fund's assets, and the restrictions on investments imposed by the guidelines in
a Mutual Fund Insurance Policy, reduce the Fund's current yield. For the fiscal
year ended March 31, 1998,
B-37
<PAGE>
the premiums paid by Tax Exempt Insured Fund for a Mutual Fund Insurance Policy
were .01% of the average net assets of the Fund.
In order to be considered as eligible insurance by the Fund, such insurance
policies must guarantee the scheduled payment of all principal and interest on
the Municipal Bonds as they become due for as long as such Bonds remain held by
the Fund in the case of a Mutual Fund Insurance Policy, and for as long as such
Bonds are outstanding in the case of a New Issue Insurance Policy. However,
such insurance may provide that in the event of non-payment of interest or
principal when due with respect to an insured Municipal Bond, the insurer is not
obligated to make such payment until a specified time period after it has been
notified by the Fund that such non-payment has occurred. (The Financial
Guaranty Fund Policy described below provides that payments will be made on the
later of the date the principal or interest becomes due for payment or the
business day following the day on which Financial Guaranty shall have received
notice of non-payment from the Fund.) For these purposes, a payment of
principal may be due only at final maturity of the Municipal Bond and not at the
time any earlier sinking fund payment is due. The insurance does not guarantee
the market value of the Municipal Bonds or the value of the shares of the Fund
and, except as described below, has no effect on the price or redemption value
of the Fund's shares.
It is anticipated that the insured Municipal Bonds held by the Fund will be
insured by Financial Guaranty (see "Financial Guaranty" below). However, the
Fund may obtain insurance on its Municipal Bonds or purchase insured Municipal
Bonds covered by policies issued by other insurers; provided, any such company
has a claims-paying ability rated "AAA" by S&P or "Aaa" by Moody's. S&P and
Moody's have rated the claims-paying ability of Financial Guaranty and the
Municipal Bonds insured by Financial Guaranty at "AAA" and "Aaa," respectively.
NEW ISSUE INSURANCE POLICIES. The New Issue Insurance Policies, if any,
----------------------------
will have been obtained by the issuer of the Municipal Bonds and all premiums
with respect to such Bonds for the lives thereof will have been paid in advance
by such issuer. Such policies are generally non-cancelable and will continue in
force so long as the Municipal Bonds are outstanding and the insurer remains in
business. Since New Issue Insurance Policies remain in effect as long as the
Bonds are outstanding, the insurance may have an effect on the resale value of
the Municipal Bonds. Therefore, New Issue Insurance Policies may be considered
to represent an element of market value in regard to Municipal Bonds thus
insured, but the exact effect, if any, of this insurance on such market value
cannot be estimated.
MUTUAL FUND INSURANCE POLICY. The Trust has obtained a Mutual Fund
----------------------------
Insurance Policy (the "Fund Policy") on behalf of the Fund from Financial
Guaranty. Under the Fund Policy, if the principal of or interest on a bond
covered by the Fund Policy is due for payment, but is unpaid by reason of non-
payment by the issuer, Financial Guaranty, upon proper notice by the Fund, will
make a payment of such amount to a fiscal agent for the benefit of the Fund,
upon the fiscal agent receiving from the Fund (i) evidence of the Fund's right
to receive payment of the principal or interest due for payment and (ii)
evidence that all of the Fund's right to such payment of the principal
B-38
<PAGE>
or interest due for payment shall thereupon vest with Financial Guaranty. The
principal of a bond is considered due for payment under the Fund Policy at the
stated maturity date of such bond or the date on which the same shall have been
duly called for mandatory sinking fund redemption. The principal of a bond will
not be considered due for payment under the Fund Policy by reason of a call for
redemption (other than a mandatory sinking fund redemption), acceleration or
other advancement of maturity. The interest on a bond is considered due under
the Fund Policy on the stated date for payment. "Non-payment," by an issuer of
bonds, is when that issuer has not provided, on a timely basis, sufficient funds
to the paying agent of the issuer for payment in full of all principal and
interest due for payment.
Financial Guaranty's obligation to insure any particular bond which it has
agreed to insure is subject only to the Fund's becoming the owner of such bond
(i) on or before the 100th day following the date on which the Fund purchases
such bond or (ii) on or before the 150th day following the purchase date in the
case of "when, as and if issued" bonds which the issuer thereof has failed on a
timely basis to deliver in definitive form to the purchasers thereof. So long
as the Fund becomes the owner on or before the 100th or 150th day following the
purchase date, as the case may be, such bond will be insured as of the purchase
date. Once the insurance under the Fund Policy is effective with respect to the
Municipal Bonds, it covers the Municipal Bonds only so long as the Fund is in
existence, Financial Guaranty is still in business, the covered Municipal Bonds
continue to be held by the Fund, and the Fund pays the insurance premium monthly
with respect to the covered Municipal Bonds. In the event of a sale of any
Municipal Bond held by the Fund or payment thereof prior to maturity, the Fund
Policy terminates as to such Municipal Bond and Financial Guaranty is liable
only for those payments of principal and interest which are then due and owing.
However, if in the judgment of the Adviser it would be to the Fund's advantage,
the Trust, on behalf of the Fund, may purchase additional insurance (if
available at an acceptable premium) that will extend the insurance coverage on
such Municipal Bond until maturity.
The Fund Policy provides that it is non-cancelable by Financial Guaranty
except for non-payment of premiums. Once the Fund purchases a bond and begins
paying a premium for that bond based upon a stated annual premium, that annual
premium rate cannot be changed by Financial Guaranty so long as the bond is
owned by the Fund and insured under the Fund Policy. Similar Municipal Bonds
purchased at different times, however, may have different premiums. The Trust,
at the request of the Fund, may cancel the Fund Policy at any time upon written
notice to Financial Guaranty and may do so if the Fund determines that the
benefits of the Fund Policy are not justified by the expense involved. In the
event the Fund were to cancel the Fund Policy and not obtain a substitute, the
Fund would satisfy its investment policy concerning the portion of its portfolio
required to be invested in insured Municipal Bonds by limiting such investments
to Municipal Bonds covered by New Issue Insurance Policies. If adequate
quantities of such Municipal Bonds were not available, the Fund would promptly
seek approval of its shareholders to change its name and its fundamental
investment policy.
If the Fund discontinues insuring newly acquired Municipal Bonds with
Financial Guaranty, it has the right to continue paying premiums to Financial
Guaranty for all Municipal Bonds
B-39
<PAGE>
previously insured and still held by the Fund and keep the insurance in force as
to those Municipal Bonds. The insurance premiums will be payable monthly in
advance by the Fund based on a statement of premiums duly supplied by Financial
Guaranty. The amount of premiums due will be computed on a daily basis for
purchases and sales of covered Municipal Bonds during the month. If the Fund
sells a Municipal Bond or that Bond is redeemed, Financial Guaranty will refund
any unused portion of the premium.
Municipal Bonds are eligible for insurance under the Fund Policy if they
are, at the time of purchase by the Fund, identified separately or by category
in qualitative guidelines (based primarily on ratings) furnished by Financial
Guaranty, and are in compliance with the aggregate limitations on amounts set
forth in such guidelines. Premium variations are based, in part, on the rating
of the Municipal Bond being insured at the time the Fund purchases such Bond.
Financial Guaranty may be willing to insure only a portion of the outstanding
bonds, or issue of bonds, by any particular issuer. In such event, Financial
Guaranty will advise the Fund, on a quarterly basis, of any limitation on the
insurance available for such Municipal Bonds. Once Financial Guaranty has
established such a limitation, it cannot reduce that limitation for any issue
during that quarter, but Financial Guaranty may, at its sole discretion, remove
at any time, any Municipal Bond from its list of bonds eligible to be insured if
the credit quality of such Municipal Bond has materially deteriorated after the
quarterly limitation is made. Once such Municipal Bond is removed from the list
of bonds eligible to be insured the Fund cannot acquire insurance upon such
Municipal Bond from Financial Guaranty. Financial Guaranty, however, must
continue to insure the full amount of such bonds previously acquired so long as
they remain held by the Fund and were, at the time of purchase by the Fund,
considered eligible by Financial Guaranty. The qualitative guidelines and
aggregate amount limitations established by Financial Guaranty, from time to
time, will not necessarily be the same as those the Adviser would use to govern
selection of Municipal Bonds for the Fund's investments. Therefore, from time
to time, such guidelines and limitations may affect investment decisions. When
the Fund's investment policies are more restrictive than the qualitative
guidelines and aggregate amount limitations established by Financial Guaranty or
any other insurer, the Fund's policies will govern.
Because coverage under the Fund Policy terminates upon sale of a Municipal
Bond held by the Fund, the insurance does not have any effect on the resale
value of Municipal Bonds. Therefore, the Adviser may decide to retain any
insured Municipal Bonds which are in default or, in the view of the Adviser, in
significant risk of default and to recommend to the Trustees that the Fund place
a value on the insurance which will be equal to the difference between the
market value of the defaulted Municipal Bond and the market value of similar
Municipal Bonds of minimum investment grade (i.e., rated "BBB") that are not in
default. As a result, the Adviser may be unable to manage fully the Fund's
investments to the extent that it holds defaulted Municipal Bonds, which will
limit the ability of the Adviser in certain circumstances to purchase other
Municipal Bonds. While a defaulted Municipal Bond is held by the Fund, the Fund
continues to pay the insurance premium thereon, but also collects interest
payments from the insurer and retains the rights to collect the full amount of
principal from the insurer when the Municipal Bond comes due. The Fund expects
that the market value of a defaulted Municipal Bond covered by a New Issue
Insurance Policy will
B-40
<PAGE>
generally be greater than the market value of an otherwise comparable defaulted
Municipal Bond covered by the Fund Policy.
SECONDARY MARKET INSURANCE POLICIES. On behalf of the Fund, the Trust
-----------------------------------
may, at any time, purchase from Financial Guaranty a secondary market insurance
policy (a "Secondary Market Policy") on any Municipal Bond currently covered by
the Fund Policy at the time such Bond was purchased by the Fund. The coverage
and obligation to pay monthly premiums under the Fund Policy would cease with
the purchase by the Trust of a Secondary Market Policy.
By purchasing a Secondary Market Policy, the Trust would, upon payment of a
single premium, obtain similar insurance for the Fund against non-payment of
scheduled principal and interest for the remaining term Municipal Bond,
regardless of whether the Fund then owned the Bond. Such insurance coverage
will be non-cancelable and will continue in force so long as the Municipal Bonds
so insured are outstanding. The purpose of acquiring such a policy would be to
enable the Fund to sell the Municipal Bond to a third party as an "AAA"/"Aaa"
rated insured Municipal Bond at a market price higher than what otherwise might
be obtainable if the security were sold without the insurance coverage. (Such
rating is not automatic, however, and must specifically be requested for each
Municipal Bond.) Any difference between the excess of a Municipal Bond's market
value as an "AAA"/"Aaa" rated Municipal Bond over its market value without such
rating and the single premium payment would inure to the Fund in determining the
net capital gain or loss realized by the Fund upon the sale of the Bond.
Since Secondary Market Policies remain in effect as long as the Municipal
Bonds insured thereby are outstanding, such insurance may have an effect on the
resale value of such Bonds. Therefore, Secondary Market Policies may be
considered to represent an element of market value with regard to Municipal
Bonds thus insured, but the exact effect, if any, of this insurance on such
market value cannot be estimated. Since the Fund has the right under the Mutual
Fund Insurance Policy to purchase such Secondary Market Policy even if an
eligible Municipal Bond is currently in default as to any payments by the
issuer, the Fund would have the opportunity to sell such Bond, rather than as
described above, be obligated to hold it in its portfolio in order to continue
the Fund Policy in force.
FINANCIAL GUARANTY. Financial Guaranty is a wholly-owned subsidiary of
------------------
FGIC Corporation, a Delaware holding company. Financial Guaranty, domiciled in
the State of New York, commenced its business of providing insurance and
financial guarantees for a variety of investment instruments in January 1984.
FGIC Corporation is a subsidiary of General Electric Capital Corporation.
Neither FGIC Corporation nor General Electric Capital Corporation is obligated
to pay the debts of or the claims against Financial Guaranty. Financial
Guaranty, in addition to providing insurance for the payment of interest and
principal of municipal bonds and notes held in mutual fund portfolios, provides
insurance for all, or a portion of, new and secondary market issues of municipal
bonds and notes and for municipal bonds and notes held in unit investment trust
portfolios. It is also authorized, in some states, to write fire, property
damage liability, worker's compensation and employers' liability and fidelity
and surety insurance.
B-41
<PAGE>
Financial Guaranty is currently licensed to provide insurance in 50 states
and the District of Columbia, files reports with state insurance regulatory
agencies and is subject to audit and review by such authorities. Such
regulation, however, is no guarantee that Financial Guaranty will be able to
perform its contracts of insurance in the event a claim should be made
thereunder at some time in the future.
The information relating to Financial Guaranty contained herein has been
furnished by Financial Guaranty. No representation is made herein as to the
accuracy or adequacy of such information subsequent to the date hereof. The
Fund may purchase insurance from Financial Guaranty or from other insurers. The
use of insurance will result in a lower yield to shareholders of the Fund than
would be the case if non-insured securities were purchased.
INVESTMENT RESTRICTIONS
Each Fund is subject to a number of investment restrictions that are
fundamental policies and may not be changed without the approval of the holders
of a majority of that Fund's outstanding voting securities. A "majority of the
outstanding voting securities" of a Fund for this purpose means the lesser of
(i) 67% of the shares of the Fund represented at a meeting at which more than
50% of the outstanding shares are present in person or represented by proxy or
(ii) more than 50% of the outstanding shares. Unless otherwise indicated, all
percentage limitations apply to each Fund on an individual basis, and apply only
at the time the investment is made; any subsequent change in any applicable
percentage resulting from fluctuations in value will not be deemed an investment
contrary to these restrictions. Under these restrictions:
(1) Each Fund may not purchase securities on margin, but each Fund
may obtain such short-term credits as may be necessary for the
clearance of transactions;
(2) Each Fund may not issue senior securities or borrow money or
pledge its assets except that: (i) each Fund may borrow for
temporary or emergency purposes in amounts not exceeding 5%
(taken at the lower of cost or current value) of its total assets
(not including the amount borrowed) and pledge its assets to
secure such borrowings; (ii) the Federal Securities Fund,
Diversified Income Fund and High Income Fund may each borrow
money to purchase securities in amounts not exceeding 50% of its
net assets and pledge its assets to secure such borrowings; and
(iii) the Diversified Income Fund and the High Income Fund may
pledge up to 5% of its assets in connection with interest-rate
swaps;
(3) Each Fund may not purchase any security (other than obligations
of the U.S. government, its agencies, or instrumentalities) if as
a result: (i) as to 75% of the Fund's total assets (taken at
current value), more than 5% of such assets would then be
invested in securities of a single issuer, or (ii) more than 25%
of the Fund's total assets (taken at current value) would be
invested in a
B-42
<PAGE>
single industry, or (iii) the Fund would then hold more than 10%
of the outstanding voting securities of an issuer;
(4) Each Fund may not buy or sell commodities or commodity contracts
(except financial futures as described under "Investment
Objectives and Policies" above) or real estate or interests in
real estate, although it may purchase and sell securities which
are secured by real estate and securities of companies which
invest or deal in real estate;
(5) Each Fund may not act as underwriter except to the extent that,
in connection with the disposition of Fund securities, it may be
deemed to be an underwriter under certain Federal securities
laws;
(6) Each Fund may not make loans, except through (i) repurchase
agreements (repurchase agreements with a maturity of longer than
7 days together with other illiquid assets being limited to 10%
of the Fund's total assets), (ii) loans of portfolio securities
(limited to 33% of a Fund's assets), (iii) participation in loans
to foreign governments or companies, and (iv) as otherwise
permitted by exemptive order of the SEC;
The following additional restrictions are not fundamental policies and may
be changed by the Trustees without a shareholder vote:
(7) Each Fund may not make short sales of securities to maintain a
short position, except that each Fund may effect short sales
against the box;
(8) Each Fund may not purchase any security if as a result the Fund
would then have more than 5% of its total assets (taken at
current value) invested in securities of companies (including
predecessors) less than three years old;
(9) Each Fund may not invest in any securities of any issuer if, to
the knowledge of the Fund, any officer, Trustee or director of
the Trust or of the Adviser owns more than 1/2 of 1% of the
outstanding securities of such issue, and such officers,
directors or Trustees who own more than 1/2 of 1% own in the
aggregate more than 5% of the outstanding securities of such
issuer;
(10) Each Fund may not make investments for the purpose of exercising
control or management;
(11) The Fund may not invest more than 10% of its net assets in
illiquid securities, including repurchase agreements that have a
maturity of longer than seven days, time deposits with a maturity
of longer than seven days, securities with legal or contractual
restrictions on resale and securities that are not readily
B-43
<PAGE>
marketable in securities markets either within or without the
United States. Restricted securities eligible for resale pursuant
to Rule 144A under the Securities Act that have a readily
available market, and commercial paper exempted from registration
under the Securities Act pursuant to Section 4(2) of the
Securities Act that may be offered and sold to "qualified
institutional buyers" as defined in Rule 144A, which the Adviser
has determined to be liquid pursuant to guidelines established by
the Trustees, will not be considered illiquid for purposes of
this 10% limitation on illiquid securities;
(12) Each Fund may not invest in securities of other registered
investment companies, except by purchases in the open market
involving only customary brokerage commissions and as a result of
which the Fund will not hold more than 3% of the outstanding
voting securities of any one investment company, will not have
invested more than 5% of its total assets in any one investment
company and will not have invested more than 10% of its total
assets in such securities of one or more investment companies
(each of the above percentages to be determined at the time of
investment), or except as part of a merger, consolidation or
other acquisition;
(13) Each Fund may not invest in interests in oil, gas or other
mineral exploration or development programs, although it may
invest in the securities of companies which invest in or sponsor
such programs; and
(14) The High Income Fund may not purchase any security if as a result
the Fund would then hold more than 10% of any class of securities
of an issuer (taking all common stock issues of an issuer as a
single class, all preferred stock issues as a single class, and
all debt issues as a single class).
TRUSTEES AND OFFICERS
The following table lists the Trustees and executive officers of the Trust,
their age, business addresses and principal occupations during the past five
years. The SunAmerica Mutual Funds consist of SunAmerica Equity Funds,
SunAmerica Income Funds, SunAmerica Money Market Funds, Inc. and Style Select
Series, Inc. An asterisk indicates those Trustees who are "interested persons"
as that term is defined in the 1940 Act.
B-44
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupations
Name, Age and Address with the Fund During Past 5 Years
- --------------------- ------------- -------------------
<S> <C> <C>
S. James Coppersmith, 66 Trustee Retired; Formerly President and General
7 Elmwood Road Manager, WCVB-TV, a division of the Hearst
Marblehead, MA 01945 Corp., from 1982 to 1994; Director/Trustee,
SunAmerica Mutual Funds and Anchor Series
Trust ("AST").
Samuel M. Eisenstat, 59 Chairman of the Board Attorney, solo practitioner, Of Counsel,
430 East 86th Street Kramer, Levin, Naftalis & Frankel; Chairman
New York, NY 10028 of the Boards of the Directors/Trustees,
SunAmerica Mutual Funds and AST.
Stephen J. Gutman, 55 Trustee Partner and Managing Member of B.B.
515 East 79th Street Associates LLC (menswear specialty retailing
New York, NY 10021 and other activities), since June 1988;
Director/Trustee, SunAmerica Mutual Funds
and AST.
Peter A. Harbeck*, 45 Trustee and President Director and President, SunAmerica Asset
The SunAmerica Center Management Corp. ("SunAmerica"); Director,
733 Third Avenue SunAmerica Capital Services, Inc. ("SACS"),
New York, NY 10017-3204 since August 1993; Director and President,
SunAmerica Fund Services, Inc. ("SAFS"),
since May 1988; President, SunAmerica
Mutual Funds and AST; Executive Vice
President and Chief Operating Officer,
SunAmerica, from May 1988 to August 1995;
Executive Vice President, SACS, from
November 1991 to August 1995; Director,
Resources Trust Company.
Sebastiano Sterpa, 69 Trustee Founder and Chairman of the Board of the
3473 Mariposa Drive Sterpa Group (real estate), since 1962;
Palm Desert, CA 92260 Director, Real Estate Business Service and
Countywide Financial; Director/Trustee,
SunAmerica Mutual Funds.
</TABLE>
B-45
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupations
Name, Age and Address with the Fund During Past 5 Years
- --------------------- ------------- -------------------
<S> <C> <C>
P. Christopher Leary, 39 Vice President Executive Vice President, SunAmerica, since
The SunAmerica Center October 1997; Senior Vice President,
733 Third Avenue SunAmerica, from October 1995 to October
New York, NY 10017-3204 1997; Vice President and Senior Portfolio
Manager, SunAmerica from October 1990 to
October 1995.
John DiVito, 27 Vice President Assistant Vice President, SunAmerica, since
The SunAmerica Center July 1997; Assistant Trader, Stoever, Glass &
733 Third Avenue Co., from 1993-1994; joined SunAmerica,
New York, New York 10017 November 1994.
James T. McGrath, 30 Vice President Portfolio Manager, SunAmerica, since August
The SunAmerica Center 1997; Investment Assistant, Assistant Vice
733 Third Avenue President and Municipal Bond Trader, Chase
New York, New York 10017 Asset Management, from 1991 to 1997.
Karolann Patranzino, 28 Vice President Assistant Vice President and Fixed Income
The SunAmerica Center Analyst, SunAmerica, since March 1992.
733 Third Avenue
New York, New York 10017
John W. Risner, 39 Vice President Senior Portfolio Manager, SunAmerica, since
The SunAmerica Center February 1997; Vice President and Senior
733 Third Avenue Portfolio Manager, Value Line Asset
New York, New York 10017 Management, from April 1992 to January
1997.
</TABLE>
B-46
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupations
Name, Age and Address with the Fund During Past 5 Years
- --------------------- ------------- -------------------
<S> <C> <C>
Peter C. Sutton, 34 Treasurer Senior Vice President, SunAmerica, since
The SunAmerica Center April 1997; Treasurer, SunAmerica Mutual
733 Third Avenue Funds and AST, since February 196; Vice
New York, NY 10017-3204 President and Assistant Treasurer of
SunAmerica Series Trust and Anchor
Pathway Fund since 1994; Vice President,
Seasons Series Trust, since April 1997;
formerly, Vice President, SunAmerica, from
1994 to 1997; Controller, SunAmerica
Mutual Funds and AST, from March 1993 to
February 1996; Assistant Controller,
SunAmerica Mutual Funds and AST, from
1990 to 1993.
Robert M. Zakem, 41 Secretary Senior Vice President and General Counsel,
The SunAmerica Center SunAmerica, since April 1993; Executive
733 Third Avenue Vice President, General Counsel and Director,
New York, NY 10017-3204 SACS, since August 1993; Vice President,
General Counsel and Assistant Secretary,
SAFS, since January 1994; Vice President,
SunAmerica Series Trust, Anchor Pathway
Fund and Seasons Series Trust; Assistant
Secretary, SunAmerica Series Trust and
Anchor Pathway Fund, since September
1993; Assistant Secretary, Seasons Series
Trust, since April 1997; formerly, Vice
President and Associate General Counsel,
SunAmerica, from March 1992 to April 1993.
</TABLE>
Trustees and officers of the Trust are also trustees and officers of some
or all of the other investment companies managed, administered or advised by the
Adviser, and distributed by the Distributor and other affiliates.
The Trustees of the Trust are responsible for the overall supervision of
the operation of the Trust and each Fund and perform various duties imposed on
trustees of investment companies by the 1940 Act and under the Trust's
Declaration of Trust. The Trust pays each Trustee who is not an interested
person of the Trust or the Adviser (each a "disinterested" Trustee) annual
compensation
B-47
<PAGE>
in addition to reimbursement of out-of-pocket expenses in connection with
attendance at meetings of the Trustees. Specifically, each disinterested Trustee
receives a pro rata portion (based upon the Trust's net assets) of $40,000 in
annual compensation for acting as director or trustee to all the retail funds in
the SunAmerica Mutual Funds. In addition, Mr. Eisenstat receives an aggregate of
$2,000 in annual compensation for serving as the Chairman of the Boards of the
SunAmerica Mutual Funds. Officers of the Trust receive no direct remuneration in
such capacity from the Trust or any of the Funds.
In addition, each disinterested Trustee also serves on the Audit Committee
of the Board of Trustees. The Audit Committee is charged with recommending to
the full Board the engagement or discharge of the Trust's independent
accountants; directing investigations into matters within the scope of the
independent accountants' duties; reviewing with the independent accountants the
audit plan and results of the audit; approving professional services provided by
the independent accountants and other accounting firms prior to the performance
of such services; reviewing the independence of the independent accountants;
considering the range of audit and non-audit fees; and preparing and submitting
Committee minutes to the full Board. Each member of the Audit Committee
receives an aggregate of $5,000 in annual compensation for serving on the Audit
Committees of all the SunAmerica Mutual Funds and Anchor Series Trust. With
respect to the Trust, each member of the committee receives a pro rata portion
of the $5,000 annual compensation, based on the relative net assets of the
Trust. The Trust also has a Nominating Committee, comprised solely of
disinterested Trustees, which recommends to the Trustees those persons to be
nominated for election as Trustees by shareholders and selects and proposes
nominees for election by Trustees between shareholders' meetings. Members of
the Nominating Committee serve without compensation.
The Trustees (and Directors) of the SunAmerica Mutual Funds have adopted
the SunAmerica Disinterested Trustees' and Directors' Retirement Plan (the
"Retirement Plan") effective January 1, 1993 for the Trustees who are
disinterested Trustees. The Retirement Plan provides generally that if a
disinterested Trustee who has at least 10 years of consecutive service as a
disinterested Trustee of any of the SunAmerica Mutual Funds (an "Eligible
Trustee") retires after reaching age 60 but before age 70 or dies while a
Trustee, such person will be eligible to receive a retirement or death benefit
from each SunAmerica Mutual Fund with respect to which he or she is an Eligible
Trustee. With respect to Sebastiano Sterpa, the Disinterested Trustees have
determined to make an exception to existing policy and allow Mr. Sterpa to
remain on the Board past age 70, until he has served for ten years. Mr. Sterpa
will cease accruing retirement benefits upon reaching age 70, although such
benefits will continue to accrue interest as provided for in the Retirement
Plan. As of each birthday, prior to the 70th birthday, each Eligible Trustee
will be credited with an amount equal to (i) 50% of his or her regular fees
(excluding committee fees) for services as a disinterested Trustee of each
SunAmerica Mutual Fund for the calendar year in which such birthday occurs, plus
(ii) 8.5% of any amounts credited under clause (i) during prior years. An
Eligible Trustee may receive any benefits payable under the Retirement Plan, at
his or her election, either in one lump sum or in up to fifteen annual
installments.
B-48
<PAGE>
The following table sets forth information summarizing the compensation of
each disinterested Trustee for his services as Trustee for the fiscal year ended
March 31, 1998. Neither the Trustees who are interested persons of the Trust
nor any officers of the Trust receive any compensation.
COMPENSATION TABLE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Pension or Estimated Total Compensation
Aggregate Retirement Benefits Annual from Registrant and
Compensation Accrued as Part Benefits on Fund Complex Paid
Trustee from Registrant of Fund Expenses* Retirement** to Trustees*
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
S. James $13,590 $39,122 $29,670 $ 65,000
Coppersmith
- --------------------------------------------------------------------------------------------------------------------
Samuel M. Eisenstat $ 8,691 $34,450 $46,089 $ 69,000
- --------------------------------------------------------------------------------------------------------------------
Stephen J. Gutman $ 8,327 $35,671 $60,912 $ 65,000
- --------------------------------------------------------------------------------------------------------------------
Sebastiano Sterpa $ 8,379 $24,038 $ 7,900 $ 43,333***
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
* Information is as of March 31, 1998 for the five investment companies in
the complex that pay fees to these directors/trustees. The complex consists
of the SunAmerica Mutual Funds and Anchor Series Trust.
** Assuming participant elects to receive benefits in 15 yearly installments.
*** Mr. Sterpa is not a trustee of Anchor Series Trust.
As of _______, the Trustees and officers of the Trust owned in the
aggregate less than 1% of the total outstanding shares of each class of each
Fund.
The following shareholders owned of record or beneficially 5% or more of
the indicated Portfolio Class' shares outstanding as of _________:
[TO BE FILED BY AMENDMENT]
A shareholder who owns beneficially, directly or indirectly, 25% or more of
a Portfolio's outstanding voting securities may be deemed to "control" (as
defined in the 1940 Act) that Portfolio.
B-49
<PAGE>
ADVISER, PERSONAL SECURITIES TRADING,
DISTRIBUTOR AND ADMINISTRATOR
THE ADVISER. The Adviser, which was organized as a Delaware corporation in
1982, is located at The SunAmerica Center, 733 Third Avenue, New York, NY 10017-
3204, and acts as adviser to each of the Funds pursuant to the Investment
Advisory and Management Agreement dated September 23, 1993 (the "Advisory
Agreement") with the Trust, on behalf of each Fund. The Adviser is a wholly-
owned subsidiary of SunAmerica Inc., which in turn is a wholly-owned subsidiary
of American International Group, Inc. ("AIG"), the leading U.S.-based
international insurance organization.
AIG, a Delaware corporation, is a holding company that through its
subsidiaries is primarily engaged in a broad range of insurance and insurance
related activities and financial services in the United States and abroad. AIG,
through its subsidiaries, is also engaged in a range of financial services
activities. AIG's asset management operations are carried out primarily by AIG
Global Investment Group, Inc., a direct wholly-owned subsidiary of AIG, and its
affiliates (collectively, "AIG Global"). AIG Global manages the investment
portfolios of various AIG subsidiaries, as well as third party assets, and is
responsible for product design and origination, marketing and distribution of
third party asset management products, including offshore and private investment
funds and direct investment. As of June 30, 1998, AIG Global managed more than
$86 billion of assets, of which approximately $10.8 billion represented assets
of unaffiliated third parties. AIG Capital Management Corp., an indirect
wholly-owned subsidiary of AIG Global Investment Group, Inc., serves as
investment adviser to The AIG Money Market Fund, a separate series of The
Advisors' Inner Circle Fund, a registered investment company. In addition, AIG
Global Investment Corp., an AIG Global group company, serves as the sub-
investment adviser to an unaffiliated registered investment company. AIG
companies do not otherwise provide investment advice to any registered
investment companies.
Under the Advisory Agreement, the Adviser selects and manages the
investments of each Fund, provides various administrative services and
supervises the Funds' daily business affairs, subject to general review by the
Trustees.
Except to the extent otherwise specified in the Advisory Agreement, each
Fund pays, or causes to be paid, all other expenses of the Trust and each of the
Funds, including, without limitation, charges and expenses of any registrar,
custodian, transfer and dividend disbursing agent; brokerage commissions; taxes;
engraving and printing of share certificates; registration costs of the Funds
and their shares under federal and state securities laws; the cost and expense
of printing, including typesetting, and distributing Prospectuses and Statements
of Additional Information regarding the Funds, and supplements thereto, to the
shareholders of the Funds; all expenses of shareholders' and Trustees' meetings
and of preparing, printing and mailing proxy statements and reports to
shareholders; all expenses incident to any dividend, withdrawal or redemption
options; fees and expenses of legal counsel and independent accountants;
membership dues of industry associations; interest on borrowings of the Funds;
postage; insurance premiums on property or
B-50
<PAGE>
personnel (including Officers and Trustees) of the Trust which inure to its
benefit; extraordinary expenses (including, but not limited to, legal claims and
liabilities and litigation costs and any indemnification relating thereto); and
all other costs of the Trust's operation.
As compensation for its services to the Funds, the Adviser receives a fee
from each Fund, payable monthly, computed daily at the following annual rates:
<TABLE>
<CAPTION>
Fund Fee
- ---- ---
<S> <C>
Government Securities Fund .75% of average daily net assets up to $200 million;
.72% of next 200 million; and .55% of average daily
net assets in excess of $400 million.
Federal Securities Fund .55% of average daily net assets up to $25 million;
.50% of the next $25 million; and .45% of average
daily net assets in excess of $50 million.
Diversified Income Fund .65% of average daily net assets up to $350 million;
and .60% of average daily net assets in excess of
$350 million.
High Income Fund .75% of average daily net assets up to $200 million;
.72% of the next $200 million; and .55% of average
daily net assets in excess of $400 million.
Tax Exempt Insured Fund .50% of average daily net assets up to $350 million;
and .45% of average daily net assets in excess of $350
million.
</TABLE>
The following table sets forth the total advisory fees received by the
Adviser from each Fund pursuant to the Advisory Agreement for the fiscal years
ended March 31, 1998, 1997 and 1996.
ADVISORY FEES
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Fund 1998 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Government Securities Fund $2,618,884 $3,370,947 $4,212,162
- --------------------------------------------------------------------------------
Amount Waived -- -- --
- --------------------------------------------------------------------------------
Federal Securities Fund 259,246 294,357 360,738
- --------------------------------------------------------------------------------
Diversified Income Fund 630,297 740,539 915,671
- --------------------------------------------------------------------------------
High Income Fund 1,128,548 1,107,351 1,273,169
- --------------------------------------------------------------------------------
Tax Exempt Insured Fund 582,729 685,760 802,564
- --------------------------------------------------------------------------------
</TABLE>
B-51
<PAGE>
With respect to the Class II shares of High Income Fund (previously
designated Class C shares), for the fiscal year ended March 31, 1998, voluntary
expense reimbursements were given to the Fund by the Adviser in the amount of
$3,859.
The Advisory Agreement continues with respect to each Fund from year to
year, if such continuance is approved at least annually by vote of a majority of
the Trustees or by the holders of a majority of the respective Fund's
outstanding voting securities. Any such continuation also requires approval by a
majority of the Trustees who are not parties to the Advisory Agreement or
"interested persons" of any such party as defined in the 1940 Act by vote cast
in person at a meeting called for such purpose. The Advisory Agreement may be
terminated with respect to a Fund at any time, without penalty, on 60 days'
written notice by the Trustees, by the holders of a majority of the respective
Fund's outstanding voting securities or by the Adviser. The Advisory Agreement
automatically terminates with respect to each Fund in the event of its
assignment (as defined in the 1940 Act and the rules thereunder).
Under the terms of the Advisory Agreement, the Adviser is not liable to the
Funds, or their shareholders, for any act or omission by it or for any losses
sustained by the Funds or their shareholders, except in the case of willful
misfeasance, bad faith, gross negligence or reckless disregard of duty.
PERSONAL SECURITIES TRADING. The Trust and the Adviser have adopted a written
Code of Ethics (the "Code of Ethics") which prescribes general rules of conduct
and sets forth guidelines with respect to personal securities trading by "Access
Persons" thereof. An Access Person as defined in the Code of Ethics is an
individual who is a trustee, director, officer, general partner or advisory
person of the Trust or the Adviser. The guidelines on personal securities
trading include: (i) securities being considered for purchase or sale, or
purchased or sold, by any Investment Company advised by the Adviser; (ii)
Initial Public Offerings; (iii) private placements; (iv) blackout periods; (v)
short-term trading profits; (vi) gifts; and (vii) services as a director. These
guidelines are substantially similar to those contained in the Report of the
Advisory Group on Personal Investing issued by the Investment Company
Institute's Advisory Panel. The Adviser reports to the Board of Trustees on a
quarterly basis, as to whether there were any violations of the Code of Ethics
by Access Persons of the Trust or the Adviser during the quarter.
THE DISTRIBUTOR. The Trust, on behalf of each Fund, has entered into a
distribution agreement (the "Distribution Agreement") with the Distributor, a
registered broker-dealer and an indirect wholly-owned subsidiary of AIG, to act
as the principal underwriter in connection with the continuous offering of each
class of shares of each Fund. The address of the Distributor is The SunAmerica
Center, 733 Third Avenue, New York, NY 10017-3204. The Distribution Agreement
provides that the Distributor has the exclusive right to distribute shares of
the Funds through its registered representatives and authorized broker-dealers.
The Distribution Agreement also provides that the Distributor will pay the
promotional expenses, including the incremental cost of printing prospectuses,
annual reports and other periodic reports respecting each Fund, for distribution
to persons who are not shareholders of such Fund and the costs of preparing and
distributing any other
B-52
<PAGE>
supplemental sales literature. However, certain promotional expenses may be
borne by the Funds (see "Distribution Plans" below).
The Distribution Agreement continues in effect from year to year, with
respect to each Fund, if such continuance is approved at least annually by vote
of a majority of the Trustees, including a majority of the disinterested
Trustees. The Trust or the Distributor each has the right to terminate the
Distribution Agreement with respect to a Fund on 60 days' written notice,
without penalty. The Distribution Agreement automatically terminates with
respect to each Fund in the event of its assignment (as defined in the 1940 Act
and the rules thereunder).
The Distributor may, from time to time, pay additional commissions or
promotional incentives to brokers, dealers or other financial services firms
that sell shares of the Funds. In some instances, such additional commissions,
fees or other incentives may be offered only to certain firms, including Royal
Alliance Associates, Inc., SunAmerica Securities, Inc., Keogler Morgan &
Company, Financial Service Corporation and Advantage Capital Corporation,
affiliates of the Distributor, that sell or are expected to sell during
specified time periods certain minimum amounts of shares of the Funds, or of
other funds underwritten by the Distributor. In addition, the terms and
conditions of any given promotional incentive may differ from firm to firm.
Such differences will, nevertheless, be fair and equitable, and based on such
factors as size, geographic location, or other reasonable determinants, and will
in no way affect the amount paid to any investor.
DISTRIBUTION PLANS. As indicated in the Prospectus, the Trustees of the Trust
and the shareholders of each class of shares of each Fund have adopted
Distribution Plans (the "Class A Plan," the "Class B Plan," and the "Class II
Plan," and, collectively, the "Distribution Plans"). Reference is made to "Fund
Management" in the Prospectus for certain information with respect to the
Distribution Plans.
Under the Class A Plan, the Distributor may receive payments from a Fund at
an annual rate of up to 0.10% of average daily net assets of such Fund's Class A
shares to compensate the Distributor and certain securities firms for providing
sales and promotional activities for distributing that class of shares. Under
the Class B and Class II Plans, the Distributor may receive payments from a Fund
at the annual rate of up to 0.75% of the average daily net assets of such Fund's
Class B and Class II shares to compensate the Distributor and certain securities
firms for providing sales and promotional activities for distributing that class
of shares. The distribution costs for which the Distributor may be reimbursed
out of such distribution fees include fees paid to broker-dealers that have sold
Fund shares, commissions and other expenses such as sales literature, prospectus
printing and distribution and compensation to wholesalers. It is possible that
in any given year the amount paid to the Distributor under any of the
Distribution Plans will exceed the Distributor's distribution costs as described
above. The Distribution Plans provide that each class of shares of each Fund may
also pay the Distributor an account maintenance and service fee of up to 0.25%
of the aggregate average daily net assets of such class of shares for payments
to broker-dealers for providing continuing account maintenance. In this regard,
some payments are used to compensate broker-dealers with account maintenance and
service fees in an amount up to 0.25% per year of the assets maintained in a
Fund by their customers.
B-53
<PAGE>
The following table sets forth the distribution and service maintenance
fees the Distributor received from the Funds for the fiscal years ended March
31, 1998, 1997 and 1996.
DISTRIBUTION AND SERVICE MAINTENANCE FEES
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------------------------
Class A Class B Class II Class A Class B Class A Class B
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Government $374,850 $2,483,056 N/A $392,498 $3,662,116 $388,894 $5,201,895
Securities Fund
- ------------------------------------------------------------------------------------------------
Federal 108,151 184,550 N/A 120,785 225,691 116,954 384,150
Securities Fund
- ------------------------------------------------------------------------------------------------
Diversified 82,072 735,197 N/A 63,781 957,064 56,515 1,247,253
Income Fund
- ------------------------------------------------------------------------------------------------
High Income 161,715 1,041,969 719 138,128 1,081,816 144,739 1,284,954
Fund
- ------------------------------------------------------------------------------------------------
Tax Exempt 324,213 239,135 N/A 379,499 287,238 462,514 283,659
Insured Fund
- ------------------------------------------------------------------------------------------------
</TABLE>
*Previously designated as Class C shares with respect to the High Income
Fund.
Continuance of the Distribution Plans with respect to each Fund is subject
to annual approval by vote of the Trustees, including a majority of the
disinterested Trustees. A Distribution Plan may not be amended to increase
materially the amount authorized to be spent thereunder with respect to a class
of shares of a Fund, without approval of the shareholders of the affected class
of shares of the Fund. In addition, all material amendments to the Distribution
Plans must be approved by the Trustees in the manner described above. A
Distribution Plan may be terminated at any time with respect to a Fund without
payment of any penalty by vote of a majority of the disinterested Trustees or by
vote of a majority of the outstanding voting securities (as defined in the 1940
Act) of the affected class of shares of the Fund. So long as the Distribution
Plans are in effect, the election and nomination of the disinterested Trustees
of the Trust shall be committed to the discretion of the disinterested Trustees.
In the Trustees' quarterly review of the Distribution Plans, they will consider
the continued appropriateness of, and the level of, compensation provided in the
Distribution Plans. In their consideration of the Distribution Plans with
respect to a Fund, the Trustees must consider all factors they deem relevant,
including information as to the benefits of the Fund and the shareholders of the
relevant class of the Fund.
THE ADMINISTRATOR. The Trust has entered into a Service Agreement, under the
terms of which SAFS, an indirect wholly-owned subsidiary of AIG, acts as a
servicing agent assisting State Street Bank and Trust Company ("State Street")
in connection with certain services offered to the shareholders of each of the
Funds. Under the terms of the Service Agreement, SAFS may receive reimbursement
of its costs in providing such shareholder services. SAFS is located at The
SunAmerica Center, 733 Third Avenue, New York, NY 10017-3204.
B-54
<PAGE>
The Service Agreement continues in effect from year to year provided that
such continuance is approved annually by vote of a majority of the Trustees
including a majority of the disinterested Trustees.
Pursuant to the Service Agreement, as compensation for services rendered,
SAFS receives a fee from the Trust, computed and payable monthly based upon an
annual rate of 0.22% of average daily net assets. This fee represents the full
cost of providing shareholder and transfer agency services to the Trust. From
this fee, SAFS pays a fee to State Street, and its affiliate, National Financial
Data Services ("NFDS" and with State Street, the "Transfer Agent") (other than
out-of-pocket charges of the Transfer Agent which are paid by the Trust). For
further information regarding the Transfer Agent, see the section entitled
"Additional Information" below.
PORTFOLIO TRANSACTIONS AND BROKERAGE
As discussed in the Prospectus, the Adviser is responsible for decisions to
buy and sell securities for each Fund, selection of broker-dealers and
negotiation of commission rates. Purchases and sales of securities on a
securities exchange are effected through brokers-dealers who charge a negotiated
commission for their services. Orders may be directed to any broker-dealer
including, to the extent and in the manner permitted by applicable law, an
affiliated brokerage subsidiary of the Adviser.
In the over-the-counter market, securities are generally traded on a "net"
basis with dealers acting as principal for their own accounts without a stated
commission (although the price of the security usually includes a profit to the
dealer). In underwritten offerings, securities are purchased at a fixed price
which includes an amount of compensation to the underwriter, generally referred
to as the underwriter's concession or discount. On occasion, certain money
market instruments may be purchased directly from an issuer, in which case no
commissions or discounts are paid.
The primary consideration of the Adviser in effecting a security
transaction is to obtain the best net price and the most favorable execution of
the order. However, the Adviser may select broker-dealers that provide it with
research services - analyses and reports concerning issuers, industries,
securities, economic factors and trends - and may cause a Fund to pay such
broker-dealers commissions which exceed those that other broker-dealers may have
charged, if in their view the commissions are reasonable in relation to the
value of the brokerage and/or research services provided by the broker-dealer.
Certain research services furnished by brokers may be useful to the Adviser with
clients other than the Trust and may not be used in connection with the Trust.
No specific value can be determined for research services furnished without cost
to the Adviser by a broker. The Adviser is of the opinion that because the
material must be analyzed and reviewed by its staff, its receipt does not tend
to reduce expenses, but may be beneficial in supplementing the Adviser's
research and analysis. Therefore, it may tend to benefit the Funds by improving
the quality of the Adviser's investment advice. The investment advisory fees
paid by the Funds are not reduced because the Adviser receives such services.
When making purchases of underwritten issues with
B-55
<PAGE>
fixed underwriting fees, the Adviser may designate the use of broker-dealers who
have agreed to provide the Adviser with certain statistical, research and other
information.
Subject to applicable law and regulations, consideration may also be given
to the willingness of particular brokers to sell shares of a Fund as a factor in
the selection of brokers for transactions effected on behalf of a Fund, subject
to the requirement of best price and execution.
Although the objectives of other accounts or investment companies which the
Adviser manages may differ from those of the Funds, it is possible that, at
times, identical securities will be acceptable for purchase by one or both of
the Funds and one or more other accounts or investment companies which the
Adviser manages. However, the position of each account or company in the
securities of the same issue may vary with the length of the time that each
account or company may choose to hold its investment in those securities. The
timing and amount of purchase by each account and company will also be
determined by its cash position. If the purchase or sale of a security is
consistent with the investment policies of one or more of the Funds and one or
more of these other accounts or companies is considered at or about the same
time, transactions in such securities will be allocated in a manner deemed
equitable by the Adviser. The Adviser may combine such transactions, in
accordance with applicable laws and regulations, where the size of the
transaction would enable it to negotiate a better price or reduced commission.
However, simultaneous transactions could adversely affect the ability of a Fund
to obtain or dispose of the full amount of a security, which it seeks to
purchase or sell, or the price at which such security can be purchased or sold.
The following table sets forth the brokerage commissions paid by those
Funds that paid commissions and the amounts of such brokerage commissions which
were paid to affiliated broker-dealers by the Funds for the fiscal year ended
March 31, 1998.
B-56
<PAGE>
1998 BROKERAGE COMMISSIONS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Percentage of Amount of
Percentage of Transactions Involving
Aggregate Amount paid to Commissions paid Payments of Commissions
Brokerage Affiliated to Affiliated to Affiliated Broker-
Fund Commissions Broker-Dealers Broker-Dealers Dealers
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Government Securities Fund $0 $0 0%
- ---------------------------------------------------------------------------------------------------------------
Federal Securities Fund $0 $0 0%
- ---------------------------------------------------------------------------------------------------------------
Diversified Income Fund $0 $0 0%
- ---------------------------------------------------------------------------------------------------------------
High Income Fund $0 $0 0%
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
For the fiscal year ended March 31, 1997, the Government Securities Fund,
the Federal Securities Fund, the Diversified Income Fund and the High Income
Fund paid brokerage commissions of $750, $250, $684 and $1,458, respectively, of
which $0 was paid to affiliated brokers. For the fiscal year ended March 31,
1996, the Federal Securities Fund, the Diversified Income Fund and the High
Income Fund paid brokerage commissions of $400, $3,000 and $30,000,
respectively, of which $0 was paid to affiliated brokers. None of the other
Funds paid any commissions during these periods.
ADDITIONAL INFORMATION REGARDING PURCHASE OF SHARES
Shares of each of the Funds are sold at the respective net asset value next
determined after receipt of a purchase order, plus a sales charge, which, at the
election of the investor, may be imposed (i) at the time of purchase (Class A
shares), (ii) on a deferred basis (Class B and certain Class A shares), or (iii)
may contain certain elements of a sales charge that is imposed at the time of
purchase and that is deferred (Class II shares). Class C shares, now designated
as Class II shares, had sales charges imposed on a deferred basis with no front-
end sales load prior to their redesignation. Reference is made to "Shareholder
Account Information" in the Prospectus for certain information as to the
purchase of Fund shares.
The following tables set forth the front-end sales charges with respect to
Class A shares of each Fund, the amount of the front-end sales charges which was
reallowed to affiliated broker-dealers, and the contingent deferred sales
charges with respect to Class B and Class II shares of each Fund, received by
the Distributor for the fiscal years ended March 31, 1998, 1997 and 1996.
B-57
<PAGE>
1998
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
Contingent
Deferred
Amount Amount Contingent Sales
Front-End Sales Reallowed to Reallowed to Deferred Charge
Concessions Affiliated Non-Affiliated Sales Charge Class II
Fund Class A Shares Broker-Dealers Broker-Dealers Class B Shares Shares
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Government $ 25,103 $ 17,121 $ 4,070 $270,398 ---
Securities Fund
- ---------------------------------------------------------------------------------------------------
Federal 36,021 11,517 16,849 19,862 ---
Securities Fund
- ---------------------------------------------------------------------------------------------------
Diversified 72,686 20,452 38,553 124,129 ---
Income Fund
- ---------------------------------------------------------------------------------------------------
High Income 353,552 115,057 178,181 402,985 ---
Fund
- ---------------------------------------------------------------------------------------------------
Tax Exempt 62,143 33,967 16,329 69,255 ---
Insured Fund
- --------------------------------------------------------------------------------------------------
</TABLE>
1997
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
Amount Amount Contingent
Front-End Sales Reallowed to Reallowed to Deferred
Concessions Affiliated Non-Affiliated Sales Charge
Fund Class A Shares Broker-Dealers Broker-Dealers Class B Shares
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Government $ 32,290 $16,822 $10,305 $924,933
Securities Fund
- ---------------------------------------------------------------------------------------
Federal 10,220 7,306 2,974 45,178
Securities Fund
- ---------------------------------------------------------------------------------------
Diversified 86,113 34,644 36,605 221,016
Income Fund
- ---------------------------------------------------------------------------------------
High Income 149,191 57,237 67,696 313,032
Fund
- ---------------------------------------------------------------------------------------
Tax Exempt 41,383 24,953 9,219 88,150
Insured Fund
- ---------------------------------------------------------------------------------------
</TABLE>
B-58
<PAGE>
1996
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Amount Amount Contingent
Front-End Sales Reallowed Reallowed to Deferred
Charge to Affiliated Non-Affiliated Sales Charge
Fund Class A Shares Broker-Dealers Broker-Dealers Class B Shares
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Government $ 34,701 $23,047 $ 6,065 $1,767,247
Securities Fund
- ----------------------------------------------------------------------------------------
Federal 51,871 26,836 17,101 92,902
Securities Fund
- ----------------------------------------------------------------------------------------
Diversified 59,956 41,282 9,079 353,984
Income Fund
- ----------------------------------------------------------------------------------------
High Income 110,516 75,941 17,311 379,578
Fund
- ----------------------------------------------------------------------------------------
Tax Exempt 118,382 78,270 19,723 113,374
Insured Fund
- ----------------------------------------------------------------------------------------
</TABLE>
B-59
<PAGE>
CDSCs APPLICABLE TO CERTAIN CLASS B SHARES. Class B shares of the Government
Securities Fund, the Federal Securities Fund, the Diversified Income Fund and
the High Income Fund issued to shareholders in exchange for shares of Old
Government Securities, Old Federal Securities, Old Diversified Income and Old
High Income, respectively, in the Reorganization, are subject to the CDSC
schedule that applied to redemptions of shares of these funds at the time of
reorganization. Upon a redemption of these shares, the shareholder will receive
credit for the periods both prior to and after the Reorganization during which
the shares were held. The following table sets forth the rates of the CDSC
applicable to shares of the Government Securities Fund, the Federal Securities
Fund and the High Income Fund:
<TABLE>
<CAPTION>
================================================================================
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS
YEAR SINCE PURCHASE PAYMENT WAS MADE INVESTED OR REDEMPTION PROCEEDS
------------------------------------ -------------------------------
- --------------------------------------------------------------------------------
<S> <C>
First 5%
- --------------------------------------------------------------------------------
Second 4%
- --------------------------------------------------------------------------------
Third 3%
- --------------------------------------------------------------------------------
Fourth 2%
- --------------------------------------------------------------------------------
Fifth 1%
- --------------------------------------------------------------------------------
Sixth and thereafter 0%
================================================================================
</TABLE>
The following table sets forth the rates of CDSC applicable to shares of the
Diversified Income Fund:
<TABLE>
<CAPTION>
================================================================================
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS
YEAR SINCE PURCHASE PAYMENT WAS MADE INVESTED OR REDEMPTION PROCEEDS
------------------------------------ -------------------------------
- --------------------------------------------------------------------------------
<S> <C>
First 3%
- --------------------------------------------------------------------------------
Second 2%
- --------------------------------------------------------------------------------
Third 1%
- --------------------------------------------------------------------------------
Fourth and thereafter 0%
================================================================================
</TABLE>
Any Class B shares purchased after the date of the Reorganization (other
than through the reinvestment of dividends and distributions, which are not
subject to the CDSC) are subject to the CDSC schedule reflected in the
Prospectus.
CONVERSION FEATURE APPLICABLE TO CERTAIN CLASS B SHARES. Shareholders of Class
B shares of the Government Securities Fund, the Federal Securities Fund, the
Diversified Income Fund and the High Income Fund issued in exchange for shares
of Old Government Securities, Old Federal Securities, Old Diversified Income and
Old High Income, respectively, in the Reorganization, will receive
B-60
<PAGE>
credit for the periods both prior to and after the Reorganization during which
the shares were held, for purposes of computing the seven year holding period
applicable to the conversion feature.
WAIVER OF CDSCs. As discussed under "Shareholder Account Information" in the
Prospectus, CDSCs may be waived on redemptions of Class B and Class II shares
under certain circumstances. The conditions set forth below are applicable with
respect to the following situations with the proper documentation:
Death. CDSCs may be waived on redemptions within one year following the
------
death (i) of the sole shareholder on an individual account, (ii) of a joint
tenant where the surviving joint tenant is the deceased's spouse, or (iii) of
the beneficiary of a Uniform Gifts to Minors Act, Uniform Transfers to Minors
Act or other custodial account. The CDSC waiver is also applicable in the case
where the shareholder account is registered as community property. If, upon the
occurrence of one of the foregoing, the account is transferred to an account
registered in the name of the deceased's estate, the date of CDSC will be waived
on any redemption from the estate account occurring within one year of the
death. If the Class B or Class II shares are not redeemed within one year of
the date of death, they will remain Class B or Class II shares, as applicable,
and be subject to the applicable CDSC, if any, when redeemed.
Disability. CDSCs may be waived on redemptions occurring within one year
-----------
after the sole shareholder on an individual account or a joint tenant on a
spousal joint tenant account becomes disabled (as defined in Section 72(m)(7) of
the Code). To be eligible for such waiver, (i) the disability must arise after
the purchase of shares and (ii) the disabled shareholder must have been under
age 65 at the time of the initial determination of disability. If the account
is transferred to a new registration and then a redemption is requested, the
applicable CDSC will be charged.
PURCHASES THROUGH THE DISTRIBUTOR. An investor may purchase shares of a Fund
through dealers which have entered into selected dealer agreements with the
Distributor. An investor's dealer who has entered into a distribution
arrangement with the Distributor is expected to forward purchase orders and
payment promptly to the Fund. Orders received by the Distributor before the
close of business will be executed at the offering price determined at the close
of regular trading on the New York Stock Exchange ("NYSE") that day. Orders
received by the Distributor after the close of business will be executed at the
offering price determined after the close of the NYSE on the next trading day.
The Distributor reserves the right to cancel any purchase order for which
payment has not been received by the fifth business day following the
investment. A Fund will not be responsible for delays caused by dealers.
PURCHASE BY CHECK. Checks should be made payable to the specific Fund or to
"SunAmerica Funds". If the payment is for a retirement plan account for which
the Adviser serves as fiduciary, please indicate on the check that payment is
for such an account. In the case of a new account, purchase orders by check must
be submitted directly by mail to SunAmerica Fund Services, Inc., Mutual Fund
Operations, The SunAmerica Center, 733 Third Avenue, New York, New York 10017-
3204, together with payment for the purchase price of such shares and a
completed New Account
B-61
<PAGE>
Application. Payment for subsequent purchases should be mailed to SunAmerica
Fund Services, Inc., c/o NFDS, P.O. Box 419373, Kansas City, Missouri 64141-6373
and the shareholder's Fund account number should appear on the check. For
fiduciary retirement plan accounts, both initial and subsequent purchases should
be mailed to SunAmerica Fund Services, Inc., Mutual Fund Operations, The
SunAmerica Center, 733 Third Avenue, New York, New York 10017-3204. Certified
checks are not necessary but checks are accepted subject to collection at full
face value in United States funds and must be drawn on a bank located in the
United States. Upon receipt of the completed New Account Application and payment
check, the Transfer Agent will purchase full and fractional shares of the
applicable Fund at the net asset value next computed after the check is
received, plus the applicable sales charge. Subsequent purchases of shares of
each Fund may be purchased directly through the Transfer Agent. SAFS reserves
the right to reject any check made payable other than in the manner indicated
above. Under certain circumstances, a Fund will accept a multi-party check
(e.g., a check made payable to the shareholder by another party and then
endorsed by the shareholder to the Fund in payment for the purchase of shares);
however, the processing of such a check may be subject to a delay. The Funds do
not verify the authenticity of the endorsement of such multi-party check, and
acceptance of the check by a Fund should not be considered verification thereof.
Neither the Funds nor their affiliates will be held liable for any losses
incurred as a result of a fraudulent endorsement. There are restrictions on the
redemption of shares purchased by check for which funds are being collected.
(See "Redemption of Shares.")
PURCHASE THROUGH SAFS. SAFS will effect a purchase order on behalf of a
customer who has an investment account upon confirmation of a verified credit
balance at least equal to the amount of the purchase order (subject to the
minimum $500 investment requirement for wire orders). If such order is received
at or prior to the Fund's close of business, the purchase of shares of a Fund
will be effected on that day. If the order is received after the Fund's close
of business, the order will be effected on the next business day.
PURCHASE BY FEDERAL FUNDS WIRE. An investor may make purchases by having his or
her bank wire Federal funds to the Trust's Transfer Agent. Federal funds
purchase orders will be accepted only on a day on which the Trust and the
Transfer Agent are open for business. In order to insure prompt receipt of a
Federal funds wire, it is important that these steps be followed:
1. You must have an existing SunAmerica Fund Account before wiring
funds. To establish an account, complete the New Account
Application and send it via facsimile to SunAmerica Fund
Services, Inc. at: (212) 551-5585.
2. Call SunAmerica Fund Services' Shareholder/Dealer Services, toll
free at (800) 858-8850, extension 5125 to obtain your new account
number.
3. Instruct the bank to wire the specified amount to the Transfer
Agent: State Street Bank and Trust Company, Boston, MA, ABA#
0110-00028; DDA# 99029712, SunAmerica [name of Fund, Class __]
(include shareholder name and account number).
B-62
<PAGE>
WAIVER OF SALES CHARGES WITH RESPECT TO CERTAIN PURCHASES OF CLASS A SHARES. To
the extent that sales are made for personal investment purposes, the sales
charge is waived as to Class A shares purchased by current or retired officers,
directors and other full-time employees of SunAmerica and its affiliates, as
well as members of the selling group and family members of the foregoing. In
addition, the sales charge is waived with respect to shares purchased by certain
qualified retirement plans or employee benefit plans (other than IRAs), which
are sponsored or administered by SunAmerica or an affiliate thereof. Further,
the sales charge is waived with respect to shares purchased by "wrap accounts"
for the benefit of clients of broker-dealers, financial institutions or
financial planners adhering to the following standards established by the
Distributor: (i) the broker-dealer, financial institution or financial planner
charges its client(s) an advisory fee based on the assets under management on an
annual basis, and (ii) such broker-dealer, financial institution or financial
planner does not advertise that shares of the Funds may be purchased by clients
at net asset value. Shares purchased under this waiver may not be resold except
to the Fund. Shares are offered at net asset value to the foregoing persons
because of anticipated economies in sales effort and sales related expenses.
Reductions in sales charges apply to purchases or shares by a "single person"
including an individual; members of a family unit comprising husband, wife and
minor children; or a trustee or other fiduciary purchasing for a single
fiduciary account. Complete details concerning how an investor may purchase
shares at reduced sales charges may be obtained by contacting the Distributor.
REDUCED SALES CHARGES (CLASS A SHARES ONLY). As discussed under "Shareholder
Account Information" in the Prospectus, investors in Class A shares of a Fund
may be entitled to reduced sales charges pursuant to the following special
purchase plans made available by the Trust.
COMBINED PURCHASE PRIVILEGE. The following persons may qualify for the sales
- ---------------------------
charge reductions or eliminations by combining purchases of Fund shares into a
single transaction:
(i) an individual, or a "company" as defined in Section 2(a)(8) of
the 1940 Act (which includes corporations which are corporate
affiliates of each other);
(ii) an individual, his or her spouse and their minor children,
purchasing for his, her or their own account;
(iii) a trustee or other fiduciary purchasing for a single trust
estate or single fiduciary account (including a pension,
profit-sharing, or other employee benefit trust created
pursuant to a plan qualified under Section 401 of the Code);
(iv) tax-exempt organizations qualifying under Section 501(c)(3) of
the Code (not including 403(b) plans);
(v) employee benefit plans of a single employer or of affiliated
employers, other than 403(b) plans; and
B-63
<PAGE>
(vi) group purchases as described below.
A combined purchase currently may also include shares of other funds in
SunAmerica of Mutual Funds (other than money market funds) purchased at the same
time through a single investment dealer, if the dealer places the order for such
shares directly with the Distributor.
RIGHTS OF ACCUMULATION. A purchaser of Fund shares may qualify for a reduced
- -----------------------
sales charge by combining a current purchase (or combined purchases as described
above) with shares previously purchased and still owned; provided the cumulative
value of such shares (valued at cost or current net asset value, whichever is
higher), amounts to $50,000 or more. In determining the shares previously
purchased, the calculation will include, in addition to other Class A shares of
the particular Fund that were previously purchased, shares of the other classes
of the same Fund, as well as shares of any class of any other Fund or of any of
the other Funds advised by the Adviser, as long as such shares were sold with a
sales charge or acquired in exchange for shares purchased with such a sales
charge.
The shareholder's dealer, if any, or the shareholder, must notify the
Distributor at the time an order is placed of the applicability of the reduced
charge under the Right of Accumulation. Such notification must be in writing by
the dealer or shareholder when such an order is placed by mail. The reduced
sales charge will not be granted if: (a) such information is not furnished at
the time of the order; or (b) a review of the Distributor's or the Transfer
Agent's records fails to confirm the investor's represented holdings.
LETTER OF INTENT. A reduction of sales charges is also available to an investor
- ----------------
who, pursuant to a written Letter of Intent which is set forth in the New
Account Application, establishes a total investment goal in Class A shares of
one or more Funds to be achieved through any number of investments over a
thirteen-month period, of $50,000 or more. Each investment in such Funds made
during the period will be subject to a reduced sales charge applicable to the
goal amount. The initial purchase must be at least 5% of the stated investment
goal and shares totaling 5% of the dollar amount of the Letter of Intent will be
held in escrow by the Transfer Agent, in the name of the investor. Shares of
any class of shares of any Fund, or of other funds advised by the Adviser which
impose a sales charge at the time of purchase, which the investor intends to
purchase or has previously purchased during a 30-day period prior to the date of
execution of the Letter of Intent and still owns, may also be included in
determining the applicable reduction; provided, the dealer or shareholder
notifies the Distributor of such prior purchase(s).
The Letter of Intent does not obligate the investor to purchase, nor the
Trust to sell, the indicated amounts of the investment goal. In the event the
investment goal is not achieved within the thirteen-month period, the investor
is required to pay the difference between the sales charge otherwise applicable
to the purchases made during this period and sales charges actually paid. Such
payment may be made directly to the Distributor or, if not paid, the Distributor
is authorized by the Letter of Intent to liquidate a sufficient number of
escrowed shares to obtain such difference. If the
B-64
<PAGE>
goal is exceeded and purchases pass the next sales charge break-point, the sales
charge on the entire amount of the purchase that results in passing that
break-point, and on subsequent purchases, will be subject to a further reduced
sales charge in the same manner as set forth above under "Rights of
Accumulation," but there will be no retroactive reduction of sales charges on
previous purchases. At any time while a Letter of Intent is in effect, a
shareholder may, by written notice to the Distributor, increase the amount of
the stated goal. In that event, shares of the applicable Funds purchased during
the previous 90-day period and still owned by the shareholder will be included
in determining the applicable sales charge. The 5% escrow and the minimum
purchase requirement will be applicable to the new stated goal. Investors
electing to purchase shares of one or more of the Funds pursuant to this
purchase plan should carefully read such Letter of Intent. Investors electing to
purchase shares of one or more of the Funds pursuant to this purchase plan
should carefully read such Letter of Intent.
REDUCED SALES CHARGE FOR GROUP PURCHASES. Members of qualified groups may
- ----------------------------------------
purchase Class A shares of the Funds under the combined purchase privilege as
described above.
To receive a rate based on combined purchases, group members must purchase
Class A shares of a Fund through a single investment dealer designated by the
group. The designated dealer must transmit each member's initial purchase to
the Distributor, together with payment and completed New Account Application.
After the initial purchase, a member may send funds for the purchase of Class A
shares directly to the Transfer Agent. Purchases of a Fund's shares are made at
the public offering price based on the net asset value next determined after the
Distributor or the Transfer Agent receives payment for the Class A shares. The
minimum investment requirements described above apply to purchases by any group
member. Class B or Class II shares are not included in calculating the
purchased amount of a Fund's shares.
Qualified groups include the employees of a corporation or a sole
proprietorship, members and employees of a partnership or association, or other
organized groups of persons (the members of which may include other qualified
groups) provided that: (i) the group has at least 25 members of which at least
-------- ----
ten members participate in the initial purchase; (ii) the group has been in
existence for at least six months; (iii) the group has some purpose in addition
to the purchase of investment company shares at a reduced sales charge; (iv) the
group's sole organizational nexus or connection is not that the members are
credit card customers of a bank or broker-dealer, clients of an investment
adviser or security holders of a company; (v) the group agrees to provide its
designated investment dealer access to the group's membership by means of
written communication or direct presentation to the membership at a meeting on
not less frequently than an annual basis; (vi) the group or its investment
dealer will provide annual certification, in form satisfactory to the Transfer
Agent, that the group then has at least 25 members and that at least ten members
participated in group purchases during the immediately preceding 12 calendar
months; and (vii) the group or its investment dealer will provide periodic
certification, in form satisfactory to the Transfer Agent, as to the eligibility
of the purchasing members of the group.
B-65
<PAGE>
Members of a qualified group include: (i) any group which meets the
requirements stated above and which is a constituent member of a qualified
group; (ii) any individual purchasing for his or her own account who is carried
on the records of the group or on the records of any constituent member of the
group as being a good standing employee, partner, member or person of like
status of the group or constituent member; or (iii) any fiduciary purchasing
shares for the account of a member of a qualified group or a member's
beneficiary. For example, a qualified group could consist of a trade
association which would have as its members individuals, sole proprietors,
partnerships and corporations. The members of the group would then consist of
the individuals, the sole proprietors and their employees, the members of the
partnership and their employees, and the corporations and their employees, as
well as the trustees of employee benefit trusts acquiring a Fund's shares for
the benefit of any of the foregoing.
Interested groups should contact their investment dealer or the
Distributor. The Trust reserves the right to revise the terms of or to suspend
or discontinue group sales with respect to shares of the Funds at any time.
NET ASSET VALUE TRANSFER PROGRAM. Investors may purchase Class A shares of
--------------------------------
a Fund at net asset value to the extent that the investment represents the
proceeds from a redemption of a non-SunAmerica mutual fund in which the investor
either (a) paid a front-end sales load or (b) was subject to, or paid a CDSC on
the redemption proceeds. Nevertheless, the Distributor will pay a commission
to any dealer who initiates or is responsible for such an investment, in the
amount of .50% of the amount invested, subject, however, to forfeiture in the
event of a redemption during the first year from the date of purchase. In
addition, it is essential that an NAV Transfer Program Form accompany the New
Account Application to indicate that the investment is intended to participate
in the Net Asset Value Transfer Program (formerly, Exchange Program for
Investment Company Shares). This program may be revised or terminated without
notice by the Distributor. For current information, contact Shareholder/Dealer
Services at (800) 858-8850.
ADDITIONAL INFORMATION REGARDING REDEMPTION OF SHARES
Reference is made to "Shareholder Account Information" in the Prospectus
for certain information as to the redemption of Fund shares.
If the Trustees determine that it would be detrimental to the best
interests of the remaining shareholders of a Fund to make payment wholly or
partly in cash, the Trust, having filed with the SEC a notification of election
pursuant to Rule 18f-1 on behalf of each of the Funds, may pay the redemption
price in whole or in part, by a distribution in kind of securities from a Fund
in lieu of cash. In conformity with applicable rules of the SEC, the Funds are
committed to pay in cash all requests for redemption, by any shareholder of
record, limited in amount with respect to each shareholder during any 90-day
period to the lesser of (i) $250,000, or (ii) 1% of the net asset value of the
applicable Fund at the beginning of such period. If shares are redeemed in
kind, the redeeming shareholder would incur brokerage costs in converting the
assets into cash. The method
B-66
<PAGE>
of valuing portfolio securities is described below in the section entitled
"Determination of Net Asset Value," and such valuation will be made as of the
same time the redemption price is determined.
DETERMINATION OF NET ASSET VALUE
The Trust is open for business on any day the NYSE is open for regular
trading. Shares are valued each day as of the close of regular trading on the
NYSE (generally, 4:00 P.M., Eastern time). Each Fund calculates the net asset
value of its shares separately by dividing the total value of each class's net
assets by the shares outstanding of such class. Investments for which market
quotations are readily available are valued at their price as of the close of
regular trading on the New York Stock Exchange for the day. All other
securities and assets are valued at fair value following procedures approved by
the Trustees.
Stocks are stated at value based upon closing sales prices reported on
recognized securities exchanges or, for listed securities having no sales
reported and for unlisted securities, upon last reported bid prices. Non-
convertible bonds, debentures, other long-term debt securities and short-term
securities with original or remaining maturities in excess of 60 days, are
normally valued at prices obtained for the day of valuation from a bond pricing
service of a major dealer in bonds, when such prices are available; however, in
circumstances in which the Manager deems it appropriate to do so, an over-the-
counter or exchange quotation at the mean of representative bid or asked prices
may be used. Securities traded primarily on securities exchanges outside the
United States are valued at the last sale price on such exchanges on the day of
valuation, or if there is no sale on the day of valuation, at the last-reported
bid price. If a security's price is available from more than one foreign
exchange, a Fund uses the exchange that is the primary market for the security.
Short-term securities with 60 days or less to maturity are amortized to maturity
based on their cost to the Trust if acquired within 60 days of maturity or, if
already held by the Trust on the 60th day, are amortized to maturity based on
the value determined on the 61st day. Options traded on national securities
exchanges are valued as of the close of the exchange on which they are traded.
Futures and options traded on commodities exchanges are valued at their last
sale price as of the close of such exchange. Other securities are valued on the
basis of last sale or bid price (if a last sale price is not available) in what
is, in the opinion of the Manager, the broadest and most representative market,
that may be either a securities exchange or the over-the-counter market. Where
quotations are not readily available, securities are valued at fair value as
determined in good faith in accordance with procedures adopted by the Board of
Trustees. The fair value of all other assets is added to the value of
securities to arrive at the respective Fund's total assets.
A Fund's liabilities, including proper accruals of expense items, are
deducted from total assets.
B-67
<PAGE>
PERFORMANCE DATA
Each Fund may advertise performance data that reflects various measures of
total return and yield. An explanation of the data presented and the methods of
computation that will be used are as follows.
A Fund's performance may be compared to the historical returns of various
investments, performance indices of those investments or economic indicators,
including, but not limited to, stocks, bonds, certificates of deposit, money
market funds and U.S. Treasury Bills. Certain of these alternative investments
may offer fixed rates of return and guaranteed principal and may be insured.
Average annual total return is determined separately for Class A, Class B
and Class II shares in accordance with a formula specified by the SEC. Average
annual total return is computed by finding the average annual compounded rates
of return for the 1-, 5- and 10-year periods or for the lesser included periods
of effectiveness. The formula used is as follows:
P(1 + T) to the nth power = ERV
P = a hypothetical initial purchase payment of $1,000
T = average annual total return
N = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10- year periods at
the end of the 1-, 5-, or 10-year periods (or fractional
portion thereof).
The above formula assumes that:
a. The maximum sales load (i.e., either the front-end sales load in
the case of the Class A shares or the deferred sales load that
would be applicable to a complete redemption of the investment at
the end of the specified period in the case of the Class B and
Class II shares) is deducted from the initial $1,000 purchase
payment;
b. All dividends and distributions are reinvested at net asset
value; and
c. Complete redemption occurs at the end of the 1-, 5-, or 10- year
periods or fractional portion thereof with all nonrecurring
charges deducted accordingly.
The Funds' average annual total return for the 1-, 5- and 10-year periods (or
from date of inception, if sooner) ended March 31, 1998, are as follows:
B-68
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
CLASS A SHARES SINCE INCEPTION ONE YEAR FIVE YEARS TEN YEARS
- -------------- --------------- -------- ---------- ---------
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Government Securities Fund /1/ 4.67% 4.42% N/A N/A
- ----------------------------------------------------------------------------------------------
Federal Securities Fund /1/ 5.78% 6.95% N/A N/A
- ----------------------------------------------------------------------------------------------
Diversified Income Fund /1/ 6.15% 10.33% N/A N/A
- ----------------------------------------------------------------------------------------------
High Income Fund /2/ 9.07% 14.37% 8.33% 9.81%
- ----------------------------------------------------------------------------------------------
Tax Exempt Insured Fund /3/ 6.48% 5.04% 4.95% 6.31%
- ----------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
CLASS B SHARES SINCE INCEPTION ONE YEAR FIVE YEARS TEN YEARS
- -------------- --------------- -------- ---------- ---------
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Government Securities Fund /1/ 6.24% 4.80% 4.79% 6.34%
- ----------------------------------------------------------------------------------------------
Federal Securities Fund /2/ 8.27% 7.54% 5.46% 7.46%
- ----------------------------------------------------------------------------------------------
Diversified Income Fund /3/ 6.50% 11.11% 6.88% N/A
- ----------------------------------------------------------------------------------------------
High Income Fund /4/ 8.04% 15.31% N/A N/A
- ----------------------------------------------------------------------------------------------
Tax Exempt Insured Fund /4/ 4.16% 5.65% N/A N/A
- ----------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS II SHARES/5/ SINCE INCEPTION ONE YEAR FIVE YEARS TEN YEARS
- ------------------ --------------- -------- ---------- ---------
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
High Income Fund /6/ 2.18% N/A N/A N/A
- -----------------------------------------------------------------------------------------------
</TABLE>
______________________________
/1/ From date of inception of March 3, 1986.
/2/ From date of inception of April 25, 1983.
/3/ From date of inception of April, 6, 1991.
/4/ From date of inception of October 1, 1993.
______________________________
/1/ From date of October 1, 1993.
/2/ From date of inception of September 16, 1986.
/3/ From date of inception of November 21, 1985.
B-69
<PAGE>
/5/ Previously designated as Class C shares.
/6/ From date of inception of February 2, 1998.
Each Fund may advertise cumulative, rather than total average return, for
each class of its shares for periods of time other than the 1-, 5- and 10-year
periods or fractions thereof, as discussed above. Such return data will be
computed in the same manner as that of average annual total return, except that
the actual cumulative return will be computed.
Each Fund may also advertise performance data that reflects yield. Yield
is determined separately for Class A, Class B and Class II shares in accordance
with a standardized formula prescribed by the SEC and is not indicative of the
amounts which were or will be paid to shareholders. The current yield quoted in
a Fund's advertisements is computed by dividing the net investment income per
share earned during the 30-day period by the maximum offering price per share on
the last day of the period. The following formula illustrates the
computation:
Yield = 2 [{A - B + 1} to the 6th power - 1 ]
-----
CD
A = dividends and interest earned during the period
B = expenses accrued for the period (net of reimbursements)
C = the average daily number of shares outstanding during the period
that were entitled to receive dividends
D = the maximum offering price per share on the last day of the
period
The yields for the one month periods ended March 31, 1998, 1997 and 1996
are as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
FUND MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
- --------------------------------------------------------------------------------------------------------------------------
Class A Class B Class II/*/ Class A Class B Class A Class B
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Government 4.94% 4.57% N/A 5.53% 5.15% 5.71% 5.33%
Securities Fund
- --------------------------------------------------------------------------------------------------------------------------
Federal Securities 4.67% 4.25% N/A 5.38% 4.98% 5.44% 5.09%
Fund
- --------------------------------------------------------------------------------------------------------------------------
Diversified 8.48% 8.31% N/A 8.63% 8.42% 8.15% 7.88%
Income Fund
- --------------------------------------------------------------------------------------------------------------------------
High Income 8.83% 8.69% 8.70% 9.10% 8.86% 9.02% 8.91%
Fund
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
B-70
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
Class A Class B Class II* Class A Class B Class A Class B
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Tax Exempt 4.00% 3.53% N/A 4.53% 4.10% 4.50% 4.08%
Insured Fund
- -------------------------------------------------------------------------------------------------
</TABLE>
/*/Previously designated as Class C shares for High Income Fund.
Current yield is not indicative of the amount which was or will be paid to
the shareholders. The amount paid to shareholders is reflected in the quoted
current distribution rate. The current distribution rate is computed by
annualizing the total amount of dividends per share paid by each Fund during the
past month and dividing by the current maximum offering price. Under some
circumstances it may be appropriate to use the dividends paid over the past
year. The current distribution rate differs from current yield in that it
includes amounts distributed to shareholders from sources other than dividends
and interest, such as short-term capital gains or option writing premiums and is
calculated over a different period of time. Such rates will be accompanied in
advertisements by standardized yield calculations as promulgated by the SEC.
COMPARISONS
- -----------
Each Fund may compare its total return or yield to similar measures as
calculated by various publications, services, indices, or averages. Such
comparisons are made to assist in evaluating an investment in a Fund. The
following references may be used:
a) Dow Jones Composite Average or its component averages -- an unmanaged index
composed of 30 blue-chip industrial corporation stocks (Dow Jones
Industrial Average), 15 utilities company stocks (Dow Jones Utilities
Average) and 20 transportation company stocks (Dow Jones Transportation
Average). Comparisons of performance assume reinvestment of dividends.
b) Standard & Poor's 500 Composite Stock Price Index or its component indices
-- an unmanaged index composed of 400 industrial stocks, 40 financial
stocks, 40 utilities stocks and 20 transportation stocks. Comparisons of
performance assume reinvestment of dividends.
c) Standard & Poor's 100 Stock Index -- an unmanaged index based on the prices
of 100 blue chip stocks, including 92 industrials, one utility, two
transportation companies and five financial institutions. The Standard &
Poor's 100 Stock Index is a smaller, more flexible index for options
trading.
d) The NYSE composite or component indices -- unmanaged indices of all
industrial, utilities, transportation and finance stocks listed on the
NYSE.
B-71
<PAGE>
e) Wilshire 5000 Equity Index or its component indices -- represents the
return on the market value of all common equity securities for which daily
pricing is available. Comparisons of performance assume reinvestment of
dividends.
f) Russell 3000 and 2000 Indices -- represents the top 3,000 and the top 2,000
stocks, respectively, traded on the New York Stock Exchange, American Stock
Exchange and National Association of Securities Dealers Automated
Quotations, by market capitalizations.
g) Lipper: Mutual Fund Performance Analysis, Fixed Income Analysis and Mutual
Fund Indices -- measures total return and average current yield for the
mutual fund industry. Ranks individual mutual fund performance over
specified time periods assuming reinvestment of all distributions,
exclusive of sales charges.
h) CDA Mutual Fund Report, published by CDA Investment Technologies, Inc.,
analyzes price, current yield, risk, total return and average rate of
return (average annual compounded growth rate) over specified time periods
for the mutual fund industry.
i) Mutual Fund Source Book, published by Morningstar, Inc. -- analyzes price,
risk and total return for the mutual fund industry.
j) Financial publications: The Wall Street Journal, Business Week, Changing
Times, Financial World, Forbes, Fortune, Money, Pension and Investment Age,
United Mutual Fund Selector, and Wiesenberger Investment Companies Service
and other publications containing financial analyses which rate mutual fund
performance over specified time periods.
k) Consumer Price Index (or Cost of Living Index), published by the U.S.
Bureau of Labor Statistics -- a statistical measure of periodic change in
the price of goods and services in major expenditure groups.
l) Stocks, Bonds, Bills, and Inflation, published by Ibbotson Associates --
historical measure of yield, price, and total return for common and small
company stock, long-term government bonds, treasury bills and inflation.
m) Savings and Loan Historical Interest Rates as published in the U.S. Savings
& Loan League Fact Book.
n) Shearson-Lehman Municipal Bond Index and Government/Corporate Bond Index --
unmanaged indices that track a basket of intermediate and long-term bonds.
Reflect total return and yield and assume dividend reinvestment.
o) Salomon GNMA Index published by Salomon Brothers Inc. -- Market value of
all outstanding 30-year GNMA Mortgage Pass-Through Securities that includes
single family and graduated payment mortgages.
B-72
<PAGE>
p) Salomon Mortgage Pass-Through Index published by Salomon Brothers Inc. --
Market value of all outstanding agency mortgage pass-through securities
that includes 15- and 30-year FNMA, FHLMC and GNMA Securities.
q) Value Line Geometric Index -- broad based index made up of approximately
1700 stocks each of which have an equal weighting.
r) Morgan Stanley Capital International EAFE Index -- an arithmetic, market
value-weighted average of the performance of over 900 securities on the
stock exchanges of countries in Europe, Australia and the Far East.
s) Goldman Sachs 100 Convertible Bond Index -- currently includes 67 bonds and
33 preferred stocks. The original list of names was generated by screening
for convertible issues of $100 million or more in market capitalization.
The index is priced monthly.
t) Salomon Brothers High Grade Corporate Bond Index -- consists of publicly
issued, non-convertible corporate bonds rated "AA" or "AAA." It is a value-
weighted, total return index, including approximately 800 issues.
u) Salomon Brothers Broad Investment Grade Bond Index -- is a market-weighted
index that contains approximately 4700 individually priced investment grade
corporate bonds rated "BBB" or better, U.S. Treasury/agency issues and
mortgage pass-through securities.
v) Salomon Brothers World Bond Index -- measures the total return performance
of high-quality securities in major sectors of the international bond
market. The index covers approximately 600 bonds from 10 currencies:
Australian Dollars Netherlands Guilders
Canadian Dollars Swiss Francs
European Currency Units UK Pound Sterling
French Francs U.S. Dollars
Japanese Yen German Deutsche Marks
w) J.P. Morgan Global Government Bond Index -- a total return, market
capitalization-weighted index, rebalanced monthly, consisting of the
following countries: Australia, Belgium, Canada, Denmark, France, Germany,
Italy, Japan, The Netherlands, Spain, Sweden, the United Kingdom and the
United States.
x) Shearson Lehman LONG-TERM Treasury Bond Index -- is comprised of all bonds
covered by the Shearson Lehman Hutton Treasury Bond Index with maturities
of 10 years or greater.
y) NASDAQ Industrial Index -- is comprised of more than 3,000 industrial
issues. It is a value-weighted index calculated on pure change only and
does not include income.
B-73
<PAGE>
z) The MSCI Combined Far East Free ex Japan Index -- a market capitalization
weighted index comprised of stocks in Hong Kong, Indonesia, Korea,
Malaysia, Philippines, Singapore and Thailand. Korea is included in this
index at 20% of its market capitalization.
aa) First Boston High Yield Index -- generally includes over 180 issues with an
average maturity range of seven to ten years with a minimum capitalization
of $100 million. All issues are individually trader-priced monthly.
bb) Merrill Lynch High Yield Bond Master Index -- generally includes over 500
issues rated "BB+" to "CCC-" with an aggregate par value of approximately
$100 billion.
cc) Morgan Stanley Capital International World Index -- An arithmetic, market
value-weighted average of the performance of over 1,470 securities list on
the stock exchanges of countries in Europe, Australia, the Far East, Canada
and the United States.
dd) In assessing such comparisons of performance, an investor should keep in
mind that the composition of the investments in the reported indices and
averages is not identical to a Fund's portfolio, that the averages are
generally unmanaged and that the items included in the calculations of such
averages may not be identical to the formula used by a Fund to calculate
its figures. In addition, there can be no assurance that a Fund will
continue its performance as compared to such other standards.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS. Each Fund intends to distribute to the registered
holders of its shares substantially all of its net investment income, which
includes dividends, interest and net short-term capital gains, if any, in excess
of any net capital losses. Each Fund intends to distribute any net long-term
capital gains in excess of any net short-term capital losses from the sale of
assets held more than twelve months. Dividends from net investment income are
declared daily and paid monthly. Dividends are paid on or about the fifteenth
day of the month. Net capital gains, if any, will be paid annually. In
determining amounts of capital gains to be distributed, any capital loss carry-
forwards from prior years will be offset against capital gains.
Distributions will be paid in additional Fund shares based on the net asset
value at the close of business on the record date, unless the dividends total in
excess of $10 per distribution period and the shareholder notifies the Fund at
least five business days prior to the payment date to receive such distributions
in cash.
TAXES. Each Fund is qualified, intends to remain qualified and elects to be
treated as a regulated investment company under Subchapter M of the Code for
each taxable year. In order to remain qualified as a regulated investment
company, each Fund generally must, among other things: (a) derive at least 90%
of its gross income from dividends, interest, proceeds from loans of stock or
securities and certain other related income; (b) diversify its holdings so that,
at the end of each fiscal
B-74
<PAGE>
quarter, (i) 50% of the market value of each Fund's assets is represented by
cash, government securities, securities of other regulated investment companies
and other securities limited, in respect of any one issuer, to an amount no
greater than 5% of each Fund's assets and not greater than 10% of the
outstanding voting securities of such issuer, and (ii) not more than 25% of the
value of its assets is invested in the securities of any one issuer (other than
government securities or the securities of other regulated investment
companies).
As a regulated investment company, each Fund will not be subject to U.S.
Federal income tax on its income and capital gains which it distributes as
dividends or capital gains distributions to shareholders provided that it
distributes to shareholders at least equal to the sum of 90% of its investment
company taxable income and 90% of its net tax-exempt interest income for the
taxable year. Each Fund intends to distribute sufficient income to meet this
qualification requirement.
Under the Code, amounts not distributed on a timely basis in accordance
with a calendar year distribution requirement are subject to a nondeductible 4%
excise tax. To avoid the tax, each Fund must distribute during each calendar
year (1) at least 98% of its ordinary income (not taking into account any
capital gains or losses) for the calendar year, (2) at least 98% of its net
capital gains, i.e., capital gains in excess of its capital losses for the 12-
month period ending on October 31 of the calendar year, and (3) all ordinary
income and net capital gains for the previous years that were not distributed
during such years. To avoid application of the excise tax, each Fund intends to
make distributions in accordance with the calendar year distribution
requirement. A distribution will be treated as paid during the calendar year if
it actually is paid during calendar year or if declared by each Fund in October,
November or December of such year, payable to shareholders of record on a date
in such month and paid by each Fund during January of the following year. Any
such distributions paid during January of the following year will be taxable to
shareholders as of December 31, rather than the date on which the distributions
are received.
Distributions of net investment income and short-term capital gains
("ordinary income dividends") are taxable to the shareholder as ordinary
dividend income regardless of whether the shareholder receives such
distributions in additional shares or in cash. The portion of such dividends
received from each Fund that will be eligible for the dividends received
deduction for corporations will be determined on the basis of the amount of each
Fund's gross income, exclusive of capital gains from sales of stock or
securities, which is derived as dividends from domestic corporations, other than
certain tax-exempt corporations and certain real estate investment trusts, and
will be designated as such in a written notice to shareholders mailed not later
than 60 days after the end of each fiscal year. Because each of the Funds will
invest principally in debt securities, it is not anticipated that a significant
portion of dividends paid by any Fund will qualify for the dividends received
deduction. Distributions of net capital gains, if any, are taxable as capital
gains regardless of whether the shareholder receives such distributions in
additional shares or in cash or how long the investor has held his or her shares
and are not eligible for the dividends received deduction for corporations. The
maximum capital gains rate for individuals is 20%. The maximum capital gains
rate for corporate shareholders currently is the same as the maximum tax rate
for ordinary income. At March 31, 1998, Government Securities Fund, Diversified
Income Fund, High Income Fund, and Tax Exempt Insured Fund had capital loss
carry-forwards of $29,467,409; $24,716,935; $22,767,991; and $3,338,986,
respectively, which are available to the extent not utilized to offset
B-75
<PAGE>
future gains from 1999 through 2005. The utilization of such losses will be
subject to annual limitations under the Code and the regulations thereunder.
Upon a sale or exchange of its shares, a shareholder may realize a taxable
gain or loss depending upon its basis in the shares. Such gain or loss will be
treated as capital gain or loss if the shares are capital assets in the
shareholder's hands. Any such capital gain or loss will be treated as long-term
capital gain or loss if the shares were held for more than one year. The amount
of any CDSC will reduce the amount realized on the sale or exchange of shares
for purposes of determining gain or loss. Generally, any loss realized on a sale
or exchange will be disallowed to the extent the shares disposed of are replaced
(by dividend reinvestments or otherwise) within a period of 61 days beginning 30
days before and ending 30 days after the shares are disposed of. Any loss
realized by a shareholder on the sale of shares of a Fund held by the
shareholder for six months or less will be treated for tax purposes as a long-
term capital loss to the extent of any distributions of net capital gains
received by the shareholder with respect to such shares.
Under certain circumstances (such as the exercise of an exchange privilege
in certain cases), the tax effect of sales load charges imposed on the purchase
of shares in a regulated investment company is deferred if the shareholder does
not hold the shares for at least 90 days.
Income received by a Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or eliminate
such taxes. It is impossible to determine in advance the effective rate of
foreign tax to which a Fund will be subject, since the amount of that Fund's
assets to be invested in various countries is not known. It is not anticipated
that any Fund will qualify to pass through to its shareholders the ability to
claim as a foreign tax credit their respective shares of foreign taxes paid by
such Fund.
Under the Code, gains or losses attributable to fluctuations in exchange
rates which occur between the time a Fund accrues interest or other receivables
or accrues expenses or other liabilities denominated in a foreign currency and
the time such Fund actually collects such receivables or pays such liabilities
are treated as ordinary income or ordinary loss. Similarly, gains or losses on
forward foreign currency exchange contracts, sales of currencies or dispositions
of debt securities denominated in a foreign currency attributable to
fluctuations in the value of the foreign currency between the date of
acquisition of the security and the date of disposition generally also are
treated as ordinary gain or loss. These gains, referred to under the Code as
"Section 988" gains or losses,
B-76
<PAGE>
increase or decrease the amount of each Fund's investment company taxable income
available to be distributed to its shareholders as ordinary income.
The Code includes special rules applicable to the listed non-equity
options, regulated futures contracts, and options on futures contracts which a
Fund may write, purchase or sell. Such options and contracts are classified as
Section 1256 contracts under the Code. The character of gain or loss resulting
from the sale, disposition, closing out, expiration or other termination of
Section 1256 contracts, except forward foreign currency exchange contracts, is
generally treated as long-term capital gain or loss to the extent of 60% thereof
and short-term capital gain or loss to the extent of 40% thereof ("60/40 gain or
loss"). Such contracts, when held by a Fund at the end of a fiscal year,
generally are required to be treated as sold at market value on the last day of
such fiscal year for Federal income tax purposes ("marked-to-market"). Over-
the-counter options are not classified as Section 1256 contracts and are not
subject to the marked-to-market rule or to 60/40 gain or loss treatment. Any
gains or losses recognized by a Fund from transactions in over-the-counter
options generally constitute short-term capital gains or losses. When call
options written, or put options purchased, by a Fund are exercised, the gain or
loss realized on the sale of the underlying securities may be either short-term
or long-term, depending on the holding period of the securities. In determining
the amount of gain or loss, the sales proceeds are reduced by the premium paid
for the over-the-counter puts or increased by the premium received for over-the-
counter calls.
A substantial portion of each Fund's transactions in options, futures
contracts and options on futures contracts, particularly its hedging
transactions, may constitute "straddles" which are defined in the Code as
offsetting positions with respect to personal property. A Straddle consisting
of a listed option, futures contract, or option on a futures contract and of
U.S. government securities would constitute a "mixed straddle" under the Code.
The Code generally provides with respect to straddles (i) "loss deferral" rules
which may postpone recognition for tax purposes of losses from certain closing
purchase transactions or other dispositions of a position in the straddle to the
extent of unrealized gains in the offsetting position, (ii) "wash sale" rules
which may postpone recognition for tax purposes of losses where a position is
sold and a new offsetting position is acquired within a prescribed period, (iii)
"short sale" rules which may terminate the holding period of securities owned by
a Fund when offsetting positions are established and which may convert certain
losses from short-term to long-term and (iv) "conversion transaction" rules
which may treat all or a portion of the gain on a transaction as ordinary income
rather than as capital gains. The Code provides that certain elections may be
made for mixed straddles that can alter the character of the capital gain or
loss recognized upon disposition of positions which form part of a straddle.
Certain other elections also are provided in the Code; no determination has been
reached to make any of these elections.
Code Section 1259 will require the recognition of gain (but not loss) if a
Fund makes a "constructive sale" of an appreciated financial position (e.g.,
stock). A Fund generally will be considered to make a constructive sale of an
appreciated financial position if it sells the same or substantially identical
property short, enters into a futures or forward contract to deliver the same or
substantially identical property, or enters into certain other similar
transactions.
B-77
<PAGE>
The Government Securities Fund, Federal Securities Fund, Diversified Income
Fund, High Income Fund and Tax Exempt Insured Fund may purchase debt securities
(such as zero-coupon or pay-in-kind securities) that contain original issue
discount. Original issue discount that accrues in a taxable year is treated as
earned by a Fund and therefore is subject to the distribution requirements of
the Code. Because the original issue discount earned by the Fund in a taxable
year may not be represented by cash income, the Fund may have to dispose of
other securities and use the proceeds to make distributions to shareholders.
With respect to the Tax Exempt Insured Fund, distributions out of net
investment income attributable to interest received on tax-exempt securities
("exempt-interest dividends") will be exempt from Federal income tax when paid
to shareholders. It should be noted, however, that interest on certain "private
activity bonds" issued after August 7, 1986 is an item of tax preference for
purposes of the alternative minimum tax, and in any event all exempt interest
dividends whether or not treated as a tax preference, must be taken into
account by corporate shareholders for purposes of determining the amount of the
adjustment to corporate alternative minimum taxable income based on adjusted
current earnings. The Fund anticipates that a portion of its investment may be
made in such "private activity bonds" with the result that a portion of the
exempt-interest dividends paid by the Fund will be an item of tax preference to
shareholders subject to the alternative minimum tax. Moreover, shareholders
should be aware that, while exempt from Federal income tax, exempt-interest
dividends may be taxable for state and local tax purposes. Any loss realized by
a shareholder on the sale of shares of the Tax Exempt Insured Fund held by the
shareholder for six months or less will be disallowed to the extent of any
exempt-interest dividend received thereon. Moreover, a shareholder may not
deduct interest on indebtedness incurred or continued to purchase or carry
shares of the Tax Exempt Insured Fund to the extent that the Fund distributes
exempt-interest dividends to the shareholders during the taxable year.
Legislation has expanded the market discount rules to apply to tax exempt
bonds purchased after April 30, 1993. Therefore, any gain on the disposition of
such a bond (including the receipt of a partial principal payment) that was
acquired for a price less than the principal amount (or in the case of a bond
issued with original issue discount, the adjusted issue price at the time of
purchase) of the bond is treated as ordinary taxable income to the extent of the
required market discount.
A Fund may be required to backup withhold U.S. Federal income tax at the
rate of 31% of all taxable distributions payable to shareholders who fail to
provide their correct taxpayer identification number or fail to make required
certifications, or who have been notified by the Internal Revenue Service that
they are subject to backup withholding. Backup withholding is not an additional
tax. Any amounts withheld may be credited against a shareholder's U.S. Federal
income tax liability.
Foreign shareholders generally will be subject to a withholding tax at the
rate of 30% (or lower treaty rate) on any ordinary income dividends paid by the
Funds.
B-78
<PAGE>
The foregoing is a general abbreviated summary of the applicable provisions
of the Code and Treasury regulations currently in effect. Shareholders are
urged to consult their tax advisers regarding specific questions as to Federal,
state and local taxes. In addition, foreign investors should consult with their
own tax advisers regarding the particular tax consequences to them of an
investment in each Fund. Qualification as a regulated investment company under
the Code for tax purposes does not entail government supervision of management
or investment policies.
RETIREMENT PLANS
Shares of each Fund (other than the Tax Exempt Insured Fund) are eligible
to be purchased in conjunction with various types of qualified retirement plans.
The summary below is only a brief description of the Federal income tax laws for
each Plan and does not purport to be complete. Further information or an
application to invest in shares of the Fund by establishing any of the
retirement plans described below may be obtained by calling Retirement Plans at
(800) 858-8850. However, it is recommended that a shareholder considering any
retirement plan consult a tax adviser before participating.
PENSION AND PROFIT-SHARING PLANS. Sections 401(a) and 401(k) of the Code permit
business employers and certain associations to establish pension and profit
sharing plans for employees. Shares of the Fund may be purchased by those who
would have been covered under the rules governing old H.R. 10 (Keogh) Plans, as
well as by corporate plans. Each business retirement plan provides tax
advantages for owners and participants. Contributions made by the employer are
tax-deductible, and participants do not pay taxes on contributions or earnings
until withdrawn.
TAX-SHELTERED CUSTODIAL ACCOUNTS. Section 403(b)(7) of the Code permits public
school employees and employees of certain types of charitable, educational and
scientific organizations specified in Section 501(c)(3) of the Code, to purchase
shares of the Fund and, subject to certain limitations, exclude the amount of
purchase payments from gross income for tax purposes.
INDIVIDUAL RETIREMENT ACCOUNTS (IRA). Section 408 of the Code permits eligible
individuals to contribute to an individual retirement program, including
Simplified Employee Pension Plans, commonly referred to as SEP-IRA. Section 408A
of the Code treats Roth IRA's as IRA's subject to certain special rules
applicable thereto. These IRA's are subject to limitations with respect to the
amount that may be contributed, the eligibility of individuals to make
contributions, the amount, if any, entitled to be contributed on a deductible
basis, and the time in which distributions would be allowed to commence. In
addition, certain distributions from some other types of retirement plans may be
placed on a tax-deferred basis in an IRA.
SALARY REDUCTION SIMPLIFIED EMPLOYEE PENSION (SARSEP). This plan was introduced
by a provision of the Tax Reform Act of 1986 as a unique way for small employers
to provide the benefit of retirement planning for their employees.
Contributions are deducted from the employee's paycheck before tax deductions
and are deposited into an IRA by the employer. These contributions
B-79
<PAGE>
are not included in the employee's income and therefore are not reported or
deducted on his or her tax return.
SAVINGS INCENTIVE MATCH PLAN FOR EMPLOYEES ("SIMPLE IRA"). This plan was
introduced by a provision of the Small Business Job Protection Act of 1996 to
provide small employers with a simplified tax-favored retirement plan.
Contributions are deducted from the employee's paycheck before taxes and are
deposited into a SIMPLE IRA by the employer, who must make either matching
contributions or non-elective contributions. Contributions are tax-deductible
for the employer and participants do not pay taxes on contributions on earnings
until they are withdrawn.
ROTH IRA. This plan, introduced by Section 302 of the Taxpayer Relief Act of
1997, generally permits individuals with adjusted gross income of up to $95,000,
and married couples with joint adjusted gross income of up to $150,000, to
contribute to a "Roth IRA." Contributions are not tax-deductible, but
distribution of assets (contributions and earnings) held in the account for at
least five years may be distributed tax-free under certain qualifying
conditions.
EDUCATION IRA. Established by the Taxpayer Relief Act of 1997, under Section
530 of the Code, this plan permits individuals to contribute to an IRA on behalf
of any child under the age of 18. Contributions are not tax-deductible but
distributions are tax-free if used for qualified educational expenses.
DESCRIPTION OF SHARES
Ownership of the Trust is represented by transferable shares of beneficial
interest. The Declaration of Trust of the Trust (the "Declaration of Trust")
permits the Trustees to issue an unlimited number of full and fractional shares,
$.01 par value, and to divide or combine the shares into a greater or lesser
number of shares without thereby changing the proportionate beneficial interests
of the Trust.
Currently, five series of shares of the Trust have been authorized pursuant
to the Declaration of Trust: the Government Securities Fund, the Federal
Securities Fund, the Diversified Income Fund, the High Income Fund and the Tax
Exempt Insured Fund. Each series has been divided into three classes of shares,
designated as Class A, Class B and Class II shares. The Trustees may authorize
the creation of additional series of shares so as to be able to offer to
investors additional investment portfolios within the Trust that would operate
independently from the Trust's present portfolios, or to distinguish among
shareholders, as may be necessary, to comply with future regulations or other
unforeseen circumstances. Each series of the Trust's shares represents the
interests of the shareholders of that series in a particular portfolio of Trust
assets. In addition, the Trustees may authorize the creation of additional
classes of shares in the future, which may have fee structures different from
those of existing classes and/or may be offered only to certain qualified
investors.
B-80
<PAGE>
Shareholders are entitled to a full vote for each full share held. The
Trustees have terms of unlimited duration (subject to certain removal
procedures) and have the power to alter the number of Trustees and appoint their
own successors, provided that at all times at least a majority of the Trustees
have been elected by shareholders. The voting rights of shareholders are not
cumulative, so that holders of more than 50% of the shares voting can, if they
choose, elect all Trustees being elected, while the holders of the remaining
shares would be unable to elect any Trustees. Although the Trust need not hold
annual meetings of shareholders, the Trustees may call special meetings of
shareholders for action by shareholder vote as may be required by the 1940 Act
or the Declaration of Trust. Also, a shareholders meeting must be called, if so
requested in writing by the holders of record of 10% or more of the outstanding
shares of the Trust. In addition, the Trustees may be removed by the action of
the holders of record of two-thirds or more of the outstanding shares. All
series of shares will vote with respect to certain matters, such as election of
Trustees. When all series of shares are not affected by a matter to be voted
upon, such as approval of investment advisory agreements or changes in a Fund's
policies, only shareholders of the series affected by the matter may be entitled
to vote.
All classes of shares of a given Fund are identical in all respects, except
that (i) each class may bear differing amounts of certain class-specific
expenses, (ii) Class A shares are subject to an initial sales charge, a
distribution fee and an ongoing account maintenance and service fee, (iii) Class
B shares are subject to a CDSC, a distribution fee and an ongoing account
maintenance and service fee, (iv) Class II shares are subject to an initial
sales charge, a CDSC, a distribution fee and an ongoing account maintenance and
service fee; (v) Class B shares convert automatically to Class A shares on the
first business day of the month seven years after the purchase of such Class B
shares, (vi) each class has voting rights on matters that pertain to the Rule
12b-1 plan adopted with respect to such class, except that under certain
circumstances, the holders of Class B shares may be entitled to vote on material
changes to the Class A Rule 12b-1 plan, and (vii) each class of shares will be
exchangeable only into the same class of shares of any of the other Funds or
other SunAmerica Mutual Funds that offers that class. All shares of the Trust
issued and outstanding and all shares offered by the Prospectus when issued, are
and will be fully paid and non-assessable. Shares have no preemptive or other
subscription rights and are freely transferable on the books of the Trust. In
addition, shares have no conversion rights, except as described above.
The Declaration of Trust provides that no Trustee, officer, employee or
agent of the Trust is liable to the Trust or to a shareholder, nor is any
Trustee, officer, employee or agent liable to any third persons in connection
with the affairs of the Trust, except as such liability may arise from his or
its own bad faith, willful misfeasance, gross negligence or reckless disregard
of his duties. It also provides that all third persons shall look solely to the
Trust's property for satisfaction of claims arising in connection with the
affairs of the Trust. With the exceptions stated, the Declaration of Trust
provides that a Trustee, officer, employee or agent is entitled to be
indemnified against all liability in connection with the affairs of the Trust.
The Trust shall continue, without limitation of time, subject to the provisions
in the Declaration of Trust concerning termination by action of the
shareholders.
B-81
<PAGE>
Under Massachusetts law, shareholders of a trust, such as the Trust, in
certain circumstances may be held personally liable as partners for the
obligations of the trust. However the Declaration of Trust, pursuant to which
the Trust was organized, contains an express disclaimer of shareholder liability
for acts or obligations of the Trust. The Declaration of Trust also provides
for indemnification out of the Trust's property for any shareholder held
personally liable for any Trust obligation. Thus the risk of a shareholder
being personally liable as a partner for obligations of the Trust, is limited to
the unlikely circumstance in which the Trust itself would be unable to meet its
obligations.
ADDITIONAL INFORMATION
Computation of Offering Price per Share
- ---------------------------------------
The offering price for Class A, Class B and Class II shares of the Funds,
based on the value of each Fund's net assets as of September 30, 1998, is
calculated as follows:
<TABLE>
<CAPTION>
Government Securities Federal Securities Diversified Income
---------------------------------------------------------------------------------------------------------
Class A Class B Class II* Class A Class B Class II* Class A Class B Class II*
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net Assets $97,495,609 $207,950,333 $31,627,516 $18,836,682 $25,516,573 $63,397,420
- ------------------------------------------------------------------------------------------------------------------------------------
Number of Outstanding 11,259,592 24,004,195 2,858,465 1,703,670 5,449,294 13,507,605
Shares
- ------------------------------------------------------------------------------------------------------------------------------------
Net Asset Value (net $ 8.66 $ 8.66 $ 11.03 $ 11.06 $ 4.68 $ 4.69 Class C/II
assets divided by number
of shares)
- ------------------------------------------------------------------------------------------------------------------------------------
Sales Charge $ 0.43 *** $ 0.55 *** $ 0.23 ***
(for Class A Shares: 4.75%
of offering price (6.10%
of net asset value per
share)**
for Class II Shares: 1.00%
of offering price (1.01%
of net asset value per
share)*
- ------------------------------------------------------------------------------------------------------------------------------------
Offering Price $ 9.09 $ 8.66 $ 11.58 $ 11.06 $ 4.91 $ 4.69
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
High Income Tax Exempt Insured
- --------------------------------------------------------------------------------------------------
Class A Class B Class II* Class A Class B Class II*
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Assets $56,442,305 $124,962,181 $88,518,909 $22,877,700
- --------------------------------------------------------------------------------------------------
</TABLE>
B-82
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------
Number of Shares 7,250,348 16,031,814 6,791,093 1,754,749
Outstanding
- ----------------------------------------------------------------------------------------------------------
Net Asset Value $ 7.78 $ 7.79 $ 13.03 $ 13.04
(net assets divided
by number of
shares)
- ----------------------------------------------------------------------------------------------------------
Sales Charge:
for Class A Shares: $ 0.39 *** $ 0.65 ***
4.75% of offering
price (6.10% of net
asset value per
share)*
for Class II Shares:
1.00% of offering
price (1.01% of net
asset value per
share)*
- ----------------------------------------------------------------------------------------------------------
Offering Price $ 8.17 $ 7.79 $ 13.68 $ 13.04
- ----------------------------------------------------------------------------------------------------------
</TABLE>
* Class II shares were not in existence prior to December 1, 1998 with
respect to any of the Funds other than the High Income Fund. With
respect to the High Income Fund, Class II shares were designated Class
C shares prior to December 1, 1998 and were subject to a different load
structure. Class II shares may be subject to a contingent deferred
sales charge on redemption of shares within eighteen months of
purchase.
** Rounded to nearest one-hundredth percent; assumes maximum sales
charge is applicable.
*** Class B shares are not subject to an initial sales charge but may be
subject to a CDSC on redemption of shares within six years of
purchase.
REPORTS TO SHAREHOLDERS. The Trust sends audited annual and unaudited semi-
annual reports to shareholders of each of the Funds. In addition, the
Transfer Agent sends a statement to each shareholder having an account
directly with the Trust to confirm transactions in the account.
CUSTODIAN AND TRANSFER AGENT. State Street Bank and Trust Company, 1776
Heritage Drive, North Quincy, MA 02171, serves as Custodian and Transfer
Agent for the Funds and in those capacities maintains certain financial and
accounting books and records pursuant to agreements with the Trust.
Transfer Agent functions are performed for State Street, by National
Financial Data Services, P.O. Box 419572, Kansas City, MO 64141-6572, an
affiliate of State Street. SunAmerica Fund Services, Inc., The SunAmerica
Center, 733 Third Avenue, New York, NY 10017-3204, acts as a servicing
agent assisting State Street Bank and Trust Company in connection with
certain services offered to the shareholders of each of the Funds.
INDEPENDENT ACCOUNTANTS AND LEGAL COUNSEL. PricewaterhouseCoopers LLP
(successor firm to Price Waterhouse LLP), 1177 Avenue of the Americas, New
York, NY 10036, serves as the Trust's
B-83
<PAGE>
independent accountants and in that capacity examines the annual financial
statements of the Trust. The firm of Swidler Berlin Shereff Friedman, LLP, 919
Third Avenue, New York, NY 10022, serves as legal counsel to the Trust.
FINANCIAL STATEMENTS
[TO BE FILED BY AMENDMENT]
B-84
<PAGE>
APPENDIX
BOND, NOTE AND COMMERCIAL PAPER RATINGS
DESCRIPTION OF MOODY'S CORPORATE AND TAX-EXEMPT BOND RATINGS
Aaa Bonds 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 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 that make the long-term risks appear somewhat larger than
in Aaa securities.
A Bonds rated A possess many favorable investment attributes and are
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
that suggest a susceptibility to impairment sometime in the future.
Baa Bonds rated Baa are considered as medium grade obligations; i.e., they are
neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any
great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba Bonds 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 therefore not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B Bonds rated B generally lack characteristics of desirable investments.
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 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 rated Ca represent obligations that are speculative in a high degree.
Such issues are often in default or have other marked shortcomings.
C Bonds 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.
Appendix-1
<PAGE>
Note: Moody's may apply numerical modifiers 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system.
The modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of the generic rating
category. The foregoing ratings for tax-exempt bonds are sometimes presented in
parentheses preceded with a "con" indicating the bonds are rated conditionally.
Bonds for which the security depends upon the completion of some act or the
fulfillment of some condition are rated conditionally. These are bonds secured
by (a) earnings of projects under construction, (b) earnings of projects
unseasoned in operation experience, (c) rentals which begin when facilities are
completed, or (d) payments to which some other limiting condition attaches.
Such parenthetical rating denotes the probable credit stature upon completion of
construction or elimination of the basis of the condition.
DESCRIPTION OF MOODY'S TAX-EXEMPT NOTE RATINGS
The ratings of Moody's for tax-exempt notes are MIG 1, MIG 2, MIG 3 and MIG
4.
MIG 1 Notes bearing the designation MIG 1 are judged to be of the
best quality, enjoying strong protection from established cash
flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both.
MIG 2 Notes bearing the designation MIG 2 are judged to be of high
quality, with margins of protection ample although not so large
as in the preceding group.
MIG 3 Notes bearing the designation MIG 3 are judged to be of
favorable quality, with all security elements accounted for but
lacking the undeniable strength of the preceding grades. Market
access for refinancing, in particular, is likely to be less
well established.
MIG 4 Notes bearing the designation MIG 4 are judged to be of
adequate quality, carrying specific risk but having protection
commonly regarded as required of an investment security and not
distinctly or predominantly speculative.
DESCRIPTION OF MOODY'S CORPORATE AND TAX-EXEMPT COMMERCIAL PAPER RATINGS
The term "commercial paper" as used by Moody's means promissory obligations
not having an original maturity in excess of nine months. Moody's makes no
representations as to whether such commercial paper is by any other definition
"commercial paper" or is exempt from registration under the Securities Act.
Moody's rating grades for commercial paper are applied to municipal
commercial paper as well as taxable commercial paper.
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's makes no representation that such obligations
are exempt from registration under the Securities Act of 1933, as amended, nor
does it represent that any specific note is a valid obligation of a rated issuer
or issued in
Appendix-2
<PAGE>
conformity with any applicable law. Moody's employs the following three
designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
Issuers rated PRIME-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. PRIME-1 repayment
capacity will normally be evidenced by the following characteristics:
-- Leading market positions in well established industries
-- High rates of return on funds employed
-- Conservative capitalization structures with moderate reliance on debt
and ample asset protection
-- Broad margins in earnings coverage of fixed financial charges and high
internal cash generation
-- Well established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated PRIME-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated PRIME-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effect of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
level of debt protection measurements and the requirement for relatively high
financial leverage. Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating
categories.
If an issuer represents to Moody's that its commercial paper obligations
are supported by the credit of another entity or entities, then the name or
names of such supporting entity or entities are listed within parentheses
beneath the name of the issuer, or there is a footnote referring the reader to
another page for the name or names of the supporting entity or entities. In
assigning ratings to such issuers, Moody's evaluates the financial strength of
the indicated affiliated corporations, commercial banks, insurance companies,
foreign governments or other entities, but only as one factor in the total
rating assessment. Moody's makes no representation and gives no opinion on the
legal validity or enforceability of any support arrangement. You are cautioned
to review with your counsel any questions regarding particular support
arrangements.
Among the factors considered by Moody's in assigning ratings are the
following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative type risks that may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships that exist with the issuer; and (8) recognition by management of
obligations that may be present or may arise as a result of public interest
questions and preparations to meet such obligations.
Appendix-3
<PAGE>
DESCRIPTION OF STANDARD & POOR'S CORPORATE AND TAX-EXEMPT BOND RATINGS
A Standard & Poor's corporate or municipal 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 Standard & Poor's from other sources it considers reliable.
Standard & Poor's 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 for other reasons.
The ratings are based, in varying degrees, on the following considerations:
(1) likelihood of default capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with the
terms of the obligation: (2) nature of and provisions of the obligation; and (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 creditors' rights.
AAA Debt rated AAA has the highest rating assigned by Standard & Poor's.
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 higher-
rated categories.
BBB Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt
in higher-rated categories.
Debt rated BB, B, CCC, CC and C are regarded as having predominantly
speculative characteristics with respect to capacity to pay interest
and repay principal. BB indicates the least degree of speculation and
C the highest degree of speculation. While such debt will likely have
some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposure to adverse conditions.
BB Debt rated BB has less near-term vulnerability to default than other
speculative grade debt. However, it faces major ongoing uncertainties
or exposure to adverse business, financial or economic conditions that
could lead to inadequate capacity to meet timely interest and
principal payment. The BB rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BBB
- rating.
Appendix-4
<PAGE>
B Debt rated B has a greater vulnerability to default but presently has
the capacity to meet interest payments and principal repayments.
Adverse business, financial or economic conditions would 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 has a current identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic
conditions to meet timely payments of interest and repayments 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 The rating CC is typically applied to debt subordinated to senior debt
that is assigned an actual or implied CCC rating.
C The rating C is typically applied to debt subordinated to senior debt
that is assigned an actual or implied CCC- debt rating. The C rating
may be used to cover a situation where a bankruptcy petition has been
filed but debt service payments are continued.
CI The rating CI is reserved for income bonds on which no interest is
being paid.
D Debt rated D is in default. The D rating is assigned on the day an
interest or principal payment is missed. 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 of "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within these
ratings categories.
Provisional ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment of
debt service requirements is largely or entirely dependent upon the successful
and timely completion of the project. This rating, however, while addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood or risk of default upon failure of such completion. The investor
should exercise judgment with respect to such likelihood and risk.
L The letter "L" indicates that the rating pertains to the principal
amount of those bonds to the extent that the underlying deposit
collateral is insured by the Federal Savings & Loan Insurance Corp. or
the Federal Deposit Insurance Corp. and interest is adequately
collateralized.
* Continuance of the rating is contingent upon Standard & Poor's receipt
of an executed copy of the escrow agreement or closing documentation
confirming investments and cash flows.
Appendix-5
<PAGE>
NR Indicates that no rating has been requested, that there is
insufficient information on which to base a rating or that Standard &
Poor's does not rate a particular type of obligation as a matter of
policy.
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 credit worthiness 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.
DESCRIPTION OF STANDARD & POOR'S TAX-EXEMPT NOTE RATINGS
The ratings of Standard & Poor's for municipal notes issued on or after
July 29, 1984 are "SP-1", "SP-2" and "SP-3." Prior to July 29, 1984, municipal
notes carried the same symbols as municipal bonds.
SP-1 The designation "SP-1" indicates a very strong capacity to pay
principal and interest. A "+" is added for those issues determined to
possess overwhelming safety characteristics.
SP-2 An "SP-2" designation indicates a satisfactory capacity to pay
principal and interest.
SP-3 "SP-3" designation indicates speculative capacity to pay principal
and interest.
DESCRIPTION OF STANDARD & POOR'S CORPORATE AND TAX-EXEMPT COMMERCIAL PAPER
RATINGS.
Standard & Poor's rating grades for commercial paper are applied to
municipal commercial paper as well as taxable commercial paper.
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of not more
than 365 days. Ratings are graded into four categories, ranging from "A" for
the highest quality obligations to "D" for the lowest.
A Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are
delineated with the numbers 1, 2 and 3 to indicate the relative degree
of safety.
A-1 This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues designated
"A-1" that are determined to possess overwhelming safety
characteristics are denoted with a plus (+) sign designation.
A-2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues
designated "A-1."
Appendix-6
<PAGE>
A-3 Issues carrying this designation have a satisfactory capacity for
timely payment. They are, however, somewhat more vulnerable to the
adverse effect of changes in circumstances than obligations carrying
the higher designations.
B Issues rated "B" are regarded as having only adequate capacity for
timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.
C This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D This rating indicates that the issue is either in default or is
expected to be in default upon maturity.
The commercial paper rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer or obtained from other sources it considers reliable. The
ratings may be changed, suspended, or withdrawn as a result of changes in or
unavailability of such information.
Appendix-7
<PAGE>
PART C
OTHER INFORMATION
Item 23: Exhibits.
(a) Declaration of Trust, as amended. Incorporated herein by
reference to Post-Effective Amendment No. 20 to the Registrant's
Registration Statement on Form N-1A (File No. 33-6502) filed on
July 27, 1995.
(b) By-Laws, as amended. Incorporated herein by reference to Post-
Effective Amendment No. 20 to the Registrant's Registration
Statement on Form N-1A (File No. 33-6502) filed on July 27, 1995.
(c) Not applicable.
(d) Investment Advisory and Management Agreement between Registrant
and SunAmerica Asset Management Corp. ("SunAmerica")*
(e) (i) Distribution Agreement between Registrant and SunAmerica
Capital Services, Inc.*
(ii) Dealer Agreement. Incorporated herein by reference to Post-
Effective Amendment No. 21 to Registrant's Registration
Statement on Form N-1A (File No. 33-6502) filed on July 19,
1996.
(f) Directors'/Trustees' Retirement Plan. Incorporated herein by
reference to Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A (File No. 33-6502) filed on
July 19, 1996.
(g) Custodian Agreement between Registrant and State Street Bank and
Trust Company. Incorporated herein by reference to Post-Effective
Amendment No. 21 to Registrant's Registration Statement on Form
N-1A (File No. 33-6502) filed on July 19, 1996.
(h) (i) Transfer Agency and Service Agreement between Registrant and
State Street Bank and Trust Company. Incorporated herein by
reference to Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A (File No. 33-6502) filed
on July 19, 1996.
(ii) Service Agreement between Registrant and SunAmerica Fund
Services, Inc. Incorporated herein by reference to Post-
Effective Amendment No. 20 to Registrant's Registration
Statement on Form N-1A (File No. 33-6502) filed on July 27,
1995.
(i) Opinion of Counsel to the Registrant. Incorporated herein by
reference to Post-Effective Amendment No. 22 to the Registrant's
Registration Statement on Form N-1A (File No. 33-6502) filed on
July 25, 1997.
(j) Consent of Independent Accountants.*
<PAGE>
(k) Not applicable.
(l) Not applicable.
(m) (i) Distribution Plan pursuant to Rule 12b-1 (Class A shares).*
(ii) Distribution Plan pursuant to Rule 12b-1 (Class B shares).*
(iii) Distribution Plan pursuant to Rule 12b-1 (Class II
Shares).*
(n) Financial Data Schedules.*
(o) (i) Amended Plan pursuant to Rule 18f-3. Incorporated herein by
reference to Post-Effective Amendment No. 24 to the
Registrant's Registration Statement on Form N-1A (File No.
33-6502) filed on July 27, 1998.
(ii) Powers of Attorney. Incorporated herein by reference to
Post-Effective Amendment No. 21 to Registrant's Registration
Statement on Form N-1A (File No. 33-6502) filed on July 19,
1996.
_________________________
* To be filed by amendment.
Item 24. Persons Controlled by or Under Common Control with Registrant
There are no persons controlled by or under common control with
Registrant.
Item 25. Indemnification
5.1 Indemnification of Trustees, Officers, Employees and Agents.
-----------------------------------------------------------
(a) The Trust shall indemnify any person who was or is a party or is threatened
to be made a party to any threatened, pending, or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the Trust or any of its shareholders) by reason
of the fact that he is or was a Trustee, officer, employee or agent of the
Trust. The indemnification shall be against expenses, including attorneys' fees,
judgments, fines and amounts paid in settlement, actually and reasonably
incurred by him in connection with the action, suit or proceeding, if he acted
in good faith and in a manner he reasonably believed to be in or not opposed to
the best interests of the Trust, and, with respect to any criminal action or
proceedings, had no reasonable cause to believe his conduct was unlawful. The
termination of any action, suit or proceeding by judgment, order, settlement,
conviction or upon a plea of nolo contendere or its equivalent, shall not, of
itself, create a presumption that the person did not act in good faith and in a
manner which he reasonably believed to be in or not opposed to the best
interests of the Trust, and, with respect to any criminal action or proceeding,
had reasonable cause to believe that his conduct was unlawful.
(b) The Trust shall indemnify any person who was or is a party
or is threatened to be made a party to any threatened, pending or completed
action or suit by or on behalf of the Trust or any of its shareholders to obtain
a judgment or decree in its favor by reason of the fact that he is or was a
Trustee, officer, employee or agent of the Trust. The indemnification shall be
against expenses, including attorneys' fees, actually and reasonably incurred by
him in connection with the defense or settlement of the action or suit, if he
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the Trust; except that such indemnification
shall preclude payment upon any liability, whether or not there is an
adjudication of liability, arising by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of duties as described in section 17(h)
and (i) of the Investment Company Act of 1940.
<PAGE>
(c) To the extent that a Trustee, officer, employee or agent of
the Trust has been successful on the merits or otherwise in defense of any
action, suit or proceeding referred to in subsections (a) or (b) or in defense
of any claim, issue or matter therein, he shall be indemnified against expenses,
including attorneys' fees, actually and reasonably incurred by him in connection
therewith.
(d) (1) Unless a court orders otherwise, any indemnification
under subsections (a) or (b) of this section may be made by the Trust only as
authorized in the specific case after a determination that indemnification of
the Trustee, officer, employee or agent is proper in the circumstances because
he has met the applicable standard of conduct set forth in subsections (a) or
(b).
(2) The determination shall be made:
(i) by the Trustees, by a majority vote of a quorum
which consists of Trustees who were not parties to the action, suit or
proceeding; or
(ii) if the required quorum is not obtainable, or if a
quorum of disinterested Trustees so directs, by independent legal counsel in a
written opinion; or
(iii) by the Shareholders.
(3) Notwithstanding the provisions of this Section 5.1, no
person shall be entitled to indemnification for any liability, whether or not
there is an adjudication of liability, arising by reason of willful malfeasance
bad faith, gross negligence or reckless disregard of duties as described in
Sections 17(h) and (i) of the Investment Company Act of 1940 ("Disabling
Conduct"). A person shall be deemed not liable by reason of Disabling Conduct
if, either:
(i) a final decision on the merits is made by a court
or other body before whom the proceeding was brought that the person to be
indemnified ("Indemnitee") was not liable by reason of Disabling Conduct;
or
(ii) in the absence of such a decision, a reasonable
determination, based upon a review of the facts, that the Indemnitee was not
liable by reason of Disabling Conduct, is made by either -
(A) a majority of a quorum of Trustees who are neither
"interested persons" of the Trust, as defined in section 2(a)(19) of the
Investment Company Act of 1940, nor parties to the action, suit or proceeding;
or
(B) an independent legal counsel in a written
opinion.
(e) Expenses, including attorneys' fees, incurred by a Trustee,
officer, employee or agent of the Trust in defending a civil or criminal action,
suit or proceeding may be paid by the Trust in advance of the final disposition
thereof if:
(1) authorized in the specific case by the Trustees;
and
(2) the Trust receives an undertaking by or on behalf of
the Trustee, officer, employee or agent of the Trust to repay the advance if it
is not ultimately determined that such person is entitled to be indemnified by
the Trust; and
(3) either,
<PAGE>
(i) such person provides a security for his
undertaking; or
(ii) the Trust is insured against losses by reason of
any lawful advances; or
(iii) a determination, based on a review of readily
available facts, that there is reason to believe that such person ultimately
will be found entitled to indemnification, is made by either -
(A) A majority of a quorum which consists of Trustees
who are neither "interested persons" of the Trust, as defined in section
2(a)(19) of the Investment Company Act of 1940, nor parties to the action, suit
or proceeding; or
(B) an independent legal counsel in a written
opinion.
(f) The indemnification provided by this Section shall not be
deemed exclusive of any other rights to which a person may be entitled under any
by-law, agreement, vote of Shareholders or disinterested Trustees or otherwise,
both as to action in his official capacity and as to action in another capacity
while holding office, and shall continue as to a person who has ceased to be a
Trustee, officer, employee or agent and inure to the benefit of the heirs,
executors and administrators of such person; provided that no person may satisfy
any right of indemnity or reimbursement granted herein or to which he may be
otherwise entitled except out of the property of the Trust, and no Shareholder,
as such, shall be personally liable with respect to any claim for indemnity or
reimbursement or otherwise.
(g) The Trust may purchase and maintain insurance on behalf of
any person who is or was a Trustee, officer, employee or agent of the Trust,
against any liability asserted against him and incurred by him in any such
capacity, or arising out of his status as such. However, in no event will the
Trust pay that portion of insurance premiums, if any, attributable to coverage
which would indemnify any officer of Trustee against liability for Disabling
Conduct.
(h) Nothing contained in this Section shall be construed to
protect any Trustee or officer of the Trust against any liability to the Trust
or to its security holders to which he would otherwise be subject by reason of
willful misfeasance, bad faith, gross negligence or reckless disregard of the
duties involved in the conduct of his office.
Item 26. Business and Other Connections of the Investment Adviser.
Information concerning business and other connections of SunAmerica is
incorporated herein by reference to SunAmerica's Form ADV (File No. 801-19813),
which is currently on file with the Securities and Exchange Commission.
Reference is also made to the caption "Fund Management" in the
Prospectus constituting Part A of the Registration Statement and "Adviser,
Personal Securities Trading, Distributor and Administrator" and "Trustees and
Officers" constituting Part B of the Registration Statement.
<PAGE>
Item 27. Principal Underwriters
(a) The principal underwriter of the Registrant also acts as
principal underwriter for:
SunAmerica Equity Funds
SunAmerica Money Market Funds, Inc.
Style Select Series, Inc.
(b) The following persons are the officers and directors of
SunAmerica Capital Services, Inc., the principal underwriter of
Registrant's Shares:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------
Name and Principal
Business Address Position With Underwriter Position with the Registrant
------------------ ------------------------- ----------------------------
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Peter A. Harbeck Director President and Trustee
The SunAmerica Center
733 Third Avenue
New York, NY 10017-3204
- -----------------------------------------------------------------------------------------------
J. Steven Neamtz President and Director None
The SunAmerica Center
733 Third Avenue
New York, NY 10017-3204
- -----------------------------------------------------------------------------------------------
Robert M. Zakem Executive Vice President, Secretary and Chief
The SunAmerica Center General Compliance
733 Third Avenue Counsel and Director Officer
New York, NY 10017-3204
- -----------------------------------------------------------------------------------------------
Susan L. Harris Secretary None
SunAmerica, Inc.
1 SunAmerica Center
Los Angeles, CA 90067-6022
- -----------------------------------------------------------------------------------------------
Debbie Potash-Turner Controller None
The SunAmerica Center
733 Third Avenue
New York, NY 10017-3204
- -----------------------------------------------------------------------------------------------
</TABLE>
(c) Not applicable.
Item 28. Location of Accounts and Records.
SunAmerica, The SunAmerica Center, 733 Third Avenue, New York, NY
10017-3204, or an affiliate thereof, will maintain physical possession of each
such accounts, books or other documents of Registrant, except for those
maintained by Registrant's custodian, State Street Bank and Trust Company, 1776
Heritage Drive, North Quincy, MA 02171, and its affiliate, National Financial
Data Services, P.O. Box 419572, Kansas City, MO 64141-6572.
Item 29. Management Services
Not applicable.
<PAGE>
Item 30. Undertakings
Not applicable.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as
amended, (the "1933 Act") and the Investment Company Act of 1940, as amended,
the Registrant has duly caused this Post-Effective Amendment No. 25 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of New York, and State of New York, on the 17/th/
day of March 1999.
SunAmerica Income Funds
By: /s/ Peter A. Harbeck
----------------------------------
Peter A. Harbeck
President
Pursuant to the requirements of the 1933 Act, this Post-Effective
Amendment No. 25 to the Registrant's Registration Statement on Form N-1A has
been signed below by the following persons in the capacities and on the date
indicated:
/s/ Peter A. Harbeck President and Trustee March 17, 1999
- --------------------------
Peter A. Harbeck (Principal Executive Officer)
* Treasurer
- --------------------------
Peter C. Sutton (Principal Financial and
Accounting Officer)
* Trustee
- --------------------------
S. James Coppersmith
* Trustee
- --------------------------
Samuel M. Eisenstat
* Trustee
- --------------------------
Stephen J. Gutman
* Trustee
- --------------------------
Sebastiano Sterpa
*By: /s/ Robert M. Zakem March 17, 1999
- --------------------------
Attorney-in-Fact
Robert M. Zakem
