<PAGE> 1
Note: This filing has been submitted to replace the 497(j) that filed on
February 5, 1999, Accession Number 0000950152-99-000680.
THE KENT FUNDS
STATEMENT OF ADDITIONAL INFORMATION
FOR
INVESTMENT AND INSTITUTIONAL SHARES
OF
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
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 LIMITED TERM TAX-FREE FUND
THE KENT MONEY MARKET FUND
THE KENT GOVERNMENT MONEY MARKET FUND
THE KENT MICHIGAN MUNICIPAL MONEY MARKET FUND
May 1, 1998, as amended
on January 14, 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 Kent Large Company Growth
Fund, dated January 14, 1999, as amended or supplemented from time to time, and
the prospectus for the Investment Shares and Institutional Shares of the other
Funds set forth above, dated May 1, 1998, as amended or supplemented from time
to time. A copy of each prospectus 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
prospectuses.
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.
<PAGE> 2
TABLE OF CONTENTS
The Trust.....................................................................3
Investment Policies...........................................................3
Investment Restrictions......................................................20
Securities Transactions......................................................23
Valuation Of Securities......................................................25
Trustees And Officers........................................................27
Expenses.....................................................................29
Investment Adviser...........................................................29
Administrator................................................................32
Distributor..................................................................33
Transfer Agent...............................................................33
Custodian, Auditors And Counsel..............................................33
Distribution Plan............................................................33
Additional Purchase And Redemption Information...............................34
Dividends And Taxes..........................................................35
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
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED IN THIS SAI, OR IN THE PROSPECTUSES RELATED HERETO,
IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUSES 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 PROSPECTUSES DO NOT
CONSTITUTE AN OFFERING BY THE TRUST OR BY ITS DISTRIBUTOR IN ANY JURISDICTION IN
WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
2
<PAGE> 3
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 changed its name to "The Kent Funds" on May 1, 1990.
The Trust consists of fifteen separate investment portfolios, each of which is
diversified and has a distinct investment objective and distinct investment
policies (individually, a "Fund," and collectively, the "Funds"). Each of the
Funds has established two classes of shares, Investment Shares and Institutional
Shares. This SAI relates to the Investment and Institutional Shares of 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, The Kent Limited Term Tax-Free 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' prospectuses. 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.
INVESTMENT POLICIES
The following information supplements the description of each Fund's
investment objective and policies as set forth in the prospectuses. 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' prospectuses, 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, in effect, 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
3
<PAGE> 4
time deposit to a third party, although there is no market for such deposits.
All investments in bank 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.
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.
GUARANTEED INVESTMENT CONTRACTS (The Bond Funds and Money Market Fund only)
The Bond Funds and Money Market Fund may make limited investments in
guaranteed investment contracts ("GICs") issued by highly rated U.S. insurance
companies. 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 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
4
<PAGE> 5
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.
VARIABLE AND FLOATING RATE INSTRUMENTS (The Bond Funds, Municipal Bond Funds and
Money Market Funds only)
The above-referenced Funds may purchase rated and unrated variable and
floating rate 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
5
<PAGE> 6
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. In order to be purchased by a Money Market Fund, these
instruments must permit a Fund to demand payment of the principal of the
instrument at least once every 397 days upon not more than 30 days' notice.
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.
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.
FORWARD COMMITMENTS, WHEN-ISSUED SECURITIES AND DELAYED-DELIVERY TRANSACTIONS
To the extent as described in the Funds' prospectuses, 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.
6
<PAGE> 7
When a Fund purchases securities on a when-issued or forward commitment
basis, the Trust's custodian will maintain in a segregated account cash, U.S.
Government securities or other liquid high-grade debt 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
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 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, which have greater price volatility than coupon obligations and
which will not result in the payment of interest until maturity, provided that
the greater price volatility of any such zero coupon obligation is not
inconsistent with the Fund's investment objective. The Funds will accrue income
on such investments for tax and accounting purposes, as required, and such
income must be distributed to shareholders. Because no cash is received at the
time of such accruals, a Fund may be required to liquidate other portfolio
securities to satisfy its distribution obligations.
STRIPPED OBLIGATIONS (The Bond Funds and Money Market Funds only)
To the extent described in the prospectus for the Bond Funds and Money
Market Funds, such Funds may purchase Treasury receipts and other "stripped"
securities that evidence ownership in either the future interest payments or the
future principal payments on U.S. Government and other obligations. 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
7
<PAGE> 8
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 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, typically a custodian bank or investment
brokerage firm. 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.
8
<PAGE> 9
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.
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 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
9
<PAGE> 10
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.
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 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
10
<PAGE> 11
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 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 obligations 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
11
<PAGE> 12
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 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).
12
<PAGE> 13
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
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 a portion of their 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.
13
<PAGE> 14
Although the Large Company Growth Fund, the Growth and 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.
AMERICAN DEPOSITORY RECEIPTS (The Equity Funds only)
The Equity Funds can invest in American Depository 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. Some institutions issuing ADRs may not be sponsored by the issuer.
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.
FOREIGN CURRENCY TRANSACTIONS (The International Growth Fund only)
In order to protect against a possible loss on investments resulting from
a decline or appreciation in the value of a particular foreign currency against
the U.S. dollar or another foreign currency or for other reasons, 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
14
<PAGE> 15
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 or appreciation 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 high-grade debt 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" 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 high-grade debt 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.
15
<PAGE> 16
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.
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 high-grade debt 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
16
<PAGE> 17
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 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 above-referenced Funds may purchase and sell futures contracts and
may purchase and sell call and put options on futures contracts. 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 Securities Act of 1933, as amended (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
17
<PAGE> 18
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 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 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
18
<PAGE> 19
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
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 a nationally recognized
statistical rating organization (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.
CALCULATION OF PORTFOLIO TURNOVER RATE
The Funds will not normally engage in the trading of securities for
short-term profits, but a Fund may sell a portfolio investment soon after it is
purchased if Lyon Street believes that such a sale is consistent with the Fund's
investment objective. A high rate of portfolio turnover involves correspondingly
greater brokerage commission expenses and other transaction costs, which must be
borne directly by a Fund and ultimately by its shareholders. High portfolio
turnover may also result in the realization of substantial net capital gains to
a Fund. The portfolio turnover rate for the Funds is calculated by dividing the
lesser of purchases or sales of portfolio investments for the reporting period
by the monthly average value of the portfolio investments owned during the
reporting period. The calculation excludes all securities, including options,
whose maturities or expiration dates at the time of acquisition are one year or
less. Portfolio turnover may vary greatly from year to year as well as within a
particular year, and may be affected by cash requirements for redemption of
shares and by requirements which enable the Funds to receive favorable tax
treatment. Because the Money Market Funds invest only in short-term investments,
their portfolio turnover rate is expected to be zero for regulatory reporting
purposes.
19
<PAGE> 20
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;
(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;
20
<PAGE> 21
(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 further consideration,
are convertible into or exchangeable for securities of the same issue as, and
equal in amount to, the securities sold short; or
21
<PAGE> 22
(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.
22
<PAGE> 23
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 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 avail able 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.
23
<PAGE> 24
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, 1995, 1996 and 1997, the
following Funds paid commissions in the amounts indicated: $557,711, $478,044
and $1,400,322, respectively, for the Growth and Income Fund; $139,571, $34,687
and $235,105, respectively, for the Index Equity Fund; $1,001,650, $453,811 and
$710,902, respectively, for the Small Company Growth Fund; and $192,985,
$211,929 and $234,749, respectively, for the International Growth Fund. The
increase in the amount of brokerage commissions paid by the Index Equity Fund
and the Small Company Growth Fund is attributable to an increase in the size of
each Fund and, in the case of the Small Company Growth Fund, an increase in the
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 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, 1997, Growth and Income Fund owned equity securities
of J.P. Morgan & Co. in the amount of $1,851,000, equity securities of Merrill
Lynch & Co. in the amount of $2,830,000, and equity securities of Charles Schwab
Corp. in the amount of $1,313,000; Index Equity Fund owned equity securities of
Merrill Lynch & Co. in the amount of $1,969,000, equity securities of Charles
Schwab Corp. in the amount of $900,000, and equity securities of J.P. Morgan &
Co. in the amount of $1,625,000; Small Company Growth Fund owned equity
securities of McDonald & Co. Investments, Inc. in the amount of $1,683,000;
Income Fund owned debt securities of Lehman Brothers Holdings, Inc. in the
amount of $2,231,000, and debt securities of Salomon, Inc. in the amount of
$2,023,000; Intermediate Bond Fund owned debt securities of J.P. Morgan & Co. in
the amount of $5,339,000, debt securities of Smith Barney Holdings, Inc. in the
amount of $5,043,000; debt securities of Salomon, Inc. in the amount of
$10,155,000, debt securities of Bear Stearns Co. in the amount of $5,580,000,
and debt securities of Lehman Brothers, Inc. in the amount of $5,252,000; Short
Term Bond Fund owned debt securities of Goldman Sachs Group, L.P. in the amount
of $4,996,000, debt securities of Morgan Stanley Group, Inc. in the amount of
$6,071,000, and debt securities of Salomon, Inc. in the amount of $3,770,000;
and the Money Market Fund owned debt securities of J.P. Morgan & Co. in the
amount of $13,999,000. As of December 31, 1997, no other Fund owned securities
of the Trust's regular broker-dealers.
24
<PAGE> 25
VALUATION OF SECURITIES
MONEY MARKET FUNDS
As stated in the prospectus for the Money Market Funds, such 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 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
25
<PAGE> 26
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;
(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 the NASDAQ system 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 the NASDAQ System 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;
(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;
(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
26
<PAGE> 27
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.
TRUSTEES AND OFFICERS
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, 45; he is President and Chief Executive
Officer of Sparrow Hospital and Health System; formerly, Director and Executive
Vice President, Sisters of Mercy Health Corporation.
* WALTER B. GRIMM, Trustee, Chairman and Vice President, 52; he is Senior
Vice President of Client Services for BISYS Fund Services and was formerly
President of Lehigh Investments.
JAMES F. RAINEY, Trustee, 55; he is Associate Dean for Academic Affairs
in The Eli Broad Graduate School of Management at Michigan State University.
RONALD F. VANSTEELAND, Trustee, 57; he is 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, 40; he is Vice President of Old Kent
Financial Corporation and was formerly Vice President and Trust Counsel for
Marshall & Ilsley Trust Company.
R. JEFFREY YOUNG, Vice President and Assistant Secretary, 33; he is Vice
President - Client Services for BISYS Fund Services and was formerly employed by
The Heebink Group.
MARTIN R. DEAN, Treasurer, 34; he is Vice President - Fund Administration
for BISYS Fund Services and was formerly employed by KPMG Peat Marwick LLP.
ROBERT L. TUCH, Secretary, 46; he is Vice President - Legal Services for
BISYS Fund Services.
W. BRUCE MCCONNEL, III, Assistant Secretary, 55; he is a partner in the
law firm of Drinker Biddle & Reath LLP.
27
<PAGE> 28
ALAINA V. METZ, Assistant Secretary, 31; she is Chief Administrator of
the Blue Sky Department for BISYS Fund Services and was 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, 1997, 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 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, 1997. 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>
Anne T. Coughlan, Trustee* $ 4,000** $ 4,000
Joseph F. Damore, Trustee $ 13,000** $ 13,000
Walter B. Grimm, Trustee $ 0 $ 0
James F. Rainey, Trustee $ 13,000** $ 13,000
Ronald F. VanSteeland, Trustee $ 13,000 $ 13,000
</TABLE>
28
<PAGE> 29
- ----------------
* Ms. Coughlan resigned from the Trust's Board of Trustees on May 23, 1997.
** During the fiscal year ended December 31, 1997, Mr. Damore deferred $10,000
of his compensation and Mr. Rainey deferred $6,500 of his compensation
pursuant to the Deferred Compensation Plan. Ms. Coughlan received payment of
all compensation (including compensation that was previously deferred
pursuant to the Deferred Compensation Plan) that was due and owing to her in
conjunction with her resignation from the Trust's Board of Trustees on May
23, 1997.
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.
EXPENSES
Operating expenses borne by the Funds include taxes, interest, fees and
expenses of Trustees, Securities and Exchange Commission fees, state securities
qualification fees, advisory fees, administration fees, charges of the Funds'
custodians and shareholder services agent, certain insurance premiums, outside
auditing and legal expenses, costs of preparing and printing prospectus for
regulatory purposes and for distribution to existing shareholders, costs of
shareholder reports and meetings and any extraordinary expenses. The Funds also
pay for brokerage fees, commissions and other transaction charges (if any) in
connection with the purchase and sale of portfolio securities.
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 March 31, 1998, Lyon
Street managed assets of approximately $4.6 billion. The Trust is the first
registered investment company for which Lyon Street has 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, 1997. 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
$13.8 billion in total consolidated assets as of December 31, 1997. 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.
29
<PAGE> 30
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 Limited Term Tax-Free 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 certain of its
institutional customers.
For the fiscal years ended December 31, 1995, 1996 and 1997, Old Kent,
the Trust's former investment adviser, earned the following advisory fees for
each Fund: $2,427,434, $3,202,775 and $4,568,032, respectively, for the Growth
and Income Fund; $834,175, $654,709 and $1,278,392, respectively, for the Index
Equity Fund; $2,210,891, $3,613,394 and $4,597,213, respectively, for the Small
Company Growth Fund; $1,483,705, $2,465,291 and $3,529,317, respectively, for
the International Growth Fund; $4,765,284, $4,537,199 and $4,262,333,
respectively, for the Intermediate Bond Fund; $1,454,445, $1,421,272 and
$857,575, respectively, for the Short Term Bond Fund; $1,582,089, $1,458,010 and
$1,424,578, respectively, for the Intermediate Tax-Free Fund; $738,023, $772,339
and $563,275, respectively, for the Michigan Municipal Bond Fund; $219,989,
$225,891 and $167,800, respectively, for the Limited Term Tax-Free Fund;
$2,056,213, $1,747,159 and $2,092,414, respectively, for the Money Market Fund;
and $590,771, $653,417 and $781,668, respectively, for the Michigan Municipal
Money Market Fund. For the fiscal period ended December 31, 1995 and the fiscal
years ended December 31, 1996 and December 31, 1997, Old Kent earned advisory
fees of $632,086, $1,209,526 and $ 1,489,950, respectively, for the Income Fund
and $442,275, $595,616 and $642,997, respectively, for the Tax-Free Income Fund.
For the fiscal period ended December 31, 1997, Old Kent earned $226,041 in
advisory fees for the Government Money Market Fund.
For the fiscal year ended December 31, 1997, Old Kent waived a portion
of its advisory fees for the Index Equity Fund. Net of such waivers, Old Kent
received $1,158,610. For the fiscal period ended December 31, 1997, Old Kent
waived a portion of its advisory fees for the Government Money Market Fund. Net
of such waivers, Old Kent received $112,896. For the fiscal year ended December
31, 1995, Old Kent waived a portion of its advisory fees for the Michigan
Municipal Bond Fund, Limited Term Tax-Free Fund, Money Market Fund and Michigan
Municipal Money Market Fund. Net of such waivers, Old Kent received $717,968,
for the Michigan Municipal Bond Fund; $199,200 for the Limited Term Tax-Free
Fund; $1,903,848, for the Money Market Fund; and $535,921, for the Michigan
Municipal Money Market Fund. For the fiscal period ended December 31, 1995, Old
Kent waived a portion of its advisory fees for the Tax-Free Income Fund. Net of
such waivers, Old Kent received $293,807.
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.
30
<PAGE> 31
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.
SUB-ADMINISTRATION AGREEMENT
Old Kent provides certain administrative services to the Funds pursuant
to a Sub-Administration Agreement between Old Kent and BISYS. BISYS has agreed
to pay Old Kent a fee, calculated daily and paid monthly, at an annual rate of
up to 0.05% of each Fund's average daily net assets. The fees paid to Old Kent
by BISYS for such administrative services come out of BISYS' administration fee
and are not an additional charge to the Funds.
THE GLASS-STEAGALL ACT AND OTHER APPLICABLE LAWS
The Glass-Steagall Act, among other things, prohibits banks from
engaging in the business of underwriting, selling or distributing securities,
although national and state-chartered banks generally are permitted to purchase
and sell securities upon the order and for the account of their customers. In
1971, the United States Supreme Court held in INVESTMENT COMPANY INSTITUTE V.
CAMP that the Glass-Steagall Act prohibits a national bank from operating a fund
for the collective investment of managed agency accounts. Subsequently, the
Board of Governors of the Federal Reserve System (the "Board") issued a
regulation and interpretation to the effect that the Glass-Steagall Act and such
decision forbid a bank holding company or any non-bank affiliate of a bank
holding company from sponsoring, organizing or controlling a registered,
open-end investment company continuously engaged in the issuance of its shares,
but do not prohibit such a holding company or affiliate from acting as
investment adviser, transfer agent and custodian to such an investment company.
In 1981, the United States Supreme Court held in BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM V. INVESTMENT COMPANY INSTITUTE that the Board did not
exceed its authority under the Bank Holding Company Act when it adopted its
regulation and interpretation authorizing bank holding companies and their
non-bank affiliates to act as investment advisers to registered closed-end
investment companies.
Old Kent has been advised by the Financial Institutions Bureau of the
Department of Commerce of the State of Michigan, which is the bureau that
regulates Michigan state chartered banks, that it is the position of that Bureau
that a bank (such as Old Kent) which has been authorized to exercise full trust
powers is authorized under Michigan banking laws to provide investment advice to
an entity such as a mutual fund.
Lyon Street believes it may lawfully serve as investment adviser to the
Trust and perform the services for the Trust required by the Investment Advisory
Agreement described in the prospectus and this SAI. However, Lyon Street's
authority to serve in such capacity has not been definitively established by any
state or federal law or regulation or any judicial decision or regulatory
interpretation that constitutes binding authority with respect to the activities
of Lyon Street. In addition, state and federal laws and regulations relating to
the permissible activities of banks and bank holding companies may change and
may be subject to further judicial or administrative interpretation, the result
of which may be to cause Lyon Street to conclude that it would be unlawful or
inadvisable to continue its relationship with the Trust. If Lyon Street
discontinues its services as investment adviser to the Trust, it is expected
that
31
<PAGE> 32
the Board of Trustees of the Trust would select a new investment adviser
and recommend that the Trust's shareholders approve the new investment adviser
so recommended.
ADMINISTRATOR
BISYS Fund Services Limited Partnership, 3435 Stelzer Road, Columbus,
Ohio 43219, a wholly-owned subsidiary of The BISYS Group, Inc., serves as the
Administrator of the Trust under an Administration Agreement dated August 5,
1996. BISYS 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 July 31,
1999. Thereafter, the agreement may be renewed for successive one-year periods.
By the terms of the Administration Agreement, BISYS 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. BISYS 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, BISYS 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 BISYS in the Administration Agreement) incurred by BISYS in
connection with the operation of the Trust are borne by the Funds. To the extent
that BISYS incurs any such expenses or provides certain additional services to
the Trust, the Funds promptly will reimburse BISYS therefor.
BISYS Fund Services, Inc., a wholly-owned subsidiary of The BISYS
Group, Inc., serves as the Trust's Fund Accountant pursuant to a Fund Accounting
Agreement, dated August 5, 1996. Under the Fund Accounting Agreement, BISYS Fund
Services, Inc. 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, BISYS Fund Services, Inc. is entitled to receive a fee computed
daily at the annual rate of .015% of the Trust's average daily net assets. The
current term of the Fund Accounting Agreement ends on July 31, 1999. Thereafter,
the agreement may be renewed for successive one-year periods.
For the fiscal periods ended December 31, 1995, 1996 and 1997, the
Trust paid the following administration fees to BISYS and the Trust's former
administrator: $693,553, $896,290 and $1,169,235, respectively, for the Growth
and Income Fund; $422,784, $212,487 and $464,741, respectively, for the Index
Equity Fund; $631,683, $1,011,600 and $1,176,682, respectively, for the Small
Company Growth Fund; $395,655, $643,425 and $842,845, respectively, for the
International Growth Fund; $1,732,831, $1,618,455 and $1,386,330, respectively,
for the Intermediate Bond Fund; $581,778, $558,367 and $306,274, respectively,
for the Short Term Bond Fund; $632,836, $571,869 and $509,532, respectively, for
the Intermediate Tax-Free Fund; $328,010, $337,467 and $223,672, respectively,
for the Michigan Municipal Bond Fund; $97,773, $95,629 and $66,670,
respectively, for the Limited Term Tax-Free Fund; $772,894, $425,618 and
$504,642, respectively, for the Money Market Fund; and $220,170, $159,777 and
$178,917, respectively, for the Michigan Municipal Money Market Fund. For the
fiscal period ended December 31, 1995 and the fiscal years ended December 31,
1996 and December 31, 1997, the Income Fund paid $210,695, $393,938 and
$444,179, respectively, and the Tax-Free Income Fund paid $160,827,
32
<PAGE> 33
$227,178 and $209,139, respectively, in administration fees. For the fiscal
period ended December 31, 1997, the Government Money Market Fund paid $36,124 in
administration fees.
DISTRIBUTOR
The Trust has entered into a Distribution Agreement dated August 5,
1996 with BISYS. 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 BISYS as agent for the Trust, and
BISYS has agreed to use its best efforts to solicit orders for the sale of
shares of the Funds.
For the fiscal years ended 1995, 1996 and 1997, the Trust paid BISYS
and the Trust's former distributor total underwriting commissions of $457,249,
$527,141 and $55,000, respectively. This entire amount was re-allocated to
broker-dealers which had selling agreements with the distributor.
TRANSFER AGENT
BISYS Fund Services, Inc. also serves as the Trust's transfer agent and
dividend disbursing agent pursuant to a Transfer Agency Agreement. Under the
Transfer Agency Agreement, BISYS Fund Services, Inc. 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.
CUSTODIAN, AUDITORS AND COUNSEL
Bankers Trust Company, 16 Wall Street, 4th Floor, New York, New York
10005 is custodian of all securities and cash of the Trust.
KPMG LLP, Two Nationwide Plaza, Columbus, Ohio 43215,
Certified Public Accountants, are the independent auditors for the Trust.
Drinker Biddle & Reath LLP, 1345 Chestnut Street, Philadelphia, PA
19107, serves as counsel to the Trust.
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.
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
33
<PAGE> 34
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 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, 1997, the following payments
were made under the Plan: Growth and Income Fund, $59,946; Index Equity Fund,
$45,030; Small Company Growth Fund, $45,018; International Growth Fund, $23,388;
Income Fund, $8,849; Intermediate Bond Fund, $17,259; Short Term Bond Fund,
$5,481; Tax-Free Income Fund, $2,621; Intermediate Tax-Free Fund, $8,298;
Michigan Municipal Bond Fund, $4,491; and Limited Term Tax-Free Fund, $463. 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, Michigan Municipal Bond Fund and
Limited Term Tax-Free 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 prospectuses 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.
34
<PAGE> 35
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 prospectuses under "How
Can I Redeem Shares," 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 prospectuses
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.
DIVIDENDS AND TAXES
The following summarizes certain additional tax considerations
generally affecting the Funds and their shareholders that are not described in
the prospectuses. No attempt is made to present a detailed explanation of the
tax treatment of the Funds or their shareholders, and the discussion here and in
the prospectus is not intended as a substitute for careful tax planning.
Potential investors should consult their tax advisers with specific reference to
their own tax situations.
The discussion of Federal income tax consequences in the prospectus and
this SAI is based on the Internal Revenue Code of 1986, as amended (the "Code")
and the laws and regulations issued thereunder as in effect on the date of this
SAI. Future legislative or administrative changes or court decisions may
significantly change the conclusions expressed herein, and any such changes or
decisions may have a retroactive effect with respect to the transactions
contemplated herein.
FEDERAL - GENERAL INFORMATION
Each Fund will be treated as a separate corporate entity under the Code
and intends to elect to qualify as a regulated investment company. In order to
qualify as a regulated investment company, each Fund must comply with certain
requirements in the Code. Each Fund is required to distribute annually an amount
equal to at least the sum of 90% of its investment company income and 90% of its
net tax-exempt interest income (the "Distribution Requirement"). Each Fund must
derive with respect to a taxable year at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans and gains
from the sale or other disposition of stock, securities or foreign currencies,
or from other
35
<PAGE> 36
income derived with respect to its business of investing in such stock,
securities, or currencies (the "Income Requirement").
In addition to the foregoing requirements, at the close of each quarter
of its taxable year, at least 50% of the value of each Fund's assets must
consist of cash and cash items, U.S. Government securities, securities of other
regulated investment companies, and securities of other issuers (as to which a
Fund has not invested more than 5% of the value of its total assets in
securities of any one issuer and as to which a Fund does not hold more than 10%
of the outstanding voting securities of any one issuer), and no more than 25% of
the value of each Fund's total assets may be invested in the securities of any
one issuer (other than U.S. Government securities and securities of other
regulated investment companies), or in two or more issuers which such Fund
controls and which are engaged in the same or similar trades or businesses.
Each Fund intends to distribute to shareholders any excess of net
long-term capital gain over net short-term capital loss ("net capital gain"), if
any, for each taxable year. Such gain is distributed as a capital gain dividend
and is taxable to shareholders as long-term capital gain, regardless of the
length of time the shareholder has held the shares, whether such gain was
recognized by the Fund prior to the date on which a shareholder acquired shares
of the Fund, or whether the distribution was paid in cash or reinvested in
shares. In addition, investors should be aware that any loss realized upon the
sale, exchange or redemption of shares held for six months or less will be
treated as a long-term capital loss to the extent any capital gain dividends
have been paid with respect to such shares.
In the case of corporate shareholders, distributions of a Fund for any
taxable year generally qualify for the dividends received deduction to the
extent of the gross amount of "qualifying dividends" from domestic corporations
received by the Fund for the year. A dividend usually will be treated as a
"qualifying dividend" if it has been received from a domestic corporation. A
portion of the dividends paid by the Large Company Growth Fund, Growth and
Income Fund, Index Equity Fund and Small Company Growth Fund may constitute
"qualifying dividends." The other Funds, however, are not expected to pay
qualifying dividends.
Ordinary income of individuals is taxable at a maximum marginal rate of
39.6%, but because of limitations on itemized deductions otherwise allowable and
the phase-out of personal exemptions, the effective maximum marginal rate of tax
for some taxpayers may be higher. An individual's long-term capital gains will
be taxable at a maximum nominal rate of 20% for assets held more than 18 months
and 28% for assets held more than 12 months but not more than 18 months. For
corporations, long-term capital gains and ordinary income are both taxable at a
maximum nominal rate of 35%.
If for any taxable year any Fund does not qualify as a regulated
investment company, all of its taxable income will be subject to tax at regular
corporate rates without any deduction for distributions to shareholders. In such
event, all distributions (whether or not derived from exempt-interest income)
would be taxable as ordinary income to the extent of such Fund's current and
accumulated earnings and profits and would be eligible for the dividends
received deduction in the case of corporate shareholders.
The Code imposes a non-deductible 4% excise tax on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). Each Fund intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and capital
gain net income each calendar year to avoid liability for this excise tax.
Although each Fund expects to qualify as a "regulated investment
company" and to be relieved of all or substantially all Federal income taxes,
depending upon the extent of its activities in states and localities in which
its offices are maintained, in which its agents or independent contractors are
located or
36
<PAGE> 37
in which it is otherwise deemed to be conducting business, each Fund may be
subject to the tax laws of such states or localities.
FEDERAL - TAX-EXEMPT INFORMATION
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 exempt-interest
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 tax-exempt
obligations. An exempt-interest dividend is any dividend or part thereof (other
than a capital gain dividend) paid by a Municipal Fund and designated as an
exempt-interest dividend in a written notice mailed to shareholders not later
than 60 days after the close of the Fund's taxable year. However, the aggregate
amount of dividends so designated by a Municipal Fund cannot exceed the excess
of the amount of interest exempt from tax under Section 103 of the Code received
by the Fund during the taxable year over any amounts disallowed as deductions
under Sections 265 and 171(a)(2) of the Code. The percentage of total dividends
paid by a Municipal Fund with respect to any taxable year which qualifies as
Federal exempt-interest dividends will be the same for all shareholders
receiving dividends from the Fund with respect to such year.
If a Municipal Fund holds certain so-called "private activity bonds,"
shareholders will be required to include as an item of tax preference for
purposes of the Federal alternative minimum tax that portion of the dividends
paid by the Fund derived from interest received on such bonds. In addition,
corporate shareholders will have to take into account all exempt-interest
dividends paid by the Municipal Funds in determining certain adjustments for the
Federal alternative minimum tax and the environmental tax.
TAXATION OF CERTAIN FINANCIAL INSTRUMENTS
Special rules govern the Federal income tax treatment of certain
financial instruments that may be held by the Funds. These rules may have a
particular impact on the amount of income or gain that the Funds must distribute
to their respective shareholders to comply with the Distribution Requirement or
the Income Requirement.
Generally, futures contracts, options on futures contracts and certain
foreign currency contracts held by a Fund (collectively, the "Instruments") at
the close of its taxable year are treated for Federal income tax purposes as
sold for their fair market value on the last business day of such year, a
process known as "marking-to-market." Except in the case of foreign currency
contracts (which result in ordinary
37
<PAGE> 38
income or loss), 40% of any gain or loss resulting from such constructive sales
is treated as short-term capital gain or loss and 60% of such gain or loss is
treated as long-term capital gain or loss without regard to the period the Fund
holds the Instruments (the "40-60 rule"). The amount of any gain or loss
actually realized by the Fund in a subsequent sale or other disposition of those
Instruments is adjusted to reflect any income, gain or loss taken into account
by the Fund in a prior year as a result of the constructive sale of the
Instruments. Losses with respect to Instruments that are regarded as parts of a
"mixed straddle" because their values fluctuate inversely to the values of
specific securities held by the Fund are subject to certain loss deferral rules
which limit the amount of loss currently deductible on either part of the
straddle to the amount thereof which exceeds the unrecognized gain (if any) with
respect to the other part of the straddle, and to certain wash sales
regulations. Under short sales rules, which are also applicable, the holding
period of the securities forming part of the straddle will (if they have not
been held for the long-term holding period) be deemed not to begin prior to
termination of the straddle. With respect to certain Instruments, deductions for
interest and carrying charges may not be allowed. Notwithstanding the rules
described above, with respect to Instruments that are part of a "mixed straddle"
and are properly identified as such, a Fund may make an election which will
exempt (in whole or in part) those identified Instruments from the rules of
Section 1256 of the Code, including the 40-60 rule and the mark-to-market on
gains and losses being treated for Federal income tax purposes as sold on the
last business day of the Fund's taxable year, but gains and losses will be
subject to such short sales, wash sales and loss deferral rules and the
requirement to capitalize interest and carrying charges. Under Temporary
Regulations, a Fund would be allowed (in lieu of the foregoing) to elect either
(a) to offset gains or losses from portions which are part of a mixed straddle
by separately identifying each mixed straddle to which such treatment applies,
or (b) to establish a mixed straddle account for which gains and losses would be
recognized and offset on a periodic basis during the taxable year. Under either
election, the 40-60 rule will apply to the net gain or loss attributable to the
Instruments, but in the case of a mixed straddle account election, not more than
50% of any net gain may be treated as long-term and no more than 40% of any net
loss may be treated as short-term.
Certain foreign currency contracts entered into by a Fund may be
subject to the marking-to-market process, but gain or loss will be treated as
100% ordinary income or loss. To receive such treatment, a foreign currency
contract must meet the following conditions: (1) the contract must require
delivery of, or settlement by reference to the value of, a foreign currency of a
type in which regulated futures contracts are traded; (2) the contract must be
entered into at arms' length at a price determined by reference to the price in
the interbank market; and (3) the contract must be traded in the interbank
market. The Treasury Department has broad authority to issue regulations under
the provisions respecting foreign currency contracts. As of the date of this
SAI, the Treasury Department has not issued any such regulations. Foreign
currency contracts entered into by a Fund may result in the creation of one or
more straddles for Federal income tax purposes, in which case certain loss
deferral, short sales, and wash sales rules and the requirement to capitalize
interest and carrying charges may apply.
Some of the non-U.S. dollar-denominated investments held by the Growth
and Income Fund and International Growth Fund, such as foreign debt securities
and foreign currency contracts, may be subject to the provisions of Subpart J of
the Code, which govern the Federal income tax treatment of certain transactions
denominated in terms of a currency other than the U.S. dollar or determined by
reference to the value of one or more currencies other than the U.S dollar. The
types of transactions covered by these provisions include the following: (1) the
acquisition of, or becoming the obligor under, a bond or other debt instrument
(including, to the extent provided in Treasury regulations, preferred stock);
(2) the accruing of certain trade receivables and payables; and (3) the entering
into or acquisition of any forward contract, futures contract, option and
similar financial instrument. The disposition of a currency other than the U.S.
dollar by a U.S. taxpayer also is treated as a transaction subject to the
special currency rules. However, regulated futures contracts and nonequity
options are generally not subject to the special currency rules if they are or
would be treated as sold for their fair market value at year-end under the
38
<PAGE> 39
mark-to-market rules, unless an election is made to have such currency rules
apply. With respect to transactions covered by the special rules, foreign
currency gain or loss is calculated separately from any gain or loss on the
underlying transaction and is normally taxable as ordinary gain or loss. A
taxpayer may elect to treat as capital gain or loss foreign currency gain or
loss arising from certain identified forward contracts, futures contracts and
options that are capital assets in the hands of the taxpayer and which are not
part of a straddle. In accordance with Treasury regulations, certain
transactions that are part of a "Section 988 hedging transaction" (as defined in
the Code and Treasury regulations) may be integrated and treated as a single
transaction or otherwise treated consistently for purposes of the Code. "Section
988 hedging transactions" are not subject to the mark-to-market or loss deferral
rules under the Code. Gain or loss attributable to the foreign currency
component of transactions engaged in by the Fund which are not subject to the
special currency rules (such as foreign equity investments other than certain
preferred stocks) is treated as capital gain or loss and is not segregated from
the gain or loss on the underlying transaction.
A Fund may be subject to U.S. Federal income tax (and possibly
additional interest charges) on a portion of any "excess distribution" from or a
gain from the disposition of shares of a passive foreign investment company
("PFIC"), even if it distributes the income to its shareholders. In the
alternative, a Fund may elect to recognize income or gain each year with respect
to its PFIC holdings, either through making a "qualified electing fund" election
for the PFIC, under which the Fund would recognize its allocable share of the
PFIC's ordinary earnings and net capital gains for each year, or through
electing to mark-to-market and recognize ordinary income each year with respect
to any appreciation in a PFIC investment.
39
<PAGE> 40
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 with two separate classes in each series -- 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 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
40
<PAGE> 41
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.
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, 1997, the yields of the Institutional Shares of the Money Market Fund,
41
<PAGE> 42
Government Money Market Fund and Michigan Municipal Money Market Fund were
5.31%, 5.25% and 3.53%, 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 5.31%, 5.13% and 3.53%, 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 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, 1997, the
effective yields of the Institutional Shares of the Money Market Fund,
Government Money Market Fund and Michigan Municipal Money Market Fund were
5.45%, 5.39% and 3.59%, 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 5.45%, 5.26% and 3.59%,
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 the
applicable period (or a fractional portion
thereof);
P = hypothetical initial payment of $1,000; and
n = period covered by the computation, expressed in
years.
42
<PAGE> 43
Based on the foregoing calculation, the average annual total returns for the
Funds for the periods ended December 31, 1997 were as follows:
INVESTMENT SHARES
<TABLE>
<CAPTION>
Inception Since
Date One Year Five Years Inception
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 12/01/92 23.89% 17.42% 17.23%
Index Equity Fund 11/25/92 32.24% 19.19% 19.20%
Small Company Growth Fund 12/04/92 27.71% 17.02% 17.18%
International Growth Fund 12/04/92 2.25% 10.80% 10.65%
Income Fund 03/17/95 10.19% N/A 9.16%
Intermediate Bond Fund 11/25/92 7.62% 6.08% 6.06%
Short Term Bond Fund 12/04/92 6.26% 4.89% 4.87%
Tax-Free Income Fund 03/31/95 8.32% N/A 7.32%
Intermediate Tax-Free Fund 12/18/92 6.80% 5.47% 5.50%
Michigan Municipal Bond Fund 05/11/93 5.38% N/A 4.22%
Limited Term Tax-Free Fund 11/01/94 4.61% N/A 5.20%
Money Market Fund 12/09/92 5.23% 4.41% 4.35%
Government Money Market Fund 06/02/97 N/A N/A N/A
Michigan Municipal Money Market Fund 12/15/92 3.31% 2.81% 2.78%
</TABLE>
43
<PAGE> 44
INSTITUTIONAL SHARES
<TABLE>
<CAPTION>
Inception Since
Date One Year Five Years Inception
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 11/02/92 24.14% 17.56% 17.84%
Index Equity Fund 11/02/92 32.55% 19.41% 19.72%
Small Company Growth Fund 11/02/92 27.94% 17.21% 18.54%
International Growth Fund 12/04/92 2.54% 11.05% 10.92%
Income Fund 03/20/95 10.55% N/A 9.44%
Intermediate Bond Fund 11/02/92 7.80% 6.16% 6.21%
Short Term Bond Fund 11/02/92 6.42% 5.00% 5.01%
Tax-Free Income Fund 03/20/95 8.59% N/A 7.56%
Intermediate Tax-Free Fund 12/16/92 7.07% 5.62% 5.69%
Michigan Municipal Bond Fund 05/03/93 5.52% N/A 4.39%
Limited Term Tax-Free Fund 09/01/94 4.78% N/A 4.74%
Money Market Fund 12/03/90 5.23% 4.42% 4.50%
Government Money Market Fund 06/02/97 N/A N/A N/A
Michigan Municipal Money Market Fund 06/03/91 3.31% 2.84% 2.92%
</TABLE>
44
<PAGE> 45
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, 1997 were as follows:
INVESTMENT SHARES
<TABLE>
<CAPTION>
Inception Since
Date One Year Five Years Inception
--------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Growth and Income Fund 12/01/92 23.89% 123.23% 124.54%
Index Equity Fund 11/25/92 32.24% 140.59% 145.05%
Small Company Growth Fund 12/04/92 27.71% 119.39% 123.72%
International Growth Fund 12/04/92 2.25% 67.02% 67.19%
Income Fund 03/17/95 10.19% N/A 27.79%
Intermediate Bond Fund 11/25/92 7.62% 34.33% 35.00%
Short Term Bond Fund 12/04/92 6.26% 26.94% 27.32%
Tax-Free Income Fund 03/31/95 8.32% N/A 21.50%
Intermediate Tax-Free Fund 12/18/92 6.80% 30.48% 31.00%
Michigan Municipal Bond Fund 05/11/93 5.38% N/A 21.19%
Limited Term Tax-Free Fund 11/01/94 4.61% N/A 17.42%
Money Market Fund 12/09/92 5.23% 24.09% 24.09%
Government Money Market Fund 06/02/97 N/A N/A 3.06%
Michigan Municipal Money Market Fund 12/15/92 3.31% 14.88% 14.88%
</TABLE>
45
<PAGE> 46
INSTITUTIONAL SHARES
<TABLE>
<CAPTION>
Inception Since
Date One Year Five Years Inception
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Growth & Income Fund 11/02/92 24.14% 124.56% 133.50%
Index Equity Fund 11/02/92 32.55% 142.74% 153.42%
Small Company Growth Fund 11/02/92 27.94% 121.26% 140.85%
International Growth Fund 12/04/92 2.54% 68.92% 69.43%
Income Fund 03/20/95 10.55% N/A 28.71%
Intermediate Bond Fund 11/02/92 7.80% 34.86% 36.55%
Short Term Bond Fund 11/02/92 6.42% 27.63% 28.75%
Tax-Free Income Fund 03/20/95 8.59% N/A 22.58%
Intermediate Tax-Free Fund 12/16/92 7.07% 31.43% 32.22%
Michigan Municipal Bond Fund 05/03/93 5.52% N/A 22.22%
Limited Term Tax-Free Fund 09/01/94 4.78% N/A 16.72%
Money Market Fund 12/03/90 5.23% 24.17% 36.55%
Government Money Market Fund 06/02/97 N/A N/A 3.10%
Michigan Municipal Money Market Fund 06/03/91 3.31% 15.02% 20.84%
</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.
46
<PAGE> 47
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 = net asset value per share on the last day of the
period.
Based on the foregoing calculations, for the 30-day period ended
December 31, 1997, the yields for the Investment Shares of the Bond Funds and
Municipal Bond Funds were as follows: Income Fund, 5.53%; Intermediate Bond
Fund, 5.09%; Short Term Bond Fund, 5.21%; Tax-Free Income Fund, 3.67%;
Intermediate Tax-Free Fund, 3.49%; Michigan Municipal Bond Fund, 3.85%; and
Limited Term Tax-Free Fund, 3.46%. For the same period, the yields on the
Institutional Shares of the Bond Funds and Municipal Bond Funds were as follows:
Income Fund, 5.79%; Intermediate Bond Fund, 5.35%; Short Term Bond Fund, 5.36%;
Tax-Free Income Fund, 3.92%; Intermediate Tax-Free Fund, 3.74%; Michigan
Municipal Bond Fund, 4.00%; and Limited Term Tax-Free Fund, 3.61%.
THE MUNICIPAL FUNDS
The Investment Shares and the Institutional Shares of the Municipal
Funds may also advertise "tax equivalent yield." Tax equivalent yield is, in
general, the yield divided by a factor equal to one minus a stated income tax
rate and reflects the yield a taxable investment would have to achieve in order
to equal on an after-tax basis a tax-exempt yield. For the 30-day period ended
December 31, 1997, 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,
6.08%; Intermediate Tax-Free Fund, 5.78%; Michigan Municipal Bond Fund, 6.37%;
Limited Term Tax-Free Fund, 5.73%; and Michigan Municipal Money Market Fund,
5.56%. For the same period, the yields on the Institutional Shares of the
Municipal Funds were as follows: Tax-Free Income Fund, 6.49%; Intermediate
Tax-Free Fund, 6.19%; Michigan Municipal Bond Fund, 6.62%; Limited Term Tax-Free
Fund, 5.98%; and Michigan Municipal Money Market Fund, 5.56%.
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
47
<PAGE> 48
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 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, 1997
Annual Report to Shareholders are incorporated by reference into this SAI. 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 indicated as of January 6, 1999.
48
<PAGE> 49
<TABLE>
<CAPTION>
NAME AND ADDRESS FUND CLASS PERCENTAGE OF
OWNERSHIP
<S> <C> <C> <C>
Trent & Co. The Kent Short Term Institutional 41%
Cash Account Bond Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Short Term Institutional 56%
Reinvestment Account Bond Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Intermediate Institutional 46%
Cash Account Bond Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Intermediate Institutional 51%
Reinvestment Account Bond Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
</TABLE>
49
<PAGE> 50
<TABLE>
<S> <C> <C> <C>
Trent & Co. The Kent Intermediate Institutional 98%
Cash Account Tax-Free Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Michigan Institutional 99%
Cash Account Municipal Bond Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Growth and Institutional 40%
Reinvestment Account Income Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Growth and Institutional 54%
Cash Account Income Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Small Company Institutional 44%
Reinvestment Account Growth Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Small Company Institutional 46%
Cash Account Growth Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent International Institutional 43%
Reinvestment Account Growth Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent International Institutional 52%
Cash Account Growth Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Corelink Financial, Inc. The Kent Index Equity Institutional 12%
P.O. Box 4054 Fund
Concord, CA 94524
</TABLE>
50
<PAGE> 51
<TABLE>
<S> <C> <C> <C>
Trent & Co. The Kent Index Equity Institutional 20%
Cash Account Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Index Equity Institutional 66%
Reinvestment Account Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Limited Term Institutional 99%
Cash Account Tax-Free Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Tax-Free Institutional 97%
Cash Account Income Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Income Fund Institutional 19%
Reinvestment Account
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Income Fund Institutional 76%
Cash Account
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
</TABLE>
51
<PAGE> 52
<TABLE>
<S> <C> <C> <C>
BHC Securities Inc. The Kent Short Term Investment 69%
Trade House Account Bond Fund
Attn Mutual Funds Dept.
One Commerce Square
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company The Kent Intermediate Investment 43%
Reinvestment Account Bond Fund
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
BHC Securities, Inc. The Kent Intermediate Investment 15%
Trade House Acct. Bond Fund
Attn: Mutual Fund Dept.
One Commerce Square
2005 Market Street
Philadelphia, PA 19103
Northern Trust Co. The Kent Intermediate Investment 7%
FBO Richard U. Light Tax-Free Fund
Irrev. S. Tr.
U/A D 062140
P.O. Box 92956
Chicago, IL 60675
Northern Trust Co. The Kent Intermediate Investment 10%
FBO Christopher U. Light Tax-Free Fund
Rev. Tr.
DTD 010976
P.O. Box 92956
Chicago, IL 60675
BHC Securities The Kent Intermediate Investment 12%
Trade House Account Tax-Free Fund
ATTN: Mutual Fund Department
One Commerce Square
2005 Market Street
Philadelphia, PA 19103
Linkins & Co. The Kent Intermediate Investment 9%
Northern Trust Bank of Florida Tax-Free Fund
Attn: Trust Accounting
P.O. Box 019688
Miami, FL 33101-9688
SEI Trust Company The Kent Intermediate Investment 21%
Reinvest Account Tax-Free Fund
Kent Moneywise
</TABLE>
52
<PAGE> 53
<TABLE>
<S> <C> <C> <C>
One Freedom Valley Drive
Oaks, PA 19456
Trent & Co. The Kent Michigan Investment 22%
Reinvest Municipal Bond Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Northern Trust Co. The Kent Michigan Investment 8%
FBO Richard U. Light Municipal Bond Fund
Irrev. S. Tr.
U/A D 062140
P.O. Box 92956
Chicago, IL 60675
Northern Trust Co. The Kent Michigan Investment 11%
FBO Christopher U. Light Municipal Bond Fund
Rev. Tr.
DTD 010976
P.O. Box 92956
Chicago, IL 60675
BHC Securities Inc. The Kent Michigan Investment 27%
Trade House Account Municipal Bond Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market St., Suite 1200
Philadelphia, PA 19103
SEI Trust Company The Kent Michigan Investment 5%
Reinvest Account Municipal Bond
Kent Moneywise Fund
One Freedom Valley Drive
Oaks, PA 19456
Linkins & Co. The Kent Michigan Investment 7%
Northern Trust Bank of Florida Municipal Bond
Attn: Trust Accounting Fund
P.O. Box 019688
Miami, FL 33101-9688
BHC Securities Inc. The Kent Growth and Investment 44%
Trade House Account Income Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market St., Suite 1200
Philadelphia, PA 19103
SEI Trust Company The Kent Growth and Investment 10%
Reinvest Account Income Fund
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
</TABLE>
53
<PAGE> 54
<TABLE>
<S> <C> <C> <C>
BHC Securities Inc. The Kent Small Company Investment 24%
Trade House Account Growth Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market St., Suite 1200
Philadelphia, PA 19103
SEI Trust Company The Kent Small Company Investment 16%
Reinvest Account Growth Fund
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
SEI Trust Company The Kent International Investment 22%
Reinvest Account Growth Fund
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
BHC Securities Inc. The Kent International Investment 23%
Trade House Account Growth Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market St., Suite 1200
Philadelphia, PA 19103
BHC Securities Inc. The Kent Index Investment 55%
Trade House Account Equity Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market St., Suite 1200
Philadelphia, PA 19103
Rose M Black The Kent Limited Term Investment 7%
Rose M Black Trust Tax-Free Fund
Dtd. 06/14/1995
1208 Baker St.
Kalamazoo, MI 49001
BHC Securities Inc. The Kent Limited Term Investment 81%
Trade House Account Tax-Free Fund
Attn: Mutual Fund Dept.
One Commerce Square
2005 Market Street, Suite 1200
Philadelphia, PA 19103
BOST & Co. The Kent Limited Term Investment 9%
Acct. 47410332001 Tax-Free Fund
Attn: Mutual Fund Operations
P.O. Box 3198
Pittsburgh, PA 19230-3198
SEI Trust Company The Kent Tax-Free Investment 26%
Reinvest Account Income Fund
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
</TABLE>
54
<PAGE> 55
<TABLE>
<S> <C> <C> <C>
BHC Securities Inc. The Kent Tax-Free Investment 38%
Trade House Account Income Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market St., Suite 1200
Philadelphia, PA 19103
FOTRU Co. The Kent Tax-Free Investment 6%
FBO Evelyn G. Varner Trust Income Fund
P.O. Box 1828
Grand Rapids, MI 49501-1828
Trent & Co. The Kent Money Market Institutional 94%
Cash Account Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Old Kent Bank The Kent Government Institutional 76%
Attn: Funds Management Money Market Fund
111 Lyon St., N.W.
Grand Rapids, MI 49503
Trent & Co. The Kent Government Institutional 24%
Cash Account Money Market Fund
Attn: Kent Fund Trader
4420 44th St., Suite A
Kentwood, MI 49512
Trent & Co. The Kent Michigan Institutional 98%
Attn: Kent Fund Trader Municipal Money Market
4420 44th St., Suite A Fund
Kentwood, MI 49512
BHC Securities Inc. The Kent Money Investment 42%
Trade House Account Market Fund
Attn: Mutual Fund Department
One Commerce Square
2005 Market Street, Suite 1200
Philidelphia, PA 19103
Fifth Third Bank, Custodian The Kent Money Investment 7%
V. Donna Berg Market Fund
Rollover IRA
403 Midlakes Boulevard
Plainwell, MI 49080
SEI Trust Company The Kent Money Investment 9%
Reinvest Account Market Fund
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
</TABLE>
55
<PAGE> 56
<TABLE>
<S> <C> <C> <C>
BHC Securities Inc. The Kent Money Investment 30%
One Commerce Square Market Fund
Attn: Cash Sweeps Department
2005 Market Street
Philadelphia, PA 19103
Daniel P. Kreuz The Kent Government Investment 44%
6685 Double Eagle Dr., Apt 212 Money Market Fund
Woodridge, IL 60517-5417
Fifth Third Bank, Custodian The Kent Government Investment 24%
Mary E. Jones Money Market Fund
IRA
125 Walnut
Schoolcroft, MI 49087
Allan C. Caldmeyer The Kent Government Investment 6%
Cust Matthew S. Caldmeyer Money Market Fund
UGMA MI
977 Gladstone SE
Grand Rapids, MI 49506
Brian T. Lee The Kent Government Investment 7%
TRST Brian T. Lee Trust Money Market Fund
U/A/D 12/8/86
1542 Whispering Oaks
Brighton, MI 48116
Frederick C. Lake The Kent Government Investment 6%
And Amy Z. Lake Money Market Fund
JT WROS
2210 Edgewood SE
Grand Rapids, MI 49546
Andrew Creasor The Kent Michigan Investment 7%
3403 Greenwood Lane Municipal Money
St. Charles, IL 60174 Market Fund
BHC Securities Inc. The Kent Michigan Investment 47%
One Commerce Square Municipal Money
Attn: Cash Sweeps Department Market Fund
2005 Market Street
Philadelphia, PA 19103
SEI Trust Company The Kent Michigan Investment 12%
Reinvestment Account Municipal Money
Kent Moneywise Market Fund
One Freedom Valley Drive
Oaks, PA 19456
</TABLE>
Set forth below are the record owners or, to the Trust's knowledge, the
beneficial owners of 5% or more of the outstanding Investment Shares of the
indicated Fund as of December 31, 1998.
<TABLE>
<S> <C> <C> <C>
BHC Securities Inc. The Kent Income Fund Investment 43%
Trade House Account
Attn: Mutual Fund Department
One Commerce Square
2005 Market Street, Suite 1200
Philadelphia, PA 19103
SEI Trust Company The Kent Income Fund Investment 33%
Reinvest Account
Kent Moneywise
One Freedom Valley Drive
Oaks, PA 19456
</TABLE>
Except as otherwise stated in the Trust's prospectuses, 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.
56
<PAGE> 57
APPENDIX A
DESCRIPTION OF SECURITIES
COMMERCIAL PAPER RATINGS
A S&P commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. The following summarizes the rating categories used by S&P for
commercial paper:
"A-1" - Obligations are rated in the highest category
indicating that the obligor's capacity to meet its financial commitment is
strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
"A-2" - Obligations are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations rated "A-1". However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory.
"A-3" - Obligations exhibit adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
"B" - Obligations are regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
"C" - Obligations are currently vulnerable to nonpayment and
are dependent on favorable business, financial, and economic conditions for the
obligor to meet its financial obligation.
"D" - Obligations are in payment default. The "D" rating
category is used when payments on an obligation are not made on the date due,
even if the applicable grace period has not expired, unless S&P believes such
payments will be made during such grace period. The "D" rating will also be used
upon the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
Moody's commercial paper ratings are opinions of the ability
of issuers to repay punctually senior debt obligations not having an original
maturity in excess of one year, unless explicitly noted. The following
summarizes the rating categories used by Moody's for commercial paper:
"Prime-1" - Issuers (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations. Prime-1
repayment ability will often be evidenced by many of the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in earnings
coverage of fixed financial charges and high internal cash generation; and
well-established access to a range of financial markets and assured sources of
alternate liquidity.
"Prime-2" - Issuers (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
A-1
<PAGE> 58
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
"Prime-3" - Issuers (or supporting institutions) have an
acceptable ability for repayment of senior short-term debt obligations. The
effect of industry characteristics and market compositions may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and may require relatively high
financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime
rating categories.
The three rating categories of Duff & Phelps for investment
grade commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff &
Phelps employs three designations, "D-1+," "D-1" and "D-1-," within the highest
rating category. The following summarizes the rating categories used by Duff &
Phelps for commercial paper:
"D-1+" - Debt possesses the highest certainty of timely
payment. Short-term liquidity, including internal operating factors and/or
access to alternative sources of funds, is outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment.
Liquidity factors are strong and supported by good fundamental protection
factors. Risk factors are very small.
"D-2" - Debt possesses good certainty of timely payment.
Liquidity factors and company fundamentals are sound. Although ongoing funding
needs may enlarge total financing requirements, access to capital markets is
good. Risk factors are small.
"D-3" - Debt possesses satisfactory liquidity and other
protection factors qualify issues as investment grade. Risk factors are larger
and subject to more variation. Nevertheless, timely payment is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to insure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or
interest payments.
Fitch IBCA short-term ratings apply to debt obligations that
have time horizons of less than 12 months for most obligations, or up to three
years for U.S. public finance securities. The following summarizes the rating
categories used by Fitch IBCA for short-term obligations:
"F1" - Securities possess the highest credit quality. This
designation indicates the strongest capacity for timely payment of financial
commitments and may have an added "+" to denote any exceptionally strong credit
feature.
"F2" - Securities possess good credit quality. This
designation indicates a satisfactory capacity for timely payment of financial
commitments, but the margin of safety is not as great as in the case of
securities rated "F1."
A-2
<PAGE> 59
"F3" - Securities possess fair credit quality. This
designation indicates that the capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
"B" - Securities possess speculative credit quality. this
designation indicates minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
"C" - Securities possess high default risk. This designation
indicates that the capacity for meeting financial commitments is solely reliant
upon a sustained, favorable business and economic environment.
"D" - Securities are in actual or imminent payment default.
Thomson BankWatch short-term ratings assess the likelihood of
an untimely payment of principal and interest of debt instruments with original
maturities of one year or less. The following summarizes the ratings used by
Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's
highest category and indicates a very high likelihood that principal and
interest will be paid on a timely basis.
"TBW-2" - This designation represents Thomson BankWatch's
second-highest category and indicates that while the degree of safety regarding
timely repayment of principal and interest is strong, the relative degree of
safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents Thomson BankWatch's
lowest investment-grade category and indicates that while the obligation is more
susceptible to adverse developments (both internal and external) than those with
higher ratings, the capacity to service principal and interest in a timely
fashion is considered adequate.
"TBW-4" - This designation represents Thomson BankWatch's
lowest rating category and indicates that the obligation is regarded as
non-investment grade and therefore speculative.
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by S&P for corporate
and municipal debt:
"AAA" - An obligation rated "AAA" has the highest rating
assigned by S&P. The obligor's capacity to meet its financial commitment on the
obligation is extremely strong.
"AA" - An obligation rated "AA" differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
"A" - An obligation rated "A" is somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions than
obligations in higher rated categories. However, the obligor's capacity to meet
its financial commitment on the obligation is still strong.
"BBB" - An obligation rated "BBB" exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
A-3
<PAGE> 60
"BB," "B," "CCC," "CC" and "C" - Debt is regarded as having
significant speculative characteristics. "BB" indicates the least degree of
speculation and "C" the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
"BB" - Debt is less vulnerable to non-payment than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
"B" - Debt is more vulnerable to non-payment than obligations
rated "BB", but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial or economic conditions
will likely impair the obligor's capacity or willingness to meet its financial
commitment on the obligation.
"CCC" - Debt is currently vulnerable to non-payment, and is
dependent upon favorable business, financial and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial or economic conditions, the obligor is not likely to
have the capacity to meet its financial commitment on the obligation.
"CC" - An obligation rated "CC" is currently highly vulnerable
to non-payment.
"C" - The "C" rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action has been taken, but
payments on this obligation are being continued.
"D" - An obligation rated "D" is in payment default. This
rating is used when payments on an obligation are not made on the date due, even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. "D" rating is also used upon the
filing of a bankruptcy petition or the taking of similar action if payments on
an obligation are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC"
may be modified by the addition of a plus or minus sign to show relative
standing within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid,
and certain other obligations that S&P believes may experience high volatility
or high variability in expected returns due to non-credit risks. Examples of
such obligations are: securities whose principal or interest return is indexed
to equities, commodities, or currencies; certain swaps and options; and
interest-only and principal-only mortgage securities. The absence of an "r"
symbol should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all
standards. Together with the "Aaa" group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective
A-4
<PAGE> 61
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in "Aaa" securities.
"A" - Bonds possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds are considered as medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of
these ratings provide questionable protection of interest and principal ("Ba"
indicates speculative elements; "B" indicates a general lack of characteristics
of desirable investment; "Caa" are of poor standing; "Ca" represents obligations
which are speculative in a high degree; and "C" represents the lowest rated
class of bonds). "Caa," "Ca" and "C" bonds may be in default.
Con. (---) - Bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which
Moody's believes possess the strongest investment attributes are designated by
the symbols, Aa1, A1, Baa1, Ba1 and B1.
The following summarizes the long-term debt ratings used by
Duff & Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit
quality. The risk factors are negligible, being only slightly more than for
risk-free U.S. Treasury debt.
"AA" - Debt is considered of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below-average protection factors but
such protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of
these ratings is considered to be below investment grade. Although below
investment grade, debt rated "BB" is deemed likely to meet obligations when due.
Debt rated "B" possesses the risk that obligations will not be met when due.
Debt rated "CCC" is well below investment grade and has considerable uncertainty
as to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
A-5
<PAGE> 62
To provide more detailed indications of credit quality, the
"AA," "A," "BBB," "BB" and "B" ratings may be modified by the addition of a plus
(+) or minus (-) sign to show relative standing within these major categories.
The following summarizes the ratings used by Fitch IBCA for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the
highest credit quality. These ratings denote the lowest expectation of
investment risk and are assigned only in case of exceptionally strong capacity
for timely payment of financial commitments. This capacity is very unlikely to
be adversely affected by foreseeable events.
"AA" - Bonds considered to be investment grade and of very
high credit quality. These ratings denote a very low expectation of investment
risk and indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
"A" - Bonds considered to be investment grade and of high
credit quality. These ratings denote a low expectation of investment risk and
indicate strong capacity for timely payment of financial commitments. This
capacity may, nevertheless, be more vulnerable to adverse changes in
circumstances or in economic conditions than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of good
credit quality. These ratings denote that there is currently a low expectation
of investment risk. The capacity for timely payment of financial commitments is
adequate, but adverse changes in circumstances and in economic conditions are
more likely to impair this category.
"BB" - Bonds considered to be speculative. These ratings
indicate that there is a possibility of credit risk developing, particularly as
the result of adverse economic changes over time; however, business or financial
alternatives may be available to allow financial commitments to be met.
Securities rated in this category are not investment grade.
"B" - Bonds are considered highly speculative. These ratings
indicate that significant credit risk is present, but a limited margin of safety
remains. Financial commitments are currently being met; however, capacity for
continued payment is contingent upon a sustained, favorable business and
economic environment.
"CCC", "CC", "C" - Bonds have high default risk. Capacity for
meeting financial commitments is reliant upon sustained, favorable business or
economic developments. "CC" ratings indicate that default of some kind appears
probable, and "C" ratings signal imminent default.
"DDD," "DD" and "D" - Bonds are in default. Securities are not
meeting obligations and are extremely speculative. "DDD" designates the highest
potential for recovery on these securities, and "D" represents the lowest
potential for recovery.
To provide more detailed indications of credit quality, the
Fitch IBCA ratings from and including "AA" to "B" may be modified by the
addition of a plus (+) or minus (-) sign to show relative standing within these
major rating categories.
Thomson BankWatch assesses the likelihood of an untimely
repayment of principal or interest over the term to maturity of long term debt
and preferred stock which are issued by United States
A-6
<PAGE> 63
commercial banks, thrifts and non-bank banks; non-United States banks; and
broker-dealers. The following summarizes the rating categories used by Thomson
BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category
assigned by Thomson BankWatch to long-term debt and indicates that the ability
to repay principal and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to
repay principal and interest on a timely basis with limited incremental risk
compared to issues rated in the highest category.
"A" - This designation indicates that the ability to repay
principal and interest is strong. Issues rated "A" could be more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment-grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned
by Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of principal and interest. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC"
may include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
MUNICIPAL NOTE RATINGS
A S&P rating reflects the liquidity concerns and market access
risks unique to notes due in three years or less. The following summarizes the
ratings used by S&P Ratings Group for municipal notes:
"SP-1" - The issuers of these municipal notes exhibit a strong
capacity to pay principal and interest. Those issues determined to possess very
strong characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit
satisfactory capacity to pay principal and interest, with some vulnerability to
adverse financial and economic changes over the term of the notes.
"SP-3" - The issuers of these municipal notes exhibit
speculative capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other
short-term loans are designated Moody's Investment Grade ("MIG") and variable
rate demand obligations are designated Variable Moody's Investment Grade
("VMIG"). Such ratings recognize the differences between short-term credit risk
and long-term risk. The following summarizes the ratings by Moody's Investors
Service, Inc. for short-term notes:
A-7
<PAGE> 64
"MIG-1"/"VMIG-1" - This designation denotes best quality,
enjoying strong protection by established cash flows, superior liquidity support
or demonstrated broad-based access to the market for refinancing.
"MIG-2"/"VMIG-2" - This designation denotes high quality, with
margins of protection ample although not so large as in the preceding group.
"MIG-3"/"VMIG-3" - This designation denotes favorable quality,
with all security elements accounted for but lacking the undeniable strength of
the preceding grades. Liquidity and cash flow protection may be narrow and
market access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - This designation denotes adequate quality,
carrying specific risk but having protection commonly regarded as required of an
investment security and not distinctly or predominantly speculative.
"SG" - This designation denotes speculative quality and lack
of margins of protection.
Fitch IBCA and Duff & Phelps use the short-term ratings
described under Commercial Paper Ratings for municipal notes.
A-8
<PAGE> 65
APPENDIX B
THE KENT MICHIGAN MUNICIPAL BOND FUND
THE KENT MICHIGAN MUNICIPAL MONEY MARKET FUND
SPECIAL INVESTMENT CONSIDERATIONS RELATING
TO INVESTING IN MICHIGAN MUNICIPAL OBLIGATIONS
The following information constitutes only a brief summary, does not
purport to be a complete description, and is based on information drawn from the
Governor's Executive Budget for fiscal year 1998-99 issued February 12, 1998,
and from other sources available as of the date of this Statement of Additional
Information. While the Trust has not independently verified such information, it
has no reason to believe that such information is not correct in all material
respects.
1997 ECONOMIC REVIEW AND 1998 ECONOMIC OUTLOOK
The State's economy is principally dependent on manufacturing
(particularly automobiles, office equipment and other durable goods), tourism
and agriculture and historically has been highly cyclical. However it has been
undergoing certain basic changes in its underlying structure and these changes
continued in 1997. These changes reflect a diversifying economy which is less
reliant on the automobile industry. As a result, the State anticipates that its
economy in the future will be somewhat less susceptible to cyclical swings and
somewhat more resilient when national downturns occur.
Total wage and salary employment is estimated to have grown by 1.5% in
1997. The rate of unemployment is estimated to have been 4.1% in 1997, below the
national average for the fourth consecutive year. Personal income grew at an
estimated 4.7% annual rate in 1997, up from 4.2% in 1996.
1997-98 STATE OF MICHIGAN BUDGET AND PRIOR RESULTS
During the past five years, improvements in the Michigan economy have
resulted in increased revenue collections which, together with restraints on the
expenditure side of the budget, have resulted in State General Fund budget
surpluses, most of which were transferred to the State's counter-cyclical Budget
and Economic Stabilization Fund. The balance of that Fund as of September 30,
1997 is estimated to have been in excess of $1.1 billion.
The State budget for the 1997-98 fiscal year, which began October 1,
1997, has been accepted by the Legislature. This budget projects State General
Fund/General Purpose revenues of approximately $8.6 billion, an increase of
approximately 4.2% from the prior year. Among the budget uncertainties facing
the State during the next several years are whether the recently-enacted school
finance reform package will provide adequate revenues to fund Kindergarten
through Twelfth Grade education in the future, whether the Asian financial
crisis will adversely affect Michigan's economy, particularly automobile
production, whether there will be adequate funds available to address the
State's need for more correctional facilities, and the uncertainties presented
by proposed changes in Federal aid policies for state and local governments.
STATE CONSTITUTIONAL PROVISIONS AFFECTING REVENUES AND EXPENDITURES
The State Constitution provides that proposed expenditures and revenues
of any State operating fund must be in balance and that any prior year's surplus
or deficit must be included in the succeeding year's budget for that fund.
B-1
<PAGE> 66
The State Constitution limits the amount of total State revenues that
can be raised from taxes and certain other sources. State revenues (excluding
federal aid and revenues for payment of principal and interest on general
obligation bonds) in any fiscal year are limited to a fixed percentage of State
personal income in the prior calendar year or average of the prior three
calendar years, whichever is greater, and this fixed percentage equals the
percentage of the 1978-79 fiscal year state government revenues to total
calendar 1977 State personal income (which was 9.49%).
If in any fiscal year revenues exceed the revenue limitation by 1% or
more, the entire amount of such excess must be rebated in the following fiscal
year's personal income tax or single business tax. Any excess of less than 1%
may be transferred to the State's Budget and Economic Stabilization Fund, a cash
reserve intended to mitigate the adverse effects on the State budget of
downturns in the business cycle. The State may raise taxes in excess of the
limit for emergencies when deemed necessary by the Governor and two-thirds of
the members of each house of the Legislature.
The State Constitution also provides that the proportion of State
spending paid to all units of local government to total State spending may not
be reduced below the proportion in effect in the 1978-79 fiscal year. The State
originally determined that portion to be 41.6%. If such spending does not meet
the required level in a given year, an additional appropriation for local
governmental units is required by the following fiscal year; which means the
year following the determinations of the shortfall, according to an opinion
issued by the State's Attorney General. Spending for local units met this
requirement for fiscal years 1986-87 through 1991-92. As the results of
litigation, the State agreed to reclassify certain expenditures, beginning with
fiscal year 1992-93, and has recalculated the required percentage of spending
paid to local government units to be 48.97%.
The State Constitution also requires the State to finance any new or
expanded activity of local governments mandated by State law. Any expenditures
required by this provision would be counted as State spending for local units of
government for the purpose of determining compliance with the provision cited
above.
STATE AND STATE-RELATED INDEBTEDNESS
The State Constitution limits State general obligation debt to (i)
short-term debt for State operating purposes, (ii) short-and long-term debt for
the purpose of making loans to school districts, and (iii) long-term debt for
voter-approved purposes.
Short-term debt for operating purposes is limited to an amount not in
excess of 15% of undedicated revenues received during the preceding fiscal year
and must be issued only to meet obligations incurred pursuant to appropriation
and repaid during the fiscal year in which incurred. Such debt does not require
voter approval.
The amount of debt incurred by the State for the purpose of making
loans to school districts is recommended by the Superintendent of Public
Instruction, who certifies the amounts necessary for loans to school districts
for the ensuing two calendar years. The bonds may be issued in whatever amount
required without voter approval. All other general obligation bonds issued by
the State must be approved as to amount, purpose and method of repayment by a
two-thirds vote of each house of the Legislature and by a majority vote of the
public at a general election. There is no limitation as to number or size of
such general obligation issues.
There are also various State authorities and special purpose agencies
created by the State which issue bonds secured by specific revenues. Such debt
is not a general obligation of the State.
B-2
<PAGE> 67
GENERAL OBLIGATION BONDS AND NOTES AND SCHOOL BOND LOAN FUND
The State has issued and outstanding general obligation full faith and
credit bonds for Water Resources, Environmental Protection Program, Recreation
Program and School Loan purposes. As of September 30, 1997, the State had
approximately $677 million of general obligations bonds outstanding.
The State may issue notes or bonds without voter approval for the
purposes of making loans to school districts. The proceeds of such notes or
bonds are deposited in the School Bond Loan Fund maintained by the State
Treasurer and used to make loans to school districts for payment of debt on
qualified general obligations bonds issued by local school districts.
As of February 12, 1998, the ratings on State of Michigan general
obligation bonds were "Aa" by Moody's, "AA+" by S&P and "AA" by Fitch Investors
Services. There is no assurance that such ratings will continue for any period
of time or that such ratings will not be revised or withdrawn. Because all or
most of the Michigan Municipal Obligations are revenue or general obligations of
local governments or authorities, rather than general obligations of the State
of Michigan itself, ratings on such Michigan Municipal Obligations may be
different from those given to the State of Michigan.
LITIGATION
The State is a party to various legal proceedings seeking damages or
injunctive or other relief. In addition to routine litigation, certain of these
proceedings could, if unfavorably resolved from the point of view of the State,
substantially affect State programs or finances. As of early 1997, these
lawsuits involved programs generally in the areas of corrections, tax
collection, commerce, and proceedings involving other budgetary reductions to
school districts and governmental units, and court funding. The ultimate
disposition of these proceedings was not determinable as of early 1998.
PROPERTY TAX AND SCHOOL FINANCE REFORM
The State Constitution limits the extent to which municipalities or
political subdivisions may levy taxes upon real and personal property through a
process that regulates assessments.
On March 15, 1994, Michigan voters approved a property tax and school
finance reform measure known as Proposal A. Under Proposal A, as approved,
effective May 1, 1994, the State sales and use tax increased from 4% to 6%, the
State income tax decreased from 4.6% to 4.4%, the cigarette tax increased from
$.25 to $.75 per pack and an additional tax of 16% of the wholesale price began
to be imposed on certain other tobacco products. A .75% real estate transfer tax
became effective January 1, 1995. Beginning in 1994, a state property tax of 6
mills began to be imposed on all real and personal property currently subject to
the general property tax. All local school boards are authorized, with voter
approval, to levy up to the lesser of 18 mills or the number of mills levied in
1993 for school operating purposes on nonhomestead property and nonqualified
agricultural property. Proposal A contains additional provisions regarding the
ability of local school districts to levy taxes, as well as a limit on
assessment increases for each parcel of property, beginning in 1995. Such
increases for each parcel of property are limited to the lesser of 5% or the
rate of inflation. When property is subsequently sold, its assessed value will
revert to the current assessment level of 50% of true cash value. Under Proposal
A, much of the additional revenue generated by the new taxes will be dedicated
to the State School Aid Fund.
Proposal A shifted significant portions of the cost of local school
operations from local school districts to the State and raised additional State
revenues to fund these additional State expenses. These additional revenues will
be included within the State's constitutional revenue limitations and may impact
the State's ability to raise additional revenues in the future.
B-3
<PAGE> 68
APPENDIX C
As stated in the Prospectus, certain of the Funds may enter into
futures contracts and options. Such transactions are described in this Appendix.
I. Interest Rate Futures Contracts
-------------------------------
USE OF INTEREST RATE FUTURES CONTRACTS. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures markets have tended to move generally in the
aggregate in concert with the cash market prices and have maintained fairly
predictable relationships. Accordingly, a Fund might use interest rate futures
as a defense, or hedge, against anticipated interest rate changes. This would
include the use of futures contract sales to protect against expected increases
in interest rates and futures contract purchases to offset the impact of
interest rate declines.
A Fund presently could accomplish a similar result to that which it
hopes to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by a Fund, through using futures contracts.
DESCRIPTION OF INTEREST RATE FUTURES CONTRACTS. An interest rate
futures contract sale would create an obligation by a Fund, as seller, to
deliver the specific type of financial instrument called for in the contract at
a specific future time for a specified price. A futures contract purchase would
create an obligation by a Fund, as purchaser, to take delivery of the specific
type of financial instrument at a specific future time at a specific price. The
specific securities delivered or taken, respectively, at settlement date, would
not be determined until at or near that date. The determination would be in
accordance with the rules of the exchange on which the futures contract sale or
purchase was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Fund entering
into a futures contract purchase for the same aggregate amount of the specific
type of financial instrument and the same delivery date. If the price of the
sale exceeds the price of the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund entering into
a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
Interest rate futures contracts are traded in an auction environment on
the floors of several exchanges -- principally, the Chicago Board of Trade and
the Chicago Mercantile Exchange. The Funds will deal only in standardized
contracts on recognized exchanges. Each exchange guarantees performance under
contract provisions through a clearing corporation, a nonprofit organization
managed by the exchange membership.
A public market now exists in futures contracts covering various
financial instruments including long-term U.S. Treasury Bonds and Notes;
Government National Mortgage Association (GNMA)
C-1
<PAGE> 69
modified pass-through mortgage-backed securities; three-month U.S. Treasury
Bills; and ninety-day commercial paper. A Fund may trade in any interest rate
futures contract for which there exists a public market, including, without
limitation, the foregoing instruments.
II. Index Futures Contracts
-----------------------
A stock or bond index assigns relative values to the stocks or bonds
included in the index, which fluctuates with changes in the market values of the
stocks or bonds included.
A Fund may sell index futures contracts in order to offset a decrease
in market value of its portfolio securities that might otherwise result from a
market decline. A Fund may do so either to hedge the value of its portfolio as a
whole, or to protect against declines, occurring prior to sales of securities,
in the value of the securities to be sold. Conversely, a Fund will purchase
index futures contracts in anticipation of purchases of securities. A long
futures position may be terminated without a corresponding purchase of
securities.
In addition, a Fund may utilize index futures contracts in anticipation
of changes in the composition of its portfolio holdings. For example, in the
event that a Fund expects to narrow the range of industry groups represented in
its holdings it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. A Fund may also
sell futures contracts in connection with this strategy, in order to protect
against the possibility that the value of the securities to be sold as part of
the restructuring of its portfolio will decline prior to the time of sale.
III. Futures Contracts on Foreign Currencies
---------------------------------------
A futures contract on foreign currency creates a binding obligation on
one party to deliver, and a corresponding obligation on another party to accept
delivery of, a stated quantity of a foreign currency, for an amount fixed in
U.S. dollars. Foreign currency futures may be used by a Fund to hedge against
exposure to fluctuations in exchange rates between the U.S. dollar and other
currencies arising from multinational transactions.
IV. Margin Payments
---------------
Unlike purchase or sales of portfolio securities, no price is paid or
received by a Fund upon the purchase or sale of a futures contract. Initially, a
Fund will be required to deposit with the broker or in a segregated account with
the Custodian an amount of cash or cash equivalents, known as initial margin,
based on the value of the contract. The nature of initial margin in futures
transactions is different from that of margin in security transactions in that
futures contract margin does not involve the borrowing of funds by the customer
to finance the transactions. Rather, the initial margin is in the nature of a
performance bond or good faith deposit on the contract which is returned to the
Fund upon termination of the futures contract assuming all contractual
obligations have been satisfied. Subsequent payments, called variation margin,
to and from the broker, will be made on a daily basis as the price of the
underlying instruments fluctuates making the long and short positions in the
futures contract more or less valuable, a process known as marking-to-market.
For example, when a particular Fund has purchased a futures contract and the
price of the contract has risen in response to a rise in the underlying
instruments, that position will have increased in value and the Fund will be
entitled to receive from the broker a variation margin payment equal to that
increase in value. Conversely, where a Fund has purchased a futures contract and
the price of the futures contract has declined in response to a decrease in the
underlying instruments, the position would be less valuable and the Fund would
be required to make a
C-2
<PAGE> 70
variation margin payment to the broker. At any time prior to expiration of the
futures contract, Lyon Street may elect to close the position by taking an
opposite position, subject to the availability of a secondary market, which will
operate to terminate the Fund's position in the futures contract. A final
determination of variation margin is then made, additional cash is required to
be paid by or released to the Fund, and the Fund realizes a loss or gain.
V. Risks of Transactions in Futures Contracts
------------------------------------------
There are several risks in connection with the use of futures by a
Fund. One risk arises because of the imperfect correlation between movements in
the price of the future and movements in the price of the instruments which are
the subject of the hedge. The price of the future may move more than or less
than the price of the instruments being hedged. If the price of the future moves
less than the price of the instruments which are the subject of the hedge, the
hedge will not be fully effective but, if the price of the instruments being
hedged has moved in an unfavorable direction, the Fund would be in a better
position than if it had not hedged at all. If the price of the instruments being
hedged has moved in a favorable direction, this advantage will be partially
offset by the loss on the future. If the price of the future moves more than the
price of the hedged instruments, the Fund involved will experience either a loss
or gain on the future which will not be completely offset by movements in the
price of the instruments which are the subject of the hedge. To compensate for
the imperfect correlation of movements in the price of instruments being hedged
and movements in the price of futures contracts, a Fund may buy or sell futures
contracts in a greater dollar amount than the dollar amount of instruments being
hedged if the volatility over a particular time period of the prices of such
instruments has been greater than the volatility over such time period of the
futures, or if otherwise deemed to be appropriate by Lyon Street. Conversely, a
Fund may buy or sell fewer futures contracts if the volatility over a particular
time period of the prices of the instruments being hedged is less than the
volatility over such time period of the futures contract being used, or if
otherwise deemed to be appropriate by Lyon Street. It is also possible that,
where a Fund has sold futures to hedge its portfolio against a decline in the
market, the market may advance and the value of instruments held in the Fund may
decline. If this occurred, the Fund would lose money on the future and also
experience a decline in value in its portfolio securities.
When futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in an orderly fashion, it is possible that the market may decline
instead; if the Fund then concludes not to invest its cash at that time because
of concern as to possible further market decline or for other reasons, the Fund
will realize a loss on the futures contract that is not offset by a reduction in
the price of the instruments that were to be purchased.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
instruments being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. Rather than
meeting additional margin deposit requirements, investors may close futures
contracts through off-setting transactions which could distort the normal
relationship between the cash and futures markets. Second, with respect to
financial futures contracts, the liquidity of the futures market depends on
participants entering into off-setting transactions rather than making or taking
delivery. To the extent participants decide to make or take delivery, liquidity
in the futures market could be reduced thus producing distortions. Third, from
the point of view of speculators, the deposit requirements in the futures market
are less onerous than margin requirements in the securities market. Therefore,
increased participation by speculators in the futures market may also cause
temporary price distortions. Due to the possibility of price distortion in the
futures market, and because of the imperfect correlation between the movements
in the cash market and movements in the price of futures, a correct forecast of
general market trends or interest rate movements by the adviser may still not
result in a successful hedging transaction over a short time frame.
C-3
<PAGE> 71
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Funds
intend to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to
close a futures investment position, and in the event of adverse price
movements, a Fund would continue to be required to make daily cash payments of
variation margin. However, in the event futures contracts have been used to
hedge portfolio securities, such securities will normally not be sold until the
futures contract can be terminated. In such circumstances, an increase in the
price of the securities, if any, may partially or completely offset losses on
the futures contract. However, as described above, there is no guarantee that
the price of the securities will in fact correlate with the price movements in
the futures contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in
a futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Fund is also subject to Lyon Street's
ability to predict correctly movements in the direction of the market. For
example, if a particular Fund has hedged against the possibility of a decline in
the market adversely affecting securities held by it and securities prices
increase instead, the Fund will lose part or all of the benefit to the increased
value of its securities which it has hedged because it will have offsetting
losses in its futures positions. In addition, in such situations, if the Fund
has insufficient cash, it may have to sell securities to meet daily variation
margin requirements. Such sales of securities may be, but will not necessarily
be, at increased prices which reflect the rising market. A Fund may also have to
sell securities at a time when it may be disadvantageous to do so.
VI. Options on Futures Contracts
----------------------------
A Fund may purchase and write options on the futures contracts
described above. A futures option gives the holder, in return for the premium
paid, the right to buy (call) from or sell (put) to the writer of the option a
futures contract at a specified price at any time during the period of the
option. Upon exercise, the writer of the option is obligated to pay the
difference between the cash value of the futures contract and the exercise
price. Like the buyer or seller of a futures contract, the holder, or writer, of
an option has the right to terminate its position prior to the scheduled
expiration of the option by selling, or purchasing an option of the same series,
at which time the person entering into the closing transaction will realize a
gain or loss.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
or sale of an option also entails the risk that changes in the value of the
underlying futures contract will not correspond to changes in the value of the
option purchased. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the securities
being hedged, an option may or may not be less risky than ownership of the
futures contract or such securities. In general, the market prices of options
can be expected to be more volatile than the market prices on the underlying
futures contract. Compared to the purchase or sale of futures contracts,
however, the purchase of call or put options on futures contracts may frequently
involve less potential risk to a Fund because the maximum amount at risk is the
premium paid for the options
C-4
<PAGE> 72
(plus transaction costs). The writing of an option on a futures contract
involves risks similar to those risks relating to the sale of futures contracts.
VII. Other Matters
-------------
Accounting for futures contracts and related options will be in
accordance with generally accepted accounting principles.
C-5
