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GLOBAL EQUITY FUNDS
IAI Developing Countries Fund
IAI International Fund
June 1, 1995
Includes Brochure and Prospectus
[LOGO OF IAI]
MUTUAL FUNDS
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[MAP]
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
Fund Information
Low Minimum Investment
You can open an account with IAI for only $5,000 ($2,000 for an IRA). The
minimum investment per Fund is $1,000. Subsequent investments can be made for
only $100 per Fund.
No-Load
With IAI, you pay no commissions to buy, sell, or exchange shares.
No-fee IRA
Unlike many others, IAI charges no annual fee for maintaining your IRA.
Family of Funds
Whatever your investment needs, IAI's diverse Mutual Fund family has the right
Fund for you. Call for a free Prospectus for the IAI Developing Countries Fund,
IAI International Fund, IAI Emerging Growth Fund, IAI Midcap Growth Fund, IAI
Regional Fund, IAI Growth Fund, IAI Value Fund, IAI Growth & Income Fund, IAI
Balanced Fund, IAI Bond Fund, IAI Minnesota Tax Free Fund, IAI Government Fund,
IAI Reserve Fund and IAI Money Market Fund. Read the Prospectus carefully before
investing or sending money.
Free Exchanges
Money can be exchanged between IAI Mutual Funds free of charge.
Automatic Investment Program
Regular monthly investments ($100 minimum) can be made automatically into the
Fund from your checking or savings account. IAI Shareholders in other Funds may
arrange to invest regularly through monthly exchanges into any of the IAI Mutual
Funds.
Liquidity
You can redeem part or all of your Fund shares at any time at the then current
share price (which may be more or less than your original cost). Special rules
apply to IRAs.
Retirement Programs
IAI offers a variety of retirement investment programs including Individual
Retirement Accounts (IRAs), Direct Rollovers for persons receiving distributions
from Qualified Retirement Plans, SEP (Simplified Employee Pension) Plans for
small business owners, and 401(k) and 403(b) retirement plans for companies and
non-profit organizations.
Toll-Free Telephone Transactions
IAI offers a convenient toll-free telephone service for investors to find out
more about IAI Mutual Funds and services and to carry out transactions such as
buying or selling shares or exchanging assets from one fund to another. The
toll-free number, 1-800-945-3863, is available from anywhere in the United
States, weekdays from 7:30 a.m. - 5:30 p.m. Central Time.
IAI Investor Library
The IAI Investor Library provides free practical and objective information on
investing and investment strategies to investors who call 1-800-945-3863 and
request the Adviser Special Reports.
Quarterly Newsletter
IAI's free quarterly newsletter keeps shareholders up to date on IAI Mutual
Funds' performance and economic conditions and provides helpful tips on
investing.
IAI Preferred
IAI shareholders with balances in excess of $100,000 receive unique privileges,
including an exclusive toll-free telephone number, an individually assigned
account representative, an "Investing for Retirement" brochure and an IAI
Preferred portfolio organizer to conveniently house all IAI correspondence.
Easy-to-Read Statements
IAI provides complete, easy to read quarterly account statements which include
summaries of all transactions and portfolio allocations for all of your IAI
Mutual Fund holdings on one report.
Dividend Options
IAI shareholders may receive dividends in cash, have them electronically
directed to their personal bank account or arrange to automatically reinvest
them in additional IAI Mutual Fund shares.
Information and Assistance
Our knowledgeable investment representatives are available to help you--with no
sales pressure.
Not part of the prospectus
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund
Fund Information
[Photo of Roy Gillson]
Roy Gillson
Fund Manager
Capital Appreciation
The IAI Developing Countries Fund is designed for aggressive investors seeking
long-term capital appreciation from opportunities offered by investing in
securities of developing market companies. Since the Fund invests in issues of
international stocks in lesser developed countries, investors often use it in
conjunction with other IAI Mutual Funds which invest primarily in more mature
companies in the United States.
International Developing Markets
The Fund invests primarily in a portfolio of foreign stocks issued by companies
in lesser developed economies, including those considered to be developing
countries by the World Bank or the International Finance Corporation.
Flexible Portfolio
At least 65% of the Fund's total assets are invested in securities of companies
domiciled or otherwise having substantial operations in developing countries.
The Fund has the flexibility to diversify or concentrate investments on both a
geographic basis or on the level of economic development of particular
countries. The Fund focuses on equity securities; however, it may also invest in
other types of investments including debt securities.
Professional Management
The IAI Developing Countries Fund is a member of the IAI Mutual Fund family.
Founded in 1947, IAI currently manages more than $14.5 billion in assets for
thousands of individual investors, as well as FORTUNE 500/(R)/ companies,
leading colleges and universities, and religious organizations.
The Fund is managed by IAI International Limited of London, which is part of
Investment Advisers, Inc., headquartered in Minneapolis, Minnesota. IAI is part
of Hill Samuel Asset Management, wholly owned by TSB Group, plc., the sixth
largest banking institution in the United Kingdom and is responsible for
creating and distributing all domestic and international financial products in
the Western Hemisphere.
It's Easy to Start
To open an account, simply complete the enclosed application and return it in
the enclosed postage-paid envelope with a check payable to "IAI Mutual Funds."
If you are a current shareholder in any IAI Mutual Fund, the minimum investment
is $1,000. If not, the minimum investment is $5,000 (this can be allocated among
IAI Funds, with $1,000 minimum per Fund).
CALL 1-800-945-3863
Not part of the prospectus
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund
Investing in International Stocks May Increase
Returns and Reduce Volatility
New Investment Opportunities in Emerging Markets
There will be increasingly major shifts in the allocation of capital around the
world over the next 10-15 years. These shifts will occur in favor of developing
countries. Developed nations will become increasingly burdened with aging
populations, making them less attractive for new investments. On the other hand,
developing countries provide a ready pool of young and educated workers suited
to meet the technological challenges of the changing world economies.
Among developing countries, the infrastructure expenditures will enhance their
growth rates in much the same way that occurred in the United States in the late
19th and early 20th centuries. And, as the emerging markets develop, savings and
investments from 1.2 billion Chinese, 900 million Indians and one billion Latin
Americans will inevitably exceed those of the lesser populated developed
nations.
The fastest growing economies in the world are Developing Countries
Developing countries in three key areas--the Asian Pacific Basin, Eastern
Europe, and Latin America--are growing much faster than the more mature
economies of the United States, Western Europe and Japan. Faster growing
economies present high-potential investment opportunities.
The IAI Developing Countries Fund is designed for aggressive investors
interested in the investment opportunities offered by developing countries. In
addition to the normal risks associated with equity securities, these securities
may contain currency, political and economic risks, exchange and liquidity
risks, and risks in accounting methods and procedures.
Adding international and developing countries stocks to a portfolio of U.S.
stocks may help reduce overall price volatility
Stock price movements among developing countries are not correlated closely with
equities in the developed countries. Therefore, declining prices in one part of
a diversified portfolio containing securities from both markets may be offset by
rising prices in the other part, resulting in increased stability for the entire
portfolio.
Developing countries may improve investment growth potential
Historically, developing countries have outperformed the U.S. markets and other
developed markets on average, and a diversified portfolio containing both U.S.
and foreign issues has consistently outperformed an all-U.S. stock portfolio.*
While investing in foreign securities typically involves additional risks,
overall portfolio risk can be reduced through proper diversification and by
IAI's conservative "value" approach to investing.
Expected Economic Growth
Predicted 1995 Real GDP Growth (%)**
[GRAPH APPEARS HERE]
China 7
India 7
Malaysia 7
Pakistan 6
Philippines 7
South Korea 7
Taiwan 7
Thailand 8
Chile 6
Costa Rica 6
Peru 6
USA 3
*Based on ten-year annualized return, S&P 500 increased 14.28%, MSCI EAFE
increased 17.89%, IFC Companie increased 18.64%.
**Source: IAI International, Ltd. A country's expected economic growth does not
predict growth in the country's stock market, underlying companies or growth in
the Fund.
"We're investing for growth in the stocks of developing markets companies."
This investor information may not be distributed unless preceded or accompanied
by a prospectus. Read the prospectus carefully before you invest or send money.
Distributed by IAI Securities, Inc. Member SIPC.
Not part of the prospectus
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IAI MUTUAL FUNDS
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IAI International Fund
Fund Information
PHOTO OF ROY GILLSON
Roy Gillson
Fund Manager
Capital Appreciation
The IAI International Fund is designed for investors seeking capital
appreciation. Income is a secondary objective. Since the Fund invests in
international stocks, investors may use it in conjunction with other IAI Mutual
Funds which invest primarily in U.S. stocks.
International Stocks
The Fund invests primarily in a portfolio of international stocks, particularly
in countries represented in the EAFE Index (Morgan Stanley Capital International
Europe, Australia, Far East Index).
High Quality Portfolio
The Fund aims to invest in a portfolio of around fifty companies representing
the best opportunities for return at acceptable risk. Companies would typically
have the following attributes:
. Healthy financial condition
. Strong management
. Strong competitive position
. Positive country/industry background
Professional Management
The IAI International Fund is a member of the IAI Mutual Fund family. Founded in
1947, IAI currently manages more than $14.5 billion in assets for thousands of
individual investors, as well as FORTUNE 500/(R)/ companies, leading colleges,
universities, and religious organizations.
The Fund is managed by IAI International Limited of London, which is part of
Investment Advisers, Inc., headquartered in Minneapolis, Minnesota. IAI is part
of Hill Samuel Asset Management, wholly owned by TSB Group, plc., the sixth
largest banking institution in the United Kingdom, and is responsible for
creating and distributing all domestic and international financial products in
the Western Hemisphere.
No-Load
All IAI Mutual Funds are no-load. You pay no sales charge to buy shares and none
to redeem shares. Exchanges between IAI Mutual Funds are free. And, with an IRA
from IAI, you pay no annual maintenance fee.
It's Easy to Start
To open an account, simply complete the enclosed application and return it in
the enclosed postage-paid envelope with a check payable to "IAI Mutual Funds."
If you are a current shareholder in any IAI Mutual Fund, the minimum investment
is $1,000. If not, the minimum investment is $5,000 (this can be allocated among
IAI Funds, with $1,000 minimum per Fund).
CALL 1-800-945-3863
Not Part of the prospectus
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IAI MUTUAL FUNDS
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IAI International Fund
Most of the world's stock market is outside the United States.
An investor who does not hold international stocks gives up the majority of the
world's investment opportunities. As of year-end 1994, 63.8% of the world's
stock market value was outside the United States.
Stock Market Value 1994
CIRCLED STOCKS GRAPH APPEARS HERE WITH THE FOLLOWING INFORMATION:
International Stocks 63.8%
U.S. Stocks 36.2%
Source: Frank Russell and Company
International stock markets often outperform the U.S. market.
In fact, from 1970 through 1994, international stocks returned significantly
more than U.S. stocks. See the chart, "Average Annual Returns 1970-1994."
During this time period, international stocks returned an average of 13.2% per
year, while U.S. stocks returned only 10.9% per year.
Average Annual Returns 1970--1994
BAR GRAPH APPEARS HERE WITH THE FOLLOWING INFORMATION:
U.S. Stocks 10.9%
International Stocks 13.2%
Source: U.S. stocks (S&P 500 Index), Standard & Poor's Corporation:
International stocks (EAFE Index), Morgan Stanley Capital International.
Adding international stocks to your U.S. stock portfolio can help reduce
volatility.
Stock price movements among foreign countries are not correlated closely with
equities in the United States. Therefore, declining prices in one part of a
diversified portfolio containing securities from both markets may be offset by
rising prices in the other part, resulting in increased stability for the entire
portfolio.
"We're investing for growth in the stocks of international companies."
This investor information may not be distributed unless preceded or accompanied
by a prospectus. Read the prospectus carefully before you invest or send money.
Distributed by IAI Securities, Inc. Member SIPC.
Not part of the prospectus
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
<TABLE>
<S> <C>
Fund Expense Information.......................... 2
Fund Directors.................................... 2
Financial Highlights.............................. 3
Investment Performance............................ 4
Investment Objectives and Policies................ 4
IAI Developing Countries Fund................... 4
IAI International Fund.......................... 5
Portfolio Securities and
Other Fund Investment Techniques.................. 9
Fund Risk Factors................................. 13
Management........................................ 17
Plan of Distribution.............................. 19
Computation of Net Asset
Value and Pricing................................. 20
Purchase of Shares................................ 20
Retirement Plans.................................. 21
Automatic Investment Plan......................... 21
Redemption of Shares.............................. 22
Exchange Privilege................................ 23
Automatic Exchange Plan........................... 23
Authorized Telephone Trading...................... 24
Systematic Cash Withdrawal Plan................... 24
Dividends, Distributions and
Tax Status........................................ 25
Description of Common Stock....................... 26
Counsel and Auditors.............................. 27
Custodian, Transfer Agent and
Dividend Disbursing Agent......................... 27
Additional Information............................ 27
</TABLE>
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
Prospectus Dated June 1, 1995
IAI Developing Countries Fund ("Developing Countries Fund") is a separate
portfolio of IAI Investment Funds III, Inc., a registered investment company
authorized to issue its shares of common stock in more than one series.
Developing Countries Fund seeks to achieve its objective of long-term capital
appreciation by investing primarily in equity securities of companies domiciled
or otherwise having substantial operations in developing countries. There can be
no assurance that Developing Countries Fund's investment objective will be
achieved.
Investing in Developing Countries Fund involves significant risks and
considerations not normally associated with a fund which invests primarily in
securities of U.S. issuers and may be considered speculative. Shares of
Developing Countries Fund are not designed to be a complete investment program.
See "Fund Risk Factors" on page 13.
IAI International Fund ("International Fund") is also a separate portfolio of
IAI Investment Funds III, Inc. International Fund's primary objective is capital
appreciation, with current income (principally from dividends) being the
secondary objective. International Fund will endeavor to achieve its objectives
by investing, under normal circumstances, at least 95% of its portfolio in
equity and equity-related securities of non-United States issuers.
Investing in International Fund involves considerations not normally associated
with a fund which invests primarily in securities of U.S. issuers. Shares of
International Fund are not designed to be a complete investment program. See
"Fund Risk Factors" on page 13.
This Prospectus sets forth concisely the information which a prospective
investor should know about each Fund before investing and it should be retained
for future reference. A "Statement of Additional Information" dated June 1,
1995, which provides a further discussion of certain areas in this Prospectus
and other matters which may be of interest to some investors, has been filed
with the Securities and Exchange Commission and is incorporated herein by
reference. For a free copy, call or write the Funds at the address or telephone
number shown on the inside back cover of this Prospectus.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
1
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
Fund Expense Information
Shareholder Transaction Expenses
<TABLE>
<CAPTION>
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IAI Developing Countries Fund IAI International Fund
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<S> <C> <C>
Sales Load Imposed on Purchases None None
Sales Load Imposed on Reinvested Dividends None None
Redemption Fees None None
Exchange Fees None None
</TABLE>
Annual Fund Operating Expenses (net of reimbursements)
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<CAPTION>
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IAI Developing Countries Fund* IAI International Fund**
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<S> <C> <C>
Management Fee .53% .95%
Rule 12b-1 Fee - .25%
Other Expenses 1.47% .52%
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Total Fund Operating Expenses 2.00% 1.72%
==================================================================
</TABLE>
Fund Directors
Madeline Betsch
W. William Hodgson
George R. Long
Noel P. Rahn
Richard E. Struthers
J. Peter Thompson
Charles H. Withers
* as a percentage of average daily net assets
** as a percentage of average month-end assets
Example: Based upon the levels of Total Fund Operating Expenses listed above,
you would pay the following expenses on a $1,000 investment, assuming a five
percent annual return and redemption at the end of each period:
1 Year 3 Years 5 Years 10 Years
----- ------- ------- --------
IAI Developing Countries Fund $20 $63
IAI International Fund $17 $54 $93 $203
The purpose of the above table is to assist you in understanding the various
costs and expenses that an investor in the Funds will bear directly or
indirectly. The example should not be considered a representation of past or
future expenses. Actual expenses may be greater or less than those shown. With
respect to International Fund, the information in the table is based upon actual
expenses incurred by the Fund during its fiscal period ended January 31, 1995.
Developing Countries Fund commenced operations on February 10, 1995.
Accordingly, the information in the table reflects expected fees and expenses
for the Fund's fiscal period ending January 31, 1996. Because each Fund's Rule
12b-1 Distribution Fee is based on a percentage of its net assets, long-term
shareholders may pay more than the economic equivalent of the maximum front-end
sales charges permitted by Section 26 of the National Association of Securities
Dealers' Rules of Fair Practice.
For the fiscal period ending January 31, 1996, Investment Advisers, Inc., the
Fund's investment adviser and manager, has voluntarily agreed to reimburse the
expenses of Developing Countries Fund which exceed 2.00% of the Fund's average
daily net assets on an annual basis. Absent such reimbursement, the Management
Fee set forth above would be 1.25%, the Rule 12b-1 Distribution Fee would be
.25% and Total Fund Operating Expenses would be approximately 2.97% of
Developing Countries Fund's average daily net assets.
With respect to International Fund, the Total Fund Operating Expenses are
subject to a contractual expense limitation of 2.00% of the Fund's average
month-end net assets as further described in the section "Management." For
additional information regarding such fees and expenses, see the section
"Management."
Further information concerning fees paid by the Funds is set forth in the
Statement of Additional Information.
2
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IAI MUTUAL FUNDS
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IAI International Fund
Financial Highlights
The following information has been audited by KMPG Peat Marwick LLP, independent
auditors, whose report is included in the International Fund's Annual Report.
The Annual Report is incorporated by reference in (and is a part of) the
Statement of Additional Information. Such Annual Report may be obtained by
shareholders on request from the Fund at no charge.
<TABLE>
<CAPTION>
Years Ended March 31,
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1995**** 1994 1993 1992 1991 1990 1989 1988*
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<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value:
Beginning of period $ 13.45 $ 11.22 $ 11.02 $ 10.75 $ 10.70 $ 10.99 $ 9.82 $ 10.02
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Operations:
Net investment income (loss) .11 .06 .06 .15 .30 .11 .12 (.01)
Net realized and unrealized
gains (losses) (.62) 2.56 .60 .67 (.11) .52 1.15 (.19)
Total from operations (.51) 2.62 .66 .82 .19 .63 1.27 (.20)
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Distributions to shareholders from:
Net investment income - (.34) (.04) (.22) - (.13) (.10) -
Net realized gains (.88) (.05) (.42) (.33) (.14) (.79) - -
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Total distributions (.88) (.39) (.46) (.55) (.14) (.92) (.10) -
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Net Asset Value:
End of period....................... $ 12.06 $ 13.45 $ 11.22 $ 11.02 $ 10.75 $ 10.70 $ 10.99 $ 9.82
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Total investment return** (4.14%) 23.85% 6.18% 8.10% 1.87% 5.59% 12.99% (1.80%)
Net assets at end of period
(000's omitted) $136,474 $134,796 $59,248 $36,239 $34,421 $29,872 $16,374 $11,883
Ratios:
Expenses to average net assets 1.72%*** 1.74% 1.91% 2.00% 1.73% 1.88% 2.10% 2.10%***
Net investment income
to average net assets 1.04%*** 0.87% 1.42% 1.39% 2.79% 1.01% 1.20% (.20%)***
Portfolio turnover rate
(excluding short-term securities) 27.6% 50.9% 28.6% 35.1% 41.3% 32.9% 71.0% 53.0%
</TABLE>
* Period from April 23, 1987 (commencement of operations) to March 31, 1988.
** Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of distributions at net
asset value.
*** Annualized.
**** Period from April 1, 1994 to January 31, 1995. Reflects fiscal year-end
change from March 31 to January 31.
3
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
Investment Performance
From time to time the Funds may advertise performance data including monthly,
quarterly, yearly or cumulative total return and average annual total return
figures. All such figures are based on historical earnings and performance and
are not intended to be indicative of future performance. The investment return
on and principal value of an investment in the Funds will fluctuate, so that an
investor's shares, when redeemed, may be worth more or less than their original
cost.
Total return is the change in value of an investment in a Fund over a given
period, assuming reinvestment of any dividends and capital gains. A cumulative
total return reflects actual performance over a stated period of time. An
average annual total return is a hypothetical rate of return that, if achieved
annually, would have produced the same cumulative total return if performance
had been constant over the entire period.
For additional information regarding the calculation of such total return
figures, see "Investment Performance" in the Statement of Additional
Information. Further information about the performance of the International Fund
is contained in the Fund's Annual Report to shareholders which may be obtained
without charge from the Fund.
Comparative performance information may be used from time to time in advertising
or marketing a Fund's shares, including data on the performance of other mutual
funds, indexes or averages of other mutual funds, indexes of related financial
assets or data, and other competing investment and deposit products available
from or through other financial institutions. The composition of these indexes,
averages or products differs from that of the Funds. The comparison of a Fund to
an alternative investment should be made with consideration of differences in
features and expected performance. A Fund may also note its mention in
newspapers, magazines, or other media from time to time. The Funds assume no
responsibility for the accuracy of such data. For additional information on the
types of indexes, averages and periodicals that might be utilized by the Funds
in advertising and sales literature, see the section "Investment Performance" in
the Statement of Additional Information.
Investment Objectives and Policies
Developing Countries Fund
The investment objective of Developing Countries Fund is to provide long-term
capital appreciation. The Fund seeks to achieve its objective by investing
primarily in equity securities of companies domiciled or otherwise having
substantial operations in developing countries. Such objective may not be
changed without shareholder approval. There can be no assurance that the Fund
will achieve its investment objective.
Under normal conditions, at least 65% of Developing Countries Fund's total
assets will be invested in securities of companies domiciled or otherwise having
substantial operations in developing countries. Developing countries include
those generally considered to
4
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
be developing or emerging by the World Bank or the International Finance
Corporation, as well as countries that are classified by the United Nations or
otherwise regarded by their authorities as developing. Countries presently not
considered developing are: Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand,
Norway, Spain, Sweden, Switzerland, the United Kingdom and the United States.
Developing Countries Fund may also invest in securities of companies that derive
50% or more of their total revenue from either goods or services produced in
developing countries or sales made in such developing countries and companies
that maintain 50% or more of their assets in developing countries.
Determinations as to eligibility will be based on publicly available information
and inquiries made to the companies.
Developing Countries Fund will not necessarily seek to diversify investments on
a geographic basis or on the basis of the level of economic development of any
particular country. The Fund focuses on equity securities, however, it may also
invest in other types of instruments including debt securities. The Fund has
established no minimum rating criteria for the debt securities in which it may
invest, and such securities may not be rated at all for creditworthiness.
Securities rated in the medium to lower rating categories of nationally
recognized statistical rating organizations and unrated securities of comparable
quality are predominantly speculative with respect to the capacity to pay
interest and repay principal in accordance with the terms of the security and
generally involve a greater volatility of price than securities in higher rating
categories. Such securities are commonly referred to as junk bonds. Developing
Countries Fund does not currently intend to invest more than 5% of its net
assets in junk bonds. See "Investment Objective and Policies" in the Statement
of Additional Information for additional information regarding ratings of debt
securities. In purchasing such securities, the Fund will rely on IAI's judgment,
analysis and experience in evaluating the creditworthiness of an issuer of such
securities. IAI will take into consideration, among other things, the issuer's
financial resources, its sensitivity to economic conditions and trends, its
operating history, the quality of the issuer's management and regulatory
matters. The Fund does not intend to purchase debt securities that are in
default or which IAI believes will be in default.
International Fund
The primary investment objective of International Fund is capital appreciation
with current income (principally from dividends) being a secondary objective.
The Fund pursues its objectives by investing, under normal circumstances, at
least 95% of its portfolio in equity and equity-related securities (as more
fully described below) of non-United States issuers. Such objectives may not be
changed without shareholder approval. There can be no assurance that
International Fund will achieve its investment objectives.
International Fund invests primarily in equity securities which have the
potential for above-average capital appreciation. Equity securities in which
International Fund will invest
5
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
include, but are not limited to, common stocks, securities convertible into
common stock, preferred stock, partnership interests and other equity
participations.
When the anticipated total return from debt securities significantly exceeds the
anticipated total return from foreign equity securities, or for temporary
defensive purposes, up to 50% of International Fund's portfolio may be comprised
of cash, cash equivalents, bonds and other debt securities of both United States
and foreign issuers including:
(a) Bonds and other fixed income securities of United States issuers which are
rated within the four highest grades ("investment grade") by Moody's
Investors Service, Inc. ("Moody's") or Standard & Poor's Corporation
("S&P").
(b) Corporate notes, bonds and other debt securities (such as Eurocurrency
instruments) of non-United States issuers judged by IAI as being equivalent
in repayment security to investment grade domestic obligations, provided
that no more than 35% of International Fund's portfolio will be invested in
foreign corporate debt securities with maturities of greater than one year
at the time of investment.
(c) United States dollars or securities with maturities of one year or less of,
or guaranteed by, the United States Government, its agencies and
instrumentalities.
(d) Foreign currencies or securities of, or guaranteed by, foreign governments
or the agencies or instrumentalities of foreign governments, or securities
issued by supranational agencies (such as the World Bank) that are
equivalent in repayment security to investment grade domestic obligations,
provided that not more than 35% of International Fund's portfolio will be
invested in foreign government obligations having a maturity of greater
than one year from the date of investment.
(e) Short-term debt instruments of domestic and foreign issuers such as
commercial paper, bank certificates of deposit, bankers' acceptances, and
repurchase agreements for such securities (provided that International Fund
will not invest in foreign repurchase agreements and provided further that
the Fund may not invest more than 10% of its total assets in domestic
repurchase agreements and may invest in such repurchase agreements for
defensive purposes only). The commercial paper purchased by the Fund will
consist only of (i) obligations rated either Prime-2 or better by Moody's
or A-2 or better by S&P, or (ii) unrated or foreign obligations issued by
companies considered by IAI to offer equivalent repayment security.
International Fund is not required to maintain any particular geographical or
currency mix of its investments. Therefore, at any particular time, the Fund's
investment portfolio may be substantially or primarily invested in securities of
one or more selected markets where it appears that the available return from
investments in such markets will equal or exceed the return available from
investments in securities of other markets. Under normal circumstances, however,
the Fund currently intends to invest a significant por-
6
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
tion of its assets in countries that generally are representative of the market
capitalization of the securities of the countries comprising the Morgan Stanley
Capital International Europe, Australia, Far East ("EAFE") Index, an unmanaged
index of foreign common stocks. The following table sets forth the approximate
weighting of the EAFE Index based upon relative market capitalizations of
securities in countries comprising the EAFE Index as of January 31, 1995, as
well as the composition of International Fund's portfolio as of the same date:
<TABLE>
<CAPTION>
Int'l.
EAFE Fund's
Index Portfolio
------ ----------
<S> <C> <C>
Far East
Japan 45% 27%
Australia 3% 6%
Malaysia 2% 4%
Singapore 1% 5%
New Zealand - 3%
Hong Kong 3% -
Europe
United Kingdom 16% 15%
Spain 2% 8%
France 6% 8%
Belgium 1% 5%
Italy 3% 2%
Germany 7% 5%
Netherlands 4% 4%
Cash NA 2%
Emerging Markets NA 3%
Bonds NA 3%
Other 7% -
Total 100% 100%
</TABLE>
In making the allocation of assets among the various markets throughout the
world, the Fund considers such factors as prospects for relative economic growth
between foreign countries, expected levels of inflation and interest rates,
government policies influencing business conditions, the range of individual
investment opportunities available to international investors, and other
pertinent financial, tax, social, political and national factors, all in
relation to the prevailing prices of securities in each country or region.
Nearly all foreign securities in which the Fund will invest will be issued by
foreign governments or traded on foreign stock exchanges.
International Fund may from time to time invest more than 50% of its total
assets in Japan, although not less than four different foreign economies will,
under normal circumstances, at any time be represented in the Fund's portfolio.
Other economies in which management anticipates that the Fund may from time to
time concentrate more than 25% of its total assets include the United Kingdom
and Germany.
International Fund may invest in developing countries, which investments involve
exposure to economic structures that are generally less diverse and mature than
in the United States, and to political systems which may be less stable. As
stated in the "Investment Objective and Policies" section for Developing
Countries Fund, developing countries include those generally considered to be
developing or emerging by the World Bank or the International Finance
Corporation, as well as countries that are clas-
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IAI Developing Countries Fund, IAI International Fund
sified by the United Nations or otherwise regarded by their authorities as
developing. In the past, markets of developing countries have been more volatile
than the markets of developed countries. Such markets, however, often have
provided investors with higher returns on their investments. International Fund
will limit its investments in developing countries not included in the EAFE
index to not more than 10% of its total assets. For purposes of determining the
country of an issuer for percentage limitation purposes, the Fund considers
where an issuer has its principal activities and interests, taking into account
such factors as the location of the issuer's assets, personnel, sales and
earnings.
International Fund can use various techniques to increase or decrease its
exposure to changing security prices, interest rates, currency exchange rates,
commodity prices, or other factors that affect security values. These techniques
include buying and selling options and futures contracts, entering into currency
exchange contracts or swap agreements, purchasing indexed securities, and
selling securities short. Further information regarding such techniques is
contained in the Statement of Additional Information.
The Economies of Japan and the United Kingdom
As discussed above, International Fund may from time to time concentrate more
than 25% of its total assets in the economies of Japan, the United Kingdom and
Germany. This section includes a general discussion of the economies of Japan
and the United Kingdom. Although the Fund may concentrate more than 25% of its
assets in the German economy, it does not expect to do so in the upcoming fiscal
year. A discussion of the economy of Germany is set forth in the Statement of
Additional Information.
Reporting, accounting and auditing standards in Japan, the United Kingdom and
Germany differ from American standards in important respects. Corporations in
such countries generally do not provide all of the disclosures required by U.S.
law and accounting practice, and such disclosure may be less timely than
required by such laws and practices.
Japan. Japan is politically organized as a democratic, parliamentary republic
and has a population of approximately 122 million. The Japanese economy is
heavily industrial and export-oriented. Although Japan is dependent upon foreign
economies for raw materials, Japan's balance of payments in recent years has
been strong and positive.
Japan has eight stock exchanges located throughout the country, but over 80% of
all trading is conducted on the Tokyo Stock Exchange.
Prices of stocks listed on the Japanese stock exchange are quoted continuously
during regular business hours. Trading commissions are at fixed scale rates
which vary by the type and the value of the transaction, but can be negotiable
for large transactions.
Securities in Japan are denominated and quoted in yen. Yen are fully convertible
and transferable based on floating exchange rates into all currencies, without
administrative or legal restrictions, for both nonresidents and residents of
Japan.
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United Kingdom. The United Kingdom is a constitutional monarchy and consists of
England, Scotland, Wales and Northern Ireland. The population of the United
Kingdom is approximately 57 million. Industry in the United Kingdom is
predominantly owned in the private sector except for certain state owned
entities in the transportation and energy industries.
The United Kingdom is centered in London. In October of 1986, stock exchange
commission rates were deregulated and stock exchange membership was opened up to
limited companies and to non-residents of the United Kingdom. Additionally, the
Financial Services Act (the "FSA") substantially restructured the U.K.
securities laws and deregulated the London Stock Exchange's own rules. FSA
created a new regulatory body known as the Securities and Investments Board (the
"SIB"), which has the power to delegate certain of its functions to various
self-regulatory organizations, of which the London Stock Exchange is one. Under
the FSA structure, the London Stock Exchange will continue to be largely self-
regulating with fundamentally the same types of self-regulatory rules in effect
prior to FSA.
Stock prices are continuously quoted during business hours on the London Stock
Exchange, and are negotiable, but have formalized for institutions. Trading
commissions in the U.K. are negotiable.
Securities in the United Kingdom are denominated and quoted in "pounds
sterling". Pounds sterling are fully convertible and transferable based on
floating exchange rates into all currencies, without administrative or legal
restrictions, for both non-residents and residents of the United Kingdom.
Portfolio Securities and other Fund Investment Techniques
The ability of the Funds to utilize certain of the investment techniques
discussed below may be subject to limitations and may subject the Funds to
additional risks. Please refer to the section "Fund Risk Factors" below and to
the Statement of Additional Information for more information regarding such
limitations and risks.
Depositary Receipts
In addition to investing in such securities directly, each Fund may invest in
the securities of foreign issuers in the form of sponsored and unsponsored
American Depositary Receipts (ADRs), European Depositary Receipts (EDRs), Global
Depositary Receipts (GDRs) or other securities convertible into securities of
foreign issuers. Generally, such securities evidence ownership of and may be
converted into securities issued by a foreign corporation. The issuers of
unsponsored depository receipts are not obligated to disclose material
information in the United States, and therefore, there may not be a correlation
between such information and the market value of such securities.
Foreign Index Linked Instruments
Each Fund may invest in instruments issued by the U.S. or a foreign government
or by private issuers that return principal and/or pay interest to investors in
amounts which are linked to the level of a particular foreign index ("Foreign
Index Linked Instruments"). Foreign Index Linked Instruments may offer
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IAI Developing Countries Fund, IAI International Fund
higher yields than comparable securities linked to purely domestic indexes but
also may be more volatile. Foreign Index Linked Instruments are relatively
recent innovations for which the market has not yet been fully developed and,
accordingly, they typically are less liquid than comparable securities linked to
purely domestic indexes. In addition, the value of Foreign Index Linked
Instruments will be affected by fluctuations in foreign exchange rates or in
foreign interest rates. Foreign currency gains and losses with respect to
Foreign Index Linked Instruments may affect the amount and timing of income
recognized by such Fund.
Brady Bonds
Each Fund may invest in Brady Bonds and other sovereign debt securities of
countries that have restructured or are in the process of restructuring
sovereign debt pursuant to the Brady Plan. Brady Bonds are debt securities
issued under the framework of the Brady Plan, a mechanism for debtor nations to
restructure their outstanding external indebtedness. Brady Bonds have been
issued only recently and, accordingly, do not have a long payment history.
Zero Coupon Securities
Each Fund may invest in zero coupon securities. Such securities are debt
obligations which do not entitle the holder to periodic interest payments prior
to maturity and are issued and traded at a discount from their face amounts. The
discount varies depending on the time remaining until maturity, prevailing
interest rates, liquidity of the security and the perceived credit quality of
the issuer. Zero coupon securities can be sold prior to their due date in the
secondary market at the then-prevailing market value which depends primarily on
the time remaining to maturity, prevailing levels of interest rates and the
perceived credit quality of the issuer. The market prices of zero coupon
securities are more volatile than the market prices of securities of comparable
quality and similar maturity that pay interest periodically and may respond to a
greater degree to fluctuations in interest rates than do such non-zero coupon
securities.
Foreign Currency Transactions
The value of the assets of a Fund as measured in United States dollars or a
foreign currency or currencies may be affected favorably or unfavorably by
changes in foreign currency exchange rates and exchange control regulations, and
each Fund may incur costs in connection with conversions between various
currencies. Each Fund will conduct its foreign currency exchange transactions
either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign
currency exchange market, or through forward contracts to purchase or sell
foreign currencies. A forward foreign currency exchange contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. These contracts are traded
directly between currency traders (usually large commercial banks) and their
customers.
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IAI Developing Countries Fund, IAI International Fund
Each Fund may enter into foreign currency transactions for hedging purposes only
and may not speculate on the fluctuations of foreign currency exchange rates.
Each Fund may hedge against adverse changes in foreign currency exchange rates
between the trade and settlement dates with respect to foreign securities it is
purchasing or during the holding period with respect to foreign securities in
its portfolio. With respect to foreign securities in its portfolio, each Fund
may hedge a maximum of 50% of the value of its investment portfolio by
establishing the value of such securities in U.S. dollars. Additionally, the
Fund may hedge a maximum of 25% of the value of its investment portfolio by
establishing the value of such securities in another foreign currency or
currencies which IAI believes to be more stable than the currencies in which
such securities are denominated.
When a Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may desire to establish the cost or
proceeds in U.S. dollars or another foreign currency. By entering into a forward
contract in such currency for the purchase or sale of the amount of foreign
currency involved in an underlying security investment, the Fund is able to
protect itself against a possible loss between trade and settlement dates of a
transaction or during the period of an investment in a foreign security
resulting from an adverse change in the relationship between such two
currencies. However, this tends to limit potential gains which might result from
a positive change in such currency relationships. A Fund may also hedge its
foreign currency exchange rate risk by engaging in currency financial futures
and options and forward foreign currency transactions.
When IAI believes that the currency of a particular foreign country may suffer a
substantial decline against the U.S. dollar or another foreign currency, it may
enter into a forward contract to sell an amount of foreign currency
approximating the value of some or all of al Fund's portfolio securities
denominated in such foreign currency. The forecasting of short-term currency
market movement is difficult and the successful execution of a short-term
hedging strategy is uncertain.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a contract. Accordingly, it may be
necessary for a Fund to purchase additional currency on the spot market (and
bear the expense of such purchase) if the market value of the security is less
than the amount of foreign currency the Fund is obligated to deliver when a
decision is made to sell the security and make delivery of the foreign currency
in settlement of a forward contract. Conversely, it may be necessary to sell on
the spot market some of the foreign currency received upon the sale of the
portfolio security if its market value exceeds the amount of foreign currency
the Fund is obligated to deliver.
If a Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss (as described below) to the
extent that there has been movement in forward contract prices. If a Fund
engages in an offsetting transaction, it may subsequently enter into a new
forward contract to sell the foreign currency. Should forward prices decline
during the period between the Fund's entering into a forward contract for the
sale of foreign currency and the date it enters into an offsetting contract for
the purchase of the foreign currency, the
11
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IAI Developing Countries Fund, IAI International Fund
Fund would realize a gain to the extent the price of the currency it has agreed
to sell exceeds the price of the currency it has agreed to purchase. Should
forward prices increase, the Fund would suffer a loss to the extent the price of
the currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. Although such contracts tend to minimize the risk of loss due to
a decline in the value of the hedged currency, they also tend to limit any
potential gain which might result should the value of such currency increase. A
Fund will have to convert its holders of foreign currencies into U.S. dollars
from time to time. Although foreign exchange dealers do not charge a fee for
conversion, they do realize a profit based on the difference (the "spread")
between the prices at which they are buying and selling various currencies.
Temporary Investments
The Funds reserve the right, as a temporary defensive measure, to provide for
redemptions or in anticipation of investment in securities of companies
domiciled or otherwise having substantial operations in developing countries, to
hold cash or cash equivalents (in U.S. dollars or foreign currencies) and short-
term securities, including money market securities.
Adjusting Investment Exposure
The Funds can use various techniques to increase or decrease exposure to
changing security prices, interest rates, currency exchange rates, commodity
prices, or other factors that affect security values. These techniques may
involve derivative transactions such as buying and selling options and futures
contracts, entering into currency exchange contracts or swap agreements,
purchasing indexed securities, and selling securities short.
Repurchase Agreements
Each Fund may invest in repurchase agreements relating to the securities in
which it may invest. In a repurchase agreement, a Fund buys a security at one
price and simultaneously agrees to sell it back at a higher price. Delays or
losses could result if the other party to the agreement defaults or becomes
insolvent. Foreign repurchase agreements may be less well secured than U.S.
repurchase agreements, and may be denominated in foreign currencies. They may
involve greater risk of loss if the counterparty defaults. Some counterparties
in these transactions may be less creditworthy than those in U.S. markets.
Borrowing
Each Fund may borrow from banks for temporary or emergency purposes or through
reverse repurchase agreements. If a Fund borrows money, its share price may be
subject to greater fluctuation until the borrowing is paid off. If a Fund makes
additional investments while borrowings are outstanding, this may be considered
a form of leverage.
Closed-End Investment Companies
A number of countries have authorized the formation of closed-end investment
companies to facilitate indirect foreign investment in their capital markets.
Each Fund may invest up to 10% of its total assets in securities of closed-end
investment companies. Shares of certain closed-end investment companies may at
times be acquired only at mar-
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
ket prices representing premiums to their net asset values. In the event that
shares acquired at a premium subsequently decline in price relative to their net
asset value or the value of portfolio investments held by such closed-end
companies declines, a Fund and its shareholders may experience a loss. If a Fund
acquires shares of closed-end investment companies, Fund shareholders would bear
both their proportionate share of expenses in such Fund (including management
and advisory fees) and, indirectly, the expenses of such closed-end investment
companies.
Illiquid Securities
The Developing Countries Fund may invest up to 10% of its total assets, while
the International Fund may invest up to 15% of its total assets, in securities
that are considered illiquid. This illiquidity may be due to the absence of a
readily available market or due to legal or contractual restrictions. Difficulty
in selling such securities may result in a loss or may be costly to a Fund.
Portfolio Turnover
The Funds will dispose of securities without regard to the time they have been
held when such action appears advisable to management either as a result of
securities having reached a price objective, or by reason of developments not
foreseen at the time of the investment decision. Since investment changes
usually will be made without reference to the length of time a security has been
held, a significant number of short-term transactions may result. Accordingly, a
Fund's annual portfolio turnover rate cannot be anticipated and may be
relatively high. A higher turnover rate generally results in higher brokerage
and other costs for a Fund. International Fund's historical portfolio turnover
rates are set forth in the section "Financial Highlights."
Further information regarding these and other techniques is contained in the
Statement of Additional Information.
Fund Risk Factors
Foreign Investment Risk Factors
Developing Countries Fund is designed for aggressive investors interested in
the investment opportunities offered in developing countries. To the extent that
International Fund invests in developing countries, the Fund may be subject to
additional risk. While IAI believes that investing in developing countries
presents the possibility for significant growth over the long-term, it also
entails significant risks. Many investments in developing countries can be
considered speculative, and the price of securities can be much more volatile
than in the more developed markets. This difference reflects the greater
uncertainties of investing in less established markets and economies.
Investing in foreign securities typically involves additional risks than
investing in securities of U.S. issuers. These risks are often heightened for
investments in developing countries and include, but are not limited to, the
risk of fluctuations in the value of the currencies in which they are
denominated, including the devaluation of the currencies of such countries
relative to the U.S. dollar, the risk of adverse political and economic
developments and the possibility of expropriation,
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
nationalization or confiscatory taxation or limitations on the removal of funds
or other assets of the Funds. Additionally, the economies of many developing
countries continue to experience significant problems, including high inflation
rates, high interest rates, large external debt and continuing trade deficits
and are characterized by extreme poverty, high unemployment and a significant
dependence on limited industries. Because the Funds will invest in securities
denominated or quoted in currencies other than the U.S. dollar, changes in
foreign currency exchange rates may affect the value of securities in the
portfolio. Foreign currency exchange rates are determined by forces of supply
and demand in the foreign exchange markets and other economic and financial
conditions affecting the world economy. A decline in the value of any particular
currency against the U.S. dollar will cause a decline in the U.S. dollar value
of a Fund's holdings of securities denominated in such currency and, therefore,
will cause an overall decline in a Fund's net asset value and net investment
income and capital gains, if any, to be distributed in U.S. dollars to
shareholders by such Fund. In many developing countries, there is less
government supervision and regulation of business and industry practices, stock
exchanges, brokers and listed companies than in the United States. In addition,
there also may be less publicly available information about foreign issuers than
domestic issuers, and foreign issuers generally are not subject to the uniform
accounting, auditing and financial reporting standards, practices and
requirements applicable to domestic issuers. The foreign securities markets of
many of the countries in which the Funds may invest may also be smaller, less
liquid and subject to greater price volatility than those in the United States.
As an open-end investment company, each Fund is limited in the extent to which
it may invest in illiquid securities. Further, the Funds may encounter
difficulties or be unable to pursue legal remedies and obtain judgments in
foreign courts. These factors could make foreign investments, especially those
in developing countries, more volatile.
Brokerage commissions, custodial services, and other costs relating to
investment in foreign countries and developing markets are generally more
expensive than in the United States. Such markets have different clearance and
settlement procedures and in certain markets there have been times when
settlements have been unable to keep pace with the volume of securities
transactions, making it difficult to conduct such transactions. The inability of
a Fund to make intended security purchases due to settlement problems could
cause such Fund to miss attractive investment opportunities. Inability to
dispose of a portfolio security due to settlement problems could result either
in losses to a Fund due to subsequent declines in value of the portfolio
security or, if a Fund has entered into a contract to sell the security, could
result in possible liability to the purchaser.
Several countries restrict, to varying degrees, foreign investments in their
securities markets. Government and private restrictions take a variety of forms,
including (a) limitations on the amount of funds that may be introduced into or
repatriated from the country (including limitations on repatriation of
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IAI Developing Countries Fund, IAI International Fund
investment income and capital gains); (b) prohibitions or substantial
restrictions on foreign investment in certain industries or market sectors, such
as defense, energy and transportation; (c) restrictions (whether contained in
the charter of an individual company or mandated by the government) on the
percentage of securities of a single issuer which may be owned by a foreign
investor; (d) limitations on the types of securities which a foreign investor
may purchase; and (e) restrictions on a foreign investor's right to invest in
companies whose securities are not publicly traded. In some circumstances, these
restrictions may limit or preclude investment in certain countries or may
increase the cost of investing in securities of particular companies.
A Fund's interest and dividend income from foreign issuers may be subject to
non-U.S. withholding taxes. A Fund also may be subject to taxes on trading
profits or on transfers of securities in some countries. The imposition of these
taxes will increase the cost to a Fund of investing in any country imposing such
taxes. For U.S. tax purposes, U.S. shareholders may be entitled to a credit or
deduction to the extent of any foreign income taxes paid by such Fund. See
"Dividends, Distributions and Tax Status."
Each Fund may purchase sovereign debt instruments issued or guaranteed by
foreign governments or their agencies. Sovereign debt may be in the form of
conventional securities or other types of debt instruments such as loans or loan
participations. The sovereign debt in which a Fund may invest may involve a high
degree of risk, including the risk of default. Governmental entities responsible
for repayment of the debt may be unable or unwilling to repay principal and
interest when due, and may require renegotiations or rescheduling of debt
payments. In addition, prospects for repayment of principal and interest may
depend on political as well as economic factors. A Fund may have limited
recourse in the event of default on a sovereign debt instrument.
Many of the currencies of developing countries have experienced steady
devaluations relative to the U.S. dollar, and major devaluations have
historically occurred in certain countries. Devaluations in the currencies in
which a Fund's portfolio securities are denominated may have a detrimental
impact on such Fund. Some developing countries also may have managed currencies
which are not free floating against the U.S. dollar. In addition, there is a
risk that certain developing countries may restrict the free conversion of their
currencies into other currencies. Further, the currencies of certain developing
countries may not be internally traded.
Many developing countries have experienced substantial, and in some periods
extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have very negative
effects on the economies and securities markets of certain developing countries.
The governments of many developing countries have exercised and continue to
exercise a significant influence over many aspects of the private sector.
Government actions concerning the economy could have a significant effect on
market conditions and prices and/or yields of securities in which a Fund
invests.
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IAI Developing Countries Fund, IAI International Fund
In some countries, the securities of banks or other financial institutions are
among the most actively traded securities. Each Fund is restricted in its
ability to invest in securities of an issuer which, in its most recent year,
derived more than 15% of its revenues from "securities related activities," as
defined by the rules under the Investment Company Act of 1940.
Risks of Transactions in Derivatives
Each Fund will spread investment risk by limiting its holdings in any one
company or industry. IAI may use futures, options, swap and currency exchange
agreements as well as short sales to adjust the risk and return characteristics
of such Fund's portfolio of investments. If IAI judges market conditions
incorrectly or employs a strategy that does not correlate well with a Fund's
investments, use of these techniques could result in a loss, regardless of
whether the intent was to reduce risk or increase return. Use of these
techniques may increase the volatility of a Fund and may involve a small
investment of cash relative to the magnitude of risk assumed. In addition, these
techniques could result in a loss if the counterparty to the transaction is
unable to perform as promised. Moreover, a liquid secondary market for any
futures or options contract may not be available when a futures or options
position is sought to be closed. Please refer to the Statement of Additional
Information which further describes these risks.
Risks of Lower-Rated Debt Securities
Developing Countries Fund may invest in debt securities commonly known as "junk"
bonds. Such securities are subject to higher risks and greater market
fluctuations than are lower-yielding, higher-rated securities. The price of junk
bonds has been found to be less sensitive to changes in prevailing interest
rates than higher-rated investments, but is likely to be more sensitive to
adverse economic changes or individual corporate developments. During an
economic downturn or substantial period of rising interest rates, highly
leveraged issuers may experience financial stress which would adversely affect
their ability to service their principal and interest payment obligations, to
meet their projected business goals or to obtain additional financing. If the
issuers of a fixed-income security owned by Developing Countries Fund were to
default, Developing Countries Fund might incur additional expenses to seek
recovery. The risk of loss due to default by issuers of junk bonds is
significantly greater than that associated with higher-rated securities because
such securities generally are unsecured and frequently are subordinated to the
prior payment of senior indebtedness. In addition, periods of economic
uncertainty and change can be expected to result in an increased volatility of
market prices of junk bonds and a concomitant volatility in the net asset value
of a share of Developing Countries Fund.
The secondary market for junk bonds is less liquid than the markets for higher
quality securities and, as such, may have an adverse effect on the market prices
of certain securities. The limited liquidity of the market may also adversely
affect the ability of Developing Countries Fund to arrive at a fair value for
certain junk bonds at certain times and could
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make it difficult for Developing Countries Fund to sell certain securities.
Both International and Developing Countries Funds are subject to certain other
investment policies and restrictions described in the Statement of Additional
Information, some of which are fundamental and may not be changed without the
approval of the shareholders of a Fund. Please refer to the Statement of
Additional Information for a further discussion concerning the risks associated
with investing in internationally and developing countries.
Management
Under Minnesota law, each Fund's Board of Directors is generally responsible for
the overall operation and management of each Fund. IAI serves as the investment
adviser and manager to each Fund pursuant to a written advisory agreement (the
"Advisory Agreement"). IAI has delegated to IAI International certain of its
responsibilities and obligations as the Funds' investment adviser pursuant to a
written agreement (the "Subadvisory Agreement"). IAI International is based in
London and maintains a United States representative office with the same address
as IAI. IAI and IAI International (collectively, "IAI") are affiliates of Hill
Samuel Group ("Hill Samuel"), an international merchant banking and financial
services group based in London, England (hereinafter, references to IAI shall
include IAI International where appropriate). Hill Samuel, in turn, is owned by
TSB Group plc, a publicly held financial services organization headquartered in
London, England. TSB Group plc is one of the largest personal and corporate
financial services groups in the United Kingdom and is engaged in a wide range
of activities including banking, unit linked life assurance, unit trust
management, investment management, credit card and finance house business. The
address of IAI is that of the Funds. IAI also furnishes investment advice to
other concerns including other investment companies, pension and profit sharing
plans, portfolios of foundations, religious, educational and charitable
institutions, trusts, municipalities and individuals, having total assets in
excess of $14 billion.
Under the Advisory Agreement, IAI provides the Funds with investment advice,
statistical and research facilities, and certain equipment and services,
including, but not limited to, office space and necessary office facilities,
equipment, and the services of required personnel. Under the Subadvisory
Agreement, IAI International has the authority and responsibility to make and
execute investment decisions for the Fund within the framework of the Funds'
investment policies, subject to review by IAI and the Funds' Board of Directors.
As compensation for these services, the Developing Countries Fund has agreed to
pay IAI a monthly advisory fee at the initial annual rate of 1.25% of the Fund's
average daily net assets, which fee declines to 1.00% of the Fund's average
daily net assets as the amount of assets in Developing Countries Fund grows.
With respect to International Fund, the Fund has agreed to pay a monthly
advisory fee at the initial annual rate of 1.00% of the Fund's average month-end
net assets, which fee declines to .70% of the Fund's average month-end net
assets as the amount of assets in the International Fund grows. IAI pays
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one-half of its advisory fee from the Funds to IAI International.
Roy Gillson and Robert Swift have responsibility for the management of
International Fund. Mr. Gillson is IAI International's Chief Investment Officer
and a member of its Board of Directors. Mr. Gillson has managed the
International Fund since 1990 and joined IAI International in 1983. Mr. Swift is
a Far East Equity Strategist, as well as Director of IAI International. Mr.
Swift began co-managing the International Fund in January 1995. Mr. Swift
joined IAI International in 1991 as a portfolio manager, and prior thereto was a
portfolio manager with Pring Dean, Australia since 1988. Mr. Gillson has
responsibility for the management of Developing Countries Fund and has managed
the Fund since its inception in February 1995.
Pursuant to the terms of an Administrative Agreement, IAI also provides all
required administrative, stock transfer, redemption, dividend disbursing and
accounting services, including, for example, the maintenance of a Fund's
accounts, books and records, the daily calculation of a Fund's net asset value,
daily and periodic reports, all information necessary to complete tax returns,
questionnaires and other reports requested by a Fund, the maintenance of stock
registry records, the processing of requested account registration changes and
redemption requests, and the administration of payments of dividends and
distributions declared by a Fund. As compensation for these services, the
Developing Countries Fund pays IAI an administrative fee at an annual rate of
.30% of the Fund's average daily net assets, while International Fund pays IAI
an administrative fee at an annual rate of .30% of the Fund's average month-end
net assets. IAI may use all or a portion of this administrative fee to pay
certain institutions which have contracted with IAI to provide certain
administrative services to their customers who invest in a Fund. Such services
include, but are not limited to, shareholder assistance and communication,
transaction processing and settlement, account set-up maintenance, shareholder
tax reporting, and accounting.
In addition to the advisory fee and the administrative fee paid to IAI, each
Fund pays all its other costs and expenses, including, for example, costs
incurred in the purchase and sale of assets, interest, taxes, charges of the
custodian of the Funds' assets, costs of reports and proxy materials sent to
Fund shareholders, fees paid for independent accounting and legal services,
costs of printing prospectuses for Fund shareholders and registering the Fund
shares, postage, fees to disinterested directors, insurance premiums and costs
of attending investment conferences.
The Advisory Agreement for International Fund provides that IAI shall reimburse
IAI International for operating expenses (other than interest and in certain
circumstances, taxes and extraordinary expenses), which, for any year, exceed
2.00% of such Fund's average month-end net assets. Additionally, IAI may from
time to time waive or reduce its management and/or administrative fee or
otherwise reimburse Fund expenses. For its fiscal year ending January 31, 1996,
IAI has voluntarily agreed to reimburse Developing Countries Fund expenses which
exceed
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
2.00% of its average daily net assets on an annual basis. IAI reserves the right
to rescind such waiver at any time upon notice to shareholders. IAI shall not be
liable for any loss suffered by a Fund in the absence of willful misfeasance,
bad faith or gross negligence in the performance of its duties and obligations.
Plan of Distribution
Each Fund has adopted a written plan of distribution (the "Plan") in accordance
with Rule 12b-1 under the 1940 Act pursuant to which it pays a distribution fee
as described below. Rule 12b-1 adopted by the Securities and Exchange Commission
under the 1940 Act permits an investment company to directly or indirectly pay
expenses associated with the distribution of the investment company's shares in
accordance with a plan adopted by the company's board of directors and approved
by its shareholders. Pursuant to the Plan, each Fund has entered into a
Distribution and Shareholders Services Agreement with IAI Securities, Inc. (the
"Underwriter") providing for the payment by each Fund to the Underwriter of a
distribution fee to cover expenses incurred by the Underwriter in distributing
the Fund's shares. Subject to the expense limitations described above,
Developing Countries Fund pays the Underwriter a distribution fee at an annual
rate of .25% of the Fund's average daily net assets, and International Fund pays
the Underwriter a distribution fee at an annual rate of .25% of the Fund's
average month-end net assets (which amount will be paid to the Underwriter
regardless of amounts spent by the Underwriter in distributing a Fund's shares).
The Rule 12b-1 Fee may be used by a Fund to compensate the Underwriter for the
provision of certain services to Fund shareholders. The services provided may
include personal services provided to shareholders, such as answering
shareholder inquiries regarding a Fund and providing reports and other
information, and services related to the maintenance of shareholder accounts.
The Underwriter may use the Rule 12b-1 Fee to make payments to qualifying
broker-dealers and financial institutions that provide such services.
The Rule 12b-1 Fee may also be used by the Underwriter for the purposes of
financing any activity which is primarily intended to result in the sale of
shares of a Fund. The expenses of such activities include, by way of example but
not by way of limitation, costs of prospectuses, semiannual reports, costs of
quarterly reports and monthly letters to prospective shareholders, expenses
associated with the preparation and distribution of sales literature and
advertising of any type, compensation and benefits paid to and expenses incurred
by personnel, including supervisory personnel, involved in direct mail and
advertising activities and activities relating to the direct marketing of Fund
shares to the public, and compensation to other broker-dealers for selling Fund
shares.
With respect to International Fund, the distribution fees payable by the Fund
are subject to the limitation on Fund operating expenses set forth in the
Advisory Agreement described above. Additionally, the Underwriter, in its sole
and absolute discretion, may from time to time out of its own assets pay for
certain additional costs of dis-
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
tributing the Fund's shares. For the fiscal period ended January 31, 1995,
International Fund paid the Underwriter a distribution fee of .25% of its
average month-end net assets. The Underwriter is an affiliate of IAI and its
offices are the same as those of the Fund.
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc., IAI may consider sales of shares of the Fund as a
factor in the selection of broker-dealers to execute the Fund's securities
transactions.
Computation of Net Asset Value and Pricing
Each Fund is open for business each day the New York Stock Exchange ("NYSE") is
open. IAI normally calculates a Fund's net asset value ("NAV") as of the close
of business of the NYSE, normally 3 p.m. Central time.
A Fund's NAV is the value of a single share. The NAV is computed by adding up
the value of a Fund's investments, cash, and other assets, subtracting its
liabilities, and then dividing the result by the number of shares outstanding.
A Fund's investments with remaining maturities of 60 days or less may be valued
on the basis of amortized cost. This method minimizes the effect of changes in a
security's market value. Other portfolio securities and assets are valued
primarily on the basis of market quotations or, if quotations are not readily
available, by a method that the Board of Directors believes accurately reflects
fair value. Foreign securities are valued on the basis of quotations from the
primary market in which they are traded.
Because of the Funds' need to obtain prices as of the close of trading on
various exchanges throughout the world, the calculation of net asset value does
not take place contemporaneously with the determination of the prices of a
Fund's portfolio securities. For purposes of determining a Fund's net asset
value, all assets and liabilities initially expressed in foreign currency values
will be converted into U.S. dollar values using current exchange rates. If an
event were to occur after the value of a Fund instrument was so established but
before the net asset value per share is determined which was likely to
materially change the net asset value, such instrument shall be valued using
fair value considerations by the Board of Directors or its delegates.
The offering price (price to buy one share) and redemption price (price to sell
one share) are referred to as a Fund's NAV.
Purchase of Shares
Each Fund offers its shares continually to the public at the net asset value of
such shares. Shares may be purchased directly from a Fund or through certain
security dealers who have responsibility to promptly transmit orders and may
charge a processing fee, provided that the Fund whose shares are being purchased
is duly registered in the state of the purchaser's residence, if required. No
sales load or commission is charged in connection with the purchase of Fund
shares.
The minimum initial investment to establish an account with the IAI Family of
Funds is
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
$5,000. Such initial investment may be allocated among a Fund and other funds in
the IAI Family of Funds as desired, provided that no less than $1,000 is
allocated to any one fund. The minimum initial investment for IRA accounts is
$2,000, provided that the minimum amount that may be allocated to any one fund
is $1,000. Once the account minimum has been met, subsequent purchases can be
made in a Fund for $100 or more.
Investors may satisfy the minimum investment requirement by participating in the
STAR Program. Participation in the STAR Program requires an initial investment
of $1,000 per Fund and a commitment to invest an aggregate of $5,000 within 24
months. If a STAR Program participant does not invest an aggregate of $5,000 in
the IAI Family of Funds within 24 months, IAI may, at its option, redeem such
shareholder's interest. Investors wishing to participate in the STAR Program
should contact a Fund to obtain a STAR Program application.
To purchase shares, forward the completed application and a check payable to
"IAI Funds" to a Fund. Upon receipt, your account will be credited with the
number of full and fractional shares which can be purchased at the net asset
value next determined.
Purchases of shares are subject to acceptance or rejection by a Fund on the same
day the purchase order is received and are not binding until so accepted. It is
the policy of the Funds and the Underwriter to keep confidential information
contained in the application and regarding the account of an investor or
potential investor in the Funds.
All correspondence relating to the purchase of shares should be directed to the
office of the Fund, P.O. Box 357, Minneapolis, Minnesota 55440 or, if using
overnight delivery, to 601 2nd Avenue South, Minneapolis, Minnesota 55402. For
assistance in completing the application please contact IAI Mutual Fund
Shareholder Services at 1-800-945-3863.
Retirement Plans
Shares of Developing Countries and International Fund may be an appropriate
investment medium for various Retirement Plans. Persons desiring information
about establishing an Individual Retirement Account (IRA) (for employed persons
and their spouses) or other Retirement Plans should contact a Fund at 1-800-945-
3863. All Retirement Plans involve a long-term commitment of assets and are
subject to various legal requirements and restrictions. The legal and tax
implications may vary according to the circumstances of the individual investor.
Therefore, you are urged to consult with an attorney or tax adviser prior to the
establishment of such a plan.
Automatic Investment Plan
Investors may arrange to make regular investments of $100 or more per fund on a
monthly basis, effective as of the 18th day of each month (or the next business
day), through automatic deductions from their checking or savings account. Such
investors may, of course, terminate their participation in the Automatic
Investment Plan at anytime upon written notice to a Fund. Any changes or
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IAI Developing Countries Fund, IAI International Fund
instructions to terminate existing Automatic Investment Plans must be received
by the last business day of the preceding month in which the change or
termination is to take place. Investors interested in participating in the
Automatic Investment Plan should complete the Automatic Investment Plan
application and return it to a Fund.
Redemption of Shares
Registered holders of Fund shares may at any time require a Fund to redeem their
shares upon their written request. Shareholders may redeem shares by phone
(subject to a limit of $50,000) provided such shareholders have authorized the
Fund to accept telephone instructions.
With respect to International Fund only, shareholders who redeem shares by
presenting stock certificates must endorse on the back of the certificate with
the signature of the person whose name appears on the certificate. If no
certificate has been issued, redemption instructions must be signed by the
person(s) in whose name the shares are registered.
If the redemption proceeds are to be paid or mailed to any person other than the
shareholder of record or if redemption proceeds are in excess of $50,000, a Fund
will require that the signature on the written instructions be guaranteed by a
participant in a signature guarantee program, which may include certain national
banks or trust companies or certain member firms of national securities
exchanges. (Notarization by a Notary Public is NOT ACCEPTED.) If the shares are
held of record in the name of a corporation, partnership, trust or fiduciary,
the Fund may require additional evidence of authority prior to accepting a
request for redemption. A Fund will not send redemption proceeds until checks
(including certified checks or cashiers checks) received in payment for shares
have cleared.
The redemption proceeds received by the investor are based on the net asset
value next determined after redemption instructions in good order are received
by a Fund. Since the value of shares redeemed is based upon the value of the
Fund investment at the time of redemption, it may be more or less than the price
originally paid for the shares.
Payment for shares redeemed will ordinarily be made within seven days after a
request for redemption has been made. Normally a Fund will mail payment for
shares redeemed on the business day following receipt of the redemption request.
Following a redemption or transfer request, if the value of a shareholder's
interest in a Fund falls below $500, such Fund reserves the right to redeem such
shareholder's entire interest and remit such amount. Such a redemption will only
be effected following: (a) a redemption or transfer by a shareholder which
causes the value of such shareholder's interest in the Fund to fall below $500;
(b) the mailing by such Fund to such shareholder of a notice of intention to
redeem; and (c) the passage of at least six months from the date of such
mailing, during which time the investor will have the opportunity to make an
additional investment in such Fund to increase the value of such investor's
account to at least $500.
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IAI Developing Countries Fund, IAI International Fund
Exchange privilege
The Exchange Privilege enables shareholders to purchase, in exchange for shares
of a Fund, shares of certain other funds managed by IAI. These funds have
different investment objectives from the Funds. Shareholders may exchange shares
of a Fund for shares of another fund managed by IAI, provided that the fund
whose shares will be acquired is duly registered in the state of the
shareholder's residence and the shareholder otherwise satisfies the fund's
purchase requirements. Although the Funds do not currently charge a fee for use
of the Exchange Privilege, they reserve the right to do so in the future.
Because excessive trading can hurt Fund performance and shareholders, there is a
limit of four exchanges out of each Fund per calendar year per account. Accounts
under common ownership or control, including accounts with the same taxpayer
identification number, will be counted together for purposes of the four
exchange limit. Each Fund reserves the right to temporarily or permanently
terminate the Exchange Privilege of any investor who exceeds this limit. The
limit may be modified for certain retirement plan accounts, as required by the
applicable plan document and/or relevant Department of Labor regulations, and
for Automatic Exchange Plan participants. Each Fund also reserves the right to
refuse or limit exchange purchases by any investor if, in IAI's judgment, such
Fund would be unable to invest the money effectively in accordance with its
investment objectives and policies, or would otherwise potentially be adversely
affected.
Fund shareholders wishing to exercise the Exchange Privilege should notify a
Fund in writing or, provided such shareholders have authorized a Fund to accept
telephone instructions, by telephone. At the time of the exchange, if the net
asset value of the shares redeemed in connection with the exchange is greater
than the investor's cost, a taxable capital gain will be realized. A capital
loss will be realized if at the time of the exchange the net asset value of the
shares redeemed in the exchange is less than the investor's cost. The Fund
reserves the right to terminate or modify the Exchange Privilege in the future.
Automatic Exchange Plan
Investors may arrange to make regular exchanges of $100 or more between any of
the funds in the IAI Mutual Fund Family on a monthly basis. Exchanges will take
place at the closing price of the fifth day of each month (or the next business
day). Shareholders are responsible for making sure sufficient shares exist in
the Fund account from which the exchange takes place. If there are not
sufficient funds in a Fund account to meet the requested exchange amount, the
Automatic Exchange Plan will be suspended. Shareholders may not close Fund
accounts through the Automatic Exchange Plan. Investors interested in
participating in the Automatic Exchange Plan should complete the Automatic
Exchange Plan portion of their application. For assistance in completing the
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IAI Developing Countries Fund, IAI International Fund
application contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.
Authorized Telephone Trading
Investors can transact account exchanges and redemptions via the telephone by
completing the Authorized Telephone Trading section of the IAI Mutual Fund
application and returning it to a Fund. Investors requesting telephone trading
privileges will be provided with a personal identification number ("PIN") that
must accompany any instructions by phone. Shares will be redeemed or exchanged
at the next determined net asset value. All proceeds must be made payable to the
owner(s) of record and delivered to the address of record.
In order to confirm that telephone instructions for redemptions and exchanges
are genuine, the Fund has established reasonable procedures, including the
requirement that a personal identification number accompany telephone
instructions. If a Fund or transfer agent fails to follow these procedures, such
Fund may be liable for losses due to unauthorized or fraudulent instructions.
None of the Funds, its transfer agent, IAI, or its principal Underwriter will be
liable for any loss, injury, damage, or expense for acting upon telephone
instructions believed to be genuine, and will otherwise not be responsible for
the authenticity of any telephone instructions, and, accordingly, the investor
bears the risk of loss resulting from telephone instructions. All telephone
redemptions and exchange requests will be tape recorded. Telephone redemptions
are not permitted on IRA or Simplified Employee Pension ("SEP") accounts. Please
call the Fund for a distribution form.
Systematic Cash Withdrawal Plan
Each Fund has available a Systematic Cash Withdrawal Plan for any investor
desiring to follow a program of systematically withdrawing a fixed amount of
money from an investment in shares of a Fund. An investment of $10,000 is
required to establish the plan. Payments under the plan will be made monthly or
quarterly in amounts of $100 or more. Shares will be sold with the closing price
of the 15th of the applicable month (or the next business day). To provide funds
for payment, a Fund will redeem as many full and fractional shares as necessary
at the redemption price, which is net asset value.
Payments under this plan, unless pursuant to a retirement plan, should not be
considered income. Withdrawal payments may exceed dividends and distributions
and, to this extent, there will be a reduction in the investor's equity. An
investor should also understand that this plan cannot insure profit, nor does it
protect against any loss in a declining market. Careful consideration should be
given to the amount withdrawn each month. Excessive withdrawals could lead to a
serious depletion of equity, especially during periods of declining market
values. Fund management will be available for consultation in this matter.
Plan application forms are available through the Funds. If you would like
assistance in completing the application contact IAI Mutual Fund Shareholder
Services at 1-800-945-3863.
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IAI Developing Countries Fund, IAI International Fund
Dividends, Distributions and Tax Status
The policy of Developing Countries Fund is to pay dividends from net investment
income and to make distributions of realized capital gains, if any, annually.
The policy of International Fund is to pay dividends from net investment income
semiannually and to make distributions of realized capital gains, if any,
annually. However, provisions in the Internal Revenue Code of 1986, as amended
(the "Code"), may result in additional net investment income and capital gains
distributions by a Fund. When you open an account, you should specify on your
application how you want to receive your distributions. Each Fund offers three
options: Full Reinvestment--your dividend and capital gain distributions will be
automatically reinvested in additional shares of the Fund; Capital Gains
Reinvestment--your capital gain distributions will be automatically reinvested,
but your income dividend distribution will be paid in cash; and Cash--your
income dividends and capital gain distributions will be paid in cash.
Distributions taken in cash can be sent via check or transferred directly to
your account at any bank, savings and loan or credit union that is a member of
the Automated Clearing House (ACH) network. Unless indicated otherwise by the
shareholder, each Fund will automatically reinvest all such distributions into
full and fractional shares at net asset value.
The Funds' Directed Dividend service allows you to invest your dividends and/or
capital gain distributions directly into another IAI Mutual Fund. Contact IAI
Mutual Fund Shareholder Services at 1-800-945-3863 for details.
Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Code during its current taxable year. If so qualified, such Fund will
not be subject to federal income tax on income that it distributes to its
shareholders.
Distributions by the Funds to shareholders, except distributions to shareholders
not subject to federal income taxation, are generally taxable to the
shareholders, whether received in cash or additional Fund shares. Distributions
paid out of the Funds' net investment income and net short-term capital gains
are taxable to shareholders as ordinary income. Distributions paid out of the
Funds' net long-term capital gains and designated as such are taxable to
shareholders as long-term capital gains, regardless of the length of time that
they have held their shares in a Fund.
A Fund may be required to pay withholding and other taxes imposed by foreign
countries, generally at rates from 10% to 40%, which would reduce such Fund's
investment income. Tax conventions between certain countries and the United
States may reduce or eliminate such taxes. If a Fund has more than 50% of its
assets invested in the stock or securities of foreign corporations at the end of
such Fund's taxable year, the Fund may make an election to allow shareholders
either to claim U.S. foreign tax credits with respect to foreign taxes paid by
the Fund or to deduct such amounts as an itemized deduction on their tax return.
In the event such an election is made,
25
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IAI MUTUAL FUNDS
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IAI Developing Countries Fund, IAI International Fund
shareholders would have to increase their taxable income by the amount of such
taxes and the Fund would not be able to deduct such taxes in computing its
taxable income.
Alternatively, if the amount of foreign taxes paid by a Fund is not large enough
to warrant its making the election described above, such Fund may claim the
amount of foreign taxes paid as a deduction against its own gross income. In
that case, shareholders would not be required to include any amount of foreign
taxes paid by the Fund in their income and would not be permitted either to
deduct any portion of foreign taxes from their own income or to claim any amount
of foreign tax credit for taxes paid by the Fund.
Information about the tax status of dividends and distributions from a Fund will
be mailed to such Fund's shareholders annually.
In general, upon redemption of shares of a Fund, the shareholder will recognize
taxable gain or loss equal to the difference between the amount realized on the
redemption and the shareholder's adjusted basis in such shares. Such gain or
loss will be capital gain or loss for any shareholder who is not a dealer in
securities. Under the Code, the deductibility of capital losses is subject to
certain limitations.
The foregoing relates to federal income taxation as in effect as of the date of
the Prospectus. Distributions from net investment income and from net realized
capital gains may also be subject to state and local taxes. For a more detailed
discussion of the federal income tax consequences of investing in shares of a
Fund, see "Tax Status" in the Statement of Additional Information.
Description of Common Stock
Developing Countries and International Fund are separate portfolios represented
by a separate classes of common stock of IAI Investment Funds III, Inc., a
Minnesota corporation. All shares of each Fund have equal rights as to
redemption, dividends and liquidation, and will be fully paid and nonassessable
when issued and will have no preemptive or conversion rights.
The shares of each Fund have noncumulative voting rights, which means that the
holders of more than 50% of the shares voting for the election of directors can
elect 100% of the directors if they choose to do so. On some issues, such as the
election of directors, all shares of IAI Investment Funds III, Inc. vote
together as one series. On an issue affecting only a particular series, such as
voting on the Advisory Agreement, only the approval of a particular series is
required to make the agreement effective with respect to such series.
Annual or periodically scheduled regular meetings of shareholders will not be
held except as required by law. Minnesota corporation law does not require an
annual meeting; instead, it provides for the Board of Directors to convene
shareholder meetings when it deems appropriate. In addition, if a regular
meeting of shareholders has not been held during the immediately preceding
fifteen months, shareholders holding three percent or more of the voting shares
of each Fund may demand a regular meeting of shareholders of such Fund by
written notice of demand given to the chief executive officer or the chief
financial officer of such Fund.
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IAI Developing Countries Fund, IAI International Fund
Within thirty days after receipt of the demand by one of those officers, the
Board of Directors shall cause a regular meeting of shareholders to be called
and held no later than ninety days after receipt of the demand, all at the
expense of such Fund. An annual meeting will be held on the removal of a
director or directors of a Fund if requested in writing by holders of not less
than 10% of the outstanding shares of a Fund.
The shares of each Fund are transferable by delivery to the Fund of transfer
instructions. Transfer instructions should be delivered to the office of the
Fund. The Fund is not bound to recognize any transfer until it is recorded on
the stock transfer books maintained by the Fund. Certificates representing Fund
shares will not be issued.
Counsel and Auditors
The firm of Dorsey & Whitney, P.L.L.P., 220 South Sixth Street, Minneapolis,
Minnesota 55402, provides legal counsel to the Fund. KPMG Peat Marwick LLP, 4200
Norwest Center, Minneapolis, Minnesota 55402, serves as independent auditors for
the Funds.
Custodian, Transfer Agent and Dividend Disbursing Agent
The Custodian for each Fund is Norwest Bank Minnesota, N.A., Norwest Center,
Sixth and Marquette, Minneapolis, Minnesota 55479. Norwest employs foreign
subcustodians and depositories, which were approved by such Fund's Board of
Directors in accordance with the rules and regulations of the Securities and
Exchange Commission, for the purpose of providing custodial services for such
Fund's assets held outside the United States. For a listing of the subcustodians
and depositories currently employed by such Fund, see the Statement of
Additional Information. IAI acts as the Funds' transfer agent, dividend
disbursing agent and IRA Custodian, at P.O. Box 357, Minneapolis, Minnesota
55440.
Additional Information
Each Fund sends to its shareholders a six-month unaudited and an annual audited
financial report, each of which includes a list of investment securities held.
In the opinion of the staff of the Securities and Exchange Commission, the use
of this combined prospectus may possibly subject all Funds to a certain amount
of liability for any losses arising out of any statement or omission in this
Prospectus regarding a particular Fund. In the opinion of the Funds' management,
however, the risk of such liability is not materially increased by use of a
combined prospectus.
Shareholder inquiries should be directed to the Funds at the telephone number or
mailing address listed on the inside back cover of this Prospectus.
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To Open
an Account
1.800.945.3863
612.376.2700
IAI
P.O. Box 357
Minneapolis, MN 55440
Overnight
Delivery Address
IAI
3700 First Bank Place
601 Second Avenue South
Minneapolis, MN 55402
Distributed by IAI Securities, Inc.
<PAGE>
[LOGO OF IAI]
MUTUAL FUNDS
3700 First Bank Place, P.O. Box 357, Minneapolis, Minnesota 55440-0357 USA fax
612.376.2737
800.945.3863
612.376.2700
<PAGE>
IAI DEVELOPING COUNTRIES FUND
IAI INTERNATIONAL FUND
STATEMENT OF ADDITIONAL INFORMATION
DATED JUNE 1, 1995
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. THIS
STATEMENT OF ADDITIONAL INFORMATION RELATES TO A PROSPECTUS DATED JUNE 1, 1995,
AND SHOULD BE READ IN CONJUNCTION THEREWITH. A COPY OF THE PROSPECTUS MAY BE
OBTAINED FROM THE FUND, 3700 FIRST BANK PLACE, P.O. BOX 357, MINNEAPOLIS,
MINNESOTA 55440 (TELEPHONE: 1-612-376-2700 OR 1-800-945-3863).
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES........................ 3
Repurchase Agreements............................... 3
Reverse Repurchase Agreements....................... 3
Securities of Foreign Issuers....................... 3
Illiquid Securities................................. 4
Lending Portfolio Securities........................ 4
Swap Agreements..................................... 4
Indexed Securities.................................. 5
Limitations on Futures and Options Transactions..... 5
Futures Contracts................................... 6
Futures Margin Payments............................. 6
Purchasing Put and Call Options..................... 6
Writing Put and Call Options........................ 7
Combined Positions.................................. 7
Correlation of Price Changes........................ 7
Liquidity of Options and Futures Contracts.......... 8
OTC Options......................................... 8
Asset Coverage for Futures and Options Positions.... 8
Economies of Japan, the United Kingdom and Germany.. 8
No Rating Criteria for Debt Securities.............. 9
Additional Risk Considerations...................... 10
INVESTMENT RESTRICTIONS.................................. 11
Portfolio Turnover.................................. 13
INVESTMENT PERFORMANCE................................... 13
MANAGEMENT............................................... 15
History............................................. 18
Investment Advisory Agreements...................... 18
Administrative Agreement............................ 18
Allocation of Expenses.............................. 19
Duration of Agreements.............................. 19
PLAN OF DISTRIBUTION..................................... 19
CUSTODIAL SERVICE........................................ 21
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE....... 24
CAPITAL STOCK............................................ 25
NET ASSET VALUE AND PUBLIC OFFERING PRICE................ 26
TAX STATUS............................................... 27
LIMITATION OF DIRECTOR LIABILITY......................... 29
</TABLE>
2
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and policies of IAI Developing Countries Fund
("Developing Countries Fund") and IAI International Fund ("International Fund")
are summarized on the front page of the Prospectus and in the text of the
Prospectus under "Investment Objective and Policies." Investors should
understand that all investments have a risk factor. There can be no guarantee
against loss resulting from an investment in the Funds, and there can be no
assurance that a Fund's investment policies will be successful, or that its
investment objective will be attained. Certain of the investment practices of
the Funds are further explained below.
REPURCHASE AGREEMENTS
Each Fund may invest in repurchase agreements relating to the securities in
which it may invest. A repurchase agreement involves the purchase of securities
with the condition that, after a stated period of time, the original seller will
buy back the securities at a predetermined price or yield. A Fund's custodian
will have custody of, and will hold in a segregated account, securities acquired
by such Fund under a repurchase agreement or other securities as collateral. In
the case of a security registered on a book entry system, the book entry will be
maintained in a Fund's name or that of its custodian. Repurchase agreements
involve certain risks not associated with direct investments in securities. For
example, if the seller of the agreement defaults on its obligation to repurchase
the underlying securities at a time when the value of the securities has
declined, a Fund may incur a loss upon disposition of such securities. In the
event that bankruptcy proceedings are commenced with respect to the seller of
the agreement, a Fund's ability to dispose of the collateral to recover its
investment may be restricted or delayed. While collateral will at all times be
maintained in an amount equal to the repurchase price under the agreement
(including accrued interest due thereunder), to the extent proceeds from the
sale of collateral were less than the repurchase price, a Fund could suffer a
loss.
REVERSE REPURCHASE AGREEMENTS
Each Fund may invest in reverse repurchase agreements. In a reverse
repurchase agreement, a Fund sells a portfolio instrument to another party, such
as a bank or broker-dealer, in return for cash and agrees to repurchase the
instrument at a particular price and time. While a reverse repurchase agreement
is outstanding, a Fund will maintain appropriate liquid assets in a segregated
custodial account to cover its obligation under the agreement. Such
transactions may increase fluctuations in the market value of a Fund's assets
and may be viewed as a form of leverage. The Funds will enter into reverse
repurchase agreements only with parties whose creditworthiness has been found
satisfactory by Investment Advisers, Inc. ("IAI"), the Funds' investment adviser
and manager or IAI International Limited (hereinafter references to IAI shall
include IAI International Limited where appropriate), the subadviser to the
Funds.
SECURITIES OF FOREIGN ISSUERS
Investing in foreign securities may result in greater risk than that
incurred by investing in domestic securities. There is generally less publicly
available information about foreign issuers comparable to reports and ratings
that are published about companies in the United States. Also, foreign issuers
are not subject to uniform accounting, auditing and financial reporting
standards, practices and requirements comparable to those applicable to United
States companies.
It is contemplated that most foreign securities will be purchased in over-
the-counter markets or on stock exchanges located in the countries in which the
respective principal offices of the issuers of the various securities are
located, if that is the best available market. Foreign stock markets are
generally not as developed or efficient as those in the United States. While
growing in volume, they usually have substantially less volume than the New York
Stock Exchange, and securities of some foreign companies are less liquid and
more volatile than securities of comparable United States companies. Similarly,
volume and liquidity in most foreign bond markets are less than in the United
States and at times volatility of price can be greater than in the United
States. Commissions on foreign stock exchanges are generally higher than
commissions on United States exchanges, although the Funds will endeavor to
achieve the most favorable net results on its portfolio transactions. There is
generally less
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government supervision and regulation of foreign stock exchanges, brokers and
listed companies than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation or
confiscatory taxation, limitations on the removal of funds or other assets of
the Funds, political or social instability, or diplomatic developments which
could affect United States investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the United States'
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
The dividends and interest payable on certain of a Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to such Fund's shareholders.
ILLIQUID SECURITIES
Developing Countries Fund may invest up to 10% of its net assets in
illiquid securities, and the International Fund may invest up to 15% of its net
assets in illiquid securities. The sale of illiquid securities often requires
more time and results in higher brokerage charges or dealer discounts and other
selling expenses than does the sale of securities eligible for trading on
national securities exchanges or in the over-the-counter markets. A Fund may be
restricted in its ability to sell such securities at a time when IAI deems it
advisable to do so. In addition, in order to meet redemption requests, a Fund
may have to sell other assets, rather than such illiquid or restricted
securities, at a time which is not advantageous.
LENDING PORTFOLIO SECURITIES
In order to generate additional income, the Funds may lend portfolio
securities to broker-dealers, banks or other financial borrowers of securities.
As with other extensions of credit, there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. However, a Fund will only enter into loan arrangements with
broker-dealers, banks or other institutions which IAI or IAI International has
determined are creditworthy under guidelines established by the Funds' Board of
Directors. The Funds may also experience a loss if, upon the failure of a
borrower to return loaned securities, the collateral is not sufficient in value
or liquidity to cover the value of such loaned securities (including accrued
interest thereon). However, a Fund will receive collateral in the form of cash,
United States Government securities, certificates of deposit or other high-
grade, short-term obligations or interest-bearing cash equivalents equal to at
least 102% of the value of the securities loaned. The value of the collateral
and of the securities loaned will be marked to market on a daily basis. During
the time portfolio securities are on loan, the borrower pays a Fund an amount
equivalent to any dividends or interest paid on the securities and a Fund may
invest the cash collateral and earn additional income or may receive an agreed
upon amount of interest income from the borrower. However, the amounts received
by a Fund may be reduced by finders' fees paid to broker-dealers and related
expenses.
SWAP AGREEMENTS
Swap agreements can be individually negotiated and structured to include
exposure to a variety of different types of investments or market factors.
Depending on their structure, swap agreements may increase or decrease a Fund's
exposure to long- or short-term interest rates (in the U.S. or abroad), foreign
currency values, mortgage securities, corporate borrowing rates, or other
factors such as security prices or inflation rates. Swap agreements can take
many different forms and are known by a variety of names. A Fund is not limited
to any particular form of swap agreement if IAI determines it is consistent with
such Fund's investment objectives and policies.
Swap agreements will tend to shift a Fund's investment exposure from one
type of investment to another. For example, if a Fund agrees to exchange
payments in dollars for payments in foreign currency, the swap agreement would
tend to decrease a Fund's exposure to U.S. interest rates and increase its
exposure to foreign
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currency and interest rates. Depending on how they are used, swap agreements
may increase or decrease the overall volatility of a Fund's investments and its
share price.
The most significant factor in the performance of swap agreements is the
change in the specific interest rate, currency, or other factors that determine
the amounts of payments due to and from a Fund. If a swap agreement calls for
payments by a Fund, such Fund must be prepared to make such payments when due.
In addition, if the counterparty's creditworthiness declined, the value of a
swap agreement would be likely to decline, potentially resulting in losses.
Each Fund expects to be able to eliminate its exposure under swap agreements
either by assignment or other disposition, or by entering into an offsetting
swap agreement with the same party or a similarly creditworthy party.
Each Fund will maintain appropriate liquid assets in a segregated custodial
account to cover its current obligations under swap agreements. If a Fund
enters into a swap agreement on a net basis, it will segregate assets with a
daily value at least equal to the excess, if any, of a Fund's accrued
obligations under the swap agreement over the accrued amount such Fund is
entitled to receive under the agreement. If a Fund enters into a swap agreement
on other than a net basis, it will segregate assets with a value equal to the
full amount of such Fund's accrued obligations under the agreement.
INDEXED SECURITIES
Each Fund may purchase securities whose prices are indexed to the prices of
other securities, securities indexes, currencies, precious metals or other
commodities, or other financial indicators. Indexed securities typically, but
not always, are debt securities or deposits whose value at maturity or coupon
rate is determined by reference to a specific instrument or statistic. Gold-
indexed securities, for example, typically provide for a maturity value that
depends on the price of gold, resulting in a security whose price tends to rise
and fall together with gold prices. Currency-indexed securities typically are
short-term to intermediate-term debt securities whose maturity values or
interest rates are determined by reference to the values of one or more
specified foreign currencies, and may offer higher yields than U.S. dollar-
denominated securities of equivalent issuers. Currency-indexed securities may
be positively or negatively indexed; that is, their maturity value may increase
when the specified currency value increases, resulting in a security that
performs similarly to a foreign-denominated instrument, or their maturity value
may decline when foreign currencies increase, resulting in a security whose
price characteristics are similar to a put on the underlying currency. Currency-
indexed securities may also have prices that depend on the values of a number of
different foreign currencies relative to each other.
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
government agencies. IAI will use its judgment in determining whether indexed
securities should be treated as short-term instruments, bonds, stocks, or as a
separate asset class for purposes of a Fund's investment policies, depending on
the individual characteristics of the securities. Indexed securities may be
more volatile than the underlying instruments.
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS
Each Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the Commodity Futures
Trading Commission (CFTC) and the National Futures Association, which regulate
trading in the futures markets, before engaging in any purchases or sales of
futures contracts or options on futures contracts. Each Fund intends to comply
with Section 4.5 of the regulations under the Commodity Exchange Act, which
limits the extent to which a Fund can commit assets to initial margin deposits
and option premiums.
In addition, each Fund will not: (a) sell futures contracts, purchase put
options, or write call options if, as a result, more than 25% of a Fund's total
assets would be hedged with futures and options under normal conditions; (b)
purchase futures contracts or write put options if, as a result, a Fund's total
obligations upon settlement or
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exercise of purchased futures contracts and written put options would exceed 25%
of its total assets; or (c) purchase call options if, as a result, the current
value of option premiums for call options purchased by a Fund would exceed 5% of
such Fund's total assets. These limitations do not apply to options attached to
or acquired or traded together with their underlying securities, and do not
apply to securities that incorporate features similar to options.
The above limitations on a Fund's investments in futures contracts and
options, and such Fund's policies regarding futures contracts and options
discussed elsewhere in this Statement of Additional Information may be changed
as regulatory agencies permit.
FUTURES CONTRACTS
When a Fund purchases a futures contract, it agrees to purchase a
specified underlying instrument at a specified future date. When a Fund sells a
futures contract, it agrees to sell the underlying instrument at a specified
future date. The price at which the purchase and sale will take place is fixed
when a Fund enters into the contract. Some currently available futures
contracts are based on specific securities, such as U.S. Treasury bonds or
notes, and some are based on indexes of securities prices, such as the Standard
& Poor's 500 Composite Stock Price Index (S&P 500). Futures can be held until
their delivery dates, or can be closed out before then if a liquid secondary
market is available.
The value of a futures contract tends to increase and decrease in tandem
with the value of its underlying instrument. Therefore, purchasing futures
contracts will tend to increase a Fund's exposure to positive and negative price
fluctuations in the underlying instrument, much as if it had purchased the
underlying instrument directly. When a Fund sells a futures contract, by
contrast, the value of its futures position will tend to move in a direction
contrary to the market. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
FUTURES MARGIN PAYMENTS
The purchaser or seller of a futures contract is not required to deliver
or pay for the underlying instrument unless the contract is held until the
delivery date. However, both the purchaser and seller are required to deposit
"initial margin" with a futures broker, known as a futures commission merchant
(FCM), when the contract is entered into. Initial margin deposits are typically
equal to a percentage of the contract's value. If the value of either party's
position declines, that party will be required to make additional "variation
margin" payments to settle the change in value on a daily basis. The party that
has a gain may be entitled to receive all or a portion of this amount. Initial
and variation margin payments do not constitute purchasing securities on margin
for purposes of a Fund's investment limitations. In the event of the bankruptcy
of an FCM that holds margin on behalf of a Fund, such Fund may be entitled to
return of margin owed to it only in proportion to the amount received by the
FMC's other customers, potentially resulting in losses to such Fund.
PURCHASING PUT AND CALL OPTIONS
By purchasing a put option, a Fund obtains the right (but not the
obligation) to sell the option's underlying instrument at a fixed strike price.
In return for this right, a Fund pays the current market price for the option
(known as the option premium). Options have various types of underlying
instruments, including specific securities, indexes of securities prices, and
futures contracts. A Fund may terminate its position in a put option it has
purchased by allowing it to expire or by exercising the option. If the option
is allowed to expire, a Fund will lose the entire premium it paid. If a Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. A Fund may also terminate a put option position by closing it out
in the secondary market at its current price, if a liquid secondary market
exists.
The buyer of a typical put option can expect to realize a gain if
security prices fall substantially. However, if the underlying instrument's
price does not fall enough to offset the cost of purchasing the option, a put
buyer can expect to suffer a loss (limited to the amount of the premium paid,
plus related transaction costs).
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The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the underlying instrument at the option's strike
price. A call buyer typically attempts to participate in potential price
increases of the underlying instrument with risk limited to the cost of the
option if security prices fall. At the same time, the buyer can expect to
suffer a loss if security prices do not rise sufficiently to offset the cost of
the option.
WRITING PUT AND CALL OPTIONS
When a Fund writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of the premium,
such Fund assumes the obligation to pay the strike price for the option's
underlying instrument if the other party to the option chooses to exercise it.
When writing an option on a futures contract a Fund would be required to make
margin payments to an FCM as described above for futures contracts. A Fund may
seek to terminate its position in a put option it writes before exercise by
closing out the option in the secondary market at its current price. If the
secondary market is not liquid for a put option a Fund has written, however,
such Fund must continue to be prepared to pay the strike price while the option
is outstanding, regardless of price changes, and must continue to set aside
assets to cover its position. If security prices rise, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received.
If security prices remain the same over time, it is likely that the
writer will also profit, because it should be able to close out the option at a
lower price. If security prices fall, the put writer would expect to suffer a
loss. This loss should be less than the loss from purchasing the underlying
instrument directly, however, because the premium received for writing the
option should mitigate the effects of the decline.
Writing a call option obligates a Fund to sell or deliver the option's
underlying instrument, in return for the strike price, upon exercise of the
option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of the option
premium, a call writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is greater,
a call writer gives up some ability to participate in security price increases.
COMBINED POSITIONS
A Fund may purchase and write options in combination with each other, or
in combination with futures or forward contracts, to adjust the risk and return
characteristics of the overall position. For example, a Fund may purchase a put
option and write a call option on the same underlying instrument, in order to
construct a combined position whose risk and return characteristics are similar
to selling a futures contract. Another possible combined position would involve
writing a call option at one strike price and buying a call option at a lower
price, in order to reduce the risk of the written call option in the event of a
substantial price increase. Because combined options positions involve multiple
trades, they result in higher transaction costs and may be more difficult to
open and close out.
CORRELATION OF PRICE CHANGES
Because there are a limited number of types of exchange-traded options
and futures contracts, it is likely that the standardized contracts available
will not match a Fund's current or anticipated investments exactly. The Fund
may invest in options and futures contracts based on securities with different
issuers, maturities, or other characteristics from the securities in which it
typically invests, which involves a risk that the options or futures position
will not track the performance of such Fund's other investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match a Fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of
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daily price fluctuation limits or trading halts. A Fund may purchase or sell
options and futures contracts with a greater or lesser value than the securities
it wishes to hedge or intends to purchase in order to attempt to compensate for
differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in a Fund's options or
futures positions are poorly correlated with its other investments, the
positions may fail to produce anticipated gains or result in losses that are not
offset by gains in other investments.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS
There is no assurance a liquid secondary market will exist for any
particular options or futures contract at any particular time. Options may have
relatively low trading volume and liquidity if their strike prices are not close
to the underlying instrument's current price. In addition, exchanges may
establish daily price fluctuation limits for options and futures contracts, and
may halt trading if a contract's price moves upward or downward more than the
limit in a given day. On volatile trading days when the price fluctuation limit
is reached or a trading halt is imposed, it may be impossible for a Fund to
enter into new positions or close out existing positions. If the secondary
market for a contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable positions, and
potentially could require a Fund to continue to hold a position until delivery
or expiration regardless of changes in its value. As a result, a Fund's access
to other assets held to cover its options or futures positions could also be
impaired.
OTC OPTIONS
Unlike exchange-traded options, which are standardized with respect to
the underlying instrument, expiration date, contract size, and strike price, the
terms of over-the-counter options (options not traded on exchanges) generally
are established through negotiation with the other party to the option contract.
While this type of arrangement allows a Fund greater flexibility to tailor an
option to its needs, OTC options generally involve greater credit risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS
Each Fund will comply with guidelines established by the Securities and
Exchange Commission with respect to coverage of options and futures strategies
by mutual funds, and if the guidelines so require will set aside appropriate
liquid assets in a segregated custodial account in the amount prescribed.
Securities held in a segregated account cannot be sold while the futures or
option strategy is outstanding, unless they are replaced with other suitable
assets. As a result, there is a possibility that segregation of a large
percentage of a Fund's assets could impede portfolio management or a Fund's
ability to meet redemption requests or other current obligations.
ECONOMIES OF JAPAN, THE UNITED KINGDOM AND GERMANY
As discussed in the Prospectus, International Fund may from time to time
concentrate more than 25% of its total assets in the economies of Japan, the
United Kingdom and Germany. This section includes a general discussion of the
economy of Germany. The economies of Japan and the United Kingdom are further
described in the Prospectus.
Germany is a federated republic with a population of approximately 80
million and a democratic parliamentary form of government. The German economy
is organized primarily on the basis of private sector ownership, with the state
exerting major influence through ownership in certain sectors, including
transportation, communication and energy. Unification of West Germany with the
formerly communist controlled East Germany took place in 1990.
Industrial activity makes the largest contribution to the German gross
national product. Although only 5% of German businesses are large-scale
enterprises, such large-scale businesses account for over half of industrial
production and employ over half the industrial labor force. Trading volume,
therefore, tends to concentrate on relatively few companies with both large
capitalizations and broad stock ownership. Historically
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the German economy has been strongly export oriented. Privatization of formerly
state owned enterprise in what was once East Germany is in progress, but will
make little difference to the predominance of large scale businesses in overall
industrial activity and the stock market.
German equity securities trade predominantly on the country's eight
independent local stock exchanges, the Frankfurt exchange accounting for 70% of
turnover. Subject to the provisions of pertinent securities law, mainly the
Stock Exchange Law of 1896, as amended, the council, management and other
executive organs of the stock exchanges constitute self-administering and self-
regulatory bodies. The "Working Group of German Stock Exchanges" headquartered
in Frankfurt, of which all eight stock exchanges are members, addresses all
policy and administrative questions of national and international character.
Prices for active stocks, including those for larger companies are quoted
continuously during stock exchange hours. Less actively traded stocks are
quoted only once a day. Equity shares are normally fully-paid and non-
assessable.
Orders for stock executed for large customers on the stock exchanges are
negotiable. A federal stock exchange turnover tax, ranging up to 0.25%, is
levied on all securities transactions other than those between banks acting as
principal. Nonresidents such as the Fund are charged half these rates.
German equity securities are denominated in Deutchemarks. Deutchemarks
are fully convertible and transferable into all currencies, without
administrative or legal restrictions, for both nonresidents and residents of
Germany. Since 1974, the Deutchemark has traded on a floating exchange rate
basis against all currencies.
NO RATING CRITERIA FOR DEBT SECURITIES
Developing Countries Fund has established no rating criteria for the debt
securities in which it may invest. Therefore, Developing Countries Fund may
invest in debt securities either (a) which are rated in one of the top four
rating categories by a nationally recognized rating organization or which
possess similar credit characteristics ("investment grade securities") or (b)
which are rated below the top four rating categories or which possess similar
credit characteristics ("high yield securities"). Ratings are one of several
factors utilized in performing a credit analysis of issuers.
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if such
issuers are highly leveraged. During such periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments or the issuer's inability to meet specific
projected business forecasts or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features which
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends to
shareholders.
Developing Countries Fund may have difficulty disposing of certain high
yield securities because there may be a thin trading market for such securities.
The secondary trading market for high yield securities is generally not as
liquid as the secondary market for higher rated securities. Reduced secondary
market liquidity may have an adverse impact on market price and Developing
Countries Fund's ability to dispose of particular issues when necessary to meet
Developing Countries Fund's liquidity needs or in response to a specific
economic event such as a deterioration in the creditworthiness of the issuer.
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Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect
Developing Countries Fund's net asset value. In addition, the Fund may incur
additional expenses to the extent it is required to seek recovery upon a default
on a portfolio holding or participate in the restructuring of the obligation.
ADDITIONAL RISK CONSIDERATIONS
Investors should consider carefully the substantial risks involved with
respect to investing in securities of companies and governments of foreign
nations, which are in addition to the usual risks inherent in domestic
investments. Such risks are heightened with respect to investments in
developing countries. There may be less publicly available information about
foreign companies comparable to the reports and ratings published about
companies in the United States. Foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards, and auditing
practices and requirements may not be comparable to those applicable to United
States companies. Foreign markets typically have substantially less volume than
the New York Stock Exchange and securities of some foreign companies are less
liquid and more volatile than securities of comparable United States companies.
Commission rates in foreign countries, which are generally fixed rather than
subject to negotiation as in the United States, are likely to be higher. In
many foreign countries there is less government supervision and regulation of
stock exchanges, brokers and listed companies than in the United States.
Investments in developing countries may be subject to potentially higher
risks than investments in developed countries. These risks include (i) less
social, political and economic stability; (ii) the small current size of the
markets for such securities and the currently low or nonexistent volume of
trading, which may result in a lack of liquidity and in greater price
volatility; (iii) certain national policies which may restrict the Fund's
investment opportunities, including restrictions on investment in issuers or
industries deemed sensitive to national interests; (iv) foreign taxation; (v)
the absence of developed structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the limited
development and recent emergence, in certain countries, of a capital market
structure or market-oriented economy; and (vii) the possibility that recent
favorable economic developments in certain countries may be slowed or reversed
by unanticipated political or social events in such countries.
Despite the recent dissolution of the Soviet Union, the Communist Party
may continue to exercise a significant role in certain (particularly Eastern
European) countries. To the extent of the Communist Party's influence,
investments in such countries will involve risks of nationalization,
expropriation and confiscatory taxation. The communist governments of a number
of such countries expropriated large amounts of private property in the past, in
many cases without adequate compensation, and there can be no assurance that
such expropriation will not occur in the future. In the event of such
expropriation, a Fund could lose a substantial portion of any investments it has
made in the affected countries. Further, no accounting standards exist in many
developing countries. Finally, even though certain currencies may be
convertible into U.S. dollars, the conversion rates may be artificial to the
actual market values and may be adverse to Fund shareholders.
Certain countries, which do not have market economies, are characterized
by an absence of developed legal structures governing private and foreign
investments and private property. Certain countries require governmental
approval prior to investments by foreign persons, or limit the amount of
investment by foreign persons in a particular company, or limit the investment
of foreign persons to only a specific class of securities of a company that may
have less advantageous terms than securities of the company available for
purchase by nationals.
Authoritarian governments in certain countries may require that a
governmental or quasi-governmental authority to act as custodian of a Fund's
assets invested in such country. To the extent such governmental or quasi-
governmental authorities do not satisfy the requirements of the 1940 Act to act
as foreign custodians of the Fund's cash and securities, a Fund's investment in
such countries may be limited or may be required to be effected through
intermediaries. The risk of loss through governmental confiscation may be
increased in such countries.
A Fund endeavors to buy and sell foreign currencies on as favorable a
basis as practicable. Some price spread on currency exchange (to cover service
charges) may be incurred, particularly when a Fund changes
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investments from one country to another or when proceeds from the sale of shares
in U.S. dollars are used for the purchase of securities in foreign countries.
Also, some countries may adopt policies which would prevent a Fund from
transferring cash out of the country, withhold portions of interest and
dividends at the source, or impose other taxes, with respect to a Fund's
investments in securities of issuers of that country. Although a Fund invests
only in foreign nations which it considers as having relatively stable and
friendly governments, there is the possibility of expropriation,
nationalization, confiscatory or other taxation, foreign exchange controls
(which may include suspension of the ability to transfer currency from a given
country), default in foreign government securities, political or social
instability or diplomatic developments that could affect investments in
securities of issuers in those nations.
A Fund may be affected either unfavorably or favorably by fluctuations in
the relative rates of exchange between the currencies of different nations, by
exchange control regulations and by indigenous economic and political
developments. Through a Fund's flexible policy, management endeavors to avoid
unfavorable consequences and to take advantage of favorable developments in
particular nations where from time to time it places a Fund's investments.
The exercise of this flexible policy may include decisions to purchase
securities with substantial risk characteristics and other decisions such as
changing the emphasis on investments from one nation to another and from one
type of security to another. Some of these decisions may later prove profitable
and others may not. No assurance can be given that profits, if any, will exceed
losses. However, in the absence of willful misfeasance, bad faith or gross
negligence on the part of the investment manager, any losses resulting from the
holding of a Fund's portfolio securities in foreign countries and/or with
securities depositories will be at the risk of the shareholders.
A Fund's ability to reduce or eliminate its futures and related options
positions will depend upon the liquidity of the secondary markets for such
futures and options. Each Fund intends to purchase or sell futures and related
options only on exchanges or boards of trade where there appears to be an active
secondary market, but there is no assurance that a liquid secondary market will
exist for any particular contract or at any particular time. Use of stock index
futures and related options for hedging may involve risks because of imperfect
correlations between movements in the prices of the futures or related options
and movements in the prices of the securities being hedged. Successful use of
futures and related options by a Fund for hedging purposes also depends upon the
investment manager's ability to predict correctly movements in the direction of
the market, as to which no assurance can be given.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, each Fund is subject to certain policies
and restrictions which are "fundamental" and may not be changed without
shareholder approval. Shareholder approval consists of the approval of the
lesser of (i) more than 50% of the outstanding voting securities of a Fund, or
(ii) 67% or more of the voting securities present at a meeting if the holders of
more than 50% of the outstanding voting securities of the Fund are present or
represented by proxy. Limitations 1 through 8 below are deemed fundamental
limitations. The remaining limitations set forth below serve as operating
policies of each Fund and may be changed by the Board of Directors without
shareholder approval.
Each Fund may not:
1. Purchase the securities of any issuer if such purchase would
cause the Fund to fail to meet the requirements of a "diversified company" as
defined under the Investment Company Act of 1940, as amended (the "1940 Act").
As defined in the 1940 Act, "diversified company" means a management
company which meets the following requirements: at least 75 per centum of the
value of its total assets is represented by cash and cash items (including
receivables), Government securities, securities of other investment companies,
and other securities for the purposes of this calculation limited in respect of
any one issuer to an amount not greater in value than 5 per
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<PAGE>
centum of the value of the total assets of such management company and not more
than 10 per centum of the outstanding voting securities of such issuer.
2. Purchase the securities of any issuer (other than "Government
securities" as defined under the 1940 Act) if, as a result, more than 25% of the
value of the Fund's total assets would be invested in the securities of
companies whose principal business activities are in the same industry.
3. Issue any senior securities, except as permitted by the 1940 Act or
the Rules and Regulations of the Securities and Exchange Commission.
4. Borrow money, except from banks for temporary or emergency purposes
provided that such borrowings may not exceed 33-1/3% of the value of the Fund's
net assets (including the amount borrowed). Any borrowings that come to exceed
this amount will be reduced within three days (not including Sundays and
holidays) to the extent necessary to comply with the 33-1/3% limitation. This
limitation shall not prohibit the Fund from engaging in reverse repurchase
agreements, making deposits of assets to margin or guarantee positions in
futures, options, swaps or forward contracts, or segregating assets in
connection with such agreements or contracts.
5. Act as an underwriter of securities of other issuers, except to the
extent that in connection with the disposition of portfolio securities the Fund
may be deemed to be an underwriter under applicable laws.
6. Purchase or sell real estate unless acquired as a result of ownership
of securities or other instruments. This restriction shall not prevent the Fund
from investing in securities or other instruments backed by real estate or
securities of companies engaged in the real estate business.
7. Purchase or sell physical commodities unless acquired as a result of
ownership of securities or other instruments (but this shall not prevent the
Fund from purchasing or selling options and future contracts or from investing
in securities or other instruments backed by physical commodities).
8. Make loans to other persons except to the extent not inconsistent with
the 1940 Act or the Rules and Regulations of the Securities and Exchange
Commission. This limitation does not apply to purchases of commercial paper,
debt securities or repurchase agreements, or to the lending of portfolio
securities.
9. Purchase securities on margin, except that the Fund may obtain such
short-term credits as may be necessary for the clearance of purchases or sales
of securities and provided that margin payments in connection with transactions
in options, futures, swaps and forward contracts shall not be deemed to
constitute purchasing securities on margin.
10. Sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, swaps and forward futures contracts are
not deemed to constitute selling securities short.
11. Except as part of a merger, consolidation, acquisition, or
reorganization, invest more than 5% of the value of its total assets in the
securities of any one investment company or more than 10% of the value of its
total assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting securities of
any one investment company.
12. Mortgage, pledge or hypothecate its assets except to the extent
necessary to secure permitted borrowings. This limitation does not apply to
reverse repurchase agreements or in the case of assets deposited to margin or
guarantee positions in futures, options, swaps or forward contracts or placed in
a segregated account in connection with such contracts.
13. Participate on a joint or a joint and several basis in any
securities trading account.
12
<PAGE>
14. Developing Countries Fund may not invest more than 10% of its net
assets in illiquid investments. International Fund may not invest more than 15%
of its securities in illiquid investments.
15. Invest directly in interests (including partnership interests) in
oil, gas or other mineral exploration or development leases or programs, except
the Fund may purchase or sell securities issued by corporations engaging in oil,
gas or other mineral exploration or development business.
Any of the Fund's investment policies set forth under "Investment Objective
and Policies" in the Prospectus, or any restriction set forth above under
"Investment Restrictions" which involves a maximum percentage of securities or
assets shall not be considered to be violated unless an excess over the
percentage occurs immediately after an acquisition of securities or utilization
of assets and results therefrom.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of portfolio securities owned by the Fund during
the same fiscal year. "Portfolio securities" for purposes of this calculation
do not include securities with a maturity date of less than twelve (12) months
from the date of investment. A 100% portfolio turnover rate would occur, for
example, if the lesser of the value of purchases or sales of portfolio
securities for a particular year were equal to the average monthly value of the
portfolio securities owned during such year. The International Fund's
historical portfolio turnover rates are set forth in the prospectus section
"Financial Highlights".
INVESTMENT PERFORMANCE
Advertisements and other sales literature for each Fund may refer to
monthly, quarterly, yearly, cumulative and average annual total return. Each
such calculation assumes all dividends and capital gain distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus, and includes all recurring fees, such as investment advisory
and management fees, charged as expenses to all shareholder accounts. Each of
monthly, quarterly and yearly total return is computed in the same manner as
cumulative total return, as set forth below.
Cumulative total return is computed by finding the cumulative rate of
return over the period indicated in the advertisement that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
CTR = (ERV-P) 100
-----
P
Where: CTR = Cumulative total return;
ERV = ending redeemable value at the end of the period
of a hypothetical $1,000 payment made at the
beginning of such period; and
P = initial payment of $1,000
Average annual total return is computed by finding the average annual
compounded rates of return over the periods indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:
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<PAGE>
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of the period
of a hypothetical $1,000 payment made at the
beginning of such period.
The table below shows the yearly total return for International Fund for the
periods indicated.
Year International
Ended 12/31 Total Return
----------- ------------
1987............................................... (7.2%)*
1988............................................... 18.0%
1989............................................... 18.4%
1990............................................... (13.1%)
1991............................................... 16.6%
1992............................................... (6.3%)
1993............................................... 39.50%
1994............................................... .46%
______________________
* Commenced operations on April 23, 1987
The average annual total return of International Fund for the one and
five year periods ended January 31, 1995 and from April 23, 1987 (commencement
of operations) through March 31, 1994 was (10.28%), 5.01% and 6.44%,
respectively.
In advertising and sales literature, each Fund may compare its
performance with that of other mutual funds, indexes or averages of other mutual
funds, indexes of related financial assets or data, and other competing
investment and deposit products available from or through other financial
institutions. The composition of these indexes, averages or products differs
from that of a Fund. The comparison of a Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. A Fund may also note its mention in newspapers, magazines, or
other media from time to time. However, a Fund assumes no responsibility for
the accuracy of such data.
For example, (1) a Fund's performance or P/E ratio may be compared to
any one or a combination of the following: (i) the Standard & Poor's 500 Stock
Index and Dow Jones Industrial Average so that you may compare a Fund's results
with those of a group of unmanaged securities widely regarded by investors as
representative of the U.S. stock market in general; (ii) other groups of mutual
funds, including the IAI Funds, tracked by: (A) Lipper Analytical Services,
Inc., a widely used independent research firm which ranks mutual funds by
overall performance, investment objectives, and assets; (B) Morningstar, Inc.,
another widely used independent research firm which rates mutual funds; or (C)
other financial or business publications, which may include, but are not limited
to, Business Week, Money Magazine, Forbes and Barron's, which provide similar
information; (iii) The Financial Times (a London based international financial
newspaper)-Actuaries World Indices, including Europe and sub indices comprising
this Index (a wide range of comprehensive measures of stock price performance
for the major stock markets, as well as for regional areas, broad economic
sectors and industry groups); (iv) Morgan Stanley Capital International Indices,
including the EAFE Index; (v) Baring International Investment Management Limited
(an international securities trading, research, and investment management firm),
as a source for market
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<PAGE>
capitalization, GDP and GNP; (vi) the International Finance Corporation (an
affiliate of the World Bank established to encourage economic development in
less developed countries), World Bank, OECD (Organization for Economic Co-
Operation and Development) and IMF (International Monetary Fund) as a source of
economic statistics; and (ix) the performance of U.S. government and corporate
bonds, notes and bills. (The purpose of these comparisons would be to illustrate
historical trends in different market sectors so as to allow potential investors
to compare different investment strategies.); (2) the Consumer Price Index
(measure for inflation) may be used to assess the real rate of return from an
investment in a Fund; (3) other U.S. or foreign government statistics such as
GNP, and net import and export figures derived from governmental publications,
e.g., The Survey of Current Business, may be used to illustrate investment
attributes of a Fund or the general economic business, investment, or financial
environment in which a Fund operates; (4) the effect of tax-deferred compounding
on a Fund's investment returns, or on returns in general, may be illustrated by
graphs, charts, etc. where such graphs or charts would compare, at various
points in time, the return from an investment in a Fund (or returns in general)
on a tax-deferred basis (assuming reinvestment of capital gains and dividends
and assuming one or more tax rates) with the return on a taxable basis; and (5)
the sectors or industries in which a Fund invests may be compared to relevant
indices or surveys (e.g., S&P Industry Surveys) in order to evaluate a Fund's
historical performance or current or potential value with respect to the
particular industry or sector.
MANAGEMENT
The names, addresses and positions of the directors and executive
officers of the Funds are given below.
<TABLE>
<CAPTION>
Name and Address Position Aggregate Compensation Aggregate Compensation
- ---------------- -------- from Each Fund* from IAI Mutual Funds**
--------------- -----------------------
<S> <C> <C> <C>
Noel P. Rahn*** Chairman of NA NA
3700 First Bank Place the Board
P.O. Box 357
Minneapolis, Minnesota 55440
Richard E. Struthers*** President, Director NA NA
3700 First Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Madeline Betsch Director $1,175 $26,350
19 South 1st Street
Minneapolis, Minnesota 55401
W. William Hodgson Director $1,175 $26,350
1698 Dodd Road
Mendota Heights, Minnesota 55118
George R. Long Director $ 975 $24,950
29 Las Brisas Way
Naples, Florida 33963
J. Peter Thompson Director $1,175 $26,350
Route 1
Mountain Lake, Minnesota 56159
Charles H. Withers Director $ 975 $24,950
Rochester Post-Bulletin
P.O. Box 6118
Rochester, Minnesota 55903
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
Name and Address Position Aggregate Compensation Aggregate Compensation
- ---------------- -------- from Each Fund* from IAI Mutual Funds**
--------------- -----------------------
<S> <C> <C> <C>
Archie C. Black III Treasurer NA NA
3700 First Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
William C. Joas Secretary NA NA
3700 First Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Roy Gillson Vice President, Investments NA NA
45 Beech Street
London, EC2 P2LX, United Kingdom
Robert Swift Vice President, Investments NA NA
45 Beech Street
London, EC2 P2LX, United Kingdom
Kirk Gove Vice President, Marketing NA NA
3700 First Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Susan Schelpf Vice President, Operations NA NA
3700 First Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Susan J. Haedt Vice President, NA NA
3700 First Bank Place Controller
P.O. Box 357
Minneapolis, Minnesota 55440
</TABLE>
_____________
* For the fiscal period April 1, 1994 through January 31, 1995.
** For the calendar year ended December 31, 1995. There are currently eighteen
portfolios within the IAI Mutual Funds.
*** Directors of each Fund who are interested persons (as that term is defined
by the Investment Company Act of 1940) of IAI and each Fund.
Noel P. Rahn has been Chief Executive Officer and a Director of IAI since
1974.
Richard E. Struthers is Executive Vice President and a Director of IAI and
has served IAI in many capacities since 1979.
Madeline Betsch, until April 1994, was Executive Vice President, Director
of Client Services, of CME-KHBB Advertising since May 1985, and prior thereto
was a Vice President with Campbell-Mithun, Inc. since February 1977. Ms. Betsch
is currently President of ESMA Corp., a start-up business in the beauty and
wellness field.
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<PAGE>
W. William Hodgson served as information manager for the North Central Home
Office of the Prudential Insurance Company of America from 1961 until 1984; he
is currently retired.
George R. Long has been Chairman of Mayfield Corp. (financial consultants
and venture capitalists) since 1973.
J. Peter Thompson has been a grain farmer in southwestern Minnesota since
1974. Prior to that, Mr. Thompson was employed by Paine Webber, Jackson &
Curtis, Incorporated, most recently as Senior Vice President and General
Partner.
Charles H. Withers was Editor of the Rochester Post-Bulletin, Rochester,
Minnesota from 1960 through March 31, 1980; he is currently retired.
Archie C. Black is a Senior Vice President and Chief Financial Officer of
IAI and has served IAI in several capacities since 1987.
William C. Joas is an Associate Vice President of IAI. Prior to joining IAI
in 1990, Mr. Joas served in the legal administration department of Tricord
Systems, Inc.
Roy Gillson is Chief Investment Officer and a Director of IAI International
Limited. Mr. Gillson joined IAI International in 1983.
Robert Swift is a Far East Equity Strategist, portfolio manager and
Director of IAI International Limited. Mr. Swift joined IAI International in
1991.
Kirk Gove is a Vice President of IAI. Prior to joining IAI in 1991, Mr.
Gove served as an Assistant Vice President of Dain Bosworth Incorporated.
Susan Schelpf is a Vice President of IAI and Director of Mutual Fund
Operations. Prior to joining IAI in 1993, Ms. Schelpf served as a Vice
President at SEI Corporation.
Susan J. Haedt is a Vice President of IAI and Funds Controller. Prior to
joining IAI in 1992, Ms. Haedt served as a Senior Manager at KPMG Peat Marwick
LLP.
Each Fund has agreed to reduced initial subscription requirements for
employees and directors of a Fund or IAI, their spouses, children and
grandchildren. With respect to such persons, the minimum initial investment in
one or more of the IAI Family of Funds is $500; provided that the minimum amount
that can be allocated to any one of the Funds is $250. Subsequent subscriptions
are limited to a minimum of $100 for each of the Funds.
No compensation is paid by a Fund to any of its officers. Directors who
are not affiliated with IAI receive $300 annually, $250 for each Board meeting
attended and $200 for each Audit or Restricted Securities Committee meeting
attended. Such unaffiliated directors also are reimbursed for expenses incurred
in connection with attending meetings.
The Board of Directors for each of the Funds, at a meeting held May 10,
1995, approved a new Code of Ethics. The Code permits access persons to engage
in personal securities transactions subject to certain policies and procedures.
Such procedures prohibit the acquiring of any securities in an initial public
offering. In addition, all securities acquired through private placement must
be pre-cleared. Procedures have been adopted which would implement blackout
periods for certain securities, as well as a ban on short-term trading profits.
Additional policies prohibit the receipt of gifts in certain instances.
Procedures have been implemented to monitor employee trading. Each access
person of the Adviser is required to certify annually that they have read and
understood the Code of Ethics. An annual report is provided to the Funds' Board
of Directors summarizing existing procedures and changes, identifying material
violations and recommending any changes needed.
17
<PAGE>
IAI and IAI International are affiliates of Hill Samuel Group ("Hill
Samuel"). Hill Samuel is an international merchant banking and financial
services firm headquartered in London, England. In addition to its ownership of
IAI, Hill Samuel owns controlling interests in over seventy insurance, merchant
banking and financial services subsidiaries located in Western Europe, Asia, the
United States, Australia, New Zealand and Great Britain. The principal offices
of Hill Samuel are located at 100 Wood Street, London EC2 P2AJ.
Hill Samuel, in turn, is owned by TSB Group, plc ("TSB"), a publicly-held
financial services organization headquartered in London, England. TSB is one of
the largest personal and corporate financial services groups in the United
Kingdom engaged in a wide range of activities including banking, unit linked
life assurance, unit trust management, investment management, credit card and
finance house business. The principal offices of TSB are located at 25 Milk
Street, London EC2 V8LU.
HISTORY
Each Fund is a separate portfolio of IAI Investment Funds III, Inc., a
Minnesota corporation whose shares of common stock are currently issued in two
series (Series A and B). The investment portfolio represented by Series A
common shares is referred to as "IAI International Fund." The investment
portfolio represented by Series B common shares is referred to as "IAI
Developing Countries Fund."
INVESTMENT ADVISORY AGREEMENTS
Pursuant to an Investment Advisory Agreement between each Fund and IAI (the
"Advisory Agreement"), IAI has agreed to provide each Fund with investment
advice, statistical and research facilities, and certain equipment and services,
including, but not limited to, office space and necessary office facilities,
equipment and the services of required personnel. In return, each Fund has
agreed to pay IAI a monthly fee. Under the Advisory Agreement, IAI has the sole
authority and responsibility to make and execute investment decisions for each
Fund within the framework of the Fund's investment policies, subject to review
by the directors of each Fund. Under a Subadvisory Agreement, IAI has delegated
certain of its investment advisory duties and responsibilities to IAI
International.
Developing Countries Fund has agreed to pay IAI an advisory fee at an
annual rate of 1.25% of Developing Countries Fund's average daily net assets for
the first $200,000,000 in assets, 1.10% for the next $200,000,000 in assets and
1.00% for assets above $400,000,000. For the fiscal year commencing February 1,
1995, IAI has voluntarily agreed to waive certain fees so that total Developing
Countries Fund expenses do not exceed 2.00% of Developing Countries Fund's
average daily net assets on an annual basis.
International Fund has agreed to pay IAI a monthly fee of 1.00% per year of
International Fund's average month-end net assets for the first $100,000,000 in
assets, .85% for the next $100,000,000 in assets, .75% for the next $100,000,000
in assets, and .70% for assets above $300,000,000. As of January 31, 1995,
International Fund had net assets of $136,473,687. For its fiscal years ended
March 31, 1993 and 1994 and for the fiscal period ended January 31, 1995, the
Fund paid IAI $468,455, $960,110 and $1,213,486, respectively.
Pursuant to the Subadvisory Agreement between IAI and IAI International,
IAI has delegated to IAI International the sole authority and responsibility to
make and execute investment decisions for each Fund within the framework of such
Fund's investment policies and subject to review by IAI and the Fund's Board of
Directors. Pursuant to the Subadvisory Agreement, IAI has agreed to pay IAI
International one-half of the advisory fee received by IAI under each Advisory
Agreement.
ADMINISTRATIVE AGREEMENT
Each Fund has engaged IAI to serve as such Fund's administrative, dividend
disbursing, redemption, accounting services and transfer agent pursuant to an
Administrative Agreement. Under the Administrative Agreement, IAI has agreed to
provide to each Fund all required administrative, stock transfer, redemption,
dividend disbursing and accounting services including, without limitation, the
following: (1) the maintenance of accounts, books and records; (2) the
calculations of the daily net asset value in accordance with the Fund's current
18
<PAGE>
Prospectus and Statement of Additional Information; (3) daily and periodic
reports; (4) all information necessary to complete tax returns, questionnaires
and other reports requested by a Fund; (5) the maintenance of stock registry
records; (6) the processing of requested account registration changes and
redemption requests; and (7) the administration of payments of dividends and
distributions declared by each Fund. As compensation for these services,
Developing Countries Fund has agreed to pay IAI a monthly fee equal to .30% of
the Fund's average daily net assets on an annual basis. International Fund has
agreed to pay IAI a monthly fee equal to .30% of the Fund's average month-end
net assets. With respect to Developing Countries Fund's fiscal year commencing
February 1, 1995, IAI has voluntarily agreed to waive certain fees so that total
Developing Countries Fund expenses do not exceed 2.00% of Developing Countries
Fund's average daily net assets on an annual basis. For the fiscal period
ended January 31, 1995, International Fund paid IAI $384,051 pursuant to the
Administrative Agreement.
ALLOCATION OF EXPENSES
In addition to the advisory and administrative fees paid to IAI, each Fund
pays all its other costs and expenses, including, for example, costs incurred in
the purchase and sale of assets, interest, taxes, charges of the custodian of a
Fund's assets, costs of reports and proxy material sent to Fund shareholders,
fees paid for independent accounting and legal services, costs of printing
Prospectuses for Fund shareholders and registering the Fund's shares, postage,
fees to directors who are not "interested persons" of a Fund, distribution
expenses pursuant to each Fund's Rule 12b-1 plan, insurance premiums, costs of
attending investment conferences and such other costs which may be designated as
extraordinary. With respect to International Fund, IAI has agreed to reimburse
the Fund for expenses (other than brokerage commissions and other expenditures
in connection with the purchase and sale of portfolio securities, interest
expense, and subject to the specific approval of a majority of the disinterested
directors of International Fund, taxes and extraordinary expenses which exceed
on an annual basis, 2.00% of the International Fund's average month-end net
assets (the "expense limit"). Certain state securities commissions may impose
limitations on certain of a Fund's expenses, and IAI may be required by such
state commissions to reimburse a Fund for expenses in excess of any limitations
as a requirement to selling shares of the Fund in those states. IAI is not
liable for any loss suffered by a Fund in the absence of willful misfeasance,
bad faith or gross negligence in the performance of its duties and obligations.
DURATION OF AGREEMENTS
The Advisory Agreements, the Subadvisory Agreements and the Administrative
Agreements terminate automatically in the event of its assignment. In addition,
each Agreement is terminable at any time without penalty by the Board of
Directors of a Fund or by vote of a majority of a Fund's outstanding voting
securities on not more than 60 days' written notice, and by IAI (or IAI
International) on 60 days' notice to the counterparty. Each Agreement shall
continue in effect from year to year only so long as such continuance is
specifically approved at least annually by either the Board of Directors of the
Fund or by vote of a majority of the outstanding voting securities, provided
that in either event such continuance is also approved by the vote of a majority
of directors who are not parties to the Agreement or interested persons of such
parties cast in person at a meeting called for the purpose of voting on such
approval.
PLAN OF DISTRIBUTION
Each Fund has adopted a Plan of Distribution relating to the payment of
certain distribution expenses pursuant to Rule 12b-1 under the 1940 Act. The
Plan was last approved by the Board of Directors at a meeting on August 10, 1994
for International Fund and on November 9, 1994 for Developing Countries Fund,
and by the shareholders of International Fund on June 25, 1993, and by
shareholders of Developing Countries Fund on January 23, 1995.
Rule 12b-1(b) provides that any payments made by a fund in connection with
the distribution of its shares may only be made pursuant to a written plan
describing all material aspects of the proposed financing of distribution and
also requires that all agreements with any person relating to implementation of
the plan must be in writing. In addition, Rule 12b-1(b)(1) requires that such
plan be approved by a vote of at least a majority of the fund's outstanding
shares, and Rule 12b-1(b)(2) requires that such plan, together with any related
agreements, be
19
<PAGE>
approved by a vote of the board of directors of the company and the directors of
the company who are not interested persons of the company and have no direct or
indirect financial interest in the operation of the plan or in any agreements
related to the plan, cast in person at a meeting called for the purpose of
voting on such plan or agreements. Rule 12b-1(b)(3) requires that the plan or
agreement provide, in substance: (1) that it shall continue in effect for a
period of more than one year from the date of its execution or adoption only so
long as such continuance is specifically approved at least annually in the
manner described in paragraph (b)(2) of Rule 12b-1; (2) that any person
authorized to direct the disposition of monies paid or payable by a fund
pursuant to its plan or any related agreement shall provide to a fund's board of
directors, and the directors shall review, at least quarterly, a written report
of the amount so expended and the purposes for which such expenditures were
made; and (3) in the case of a plan, that it may be terminated at any time by
vote of a majority of the members of the board of directors of a fund who are
not interested persons of the fund and have no direct or indirect financial
interest in the operation of the plan or in any agreements related to the plan
or by vote of a majority of the outstanding voting securities of a fund.
Rule 12b-1(b)(4) requires that such plans may not be amended to increase
materially the amount to be spent for distribution without shareholder approval
and that all material amendments of the plan must be approved in the manner
described in paragraph (b)(2) of Rule 12b-1. Rule 12b-1(c) provides that a fund
may rely upon Rule 12b-1(1) only if selection and nomination of its
disinterested directors are committed to the discretion of such disinterested
directors. Rule 12b-1(e) provides that a fund may implement or continue a plan
pursuant to Rule 12b-1(b) only if the directors who vote to approve such
implementation or continuation conclude, in the exercise of reasonable business
judgment and in light of their fiduciary duties under state law, and under
Section 36(a) and (b) of the 1940 Act, that there is a reasonable likelihood
that the plan will benefit the fund and its shareholders. At the meeting of the
Board of Directors on August 10, 1994 for International Fund and at the Board of
Directors on November 9, 1994, the directors so concluded with respect to the
Fund's Plan of Distribution.
Pursuant to the Plan of Distribution, each Fund has entered into an
Underwriting and Distribution Agreement pursuant to which each Fund will make
payments to IAI Securities, Inc. (the "Underwriter") at an annual rate of .25%
of Developing Countries Fund's average daily net assets, and .25% of
International Fund's average month-end net assets to cover expenses incurred by
the Underwriter in connection with the distribution of each Fund's shares (which
amount is paid to the Underwriter regardless of amounts spent by the Underwriter
in distributing a Fund's shares). The distribution fee payable by a Fund to the
Underwriter may be used by the Underwriter to pay advertising and promotional
expenses including, without limitation, costs of printing and providing
Prospectuses, Statements of Additional Information, annual reports and
semiannual reports to prospective shareholders, expenses of preparing and
providing sales literature advertising of any type, and compensation and
benefits paid to and expenses incurred by personnel, including supervisory
personnel, involved in direct mail and advertising activities and activities
relating to the direct marketing of shares of the Fund to the public and
compensation to other broker-dealers for their sale of Fund Shares.
The distribution fee payable by International Fund is subject to the
expense limitations set forth in the Advisory Agreement as described above.
With respect to Developing Countries Fund, for the Fund's fiscal year commencing
February 1, 1995, the Underwriter has voluntarily agreed to waive certain fees
so that total Developing Countries Fund expenses do not exceed 2.00% of
Developing Countries Fund's average daily net assets on an annual basis.
Additionally, the Underwriter, in its sole and absolute discretion, may from
time to time out of its own assets pay for certain additional costs of
distributing the Fund's shares. The Underwriter is an affiliate of IAI.
The distribution fee paid by International Fund pursuant to its Plan of
Distribution during its fiscal period from April 1, 1994 to January 31, 1995 was
$320,042. All such distribution fees were paid to, and retained by, the
Underwriter pursuant to the Underwriting and Distribution Agreement discussed
above. During the period ended January 31, 1995, such distribution fees were
paid by the Underwriter in connection with the distribution of the Fund's shares
as follows:
20
<PAGE>
<TABLE>
<S> <C>
Advertising.............................. $133,458
Printing and mailing of prospectuses to
other than current shareholders......... $ 69,769
Payments to brokers or dealers........... $ 48,646
Direct payments to sales personnel....... $ 46,406
Other.................................... $ 21,763
</TABLE>
CUSTODIAL SERVICE
The custodian for the Funds is Norwest Bank Minnesota, N.A. Norwest Center,
Sixth and Marquette, Minneapolis, MN 55479. Norwest has entered into an
agreement with Morgan Stanley Trust Company, 1 Pierrepont Plaza, Brooklyn, New
York ("Morgan Stanley") which enables Developing Countries and International
Fund to utilize the subcustodian and depository network of Morgan Stanley. Such
agreements, subcustodians and depositories were approved by the Fund's Board of
Directors in accordance with the rules and regulations of the Securities and
Exchange Commission, for the purpose of providing custodial services for the
Fund's assets held outside the United States.
The following is a listing of the subcustodians and depositories currently
approved by Developing Countries and International Funds' directors and the
countries in which such subcustodians and depositories are located:
BRANCHES OF THE CUSTODIAN
AND SUBCUSTODIAN BANKS
----------------------
Argentina Citibank, N.A., Buenos Aires Branch
Australia Australia & New Zealand Banking Group, Ltd.
Belgium Banque Bruxelles Lambert (BBL)
Botswana Barclays Bank of Botswana
Brazil Banco de Boston
Canada Toronto Dominion Bank
Chile Citibank, N.A., Santiago Branch
China Hong Kong & Shanghai Banking, Corp. Ltd.
Columbia Cititrust
Czech Republic ING Bank
France Banque Indosuez
Germany Berliner Handels-und-Frankfurter Bank
Ghana Barclays Bank of Ghana
21
<PAGE>
Greece Citibank, N.A., Athens Branch
Hong Kong Hong Kong & Shanghai Banking Corp. Ltd.
Hungary Citibank, N.A., Budapest Branch
India Standard Chartered Bank
Indonesia Hong Kong & Shanghai Banking Corp. Ltd.
Ireland Allied Irish Bank
Israel Bank Leumi
Italy Barclays Bank PLC
Japan The Mitsubishi Bank Limited
Jordan Arab Bank plc
Korea Standard Chartered Bank
Luxembourg Banque Bruxelles Lambert
Malaysia Oversea Chinese Banking Corporation
Mexico Citibank, N.A., Mexico City Branch
Morocco Banque Commerciale du Maroc
Netherlands ABN Amro Bank
New Zealand Bank of New Zealand
Pakistan Standard Chartered Bank
Papua New Guinea Australia and New Zealand Bank
Peru Citibank N.A., Lima Branch
Philippines Hong Kong & Shanghai Banking Corp. Ltd.
Poland Citibank, S.A.
Portugal Banco Commercial Portugues
Singapore Oversea Chinese Banking Corporation
South Africa First National Bank of Southern Africa
Spain Banco Santader
Sri Lanka Hong Kong & Shanghai Banking, Corp. Ltd.
22
<PAGE>
Switzerland Morgan Guaranty Trust Company of New
York, Zurich Branch
Taiwan Hong Kong & Shanghai Banking Corp. Ltd.
Thailand Standard Chartered Bank
Turkey Citibank, N.A., Istanbul Branch
United Kingdom Barclays Bank PLC
Uruguay Citibank, N.A., Montevideo Branch
Venezuela Citibank, N.A., Caracas Branch
Zimbabwe Barclays Bank of Zimbabwe
DEPOSITORIES
------------
Argentina Caja de Valores
Australia Clearing House Electronic Subregister System
Austria Euroclear Clearance System
OsterreicheKontrollbank
Belgium C.I.K. (Caisse Interprofessionelle de
Depot et de Virements de Titres S.A.)
Brazil Sao Paulo Stock Exchange
Canada CDS (The Canadian Depository
for Securities Ltd.)
Czech Republic Center for Securities (SCP)
Denmark Euroclear Clearance System
Vaerdipapircentralen
Finland Euroclear Clearance System
France SICOVAM (Societe Interprofessionelle la
Compensacion des Valuers Mobilieres)
Germany Kassenverein (Deutscher Kassenverein AG)
Hong Kong Central Clearing and Settlement System
Hungary Euroclear Clearance System
OsterreicheKontrollbank
Italy Monte Titoli, S.p.A
Japan Japan Securities Depository Center
23
<PAGE>
Korea The Korean Central Depository
Malaysia The Malaysian Central Depository
Mexico Instituto para el Deposito de Valores
Netherlands NECIGEF (Netherlands Centraal Instit
voor Giraal Effectenverkeer B.V.)
Norway Euroclear Clearance System
Verdipapirsentralen
Singapore Central Depository Pte Ltd.
Spain Servicio de Compensacion y Liquidacion de
Valores
Sweden Euroclear Clearance System
Vardepapperscentralen VPC AB
Switzerland SEGA (Schweizerische Effekten Giro A.G.)
Taiwan Taiwan Securities Depository Co.
Thailand Share Depository Center
United Kingdom Stock Exchange Talisman System
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
Most of the Fund's portfolio transactions are effected with dealers
without the payment of brokerage commissions but at a net price which usually
includes a spread or markup. In effecting such portfolio transactions on behalf
of a Fund, IAI seeks the most favorable net price consistent with the best
execution.
Generally, however, a Fund must deal with brokers. IAI selects and
(where applicable) negotiates commissions with the brokers who execute the
transactions for such Fund. The primary criteria for the selection of a broker
is the ability of the broker, in the opinion of IAI, to secure prompt execution
of the transactions on favorable terms, including the reasonableness of the
commission and considering the state of the market at the time. In selecting a
broker, IAI may consider whether such broker provides brokerage and research
services (as defined in the Securities Exchange Act of 1934). IAI may direct
Fund transactions to brokers who furnish research services to IAI. Such
research services include advice, both directly and in writing, as to the value
of securities, the advisability of investing in, purchasing or selling
securities, and the availability of securities or purchasers or sellers of
securities, as well as analyses and reports concerning issues, industries,
securities, economic factors and trends, portfolio strategy, and the performance
of accounts. By allocating brokerage business in order to obtain research
services for IAI, a Fund enables IAI to supplement its own investment research
activities and allows IAI to obtain the views and information of individuals and
research staffs of many different securities research firms prior to making
investment decisions for a Fund. To the extent such commissions are directed to
brokers who furnish research services to IAI, IAI receives a benefit, not
capable of evaluation in dollar amounts, without providing any direct monetary
benefit to the Fund from these commissions. Generally a Fund pays higher than
the lowest commission rates available.
IAI believes that most research services obtained by it generally
benefit one or more of the investment companies or other accounts which it
manages. Normally research services obtained through commissions paid by
24
<PAGE>
the managed fund investing in common stocks and managed accounts investing in
common stocks would primarily benefit the fund and accounts.
There is no formula for the allocation by IAI of each Fund's brokerage
business to any broker-dealers for brokerage and research services. However,
IAI will authorize a Fund to pay an amount of commission for effecting a
securities transaction in excess of the amount of commission another broker
would have charged only if IAI determines in good faith that such amount of
commission is reasonable in relation to the value of the brokerage and research
services provided by such broker viewed in terms of either that particular
transaction or IAI's overall responsibilities with respect to the accounts as to
which it exercises investment discretion.
Although investment decisions for a Fund are made independently from
other accounts as to which IAI gives investment advice, it may occasionally
develop that the same security is suitable for more than one account. If and
when more than one account simultaneously purchase or sell the same security,
the transactions will be averaged as to price and allocated as to amount in
accordance with arrangements equitable to each Fund and such accounts. The
simultaneous purchase or sale of the same securities by a Fund and other
accounts may have detrimental effects on the Fund, as they may affect the price
paid or received by a Fund or the size of the position obtainable by a Fund.
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and subject to the policies set forth in the preceding
paragraphs and such other policies as the Board of Directors of the Fund may
determine, IAI may consider sales of shares of a Fund as a factor in the
selection of broker-dealers to execute the Fund's securities transactions.
CAPITAL STOCK
Each Fund is a separate portfolio of IAI Investment Funds III, Inc., a
Minnesota corporation whose shares of common stock are currently issued in two
series (Series A and B). Each share of a series is entitled to participate pro
rata in any dividends and other distributions of such series and all shares of a
series have equal rights in the event of liquidation of that series. The Board
of Directors of IAI Investment Funds III, Inc., is empowered under the Articles
of Incorporation of such company to issue other series of the company's common
stock without shareholder approval. IAI Investment Funds III, Inc., has
authorized 10,000,000,000 shares of $.01 par value common stock to be issued as
Series A common shares, and 10,000,000,000 shares of $.01 par value common stock
to be issued as Series B common shares. As of January 31, 1995, International
Fund has 11,314,584 shares outstanding.
As of May 12, 1995, no person held of record or, to the knowledge of
International Fund, beneficially owned more than 5% of the outstanding shares of
International Fund, except as set forth in the following table:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
Name and Address Number of Percent of
of Shareholder Shares Class
- ----------------------------------------------------------------
<S> <C> <C>
Greater Cleveland Hospital Association 1,078,594 9.39
1226 Huron Rd., Playhouse Square
Cleveland, OH 44115
Charles Schwab & Co., Inc. 1,125,855 9.80
101 Montgomery Street
San Francisco, CA 94104
</TABLE>
In addition, as of May 15, 1995, the Fund's officers and directors as a
group owned less than 1% of the Fund's outstanding shares.
25
<PAGE>
As of May 12, 1995, no person held of record or, to the knowledge of
Developing Countries Fund, beneficially owned more than 5% of the outstanding
shares of Developing Countries Fund, except as set forth in the following table:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
Name and Address Number of Percent of
of Shareholder Shares Class
- ------------------------------------------------------------------
<S> <C> <C>
Donaldson, Lufkin, Jenrette Securities C 18,815 6.78
Pershing Division, Mutual Fund Balancing
PO Box 2052
Jersey City, NJ 07303
IAI Trust Company as Trustee 18,523 6.67
fbo Investment Advisers, Inc.
Profit Sharing and Pension Trust
3700 First Bank Place
PO Box 357
Minneapolis, MN 55440
Camden Physicians, LTD PST 28,310 10.20
fbo Glenn Schiffler
Camden Emerson Clinics
4010 Orleans Lane N.
Plymouth, MN 55441
Norwest Capital Management & Trust Co. 15,560 5.61
North Dakota Meritcare PST IA
Attn: Barb
4th and Main
Fargo, ND 58126
</TABLE>
In addition, as of May 15, 1995, Developing Countries Fund officers and
directors as a group owned approximately 10,200 shares, representing
approximately 3.67% of Developing Countries Fund's outstanding shares.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The portfolio securities in which each Fund invests fluctuate in value, and
hence, for each Fund, the net asset value per share also fluctuates.
The net asset value per share of a Fund is determined once daily as of the
close of trading on the New York Stock Exchange on each business day on which
the New York Stock Exchange is open for trading, and may be determined on
additional days as required by the Rules of the Securities and Exchange
Commission. The New York Stock Exchange is closed, and the net asset value per
share of a Fund is not determined, on the following national holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day, and Christmas Day.
On January 31, 1995, the net asset value and public offering price per
share of International Fund was calculated as follows:
NAV = Net Assets ($136,473,687) = $12.06
-------------------------------
Shares Outstanding (11,314,584)
26
<PAGE>
TAX STATUS
The tax status of the Funds and the distributions of the Funds are
summarized in the Prospectus under "Dividends, Distributions and Tax Status."
Because it is expected that no portion of the net investment income of the
Funds will derive from dividends from domestic corporations, it is probable that
no portion of the dividends paid by the Funds will qualify for the 70% deduction
for dividends received under the provisions of Internal Revenue Code of 1986, as
amended (the "Code").
If Fund shares are sold or otherwise disposed of more than one year from
the date of acquisition, the difference between the price paid for the shares
and the sales price will result in long-term capital gain or loss to the Fund
shareholder if, as is usually the case, the Fund shares are a capital asset in
the hands of the Fund shareholder at that time. However, under a special
provision in the Code, if Fund shares with respect to which a long-term capital
gain distribution has been, or will be, made are held for six months or less,
any loss on the sale or other disposition of such shares will be long-term
capital loss to the extent of such gain distribution.
Ordinarily, distributions and redemption proceeds earned by Fund
shareholders are not subject to withholding of federal income tax. However,
each Fund is required to withhold 31% of a shareholder's distributions and
redemption proceeds upon the occurrence of certain events specified in Section
3406 of the Code and regulations promulgated thereunder. These events include
the failure of a Fund shareholder to supply the Fund with such shareholder's
taxpayer identification number, and the failure of a Fund shareholder who is
otherwise exempt from withholding to properly document such shareholder's status
as an exempt recipient. Additionally, distributions may be subject to state and
local income taxes, and the treatment thereunder may differ from the federal
income tax consequences discussed above.
Under the Code, each Fund will be subject to a non-deductible excise tax
equal to 4% of the excess, if any, of the amount of investment income and
capital gains required to be distributed pursuant to the Code for each calendar
year over the amount actually distributed. In order to avoid this excise tax,
each Fund generally must declare dividends by the end of each calendar year
representing 98% of each Fund's ordinary income for such calendar year and 98%
of its capital gain net income (both long-term and short-term) for the twelve-
month period ending October 31 of the same calendar year. The excise tax is not
imposed, however, on undistributed income that is already subject to corporate
income tax. It is each Fund's policy not to distribute capital gains until
capital loss carryovers, if any, either are utilized or expire.
The amount of any gain or loss realized by each Fund on closing out a
futures contract may result in a capital gain or loss for federal income tax
purposes. Generally, futures contracts held by each Fund at the close of the
Fund's taxable year will be treated for federal income tax purposes as sold for
their fair market value on the last business day of such year. Forty percent of
any gain or loss resulting from such constructive sale will be treated as short-
term capital gain or loss, and 60% of such gain or loss will be treated as long-
term capital gain or loss. The amount of any capital gain or loss actually
realized by a Fund in a subsequent sale or other disposition of these futures
contracts will be adjusted to reflect any capital gain or loss taken into
account by a Fund in a prior year as a result of the constructive sale of the
contract. Notwithstanding the rules described above, with respect to certain
futures contracts, a Fund may make an election which will have the effect of
exempting all or a part of those identified futures contracts from being treated
for federal income tax purposes as sold on the last business day of a Fund's
taxable year. All or part of any loss realized by a Fund on any closing of a
futures contract may be deferred until all of a Fund's offsetting positions with
respect to the futures contract are closed.
Generally, in order to qualify as a regulated investment company under
Subchapter M of the Code, each Fund must derive at least 90% of its gross income
from dividends, interest, and gains from the sale or other disposition of stock
or securities. Under the Code, each Fund may include income from options,
futures and forward contracts and other gains derived from the Fund's business
of investing in stock, securities or currencies in determining qualifying income
for purposes of the 90% test. Treasury regulations may exclude foreign currency
gains not directly related to a Fund's principal business of investing in stocks
or securities (or options and futures
27
<PAGE>
with respect to stock or securities). It is impossible to predict what amount
of such gains, if any, future Treasury regulations will exclude from qualifying
income.
Subchapter M of the Code also requires that less than 30% of each Fund's
gross income for any year be derived from gains realized on the sale or other
disposition of securities, options, futures contracts or forward contracts held
by a Fund for less than three months. This rule, under certain circumstances,
could require the Fund to defer the closing out of futures contracts until after
three months from the date a Fund acquired the contracts, even if it would be
more advantageous to close out the contracts prior to that time. However, a
special rule is provided with respect to certain designated hedging transactions
which has the effect of allowing a Fund to engage in such short-term
transactions in limited circumstances. Any gains realized by a Fund as a result
of the constructive sales of futures contracts held by a Fund at the end of its
taxable year will be treated as derived from the sale of securities held for
three months or more, regardless of the actual period for which a Fund has held
the futures contracts at the end of the year.
Under the Code, dividends of net investment income received from a Fund by
a shareholder who, as to the United States, is a nonresident alien individual,
nonresident fiduciary of a foreign trust or estate, foreign corporation or
foreign partnership ("foreign shareholder") are subject to a withholding tax of
30% (or such lower rate as is prescribed by the income tax convention, if any,
in force between the U.S. and the foreign shareholder's country) without regard
to the amount of gross income that a Fund derives from sources within the United
States. Distributions of net long-term capital gains to a foreign shareholder
will not be subject to U.S. tax unless the foreign shareholder is engaged in a
U.S. trade or business to which the distributions are attributable, the gains
are attributable to the disposition of a United States real property interest,
or, in the case of a foreign shareholder who is a nonresident alien individual,
such foreign shareholder is physically present in the United States for more
than 182 days during the taxable year.
A disposition of shares in a Fund by a foreign shareholder resulting in
alternative minimum taxable income or net United States real property gain to
the foreign shareholder may be subject to U.S. tax and withholding if the shares
constitute United States real property interests under the Code. It is not
expected that the shares of a Fund will constitute such interests, and a Fund
will furnish affidavits to such effect if necessary and appropriate to avoid
application of U.S. tax or withholding on a disposition of shares.
Income received from sources within foreign countries may be subject to
withholding and other taxes imposed by such countries. Tax conventions between
certain countries and the United States may reduce or eliminate such taxes. It
is impossible to determine the effective rate of foreign tax applicable to such
income in advance since the precise amount of a Fund's assets to be invested in
various countries is not known. Any amount of taxes paid by the Fund to foreign
countries will reduce the amount of income available to a Fund for distributions
to shareholders.
If a Fund is liable for foreign taxes, such Fund expects to meet the
requirements of the Code for passing through to its shareholders foreign taxes
paid, but there can be no assurance that a Fund will be able to do so. Under
the Code, if more than 50% of the value of a Fund's total assets at the close of
its taxable year consist of stock or securities of foreign corporations, a Fund
may file an election with the Internal Revenue Service to pass through to the
Fund's shareholders the amount of foreign taxes paid by the Fund. Pursuant to
this election, shareholders will be required to: (i) include in gross income
their pro rata share of the foreign taxes paid by a Fund; (ii) treat their pro
rata share of foreign taxes as paid by them; and (iii) either deduct their pro
rata share of foreign taxes in computing their taxable income or use their share
as a foreign tax credit against U.S. income taxes. No deduction for foreign
taxes may be claimed by a shareholder who does not itemize deductions. Each
shareholder will be notified within 60 days after the close of a Fund's taxable
year whether the foreign taxes paid by a Fund will pass through for that year.
Under the Code, the amount of foreign taxes for which a shareholder may
claim a foreign tax credit is subject to limitation based on certain categories
applicable to the income subjected to foreign tax. Specifically, the available
foreign tax credit must be determined separately with respect to nine categories
of income. Each Fund may have foreign source income allocable to the four
following categories: (i) passive income; (ii) high withholding tax interest;
(iii) dividends from a noncontrolled foreign corporation pursuant to Section 902
of the
28
<PAGE>
Code; and (iv) other income not specifically categorized. Of these categories, a
substantial part of a Fund income is likely to constitute passive income.
However, in the absence of specific regulatory guidance on the application of
the income categories, such Fund cannot assure shareholders of the correctness
of any allocation made.
The foregoing is a general and abbreviated summary of the Code and Treasury
regulations in effect as of the date of the Funds' Prospectus and this Statement
of Additional Information.
LIMITATION OF DIRECTOR LIABILITY
Under Minnesota law, each Fund's Board of Directors owes certain fiduciary
duties to the Fund and to its shareholders. Minnesota law provides that a
director "shall discharge the duties of the position of director in good faith,
in a manner the director reasonably believes to be in the best interest of the
corporation, and with the care an ordinarily prudent person in a like position
would exercise under similar circumstances." Fiduciary duties of a director of
a Minnesota corporation include, therefore, both a duty of "loyalty" (to act in
good faith and act in a manner reasonably believed to be in the best interests
of the corporation) and a duty of "care" (to act with the care an ordinarily
prudent person in a like position would exercise under similar circumstances).
Minnesota law authorizes corporations to eliminate or limit the personal
liability of a director to the corporation or its shareholders for monetary
damages for breach of the fiduciary duty of "care." Minnesota law does not,
however, permit a corporation to eliminate or limit the liability of a director
(i) for any breach of the director's duty of "loyalty" to the corporation or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for authorizing a
dividend, stock repurchase or redemption or other distribution in violation of
Minnesota law or for violation of certain provisions of Minnesota securities
laws, or (iv) for any transaction from which the director derived an improper
personal benefit. The Articles of Incorporation of IAI Investment Funds III,
Inc., limit the liability of directors to the fullest extent permitted by
Minnesota statutes, except to the extent that such liability cannot be limited
as provided in the Investment Company Act of 1940 (which Act prohibits any
provisions which purport to limit the liability of directors arising from such
directors' willful misfeasance, bad faith, gross negligence, or reckless
disregard of the duties involved in the conduct of their role as directors).
Minnesota law does not eliminate the duty of "care" imposed upon a
director. It only authorizes a corporation to eliminate monetary liability for
violations of that duty. Minnesota law, further, does not permit elimination or
limitation of liability of "officers" of the corporation for breach of their
duties as officers (including the liability of directors who serve as officers
for breach of their duties as officers.) Minnesota law does not permit
elimination or limitation of the availability of equitable relief, such as
injunctive or rescissionary relief. Further, Minnesota law does not permit
elimination or limitation of a director's liability under the Securities Act of
1933 or the Securities Exchange Act of 1934, and it is uncertain whether and to
what extent the elimination of monetary liability would extend to violations of
duties imposed on directors by the Investment Company Act of 1940 and the rules
and regulations adopted under such Act.
FINANCIAL STATEMENTS
The financial statements, included as part of the Funds' 1995 Annual Report
to Shareholders, are incorporated herein by reference. Such Annual Report may
be obtained by shareholders on request from the Funds at no additional charge.
29
<PAGE>
APPENDIX A
RATINGS OF DEBT SECURITIES
--------------------------
RATINGS BY MOODY'S
- ------------------
CORPORATE BONDS
Aaa. Bonds rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa. Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group, they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities.
A. Bonds rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa. Bonds rated Baa are considered medium grade obligations; i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate, and thereby
not well safeguarded during other good and bad times over the future.
Uncertainty of position characteristizes bonds in this class.
B. Bonds rated B generally lack characteristics of the desirable
investment. Assurances of interest and principal payment or maintenance of other
terms of the contract over any long period of time may be small.
Caa. Bonds rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca. Bonds rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
C. Bonds rated C are the lowest-rated class of bonds and issued so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Conditional Ratings. The designation "Con." followed by a rating
indicates bonds for which the security depends upon the completion of some act
or the fulfillment of some condition. These are bonds secured by (a) earnings
of projects under construction, (b) earnings or projects unseasoned in operating
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which
A-1
<PAGE>
some other limiting condition attaches. Parenthetical rating denotes probable
credit stature upon completion of construction or elimination of basis of
condition.
Note: Moody's applies numerical modifiers 1, 2, and 3 in the Aa and A
classifications of its corporate bond rating system. The modifier 1 indicates
that the security ranks in the higher end of its generic rating category; the
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the
issue ranks in the lower end of its generic rating category. With respect to
municipal securities, 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.
COMMERCIAL PAPER
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime - 1 Superior ability for repayment of senior short-term
debt obligations
Prime - 2 Strong ability for repayment of senior short-term
debt obligations
Prime - 3 Acceptable ability for repayment of senior
short-term debt obligations
If an issuer represents to Moody's that its Commercial Paper
obligations are supported by the credit of another entity or entities, Moody's,
in assigning ratings to such issuers, evaluates the financial strength of the
indicated affiliated corporations, commercial banks, insurance companies,
foreign governments, or other entities, but only as one factor in the total
rating assessment.
RATINGS BY S&P
- --------------
CORPORATE BONDS
AAA. Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB. Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay interest and repay
principal for debt in this category than in higher-rated categories.
BB. Debt rated BB has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could
lead to inadequate capacity to meet timely interest and principal payments.
A-2
<PAGE>
B. Debt rated B has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal repayments.
Adverse business, financial, or economic conditions will likely impair capacity
or willingness to pay interest and repay principal. The B rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied BB-rating.
CCC. Debt rated CCC has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial or economic conditions, it is not
likely to have the capacity to pay interest and repay principal.
CC. Debt rated CC is typically applied to debt subordinated to
senior debt which is assigned an actual or implied CCC debt rating.
C. The rating C typically applied to debt subordinated to senior
debt which assigned an actual or implied CCC-debt rating. The C rating may be
used to cover a situation where a bankruptcy petition has been filed but debt
service payments are continued.
C1. The rating C1 is reserved for income bonds on which no interest
is being paid.
D. Debt rated D is in payment default. The D rating category is
used when interest payments or principal payments are not made on the date due
even if the applicable grace period has not expired, unless S & P believes that
such payments will be made during such grace period. The D rating will be used
upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
In order to provide more detailed indications of credit quality, S&P's
bond letter ratings described above (except for the AAA category) may be
modified by the addition of a plus or a minus sign to show relative standing
within the rating category.
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A. This highest rating category indicates the greatest capacity for
timely payment. Issues in this category are further defined with the
designations 1, 2, and 3 to indicate the relative degree to safety.
A-1. This designation indicates that the degree of safety
regarding timely payment is either overwhelming or very strong. Those issues
determined to possess overwhelming safety characteristics are designed A-1+.
A-2. Capacity for timely payments on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designed A-1.
A-3. Issues carrying this designation have adequate capacity for
timely repayment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
A-3
