STATEMENT OF ADDITIONAL INFORMATION October 31, 1998
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EASTCLIFF FUNDS, INC.
900 Second Avenue South
300 International Centre
Minneapolis, Minnesota 55402
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the prospectus of Eastcliff Funds, Inc. dated
October 31, 1998. Requests for copies of the prospectus should be made in
writing to Eastcliff Funds, Inc., 900 Second Avenue South, 300 International
Centre, Minneapolis, Minnesota 55402, Attention: Corporate Secretary, or by
calling (612) 336-1444.
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EASTCLIFF FUNDS, INC.
Table of Contents
Page No.
GENERAL INFORMATION AND HISTORY.................................... 1
INVESTMENT RESTRICTIONS............................................ 1
INVESTMENT CONSIDERATIONS.......................................... 3
DIRECTORS AND OFFICERS OF THE CORPORATION.......................... 12
OWNERSHIP OF MANAGEMENT AND PRINCIPAL SHAREHOLDERS................. 17
INVESTMENT ADVISER, PORTFOLIO MANAGERS AND ADMINISTRATOR........... 18
DETERMINATION OF NET ASSET VALUE AND PERFORMANCE................... 21
DISTRIBUTION OF SHARES............................................. 24
ALLOCATION OF PORTFOLIO BROKERAGE.................................. 25
CUSTODIAN.......................................................... 26
TAXES ..............................................................27
SHAREHOLDER MEETINGS............................................... 27
INDEPENDENT ACCOUNTANTS............................................ 28
FINANCIAL STATEMENTS............................................... 29
DESCRIPTION OF SECURITIES RATINGS.................................. 29
No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated October 31, 1998 and, if given or made,
such information or representations may not be relied upon as having been
authorized by Eastcliff Funds, Inc.
The Statement of Additional Information does not constitute an offer
to sell securities.
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GENERAL INFORMATION AND HISTORY
Eastcliff Funds, Inc., a Wisconsin corporation organized on May 23,
1986 (the "Corporation"), is an open-end, diversified investment management
company consisting of four portfolios, Eastcliff Growth Fund (the "Growth
Fund"), Eastcliff Total Return Fund (the "Total Return Fund"), Eastcliff
Regional Small Capitalization Value Fund (the "Regional Small Cap Fund") and
Eastcliff Contrarian Value Fund (the "Contrarian Value Fund") (collectively, the
"Eastcliff Funds" or the "Funds"). The Corporation was called "Fiduciary Total
Return Fund, Inc." prior to December 23, 1994.
INVESTMENT RESTRICTIONS
As set forth in the prospectus dated October 31, 1998 of the
Corporation under the caption "Investment Objectives and Policies", the
investment objective of the Growth Fund is to produce long-term growth of
capital. The investment objective of the Total Return Fund is to realize a
combination of capital appreciation and income which will result in the highest
total return, while assuming reasonable risks. (The term "reasonable risks"
refers to the judgment of the Total Return Fund's investment adviser or
portfolio manager that investment in certain securities would not present an
excessive risk of loss in light of current and anticipated future general market
and economic conditions, trends in yields and interest rates, and fiscal and
monetary policies.) The investment objective of the Regional Small Cap Fund is
to produce capital appreciation. The investment objective of the Contrarian
Value Fund is to produce long-term capital appreciation. Consistent with these
investment objectives, each of the Funds has adopted the following investment
restrictions which are matters of fundamental policy. Each Fund's fundamental
investment policies cannot be changed without approval of the holders of the
lesser of: (i) 67% of that Fund's shares present or represented at a
shareholders' meeting at which the holders of more than 50% of such shares are
present or represented; or (ii) more than 50% of the outstanding shares of that
Fund.
1. None of the Funds will purchase securities on margin, participate
in a joint-trading account, sell securities short, or write or invest in put or
call options, except that (a) the Growth Fund may invest for hedging purposes up
to 5% of its net assets in put or call options and options on futures contracts
and up to 5% of its net assets in futures contracts, and (b) each of the
Regional Small Cap Fund and the Contrarian Value Fund may write or invest in put
and call options to the extent permitted by the Investment Company Act of 1940.
No Fund's investments in warrants, valued at the lower of cost or market, will
exceed 5% of the value of such Fund's net assets.
2. None of the Funds will borrow money or issue senior securities,
except for temporary bank borrowings (not in excess of 5% of the value of its
net assets) or for emergency or extraordinary purposes, and none of the Funds
will pledge any of its assets, except to secure borrowings and only to an extent
not greater than 10% of the value of such Fund's net assets.
3. None of the Funds will lend money (except by purchasing publicly
distributed debt securities or entering into repurchase agreements provided that
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repurchase agreements maturing in more than seven days plus all other illiquid
securities will not exceed 10% of such Fund's net assets) or will lend its
portfolio securities. A repurchase agreement involves a sale of securities to a
Fund with the concurrent agreement of the seller to repurchase the securities at
the same price plus an amount equal to an agreed upon interest rate, within a
specified time. In the event of a bankruptcy or other default of a seller of a
repurchase agreement, such Fund could experience both delays in liquidating the
underlying securities and losses, including: (a) possible decline in value of
the collateral during the period while such Fund seeks to enforce its rights
thereto; (b) possible decreased levels of income during this period; and (c)
expenses of enforcing its rights.
4. None of the Funds will make investments for the purpose of
exercising control or management of any company.
5. None of the Funds will purchase securities of any issuer (other
than the United States or an agency or instrumentality of the United States) if,
as a result of such purchase, such Fund would hold more than 10% of any class of
securities, including voting securities, of such issuer or more than 5% of such
Fund's assets, taken at current value, would be invested in securities of such
issuer, except that up to 25% of the assets of each of the Regional Small Cap
Fund and the Contrarian Value Fund may be invested without regard to these
limitations.
6. None of the Funds will concentrate more than 25% of the value of
its net assets, determined at the time an investment is made, exclusive of
government securities, in securities issued by companies primarily engaged in
the same industry.
7. None of the Funds will acquire or retain any security issued by a
company, an officer or director of which is an officer or director of the
Corporation or an officer, director or other affiliated person of any Fund's
investment adviser.
8. None of the Funds will acquire or retain any security issued by a
company if any of the directors or officers of the Corporation, or directors,
officers or other affiliated persons of any Fund's investment adviser,
beneficially own more than 1/2% of such company's securities and all of the
above persons owning more than 1/2% own together more than 5% of its securities.
9. None of the Funds will act as an underwriter or distributor of
securities other than shares of the Corporation and none of the Funds, other
than the Contrarian Value Fund, may purchase any securities which are restricted
from sale to the public without registration under the Securities Act of 1933,
as amended.
10. None of the Funds will purchase oil, gas or other mineral leases
or any interest in any oil, gas or any other mineral exploration or development
program.
11. None of the Funds will purchase or sell real estate, real estate
mortgage loans or real estate limited partnerships.
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12. None of the Funds will purchase or sell commodities or commodities
contracts, except that the Growth Fund may invest in futures contracts and
options on future contracts to the extent set forth in Investment Restriction
No. 1 above.
13. The Total Return Fund will not invest more than 5% of its total
assets, and each of the Growth Fund, the Regional Small Cap Fund and the
Contrarian Value Fund will not invest more than 10% of its total assets, in
securities of issuers which have a record of less than three years of continuous
operation, including the operation of any predecessor business of a company
which came into existence as a result of a merger, consolidation, reorganization
or purchase of substantially all of the assets of such predecessor business.
The following investment limitation is not fundamental, and may be
changed without shareholder approval.
1. None of the Funds will purchase securities of other investment
companies except (a) as part of a plan of merger, consolidation or
reorganization approved by the shareholders of such Fund; (b) securities of
money market mutual funds; or (c) securities of registered closed-end investment
companies on the open market where no commission or profit results, other than
the usual and customary broker's commission. No purchases described in (b) and
(c) will be made if as a result of such purchase such Fund would hold more than
3% of any class of securities, including voting securities, of any registered
investment company or more than 5% of such Fund's assets, taken at current
value, would be invested in the securities of any registered investment company
or in securities of registered closed-end investment companies.
INVESTMENT CONSIDERATIONS
Low-Rated Securities
As set forth in the Funds' prospectus dated October 31, 1998 under the
caption "Investment Practices and Risks", each of the Funds will limit its
investments in convertible securities to those for which such Fund's investment
adviser believes (a) the underlying common stock is a suitable investment for
that Fund and (b) a greater potential for total return exists by purchasing the
convertible security because of its higher yield. Moreover, none of the Funds
will invest more than 5% of its net assets at the time of investment in
convertible securities rated less than investment grade.
Corporate obligations rated less than investment grade (hereinafter
referred to as "low-rated securities") are commonly referred to as "junk bonds",
and while generally offering higher yields than investment grade securities with
similar maturities, involve greater risks, including the possibility of default
or bankruptcy. They are regarded as predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal. The special risk
considerations in connection with investments in low-rated securities are
discussed below.
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Effect of Interest Rates and Economic Changes. Even though the
exposure of each of the Funds to the low-rated security market is limited to a
maximum of 5% of its net assets, the Funds are required to provide the following
discussion of such market.
The low-rated security market is relatively new and its growth
paralleled a long economic expansion. As a result, it is not clear how this
market may withstand a prolonged recession or economic downturn. Such a
prolonged economic downturn could severely disrupt the market for and adversely
affect the value of high-yield securities.
Interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of low-rated securities tend to reflect individual corporate developments
to a greater extent than do higher rated securities, which react primarily to
fluctuations in the general level of interest rates. Low-rated securities also
tend to be more sensitive to economic conditions than are higher-rated
securities. As a result, they generally involve more credit risks than
securities in the higher-rated categories. During an economic downturn or a
sustained period of rising interest rates, highly leveraged issuers of low-rated
securities may experience financial stress and may not have sufficient revenues
to meet their payment obligations. The issuer's ability to service its debt
obligations may also be adversely affected by specific corporate developments,
or the issuer's inability to meet specific projected business forecasts or the
unavailability of additional financing. The risk of loss due to default by an
issuer of low-rated securities is significantly greater than issuers of
higher-rated securities because such securities are generally unsecured and are
often subordinated to other creditors. Further, if the issuer of a low-rated
security defaulted, the applicable Fund might incur additional expenses in
seeking recovery. Periods of economic uncertainty and changes would also
generally result in increased volatility in the market prices of low-rated
securities and thus in the applicable Fund's net asset value.
As previously stated, the value of a low-rated security generally will
decrease in a rising interest rate market, and accordingly, so normally will the
applicable Fund's net asset value. If such Fund experiences unexpected net
redemptions in such a market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment merits. Due to the
limited liquidity of low-rated securities (discussed below), the Fund may be
forced to liquidate these securities at a substantial discount. Any such
liquidation would reduce the Fund's asset base over which expenses could be
allocated and could result in a reduced rate of return for the Fund.
Payment Expectations. Low-rated securities typically contain
redemption, call or prepayment provisions which permit the issuer of such
securities containing such provisions to, at their discretion, redeem the
securities. During periods of falling interest rates, issuers of low-rated
securities are likely to redeem or prepay the securities and refinance them with
debt securities with a lower interest rate. To the extent an issuer is able to
refinance the securities or otherwise redeem them, the applicable Fund may have
to replace the securities with a lower yielding security which would result in
lower returns for the Fund.
Credit Ratings. Credit ratings issued by credit rating agencies
evaluate the safety of principal and interest payments of rated securities. They
do not, however, evaluate
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the market value risk of low-rated securities and therefore may not fully
reflect the true risks of an investment. In addition, credit rating agencies may
or may not make timely changes in a rating to reflect changes in the economy or
in the condition of the issuer that affect the market value of the security.
Consequently, credit ratings are used only as a preliminary indicator of
investment quality.
Liquidity and Valuation. A Fund may have difficulty disposing of
certain low-rated securities because there may be a thin trading market for such
securities. Because not all dealers maintain markets in all low-rated securities
there is no established retail secondary market for many of these securities.
The Funds anticipate that such securities could be sold only to a limited number
of dealers or institutional investors. To the extent a secondary trading market
does exist, it is generally not as liquid as the secondary market for higher
rated securities. The lack of a liquid secondary market may have an adverse
impact on the market price of the security, and accordingly, the net asset value
of a particular Fund and its ability to dispose of particular securities when
necessary to meet its liquidity needs, or in response to a specific economic
event, or an event such as a deterioration in the creditworthiness of the
issuer. The lack of a liquid secondary market for certain securities may also
make it more difficult for a Fund to obtain accurate market quotations for
purposes of valuing their respective portfolios. Market quotations are generally
available on many low-rated issues only from a limited number of dealers and may
not necessarily represent firm bids of such dealers or prices for actual sales.
During periods of thin trading, the spread between bid and asked prices is
likely to increase significantly. In addition, adverse publicity and investor
perceptions, whether or not based on fundamental analysis, may decrease the
values and liquidity of high-yield securities, especially in a thinly-traded
market.
Mortgage-Backed and Asset-Backed Securities
Each of the Funds may purchase residential and commercial
mortgage-backed as well as other asset-backed securities (collectively called
"asset-backed securities") that are secured or backed by automobile loans,
installment sale contracts, credit card receivables or other assets and are
issued by entities such as Government National Mortgage Association ("GNMA"),
Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage
Corporation ("FHLMC"), commercial banks, trusts, financial companies, finance
subsidiaries of industrial companies, savings and loan associations, mortgage
banks and investment banks. These securities represent interests in pools of
assets in which periodic payments of interest and/or principal on the securities
are made, thus, in effect passing through periodic payments made by the
individual borrowers on the assets that underlie the securities, net of any fees
paid to the issuer or guarantor of the securities. The average life of these
securities varies with the maturities and the prepayment experience of the
underlying instruments.
There are a number of important differences among the agencies and
instrumentalities of the U.S. government that issue mortgage-backed securities
and among the securities that they issue. Mortgage-backed securities guaranteed
by GNMA include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Maes") which are guaranteed as to the timely payment of principal and interest
by GNMA and such guarantee is backed by the
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full faith and credit of the United States. GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA certificates also are supported by the authority of GNMA to borrow funds
from the U.S. Treasury to make payments under its guarantee. Mortgage-backed
securities issued by FNMA include FNMA Guaranteed Mortgage Pass-Through
Certificates (also known as "Fannie Maes") which are solely the obligations of
FNMA and are not backed by or entitled to the full faith and credit of the
United States, but are supported by the right of the issuer to borrow from the
Treasury. FNMA is a government-sponsored organization owned entirely by private
stockholders. Fannie Maes are guaranteed as to timely payment of the principal
and interest by FNMA. Mortgage-backed securities issued by the FHLMC include
FHLMC Mortgage Participation Certificates (also known as "Freddie Macs" or
"PCs"). FHLMC is a corporate instrumentality of the United States, created
pursuant to an Act of Congress. Freddie Macs are not guaranteed by the United
States or by any Federal Home Loan Bank and do not constitute a debt or
obligation of the United States or of any Federal Home Loan Bank. Freddie Macs
entitle the holder to timely payment of interest, which is guaranteed by the
FHLMC. FHLMC guarantees either ultimate collection or timely payment of all
principal payments on the underlying mortgage loans. When FHLMC does not
guarantee timely payment of principal, FHLMC may remit the amount due on account
of its guarantee of ultimate payment of principal at any time after default on
an underlying mortgage, but in no event later than one year after it becomes
payable.
Each of the Funds may also purchase mortgage-backed securities
structured as CMOs. CMOs are issued in multiple classes and their relative
payment rights may be structured in many ways. In many cases, however, payments
of principal are applied to the CMO classes in order of their respective
maturities, so that no principal payments will be made on a CMO class until all
other classes having an earlier maturity date are paid in full. The classes may
include accrual certificates (also known as "Z-Bonds"), which do not accrue
interest at a specified rate until other specified classes have been retired and
are converted thereafter to interest-paying securities. They may also include
planned amortization classes ("PACs") which generally require, within certain
limits, that specified amounts of principal be applied to each payment date, and
generally exhibit less yield and market volatility than other classes. The
classes may include "IOs" which pay distributions consisting solely or primarily
for all or a portion of the interest in an underlying pool of mortgages or
mortgage-backed securities. "POs" which pay distributions consisting solely or
primarily of all or a portion of principal payments made from the underlying
pool of mortgages or mortgage-backed securities, and "inverse floaters" which
have a coupon rate that moves in the reverse direction to an applicable index.
Investments in CMO certificates can expose the Funds to greater
volatility and interest rate risk than other types of mortgage-backed
obligations. Among tranches of CMOs, inverse floaters are typically more
volatile than fixed or adjustable rate tranches of CMOs. Investments in inverse
floaters could protect a Fund against a reduction in income due to a decline in
interest rates. A Fund would be adversely affected by the purchase of an inverse
floater in the event of an increase in interest rates because the coupon rate
thereon will decrease as interest rates increase, and like other mortgage-backed
securities, the value of an inverse floater will decrease as interest rates
increase. The cash flows and yields on IO and
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PO classes are extremely sensitive to the rate of principal payments (including
prepayments) on the related underlying pool of mortgage loans or mortgage-backed
securities. For example, a rapid or slow rate of principal payments may have a
material adverse effect on the yield to maturity of IOs or POs, respectively. If
the underlying assets experience greater than anticipated prepayments of
principal, the holder of an IO may incur substantial losses irrespective of its
rating. Conversely, if the underlying assets experience slower than anticipated
prepayments of principal, the yield and market value for the holders of a PO
will be affected more severely than would be the case with a traditional
mortgage-backed security. Prepayments on mortgage-backed securities generally
increase with falling interest rates and decrease with rising interest rates.
Prepayments are also influenced by a variety of other economic and social
factors.
The yield characteristics of asset-backed securities differ from
traditional debt securities. A major difference is that the principal amount of
the obligations may be prepaid at any time because the underlying assets (i.e.,
loans) generally may be prepaid at any time. As a result, if an asset-backed
security is purchased at a premium, a prepayment rate that is faster than
expected may reduce yield to maturity, while a prepayment rate that is slower
than expected may have the opposite effect of increasing yield to maturity.
Conversely, if an asset-backed security is purchased at a discount, faster than
expected prepayments may increase, while slower than expected prepayments may
decrease, yield to maturity.
In general, the collateral supporting non-mortgage asset-backed
securities is of shorter maturity than mortgage loans. Like other fixed income
securities, when interest rates rise the value for an asset-backed security
generally will decline; however, when interest rates decline, the value of an
asset-backed security with prepayment features may not increase as much as that
of other fixed income securities.
Hedging Instruments
As set forth above under the caption "Investment Restrictions", the
Growth Fund may invest up to 5% of its net assets in put or call options and
options on futures contracts and up to 5% of its net assets in futures
contracts. Similarly, as set forth in the Prospectus under the captions
"Investment Objectives and Policies -- Eastcliff Regional Small Capitalization
Value Fund" and "Investment Objectives and Policies --Eastcliff Contrarian Value
Fund", each of the Regional Small Cap Fund and Contrarian Value Fund may
purchase put and call options on equity securities and on stock indices and
write covered call options on equity securities owned by the Fund, provided not
more than 5% of the Fund's net assets will be invested in put and call options
and the premiums received by the Fund with respect to unexpired call options
written by the Fund will not exceed 5% of the Fund's net assets. The foregoing
investments will be effected during periods of anticipated market weakness and
will not result in leveraging of the applicable Fund's portfolio.
Futures Contracts. When the Growth Fund purchases a futures contract,
it agrees to purchase a specified underlying instrument at a specified future
date. When the Growth Fund sells a futures contract, it agrees to sell the
underlying instrument at a specified future date. The price at which the
purchase and sale will take place is fixed when the Growth
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Fund enters into the contract. Futures can be held until their delivery dates,
or can be closed out before then if a liquid secondary market is available.
The value of a futures contract tends to increase and decrease in
tandem with the value of its underlying instrument. Therefore, purchasing
futures contracts will tend to increase the Growth Fund's exposure to positive
and negative price fluctuations in the underlying instrument, much as if the
Growth Fund had purchased the underlying instrument directly. When the Growth
Fund sells a futures contract, by contrast, the value of its future position
will tend to move in a direction contrary to the market. Selling futures
contracts, therefore, will tend to offset both positive and negative market
price changes, much as if the underlying instrument had been sold.
Futures Margin Payments. The purchaser or seller of a futures contract
is not required to deliver or pay for the underlying instrument unless the
contract is held until the delivery date. However, both the purchaser and seller
are required to deposit "initial margin" with a futures broker, known as a
Futures Commission Merchant ("FCM"), when the contract is entered into. Initial
margin deposits are equal to a percentage of the contract's value. If the value
of either party's position declines, that party will be required to make
additional "variation margin" payments to settle the change in value on a daily
basis. The party that has a gain may be entitled to receive all or a portion of
this amount. Initial and variation margin payments do not constitute purchasing
securities on margin for purposes of the Growth Fund's investment limitations.
In the event of the bankruptcy of an FCM that holds margin on behalf of the
Growth Fund, such Fund may be entitled to return of margin owed to it only in
proportion to the amount received by the FCM's other customers, potentially
resulting in losses to the Fund.
Purchasing Put and Call Options. By purchasing a put option, the
Growth Fund, the Regional Small Cap Fund or the Contrarian Value Fund, as the
case may be, obtains the right (but not the obligation) to sell the option's
underlying instrument at a fixed strike price. In return for this right, the
Fund pays the current market price for the option (known as the option premium).
The Growth Fund may purchase options on futures contracts, as well as options on
equity securities and stock indices. The Regional Small Cap Fund and the
Contrarian Value Fund may purchase options on equity securities and on stock
indices. The Growth Fund, the Regional Small Cap Fund or the Contrarian Value
Fund, as the case may be, may terminate its position in a put option it has
purchased by allowing it to expire or by exercising the option. If the option is
allowed to expire, the Fund will lose the entire premium it paid. If a Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. Such Fund may also terminate a put option position by closing it
out in the secondary market at its current price, if a liquid secondary market
exists. The buyer of a put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus related
transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the
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underlying instrument at the option's strike price. A call buyer attempts to
participate in potential price increases of the underlying instrument with risk
limited to the cost of the option if security prices fall. At the same time, the
buyer can expect to suffer a loss if security prices do not rise sufficiently to
offset the cost of the option. Only exchange listed options will be acquired.
Stock Index Options. Stock index options are put options and call
options on various stock indexes. In most respects, they are identical to listed
options on common stocks. The primary difference between stock options and index
options occurs when index options are exercised. In the case of stock options,
the underlying security, common stock, is delivered. However, upon the exercise
of an index option, settlement does not occur by delivery of the securities
comprising the index. The option holder who exercises the index option receives
an amount of cash if the closing level of the stock index upon which the option
is based is greater than, in the case of a call, or less than, in the case of a
put, the exercise price of the option. This amount of cash is equal to the
difference between the closing price of the stock index and the exercise price
of the option expressed in dollars times a specified multiple. A stock index
fluctuates with changes in the market value of the stocks included in the index.
For example, some stock index options are based on a broad market index, such as
the Standard & Poor's 500 or the Value Line Composite Index, or a narrower
market index, such as the Standard & Poor's 100. Indexes also may be based on an
industry or market segment, such as the AMEX Oil and Gas Index or the Computer
and Business Equipment Index. Options on stock indexes are currently traded on
the following exchanges: the Chicago Board Options Exchange, the New York Stock
Exchange, the American Stock Exchange, the Pacific Stock Exchange, and the
Philadelphia Stock Exchange.
Writing Call and Put Options. When the Growth Fund, the Regional Small
Cap Fund or the Contrarian Value Fund, as the case may be, writes a call option,
it receives a premium and agrees to sell the related investments to a purchaser
of the call during the call period (usually not more than nine months) at a
fixed exercise price (which may differ from the market price of the related
investments) regardless of market price changes during the call period. If the
call is exercised, the Fund forgoes any gain from an increase in the market
price over the exercise price. When writing an option on a futures contract the
Growth Fund will be required to make margin payments to an FCM as described
above for futures contracts.
To terminate its obligations on a call which it has written, the
Growth Fund, the Regional Small Cap Fund or the Contrarian Value Fund, as the
case may be, may purchase a call in a "closing purchase transaction." (As
discussed above, such Funds may also purchase calls other than as part of such
closing transactions.) A profit or loss will be realized depending on the amount
of option transaction costs and whether the premium previously received is more
or less than the price of the call purchased. A profit may also be realized if
the call lapses unexercised, because the Fund retains the premium received. Any
such profits are considered short-term gains for federal income tax purposes
and, when distributed, are taxable as ordinary income.
Writing calls generally is a profitable strategy if prices remain the
same or fall. Through receipt of the option premium, a call writer mitigates the
effects of a price decline.
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At the same time, because a call writer must be prepared to deliver the
underlying instrument in return for the strike price, even if its current value
is greater, a call writer gives up some ability to participate in security price
increases.
When a Fund writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of a premium, the
Fund assumes the obligation to pay the strike price for the option's underlying
instrument if the other party to the option chooses to exercise it. The Growth
Fund may only write covered puts and the Regional Small Cap Fund and the
Contrarian Value Fund currently will not write put options. For a put to be
covered, the Growth Fund must maintain in a segregated account cash or
high-quality, short-term readily marketable obligations equal to the option
price. A profit or loss will be realized depending on the amount of option
transaction costs and whether the premium previously received is more or less
than the put purchased in a closing purchase transaction. A profit may also be
realized if the put lapses unexercised because the Fund retains the premium
received. Any such profits are considered short-term gains for federal income
tax purposes and, when distributed, are taxable as ordinary income.
Combined Option Positions. The Growth Fund, the Regional Small Cap
Fund or the Contrarian Value Fund may purchase and write options (subject to the
limitations discussed above) in combination with each other to adjust the risk
and return characteristics of the overall position. For example, either Fund may
purchase a put option and write a call option on the same underlying instrument,
in order to construct a combined position whose risk and return characteristics
are similar to selling a futures contract. Another possible combined position
would involve writing a call option at one strike price and buying a call option
at a lower price, in order to reduce the risk of the written call option in the
event of a substantial price increase. Because combined options involve multiple
trades, they result in higher transaction costs and may be more difficult to
open and close out.
Correlation of Price Changes. Because there are a limited number of
types of exchange-traded options and futures contracts, it is likely that the
standardized contracts available will not match the applicable Fund's current or
anticipated investments. The Growth Fund, the Regional Small Cap Fund or the
Contrarian Value Fund may invest in options and (with respect to the Growth Fund
only) futures contracts based on securities which differ from the securities in
which it typically invests. This involves a risk that the options or futures
position will not track the performance of the Fund's investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instrument match the applicable
Fund's investments well. Options and future prices are affected by such factors
as current and anticipated short-term interest rates, changes in volatility of
the underlying instrument, and the time remaining until expiration of the
contract, which may not affect security prices the same way. Imperfect
correlation may also result from differing levels of demand in the options and
futures markets and the securities markets, from structural differences in how
options and futures and securities are traded, or from imposition of daily price
fluctuation limits or trading halts. The Growth Fund, the Regional Small Cap
Fund and the Contrarian Value Fund may purchase or sell options and (with
respect to the Growth Fund only) futures contracts with a greater or less
-10-
<PAGE>
value than the securities it wishes to hedge or intends to purchase in order to
attempt to compensate for differences in historical volatility between the
contract and the securities, although this may not be successful in all cases.
If price changes in the applicable Fund's options or futures positions are
poorly correlated with its other investments, the positions may fail to produce
anticipated gains or result in losses that are not offset by gains in other
investments. Successful use of these techniques requires skills different from
those needed to select portfolio securities.
Liquidity of Options and Futures Contracts. There is no assurance a
liquid secondary market will exist for any particular option or futures contract
at any particular time. Options may have relatively low trading volume and
liquidity if their strike prices are not close to the underlying instruments'
current price. In addition, exchanges may establish daily price fluctuation
limits for options and futures contracts, and may halt trading if a contract's
price moves upward or downward more than the limit in a given day. On volatile
trading days when the price fluctuation limit is reached or a trading halt is
imposed, it may be impossible for the Growth Fund, the Regional Small Cap Fund
or the Contrarian Value Fund, as the case may be, to enter into new positions or
close out existing positions. If the secondary market for a contract is not
liquid because of price fluctuation limits or otherwise, it could prevent prompt
liquidation of unfavorable positions, and potentially could require the
applicable Fund to continue to hold a position until delivery or expiration
regardless of changes in its value. As a result, such Fund's access to other
assets held to cover its options or futures positions could also be impaired.
Asset Coverage for Futures and Option Positions. The Growth Fund, the
Regional Small Cap Fund and the Contrarian Value Fund will comply with
guidelines established by the Securities and Exchange Commission with respect to
coverage of options and futures strategies by mutual funds, and if the
guidelines so require will set aside cash or liquid securities in a segregated
custodial account in the amount prescribed. Securities held in a segregated
account cannot be sold while the futures or option strategy is outstanding,
unless they are replaced with other suitable assets. As a result, there is a
possibility that segregation of a portion of the applicable Fund's assets could
impede portfolio management or such Fund's ability to meet redemption requests
or other current obligations.
Special Risks of Hedging and Income Enhancement Strategies.
Participation in the options or futures markets involves investment risks and
transactions costs to which the Growth Fund, the Regional Small Cap Fund or the
Contrarian Value Fund, as applicable, would not be subject absent the use of
these strategies. In particular, the loss from investing in futures contracts is
potentially unlimited. If the applicable Fund's portfolio manager(s)' prediction
of movements in the direction of the securities and interest rate markets are
inaccurate, the adverse consequences to such Fund may leave such Fund in a worse
position than if such strategies were not used. Risks inherent in the use of
futures contracts and options on futures contracts include: (1) dependence on
the portfolio manager(s)' ability to predict correctly movements in the
direction of interest rates, securities prices and currency markets; (2)
imperfect correlation between the price of options and futures contracts and
options thereon and movements in the prices of the securities being hedged; (3)
the fact that skills needed to use these strategies are different from those
needed to select portfolio securities; (4) the
-11-
<PAGE>
possible absence of a liquid secondary market for any particular instrument at
any time; and (5) the possible need to defer closing out certain hedged
positions to avoid adverse tax consequences.
Illiquid Securities. Each of the Funds may invest up to 10% of
its net assets in securities for which there is no readily available market
("illiquid securities"). The 10% limitation includes certain securities whose
disposition would be subject to legal restrictions ("restricted securities")
which may be purchased by the Contrarian Value Fund but not the other Funds.
However, certain restricted securities that may be resold pursuant to Rule 144A
under the Securities Act may be considered liquid. The Board of Directors of the
Corporation has delegated to Resource Capital Advisers, Inc. (the "Adviser") the
day-to-day determination of the liquidity of a security although it has retained
oversight and ultimate responsibility for such determinations. Although no
definite quality criteria are used, the Board of Directors has directed the
Adviser to consider such factors as (i) the nature of the market for a security
(including the institutional private resale markets); (ii) the terms of these
securities or other instruments allowing for the disposition to a third party or
the issuer thereof (e.g. certain repurchase obligations and demand instruments);
(iii) and availability of market quotations; and (iv) other permissible factors.
Restricted securities may be sold in private negotiated or other
exempt transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. When registration is required,
the Contrarian Value Fund may be obligated to pay all or part of the
registration expenses and a considerable time may elapse between the decision to
sell and the sale date. If, during such period, adverse market conditions were
to develop, the Contrarian Value Fund might obtain a less favorable price than
the price which prevailed when it decided to sell. Restricted securities will be
priced at fair value as determined in good faith by the Board of Directors.
DIRECTORS AND OFFICERS OF THE CORPORATION
The name, age, address, principal occupation(s) during the past five
years and other information with respect to each of the directors and officers
of the Corporation are as follows:
CONLEY BROOKS, JR.*
- -------------------
900 Second Avenue South
Suite 300
Minneapolis, Minnesota 55402
(PRESIDENT AND A DIRECTOR OF THE CORPORATION)
Mr. Brooks, age 52, has been President of Brooks Associates, Inc., an
asset and investment management firm, since 1982. He has been Chairman of the
Board of
- -------------------------
*Messrs. Brooks, Welch and Wilson are directors who are "interested persons" of
the Fund as that term is defined in the Investment Company Act of 1940.
-12-
<PAGE>
Resource Companies, Inc. since 1992 and was elected CEO in 1998. Resource
Companies, Inc. is a bank holding company which owns Resource Trust Company
(where Mr. Brooks has also been CEO since 1998), the corporate parent of
Resource Capital Advisers, Inc. Mr. Brooks has been President and a director of
the Corporation since December, 1994.
ROLF ENGH
- ---------
1101 S. 3rd St.
Minneapolis, Minnesota 55415
(A DIRECTOR OF THE CORPORATION)
Mr. Engh, age 45, has been General Counsel, Vice
President-International Sales, General Manager Color Corp. and Corporate
Secretary of The Valspar Corporation, a paint manufacturing company, since 1993.
Mr. Engh has been a director of the Corporation since July, 1998.
JOHN J. FAUTH
- -------------
3100 Metropolitan Centre 333 South Seventh Street Minneapolis, Minnesota 55402
(A DIRECTOR OF THE CORPORATION)
Mr. Fauth, age 53, has been Chairman and Chief Executive Officer of
The Churchill Companies, a private investment company, since April, 1982. Mr.
Fauth has been a director of the Corporation since December, 1994. He is also a
director of Kinnard Investments, Inc.
A. SKIDMORE THORPE
- ------------------
4900 IDS Center
80 South Eighth Street
Minneapolis, Minnesota 55402
(A DIRECTOR OF THE CORPORATION)
Mr. Thorpe, age 69, is a private investor; he has been Chairman of
Andrus California Timberland Partnerships, a private investment firm, since
1988. Mr. Thorpe has been a director of the Corporation since December, 1994.
E. THOMAS WELCH*
- ----------------
900 Second Avenue South
Suite 300
Minneapolis, Minnesota 55402
(VICE PRESIDENT AND A DIRECTOR OF THE CORPORATION)
-13-
<PAGE>
Mr. Welch, age 60, has been President and Managing Director of
Resource Trust Company since 1984, President of Resource Companies, Inc. since
January, 1990 and Chief Operating Officer of Resource Capital Advisers, Inc.
since February, 1992. He has served as Vice President and a director of the
Corporation since December, 1994. Mr. Welch is also a director of Casino Magic.
JOHN A. CLYMER
- --------------
900 Second Avenue South
Suite 300
Minneapolis, Minnesota 55402
(VICE PRESIDENT, SECRETARY AND TREASURER OF THE CORPORATION)
Mr. Clymer, age 50, has been a Managing Director of Resource Trust
Company and President of Resource Capital Advisers, Inc. since 1994. Prior to
joining the Resource companies, he was president of Minnesota Mutual Life
Insurance Company, and had held various positions within Minnesota Mutual Life
Insurance Company since 1972. Mr. Clymer has served as a Vice President of the
Corporation since June, 1996 and as Secretary and Treasurer of the Corporation
since June, 1997. Mr. Clymer is a director of Hanover Capital Mortgage Holdings,
Inc., a real estate investment trust, and WTC Industries, Inc.
DONALD S. WILSON*
- ----------------
225 East Mason Street Milwaukee, Wisconsin 53202 (A DIRECTOR OF THE CORPORATION)
Mr. Wilson, age 55, co-founded Fiduciary Management, Inc., a
Milwaukee, Wisconsin, investment advisory firm, in 1980 and has served as a
director and in various executive capacities since that time, including as
President and Treasurer since 1987. Mr. Wilson has served in various capacities
with the Corporation since its inception in 1986. He has been a director of the
Corporation since 1987. From 1986 through December, 1994, Mr. Wilson served as
Vice President and Assistant Secretary of the Corporation, and from December,
1994 through June, 1997, he served as Secretary and Treasurer of the
Corporation. Mr. Wilson also serves as a director of Fiduciary Capital Growth
Fund, Inc. and FMI Funds, Inc.
A. RODNEY BOREN
- ---------------
900 Second Avenue South
Suite 300
Minneapolis, Minnesota 55402
(VICE PRESIDENT OF THE CORPORATION)
- ------------------------------
* Messrs. Brooks, Welch and Wilson are directors who are "interested persons" of
the Fund as that term is defined in the Investement Company Act of 1940.
-14-
<PAGE>
Mr. Boren, age 52, has been a Managing Director of Resource
Trust Company since January, 1996. Prior to joining Resource Trust Company, he
was with Norwest Bank since 1974, most recently serving as Executive Vice
President, Norwest Institutional Trust Services, from 1990 to 1995. Mr. Boren
served as an Investment Officer of the Corporation from February, 1996 to June,
1997 and has served as Vice President of the Corporation since June, 1997.
SARAH A. HILLESHEIM
- -------------------
900 Second Avenue South
Suite 300
Minneapolis, Minnesota 55402
(VICE PRESIDENT AND ASSISTANT SECRETARY OF THE CORPORATION)
Ms. Hillesheim, age 37, has been employed at Resource Capital
Advisers, Inc. in various capacities since 1994. From November 1992 until June
1994, she was employed at the Center for Diagnostic Imaging. Ms. Hillesheim has
been a Vice President and Assistant Secretary of the Corporation since November,
1995.
ROBERT W. WHALEN
- ----------------
249 Royal Palm Way
Suite 400
Palm Beach, Florida 33480
(VICE PRESIDENT OF THE CORPORATION)
Mr. Whalen, age 55, has been President and Chief Executive Officer of
Palm Beach Investment Advisers, LLC. since April 1998. From 1992 to April 1998
he was the Vice President/Managing Director of U.S. Trust Company of Florida in
Vero Beach Florida. Mr. Whalen served as Vice President of Managers Funds, Inc.
from 1990 to 1992 and Greenwich Capital Markets, Inc. from 1988 to 1990 and
Chief Executive Officer of Lomas & Nettleton Securities Corp. from 1983 to 1988.
PATRICE J. NEVERETT
- -------------------
249 Royal Palm Way
Suite 400
Palm Beach, Florida 33480
(VICE PRESIDENT OF THE CORPORATION)
Ms. Neverett, age 45, has been Executive Vice President and Senior
Portfolio Manager of Palm Beach Investment Advisers, LLC. since 1990. Ms.
Neverett is the Investment Manager of the Eastcliff Total Return Fund.
The Corporation's standard method of compensating directors is to pay
each director who is not an officer of the Corporation a fee of $500 for each
meeting of the Board
-15-
<PAGE>
of Directors attended. During the fiscal year ended June 30, 1998 the
Corporation paid $1,000 in directors' fees to the Corporation's directors who
are not officers of the Corporation. The table below sets forth the compensation
paid by the Corporation to each of the current directors of the Corporation
during the fiscal year ended June 30, 1998:
<TABLE>
COMPENSATION TABLE
<CAPTION>
Total
Pension or Retirement Estimated Annual Compensation
Name of Aggregate Compensation Benefits Accrued As Benefits Upon from Corporation
Person from Corporation Part of Fund Expenses Retirement Paid to Directors
------ ---------------- --------------------- ---------- -----------------
<S> <C> <C> <C> <C>
Conley Brooks, Jr. $0 $0 $0 $0
John J. Fauth $500 $0 $0 $500
A. Skidmore Thorpe $500 $0 $0 $500
E. Thomas Welch $0 $0 $0 $0
Donald S. Wilson $0 $0 $0 $0
Rolf Engh* $0 $0 $0 $0
- ------------------
<FN>
*Mr. Engh did not become a director of the Corporation until July, 1998.
</FN>
</TABLE>
OWNERSHIP OF MANAGEMENT AND PRINCIPAL SHAREHOLDERS
As of September 30, 1998. All officers and directors of the
Corporation as a group (11 persons) beneficially owned 139,537 shares of the
Growth Fund (which constituted 3.83% of its then outstanding shares), 2,514
shares of the Total Return Fund (which constituted 0.21% of its then outstanding
shares), 28,689 shares of the Regional Small Cap Fund (which constituted 0.64%
of its then outstanding shares) and 4,970 shares of the Contrarian Value Fund
(which constituted 0.25% of its then outstanding shares). As of such date, the
sole beneficial holders of more than 5% of the Growth Fund's then outstanding
shares were Resource Trust Company, Suite 300, 900 Second Avenue South,
Minneapolis, Minnesota 55402, which owned 3,127,444 shares of such Fund
(constituting 85.82% of its then outstanding shares), and Hollybrook & Company,
an affiliate of Conley Brooks, Jr., which owned 207,273 shares of the Growth
Fund (constituting 5.69% of its then outstanding shares). The Growth Fund shares
held by Hollybrook & Company are included in the 3,127,444 shares held by
Resource Trust Company. As of the same date, the sole beneficial holder of more
than 5% of the Total Return Fund's then outstanding shares was Resource Trust
Company, Suite 300, 900 Second Avenue South, Minneapolis, Minnesota 55402, which
owned 1,065,035 shares, or 90.30% of the total shares of such Fund then
outstanding. As of the same date, the sole beneficial holders of more than 5% of
the Regional Small Cap Fund's then outstanding shares were Resource Trust
Company, Suite 300, 900 Second Avenue South, Minneapolis, Minnesota 55402, which
owned 1,683,256 shares of such Fund (constituting 37.78% of its then outstanding
shares), First Trust National Association, 180 E. 5 St., P.O. Box 64488, St.
Paul, Minnesota 55164-0488, which owned 988,433 shares of such Fund
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<PAGE>
(constituting 22.18% of its then outstanding shares), and Norwest Bank MN, NA,
P. O. Box 1533, Minn, MN 55480, which owned 266,344 shares of such Fund
(constituting 5.98% of its then outstanding shares). As of the same date, the
sole beneficial holder of more than 5% of the Contrarian Value Fund's then
outstanding shares was Resource Trust Company, 900 Second Avenue South, Minn, MN
55402, which owned 1,894,333 shares, or 95.08% of the total shares of such Fund
then outstanding. Resource Trust Company, a Minnesota corporation, is the parent
company of Resource Capital Advisers, Inc., the investment adviser to each of
the Funds.
The Growth Fund, the Total Return Fund, the Regional Small Cap Fund,
the Contrarian Value Fund and the Corporation are controlled by Resource Trust
Company. Resource Trust Company owns sufficient shares of the Growth Fund, the
Total Return Fund, the Contrarian Value Fund and, with First Trust National
Association, the Regional Small Cap Fund to approve or disapprove all matters
brought before shareholders of such Funds, including the election of directors
of the Corporation and the approval of auditors. The Corporation does not
control any person.
INVESTMENT ADVISER, PORTFOLIO MANAGERS AND ADMINISTRATOR
As set forth in the Prospectus under the caption "Management of the
Funds" the investment adviser to each of the Funds is Resource Capital Advisers,
Inc. (the "Adviser"), the portfolio manager to the Growth Fund is Winslow
Capital Management, Inc. ("WCM"), the portfolio manager to the Total Return Fund
is Palm Beach Investment Advisers, LLC ("PBIA"), the portfolio manager to the
Regional Small Cap Fund is Woodland Partners LLC ("WP") and the portfolio
manager to the Contrarian Value Fund is Sasco Capital, Inc. ("Sasco"). The
Adviser is a wholly-owned subsidiary of Resource Trust Company, a Minnesota
state bank. Resource Trust Company is a wholly-owned subsidiary of Resource
Companies, Inc., a Minnesota corporation. The Adviser's executive officers
include E. Thomas Welch, Chief Operating Officer, John A. Clymer, President,
Compliance Officer and Chief Investment Officer, and Dan W. Melcher, Chief
Financial Officer. The directors of the Adviser are E. Thomas Welch, Conley
Brooks, Jr. and Lyman E. Wakefield, Jr. WCM is controlled by Clark J. Winslow,
its President, Chief Executive Officer, and principal shareholder. PBIA is
controlled by the Adviser. WP is owned in equal parts by Richard W. Jensen,
Elizabeth M. Lilly and Richard J. Rinkoff. Sasco is owned by Hoda Bibi, Bruce
Bottomley, Lee Garcia and Daniel Leary.
Pursuant to separate investment advisory agreements entered into
between the Funds and the Adviser effective July 1, 1995 with respect to the
Growth Fund and the Total Return Fund, September 16, 1996 with respect to the
Regional Small Cap Fund and December 30, 1997 with respect to the Contrarian
Value Fund (the "Management Agreements"), the Adviser provides consulting,
investment and administrative services to each of the Funds. The specific
investments for each Fund will be made by one or more portfolio managers
selected for such Fund by the Adviser. The Adviser has overall responsibility
for assets under management, provides overall investment strategies and programs
for the Funds, selects portfolio managers, allocates assets among the portfolio
managers and monitors and evaluates the portfolio managers' performance. The
Adviser and each of the Funds enter into separate
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<PAGE>
sub-advisory agreements with such Fund's portfolio managers. The Adviser also
provides each of the Funds with office space, equipment and personnel necessary
to operate and administer such Fund's business and to supervise the provision of
services by third parties such as the transfer agent and the custodian. During
the fiscal years ended June 30, 1998, 1997 and 1996 the Total Return Fund paid
the Adviser advisory fees of $236,368, $191,191 and $129,207, respectively, and
the Adviser waived $0, $0 and $38,729, respectively, in additional advisory
fees. During the fiscal years ended June 30, 1998, 1997 and 1996, the Growth
Fund paid the Adviser advisory fees of $512,180, $454,388 and $372,152,
respectively, and the Adviser waived $0, $0 and $15,451 in additional advisory
fees, respectively. The Regional Small Cap Fund did not begin operations until
September 16, 1996. During the fiscal year ended June 30, 1998 and during the
period from September 16, 1996 through June 30, 1997, the Regional Small Cap
Fund paid the Adviser advisory fees of $544,391 and $144,375, respectively. The
Contrarian Value Fund did not begin operations until December 30, 1997. During
the period from December 30, 1997 through June 30, 1998, the Contrarian Value
Fund paid the Adviser advisory fees of $90,399.
The Adviser has undertaken to reimburse each Fund to the extent that
the aggregate annual operating expenses exceed that percentage of the daily net
assets of such Fund for such year, as determined by valuations made as of the
close of each business day of the year, which is the most restrictive percentage
provided by the state laws of the various states in which the shares of such
Fund are qualified for sale or, if the states in which the shares of such Fund
are qualified for sale impose no such restrictions, 2%. As of the date of this
Statement of Additional Information the shares of the Funds are not qualified
for sale in any state which imposes an expense limitation. Notwithstanding the
most restrictive applicable expense limitation of state securities commissions
set forth above or the terms of the Management Agreements, the Adviser has
voluntarily agreed to reimburse each of the Funds for expenses in excess of 1.3%
of such Fund's average daily net assets during the fiscal year ending June 30,
1999, and did so for the fiscal years ended June 30, 1998, 1997 and 1996 for
each of the Funds operating at such times. Each Fund monitors its expense ratio
on a monthly basis. If the accrued amount of the expenses of a Fund exceeds the
expense limitation, such Fund creates an account receivable from the Adviser for
the amount of such excess. In such a situation the monthly payment of the
Adviser's fee will be reduced by the amount of such excess, subject to
adjustment month by month during the balance of such Fund's fiscal year if
accrued expenses thereafter fall below this limit. During the fiscal years ended
June 30, 1998, 1997 and 1996, the Adviser reimbursed the Total Return Fund
$27,489, $35,832 and $9,060, respectively (in addition to the waiver of advisory
fees described above), for excess expenses. During the fiscal years ended June
30, 1998, 1997 and 1996, the Adviser reimbursed the Growth Fund $0, $14,325 and
$17,342, respectively, (in addition to the waiver of advisory fees described
above) for excess expenses. The Regional Small Cap Fund did not begin operations
until September 16, 1996. During the fiscal year ended June 30, 1998 and during
the period from September 16, 1996 through September 30, 1997, the Advisor
reimbursed the Regional Small Cap Fund $0 and $45,235 for excess expenses. The
Contrarian Value Fund did not begin operations until December 30, 1997. During
the period from December 30, 1997 through June 30, 1998, the Advisor reimbursed
the Contrarian Value Fund $17,544 for excess expenses.
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<PAGE>
As of the date hereof, WCM is the sole portfolio manager of the Growth
Fund, PBIA is the sole portfolio manager of the Total Return Fund, WP is the
sole portfolio manager of the Regional Small Cap Fund and Sasco is the sole
portfolio manager of the Contrarian Value Fund. Each of WCM, PBIA, WP and Sasco
has entered into a separate sub-advisory contract with the applicable Fund and
the Adviser (the Sub-Advisory Agreements"). Pursuant to their respective
Sub-Advisory Agreements, WCM makes specific portfolio investments for that
segment of the assets of the Growth Fund under its management in accordance with
such Fund's investment objective and WCM's investment approach and strategies,
PBIA makes specific portfolio investments for that segment of the assets of the
Total Return Fund under its management in accordance with such Fund's investment
objective and PBIA's investment approach and strategies, WP makes specific
portfolio investments for that segment of the assets of the Regional Small Cap
Fund under its management in accordance with such Fund's investment objectives
and WP's investment approach and strategies and Sasco makes specific portfolio
investments for that segment of the assets of the Contrarian Value Fund under
its management in accordance with such Fund's investment objectives and Sasco's
investment approach and strategies.
Portfolio managers of the Funds, including WCM, PBIA, WP, and Sasco
are employed and may be terminated by the Adviser subject to prior approval by
the Board of Directors of the Corporation. The employment of a new portfolio
manager currently requires the prior approval of the shareholders of the
applicable Fund. The Corporation, however, may request an order of the
Securities and Exchange Commission exempting the Funds from the requirements
under the Investment Company Act of 1940 relating to shareholder approval of new
portfolio managers. There can be no assurance that the Corporation will request
such an order, or, if requested, that such an order will be granted with respect
to the Funds. Selection and retention criteria for portfolio managers include:
(i) their historical performance records; (ii) consistent performance in the
context of the markets and preservation of capital in declining markets; (iii)
organizational stability and reputation; (iv) the quality and depth of
investment personnel; and (v) the ability of the portfolio manager to apply its
approach consistently. Each portfolio manager will not necessarily exhibit all
of the criteria to the same degree. Portfolio managers are paid by the Adviser
(not the Funds).
The portfolio managers' activities are subject to general supervision
by the Adviser and the Board of Directors of the Corporation. Although the
Adviser and the Board do not evaluate the investment merits of the portfolio
managers' specific securities selections, they do review the performance of each
portfolio manager relative to the selection criteria.
As set forth in the Prospectus under the caption "Management of the
Funds", Fiduciary Management, Inc. (the "Administrator") is the administrator to
each of the Funds. The Administrator is controlled by Mr. Wilson and Ted D.
Kellner. Pursuant to separate administration agreements entered into between
each of the Funds and the Administrator (the "Administration Agreements"), the
Administrator supervises all aspects of the Funds' operations except those
performed by the Adviser or the portfolio managers. In connection with such
supervision the Administrator prepares and maintains the books, accounts and
other documents required by the Investment Company Act of 1940 (the "Act"),
calculates the Fund's net asset value, responds to shareholder inquiries,
prepares the Fund's financial
-19-
<PAGE>
statements and excise tax returns, prepares reports and filings with the
Securities and Exchange Commission and with state Blue Sky authorities,
furnishes statistical and research data, clerical, accounting and bookkeeping
services and stationery and office supplies, keeps and maintains the Fund's
financial accounts and records and generally assists in all aspects of the
Fund's operations. During the fiscal years ended June 30, 1998, 1997 and 1996,
the Total Return Fund paid the Administrator $47,236, $38,238 and $33,575,
respectively, pursuant to such Fund's Administration Agreement. During the
fiscal years ended June 30, 1998, 1997 and 1996, the Growth Fund paid the
Administrator $76,677, $75,438 and $68,201, respectively, pursuant to such
Fund's Administration Agreement. The Regional Small Cap Fund did not commence
operations until September 16, 1996. During the fiscal year ended June 30, 1998
and during the period from September 16, 1996 through June 30, 1997, the
Regional Small Cap Fund paid the Administrator $77,094 and $28,875, respective
pursuant to such Fund's Administration Agreement. The Contrarian Value Fund did
not commence operations until December 30, 1997. During the period from December
30, 1997 through June 30, 1998, the Contrarian Value Fund paid the Administrator
$18,080 pursuant to such Fund's Administration Agreement.
The respective Management Agreements and Sub-Advisory Agreements of
each of the Funds will remain in effect as long as its continuance is
specifically approved at least annually (i) by the Board of Directors of the
Corporation, or, in the case of the Management Agreements, by the vote of a
majority (as defined in the Act) of the outstanding shares of the applicable
Fund, and (ii) by the vote of a majority of the directors of the Corporation who
are not parties to the Management Agreement or Sub-Advisory Agreement relating
to the applicable Fund or interested persons of the Adviser or applicable
Portfolio Manager, cast in person at a meeting called for the purpose of voting
on such approval. The Administration Agreements will remain in effect until
terminated. Each of the Management Agreements provides that it may be terminated
at any time without the payment of any penalty, by the Board of Directors of the
Corporation or by vote of a majority of the applicable Fund's shareholders, on
sixty days written notice to the Adviser and by the Adviser on the same notice
to the applicable Fund, and that it shall be automatically terminated if it is
assigned. Each of the Sub-Advisory Agreements provides that it may be terminated
by any party upon giving 30 days written notice to the other parties and that it
shall be automatically terminated if it is assigned. Each of the Administration
Agreements provides that it may be terminated at any time without the payment of
any penalty by the Board of Directors of the Corporation on ninety days written
notice to the Administrator and by the Administrator on the same notice to the
applicable Fund.
The Management Agreements, the Sub-Advisory Agreements and the
Administration Agreements provide that the Adviser, WCM, PBIA, WP, Sasco and the
Administrator, as the case may be, shall not be liable to either of the Funds or
their shareholders for anything other than willful misfeasance, bad faith, gross
negligence or reckless disregard of its obligations or duties. The Management
Agreements, the Sub-Advisory Agreements and the Administration Agreements also
provide that the Adviser, WCM, PBIA, WP, Sasco and the Administrator, and their
respective officers, directors and employees, may engage in other businesses,
devote time and attention to any other business whether of a similar or
dissimilar nature, and render services to others.
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<PAGE>
DETERMINATION OF NET ASSET VALUE AND PERFORMANCE
As set forth in the Prospectus under the caption "Determination of Net
Asset Value", the net asset value of each Fund will be determined as of the
close of regular trading (currently 4:00 P.M. Eastern Time) on each day the New
York Stock Exchange is open for trading. The New York Stock Exchange is open for
trading Monday through Friday except New Year's Day, Dr. Martin Luther King, Jr.
Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Additionally, if any of the aforementioned
holidays falls on a Saturday, the New York Stock Exchange will not be open for
trading on the preceding Friday and when any such holiday falls on a Sunday, the
New York Stock Exchange will not be open for trading on the succeeding Monday,
unless unusual business conditions exist, such as the ending of a monthly or the
yearly accounting period. The New York Stock Exchange may also be closed on
national days of mourning.
Any total rate of return quotation for a particular Fund will be for a
period of three or more months and will assume the reinvestment of all dividends
and capital gains distributions which were made by such Fund during that period.
Any period total rate of return quotation of a Fund will be calculated by
dividing the net change in value of a hypothetical shareholder account
established by an initial payment of $1,000 at the beginning of the period by
1,000. The net change in the value of a shareholder account is determined by
subtracting $1,000 from the product obtained by multiplying the net asset value
per share at the end of the period by the sum obtained by adding (A) the number
of shares purchased at the beginning of the period plus (B) the number of shares
purchased during the period with reinvested dividends and distributions. Any
average annual compounded total rate of return quotation of a Fund will be
calculated by dividing the redeemable value at the end of the period (i.e., the
product referred to in the preceding sentence) by $1,000. A root equal to the
period, measured in years, in question is then determined and 1 is subtracted
from such root to determine the average annual compounded total rate of return.
The foregoing computation may also be expressed by the following
formula:
P(1+T)n = ERV
P = a hypothetical initial 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 stated periods
at the end of the stated periods.
Total return is the cumulative rate of investment growth which assumes
that income dividends and capital gains are reinvested. It is determined by
assuming a hypothetical investment at the net asset value at the beginning of
the period, adding in the reinvestment of all income dividends and capital
gains, calculating the ending value of the investment at the net asset value as
of the end of the specified time period, subtracting the amount of the original
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investment, and dividing this amount by the amount of the original investment.
This calculated amount is then expressed as a percentage by multiplying by 100.
The Growth Fund's average annual compounded return for the one-year
period ended June 30, 1998 was 33.86% and for the period from the Growth Fund's
commencement of operations (July 1, 1995) through June 30, 1998 was 23.08%. The
Total Return Fund's average annual compounded returns for the one-year,
five-year and ten-year periods ended June 30, 1998 and for the period from the
Fund's commencement of operations (December 30, 1986) through June 30, 1998 were
33.33%, 19.43%, 14.50% and 15.65%, respectively. The Regional Small Cap Fund's
average annual compounded return for the one-year period ended June 30, 1998 was
11.69%, and for the period from the Regional Small Cap Fund's commencement of
operations (September 16, 1996) through June 30, 1998 was 19.18%. The Contrarian
Value Fund's return for the period from the Contrarian Value Fund's Commencement
of operations (December 30, 1997) through June 30, 1998 was 4.10%.
The results below show the value of an assumed initial investment in
the Growth Fund of $10,000 made on June 30, 1995 through June 30, 1998, assuming
reinvestment of all dividends and distributions.
Value of $10,000 Cumulative % Change
Date Investment (i.e. total return)
- ---- --------------- -------------------
December 31, 1995 $ 10,860 + 8.6%
December 31, 1996 12,690 +26.9
December 31, 1997 15,533 +55.3
June 30, 1998 18,633 +86.3
The results below show the value of an assumed initial investment in
the Total Return Fund of $10,000 made on December 30, 1986 through June 30,
1998, assuming reinvestment of all dividends and distributions.
Value of $10,000 Cumulative % Change
Date Investment (i.e. total return)
- ---- ---------------- -------------------
December 31, 1986 $ 10,000 ---
December 31, 1987 11,225 +12.2%
December 31, 1988 13,554 +35.5
December 31, 1989 15,341 +53.4
December 31, 1990 14,663 +46.6
December 31, 1991 19,070 +90.7
December 31, 1992 21,052 +110.5
December 31, 1993 23,381 +133.8
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December 31, 1994 22,909 +129.1
December 31, 1995 28,221 +182.2
December 31, 1996 34,000 +240.0
December 31, 1997 44,214 +342.1
June 30, 1998 53,225 +432.2
The results below show the value of an assumed initial investment in
the Regional Small Cap Fund of $10,000 made on September 16, 1996 through June
30, 1998, assuming reinvestment of all dividends and distributions.
Value of $10,000 Cumulative % Change
Investment (i.e. total return)
Date
December 31, 1996 $ 10,908 9.1%
December 31, 1997 13,207 32.1
June 30, 1998 13,682 36.8
The results below show the value of an assumed initial investment in
the Contrarian Value Fund of $10,000 made on December 30, 1997 through June 30,
1998, assuming reinvestment of all dividends and distributions.
Cumulative % Change
Date Value of $10,000 Investment (i.e. total return)
- ---- --------------------------- -------------------
December 31, 1997 $10,030 +0.3%
June 30, 1998 10,410 +4.1
The foregoing performance results are based on historical earnings and
should not be considered as representative of the performance of the Growth
Fund, the Total Return Fund, the Regional Small Cap Fund or the Contrarian Value
Fund in the future. Such performance results also reflect reimbursements made by
the Adviser to keep total fund operating expenses at or below 1.3% of average
daily net assets. An investment in the Growth Fund, the Total Return Fund, the
Regional Small Cap Fund or the Contrarian Value Fund will fluctuate in value and
at redemption its value may be more or less than the initial investment.
DISTRIBUTION OF SHARES
Each of the Funds has adopted a Distribution Plan (the "Plan") in
anticipation that such Fund will benefit from the Plan through increased sales
of shares, thereby reducing such Fund's expense ratio and providing an asset
size that allows the Adviser greater flexibility in management. However, each of
the Funds presently intends not to utilize the Plan or pay any 12b-1 fees during
the fiscal year ending June 30, 1999. The Plan may be terminated by any Fund at
any time by a vote of the directors of the Corporation who are not
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interested persons of the Corporation and who have no direct or indirect
financial interest in the Plan or any agreement related thereto (the "Rule 12b-1
Directors") or by a vote of a majority of the outstanding shares of such Fund.
Messrs. Fauth and Thorpe are currently the Rule 12b-1 Directors. Any change in
the Plan that would materially increase the distribution expenses of a
particular Fund provided for in the Plan requires approval of the shareholders
of such Fund and the Board of Directors, including the Rule 12b-1 Directors.
While the Plan is in effect, the selection and nomination of directors
who are not interested persons of the Corporation will be committed to the
discretion of the directors of the Corporation who are not interested persons of
the Corporation. The Board of Directors of the Corporation must review the
amount and purposes of expenditures pursuant to the Plan quarterly as reported
to it by a Distributor, if any, or officers of the Corporation. The Plan will
continue in effect for as long as its continuance is specifically approved at
least annually by the Board of Directors, including the Rule 12b-1 Directors.
The Growth Fund did not begin operations until June 30, 1995, and such Fund has
not incurred any distribution costs to date. The Regional Small Cap Fund did not
begin operations until September 16, 1996 and such Fund has not incurred any
distribution costs to date. The Contrarian Value Fund did not begin operations
until December 30, 1997 and, such Fund has not incurred any distribution costs
to date.
ALLOCATION OF PORTFOLIO BROKERAGE
Decisions to buy and sell securities for the Growth Fund are made by
the Adviser and WCM, for the Total Return Fund are made by the Adviser and PBIA,
for the Regional Small Cap Fund are made by the Adviser and WP and for the
Contrarian Value Fund are made by the Adviser and Sasco, in each case subject to
review by the Corporation's Board of Directors. In placing purchase and sale
orders for portfolio securities for the Funds, it is the policy of the Adviser,
WCM, PBIA, WP and Sasco to seek the best execution of orders at the most
favorable price in light of the overall quality of brokerage and research
services provided, as described in this and the following paragraph. In
selecting brokers to effect portfolio transactions, the determination of what is
expected to result in best execution at the most favorable price involves a
number of largely judgmental considerations. Among these are the evaluation by
the Adviser, WCM, PBIA, WP and/or Sasco of the broker's efficiency in executing
and clearing transactions, block trading capability (including the broker's
willingness to position securities) and the broker's financial strength and
stability. The most favorable price to a Fund means the best net price without
regard to the mix between purchase or sale price and commission, if any.
Over-the-counter securities are generally purchased and sold directly with
principal market makers who retain the difference in their cost in the security
and its selling price. In some instances, the Adviser, WCM, PBIA, WP or Sasco
may feel that better prices are available from non-principal market makers who
are paid commissions directly. Although none of the Funds intends to market its
shares through intermediary broker-dealers, a Fund may place portfolio orders
with broker-dealers who recommend the purchase of such Fund's shares to clients
if the Adviser, WCM, PBIA, WP or Sasco, as the case may be, believes the
commissions and transaction quality are comparable to that available from other
brokers and may allocate portfolio brokerage on that basis.
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In allocating brokerage business for the Funds, the Adviser, WCM,
PBIA, WP and Sasco also take into consideration the research, analytical,
statistical and other information and services provided by the broker, such as
general economic reports and information, reports or analyses of particular
companies or industry groups, market timing and technical information, and the
availability of the brokerage firm's analysts for consultation. While each of
the Adviser, WCM, PBIA, WP and Sasco believes these services have substantial
value, they are considered supplemental to the efforts of the Adviser, WCM,
PBIA, WP or Sasco in the performance of its duties under the applicable
Management Agreement or Sub-Advisory Agreement. Other clients of the Adviser,
WCM, PBIA, WP or Sasco may indirectly benefit from the availability of these
services to the Adviser, WCM, PBIA, WP or Sasco, and the Funds may indirectly
benefit from services available to the Adviser, WCM, PBIA, WP or Sasco as a
result of transactions for other clients. Each of the Management Agreements and
Sub-Advisory Agreements provides that the Adviser, WCM, PBIA, WP or Sasco, as
the case may be, may cause the applicable Fund to pay a broker which provides
brokerage and research services to the Adviser, WCM, PBIA, WP or Sasco, a
commission for effecting a securities transaction in excess of the amount
another broker would have charged for effecting the transaction, if the Adviser,
WCM, PBIA, WP or Sasco determines in good faith that such amount of commission
is reasonable in relation to the value of brokerage and research services
provided by the executing broker viewed in terms of either the particular
transaction or the overall responsibilities of the Adviser, WCM, PBIA, WP or
Sasco with respect to the applicable Fund and the other accounts as to which it
exercises investment discretion. During the fiscal years ended June 30, 1996,
1997, and 1998, the Growth Fund paid brokerage commissions of $70,820 on
transactions having a total market value of $67,831,156, $43,545 on transactions
having a total market value of $25,936,201 and $75,062 on transactions having a
total market value of $60,131,748, respectively. Brokerage commissions paid by
the Total Return Fund totaled $28,705 on transactions having a total market
value of $32,270,945, $19,854 on transactions having a total market value of
$15,590,327 and $7,130 on transactions having a total market value of $6,703,149
for the fiscal years ended June 30, 1996, 1997 and 1998, respectively. The
Regional Small Cap Fund did not commence operations until September 16, 1996.
During the period from September 16, 1996 through June 30, 1997, the Regional
Small Cap Fund paid brokerage commissions of $50,392 on transactions having a
total market value of $15,758,909 and for the fiscal year ended June 30, 1998
paid $77,720 on transactions having a market value of $34,327,567. The
Contrarian Value Fund did not commence operations until December 30, 1997.
During the period from December 30, 1997 through June 30, 1998, The Contrarian
Value Fund paid brokerage Commission of $40,438 on transactions having a total
market value of $22,255,053. All of the brokers to whom commissions were paid by
the Growth Fund, the Total Return Fund, the Regional Small Cap Fund and the
Contrarian Value Fund provided research services to the Adviser.
CUSTODIAN
Firstar Bank Milwaukee, N.A., 615 East Michigan Street, Milwaukee,
Wisconsin 53202, acts as custodian for the Funds. As such, Firstar Bank
Milwaukee, N.A. holds all securities and cash of the Funds, delivers and
receives payment for securities sold, receives and pays for securities
purchased, collects income from investments and performs
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other duties, all as directed by officers of the Corporation. Firstar Bank
Milwaukee, N.A. does not exercise any supervisory function over the management
of the Funds, the purchase and sale of securities or the payment of
distributions to shareholders. Firstar Mutual Fund Services LLC also acts as the
Funds' transfer agent and dividend disbursing agent.
TAXES
As set forth in the Prospectus under the caption "Dividends,
Distributions and Taxes", each of the Funds will endeavor to qualify as a
regulated investment company under Subchapter M of the Internal Revenue Code. A
portion of each Fund's ordinary income distribution may be eligible for the 70%
dividends-received deduction for domestic corporation shareholders.
Dividends from each Fund's net investment income and distributions
from each Fund's net realized capital gains may be taxable to shareholders,
whether received in cash or additional shares of such Fund.
Any dividend or capital gains distribution paid shortly after a
purchase of shares will have the effect of reducing the per share net asset
value of such shares by the amount of the dividend or distribution. Furthermore,
if the net asset value of the shares immediately after a dividend or
distribution is less than the cost of such shares to the shareholder, the
dividend or distribution will be taxable to the shareholder even though it
results in a return of capital to him.
Each Fund may be required to withhold Federal income tax at a rate of
31% ("backup withholding") from dividend payments and redemption proceeds if a
shareholder fails to furnish such Fund with his social security number or other
tax identification number and certify under penalty of perjury that such number
is correct and that he is not subject to backup withholding due to the under
reporting of income. The certification form is included as part of the share
purchase application and should be completed when the account is opened.
SHAREHOLDER MEETINGS
The Wisconsin Business Corporation Law permits registered investment
companies, such as the Corporation, to operate without an annual meeting of
shareholders under specified circumstances if an annual meeting is not required
by the Act. The Corporation has adopted the appropriate provisions in its bylaws
and, at its discretion, may not hold an annual meeting in any year in which none
of the following matters is required to be acted upon by the shareholders under
the Act: (i) election of directors; (ii) approval of an investment advisory
agreement; (iii) ratification of the selection of auditors; and (iv) approval of
a distribution agreement.
The Corporation's bylaws also contain procedures for the removal of
directors by its shareholders. At any meeting of shareholders, duly called and
at which a quorum is present, the shareholders may, by the affirmative vote of
the holders of a majority of the votes entitled to be cast thereon, remove any
director or directors from office and may elect a
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successor or successors to fill any resulting vacancies for the unexpired terms
of removed directors.
Upon the written request of the holders of shares entitled to not less
than ten percent (10%) of all the votes entitled to be cast at such meeting, the
Secretary of the Corporation shall promptly call a special meeting of
shareholders for the purpose of voting upon the question of removal of any
director. Whenever ten or more shareholders of record who have been such for at
least six months preceding the date of application, and who hold in the
aggregate either shares having a net asset value of at least $25,000 or at least
one percent (1%) of the total outstanding shares, whichever is less, shall apply
to the Corporation's Secretary in writing, stating that they wish to communicate
with other shareholders with a view to obtaining signatures to a request for a
meeting as described above and accompanied by a form of communication and
request which they wish to transmit, the Secretary shall within five business
days after such application either: (1) afford to such applicants access to a
list of the names and addresses of all shareholders as recorded on the books of
the Corporation; or (2) inform such applicants as to the approximate number of
shareholders of record and the approximate cost of mailing to them the proposed
communication and form of request.
If the Secretary elects to follow the course specified in clause (2)
of the last sentence of the preceding paragraph, the Secretary, upon the written
request of such applicants, accompanied by a tender of the material to be mailed
and of the reasonable expenses of mailing, shall, with reasonable promptness,
mail such material to all shareholders of record at their addresses as recorded
on the books unless within five business days after such tender the Secretary
shall mail to such applicants and file with the Securities and Exchange
Commission, together with a copy of the material to be mailed, a written
statement signed by at least a majority of the Board of Directors to the effect
that in their opinion either such material contains untrue statements of fact or
omits to state facts necessary to make the statements contained therein not
misleading, or would be in violation of applicable law, and specifying the basis
of such opinion.
After opportunity for hearing upon the objections specified in the
written statement so filed, the Securities and Exchange Commission may, and if
demanded by the Board of Directors or by such applicants shall, enter an order
either sustaining one or more of such objections or refusing to sustain any of
them. If the Securities and Exchange Commission shall enter an order refusing to
sustain any of such objections, or if, after the entry of an order sustaining
one or more of such objections, the Securities and Exchange Commission shall
find, after notice and opportunity for hearing, that all objections so sustained
have been met, and shall enter an order so declaring, the Secretary shall mail
copies of such material to all shareholders with reasonable promptness after the
entry of such order and the renewal of such tender.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 3100 Multifoods Tower, 33 South Sixth
Street, Minneapolis, Minnesota 55402, currently serves as the independent
accountants for the Corporation and has so served since the fiscal year ended
September 30, 1989.
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FINANCIAL STATEMENTS
The following audited financial statements are incorporated by
reference to the Annual Report, dated June 30, 1998, of Eastcliff Funds, Inc.
(File No. 811-4722), as filed with the Securities and Exchange Commission on
August 5, 1998:
o Statement of Asset & Liabilities (Growth Fund only)
o Schedule of Investments (Growth Fund only)
o Statements of Net Assets (Total Return Fund, Regional Small Cap Fund and
Contrarian Value Fund only)
o Statements of Operations
o Statements of Changes in Net Assets
o Financial Highlights
o Notes to the Financial Statements
o Report of Independent Accountants
DESCRIPTION OF SECURITIES RATINGS
As set forth in the Prospectus under the caption "Investment
Objectives and Policies", each of the Funds may invest in various securities
assigned ratings of either Standard & Poor's Corporation or Moody's Investors
Service, Inc. A brief description of the ratings symbols and their meanings
follows.
Standard & Poor's Corporation Bond Ratings. A Standard & Poor's
corporate debt rating is a current assessment of the creditworthiness of an
obligor with respect to a specific obligation. This assessment may take into
consideration obligors such as guarantors, insurers of 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 any 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 circumstances.
The ratings are based, in varying degrees, on the following
considerations:
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I. 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;
II. Nature of and provisions of the obligation;
III. 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 higher rated issues only in small degree.
A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in the higher rated
categories.
BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B, CCC, CC Bonds are regarded, on balance, as predominately
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the lowest degree of
speculation and CC the highest degree of speculation. While such debt will
likely have some quality and protective characteristics, they are outweighed by
large uncertainties or major risk exposures to adverse conditions.
Moody's Investors Service, Inc Bond Ratings.
-------------------------------------------
Aaa - Bonds which are rated Aaa are judged to be the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged." Interest payments are protected by a large, or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude, or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
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A - Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment sometime in the
future.
Baa - Bonds which are rated Baa are considered as medium grade
obligations; (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca - Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in each of the
foregoing generic rating classifications. The modifier 1 indicates that the
company 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 company
ranks in the lower end of its generic rating category.
Standard & Poor's Commercial Paper Ratings. A Standard & Poor's
commercial paper rating is a current assessment of the likelihood of timely
payment of debt considered short-term in the relevant market. Ratings are graded
into several categories, ranging from A-1 for the highest quality obligations to
D for the lowest. The three highest categories are as follows:
A-1. This highest category indicates that the degree of safety
regarding timely payment is strong. Those issuers determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation.
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A-2. Capacity for timely payment on issues with this designation is
satisfactory. However the relative degree of safety is not as high as for
issuers designated "A-1".
A-3. Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying a higher designation.
Standard & Poor's Preferred Stock Ratings. A Standard & Poor's
preferred stock rating is an assessment of the capacity and willingness of an
issuer to pay preferred stock dividends and any applicable sinking fund
obligations. A preferred stock rating differs from a bond rating inasmuch as it
is assigned to an equity issue, which issue is intrinsically different from, and
subordinated to, a debt issue. Therefore, to reflect this difference, the
preferred stock rating symbol will normally not be higher than the bond rating
symbol assigned to, or that would be assigned to, the senior debt of the same
issuer.
The preferred stock ratings are based on the following considerations:
I. Likelihood of payment -- capacity and willingness of the issuer to
meet the timely payment of preferred stock dividends and any applicable sinking
fund requirements in accordance with the terms of the obligation.
II. Nature of, and provisions of, the issue.
III. Relative position of the issue in the event of bankruptcy,
reorganization, or other arrangements affecting creditors' rights.
"AAA" This is the highest rating that may be assigned by Standard &
Poor's to a preferred stock issue and indicates an extremely strong capacity to
pay the preferred stock obligations.
"AA" A preferred stock issue rated "AA" also qualifies as a
high-quality fixed income security. The capacity to pay preferred stock
obligations is very strong, although not as overwhelming as for issues rated
"AAA."
"A" An issued rated "A" is backed by a sound capacity to pay the
preferred stock obligations, although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions.
"BBB" An issue rated "BBB" is regarded as backed by an adequate
capacity to pay the preferred stock obligations. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to make payments
for a preferred stock in this category than for issues in the "A" category.
"BB," "B," "CCC" Preferred stock rated "BB," "B," and "CCC" are
regarded, on balance, as predominately speculative with respect to the issuer's
capacity to pay
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preferred stock obligations. "BB" indicates the lowest degree of speculation and
"CCC" the highest degree of speculation. While such issues will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
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