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THE KENT FUNDS
STATEMENT OF ADDITIONAL INFORMATION
FOR
INVESTMENT AND INSTITUTIONAL SHARES
OF
THE KENT GROWTH AND INCOME FUND
THE KENT INDEX EQUITY FUND
THE KENT LARGE COMPANY GROWTH FUND
THE KENT SMALL COMPANY GROWTH FUND
THE KENT INTERNATIONAL GROWTH FUND
THE KENT INCOME FUND
THE KENT INTERMEDIATE BOND FUND
THE KENT SHORT TERM BOND FUND
THE KENT TAX-FREE INCOME FUND
THE KENT INTERMEDIATE TAX-FREE FUND
THE KENT MICHIGAN MUNICIPAL BOND FUND
THE KENT MONEY MARKET FUND
THE KENT GOVERNMENT MONEY MARKET FUND
THE KENT MICHIGAN MUNICIPAL MONEY MARKET FUND
May 1, 1999, as amended and restated December 17, 1999
This Statement of Additional Information ("SAI") is not a prospectus
but relates to, and should be read in conjunction with the prospectus for the
Investment Shares and Institutional Shares of the foregoing Funds dated May 1,
1999, as amended or supplemented from time to time. The Financial Statements
included in the Funds' December 31, 1998 Annual Report to Shareholders are
incorporated by reference into this SAI. No other part of the Annual Reports is
incorporated herein. Copies of the prospectus and the Annual Report may be
obtained by writing to The Kent Funds, P.O. Box 182201, Columbus, Ohio 43218-
2201 or by calling 1-800-633-KENT (5368). Capitalized terms not otherwise
defined herein have the same meaning as in the prospectus.
SHARES OF THE FUNDS ARE NOT BANK DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, OLD KENT BANK OR ANY OF ITS AFFILIATES, AND ARE NOT
INSURED BY, GUARANTEED BY, OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S.
GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD, OR ANY OTHER GOVERNMENTAL AGENCY. AN INVESTMENT IN THE FUNDS INVOLVES
RISK, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL. EACH MONEY MARKET FUND SEEKS TO
MAINTAIN A NET ASSET VALUE PER SHARE OF $1.00 ALTHOUGH THERE CAN BE NO ASSURANCE
THAT THEY WILL BE ABLE TO DO SO.
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TABLE OF CONTENTS
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The Trust............................................................. 3
Investment Objectives and Policies.................................... 3
Investment Restrictions............................................... 24
Securities Transactions............................................... 26
Valuation Of Securities............................................... 28
Trustees And Officers................................................. 31
Investment Adviser.................................................... 32
Administrator......................................................... 35
Distributor........................................................... 36
Transfer Agent........................................................ 36
Custodian, Auditors And Counsel....................................... 37
Distribution Plan..................................................... 37
Additional Purchase And Redemption Information........................ 38
Dividends And Taxes................................................... 39
Declaration Of Trust.................................................. 40
Standardized Total Return And Yield Quotations........................ 41
Advertising Information............................................... 47
Financial Statements.................................................. 48
Additional Information................................................ 48
Appendix A............................................................A-1
Appendix B............................................................B-1
Appendix C............................................................C-1
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED IN THIS SAI, OR IN THE PROSPECTUS RELATED HERETO,
IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE TRUST OR ITS DISTRIBUTOR. THIS SAI AND THE PROSPECTUS DO NOT
CONSTITUTE AN OFFERING BY THE TRUST OR BY ITS DISTRIBUTOR IN ANY JURISDICTION IN
WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
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THE TRUST
The Kent Funds (the "Trust") is an open-end management investment
company, commonly known as a mutual fund, which was organized on May 9, 1986 as
a Massachusetts business trust. The original name of the Trust was "Master
Municipal Trust." The Trust consists of fifteen separate investment portfolios,
each of which is diversified and has a distinct investment objective and
distinct investment policies. This SAI relates to the following fourteen
investment portfolios (individually, a "Fund," and collectively, the "Funds"),
each of which has established two classes of shares, Investment Shares and
Institutional Shares: The Kent Large Company Growth Fund, The Kent Growth and
Income Fund, The Kent Index Equity Fund, The Kent Small Company Growth Fund, The
Kent International Growth Fund (collectively, the "Equity Funds"), The Kent
Income Fund, The Kent Intermediate Bond Fund, The Kent Short Term Bond Fund
(collectively, the "Bond Funds"), The Kent Tax-Free Income Fund, The Kent
Intermediate Tax-Free Fund, The Kent Michigan Municipal Bond Fund (collectively,
the "Municipal Bond Funds"), The Kent Money Market Fund, The Kent Government
Money Market Fund, and The Kent Michigan Municipal Money Market Fund
(collectively, the "Money Market Funds"). The Equity Funds, Bond Funds and
Municipal Bond Funds are sometimes collectively referred to as the "Non-Money
Market Funds." The Municipal Bond Funds and The Kent Michigan Municipal Money
Market Fund are sometimes collectively referred to as the "Municipal Funds."
Each Fund is advised by Lyon Street Asset Management Company ("Lyon Street" or
the "Investment Adviser").
Important information about the Trust and the Investment and
Institutional Shares of the Funds is contained in the Funds' prospectus. This
SAI provides additional information about the Trust and the Investment and
Institutional Shares of the Funds that may be of interest to some investors. The
Trust also offers an additional investment portfolio in a single class of
shares, the Lyon Street Institutional Money Market Fund, which is described in a
separate prospectus and statement of additional information.
INVESTMENT OBJECTIVES AND POLICIES
The following information supplements the description of each Fund's
investment objective and strategies as set forth in the prospectus.
EQUITY FUNDS
GROWTH AND INCOME FUND
OTHER INVESTMENT STRATEGIES: Under ordinary circumstances, the Fund intends to
invest at least 65% of its total assets in U.S. companies with at least $100
million in market capitalization which are listed on the New York Stock Exchange
or American Stock Exchange or are traded over the counter. Up to 10% of the
Fund's assets may also be invested in foreign securities and American Depositary
Receipts ("ADRs"), which are U.S. dollar denominated securities representing
ownership in foreign securities. A portion of the Fund's assets may be invested
in preferred stock or bonds convertible into common stock. The Fund will
purchase only convertible bonds having a rating in one of the four highest
rating categories by a nationally recognized statistical rating organization (a
"NRSRO") or those which, if not rated, are of comparable quality as determined
by Lyon Street. The Fund expects to earn current income mainly from stock
dividends and interest on convertible bonds.
INDEX EQUITY FUND
OTHER INVESTMENT STRATEGIES: Although Lyon Street will generally try to
match the industry composition of the S&P 500 exactly, because of the difficulty
and expense of executing relatively small stock transactions, the Fund may not
always be invested in the less heavily weighted S&P 500 stocks, or may be
invested in stocks in different proportions than the S&P 500, especially when
the Fund has a low level of assets. The Fund will try to achieve a correlation
between the performance of its portfolio and that of the S&P 500 of at least
0.95 (not accounting for expenses). A correlation of 1.0 would mean that the
Fund's NAV (including the value of its dividends and capital gains
distributions) increases or decreases in exact proportion to changes in the S&P
500.
LARGE COMPANY GROWTH FUND
OTHER INVESTMENT STRATEGIES: Under ordinary circumstances, the Fund intends to
invest at least 65% of its total assets in equity securities of U.S. companies
with at least $4 billion in market capitalization which are listed on the New
York Stock Exchange or the American Stock Exchange or are traded over the
counter. The Fund may also invest in foreign securities and ADRs. A portion of
the Fund's assets may also be invested in preferred stock or bonds that are
convertible into common stock.
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SMALL COMPANY GROWTH FUND
OTHER INVESTMENT STRATEGIES: Under ordinary circumstances, the Fund intends to
invest at least 65% of its total assets in a diverse group of small U.S.
companies, which are companies whose market capitalizations are less than $2
billion. The Fund may also purchase stocks which are listed on other U.S.
securities exchanges or which are traded over the counter.
INTERNATIONAL GROWTH FUND
OTHER INVESTMENT STRATEGIES: The Fund will invest mostly in common and preferred
stocks. Under ordinary circumstances, the Fund intends to invest at least 65% of
its total assets in at least 3 countries other than the United States, including
(but not limited to) Australia, Austria, Belgium, Denmark, Finland, France,
Germany, Hong Kong, Italy, Japan, Malaysia, the Netherlands, New Zealand,
Norway, Singapore, Spain, Sweden, Switzerland and the United Kingdom. The Fund
invests in countries represented in the Morgan Stanley Capital International
Europe and Australasia and Far East Equity Index (the "EAFE Index"). Although
the International Growth Fund seeks to equal or exceed the return of the EAFE
Index, the Fund may invest its asset in proportions that differ from this index.
The Fund is not, therefore, an "index" fund, which typically holds securities in
approximately the same proportion as the index it attempts to replicate. Lyon
Street believes that the EAFE Index is generally representative of the
performance of the common stocks of large companies in industrialized countries
traded outside of the United States taken as a whole. Stocks are included in the
EAFE Index based on national and industry representation and are weighted
according to their relative market values. The Fund may also invest in ADRs,
which are U.S. dollar-denominated securities representing ownership in foreign
companies, and enter into currency and other futures contracts and related
options for hedging purposes. The Fund may invest more than 25% of its assets in
a particular foreign country.
BOND FUNDS
OTHER INVESTMENT STRATEGIES: Under ordinary circumstances, each Bond Fund
intends to invest at least 65% of its total assets in debt securities. In
addition, the Income Fund intends to invest at least 65% of its total assets in
a combination of (i) corporate debt obligations that are rated in one of
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the three highest rating categories by a NRSRO (for example, A or higher by
Standard & Poor's Ratings Group ("S&P") or by Moody's Investors Service, Inc.
("Moody's")) or, if unrated, will be deemed to be of comparable quality by Lyon
Street, or (ii) obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities. Debt securities, other than securities known as
zero coupon bonds, generally pay interest at set times, at either a fixed (set)
rate or a variable (changing) rate. Debt securities purchased by the Bond Funds
may include corporate debt obligations, U.S. Government securities, stripped
securities, variable and floating rate securities, mortgage-backed securities,
custodial receipts for Treasury certificates, zero-coupon bonds, asset-backed
securities, equipment trust certificates and certain so-called "derivative
securities." Each Bond Fund may also invest a portion of its assets in bonds
convertible into common stock.
Debt securities purchased by the Bond Funds will be rated in one of the four
highest rating categories by an NRSRO (for example, BBB or higher by S&P, or Baa
or higher by Moody's) or, if unrated, will be deemed to be of comparable quality
by Lyon Street. See Appendix A to the SAI for a description of applicable S&P,
Moody's and other NRSRO ratings.
MUNICIPAL BOND FUNDS
OTHER INVESTMENT STRATEGIES: Each Municipal Bond Fund intends to invest at least
80% of its net assets in federally tax-exempt obligations, except during periods
of unusual market conditions. This policy is a fundamental policy which cannot
be changed by a Municipal Bond Fund without the approval of its shareholders. In
calculating the 80% limitation, for all Municipal Bond Funds other than Michigan
Municipal Bond Fund, a security whose interest is treated as a specific tax
preference item under the federal alternative minimum tax is considered taxable.
In calculating the 80% limitation for the Michigan Municipal Bond Fund,
securities whose interest is treated as a specific tax preference item under the
federal alternative minimum tax and is treated as exempt from Michigan personal
income tax are considered non-taxable. Under ordinary circumstances, at least
65% of the Michigan Municipal Bond Fund's total assets will be invested in
municipal obligations issued by the State of Michigan or its political
subdivisions, authorities or corporations.
The Municipal Bond Funds will principally invest in municipal bonds which are
issued by state or local governments typically for general funding purposes or
to finance specific projects.
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The amount of information regarding the financial condition of issuers of
municipal obligations may be less extensive than the information for public
corporations, and the secondary market for municipal obligations may be less
liquid than that for taxable obligations. Accordingly, the ability of a
Municipal Bond Fund to buy and sell municipal obligations may, at any particular
time and with respect to any particular securities, be limited. In addition,
municipal obligations purchased by the Municipal Bond Funds include obligations
backed by letters of credit and other forms of credit enhancement issued by
domestic and foreign banks, as well as other financial institutions and
corporations. Adverse changes in the credit quality of these institutions could
cause loss to a Municipal Bond Fund and affect its share price.
Municipal obligations purchased by the Municipal Bond Funds will be rated in one
of the four highest rating categories by an NRSRO (for example, BBB or higher by
S&P, or Baa or higher by Moody's) or, if unrated, will be deemed to be of
comparable quality by Lyon Street. See Appendix A to the SAI for a description
of applicable S&P, Moody's and other NRSRO ratings.
MONEY MARKET FUNDS
The Trust currently offers the three Money Market Funds described below. Money
market funds typically seek to maintain a stable net asset value of $1.00 per
share, although there is no guarantee that their net asset value will not vary.
The Money Market Funds, in general, will only purchase U.S. dollar-denominated
"Eligible Securities" (as defined by the Securities and Exchange Commission),
which are generally securities that either (i) have short-term debt ratings when
purchased in the two highest rating categories by at least two NRSROs, or (ii)
are unrated, but are deemed by Lyon Street to be of comparable quality pursuant
to guidelines approved by the Board of Trustees. The dollar-weighted average
maturity of each Money Market Fund's portfolio will not exceed 90 days and with
certain exceptions, the Money Market Funds will not purchase any securities
which mature in more than 397 days from the date of purchase. All securities
purchased by the Money Market Funds will be determined by Lyon Street, under
guidelines established by the Board of Trustees, to present minimal credit
risks.
MONEY MARKET FUND
OTHER INVESTMENT STRATEGIES: The Fund invests in a broad range of government,
bank and commercial obligations. These instruments primarily include obligations
of banks having total assets in excess of $1 billion at the time of purchase and
commercial paper that matures in 13 months
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or less. The Fund may also invest in short-term obligations guaranteed by the
U.S. Government, its agencies or instrumentalities.
GOVERNMENT MONEY MARKET FUND
The investment strategies and risks of investing in the Fund are disclosed in
the Prospectus.
MICHIGAN MUNICIPAL MONEY MARKET FUND
OTHER INVESTMENT STRATEGIES: At least 80% of the Fund's net assets will be
invested in federally tax-exempt obligations, except during periods of unusual
market conditions. This policy is a fundamental policy which cannot be changed
by the Fund without the approval of its shareholders. Federally tax-exempt
obligations consist of municipal bonds, notes and commercial paper issued by
states, territories or possessions of the United States, the District of
Columbia and their political subdivisions, agencies and instrumentalities, the
interest on which is, in the opinion of counsel to the issuer of such
obligations, exempt from federal income taxes. Under ordinary circumstances, the
Fund intends to invest at least 65% of its total assets in municipal obligations
issued by the State of Michigan or its political subdivisions, authorities or
corporations. Taxable obligations acquired by the Fund will not exceed 20% of
the Fund's net assets at the time of purchase under normal market conditions.
In calculating the 80% limitation for the Michigan Municipal Money Market Fund,
securities whose interest is treated as a specific tax preference item under the
federal alternative minimum tax and is treated as exempt from Michigan personal
income tax are considered non-taxable.
DETAILED DESCRIPTION OF INVESTMENT VEHICLES AND POTENTIAL RISKS
The investment policies discussed below are applicable to all Funds unless
otherwise noted, except that the Government Money Market Fund will purchase only
U.S. Treasury bills, notes and other obligations issued by the U.S. Government,
its agencies or instrumentalities, repurchase agreements with respect to such
securities and shares of registered money market investment companies that
invest exclusively in such securities.
MONEY MARKET INSTRUMENTS
To the extent described in the Funds' prospectus or statement of
additional information, each Fund may invest from time to time in "money market
instruments," a term that includes, among other things, bank obligations,
commercial paper, variable amount master demand notes and corporate bonds and
U.S. Government obligations with remaining maturities of thirteen months or
less.
Bank obligations include certificates of deposit, bankers' acceptances
and time deposits, issued or supported by the credit of U.S. or foreign banks or
savings institutions. Certificates of deposit are negotiable certificates issued
against funds deposited in a commercial bank for a definite period of time and
earning a specified return. Bankers' acceptances are negotiable drafts or bills
of exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Fixed time deposits are bank obligations payable at a stated maturity date and
bearing interest at a fixed rate. Fixed time deposits may be withdrawn on demand
by the investor, but may be subject to early withdrawal penalties that vary
depending upon market conditions and the remaining maturity of the obligation.
There are no contractual restrictions on the right to transfer a beneficial
interest in a fixed time deposit to a third party, although there is no market
for such deposits. All investments in bank
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obligations are limited to the obligations of financial institutions having more
than $1 billion in total assets at the time of purchase.
The Funds may invest a portion of their assets in the obligations of
foreign banks and foreign branches of domestic banks. Such obligations include
Eurodollar Certificates of Deposit ("ECDs") which are U.S. dollar-denominated
certificates of deposit issued by offices of foreign and domestic banks located
outside the United States; Eurodollar Time Deposits ("ETDs") which are U.S.
dollar-denominated deposits in a foreign branch of a U.S. bank or a foreign
bank; Canadian Time Deposits ("CTDs") which are essentially the same as ETDs
except they are issued by Canadian offices of major Canadian banks; Schedule Bs,
which are obligations issued by Canadian branches of foreign or domestic banks;
Yankee Certificates of Deposit ("Yankee CDs") which are U.S. dollar-denominated
certificates of deposit issued by a U.S. branch of a foreign bank and held in
the United States; and Yankee Bankers' Acceptances ("Yankee BAs") which are U.S.
dollar-denominated bankers' acceptances issued by a U.S. branch of a foreign
bank and held in the United States.
Although the Funds will invest in obligations of foreign banks or
foreign branches of U.S. banks only when Lyon Street deems the instrument to
present minimal credit risk, such investments nevertheless entail risks that are
different from those of investments in domestic obligations of U.S. banks. These
additional risks include future political and economic developments, the
possible imposition of withholding taxes on interest income, possible seizure or
nationalization of foreign deposits, the possible establishment of exchange
controls, or the adoption of other foreign governmental restrictions which might
adversely affect the payment of principal and interest on such obligations. In
addition, foreign branches of U.S. banks and U.S. branches of foreign banks may
be subject to less stringent reserve requirements and to different accounting,
auditing, reporting and record keeping standards than those applicable to
domestic branches of U.S. banks. Commercial paper represents short-term
unsecured promissory notes issued in bearer form by banks or bank holding
companies, corporations and finance companies. Investments by the Funds in
taxable commercial paper will consist of issues that are rated A-1 by Standard &
Poor's Ratings Group ("S&P") or Prime-1 by Moody's Investors Service, Inc.
("Moody's"). In addition, the Funds may acquire unrated commercial paper and
corporate bonds that are determined by Lyon Street at the time of purchase to be
of comparable quality to rated instruments that may be acquired by the Funds.
Commercial paper may include variable and floating rate instruments. Commercial
paper issues include securities issued by corporations without registration
under the Securities Act of 1933, as amended (the "1933 Act"), in reliance on
the exemption in Section 3(a)(3), and commercial paper issued in reliance on the
so-called "private placement" exemption in Section 4(2) ("Section 4(2) Paper").
Section 4(2) Paper is restricted as to disposition under the federal securities
laws in that any resale must similarly be made in an exempt transaction. Section
4(2) Paper is normally resold to other institutional investors through or with
the assistance of investment dealers which make a market in Section 4(2) Paper,
thus providing liquidity. For purposes of each Fund's limitation on purchases of
illiquid instruments, Section 4(2) Paper will not be considered illiquid if Lyon
Street has determined, in accordance with guidelines approved by the Board of
Trustees, that an adequate trading market exists for such securities.
Variable amount master demand notes are unsecured instruments that
permit the indebtedness thereunder to vary and provide for periodic adjustments
in the interest rate. Although such notes are not normally traded and there may
be no secondary market in the notes, the Funds may demand payment of the
principal of the instrument at any time. If an issuer of a variable amount
master demand note defaulted on its payment obligation, the Funds might be
unable to dispose of the note because of the absence of a secondary market and
might, for this or other reasons, suffer a loss to the extent of the default.
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GUARANTEED INVESTMENT CONTRACTS (The Bond Funds and Money Market Fund only)
The Bond Funds and the Money Market Fund may make limited investments
in guaranteed investment contracts ("GICs") issued by highly rated U.S.
insurance companies. Under a GIC, the Fund gives cash to an insurance company
which credits the Fund with the amount given plus interest based on a certain
index, which interest is guaranteed to be not less than a certain minimum rate.
A GIC is normally a general obligation of the issuing insurance company and not
a separate account. The purchase price paid for a GIC becomes part of the
general assets of the insurance company, and the contract is paid from the
insurance company's general assets. The Bond Funds and the Money Market Fund
will only purchase GICs from insurance companies which, at the time of purchase,
have total assets of $1 billion or more and meet quality and credit standards
established by Lyon Street pursuant to guidelines approved by the Board of
Trustees. Generally, GICs are not assignable or transferable without the
permission of the issuing insurance companies, and an active secondary market in
GICs does not currently exist. Therefore, GICs will normally be considered
illiquid investments, and will be subject to a Fund's limitation on illiquid
investments.
REPURCHASE AGREEMENTS
Each Fund may agree to purchase portfolio securities from financial
institutions subject to the seller's agreement to repurchase them at a mutually
agreed upon date and price ("repurchase agreements"). The Funds will enter into
such repurchase agreements only with financial institutions that are deemed to
be creditworthy by Lyon Street, pursuant to guidelines established by the
Trust's Board of Trustees. During the term of any repurchase agreement, Lyon
Street will continue to monitor the creditworthiness of the seller. The Funds
will not enter into repurchase agreements with Lyon Street or its affiliates.
Although the securities subject to a repurchase agreement may bear maturities
exceeding one year, settlement for the repurchase agreement will never be more
than one year after a Fund's acquisition of the securities and normally will be
within a shorter period of time. Repurchase agreements with deemed maturities in
excess of seven days are considered illiquid investments, and will be subject to
a Fund's limitation on illiquid investments. Securities subject to repurchase
agreements are held either by the Trust's custodian or in the Federal
Reserve/Treasury Book-Entry System. The seller under a repurchase agreement will
be required to maintain the value of the securities subject to the agreement in
an amount exceeding the repurchase price (including accrued interest). Default
by the seller would, however, expose a Fund to possible loss because of adverse
market action or delay in connection with the disposition of the underlying
collateral obligations. Repurchase agreements are considered to be loans by a
Fund under the Investment Company Act of 1940, as amended (the "1940 Act").
REVERSE REPURCHASE AGREEMENTS
Each Fund may borrow funds for temporary or emergency purposes by
selling portfolio securities to financial institutions such as banks and
broker/dealers and agreeing to repurchase them at a mutually specified date and
price ("reverse repurchase agreements"). Reverse repurchase agreements involve
the risk that the market value of the securities sold by a Fund may decline
below the repurchase price. A Fund will pay interest on amounts obtained
pursuant to a reverse repurchase agreement. While reverse repurchase agreements
are outstanding, a Fund will maintain in a segregated account cash, U.S.
Government securities or other liquid high-grade debt securities of an amount at
least equal to the market value of the securities, plus accrued interest,
subject to the agreement. Reverse repurchase agreements are considered to be
borrowings by a Fund under the 1940 Act.
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VARIABLE AND FLOATING RATE INSTRUMENTS (The Bond Funds, Municipal Bond Funds and
Money Market Funds only)
The Bond, Municipal Bond and Money Market Funds may purchase rated and
unrated variable and floating rate instruments. These instruments may include
variable amount master demand notes that permit the amount of indebtedness to
vary in addition to providing for periodic adjustments in the interest rate.
Such notes are direct lending arrangements between the Fund and a borrower and,
therefore, the notes generally are not traded and there is no market in which to
sell them to third parties. A Fund could suffer a loss if, for example, the
borrower defaults on the note. This type of note will be subject to a Fund's
limitations on illiquid investments if the Fund cannot demand payment of the
principal amount of the note within seven days. The absence of an active
secondary market with respect to particular variable and floating rate
instruments could make it difficult for a Fund to dispose of the instruments if
the issuer defaulted on its payment obligation or during periods that the Fund
is not entitled to exercise demand rights, and a Fund could, for these or other
reasons, suffer a loss with respect to such instruments.
When purchasing such instruments for the Funds, Lyon Street will
consider the earning power, cash flows and other liquidity ratios of the issuers
and guarantors of such instruments and, if the instruments are subject to demand
features, will monitor their financial status to meet payment on demand. In
determining weighted average portfolio maturity, an instrument will usually be
deemed to have a maturity equal to the longer of the period remaining until the
next regularly scheduled interest rate adjustment or the time a Fund can recover
payment of principal as specified in the instrument. Variable rate U.S.
Government obligations and certain variable rate instruments having a nominal
maturity of 397 days or less when purchased, however, will be deemed to have
maturities equal to the period remaining until the next interest rate
adjustment. Variable and floating rate instruments purchased by the Money Market
Funds may carry nominal maturities in excess of those Funds' maturity
limitations if such instruments carry demand features that comply with
conditions established by the Securities and Exchange Commission.
LOAN PARTICIPATION NOTES (the Money Market Fund and Michigan Municipal Money
Market Fund only)
The Money Market Fund and Michigan Municipal Money Market Fund may
purchase loan participation notes. A loan participation note represents
participation in a corporate loan of a commercial bank with a remaining maturity
of one year or less. Such loans must be to corporations in whose obligations the
Funds may invest. Any participation purchased by a Fund must be issued by a bank
in the United States with total assets exceeding $1 billion. Because the issuing
bank does not guarantee the participation in any way, they are subject to the
credit risks generally associated with the underlying corporate borrower. In
addition, because it may be necessary under the terms of the loan participation
for a Fund to assert through the issuing bank such rights as may exist against
the corporate borrower if the underlying corporate borrower fails to pay
principal and interest when due, a Fund may be subject to delays, expenses and
risks that are greater than those that would have been involved if the Fund had
purchased a direct obligation of such borrower. Moreover, under the terms of the
loan participation a Fund may be regarded as a creditor of the issuing bank
(rather than the underlying corporate borrower), so that the Fund may also be
subject to the risk that the issuing bank may become insolvent. The secondary
market, if any, for loan participations is extremely limited and any such
participation purchased by a Fund may be regarded as illiquid.
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FORWARD COMMITMENTS, WHEN-ISSUED SECURITIES AND DELAYED-DELIVERY TRANSACTIONS
Each Fund may purchase securities on a when-issued basis or purchase or
sell securities on a forward commitment (sometimes called delayed delivery)
basis. These transactions involve a commitment by the Fund to purchase or sell
securities at a future date. The price of the underlying securities and the date
when the securities will be delivered and paid for (the settlement date) are
fixed at the time the transaction is negotiated. When-issued purchases and
forward commitment transactions are normally negotiated directly with the other
party.
A Fund will purchase securities on a when-issued basis or purchase or
sell securities on a forward commitment basis only with the intention of
completing the transaction and actually purchasing or selling the securities. If
deemed advisable as a matter of investment strategy, however, a Fund may dispose
of or negotiate a commitment after entering into it. A Fund also may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date.
Securities purchased or sold on a when-issued or forward commitment
basis involve a risk of loss if the value of the security to be purchased
declines, or the value of the security to be sold increases, before the
settlement date. When a Fund engages in when-issued and forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
When a Fund purchases securities on a when-issued or forward commitment
basis, the Fund will segregate cash or liquid securities having a value
(determined daily) at least equal to the amount of the Fund's purchase
commitments. In the case of a forward commitment to sell portfolio securities,
the custodian will hold the portfolio securities themselves in a segregated
account while the commitment is outstanding. These procedures are designed to
ensure that the Fund will maintain sufficient assets at all times to cover its
obligations under when-issued and forward commitment transactions. Because a
Fund sets aside liquid assets to satisfy its purchase commitments in the manner
described, its liquidity and ability to manage its portfolio might be affected
in the event its purchase commitments exceed 25% of the value of its assets. For
purposes of determining a Fund's average dollar-weighted maturity, the maturity
of when-issued or forward commitment securities will be calculated from the
commitment date.
UNITED STATES GOVERNMENT OBLIGATIONS
Each Fund may purchase U.S. Government obligations, which are
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. Examples of the types of U.S. Government obligations that may
be acquired by the Funds include U.S. Treasury bills, notes and bonds and
obligations of Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land
Banks, the Federal Housing Administration, Farmers Home Administration,
Export-Import Bank of the United States, Small Business Administration, Federal
National Mortgage Association ("FNMA"), Government National Mortgage Association
("GNMA"), General Services Administration, Central Bank for Cooperatives,
Federal Home Loan Mortgage Corporation ("FHLMC"), Federal Intermediate Credit
Banks, Tennessee Valley Authority, Resolution Funding Corporation and Maritime
Administration. Obligations of certain agencies and instrumentalities of the
U.S. Government, such as those of the GNMA, are supported by the full faith and
credit of the U.S. Treasury; others, such as those of the Export-Import Bank of
the United States, are supported by the right of the issuer to borrow from the
Treasury; others, such as those of the FNMA, are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; still
others, are supported only by the credit of the
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instrumentality. No assurance can be given that the U.S. Government would
provide financial support to U.S. Government-sponsored instrumentalities if it
is not obligated to do so by law.
ZERO COUPON OBLIGATIONS (The Bond Funds and Money Market Funds only)
The Bond Funds and Money Market Funds may acquire zero coupon
obligations. Zero coupon obligations do not make interest payments; instead,
they are sold at a deep discount from their face value and are redeemed at face
value when they mature. Because zero coupon obligations do not pay current
income, their prices can be volatile when interest rates change. The Funds will
accrue income on such investments for tax and accounting purposes, as required,
and such income must be distributed to shareholders. A Fund may be required to
liquidate other portfolio securities to satisfy its distribution obligations
because no cash is received at the time of such income accruals. The return on a
zero coupon obligation, when held to maturity, equals the difference between the
par-value and the original purchase price.
STRIPPED OBLIGATIONS (The Bond Funds and Money Market Funds only)
The Bond and Money Market Funds may purchase U.S. Treasury obligations
and their unmatured interest coupons that have been separated ("stripped") by
their holder, typically a custodian bank or other institutuon. These "stripped"
U.S. Treasury obligations are offered under the Separate Trading of Registered
Interest and Principal Securities ("STRIPS") program or Coupon Under Bank-Entry
Safekeeping ("CUBES") program. These Funds may also purchase other stripped
securities issued directly by agencies or instrumentalities of the U.S.
Government. STRIPS and CUBES represent either future interest or principal
payments and are direct obligations of the U.S. Government that clear through
the Federal Reserve System. These participations, which may be issued by the
U.S. Government (or a U.S. Government agency or instrumentality) or by private
issuers such as banks and other institutions, are issued at a discount to their
face value, and may, with respect to the Bond Funds, include stripped mortgage-
backed securities ("SMBS"). Stripped securities, particularly SMBS, may exhibit
greater price volatility than ordinary debt securities because of the manner in
which their principal and interest are returned to investors. The Funds also may
purchase U.S. dollar-denominated stripped securities that evidence ownership in
the future interest payments or principal payments on obligations of foreign
governments.
SMBS are usually structured with two or more classes that receive
different proportions of the interest and principal distributions from a pool of
mortgage-backed obligations. A common type of SMBS will have one class receiving
all of the interest, while the other class receives all of the principal.
However, in some cases, one class will receive some of the interest and most of
the principal while the other class will receive most of the interest and the
remainder of the principal. If the underlying obligations experience greater
than anticipated prepayments of principal, a Fund may fail to fully recoup its
initial investment. The market value of the class consisting entirely of
principal payments can be extremely volatile in response to changes in interest
rates. The yields on a class of SMBS that receives all or most of the interest
are generally higher than prevailing market yields on other mortgage-backed
obligations because their cash flow patterns are also volatile and there is a
greater risk that the initial investment will not be fully recouped.
SMBS which are not issued by the U.S. Government (or a U.S. Government
agency or instrumentality) are considered illiquid. SMBS issued by the U.S.
Government (or a U.S. Government agency or instrumentality) may be considered
liquid under guidelines established by the Trust's Board of Trustees if they can
be disposed of promptly in the ordinary course of business at a value reasonably
close to that used in the calculation of a Fund's per share net asset value.
Within the past several years, the Treasury Department has facilitated
transfers of ownership of stripped securities by accounting separately for the
beneficial ownership of particular interest coupon and
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principal payments on Treasury securities through the Federal Reserve book-entry
record-keeping system. The Federal Reserve program as established by the
Treasury Department is known as "STRIPS" or "Separate Trading of Registered
Interest and Principal Securities." Under the STRIPS program, the Funds will be
able to have their beneficial ownership of stripped securities recorded directly
in the book-entry record-keeping system in lieu of having to hold certificates
or other evidences of ownership of the underlying U.S. Treasury securities.
In addition, the Bond Funds and Money Market Funds may acquire other
U.S. Government obligations and their unmatured interest coupons that have been
separated ("stripped") by their holder. Having separated the interest coupons
from the underlying principal of the U.S. Government obligations, the holder
will resell the stripped securities in custodial receipt programs with a number
of different names, including "Treasury Income Growth Receipts" ("TIGRs") and
"Certificate of Accrual on Treasury Securities" ("CATS"). The stripped coupons
are sold separately from the underlying principal, which is usually sold at a
deep discount because the buyer receives only the right to receive a future
fixed payment on the security and does not receive any rights to periodic
interest (cash) payments. The underlying U.S. Treasury bonds and notes
themselves are held in book-entry form at the Federal Reserve Bank or, in the
case of bearer securities (i.e., unregistered securities which are ostensibly
owned by the bearer or holder), in trust on behalf of the owners. Counsel to the
underwriters of these certificates or other evidences of ownership of U.S.
Treasury securities have stated that, in their opinion, purchasers of the
stripped securities most likely will be deemed the beneficial holders of the
underlying U.S. Government obligations for federal tax purposes. The Trust is
unaware of any binding legislative, judicial or administrative authority on this
issue. The staff of the Securities and Exchange Commission believes that
participations in TIGRs, CATS and other similar trusts are not U.S. Government
securities.
Although a "stripped" security may not pay interest to holders prior to
maturity, federal income tax regulations require a Fund to recognize as interest
income a portion of the security's discount each year. This income must then be
distributed to shareholders along with other income earned by the Fund. To the
extent that any shareholders in a Fund elect to receive their dividends in cash
rather than reinvest such dividends in additional Fund shares, cash to make
these distributions will have to be provided from the assets of the Fund or
other sources such as proceeds of sales of Fund shares and/or sales of portfolio
securities. In such cases, the Fund will not be able to purchase additional
income producing securities with cash used to make such distributions and its
current income may ultimately be reduced as a result.
MORTGAGE-BACKED SECURITIES (The Bond Funds and Money Market Funds only)
The Bond Funds and Money Market Funds may invest in mortgage-backed
securities, including those representing an undivided ownership interest in a
pool of mortgages, such as certificates of the GNMA and the FHLMC. These
certificates are in most cases pass-through instruments, through which the
holder receives a share of all interest and principal payments from the
mortgages underlying the certificate, net of certain fees. The average life of a
mortgage-backed security varies with the underlying mortgage instruments, which
have maximum maturities of 40 years. The average life is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities as the result of prepayments, mortgage refinancings or
foreclosure. Mortgage prepayment rates are affected by factors including the
level of interest rates, general economic conditions, the location and age of
the mortgage and other social and demographic conditions. Such prepayments are
passed through to the registered holder with the regular monthly payments of
principal and interest and have the effect of reducing future payments.
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In periods of falling interest rates, the rate of mortgage prepayments
tends to increase. During such periods, the reinvestment of prepayment proceeds
by a Fund will generally be at lower rates than the rates that were carried by
the obligations that have been prepaid. As a result, the relationship between
mortgage prepayments and interest rates may give some high-yielding mortgage-
related securities less potential for growth in value than conventional bonds
with comparable maturities. In calculating the average weighted maturity of each
Fund, the maturity of mortgage-backed securities will be based on estimates of
average life.
There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage-related securities
and among the securities that they issue. Mortgage-related 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 backed by the full faith and credit of the United States. 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. Fannie Maes are guaranteed as to timely payment of the principal and
interest by FNMA. Mortgage-related securities issued by FHLMC include FHLMC
Mortgage Participation Certificates (also known as "Freddie Macs" or "Pcs").
Freddie Macs are not guaranteed 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 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.
The Bond Funds also may acquire collateralized mortgage obligations
("CMOs"), which provide the holder with a specified interest in the cash flow of
a pool of underlying mortgages or other mortgage-backed securities. Issuers of
CMOs ordinarily elect to be taxed as pass-through entities known as real estate
mortgage investment conduits ("REMICs"). CMOs are issued in multiple classes,
each with a specified fixed or floating interest rate and a final distribution
date. The relative payment rights of the various CMO classes may be structured
in a variety of ways.
There are risks inherent in the purchase of mortgage-backed securities.
For example, these securities are subject to a risk that default in payment will
occur on the underlying mortgages. In addition to default risk, these securities
are subject to the risk that prepayment on the underlying mortgages will occur
earlier or later or at a lessor or greater rate than expected. To the extent
that Lyon Street's assumptions about prepayments are inaccurate, these
securities may expose the Funds to significantly greater market risks than
expected.
MORTGAGE DOLLAR ROLLS (The Bond Funds and Money Market Funds only)
The Bond Funds and Money Market Funds may enter into mortgage dollar
rolls in which the Funds sell securities for delivery in the current month and
simultaneously contract with the same counterparty to repurchase similar (same
type, coupon and maturity) but not identical securities on a specified future
date. When a Fund enters into mortgage dollar rolls, the Fund will hold and
maintain in a segregated account until the settlement date cash or other liquid
assets in an amount equal to the forward purchase price. The Funds benefit to
the extent of any difference between the price received or the securities sold
and the lower forward price for the future purchase (often referred to as the
"drop") or fee income plus the interest earned on the cash proceeds of the
securities sold until the settlement date of the forward purchase. Unless such
benefits exceed the income, capital appreciation and gain or loss due to
mortgage prepayments that would have been realized on the securities sold as
part of the mortgage dollar roll, the use of this technique will diminish the
investment performance of the Funds compared with what such performance would
have been without the use of mortgage dollar rolls. The benefits derived from
the use or mortgage dollar rolls may depend upon Lyon Street's ability to
predict correctly mortgage prepayments and interest rates. There is no assurance
that mortgage dollar rolls can be successfully employed. For financial reporting
and tax purposes, the Funds treat mortgage dollar rolls as two separate
transactions: one involving the purchase of a security and a separate
transaction involving a sale. The Funds do not currently intend to enter into
mortgage dollar rolls that are accounted for as financing and do not treat them
as borrowings.
ASSET-BACKED SECURITIES (The Bond Funds and Money Market Funds only)
The Bond Funds and Money Market Funds may purchase asset-backed
securities, which are securities backed by installment contracts, credit card
receivables or other assets. Asset-backed securities represent interests in
"pools" of assets in which payments of both interest and principal on the
securities are made monthly, thus in effect "passing through" monthly 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 asset-backed securities varies with the maturities of the underlying
instruments, and is likely to be substantially less than the original maturity
of the assets underlying the securities as a result
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of prepayments. For this and other reasons, an asset-backed security's stated
maturity may be shortened, and the security's total return may be difficult to
predict precisely.
Non-mortgage asset-backed securities involve certain risks that are not
presented by mortgage-backed securities. Primarily, these securities do not have
the benefit of a security interest in the underlying collateral. Credit card
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
have given debtors the right to set off certain amounts owed on the credit
cards, thereby reducing the balance due. Most issuers of automobile receivables
permit the servicers to retain possession of the underlying obligations. If the
servicer were to sell these obligations to another party, there is a risk that
the purchaser would acquire an interest superior to that of the holders of the
related automobile receivables. In addition, because of the large number of
vehicles involved in a typical issuance and technical requirements under state
laws, the trustee for the holders of the automobile receivables may not have an
effective security interest in all of the obligations backing such receivables.
Therefore, there is a possibility that recoveries on repossessed collateral may
not, in some cases, be able to support payments on these securities.
CERTAIN DERIVATIVE SECURITIES (The Bond Funds and Municipal Bond Funds only)
The Bond Funds and Municipal Bond Funds may invest in structured notes,
bonds or other instruments with interest rates that are determined by reference
to changes in the value of other interest rates, indices or financial indicators
("References") or the relative change in two or more References. Such Funds also
may hold derivative instruments that have interest rates that reset inversely to
changing current market rates and/or have embedded interest rate floors and caps
that require the issuer to pay an adjusted interest rate if market rates fall
below or rise above a specified rate. These instruments represent relatively
recent innovations in the bond markets, and the trading market for these
instruments is less developed than the markets for traditional types of debt
instruments. It is uncertain how these instruments will perform under different
economic and interest-rate scenarios. Because certain of these instruments are
leveraged, their market values may be more volatile than other types of bonds
and may present greater potential for capital gain or loss. On the other hand,
the embedded option features of other derivative instruments could limit the
amount of appreciation a Fund can realize on its investment, could cause a Fund
to hold a security it might otherwise sell or could force the sale of a security
at inopportune times or for prices that do not reflect current market value. The
possibility of default by the issuer or the issuer's credit provider may be
greater for these structured and derivative instruments than for other types of
instruments. In some cases it may be difficult to determine the fair value of a
structured or derivative instrument because of a lack of reliable objective
information and an established secondary market for some instruments may not
exist. With respect to purportedly tax-exempt derivative securities, in many
cases the Internal Revenue Service has not ruled on whether the interest
received on such securities is in fact free from federal income taxes. Purchases
of such securities by the Municipal Bond Funds are therefore based on the
opinion of counsel to the sponsors of the security.
MUNICIPAL OBLIGATIONS (The Municipal Funds only)
The two principal classifications of municipal obligations which may be
held by the Municipal Funds are "general obligation" securities and "revenue"
securities. General obligation securities are secured by the issuer's pledge of
its full faith, credit and taxing power for the payment of principal and
interest. Revenue securities are generally payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source such
as the user of the facility being financed. Private activity bonds (e.g., bonds
issued by industrial development authorities) are issued by or on behalf of
public authorities to finance various privately-operated facilities. Private
activity bonds are in most cases revenue securities and are not
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payable from the unrestricted revenues of the issuer. Additionally, the
principal and interest on these obligations may or may not be payable from the
general revenue of the users of the facilities involved. The credit quality of
private activity bonds is usually directly related to the credit standing of the
corporate user of the facility involved. The Funds may also purchase "moral
obligation" securities, which are normally issued by special purpose public
authorities. If the issuer of moral obligation securities is unable to meet its
debt service obligations from current revenues, it may draw on a reserve fund,
the restoration of which is a moral commitment but not a legal obligation of the
state or municipality which created the issuer.
Opinions relating to the validity of municipal obligations and to the
exemption of interest thereon from regular Federal income tax and, in the case
of Michigan municipal obligations, Michigan state personal income tax, are
rendered by counsel to the respective issuing authorities at the time of
issuance. Such opinions may contain various assumptions, qualifications or
exceptions that are reasonably acceptable to Lyon Street. Neither the Trust nor
Lyon Street will review the proceedings relating to the issuance of municipal
obligations or the bases for such opinions.
An issuer's responsibilities under its municipal obligations are
subject to the provisions of bankruptcy, insolvency and other laws affecting the
rights and remedies of creditors, such as the Federal Bankruptcy Code, and laws,
if any, which may be enacted by federal or state legislatures extending the time
for payment of principal or interest, or both, or imposing other constraints
upon enforcement of such obligations or upon the ability of municipalities to
levy taxes. The power or ability of an issuer to meet its obligations for the
payment of interest on and principal of its municipal obligations may be
materially adversely affected by litigation or other conditions.
From time to time proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on municipal obligations. For example, under the Tax Reform Act of 1986
interest on certain private activity bonds must be included in an investor's
Federal alternative minimum taxable income, and corporate investors must include
all tax-exempt interest in their federal alternative minimum taxable income. The
Trust cannot predict what legislation, if any, may be proposed in the future in
Congress as regards the federal income tax status of interest on municipal
obligations or which proposals, if any, might be enacted. Such proposals, if
enacted, might materially adversely affect the availability of municipal
obligations and a Fund's liquidity and value. In such an event the Board of
Trustees would reevaluate the Funds' investment objectives and policies and
consider changes in their structure or possible dissolution.
Certain of the municipal obligations held by a Fund may be insured as
to the timely payment of principal and interest. The insurance policies will
usually be obtained by the issuer of the municipal obligations at the time of
its original issuance. In the event that the issuer defaults on an interest or
principal payment, the insurer will be notified and will be required to make
payment to the bondholders. There is, however, no guarantee that the insurer
will meet its obligations. In addition, such insurance will not protect against
market fluctuations caused by changes in interest rates and other factors. The
Municipal Funds may invest more than 25% of their assets in municipal
obligations covered by insurance policies.
The Municipal Funds also may purchase municipal obligations known as
"certificates of participation" which represent undivided proportional interests
in lease payments by a governmental or nonprofit entity. The lease payments and
other rights under the lease provide for and secure the payments on the
certificates. Lease obligations may be limited by applicable municipal charter
provisions or the nature of the appropriation for the lease. In particular,
lease obligations may be subject to periodic appropriation. If the entity does
not appropriate funds for future lease payments, the
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entity cannot be compelled to make such payments. Furthermore, a lease may or
may not provide that the certificate trustee can accelerate lease obligations
upon default. If the trustee could not accelerate lease obligations upon
default, the trustee would only be able to enforce lease payments as they became
due. In the event of a default or failure of appropriation, it is unlikely that
the trustee would be able to obtain an acceptable substitute source of payment.
Certificates of participation are generally subject to redemption by the issuing
municipal entity under specified circumstances. If a specified event occurs, a
certificate is callable at par either at any interest payment date or, in some
cases, at any time. As a result, certificates of participation are not as liquid
or marketable as other types of municipal obligations and are generally valued
at par or less than par in the open market. Municipal leases may be considered
liquid, however, under guidelines established by the Trust's Board of Trustees.
The guidelines will provide for determination of the liquidity and proper
valuation of a municipal lease obligation based on factors including the
following: (1) the frequency of trades and quotes for the obligation; (2) the
number of dealers willing to purchase or sell the security and the number of
other potential buyers; (3) the willingness of dealers to undertake to make a
market in the security; and (4) the nature of the marketplace trades, including
the time needed to dispose of the security, the method of soliciting offers and
the mechanics of transfer. Lyon Street, under the supervision of the Trust's
Board of Trustees, will also consider the continued marketability of a municipal
lease obligation based upon an analysis of the general credit quality of the
municipality issuing the obligation and the essentiality to the municipality of
the property covered by the lease.
STANDBY COMMITMENTS (The Municipal Funds only)
The Municipal Funds may enter into standby commitments with respect to
municipal obligations held by them. Under a standby commitment, a dealer agrees
to purchase at a Fund's option a specified municipal obligation at its amortized
cost value to the Fund plus accrued interest, if any. Standby commitments may be
exercisable by a Fund at any time before the maturity of the underlying
municipal obligations and may be sold, transferred or assigned only with the
instruments involved.
The Funds expect that standby commitments will generally be available
without the payment of any direct or indirect consideration. However, if
necessary or advisable, the Funds may pay for a standby commitment either
separately in cash or by paying a higher price for municipal obligations which
are acquired subject to the commitment (thus reducing the yield to maturity
otherwise available for the same securities).
The Funds intend to enter into standby commitments only with dealers,
banks and broker-dealers which, in Lyon Street's opinion, present minimal credit
risks. The Funds will acquire standby commitments solely to facilitate portfolio
liquidity and do not intend to exercise their rights thereunder for trading
purposes. Standby commitments will be valued at zero in determining net asset
value of a Fund. Accordingly, where a Fund pays directly or indirectly for a
standby commitment, its cost will be reflected as unrealized depreciation for
the period during which the commitment is held by the Fund and will be reflected
in realized gain or loss when the commitment is exercised or expires.
WARRANTS (The Equity Funds only)
The Equity Funds may purchase warrants and similar rights, which are
privileges issued by corporations enabling the owners to subscribe to and
purchase a specified number of shares of the corporation at a specified price
during a specified period of time. The purchase of warrants involves the risk
that a Fund could lose the purchase value of a warrant if the right to subscribe
to additional shares is not exercised prior to the warrant's expiration. Also,
the purchase of warrants involves the risk that the effective price paid for the
warrant added to the subscription price of the related security may exceed the
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value of the subscribed security's market price such as when there is no
movement in the level of the underlying security.
FOREIGN SECURITIES
The International Growth Fund intends to invest primarily in the
securities of foreign issuers. In addition, the Large Company Growth Fund and
the Growth and Income Fund may invest up to 10% of their total assets in such
securities. These obligations may be issued by supranational entities, including
international organizations designated or supported by governmental entities to
promote economic reconstruction or development and internal banking institutions
and related government agencies. As noted above, all of the Funds may invest in
certain obligations of foreign banks and foreign branches of domestic banks.
Investment in foreign securities involves special risks. The
performance of investments in securities denominated in a foreign currency will
depend on the strength of the foreign currency against the U.S. dollar and the
interest rate environment in the country issuing the currency. Absent other
events which could otherwise affect the value of a foreign security (such as a
change in the political climate or an issuer's credit quality), appreciation in
the value of the foreign currency increases the value of a foreign
currency-denominated security in terms of U.S. dollars. A rise in foreign
interest rates or decline in the value of the foreign currency relative to the
U.S. dollar generally can be expected to depress the value of a foreign
currency-denominated security.
There are other risks and costs involved in investing in foreign
securities which are in addition to the usual risks inherent in domestic
investments. Investment in foreign securities involves higher costs than
investment in U.S. securities, including higher transaction and custody costs as
well as the imposition of additional taxes by foreign governments. Foreign
investments also involve risks associated with the level of currency exchange
rates, less complete financial information about the issuers, less market
liquidity, more market volatility and political instability. Future political
and economic developments, the possible imposition of withholding taxes on
dividend income, the possible seizure or nationalization of foreign holdings,
the possible establishment of exchange controls, or the adoption of other
governmental restrictions might adversely affect an investment in foreign
securities. With respect to securities issued by foreign governments, such
governments may default on their obligations, may not respect the integrity of
such debt, may attempt to renegotiate the debt at a lower rate, and may not
honor investments by United States entities or citizens.
Although the Large Company Growth Fund, the Growth and the Income Fund
and the International Growth Fund may invest in securities denominated in
foreign currencies, their portfolio securities and other assets are valued in
U.S. dollars. Currency exchange rates may fluctuate significantly over short
periods of time causing, together with other factors, a Fund's net asset value
to fluctuate as well. Currency exchange rates generally are determined by the
forces of supply and demand in the foreign exchange markets and the relative
merits of investments in different countries, actual or anticipated changes in
interest rates and other complex factors, as seen from an international
perspective. Currency exchange rates also can be affected unpredictably by the
intervention or the failure to intervene by U.S. or foreign governments or
central banks, or by currency controls or political developments in the U.S. or
abroad. The Funds are also subject to the possible imposition of exchange
control regulations or freezes on convertibility of currencies.
Dividends and interest payable on a Fund's foreign portfolio securities
may be subject to foreign withholding taxes. To the extent such taxes are not
offset by credits or deductions allowed to investors under U.S. federal income
tax law, they may reduce the net return to the shareholders.
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AMERICAN DEPOSITARY RECEIPTS (The Equity Funds only)
The Equity Funds can invest in American Depositary Receipts ("ADRs").
ADRs are receipts typically issued by a United States bank or trust company
evidencing ownership of underlying foreign securities and are denominated in
U.S. dollars. ADRs traded in the over-the-counter market which do not have an
active or substantial secondary market will be considered illiquid and therefore
will be subject to the Funds' respective limitations with respect to such
securities. Investments in ADRs involve risks similar to those accompanying
direct investments in foreign securities.
Some Institutions issuing ADRs may not be sponsored by the issuer. If a
Fund invests in an unsponsored ADR, there may be less information available to
the Fund concerning the issuer of the securities underlying the unsponsored ADR
than is available for an issuer of securities underlying a sponsored ADR. A
non-sponsored depository may not provide the same shareholder information that a
sponsored depository is required to provide under its contractual arrangement
with the issuer. Certain of these risks are described above under "Detailed
Description of Investment Vehicles and Potential Risks--Foreign Securities."
FOREIGN CURRENCY TRANSACTIONS (The International Growth Fund only)
In order to protect against a possible loss on investments resulting
from a decline in the value of a particular foreign currency against the U.S.
dollar or another foreign currency, the International Growth Fund is authorized
to enter into forward currency exchange contracts. A forward currency exchange
contract is an obligation to purchase or sell a specific currency, or a "basket"
of currencies, at a future date, which may be any fixed number of days from the
date of the contract agreed upon by the parties, at a price set at the time of
contract. Although the contracts may be used to minimize the risk of loss due to
a decline in the value of the hedged currency, at the same time they tend to
limit any potential gain that might be realized should the value of such
currency increase. The Fund may also engage in cross-hedging by using forward
currency exchange contracts in one currency to hedge against fluctuations in the
value of securities denominated in a different currency if Lyon Street believes
that there is a pattern of correlation between the two currencies.
The Fund may enter into forward currency exchange contracts in several
circumstances. When entering into a contract for the purchase or sale of a
security, the Fund may enter into a forward currency exchange contract for the
amount of the purchase or sale price to protect against variations, between the
date the security is purchased or sold and the date on which payment is made or
received, in the value of the foreign currency relative to the U.S. dollar or
other foreign currency.
When Lyon Street anticipates that a particular foreign currency may
decline substantially relative to the U.S. dollar or other leading currencies,
in order to reduce risk, the Fund may enter into a forward contract to sell, for
a fixed amount, the amount of foreign currency approximating the value of some
or all of the Fund's securities denominated in such foreign currency. Similarly,
when the securities held by the Fund create a short position in a foreign
currency, the Fund may enter into a forward contract to buy, for a fixed amount,
an amount of foreign currency approximating the short position. With respect to
any forward foreign currency contract, it will not generally be possible to
match precisely the amount covered by that contract and the value of the
securities involved due to the changes in the values of such securities
resulting from market movements between the date the forward contract is entered
into and the date it matures. While forward contracts may offer protection from
losses resulting from declines in the value of a particular foreign currency,
they also limit potential gains which might result from changes in the value of
such currency. The Fund will also incur costs in connection with forward foreign
currency exchange contracts and conversions of foreign currencies and U.S.
dollars.
A separate account consisting of cash, U.S. Government securities or
other liquid securities, equal to the amount of the Fund's assets that could be
required to consummate forward contracts will be established with the Fund's
custodian except to the extent the contracts are otherwise "covered." For the
purpose of determining the adequacy of the securities in the account, the
deposited securities will be valued at market or fair value. If the market or
fair value of such securities declines, additional cash or securities will be
placed in the account daily so that the value of the account will equal the
amount of such commitments by the Fund. A forward contract to sell a foreign
currency is "covered"
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if the Fund owns the currency (or securities denominated in the currency)
underlying the contract, or holds a forward contract (or call option) permitting
the Fund to buy the same currency at a price no higher than the Fund's price to
sell the currency. A forward contract to buy a foreign currency is "covered" if
a Fund holds a forward contract (or put option) permitting the Fund to sell the
same currency at a price as high as or higher than the Fund's price to buy the
currency.
CURRENCY SWAPS (The International Growth Fund only)
The International Growth Fund may also enter into currency swaps, which
involve the exchange of the rights of the Fund and another party to make or
receive payments in specific currencies. The net amount of the excess, if any,
of the Fund's obligations over its entitlements with respect to each currency
swap will be accrued on a daily basis and an amount of liquid assets, such as
cash, U.S. Government securities or other liquid securities, having an aggregate
net asset value at least equal to such accrued excess will be maintained in
segregated accounts by the Trust's custodian. Inasmuch as these transactions are
entered into for good faith hedging purposes, the Funds and Lyon Street believe
that such obligations do not constitute senior securities as defined in the 1940
Act and, accordingly, will not treat them as being subject to the Fund's
borrowing restrictions.
The Fund will not enter into a currency swap unless the unsecured
commercial paper, senior debt or the claims-paying ability of the other party
thereto is rated either A or A-1 or better by S&P or Moody's. If there is a
default by the other party to such transaction, the Fund will have contractual
remedies pursuant to the agreements related to the transaction. The swap market
has grown substantially in recent years with a large number of banks and
investment banking firms acting both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid in comparison with markets for other similar instruments which
are traded in the Interbank market.
OPTIONS (The Equity, Bond and Municipal Bond Funds only)
The above-referenced Funds may buy put and call options and write
covered call and secured put options. Such options may relate to particular
securities, indices, financial instruments or foreign currencies, and may or may
not be listed on a domestic or foreign securities exchange and may or may not be
issued by the Options Clearing Corporation. Options trading is a highly
specialized activity which entails greater than ordinary investment risk.
Options may be more volatile than the underlying instruments, and therefore, on
a percentage basis, an investment in options may be subject to greater
fluctuation than an investment in the underlying instruments themselves. A Fund
will not purchase put or call options where the aggregate premiums on
outstanding options exceed 5% of the Fund's net assets and will not write
options on more than 25% of the value of its net assets.
A call option for a particular security gives the purchaser of the
option the right to buy, and a writer has the obligation to sell, the underlying
security at the stated exercise price at any time prior to the expiration of the
option, regardless of the market price of the security. The premium paid to the
writer is in consideration for undertaking the obligation under the option
contract. A put option for a particular security gives the purchaser the right
to sell the security at the stated exercise price at any time prior to the
expiration date of the option, regardless of the market price of the security.
Options on indices provide the holder with the right to make or receive a cash
settlement upon exercise of the option. With respect to options on indices, the
amount of the settlement will equal the difference between the closing price of
the index at the time of exercise and the exercise price of the option expressed
in dollars, times a specified multiple.
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The Funds will write call options only if they are "covered." In the
case of a call option on a security or currency, the option is "covered" if a
Fund owns the instrument underlying the call or has an absolute and immediate
right to acquire that instrument without additional cash consideration (or, if
additional cash consideration is required, cash, U.S. Government securities or
other liquid securities, in such amount are held in a segregated account by the
Fund's custodian) upon conversion or exchange of other securities held by it.
For a call option on an index, the option is covered if a Fund maintains with
its custodian a diversified portfolio of securities comprising the index or
liquid assets equal to the contract value. A call option is also covered if a
Fund holds a call on the same instrument or index as the call written where the
exercise price of the call held is (i) equal to or less than the exercise price
of the call written, or (ii) greater than the exercise price of the call written
provided the difference is maintained by the Fund in liquid assets in a
segregated account with its custodian. The Funds will write put options only if
they are secured by liquid assets maintained in a segregated account by the
Funds' custodian in an amount not less than the exercise price of the option at
all times during the option period.
A Fund's obligation to sell an instrument subject to a covered call
option written by it, or to purchase an instrument subject to a secured put
option written by it, may be terminated prior to the expiration date of the
option by the Fund's execution of a closing purchase transaction, which is
effected by purchasing on an exchange an option of the same series (i.e., same
underlying instrument, exercise price and expiration date) as the option
previously written. Such a purchase does not result in the ownership of an
option. A closing purchase transaction will ordinarily be effected to realize a
profit on an outstanding option, to prevent an underlying instrument from being
called, to permit the sale of the underlying instrument or to permit the writing
of a new option containing different terms on such underlying instrument. The
cost of such a liquidation purchase plus transaction costs may be greater than
the premium received upon the original option, in which event the Fund will have
incurred a loss in the transaction. There is no assurance that a liquid
secondary market will exist for any particular option. An option writer, unable
to effect a closing purchase transaction, will not be able to sell the
underlying instrument (in the case of a covered call option) or liquidate the
segregated account (in the case of a secured put option) until the option
expires or the optioned instrument or currency is delivered upon exercise with
the result that the writer in such circumstances will be subject to the risk of
market decline or appreciation in the instrument during such period.
When a Fund purchases an option, the premium paid by it is recorded as
an asset of the Fund. When a Fund writes an option, an amount equal to the net
premium (the premium less the commission) received by a Fund is included in the
liability section of the Fund's statement of assets and liabilities as a
deferred credit. The amount of this asset or deferred credit will be
subsequently marked-to-market to reflect the current value of the option
purchased or written. The current value of the traded option is the last sale
price or, in the absence of a sale, the current bid price. If an option
purchased by a Fund expires unexercised, the Fund realizes a loss equal to the
premium paid. If a Fund enters into a closing sale transaction on an option
purchased by it, the Fund will realize a gain if the premium received by the
Fund on the closing transaction is more than the premium paid to purchase the
option, or a loss if it is less. If an option written by a Fund expires on the
stipulated expiration date or if a Fund enters into a closing purchase
transaction, it will realize a gain (or loss if the cost of a closing purchase
transaction exceeds the net premium received when the option is sold) and the
deferred credit related to such option will be eliminated. If an option written
by a Fund is exercised, the proceeds of the sale will be increased by the net
premium originally received and the Fund will realize a gain or loss.
There are several risks associated with transactions in options. For
example, there are significant differences between the securities, currency and
options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. In addition,
a
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liquid secondary market for particular options, whether traded over-the-counter
or on an exchange may be absent for reasons which include the following: there
may be insufficient trading interest in certain options; restrictions may be
imposed by an exchange on opening transactions or closing transactions or both;
trading halts, suspensions or other restrictions may be imposed with respect to
particular classes or series of options or underlying securities or currencies;
unusual or unforeseen circumstances may interrupt normal operations on an
exchange; the facilities of an exchange or the Options Clearing Corporation may
not at all times be adequate to handle current trading value; or one or more
exchanges could, for economic or other reasons, decide or be compelled at some
future date to discontinue the trading of options (or a particular class or
series of options), in which event the secondary market on that exchange (or in
that class or series of options) would cease to exist, although outstanding
options that had been issued by the Options Clearing Corporation as a result of
trades on that exchange would continue to be exercisable in accordance with
their terms.
FUTURES CONTRACTS AND RELATED OPTIONS (The Equity, Bond and Municipal Bond Funds
only)
The Equity, Bond and Municipal Bond Funds may also purchase futures
contracts, which are contracts in which a Fund agrees, at maturity, to take or
make delivery of certain securities, other financial instruments, the cash value
of a specified index or, in the case of the International Growth Fund, a stated
quantity of foreign currency. The Equity, Bond and Municipal Bond Funds may also
purchase and sell put and call options on futures contracts traded on an
exchange or board of trade. Futures may be used for hedging purposes or to
provide liquid assets. A Fund will not enter into a futures contract unless
immediately after any such transaction the aggregate amount of margin deposits
on its existing futures positions plus premiums paid for related options is less
than 5% of the Fund's net assets. For a detailed description of futures
contracts and related options, see Appendix C to this SAI.
ILLIQUID AND RESTRICTED SECURITIES
The Funds will not invest more than 15% (10% in the case of the Money
Market Funds) of the value of their net assets in securities that are illiquid
because of restrictions on transferability or other reasons. Repurchase
agreements with deemed maturities in excess of seven days, time deposits
maturing in more than seven days, currency swaps, SMBSs issued by private
issuers, unlisted over-the-counter options, GICs and securities that are not
registered under the 1933 Act, but that may be purchased by institutional buyers
under Rule 144A are subject to this limit (unless such securities are variable
amount master demand notes with maturities of nine months or less or unless the
Board determines that a liquid trading market exists).
Rule 144A allows for a broader institutional trading market for
securities otherwise subject to restriction on resale to the general public.
Rule 144A establishes a safe harbor from the registration requirements of the
1933 Act for resales of certain securities to qualified institutional buyers.
Lyon Street believes that the market for certain restricted securities such as
institutional commercial paper may expand further as a result of this regulation
and the development of automated systems for the trading, clearance and
settlement of unregistered securities of domestic and foreign issuers, such as
the PORTAL System sponsored by the National Association of Securities Dealers,
Inc.
Lyon Street monitors the liquidity of restricted securities in the
Funds' portfolios under the supervision of the Board of Trustees. In reaching
liquidity decisions, Lyon Street will consider such factors as: (a) the
frequency of trades and quotes for the security; (b) the number of dealers
wishing to purchase or sell the security and the number of other potential
purchasers; (c) the willingness of dealers to undertake to make a market in the
security; and (d) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers and the
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mechanics of the transfer). The use of Rule 144A transactions could have the
effect of increasing the level of illiquidity in the Funds during any period
that qualified institutional buyers become uninterested in purchasing these
restricted securities.
SECURITIES LENDING
A Fund may lend its portfolio securities to broker-dealers and other
institutional investors pursuant to agreements requiring that the loans be
continuously secured by collateral equal at all times in value to at least the
market value of the securities loaned. Such loans will not be made by a Fund if,
as a result, the aggregate of all outstanding loans of the Fund exceeds
one-third of the value of its total assets. There may be risks of delay in
receiving additional collateral or in recovering the securities loaned or
(including the value of the collateral received for the loan) even a loss of
rights in the collateral should the borrower of the securities fail financially.
However, loans are made only to borrowers deemed by Lyon Street to be of good
standing and when, in Lyon Street's judgment, the income to be earned from the
loan justifies the attendant risks.
Collateral for loans of portfolio securities made by a Fund may consist
of cash, securities issued or guaranteed by the U.S. Government or its agencies
or instrumentalities, irrevocable bank letters of credit or any other liquid
high-grade short-term instrument approved for use as collateral by the
Securities and Exchange Commission (or any combination thereof). The borrower of
securities will be required to maintain the market value of the collateral at
not less than the market value of the loaned securities, and such value will be
monitored on a daily basis. When a Fund lends its securities, it continues to
receive dividends and interest on the securities loaned and may simultaneously
earn interest on the investment of the cash collateral. Although voting rights,
or rights to consent, attendant to securities on loan pass to the borrower, such
loans will be called so that the securities may be voted by a Fund if a material
event affecting the investment is to occur.
CONVERTIBLE SECURITIES (The Large Company Growth Fund, The Growth and Income
Fund and The Bond Funds only)
Convertible securities entitle the holder to receive interest paid or
accrued on debt or the dividend paid on preferred stock until the convertible
securities mature or are redeemed, converted or exchanged. Prior to conversion,
convertible securities have characteristics similar to ordinary debt securities
in that they normally provide a stable stream of income with generally higher
yields than those of common stock of the same or similar issuers. Convertible
securities rank senior to common stock in a corporation's capital structure and
therefore generally entail less risk than the corporation's common stock,
although the extent to which such risk is reduced depends in large measure upon
the degree to which the convertible security sells above its value as a fixed
income security.
In selecting convertible securities, Lyon Street will consider, among
other factors, the creditworthiness of the issuers of the securities; the
interest or dividend income generated by the securities; the potential for
capital appreciation of the securities and the underlying common stocks; the
prices of the securities relative to other comparable securities and to the
underlying common stocks; whether the securities are entitled to the benefits of
sinking funds or other protective conditions; diversification of the Funds'
portfolios as to issuers; and whether the securities are rated by a rating
agency and, if so, the ratings assigned.
The value of convertible securities is a function of their investment
value (determined by yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and
their conversion value (their worth, at market value, if converted into the
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underlying common stock). The investment value of convertible securities is
influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline, and by the
credit standing of the issuer and other factors. The conversion value of
convertible securities is determined by the market price of the underlying
common stock. If the conversion value is low relative to the investment value,
the price of the convertible securities is governed principally by their
investment value. To the extent the market price of the underlying common stock
approaches or exceeds the conversion price, the price of the convertible
securities will be increasingly influenced by their conversion value. In
addition, convertible securities generally sell at a premium over their
conversion value determined by the extent to which investors place value on the
right to acquire the underlying common stock while holding fixed income
securities.
INVESTMENT COMPANIES
The Funds may invest in securities issued by other investment
companies, including, but not limited to, money market investment companies,
within the limits prescribed by the 1940 Act. As a shareholder of another
investment company, a Fund would bear, along with other shareholders, its pro
rata portion of the expenses of such other investment company, including
advisory fees. These expenses would be in addition to the advisory and other
expenses that a Fund bears directly in connection with its own operations, and
may represent a duplication of fees to shareholders of a Fund.
YIELDS AND RATINGS
The yields on certain obligations, including the money market
instruments in which the Funds invest, are dependent on a variety of factors,
including general economic conditions, conditions in the particular market for
the obligation, financial condition of the issuer, size of the offering,
maturity of the obligation and ratings of the issue. The ratings of an NRSRO
represent its opinion as to the quality of the obligations it undertakes to
rate. Ratings, however, are general and are not absolute standards of quality.
Consequently, obligations with the same rating, maturity and interest rate may
have different market prices.
After its purchase by a Fund, a rated security may cease to be rated or
its rating may be reduced below the minimum rating required for purchase by the
Fund. Lyon Street will consider such an event in determining whether the Fund
should continue to hold the security. For a description of applicable securities
ratings, see Appendix A.
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MISCELLANEOUS
The Funds are not restricted by policy with regard to portfolio
turnover and will make changes in their investment portfolios from time to time
as business and economic conditions as well as market prices may dictate.
Securities may be purchased on margin by the Funds only to obtain such
short-term credits as are necessary for the clearance of purchases and sales of
securities. The Funds will not engage in selling securities short. The Non-Money
Market Funds may, however, make short sales against the box. "Selling short
against the box" involves selling a security that a Fund owns for delivery at a
specified date in the future. The Equity Funds may acquire corporate debt
securities as a consequence of distributions that are made to holders of equity
securities by certain corporations. The Equity Funds do not intend to hold such
debt securities for investment purposes but, rather, will liquidate their
holdings in such securities at an appropriate time following receipt.
INVESTMENT RESTRICTIONS
The following investment restrictions include those that have been
designated as "fundamental," which may not be changed with respect to a Fund
without the vote of a majority of the Fund's outstanding shares (as defined in
"Declaration of Trust--Voting Rights"), and those that have been designated as
"non-fundamental," which may be changed without shareholder approval. If a
percentage limitation is satisfied at the time of investment, a later increase
in such percentage resulting from a change in the value of a Fund's assets will
not constitute a violation of the limitation. Unless otherwise stated, each
restriction applies to all Funds.
The following investment restrictions are fundamental:
A Fund may not:
(1) Purchase any security (other than obligations issued or guaranteed
by the U.S. Government, its agencies or instrumentalities) of any issuer if as a
result more than 5% of its total assets would be invested in securities of the
issuer, except that up to 25% of its total assets may be invested without regard
to this limit;
(2) Borrow money, which includes entering into reverse repurchase
agreements, except that a Fund may enter into reverse repurchase agreements or
borrow money from banks for temporary or emergency purposes in aggregate amounts
up to one-third of the value of the Fund's net assets; provided that while
borrowings from banks exceed 5% of a Fund's net assets, any such borrowings and
reverse repurchase agreements will be repaid before additional investments are
made;
(3) Pledge more than 15% of its net assets to secure indebtedness; the
purchase or sale of securities on a "when issued" basis, or collateral
arrangements with respect to the writing of options on securities, are not
deemed to be a pledge of assets;
(4) Issue senior securities; the purchase or sale of securities on a
"when issued" basis, or collateral arrangements with respect to the writing of
options on securities, are not deemed to be the issuance of a senior security;
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(5) Make loans, except that a Fund may purchase or hold debt securities
consistent with its investment objective, lend Fund securities valued at not
more than 33 1/3% of its total assets to brokers, dealers and financial
institutions, and enter into repurchase agreements;
(6) With respect to each Fund, other than the Municipal Funds, purchase
any security of any issuer if as a result more than 25% of its total assets
would be invested in a single industry; except that there is no restriction with
respect to obligations issued or guaranteed by the U.S. Government, its agencies
or instrumentalities;
(7) With respect to the Municipal Funds, purchase any security (other
than obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities) of any issuer if as a result more than 25% of its total
assets would be invested in a single industry, including industrial development
bonds from the same facility or similar types of facilities if backed solely by
non-governmental users; governmental issuers of municipal bonds are not regarded
as members of an industry, and the Michigan Municipal Bond Fund and the Michigan
Municipal Money Market Fund may invest more than 25% of its assets in industrial
development bonds;
(8) Purchase or sell commodities or commodity contracts or real estate,
except a Fund may purchase and sell securities secured by real estate and
securities of companies which deal in real estate and may engage in currency or
other financial futures contracts and related options transactions;
(9) Underwrite securities of other issuers, except that a Fund may
purchase securities from the issuer or others and dispose of such securities in
a manner consistent with its investment objective; or
(10) With respect to the Equity Funds, purchase any security (other
than U.S. Government securities) of any issuer if as a result the Fund would
hold more than 10% of the voting securities of the issuer.
The following investment restrictions are "non-fundamental" and may be
changed with respect to a Fund without shareholder approval:
A Fund may not:
(1) Purchase securities on margin, except that it may obtain such
short-term credit as may be necessary for the clearance of purchases and sales
of securities;
(2) Invest more than 15% of its total assets (10% of total assets for
the Money Market Funds) in (i) securities with legal or contractual restrictions
on resale; (ii) securities for which market quotations are not readily
available; and (iii) repurchase agreements maturing in more than seven days;
(3) Invest more than 5% of its total assets in securities of any
company having a record, together with its predecessors, of less than three
years of continuous operation except that each of the Small Company Growth Fund
and the International Growth Fund may invest up to 10% of its total assets in
such companies;
(4) Make short sales of securities or maintain a short position unless
at all times when a short position is open it owns an equal amount of such
securities or of securities which, without payment of any
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further consideration, are convertible into or exchangeable for securities of
the same issue as, and equal in amount to, the securities sold short; or
(5) Invest in the securities of other investment companies except as
permitted by the Investment Company Act of 1940, as amended, or the rules
promulgated thereunder.
With respect to Non-fundamental Investment Restriction (2), the Funds
currently intend to limit investment in illiquid securities to no more than 15%
(10% for the Money Market Funds) of each Fund's respective net assets. With
respect to fundamental Investment Restriction (7), examples of types of
facilities using industrial development bonds purchased by the Municipal Funds
include water treatment plants, educational and hospital facilities.
In order to comply with Securities and Exchange Commission regulations
relating to money market funds, the Money Market Funds will limit investments in
the securities of any single issuer (other than securities issued or guaranteed
by the U.S. Government, its agencies or instrumentalities and repurchase
agreements collateralized by such securities) to not more than 5% of the value
of their total assets at the time of purchase, except for 25% of the value of
their total assets which, in the case of the Michigan Municipal Money Market
Fund, may be invested without regard to the 5% limit in "First Tier Securities"
(as defined by the Securities and Exchange Commission), and, in the case of the
Money Market Fund and the Government Money Market Fund, may be invested in First
Tier Securities of any one issuer for a period of up to three business days. In
addition, no Money Market Fund will engage in options or futures as provided in
fundamental Investment Restrictions (3), (4) and (8), nor will the Money Market
Funds borrow money, pursuant to fundamental Investment Restriction (2), in
excess of 10% of their total assets. With respect to fundamental Investment
Restrictions (6) and (7), the Money Market Funds are permitted to invest in
excess of 25% of their total assets in obligations of U.S. banks and domestic
branches of foreign banks that are subject to the same regulation as U.S. banks.
SECURITIES TRANSACTIONS
Lyon Street, under policies established by the Board of Trustees,
selects broker-dealers to execute transactions for the Funds. It is the policy
of the Trust, in effecting transactions in portfolio securities, to seek best
price and execution of orders. The determination of what may constitute best
price and execution in the execution of a transaction by a broker involves a
number of considerations, including, without limitation, the overall direct net
economic result to a Fund, involving both price paid or received and any
commissions and other costs paid, the breadth of the market where the
transaction is executed, the efficiency with which the transaction is effected,
the ability to effect the transaction at all where a large block is involved,
the availability of the broker to stand ready to execute potentially difficult
transactions in the future and the financial strength and stability of the
broker. Such considerations are judgmental and are weighed by Lyon Street in
determining the overall reasonableness of brokerage commissions paid. In
determining best price and execution and selecting brokers to execute
transactions, Lyon Street may consider brokerage and research services, such as
analyses and reports concerning issuers, industries, securities, economic
factors and trends, and other statistical and factual information provided to a
Fund. Lyon Street is authorized to pay a broker-dealer who provides such
brokerage and research services a commission for executing a Fund's transactions
which is in excess of the amount of commission another broker-dealer would have
charged for effecting that transaction if, but only if, Lyon Street determines
in good faith that such commission was reasonable in relation to the value of
the brokerage and research services provided by such broker-dealer viewed in
terms of that particular transaction or the overall responsibilities of Lyon
Street to the Funds. Any such research and other statistical and factual
information provided by brokers to a Fund or Lyon Street is considered to be in
addition to and not in lieu of services required to be performed by Lyon Street
under its Investment
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Advisory Agreement with the Trust. The cost, value and specific application of
such information are indeterminable and hence are not practicably allocable
among the Trust and other clients of Lyon Street who may indirectly benefit from
the availability of such information. Similarly, the Trust may indirectly
benefit from information made available as a result of transactions effected for
such other clients.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of a transaction may vary among different brokers. Transactions on foreign
stock exchanges involve payment for brokerage commissions which are generally
fixed. Over-the-counter issues, including corporate debt and government
securities, are normally traded on a net basis (i.e., without commission)
through dealers, or otherwise involve transactions directly with the issuer of
an instrument. With respect to over-the-counter transactions, Lyon Street will
normally deal directly with dealers who make a market in the instruments
involved except in those circumstances where more favorable prices and execution
are available elsewhere. The cost of newly issued securities purchased from
underwriters includes an underwriting commission or concession, and the prices
at which securities are purchased from and sold to dealers include a dealer's
mark-up or mark-down. Each Fund may participate, if and when practicable, in
group bidding for the purchase of certain securities directly from an issuer in
order to take advantage of the lower purchase price available to members of such
a group.
Neither Lyon Street nor the Funds intend to place securities
transactions with any particular broker-dealer or group thereof. However, the
Trust's Board of Trustees has determined that each Fund may follow a policy of
considering sales of the Funds' shares as a factor in the selection of
broker-dealers to execute portfolio transactions, subject to the requirements of
best price and execution described above. The policy of each Fund with respect
to brokerage is and will be reviewed by the Trust's Board of Trustees from time
to time. Because of the possibility of further regulatory developments affecting
the securities exchanges and brokerage practices generally, the foregoing
practices may be changed, modified or eliminated.
Lyon Street expects that purchases and sales of securities for the
Equity Funds usually will be effected through brokerage transactions for which
commissions are payable. Lyon Street expects that purchases and sales of
municipal bonds and other debt instruments for the Bond Funds, Municipal Bond
Funds and Money Market Funds usually will be principal transactions. Municipal
bonds and other debt instruments are normally purchased directly from the issuer
or from an underwriter or market maker for the securities. There usually will be
no brokerage commissions paid by the Funds for such purchases.
For the fiscal years ended December 31, 1996, 1997 and 1998, the
following Funds paid commissions in the amounts indicated: $478,044, $1,400,322
and $324,798, respectively, for the Growth and Income Fund; $34,687, $235,105
and $124,194, respectively, for the Index Equity Fund; $453,811, $710,902 and
$1,349,232, respectively, for the Small Company Growth Fund; and $211,929,
$234,749 and $419,688, respectively, for the International Growth Fund. The
increase in the amount of brokerage commissions paid by the Small Company Growth
Fund and the International Growth Fund is attributable to an increase in the
size of each Fund and an increase in each Fund's portfolio turnover. The Tax-
Free Income Fund paid commissions in the amount of $2,500 for the fiscal year
ended December 31, 1996. No other Fund paid brokerage commissions during the
last three fiscal years. No Fund paid any brokerage commissions to an affiliated
broker of the Trust.
Investment decisions for each Fund are made independently by Lyon
Street from those of the other Funds and investment accounts advised by Lyon
Street. It may frequently develop that the same
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investment decision is made for more than one Fund or account. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one Fund or account. When two or more Funds or
accounts are engaged in the purchase or sale of the same security, the
transaction is allocated as to amount in accordance with a formula which Lyon
Street believes is equitable to each Fund or account. It is recognized that in
some cases this system could have a detrimental effect on the price or volume of
the security as far as a particular Fund is concerned. To the extent permitted
by law, Lyon Street may aggregate the securities to be sold or purchased for a
Fund with those to be sold or purchased for another Fund or account.
In no instances will securities held by a Fund be purchased from or
sold to Lyon Street, the Trust's Distributor or any of their "affiliated
persons," as defined in the 1940 Act, except as may be permitted by any
applicable regulatory exemption or exemptive order.
As of December 31, 1998, Growth and Income Fund owned equity securities
of Merrill Lynch & Co. in the amount of $2,483,000 and equity securities of
Morgan Stanley, Dean Witter & Co. in the amount of $4,686,000; Index Equity Fund
owned equity securities of Merrill Lynch & Co. in the amount of $1,889,000,
equity securities of Morgan Stanley, Dean Witter & Co. in the amount of
$3,324,000, equity securities of Bear Stearns Co., Inc in the amount of
$344,000, and equity securities of Lehman Brothers, Inc. in the amount of
$423,000; International Growth Fund owned equity securities of HSBC Group in
the amount of $4,633,000; Short Term Bond Fund owned debt securities of Merrill
Lynch & Co. in the amount of $5,156,000 and debt securities of Morgan Stanley,
Dean Witter & Co. in the amount of $6,128,000; Intermediate Bond Fund owned debt
securities of Bear Stearns Co. in the amount of $5,644,000 and debt securities
of HSBC Group in the amount of $8,150,000; and the Income Fund owned debt
securities of HSBC Group in the amount of $2,038,000 and debt securities of
Lehman Brothers, Inc. in the amount of $2,215,000. As of December 31, 1998, no
other Fund owned securities of the Trust's regular broker-dealers.
VALUATION OF SECURITIES
MONEY MARKET FUNDS
As stated in the prospectus, the Money Market Funds seek to maintain a
net asset value of $1.00 per share and, in this connection, value their
instruments on the basis of amortized cost pursuant to Rule 2a-7 under the 1940
Act. This method values a security at its cost on the date of purchase and
thereafter assumes a constant accretion or amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates on
the market value of the instrument. While this method provides certainty in
valuation, it may result in periods during which value, as determined by
amortized cost, is higher or lower than the price a Fund would receive if the
Fund sold the instrument. During such periods the yield to investors in the Fund
may differ somewhat from that obtained in a similar entity which uses available
indications as to market value to value its portfolio instruments. For example,
if the use of amortized cost resulted in a lower (higher) aggregate Fund value
on a particular day, a prospective investor in the Fund would be able to obtain
a somewhat higher (lower) yield and ownership interest than would result from
investment in such similar entity and existing investors would receive less
(more) investment income and ownership interest. However, the Trust expects that
the procedures and
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<PAGE>
limitations referred to in the following paragraphs of this section will tend to
minimize the differences referred to above.
Under Rule 2a-7, the Trust's Board of Trustees, in supervising the
Money Market Funds' operations and delegating special responsibilities involving
portfolio management to Lyon Street, has established procedures that are
intended, taking into account current market conditions and the Funds'
investment objectives, to stabilize the net asset value of each Money Market
Fund, as computed for the purposes of purchases and redemptions, at $1.00 per
share. The Trustees' procedures include periodic monitoring of the difference
between the amortized cost value per share and the net asset value per share
based upon available indications of market value (the "Market Value
Difference"). Available indications of market value consist of actual market
quotations or appropriate substitutes which reflect current market conditions
and include (a) quotations or estimates of market value for individual portfolio
instruments and/or (b) values for individual portfolio instruments derived from
market quotations relating to varying maturities of a class of money market
instruments.
In the event the Market Value Difference exceeds 1/2 of 1%, the
Trustees' procedures provide that the Trustees will take such steps as they
consider appropriate (e.g., selling portfolio instruments to shorten the
dollar-weighted average portfolio maturity or to realize capital gains or
losses, reducing or suspending shareholder income accruals, redeeming shares in
kind, or utilizing a net asset value per share based upon available indications
of market value which under such circumstances would vary from $1.00) to
eliminate or reduce to the extent reasonably practicable any material dilution
or other unfair results to investors or existing shareholders which might arise
from Market Value Differences.
The Funds limit their investments to instruments which Lyon Street has
determined present minimal credit risk (pursuant to guidelines established by
the Board of Trustees) and which are "Eligible Securities" as defined by Rule
2a-7. The Funds are also required to maintain a dollar-weighted average
portfolio maturity (not more than 90 days) appropriate to its objective of
maintaining a stable net asset value of $1.00 per share. Should the disposition
of a security result in a dollar-weighted average portfolio maturity of more
than 90 days, a Fund will invest its available cash in such a manner as to
reduce such maturity to 90 days or less as soon as practicable.
It is the normal practice of the Funds to hold securities to maturity
and realize par therefor, unless a sale or other disposition is mandated by
redemption requirements or other extraordinary circumstances. Under the
amortized cost method of valuation traditionally employed by institutions for
valuation of money market instruments, neither the amount of daily income nor
the net asset value is affected by any unrealized appreciation or depreciation
of the Funds. In periods of declining interest rates, the indicated daily yield
on shares of the Funds, computed by dividing its annualized daily income by the
net asset value computed as above, may tend to be lower than similar
computations made by utilizing a method of valuation based upon market prices
and estimates. In periods of rising interest rates, the daily yield of shares at
the value computed as described above may tend to be higher than a similar
computation made by utilizing a method of calculation based upon market prices
and estimates.
NON-MONEY MARKET FUNDS
Current values for the Non-Money Market Funds' portfolio securities are
determined as follows:
(1) Common stock, preferred stock and other equity securities listed on
the NYSE are valued on the basis of the last sale price on the exchange. In the
absence of any sales, such securities are valued at the last bid price;
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<PAGE>
(2) Common stock, preferred stock and other equity securities listed on
other U.S. or foreign exchanges will be valued as described in (1) above using
quotations on the exchange on which the security is primarily traded;
(3) Common stock, preferred stock and other equity securities which are
unlisted and quoted on the National Market System (NMS) are valued at the last
sale price, provided a sale has occurred. In the absence of any sales, such
securities are valued at the high or "inside" bid, which is the bid supplied by
the National Association of Securities Dealers on its NASDAQ system for
securities traded in the over-the-counter market;
(4) Common stock, preferred stock and other equity securities which are
quoted on NASDAQ but not listed on NMS are valued at the high or "inside" bid;
(5) Common stock, preferred stock and other equity securities which are
not listed and not quoted on NASDAQ and for which over-the-counter market
quotations are readily available are valued at the mean between the current bid
and asked prices for such securities;
(6) Non-U.S. common stock, preferred stock and other equity securities
which are not listed or are listed and subject to restrictions on sale are
valued at prices supplied by a dealer selected by Lyon Street and approved by
the Board of Trustees;
(7) Bonds, debentures and other debt securities, whether or not listed
on any national securities exchange, are valued at a price supplied by a pricing
service or a bond dealer selected by Lyon Street and approved by the Board of
Trustees;
(8) Short-term debt securities which when purchased have maturities of
sixty days or less are valued at amortized cost (original purchase cost as
adjusted for amortization of premium or accretion of discount) which, when
combined with accrued interest, approximates market value and which reflects
fair value as determined by the Board of Trustees;
(9) Short-term debt securities having maturities of more than sixty
days when purchased which are held on the sixtieth day prior to maturity are
thereafter valued at amortized cost (market value on the sixtieth day adjusted
for amortization of premium or accretion of discount) which, when combined with
accrued interest, approximates market value and which reflects fair value as
determined by the Board of Trustees; and
(10) The following are valued at prices deemed in good faith to be fair
under procedures established by the Board of Trustees: (a) securities, including
restricted securities, for which market quotations are not readily available,
and (b) any other security for which the application of the above methods is
deemed by Lyon Street not to be representative of the market value of such
security.
In valuing each Fund's assets, the Trust's fund accountant will
"mark-to-market" the current value of a Fund's open futures contracts and
options. For valuation purposes, quotations of securities denominated in foreign
currencies are converted to into U.S. dollars at the prevailing currency
exchange rate on the day of the conversion.
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<PAGE>
TRUSTEES AND OFFICERS
The Trust is governed by a Board of Trustees. The Trustees are
responsible for the overall management of the Trust and retain and supervise the
Funds' Adviser, Administrator, Distributor, Transfer Agent and Custodian.
The names, ages and principal occupations during the last five years of
the Trustees and officers of the Trust are listed below. The address of all the
Trustees and officers is 3435 Stelzer Road, Columbus, Ohio 43219.
JOSEPH F. DAMORE, Trustee, 46; President and Chief Executive Officer of
Sparrow Hospital and Health System; formerly Director and Executive Vice
President, Sisters of Mercy Health Corporation.
* E. PHILIP FARLEY, Trustee, 59; retired; formerly Executive Vice
President of Old Kent Financial Corporation - Manager of Community Banks from
1998 to retirement; prior to that Executive Vice President of the Investment
Management and Trust Department of Old Kent Bank.
* WALTER B. GRIMM, Trustee, Chairman and Vice President, 53; Senior
Vice President of Client Services for BISYS Fund Services; formerly President of
Lehigh Investments.
JAMES F. RAINEY, Trustee, 56; Associate Dean for Academic Affairs in
The Eli Broad Graduate School of Management at Michigan State University.
RONALD F. VANSTEELAND, Trustee, 58; Vice President for Finance and
Administration and Treasurer of Grand Valley State University, Allendale,
Michigan and Treasurer of Grand Valley State University Foundation.
JAMES F. DUCA, II, President, 41; Vice President of Old Kent Financial
Corporation; and formerly Vice President and Trust Counsel for Marshall & Ilsley
Trust Company.
R. JEFFREY YOUNG, Vice President and Assistant Secretary, 34; Vice
President - Client Services for BISYS Fund Services; and formerly employed by
The Heebink Group.
MARTIN R. DEAN, Treasurer, 35; Vice President - Administration Services
for BISYS Fund Services; and formerly employed by KPMG LLP.
ROBERT L. TUCH, Secretary, 47; Vice President - Legal Services for
BISYS Fund Services.
W. BRUCE MCCONNEL, III, Assistant Secretary, 56; Partner in the law
firm of Drinker Biddle & Reath LLP.
ALAINA V. METZ, Assistant Secretary, 32; Chief Administrator of the
Blue Sky Department for BISYS Fund Services; and formerly employed by Alliance
Capital Management.
- - -----------------------------------
* This Trustee is an interested person of the Trust as defined under the 1940
Act.
During the fiscal year ended December 31, 1998, no officer, director or
employee of the Trust's service contractors, or any of their parents or
subsidiaries, received any direct remuneration from the Trust for serving as a
Trustee or officer of the Trust, although BISYS and its affiliates, of which
Messrs. Grimm, Young, Dean, and Tuch and Ms. Metz are also employees, receives
fees from the Trust for administrative, fund accounting and transfer agency
services. Drinker Biddle & Reath LLP, of which Mr. McConnel is a partner,
receives legal fees as counsel to the Trust. Each Trustee earns an annual fee of
$8,000 and additional fees of $1,750 for each regular meeting attended, $1,000
for each special
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meeting attended and $500 for each telephonic meeting, plus reimbursement of
expenses incurred as a Trustee.
Listed below is the compensation paid to each Trustee by the Trust for
the fiscal year ended December 31, 1998. The Board of Trustees has established
The Kent Funds Deferred Compensation Plan (the "Deferred Compensation Plan")
pursuant to which the Trustees may elect to defer receipt of the compensation
payable to them by the Trust. Under the terms of the Deferred Compensation Plan,
amounts deferred by the Trustees are credited with the earnings on certain
investment options which may include one or more of the Funds. Trustees receive
payment of their deferred compensation and any related earnings upon ceasing to
be a Trustee of the Trust. Such payment is made at the election of the Trustee,
either in a lump sum or in annual installments over two to fifteen years. The
Trust's obligation to pay the Trustee's deferred compensation is a general
unsecured obligation.
<TABLE>
<CAPTION>
TOTAL COMPENSATION
FROM THE TRUST AND
NAME OF PERSON AGGREGATE COMPENSATION FUND COMPLEX PAID
AND POSITION FROM THE TRUST TO TRUSTEES
------------ -------------- -----------
<S> <C> <C>
Joseph F. Damore, Trustee $ 15,000 * $ 15,000
E. Philip Farley, Trustee $ 0 $ 0
Walter B. Grimm, Trustee $ 0 $ 0
James F. Rainey, Trustee $ 15,000 * $ 15,000
Ronald F. VanSteeland, Trustee $ 15,000 $ 15,000
- - -------------------
* During the fiscal year ended December 31, 1998, Mr. Damore deferred
$15,000 of his compensation and Mr. Rainey deferred
$7,500 of his compensation pursuant to the Deferred
Compensation Plan.
</TABLE>
As of the date hereof, the Trustees and officers of the Trust as a
group beneficially owned less than 1% of the Trust's outstanding shares.
INVESTMENT ADVISER
LYON STREET ASSET MANAGEMENT COMPANY
Lyon Street is the investment adviser to the Funds. Effective as of
March 2, 1998, Lyon Street, a wholly-owned subsidiary of Old Kent Bank ("Old
Kent"), assumed the investment advisory responsibilities of Old Kent for each of
the Funds on the terms and conditions stated in the prospectus. This change did
not involve a change in control or management of the investment adviser or a
change in the Funds' portfolio managers. As of December 31, 1998, Lyon Street
managed assets of approximately $6.1 billion. The Trust is the first
registered investment company for which Lyon Street has
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<PAGE>
provided investment advisory services. Lyon Street is located at 111 Lyon
Street, N.W., Grand Rapids, MI 49503.
Old Kent is a Michigan banking corporation which, with its affiliates,
provided commercial and retail banking and trust services through more than 200
banking offices in Michigan and Illinois as of December 31, 1998. Old Kent
offers a broad range of financial services, including commercial and consumer
loans, corporate and personal trust services, demand and time deposit accounts,
letters of credit and international financial services.
Old Kent is a subsidiary of Old Kent Financial Corporation, a bank
holding company headquartered in Grand Rapids, Michigan, with approximately
$16.6 billion in total consolidated assets as of December 31, 1998. Through
offices in numerous states, Old Kent Financial Corporation and its subsidiaries
provide a broad range of financial services to individuals and businesses.
Lyon Street employs an experienced staff of professional investment
analysts, portfolio managers and traders and uses several proprietary
computer-based systems in conjunction with fundamental analysis to identify
investment opportunities.
INVESTMENT ADVISORY AGREEMENT
The overall supervision and management of the Funds rests with the
Trust's Board of Trustees. Pursuant to a written Investment Advisory Agreement
with the Trust, dated October 12, 1990, as amended, Lyon Street furnishes to the
Trust investment advice with respect to the Funds, makes all investment
decisions for the Funds, and places purchase and sale orders for the Funds'
securities. Lyon Street is responsible for all expenses incurred by it in
connection with its advisory activities, other than the cost of securities and
other investments purchased or sold for the Funds, and any brokerage commissions
or other transaction charges that may be associated with such purchases and
sales.
For its services to each Fund, Lyon Street is entitled to an annual fee
based on the average daily net asset value of each Fund, payable monthly, at the
following rates: the Large Company Growth Fund, 0.70%; the Growth and Income
Fund, 0.70%; the Index Equity Fund, 0.30%; the Small Company Growth Fund, 0.70%;
the International Growth Fund, 0.75%; the Income Fund, 0.60%; the Intermediate
Bond Fund, 0.55%; the Short Term Bond Fund, 0.50%; the Tax-Free Income Fund,
0.55%; the Intermediate Tax-Free Fund, 0.50%; the Michigan Municipal Bond Fund,
0.45%; the Money Market Fund, 0.40%; the Government Money Market Fund, 0.40%;
and the Michigan Municipal Money Market Fund, 0.40%. Lyon Street may rebate its
advisory fees to the trust accounts of certain of its institutional
customers.
For the fiscal years ended December 31, 1996, 1997 and 1998, Lyon
Street and Old Kent, the Trust's former investment adviser, earned the following
advisory fees for each Fund: $3,202,775, $4,568,032 and $5,462,664,
respectively, for the Growth and Income Fund; $654,709, $1,278,392 and
$2,128,823, respectively, for the Index Equity Fund; $3,613,394, $4,597,213 and
$5,258,368, respectively, for the Small Company Growth Fund; $2,465,291,
$3,529,317, and $3,990,372, respectively, for the International Growth Fund;
$4,537,199, $4,262,333, and $4,345,604, respectively, for the Intermediate Bond
Fund; $1,421,272, $857,575, and $696,368, respectively, for the Short Term Bond
Fund; $1,458,010, $1,424,578, and $1,431,252, respectively, for the Intermediate
Tax-Free Fund; $772,339, $563,275, and $561,713, respectively, for the Michigan
Municipal Bond Fund; $1,747,159, $2,092,414, and $2,260,092, respectively, for
the Money Market Fund; $653,417, $781,668, and $1,279,122, respectively, for the
Michigan Municipal Money Market Fund; $1,209,526, $1,489,950, and $1,481,491,
respectively, for the Income Fund and $595,616, $642,997 and $687,774,
respectively, for the Tax-Free Income Fund. For the fiscal
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<PAGE>
period ended December 31, 1997, and the fiscal year ended December 31, 1998, Old
Kent and Lyon Street earned $226,041 and $466,055, respectively in advisory fees
for the Government Money Market Fund.
For the fiscal years ended December 31, 1997 and December 31, 1998, Old
Kent and Lyon Street waived a portion of their advisory fees for the Index
Equity Fund. Net of such waivers, they received $1,158,610 and $1,774,016,
respectively. For the fiscal period ended December 31, 1997 and the fiscal year
ended December 31, 1998, Old Kent and Lyon Street waived a portion of their
advisory fees for the Government Money Market Fund. Net of such waivers, Old
Kent and Lyon Street received $112,896 and $233,030, respectively.
Under the Investment Advisory Agreement, Lyon Street's liability in
connection with rendering services thereunder is limited to situations involving
a breach of its fiduciary duty, its willful misfeasance, bad faith, gross
negligence or reckless disregard of its obligations and duties.
The Trustees of the Trust, including a majority of those Trustees who
are not parties to the Investment Advisory Agreement or interested persons of
any such party, most recently approved the agreement, as amended, on May 22,
1998. The Agreement continues in effect from year to year with respect to each
Fund only if such continuance is specifically approved at least annually by the
Trustees of the Trust, including the "non-interested" Trustees, or by vote of a
majority of the outstanding voting shares of such Fund. The Investment Advisory
Agreement will terminate automatically upon its assignment and may be terminated
with respect to any Fund or Funds without penalty on 60-days' written notice at
the option of either party or by a vote of the shareholders of such Fund or
Funds.
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<PAGE>
ADMINISTRATOR
Old Kent Securities Corporation ("OKSC"), 111 Lyon Street NW, Grand
Rapids, Michigan 49503 serves as the Administrator of the Trust under an
Administration Agreement dated December 1, 1999. OKSC provides management and
administrative services and, in general, supervises the operation of each Fund
(other than investment advisory operations). The current term of the
Administration Agreement ends on December 31, 2001. Thereafter, the agreement
may be renewed for successive one-year periods.
By the terms of the Administration Agreement, OKSC is required to
provide to the Funds management and administrative services, as well as all
necessary office space, equipment and clerical personnel for managing and
administering the affairs of the Funds. OKSC is required to supervise the
provision of custodial, auditing, valuation, bookkeeping, legal, stock transfer
and dividend disbursing services and provide other management and administrative
services.
As compensation for the services and facilities provided to the Funds
pursuant to the Administration Agreement, OKSC is entitled to receive an annual
fee, payable monthly as one twelfth of the annual fee, based on the Trust's
aggregate average daily net assets as follows: up to $5.0 billion - .185% of
such assets; between $5.0 and $7.5 billion - .165% of such assets; and over $7.5
billion - .135% of such assets provided, however, that such annual fee shall be
subject to an annual minimum fee of $45,000 per fund that is applicable to
certain Funds of the Trust. All expenses (other than those specifically referred
to as being borne by OKSC in the Administration Agreement) incurred by OKSC in
connection with the operation of the Trust are borne by the Funds. To the extent
that OKSC incurs any such expenses or provides certain additional services to
the Trust, the Funds promptly will reimburse OKSC therefor.
OKSC also serves as the Trust's Fund Accountant pursuant to a Fund
Accounting Agreement, dated December 1, 1999. Under the Fund Accounting
Agreement, OKSC prices each Fund's shares, calculates each Fund's net asset
value, and maintains the general ledger accounting records for each Fund. For
these services, OKSC is entitled to receive a fee computed daily at the annual
rate of .015% of the Trust's average daily net assets, provided, however, that
such annual fee shall be subject to an annual minimum fee of $10,000 per fund
that is applicable to certain Funds of the Trust. The current term of the Fund
Accounting Agreement ends on December 31, 2001. Thereafter, the agreement may be
renewed for successive one-year periods.
36
<PAGE>
For the fiscal periods ended December 31, 1996, 1997 and 1998, the
Trust paid the following administration fees to its former administrators:
$896,290, $1,169,235, and $1,411,202, respectively, for the Growth and Income
Fund; $212,487, $464,741, and $857,078, respectively, for the Index Equity Fund;
$1,011,600, $1,176,682, and $1,358,690, respectively, for the Small Company
Growth Fund; $643,425, $842,845, and $962,462, respectively, for the
International Growth Fund; $1,618,455, $1,386,330 and $1,429,015, respectively,
for the Intermediate Bond Fund; $558,367, $306,274 and $251,895, respectively,
for the Short Term Bond Fund; $571,869,$509,532 and $517,725, respectively, for
the Intermediate Tax-Free Fund; $337,467, $223,672 and $225,753, respectively,
for the Michigan Municipal Bond Fund; $425,618, $504,642 and $624,863,
respectively, for the Money Market Fund; $159,777, $178,917 and $321,507,
respectively, for the Michigan Municipal Money Market Fund; $393,938, $444,179
and $446,634, respectively for the Income Fund; and $227,178, $209,139 and
$226,159, respectively, for the Tax Free Income Fund. For the fiscal period
ended December 31, 1997 and the fiscal year ended December 31, 1998, the
Government Money Market Fund paid $36,124 and $95,865, respectively, in
administration fees.
The amounts listed above as paid are net of the following waivers. For
the fiscal period ended December 31, 1998, the administration fees waived by the
Trust's former administrator were $425,483 for the Index Equity Fund, $394,533
for the Money Market Fund, $255,083 for the Michigan Municipal Money Market
Fund, and $114,295 for the Government Money Market Fund.
Sub-Administration and Sub-Fund Accounting Agreements
BISYS Fund Services Ohio, Inc., 3435 Stelzer Road, Columbus, Ohio 43219
("BISYS"), provides certain administrative services to the Trust pursuant to a
Sub-Administration Agreement between OKSC and BISYS. BISYS also provides certain
fund accounting services to the Trust pursuant to a Sub-Fund Accounting
Agreement between OKSC and BISYS. As compensation for its services, BISYS
receives fees from OKSC. The fees paid to BISYS by OKSC for such services come
out of OKSC's fees and are not an additional charge to the Funds.
DISTRIBUTOR
The Trust has entered into a Distribution Agreement dated July 1, 1999
with Kent Fund Distributors, Inc., 3435 Stelzer Road, Columbus, Ohio 43219
("KDFI"). After the initial one year term unless otherwise terminated, the
Distribution Agreement will continue in effect from year to year if approved at
least annually at a meeting called for that purpose by a majority of the
Trustees and a majority of the "non-interested" Trustees, as that term is
defined in the 1940 Act. Shares of the Funds are sold on a continuous basis by
KDFI as agent for the Trust, and KDFI has agreed to use its best efforts to
solicit orders for the sale of shares of the Funds.
For the fiscal years ended 1996, 1997 and 1998, the Trust paid its
former distributors total underwriting commissions of $527,141, $55,000 and $0,
respectively. This entire amount was re-allocated to broker-dealers which had
selling agreements with the distributor.
TRANSFER AGENT
OKSC serves as the Trust's transfer agent and dividend disbursing agent
pursuant to a Transfer Agency Agreement. Under the Transfer Agency Agreement,
OKSC processes purchases and redemptions of each Fund's shares and maintains
each Fund's shareholder transfer and accounting records, such as the history of
purchases, redemptions, dividend distributions, and similar transactions in a
shareholder's account.
BISYS provides certain transfer agent and dividend disbursing agent
services to the Trust pursuant to a Sub-Transfer Agency Agreement between OKSC
and BISYS.
CUSTODIAN, AUDITORS AND COUNSEL
The Bank of New York, 100 Church Street, New York, New York 10286 is
custodian of all securities and cash of the Trust.
KPMG LLP, Two Nationwide Plaza, Suite 1600, Columbus, Ohio 43215,
Certified Public Accountants, are the independent auditors for the Trust.
Drinker Biddle & Reath LLP, One Logan Square, 18th and Cherry Streets,
Philadelphia, PA 19103, serves as counsel to the Trust.
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<PAGE>
DISTRIBUTION PLAN
THIS SECTION RELATES ONLY TO THE INVESTMENT SHARES OF THE FUNDS. THE
INSTITUTIONAL SHARES HAVE NOT ADOPTED A DISTRIBUTION PLAN.
As described in the prospectuses, the Trust has adopted with respect to
its Investment Shares a Distribution Plan (the "Plan") pursuant to Rule 12b-1
under the 1940 Act which regulates circumstances under which an investment
company may bear expenses associated with the distribution of its shares. The
Plan provides that the Investment Shares of a Fund may incur certain expenses
which may not exceed a maximum amount equal to 0.25% (on an annualized basis) of
the average daily net asset value of the Investment Shares. Under the Plan, the
Distributor is entitled to receive from the Fund a distribution fee, which is
accrued daily and paid monthly, of up to 0.25%. The Plan obligates a Fund,
during the period it is in effect, to accrue and pay to the Distributor on
behalf of a Fund the fee agreed to under the Distribution Plan. Payments under
the Plan are not tied exclusively to expenses actually incurred by the
Distributor, and the payments may exceed distribution expenses actually
incurred.
All persons authorized to direct the disposition of monies paid or
payable by a Fund pursuant to the Plan or any related agreement must provide to
the Trust's Board of Trustees at least quarterly a written report of the amounts
so expended and the purposes for which such expenditures were made.
Representatives, brokers, dealers or others receiving payments pursuant to the
Plan must determine that such payments and the services provided in connection
with such payments are appropriate for such persons and are not in violation of
regulatory limitations applicable to such persons.
The services under the Plan may include assistance in advertising and
marketing of Investment Shares, aggregating and processing purchase, exchange
and redemption requests for Investment Shares, maintaining account records,
issuing confirmations of transactions and providing sub-accounting with respect
to Investment Shares.
As required by Rule 12b-1, the Plan and the related Distribution and
Servicing Agreements have been approved, and are subject to annual approval, by
a majority of the Trust's Board of Trustees, and by a majority of the Trustees
who are not "interested" persons of the Trust (as defined by the 1940 Act) and
who have no direct or indirect interest in the operation of the Plan and the
agreements related thereto ("Independent Trustees"), by a vote cast in person at
a meeting called for the purpose of voting on the Plan and related agreements.
The Plan was most recently approved by the Board of Trustees as a whole and by
the Independent Trustees on November 19, 1998. In compliance with Rule 12b-1,
the Trustees requested and evaluated information they thought necessary to an
informed determination of whether the Plan and related agreements should be
implemented, and concluded, in the exercise of reasonable business judgment and
in light of their fiduciary duties, that there was a reasonable likelihood that
the Plan and the related agreements would benefit the Funds and their
shareholders. The Trustees concluded that the Plan could enhance the retail
distribution of the Funds, thereby resulting in growth of the Funds' assets and
a wider shareholder base. This could help the Funds to remain competitive with
other funds by, among other things, lessening the impact on shareholders of
redemptions, attracting talented investment managers and providing flexibility
to portfolio managers in the execution of Fund orders. The Plan may not be
amended in order to increase materially the amount of distribution expenses
permitted under the Plan without such amendment being approved by a majority
vote of the outstanding Investment Shares of the affected Fund. The Plan may be
terminated at any time by a majority vote of the Independent Trustees or by a
majority vote of the outstanding Investment Shares of the affected Fund.
While the Plan is in effect, the selection and nomination of Trustees
who are not "interested persons" has been committed to the discretion of the
"non-interested" Trustees then in office.
For the fiscal year ended December 31, 1998, the following payments
were made under the Plan: Growth and Income Fund, $109,568; Index Equity
Fund, $84,973; Small Company Growth Fund, $59,520; International Growth
Fund, $27,994; Income Fund, $21,966; Intermediate Bond Fund, $24,241;
Short Term Bond Fund, $10,270; Tax-Free Income Fund, $4,710;
Intermediate Tax-Free Fund, $9,397; and Michigan Municipal Bond Fund,
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<PAGE>
$7,003. All of such payments were made to broker-dealers and other selling
and/or servicing institutions. For the current fiscal year, Investment Shares of
the Growth and Income Fund, Index Equity Fund, Small Company Growth Fund,
International Growth Fund, Income Fund, Intermediate Bond Fund, Tax-Free Income
Fund and Intermediate Tax-Free Fund will be charged a fee pursuant to the Plan
at an annual rate of 0.25% of their average Investment class net assets. For the
current fiscal year, Investment Shares of the Short Term Bond Fund, and Michigan
Municipal Bond Fund will be charged a fee pursuant to the Plan at an annual rate
of 0.15% of their average Investment class net assets. The Trust does not
currently intend to charge a fee under the Plan for the Money Market Funds.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The prospectus for the Funds describe those investors who are eligible
to purchase Investment Shares and those who are eligible to purchase
Institutional Shares.
In an exchange, shares in the Fund from which an investor is
withdrawing will be redeemed at the net asset value per share next determined
after the exchange request is received. Shares of the Fund in which the investor
is investing will also normally be purchased at the net asset value per share
next determined after acceptance of the purchase order by the Trust in
accordance with its customary policies for accepting investments.
Under the 1940 Act, the Trust may suspend the right of redemption or
postpone the date of payment for shares during any period when (a) trading on
the NYSE is restricted by applicable rules and regulations of the Securities and
Exchange Commission; (b) the NYSE is closed for other than customary weekend and
holiday closings; (c) the Securities and Exchange Commission has by order
permitted such suspension; or (d) an emergency exists as determined by the
Securities and Exchange Commission. (The Trust may also suspend or postpone the
recordation of the transfer of its shares upon the occurrence of any of the
foregoing conditions.)
In addition to the situation described in the prospectus under
"Shareholder Information--Closing of Small Accounts," the Trust may redeem
shares involuntarily if it appears appropriate to do so in light of the Trust's
responsibilities under the 1940 Act, to reimburse the Funds for any loss
sustained by reason of the failure of a shareholder to make full payment for
shares purchased by the shareholder, or to collect any charge relating to a
transaction effected for the benefit of a shareholder which is applicable to
Fund shares as provided in the prospectus from time to time.
A Fund may make payment for redemption in securities or other property
if it appears appropriate to do so in light of the Fund's responsibilities under
the 1940 Act. In the event shares are redeemed for securities or other property,
shareholders may incur additional costs in connection with the conversion
thereof to cash. Redemption in kind is not as liquid as a cash redemption.
Shareholders who receive a redemption in kind may receive less than the
redemption value of their shares upon sale of the securities or property
received, particularly where such securities are sold prior to maturity.
The Trust has filed an election pursuant to Rule 18f-1 under the 1940
Act which provides that each portfolio of the Trust is obligated to redeem
shares solely in cash up to $250,000 or 1% of such portfolio's net asset value,
whichever is less, for any one shareholder within a 90-day period. Any
redemption beyond this amount may be made in proceeds other than cash.
39
<PAGE>
DIVIDENDS AND TAXES
FEDERAL - GENERAL
Each Fund intends to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code, and to distribute its income to
shareholders each year, so that each Fund itself generally will be relieved of
federal income and excise taxes. If a Fund were to fail to so qualify: (1) the
Fund would be taxed at regular corporate rates without any deduction for
distributions to shareholders; and (2) shareholders would be taxed as if they
received ordinary dividends, although corporate shareholders could be eligible
for the dividends received deduction.
As described in the prospectus for the Municipal Funds, such Funds are
designed to provide investors with tax-exempt interest income. The Municipal
Funds are not intended to constitute a balanced investment program and are not
designed for investors seeking capital appreciation or maximum tax-exempt income
irrespective of fluctuations in principal. Shares of the Municipal Funds would
not be suitable for tax-exempt institutions and may not be suitable for
retirement plans qualified under Section 401 of the Code, H.R. 10 plans and
individual retirement accounts because such plans and accounts are generally
tax-exempt and, therefore, would not gain any additional benefit from the Funds'
dividends being tax-exempt. In addition, the Municipal Funds may not be an
appropriate investment for persons or entities that are "substantial users" of
facilities financed by private activity bonds or "related persons" thereof.
"Substantial user" is defined under U.S. Treasury Regulations to include a
non-exempt person which regularly uses a part of such facilities in its trade or
business and whose gross revenues derived with respect to the facilities
financed by the issuance of bonds are more than 5% of the total revenues derived
by all users of such facilities, which occupies more than 5% of the usable area
of such facilities or for which such facilities or a part thereof were
specifically constructed, reconstructed or acquired. "Related persons" include
certain related natural persons, affiliated corporations, a partnership and its
partners and an S corporation and its shareholders.
In order for the Municipal Funds to pay federal tax-exempt dividends
with respect to any taxable year, at the close of each taxable quarter at least
50% of the aggregate value of the Fund must consist of exempt-interest
obligations.
The provisions regarding financial instruments, foreign currencies and
foreign corporations may from time to time cause a Fund to recognize income in
excess of cash received in a transaction. Moreover, a Fund's investment
alternatives will to some extent be constrained by tax requirements applicable
to regulated investment companies.
DECLARATION OF TRUST
DESCRIPTION OF SHARES
The Trust's Restatement of Declaration of Trust authorizes the issuance
of an unlimited number of shares of beneficial interest in one or more separate
series, and the creation of one or more classes of shares within each series.
Each share of a series represents an equal proportionate interest in the Trust
with each other share of that series. Each series represents interests in a
different investment portfolio. The Trust currently offers fifteen series of
shares. One of those series has established a single class of shares. The other
fourteen series have established two separate classes of shares - Investment
Shares and Institutional Shares. Each share of the Trust has no par value and is
entitled to such dividends and distributions of the income earned on its
respective series' assets as are declared at the discretion of the Trustees.
Each class or series is entitled upon liquidation of such class or series to a
pro rata share in the
40
<PAGE>
net assets of that class or series. Shareholders have no preemptive rights. When
issued for payment as described in the prospectus, shares will be legally
issued, fully paid and non-assessable.
The proceeds received by each Fund for each issue or sale of its
shares, and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to and constitute the underlying assets of that Fund. The underlying assets of
each Fund will be segregated on the books of account, and will be charged with
the liabilities in respect to that Fund and with a share of the general
liabilities of the Trust. Expenses with respect to the portfolios of the Trust
are normally allocated in proportion to the net asset value of the respective
portfolios except where allocations of direct expenses can otherwise be fairly
made.
SHAREHOLDER LIABILITY
The Trust is an entity of the type commonly known as a "Massachusetts
Business Trust." Pursuant to certain decisions of the Supreme Judicial Court of
Massachusetts, there is a possibility that shareholders of such a trust may,
under certain circumstances, be held personally liable as partners for the
obligations of the trust. However, even if the Trust were held to be a
partnership, the possibility of the shareholders incurring financial loss for
that reason appears remote because the Trust's Restatement of Declaration of
Trust contains an express disclaimer of shareholder liability for obligations of
the Trust and requires that notice of such disclaimer be given in every note,
bond, contract or other undertaking entered into or executed by the Trust or the
Trustees. In addition, the Restatement of Declaration of Trust provides for
indemnification out of the Trust property for any shareholder held personally
liable for the obligations of the Trust.
VOTING RIGHTS
Rule 18f-2 under the 1940 Act provides that any matter required by the
provisions of the 1940 Act or applicable state law, or otherwise, to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Trust shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each investment portfolio affected by such matter. Rule 18f-2 further provides
that an investment portfolio shall be deemed to be affected by a matter unless
the interests of each investment portfolio in the matter are substantially
identical or the matter does not affect any interest of the investment
portfolio. Under the Rule, the approval of an investment advisory agreement, a
distribution plan subject to Rule 12b-1, or any change in a fundamental
investment policy would be effectively acted upon with respect to an investment
portfolio only if approved by a majority of the outstanding shares of that
investment portfolio. However, the Rule also provides that the ratification of
the appointment of independent accountants, the approval of principal
underwriting contracts and the election of Trustees may be effectively acted
upon by shareholders of the Trust voting together in the aggregate without
regard to a particular investment portfolio.
The term "majority of the outstanding shares" of a Fund means the vote
of the lesser of (i) 67% or more of the shares of the Fund present at a meeting,
if the holders of more than 50% of the outstanding shares of the Fund are
present or represented by proxy, or (ii) more than 50% of the outstanding shares
of the Fund.
Shares of the Trust have non-cumulative voting rights, which means that
the holders of more than 50% of the shares of the Trust voting for the election
of Trustees can elect 100% of the Trustees to be elected at a meeting and, in
such event, the holders of the remaining less than 50% of the shares of the
Trust voting will not be able to elect any Trustees.
41
<PAGE>
As a general matter, the Trust does not hold annual or other meetings
of shareholders. At such time, however, as less than a majority of the Trustees
holding office have been elected by shareholders, the Trustees then in office
will call a shareholders meeting for the election of Trustees. The Trustees
shall continue to hold office indefinitely, unless otherwise required by law,
and may appoint successor Trustees. A Trustee may be removed from office: (1) at
any time by two-thirds vote of the Trustees; or (2) at a special meeting of
shareholders by a two-thirds vote of the outstanding shares. Trustees may also
voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
The Restatement of Declaration of Trust provides that the Trustees
shall not be responsible or liable for any neglect or wrongdoing of any officer,
agent, employee or adviser of the Trust, provided that they have exercised
reasonable care in the selection of such individuals. The Restatement of
Declaration of Trust also provides that a Trustee shall be indemnified against
all liabilities and expenses reasonably incurred in connection with the defense
or disposition of any action, suit or other proceeding in which said Trustee is
involved by reason of being or having been a Trustee of the Trust, except with
respect to any matter as to which such Trustee has been finally adjudicated not
to have acted in good faith in the reasonable belief that his or her actions
were in the best interest of the Trust. Nothing in the Restatement of
Declaration of Trust shall protect a Trustee against any liability for his or
her willful misfeasance, bad faith, gross negligence or reckless disregard of
the duties involved in the conduct of his or her office as Trustee.
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
MONEY MARKET FUNDS
The yields for the Investment Shares and Institutional Shares of the
Money Market Funds as they may appear from time to time in advertisements will
be calculated by determining the net change exclusive of capital changes (all
realized and unrealized gains and losses) in the value of a hypothetical
pre-existing account having a balance of one share at the beginning of the
period, dividing the net change in account value by the value of the account at
the beginning of the base period to obtain the base period return, multiplying
the base period return by (365/7) and carrying the resulting yield figure to the
nearest hundredth of one percent. The determination of net change in account
value will reflect the value of additional shares purchased with dividends from
the original share and dividends declared on both the original share and any
such additional shares and all fees charged to all shareholder accounts for each
class of shares in proportion to the length of the base period and the average
account size for each class. The 30-day yield for each Fund is determined
similarly. Based on the foregoing formula, for the 7-day period ended December
31, 1998, the yields of the Institutional Shares of the Money Market Fund,
Government Money Market Fund and Michigan Municipal Money Market Fund were
4.78%, 4.73% and 3.17%, respectively. For the same period, the 7-day yields of
the Investment Shares of the Money Market Fund, Government Money Market Fund and
Michigan Municipal Money Market Fund were 4.78%, 4.72% and 3.17%, respectively.
The yield figures reflect waivers of certain expenses.
If realized and unrealized gains and losses were included in the yield
calculation, the yield of a Fund might vary materially from that reported in
advertisements.
In addition to the yields for each class of shares of the Money Market
Funds, the effective yields for each class may appear from time to time in
advertisements. The effective yield will be calculated by compounding the
unannualized base period return by adding 1 to the quotient, raising the sum to
a power
42
<PAGE>
equal to 365 divided by 7, subtracting 1 from the result and carrying the
resulting effective yield figure to the nearest hundredth of one percent. Based
on the foregoing formula, for the period ended December 31, 1998, the effective
yields of the Institutional Shares of the Money Market Fund, Government Money
Market Fund and Michigan Municipal Money Market Fund were 4.89%, 4.84% and
3.22%, respectively. For the same period, the effective yields of the Investment
Shares of the Money Market Fund, Government Money Market Fund and Michigan
Municipal Money Market Fund were 4.89%, 4.83% and 3.22%, respectively. These
yield figures reflect waivers of certain expenses.
Each Money Market Fund may also quote from time to time its total
return in accordance with Securities and Exchange Commission Regulations.
NON-MONEY MARKET FUNDS
A Fund calculates its average annual total return by determining the
average annual compounded rate of return during specified periods that equates
the initial amount invested to the ending redeemable value of such investment
according to the following formula:
ERV 1/n
T = [(-------) - 1]
P
Where: T = average annual total return;
ERV = ending redeemable value of a hypothetical
$1,000 payment made at the beginning of the 1, 5
or 10 year (or other) periods at the end of such
applicable period (or a fractional portion
thereof);
P = hypothetical initial payment of $1,000; and
n = number of years.
43
<PAGE>
Based on the foregoing calculation, the average annual total returns for the
Funds for the periods ended December 31, 1998 were as follows:
<TABLE>
<CAPTION>
INVESTMENT SHARES
Inception Since
Date One Year Five Years Inception
---- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 12/01/92 27.68% 20.58% 18.90%
Index Equity Fund 11/25/92 27.93% 23.05% 20.60%
Small Company Growth Fund 12/04/92 -6.40% 11.94% 12.94%
International Growth Fund 12/04/92 17.60% 8.62% 11.77%
Income Fund 03/22/95 9.04% N/A 9.14%
Intermediate Bond Fund 11/25/92 7.26% 5.89% 6.22%
Short Term Bond Fund 12/04/92 6.00% 5.48% 5.06%
Tax-Free Income Fund 03/31/95 5.43% N/A 6.82%
Intermediate Tax-Free Fund 12/18/92 5.09% 4.83% 5.44%
Michigan Municipal Bond Fund 05/11/93 4.60% 4.27% 4.29%
Money Market Fund 12/09/92 5.13% 4.94% 4.48%
Government Money Market Fund 06/02/97 5.17% N/A 5.23%
Michigan Municipal Money Market Fund 12/15/92 3.06% 3.07% 2.83%
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
INSTITUTIONAL SHARES
Inception Since
Date One Year Five Years Inception
---- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 11/02/92 28.07% 20.83% 19.46%
Index Equity Fund 11/02/92 28.26% 23.33% 21.08%
Small Company Growth Fund 11/02/92 -6.15% 12.17% 14.15%
International Growth Fund 12/04/92 17.92% 8.87% 12.07%
Income Fund 03/20/95 9.29% N/A 9.41%
Intermediate Bond Fund 11/02/92 7.65% 6.09% 6.45%
Short Term Bond Fund 11/02/92 6.14% 5.62% 5.20%
Tax-Free Income Fund 03/20/95 5.71% N/A 7.07%
Intermediate Tax-Free Fund 12/16/92 5.37% 5.04% 5.64%
Michigan Municipal Bond Fund 05/03/93 4.75% 4.43% 4.46%
Money Market Fund 12/03/90 5.13% 4.95% 4.58%
Government Money Market Fund 06/02/97 5.17% N/A 5.25%
Michigan Municipal Money Market Fund 06/03/91 3.06% 3.07% 2.94%
</TABLE>
45
<PAGE>
A Fund calculates its aggregate total return by determining the
aggregate compounded rates of return during specified periods that likewise
equate the initial amount invested to the ending redeemable value of such
investment. The formula for calculating aggregate total return is as follows:
ERV
Aggregate Total Return = [(-------) - 1]
P
Based on the foregoing calculation, the aggregate total returns for the Funds
for the periods ended December 31, 1998 were as follows:
<TABLE>
<CAPTION>
INVESTMENT SHARES
Inception Since
Date One Year Five Years Inception
---- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 12/01/92 27.68% 154.89% 186.66%
Index Equity Fund 11/25/92 27.93% 182.12% 213.47%
Small Company Growth Fund 12/04/92 -6.40% 75.74% 109.37%
International Growth Fund 12/04/92 17.60% 51.17% 96.61%
Income Fund 03/22/95 9.04% N/A 39.33%
Intermediate Bond Fund 11/25/92 7.26% 33.15% 44.48%
Short Term Bond Fund 12/04/92 6.00% 30.57% 34.95%
Tax-Free Income Fund 03/31/95 5.43% N/A 28.09%
Intermediate Tax-Free Fund 12/18/92 5.09% 26.61% 37.65%
Michigan Municipal Bond Fund 05/11/93 4.60% 23.25% 26.76%
Money Market Fund 12/09/92 5.13% 27.25% 30.46%
Government Money Market Fund 06/02/97 5.17% N/A 8.39%
Michigan Municipal Money Market Fund 12/15/92 3.06% 16.30% 18.39%
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
INSTITUTIONAL SHARES
Inception Since
Date One Year Five Years Inception
---- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 11/02/92 28.07% 157.57% 199.07%
Index Equity Fund 11/02/92 28.26% 185.33% 225.03%
Small Company Growth Fund 11/02/92 -6.15% 77.57% 126.00%
International Growth Fund 12/04/92 17.92% 52.97% 99.76%
Income Fund 03/20/95 9.29% N/A 40.63%
Intermediate Bond Fund 11/02/92 7.65% 34.42% 46.99%
Short Term Bond Fund 11/02/92 6.14% 31.44% 36.63%
Tax-Free Income Fund 03/20/95 5.71% N/A 29.57%
Intermediate Tax-Free Fund 12/16/92 5.37% 27.86% 39.29%
Michigan Municipal Bond Fund 05/03/93 4.75% 24.23% 28.02%
Money Market Fund 12/03/90 5.13% 27.32% 43.56%
Government Money Market Fund 06/02/97 5.17% N/A 8.43%
Michigan Municipal Money Market Fund 06/03/91 3.06% 16.34% 24.53%
</TABLE>
The calculations are made assuming that (a) all dividends and capital
gain distributions are reinvested on the reinvestment dates at the price per
share existing on the reinvestment date, and (b) all recurring fees charged to
all shareholder accounts are included. The ending redeemable value (variable
"ERV" in the formula) is determined by assuming complete redemption of the
hypothetical investment after deduction of all nonrecurring charges at the end
of the measuring period.
A Fund calculates its 30-day (or one month) standard yield in
accordance with the method prescribed by the Securities and Exchange Commission
for mutual funds:
a - b
Yield = 2 [ (------ + 1)(6) - 1]
cd
Where:
a = dividends and interest earned during the period;
b = expenses accrued for the period (net of reimbursements);
c = average daily number of shares outstanding during
the period entitled to receive dividends; and
d = the maximum offering price per share on the last day of
the period.
47
<PAGE>
Based on the foregoing calculations, for the 30-day period ended
December 31, 1998, the yields for the Investment Shares of the Bond Funds and
Municipal Bond Funds were as follows: Income Fund, 4.71%; Intermediate Bond
Fund, 4.34%; Short Term Bond Fund, 4.44%; Tax-Free Income Fund, 3.31%;
Intermediate Tax-Free Fund, 3.18%; and Michigan Municipal Bond Fund, 3.57%. For
the same period, the yields on the Institutional Shares of the Bond Funds and
Municipal Bond Funds were as follows: Income Fund, 4.97%; Intermediate Bond
Fund, 4.57%; Short Term Bond Fund, 4.59%; Tax-Free Income Fund, 3.56%;
Intermediate Tax-Free Fund, 3.43%; and Michigan Municipal Bond Fund, 3.72%.
THE MUNICIPAL FUNDS
The Investment Shares and the Institutional Shares of the Municipal
Funds may also advertise "tax equivalent yield." Tax equivalent yield is
calculated by dividing that portion of the Fund's yield that is tax-exempt by 1
minus a stated income tax rate and adding the quotient to that portion, if any,
of the Fund's yield that is not tax-exempt. For the 30-day period ended December
31, 1998, the tax equivalent yields, assuming a 39.6% tax rate for the
Investment Shares of the Municipal Funds were as follows: Tax-Free Income Fund,
5.48%; Intermediate Tax-Free Fund, 5.26%; Michigan Municipal Bond Fund, 5.91%;
and Michigan Municipal Money Market Fund, 4.75%. For the same period, the yields
on the Institutional Shares of the Municipal Funds were as follows: Tax-Free
Income Fund, 5.89%; Intermediate Tax-Free Fund, 5.68%; Michigan Municipal Bond
Fund, 6.16%; and Michigan Municipal Money Market Fund, 4.75%.
ADVERTISING INFORMATION
The Funds may from time to time include in advertisements, sales
literature, communications to shareholders and other materials (collectively,
"Materials") a total return figure that more accurately compares a Fund's
performance with other measures of investment return than the total return
calculated as described above. For example, in comparing a Fund's total return
with data published by Lipper Analytical Services, Inc., CDA Investment
Technologies, Inc. or Weisenberger Investment Company Service, or with the
performance of an index, a Fund may calculate its aggregate total return for the
period of time specified in the Materials by assuming the investment of $10,000
in shares of a Fund and assuming the reinvestment of all dividends and
distributions. Percentage increases are determined by subtracting the initial
value of the investment from the ending value and by dividing the remainder by
the beginning value.
The Funds may also from time to time include discussions or
illustrations of the effects of compounding in Materials. "Compounding" refers
to the fact that, if dividends or other distributions on an investment in a Fund
are paid in the form of additional shares of the Fund, any future income or
capital appreciation of the Fund would increase the value, not only of the
original investment, but also of the additional shares received through
reinvestment. As a result, the value of the investment in the Fund would
increase more quickly than if dividends or other distributions had been paid in
cash.
In addition, the Funds may also include in Materials discussions and/or
illustrations of the potential investment goals of a prospective investor,
investment management strategies, techniques, policies or investment suitability
of a Fund (such as value investing, market timing, dollar cost averaging, asset
allocation, constant ratio transfer, automatic account rebalancing, the
advantages and disadvantages of investing in tax-deferred and taxable
investments), economic conditions, the relationship between sectors of the
economy and the economy as a whole, various securities markets, the effects of
inflation and historical performance of various asset classes, including but not
limited to, stocks, bonds and
48
<PAGE>
Treasury securities. From time to time, Materials may summarize the substance of
information contained in shareholder reports (including the investment
composition of a Fund), as well as the views of the adviser as to current
market, economic, trade and interest rate trends, legislative, regulatory and
monetary developments, investment strategies and related matters believed to be
of relevance to a Fund. The Funds may also include in Materials charts, graphs
or drawings which compare the investment objective, return potential, relative
stability and/or growth possibilities of the Funds and/or other mutual funds, or
illustrate the potential risks and rewards of investment in various investment
vehicles, including but not limited to, stocks, bonds, Treasury securities and
shares of a Fund and/or other mutual funds. Materials may include a discussion
of certain attributes or benefits to be derived by an investment in a Fund
and/or other mutual funds, shareholder profiles and hypothetical investor
scenarios, timely information on financial management, tax and retirement
planning and investment alternatives to certificates of deposit and other
financial instruments. Such Materials may include symbols, headlines or other
material which highlight or summarize the information discussed in more detail
therein.
FINANCIAL STATEMENTS
The Financial Statements included in the Funds' December 31, 1998
Annual Report to Shareholders are incorporated by reference into this SAI. The
Financial Statements included in the Annual Report have been audited by the
Trust's independent auditors, KPMG LLP, whose report thereon also appears in the
Annual Report and are incorporated herein by reference. The Financial Statements
in such Annual report have been incorporated herein in reliance upon such report
given upon the authority of such firm as experts in accounting and auditing. No
other part of the Annual Reports are incorporated herein. Copies of the
Financial Statements may be obtained without charge by contacting The Kent Funds
at P.O. Box 182201, Columbus, Ohio 43218-2201 or at 1-800-633-KENT (5368).
ADDITIONAL INFORMATION
Set forth below are the record owners or, to the Trust's knowledge, the
beneficial owners of 5% or more of the outstanding Investment and Institutional
Shares of the Funds as of April 5, 1999.
<TABLE>
<CAPTION>
PERCENTAGE OF
NAME AND ADDRESS FUND CLASS OWNERSHIP
- ----------------- ---- ----- -------------
<S> <C> <C> <C>
Trent & Co. Growth and Income Institutional 93.55%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Growth and Income Investment 43.47%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Growth and Income Investment 12.49%
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. Index Equity Institutional 85.19%
4420 44th Street Suite A
Kentwood, MI 49512
BISYS Brokerage Services Index Equity Institutional 14.24%
P.O. Box 4054
Concord, CA 94524
BHC Securities, Inc. Index Equity Investment 54.55%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
Trent & Co. Small Company Growth Institutional 93.73%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Small Company Growth Investment 24.64%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Small Company Growth Investment 14.99%
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. International Growth Institutional 95.35%
4420 44th Street Suite A
Kentwood, MI 49512
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Name and Address Fund Class Ownership
- ----------------- ---- ----- -------------
<S> <C> <C> <C>
BHC Securities, Inc. International Growth Investment 22.93%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company International Growth Investment 22.31%
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. Income Institutional 94.95%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Income Investment 41.12%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Income Investment 36.46%
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. Intermediate Bond Institutional 96.70%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Intermediate Bond Investment 14.10%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Intermediate Bond Investment 47.54%
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. Short Term Bond Institutional 97.44%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Short Term Bond Investment 65.92%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
PERCENTAGE OF
NAME AND ADDRESS FUND CLASS OWNERSHIP
---------------- ---- ----- -------------
<S> <C> <C> <C>
Trent & Co. Tax-Free Income Institutional 96.60%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Tax-Free Income Investment 39.00%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Tax-Free Income Investment 26.64%
One Freedom Valley Drive
Oaks, PA 19456
Fotru Co. Tax-Free Income Investment 5.76%
Evelyn G. Varner Trust
P.O. Box 1828
Grand Rapids, MI 49501-1828
Trent & Co. Intermediate Tax-Free Institutional 97.17%
4420 44th Street Suite A
Kentwood, MI 49512
BHC Securities, Inc. Intermediate Tax-Free Investment 20.18%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Intermediate Tax-Free Investment 20.16%
One Freedom Valley Drive
Oaks, PA 19456
Northern Trust Company Intermediate Tax-Free Investment 6.47%
Richard U. Light Irrev. S Trust
P.O. Box 92956
Chicago, IL 60675
Northern Trust Company Intermediate Tax-Free Investment 9.52%
Richard U. Light Rev. S Trust
P.O. Box 92956
Chicago, IL 60675
Trent & Co. Michigan Municipal Bond Institutional 98.16%
4420 44th Street Suite A
Kentwood, MI 49512
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Name and Address Fund Class Ownership
---------------- ---- ----- -------------
<S> <C> <C> <C>
BHC Securities, Inc. Michigan Municipal Bond Investment 25.60%
Trade House Account
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company Michigan Municipal Bond Investment 5.06%
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. Michigan Municipal Bond Investment 33.62%
4420 44th Street Suite A
Kentwood, MI 49512
Northern Trust Company Michigan Municipal Bond Investment 7.83%
Richard U. Light Irrev. S Trust
P.O. Box 92956
Chicago, IL 60675
Northern Trust Company Michigan Municipal Bond Investment 11.39%
Christopher U. Light Rev. Tr
P.O. Box 92956
Chicago, IL 60675
Trent & Co. Money Market Institutional 92.13%
4420 44th Street Suite A
Kentwood, MI 49512
V. Donna Berg Money Market Investment 8.71%
403 Midlakes Boulevard
Plainwell, MI 49080
SEI Trust Company Money Market Investment 14.30%
One Freedom Valley Drive
Oaks, PA 19456
BHC Securities, Inc. Money Market Investment 44.79%
Twelve Hundred
One Commerce Square
2005 Market Street, Suite 1200
Philadelphia, PA 19103
Old Kent Bank Government Money Market Institutional 56.22%
111 Lyon Street, NW
Grand Rapids, MI 49503
Trent & Co. Government Money Market Institutional 43.78%
4420 44th Street Suite A
Kentwood, MI 49512
</TABLE>
52
<PAGE>
<TABLE>
<CAPTION>
PERCENTAGE OF
NAME AND ADDRESS FUND CLASS OWNERSHIP
- ------------------ ---- ----- -------------
<S> <C> <C> <C>
Daniel P. Kreuz Government Money Market Investment 39.92%
139 Horseshoe Lane
Marlton, NJ 08053
Helen Glynn Government Money Market Investment 21.68%
Margaret A. McGovern Trust
11050 Valley Drive
Fountain Hills, AZ 85268
Mary E. Jones Government Money Market Investment 17.95%
125 Walnut
Schoolcroft, MI 49087
Allan C. Caldmeyer Government Money Market Investment 5.61%
Matthew S. Caldmeyer
977 Gladstone SE
Grand Rapids, MI 49506
Frederick C. Lake Government Money Market Investment 5.53%
Amy Z. Lake
2210 Edgewood SE
Grand Rapids, MI 49546
Trent & Co. Michigan Municipal Money Institutional 96.36%
4420 44th Street Suite A Market
Kentwood, MI 49512
BHC Securities, Inc. Michigan Municipal Money Investment 84.05%
Twelve Hundred Market
One Commerce Square
2005 Market Street
Philadelphia, PA 19103
SEI Trust Company Michigan Municipal Investment 5.41%
One Freedom Valley Drive Money Market
Oaks, Pa 19456
</TABLE>
Any persons or organizations listed above as owning 25% or more of the
outstanding shares of a Fund may be presumed to "control" (as that term is
defined in the 1940 Act) the Fund. As a result, those persons or organizations
could have the ability to vote a majority of the shares of the Fund on any
matter requiring the approval of shareholders of the Fund.
Except as otherwise stated in the Trust's prospectus, this SAI or
required by law, the Trust reserves the right to change the terms of the offers
stated in its prospectus or this SAI without shareholder approval, including the
right to impose or change certain fees for services provided.
53
