Prospectus Dated December 4, 1996
IAI LATIN AMERICA FUND
3700 First Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Telephone 1-612-376-2700
1-800-945-3863
IAI Latin America Fund ("the Fund") is a separate portfolio of IAI Investment
Funds III, Inc., an open-end diversified management investment company
authorized to issue its shares of common stock in more than one series. The
investment objective of the Fund is to provide long-term capital appreciation.
The Fund seeks to achieve its objective by investing primarily in the securities
of Latin American issuers. There can be no assurance that the Fund's investment
objective will be achieved.
INVESTING IN THE FUND INVOLVES SIGNIFICANT RISKS AND CONSIDERATIONS NOT NORMALLY
ASSOCIATED WITH A MUTUAL FUND WHICH INVESTS PRIMARILY IN SECURITIES OF U.S.
ISSUERS AND MAY BE CONSIDERED SPECULATIVE. SHARES OF THE FUND ARE NOT DESIGNED
TO BE A COMPLETE INVESTMENT PROGRAM. SEE "FUND RISK FACTORS" ON PAGE 9.
This Prospectus sets forth concisely the information which a prospective
investor should know about the Fund before investing and it should be retained
for future reference. A "Statement of Additional Information" dated December 4,
1996, 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 Fund at the address or telephone
number shown above.
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.
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TABLE OF CONTENTS
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FUND EXPENSE INFORMATION...................................................3
FUND DIRECTORS.............................................................3
INVESTMENT OBJECTIVE AND POLICIES..........................................4
PORTFOLIO SECURITIES AND OTHER INVESTMENT TECHNIQUES.......................5
FUND RISK FACTORS..........................................................9
MANAGEMENT.................................................................13
INVESTMENT PERFORMANCE.....................................................13
COMPUTATION OF NET ASSET VALUE AND PRICING.................................14
PURCHASE OF SHARES.........................................................14
RETIREMENT PLANS...........................................................15
AUTOMATIC INVESTMENT PLAN..................................................15
REDEMPTION OF SHARES.......................................................15
EXCHANGE PRIVILEGE.........................................................16
AUTOMATIC EXCHANGE PLAN....................................................17
AUTHORIZED TELEPHONE TRADING...............................................17
SYSTEMATIC CASH WITHDRAWAL PLAN............................................18
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS....................................18
DESCRIPTION OF COMMON STOCK................................................19
COUNSEL AND AUDITORS.......................................................20
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT....................20
ADDITIONAL INFORMATION.....................................................20
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FUND EXPENSE INFORMATION
Shareholder Transaction Expenses
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Sales Load Imposed on Purchase........................ None
Sales Load Imposed on Reinvested Dividends............ None
Redemption Fees (as a percentage of amount redeemed).. 2.00%*
Exchange Fees......................................... None
Annual Fund Operating Expenses
(as a percentage of average daily net assets)
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Management Fee**...................................... 2.00%
Rule 12b-1 Distribution Fee........................... None
Other Expenses........................................ None
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Total Fund Operating Expenses**..................... 2.00%
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* On shares purchased and held for less than one year.
For additional information, see "Redemption of Shares".
** After voluntary fee waiver.
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
------ -------
$ 20 $ 63
The purpose of the above table is to assist you in understanding the various
costs and expenses that an investor in the Fund 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. The
Fund's investment adviser has voluntarily agreed to waive the Management Fee in
excess of 2.00% of the Fund's average daily net assets until March 1, 1998.
Absent such voluntary waiver, the Management Fee would be 3.00% of the Fund's
average daily net assets, as would Total Fund Operating Expenses. Further
information concerning fees paid by the Fund is set forth in the section
"Management" below and in the Statement of Additional Information.
FUND DIRECTORS
Madeline Betsch Richard E. Struthers
W. William Hodgson J. Peter Thompson
George R. Long Charles H. Withers
Noel P. Rahn
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INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is long-term capital appreciation.
The Fund seeks to achieve its objective by investing primarily in the securities
of Latin American issuers. 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 the Fund's total assets will be
invested in securities of Latin American issuers and at least 50% of the Fund's
total assets will be invested in Latin American equity securities. For purposes
of this Prospectus, Latin America is defined as Argentina, Belize, Brazil,
Bolivia, Chile, Colombia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras,
Mexico, Nicaragua, Paraguay, Peru, Panama, Uruguay and Venezuela. The Fund
defines securities of Latin American issuers as follows: (a) securities of
companies organized under the laws of a Latin American country or for which the
principal trading market is located in Latin America; (b) securities that are
issued or guaranteed by the government of a Latin America country, its agencies
or instrumentalities, political subdivisions, or the country's central bank; or
(c) securities of Latin American issuers, as previously defined, in the form of
depositary shares. Determinations as to eligibility will be based on publicly
available information and inquiries made to the companies. The Fund intends to
allocate investments among at least four countries at all times and will not
concentrate investments in any particular industry.
The Fund's equity investments consist of common stock, preferred stock
(either convertible or non-convertible), sponsored or unsponsored depository
receipts (including American Depository Receipts, American Depository Shares and
Global Depository Shares) and warrants. These may be restricted securities and
may also be purchased through rights. Securities may be listed on the securities
exchanges, traded over-the-counter, or have no organized market.
Although the Fund focuses on equity securities, it may also invest in debt
securities. These include debt securities issued by governmental units of Latin
American countries ("Sovereign Debt"). Generally, the Fund will invest in debt
securities when IAI, the Fund's investment adviser and manager, believes that
the potential for capital appreciation is likely to equal or exceed that of
equity securities. Capital appreciation in debt securities may arise from a
favorable change in relative foreign exchange rates, in interest rate levels, or
in the creditworthiness of issuers. The Fund has established no minimum rating
criteria for the debt securities in which it may invest, and such securities may
not be rated for creditworthiness at all. 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. The Fund does not currently intend to
invest more than 10% 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.
The allocation between equity and debt, and among various Latin
American countries, varies based on a number of factors, including: expected
rates of economic and corporate profit growth; past performance and current and
comparative valuations in Latin American capital markets; the level and
anticipated direction of interest rates; changes or anticipated changes in Latin
American government policy; and the condition of the balance of payments and
changes in the terms of trade. The Fund, in seeking undervalued markets or
individual securities, also considers the effects of past economic crises or
ongoing financial and political uncertainties.
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PORTFOLIO SECURITIES AND OTHER INVESTMENT TECHNIQUES
The ability of the Fund to utilize certain of the investment techniques
discussed below may be subject to limitations and may subject the Fund to
additional risks. Please refer to the section "Fund Risk Factors" and the
Statement of Additional Information for further information regarding such
limitations and risks. Unless otherwise indicated herein, elsewhere in this
Prospectus, or in the Statement of Additional Information, the Fund may invest
up to 100% of its assets in the securities listed below.
DEPOSITARY RECEIPTS
The Fund may invest in securities of Latin American issuers in the form
of both sponsored and unsponsored American Depository Receipts ("ADRs") or other
similar securities, such as American Depository Shares and Global Depository
shares, convertible into securities of foreign issuers. These securities may not
necessarily be denominated in the same currency as the securities into which
they may be converted. ADRs are receipts typically issued by a United States
bank or trust company evidencing ownership of the underlying securities.
Unsponsored programs are organized independently and without the cooperation of
the issuer of the underlying securities. As a result, available information
concerning the issuer may not be as current as for sponsored depositary
instruments and their prices may be more volatile than if they were sponsored by
the issuers of the underlying securities. Generally, ADRs, in sponsored form,
are designed for use in United States securities markets. As a result of the
absence of established securities markets and publicly-owned corporations in
certain Latin American countries, as well as restrictions on direct investment
by foreign entities, the Fund may be able to invest in such countries solely or
primarily through ADRs or similar securities and government approved investment
vehicles. For example, due to Chile's current investment restrictions (in most
cases capital invested directly in Chile cannot be repatriated without penalty
for at least one year), the Fund's investments in Chile primarily will be
through investment in ADRs and established Chilean investment companies not
subject to repatriation restrictions.
FOREIGN INDEX LINKED INSTRUMENTS
The 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
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 the Fund.
BRADY BONDS
The 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 along payment history.
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ZERO COUPON SECURITIES
The 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 the 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 the Fund may incur costs in connection with conversions between
various currencies. The 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.
The Fund may enter into foreign currency transactions for hedging
purposes only and may not speculate on the fluctuations of foreign currency
exchange rates. The 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, the 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 the 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. The 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 the 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.
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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 the 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 the 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 the 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 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. The Fund will have to convert its
holdings 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.
PRIVATIZATIONS
The governments of some Latin American countries have been engaged in
programs of selling part or all of their stakes in government owned or
controlled enterprises ("privatizations"). IAI believes that privatizations may
offer opportunities for significant capital appreciation, and intends to invest
assets of the Fund in privatizations in appropriate circumstances. In certain
Latin American countries, the ability of foreign entities such as the Fund to
participate in privatizations may be limited by local law and/or the terms on
which the Fund may be permitted to participate may be less advantageous than
those afforded local investors. There can be no assurance that Latin American
governments will continue to sell companies currently owned or controlled by
them or that privatization programs will be successful.
CONVERTIBLE SECURITIES
A convertible security is a bond, debenture, note, preferred stock or
other security that may be converted into or exchanged for a prescribed amount
of common stock of the same or a different issuer within a particular period of
time at a specified price or formula. Convertible securities rank senior to
common stocks in a corporation's capital structure and, therefore, entail less
risk than the corporation's common stock. The value of a convertible security is
a function of its "investment value" (its value as if it did not have a
conversion privilege), and its "conversion value" (the security's worth if it
were to be exchanged for the underlying security, at market value, pursuant to
its conversion privilege).
TEMPORARY INVESTMENTS
The Fund reserves the right, as a temporary defensive measure, such as
during periods of adverse market conditions or when equity or debt securities
are deemed overvalued, to hold up to 100% of its total assets in cash or cash
equivalents (in U.S. dollars or foreign currencies) and short-term securities,
including money market securities.
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ADJUSTING INVESTMENT EXPOSURE
The Fund 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. Such investment
techniques will be utilized consistent with the investment restrictions set
forth in the Statement of Additional Information. If IAI judges market
conditions incorrectly or employs a strategy that does not correlate well with
the 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 the 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.
BORROWING
The Fund may borrow from banks (or through reverse repurchase agreements)
for temporary or emergency purposes. If the Fund borrows money, its share price
may be subject to greater fluctuation until the borrowing is paid off. If the
Fund makes additional investments while borrowings are outstanding, this may be
considered a form of leverage. The Fund does not intend its borrowings to exceed
5% of its total assets.
CLOSED-END INVESTMENT COMPANIES
Because of the absence of securities markets and publicly-owned
corporations, and because of restrictions on direct investment by foreign
entities in certain Latin American countries, the 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 market
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, the Fund and its shareholders may experience a loss. If the Fund
acquires shares of closed-end investment companies, Fund shareholders would bear
both their proportionate share of expenses in the Fund (including management and
advisory fees) and, indirectly, the expenses of such closed-end investment
companies.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net 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 the Fund.
PORTFOLIO TURNOVER
The Fund 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,
the Fund's annual portfolio turnover rate cannot be anticipated and may be
relatively high. High turnover rates (100% or more) generally result in higher
brokerage and other costs for the Fund and may increase taxable capital gains.
IAI generally expects that the Fund's portfolio turnover rate will not exceed
100%.
Further information regarding these and other techniques is contained
in the Statement of Additional Information.
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FUND RISK FACTORS
RISK FACTORS ASSOCIATED WITH INVESTING IN LATIN AMERICA
The Fund is designed for aggressive investors interested in the
investment opportunities offered in Latin America. While IAI believes that
investing in Latin America presents the possibility for significant growth over
the long-term, it also entails significant risks. Many investments in Latin
America can be considered speculative, and the price of securities and value of
currencies 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 Latin America 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, nationalization or confiscatory taxation or
limitations on the removal of funds or other assets of the Fund. Additionally,
the economies of many Latin American 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 Fund 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 the Fund's holdings of securities
denominated in such currency and, therefore, will cause an overall decline in
the Fund's net asset value and net investment income and capital gains, if any,
to be distributed in U.S. dollars to shareholders by the Fund. In many Latin
American 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
Fund 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,
the Fund is limited in the extent to which it may invest in illiquid securities.
Further, the Fund 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 Latin America, more volatile.
Brokerage commissions, custodial services, and other costs relating to
investment in Latin America 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 the Fund to make intended security purchases
due to settlement problems could cause the Fund to miss attractive investment
opportunities. Inability to dispose of a portfolio security due to settlement
problems could result either in losses to the Fund due to subsequent declines in
value of the portfolio security or, if the Fund has entered into a contract to
sell the security, could result in possible liability to the purchaser.
Several Latin American 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 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.
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The Fund's interest and dividend income from Latin American issuers may be
subject to non-U.S. withholding taxes. The Fund also may be subject to taxes on
trading profits or on transfers of securities in some Latin American countries.
The imposition of these taxes will increase the cost to the 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 the Fund. See "Dividends, Distributions and Tax Status."
Many of the currencies of Latin American 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 the Fund's portfolio securities are denominated may have a detrimental
impact on the Fund. Some Latin American countries also may have managed
currencies which are not free floating against the U.S. dollar. In addition,
there is a risk that certain Latin American countries may restrict the free
conversion of their currencies into other currencies. Further, the currencies of
certain Latin American countries may not be internally traded.
Many Latin American 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 Latin American
countries. The governments of many Latin American 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 the
Fund invests.
RISKS OF TRANSACTIONS IN DERIVATIVES
The 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 of
characteristics of the Fund's portfolio of investments. If IAI judges market
conditions incorrectly or employs a strategy that does not correlate well with
the 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 the Fund and may involve a small
investment of cash relative to the magnitude of the 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 DEBT SECURITIES GENERALLY
The value of the debt securities held by the Funds generally will vary
inversely with market rates. If interest rates in a market fall, the Fund debt
securities issued by governments or companies in that market ordinarily will
increase in value. If market interest rates increase, however, the debt
securities owned by the Funds in that market will likely decrease in value.
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Debt rated Baa by Moody's is considered by Moody's to have speculative
characteristics. Debt rated BB, B, CCC, CC or C by S&P and debt rated Ba, B,
Caa, Ca or C by Moody's is regarded, on balance, as predominantly speculative
with respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation. For S&P, BB indicates the lowest
degree of speculation for such lower quality debt and C the highest degree of
speculation. For Moody's, Baa indicates the lowest degree of speculation for
such lower quality debt and C the highest degree to speculation. While such
lower quality debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to adverse
conditions. Debt rated B by Moody's or S&P is the lowest rated debt that is not
in default as to principal or interest and such issues so rated can be regarded
as having extremely poor prospects of ever attaining any real investment
standing. Lower quality debt securities are also generally considered to be
subject to greater risk than securities with higher ratings with regard to a
deterioration of general economic conditions. These foreign debt securities are
the equivalent of high yield, high risk bonds, commonly known as "junk bonds."
More information on the ratings of debt securities is contained in the Appendix
to the Statement of Additional Information.
Ratings of debt securities represent the rating agency's opinion
regarding their quality and are not a guarantee to quality. Rating agencies
attempt to evaluate the safety or principal and interest payments do not
evaluate the risks of fluctuations in market value. Also, rating agencies may
fail to make timely changes in credit ratings in response to subsequent events,
so that an issuer's current financial condition may be better or worse than a
rating indicates.
The market values of lower quality debt securities tend to reflect
individual developments of the issuer to a greater extent than do higher quality
securities, which react primarily to fluctuations in the general level of
interest rates. In addition, lower quality debt securities tend to be more
sensitive to economic conditions and generally have more volatile prices than
higher quality securities. Issuers of lower quality securities are often highly
leveraged and may not have available to them more traditional methods of
financing. For example, during an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower quality securities may
experience financial stress. 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 may also be adversely affected by
specific developments affecting the issuer, such as the issuer's inability to
meet specific projected business forecasts or the unavailability of additional
financing. Similarly, certain Latin American governments that issue lower
quality debt securities are among the largest debtors to commercial banks,
foreign governments and supranational organizations such as the World Bank and
may not be able or willing to make principal and/or interests repayments as they
come due. The risk of loss due to default by the issuer is significantly greater
for the holders of lower quality securities because such securities are
generally unsecured and may be subordinated to the claims of other creditors of
the issuer.
Lower quality debt securities frequently have call or buy-back features
which would permit an issuer to call or repurchase the security from the Fund.
In addition, the Fund may have difficulty disposing of lower quality securities
because they may have a thin trading market. There may be no established retail
secondary market for many of these securities, and the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. The lack of a liquid secondary market also may have an
adverse impact on market prices of such instruments and may make it more
difficult for the Fund to obtain accurate market quotations for purposes of
valuing the Fund portfolios. The Fund may also acquire lower quality debt
securities during an initial underwriting or which are sold without registration
under applicable securities laws. Such securities involve special considerations
and risks.
In addition to the foregoing, factors that could have an adverse effect
on the market value of lower quality debt securities in which the Fund may
invest include: (i) potential adverse publicity; (ii) heightened sensitivity to
general economic or political conditions; and (iii) the likely adverse impact of
a major economic recession.
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IAI attempts to minimize the speculative risks associated with investments
in lower quality securities through credit analysis and by carefully monitoring
current trends in interest rates, political developments and other factors.
Nonetheless, investors should carefully review the investment objective and
policies of the Fund and consider their ability to assume the investment risks
involved before making an investment.
RISKS ASSOCIATED WITH SOVEREIGN DEBT
Certain Latin American countries such as Argentina, Brazil and Mexico
are among the largest debtors to commercial banks and foreign governments. At
times, certain Latin American countries have declared moratoria on the payment
of principal and/or interest on outstanding debt.
Investment in Sovereign Debt, including Brady Bonds, involves a high
degree of risk. The governmental entity that controls the repayment of Sovereign
Debt may not be able or willing to repay the principal and/or interest when due
in accordance with the terms of such debt. A governmental entity's willingness
or ability to repay principal and interest due in a timely manner may be
affected by, among other factors, its cash flow situation, the extent of its
foreign reserves, the availability of sufficient foreign exchange on the date a
payment is due, the relative size of the debt service burden to the economy as a
whole, the governmental entity's policy towards the International Monetary Fund
and the political constraints to which a governmental entity may be subject.
Governmental entities may also be dependent on expected disbursements from
foreign governments, multilateral agencies and other abroad to reduce principal
and interest arrearages on their debt. The commitment on the part of these
governments, agencies and others to make such disbursements may be conditioned
in a governmental entity's implementation of economic reforms and/or economic
performance and the timely service of such debtor's obligations. Failure to
implement such reforms, achieve such levels of economic performance or repay
principal or interest when due may result in the cancellation of such third
parties' commitments to lend funds to governmental entity, which may further
impair such debtor's ability or willingness to timely service its debts.
Consequently, governmental entities may default on their Sovereign Debt.
Holders of Sovereign Debt, including the Fund, may be requested to
participate in the rescheduling of such debt and to extend further loans to
governmental entities. There is no bankruptcy proceeding by which Sovereign Debt
on which a governmental entity has defaulted may be collected in whole or in
part.
The Sovereign Debt instruments in which the Fund may invest involve
great risk and are deemed to be the equivalent in terms of quality to high
yield/high risk securities discussed above and are subject to many of the same
risks as such securities. Similarly, the Fund may have difficulty disposing of
certain Sovereign Debt obligations because there may be a thin trading market
for such securities. The Fund will not invest in Sovereign Debt which is in
default.
MANAGER RISK
IAI manages the Fund according to the traditional methods of "active"
investment management, which involve the buying and selling of securities based
upon economic, financial and market analysis and investment judgment. Manager
risk refers to the possibility that IAI may fail to execute the Fund's
investment strategy effectively. As a result, the Fund may fail to achieve its
stated objective.
INVESTMENT RESTRICTIONS
The Fund is 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 the Fund. As a fundamental policy, with respect to 75% of its total assets,
the Fund may not invest more than 5% of its total assets in any one issuer. The
Fund may not invest 25% or more of its assets in any one industry. The Fund may
borrow only for temporary or emergency purposes in an amount not exceeding
one-third of its total assets. Please refer to the Statement of Additional
Information for a further discussion of the Fund's investment restrictions.
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MANAGEMENT
The Fund was created on August 28, 1996 as a separate portfolio represented
by a separate class of common stock of IAI Investment Funds III, Inc., a
Minnesota company incorporated on September 16, 1986. Under Minnesota law, the
Fund's Board of Directors is generally responsible for the overall operation and
management of the Fund. IAI serves as the investment adviser to the Fund. IAI
has delegated to IAI International Limited ("IAI International") certain of its
responsibilities and obligations as the Fund's 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. The ultimate corporate parent of IAI and IAI International is Lloyds TSB
Group plc, a publicly held financial services organization headquartered in
London, England. Lloyds 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 commercial and retail banking. The address of
IAI is that of the Fund. 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, and has total assets under management in
excess of $16 billion.
Pursuant to a written agreement with the Fund (the "Management Agreement"),
IAI provides the Fund with investment advisory services and is responsible for
the overall management of the Fund's business affairs subject to the authority
of the Board of Directors. The Management Agreement also provides that, except
for brokerage commissions and other expenditures in connection with the purchase
and sale of portfolio securities, interest and, in certain circumstances, taxes
and extraordinary expenses, IAI shall pay all of the Fund's operating expenses.
As compensation under the Management Agreement, the Fund has agreed to pay IAI
an annual fee of 3.00% of the Fund's first $100 million of average daily net
assets, 2.95% of the Fund's next $150 million of average daily net assets, 2.75%
of the Fund's next $250 million of average daily net assets, and 2.65% of the
Fund's average daily net assets in excess of $500 million, less any fees and
expenses the Fund pays to its disinterested directors. Until March 1, 1988, IAI
has voluntarily agreed to waive its fee in excess of 2.00% of the Fund's average
daily net assets. Under the Subadvisory Agreement, IAI pays IAI International
.9357% of the Fund's first $100 million of average daily net assets, .8875% of
the Fund's next $150 million of average daily net assets, .6875% of the Fund's
next $250 million of average daily net assets, and .5875% of the Fund's average
daily net assets in excess of $500 million. Until March 1, 1998, IAI
International has voluntarily agreed to waive its fee in excess of .625% of the
Fund's average dialy net assets. With respect to certain of the services for
which it is responsible under the Management Agreement, IAI may also pay
qualifying broker-dealers, financial institutions and other entities for
providing such services to Fund shareholders. IAI shall not be liable for any
loss suffered by the Fund in the absence of willful misfeasance, bad faith or
negligence in the performance of its duties and obligations.
Nigel Hart, a Fund Manager with IAI International, has managed the Fund since
inception. Mr. Hart has served as an equity investment analyst since joining IAI
International in 1991.
INVESTMENT PERFORMANCE
From time to time the Fund 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 Fund 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 the 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.
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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 Fund is contained
in the Fund's Annual Report to shareholders which, when available, may be
obtained without charge from the Fund.
Comparative performance information may be used from time to time in
advertising or marketing the 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 Fund. The
comparison of the Fund to an alternative investment should be made with
consideration of differences in features and expected performance. The Fund may
also note its mention in newspapers, magazines, or other media from time to
time. The Fund assumes 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 Fund in advertising and sales literature, see the
section "Investment Performance" in the Statement of Additional Information.
COMPUTATION OF NET ASSET VALUE AND PRICING
The Fund is open for business each day the New York Stock Exchange
("NYSE") is open. IAI normally calculates the Fund's net asset value ("NAV") as
of the close of business of the NYSE, normally 3 p.m. Central time.
The Fund's NAV is the value of a single share. The NAV is computed by
adding up the value of the Fund's investments, cash, and other assets,
subtracting its liabilities, and then dividing the result by the number of
shares outstanding.
The 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 Fund's 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
the Fund's portfolio securities. For purposes of determining the 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 the 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 the Fund's NAV.
PURCHASE OF SHARES
The Fund offers its shares continually to the public at the net asset
value of such shares. Shares may be purchased directly from the 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.
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The minimum initial investment to establish a retail account with the
IAI Family of Funds is $5,000. Such initial investment may be allocated among
the 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 the Fund for $100 or more. Such minimums may
be waived for participants in the IAI Investment Club.
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 the Fund to obtain a STAR Program application.
To purchase shares, forward the completed application and a check
payable to "IAI Funds" to the 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 after receipt of the purchase order by the Fund.
Purchases of shares are subject to acceptance or rejection by the Fund
on the same day the purchase order is received and are not binding until so
accepted. It is the policy of the Fund and the Underwriter to keep confidential
information contained in the application and regarding the account of an
investor or potential investor in the Fund.
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 the 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 the 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 4th or 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 the Fund. Any
changes or instructions to terminate existing Automatic Investment Plans must be
received 30 days preceding the day on 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 the
Fund.
REDEMPTION OF SHARES
Registered holders of Fund shares may at any time require the Fund to
redeem their shares upon their written request. All correspondence relating to
the redemption of shares should be directed to the IAI Mutual Funds, P.O. Box
357, Minneapolis, Minnesota 55440 or, if using overnight delivery, to 601 2nd
Avenue South, Minneapolis, Minnesota 55402. Shareholders may redeem shares by
phone (subject to a limit of $50,000) provided such shareholders have authorized
the Fund to accept telephone instructions. For assistance in redeeming shares by
phone, please contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.
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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, the 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.
Upon the redemption (or exchange) of shares held less than a year, a fee of 2%
of the lower of the cost or the current net asset value of the shares will be
assessed and retained by the Fund for the benefit of the remaining shareholders.
The fee is waived for all shares purchased by IAI for its discretionary advisory
clients (unless the redemption decision is made by the client)and for shares
purchased by certain retirement plans such as 401(k) plans and 403(b) plans.
However, this fee waiver does not apply to IRA or SEP-IRA accounts. This fee is
intended to encourage long-term investment in the Fund, to avoid transaction and
other expenses caused by early redemptions, and to facilitate portfolio
management. The fee is not a deferred sales charge, is not a commission paid to
IAI or its subsidiaries, and does not directly benefit IAI. The Fund reserves
the right to modify the terms of or terminate this fee at any time. The fee
applies to redemptions from the Fund and exchanges to other Funds, but not to
dividend or capital gains distributions which have been automatically reinvested
in the Fund. The fee is applied to the shares being redeemed or exchanged in the
order in which they were purchased. See "Exchanges and Redemptions" in the
Fund's Statement of Additional Information for a more detailed description of
the redemption fee.
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 the Fund less any applicable redemption fee. 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 the Fund will mail
payment for shares redeemed on the business day following receipt of the
redemption request. The Fund will not send redemption proceeds until checks
(including certified checks or cashiers checks) received in payment for shares
have cleared, which may take up to ten days or more.
Following a redemption or transfer request, if the value of a
shareholder's interest in the Fund falls below $500, the 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 the 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 the Fund to increase the value of such investor's
account to at least $500.
EXCHANGE PRIVILEGE
The Exchange Privilege enables shareholders to purchase, in exchange
for shares of the Fund, shares of certain other funds managed by IAI. These
funds have different investment objectives from the Fund. Shareholders may
exchange shares of the 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 Fund does not currently charge a fee for use
of the Exchange Privilege, it reserves the right to do so in the future.
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Because excessive trading can hurt Fund performance and shareholders,
there is a limit of four exchanges out of the 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. The 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. The Fund also
reserves the right to refuse or limit exchange purchases by any investor if, in
IAI's judgment, the Fund would be unable to invest the money effectively in
accordance with its investment objectives and policies, or would otherwise
potentially be adversely affected. Please see "Redemption of Shares" for
information concerning fees imposed on redemptions, including redemptions
through the Exchange Privilege.
Fund shareholders wishing to exercise the Exchange Privilege should
notify the Fund in writing or, provided such shareholders have authorized the
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 the 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
application contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.
Please see "Redemption of Shares" for information concerning fees imposed on
redemptions, including redemptions through the Automatic Exchange Plan.
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 the 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 the Fund or transfer agent fails to follow these procedures,
the Fund may be liable for losses due to unauthorized or fraudulent
instructions. To the extent these reasonable procedures are followed, none of
the Fund, its transfer agent, IAI, or any affiliated broker-dealer 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.
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SYSTEMATIC CASH WITHDRAWAL PLAN
The 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 the Fund. To established the plan, an
account must have at least $10,000 and be at least one year old. 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, the 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 Fund. If you would like
assistance in completing the application contact IAI Mutual Fund Shareholder
Services at 1-800-945-3863. Please see "Redemption of Shares" for information
concerning fees imposed on redemptions, including redemptions through the
Automatic Exchange Plan.
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS
The policy of the Fund is to pay dividends from net investment income
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
the Fund. When you open an account, you should specify on your application how
you want to receive your distributions. The 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, the Fund will
automatically reinvest all such distributions into full and fractional shares at
net asset value.
The Fund's 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.
The Fund intends to qualify as a regulated investment company under
Subchapter M of the Code during its current taxable year. If so qualified, the
Fund will not be subject to federal income tax on income that it distributes to
its shareholders.
Distributions by the Fund 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 Fund's net investment income and net short-term
capital gains are taxable to shareholders as ordinary income. Distributions paid
out of the Fund's' 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 the Fund.
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The Fund may be required to pay withholding and other taxes imposed by
foreign countries, generally at rates from 10% to 40%, which would reduce the
Fund's investment income. Tax conventions between certain countries and the
United States may reduce or eliminate such taxes. If the Fund has more than 50%
of its assets invested in the stock or securities of foreign corporations at the
end of the 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, 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 the Fund is not
large enough to warrant its making the election described above, the 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
the Fund will be mailed to the Fund's shareholders annually.
In general, upon redemption of shares of the 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 the Fund, see "Tax Status" in the Statement of Additional Information.
DESCRIPTION OF COMMON STOCK
All shares of the 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 the 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 Management 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 the Fund may demand a regular meeting of shareholders of the
Fund by written notice of demand given to the chief executive officer or the
chief financial officer of the 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 the Fund. An annual meeting will be
held on the removal of a director or directors of the Fund if requested in
writing by holders of not less than 10% of the outstanding shares of the Fund.
The shares of the 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.
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<PAGE>
COUNSEL AND AUDITORS
The firm of Dorsey & Whitney LLP, 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 Fund.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
The Custodian for the 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 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. For a listing of the subcustodians
and depositories currently employed by the Fund, see the Statement of Additional
Information. IAI acts as the Fund's' transfer agent, dividend disbursing agent
and IRA Custodian, at P.O. Box 357, Minneapolis, Minnesota 55440.
ADDITIONAL INFORMATION
The 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. To reduce the volume of mail you receive, only one copy of most Fund
reports, such as the Fund's Annual Report, may be mailed to your household (same
surname, same address). Please call IAI Mutual Fund Shareholder Services at
1-800-945-3863 if you wish to receive additional shareholder reports.
Shareholder inquiries should be directed to the Fund at the telephone
number or mailing address listed on the cover page of this Prospectus.
-20-
<PAGE>
IAI LATIN AMERICA FUND
Statement of Additional Information
dated December 4, 1996
This Statement of Additional Information is not a Prospectus. This
Statement of Additional Information relates to a Prospectus dated December 4,
1996, 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
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<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.................6
Futures Contracts...............................................6
Futures Margin Payments.........................................6
Purchasing Put and Call Options.................................7
Writing Put and Call Options....................................7
Combined Positions..............................................8
Correlation of Price Changes....................................8
Liquidity of Options and Futures Contracts......................8
OTC Options.....................................................8
Asset Coverage for Futures and Options Positions................9
No Rating Criteria for Debt Securities..........................9
Special Considerations Affecting Latin America..................9
Additional Risk Considerations..................................11
INVESTMENT RESTRICTIONS..................................................12
Portfolio Turnover..............................................14
INVESTMENT PERFORMANCE...................................................14
MANAGEMENT...............................................................16
History.........................................................18
Management Agreement............................................19
Duration of Agreement...........................................20
CUSTODIAL SERVICE........................................................20
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE.......................24
CAPITAL STOCK............................................................25
NET ASSET VALUE AND PUBLIC OFFERING PRICE................................25
SPECIAL REDEMPTION AND EXCHANGE INFORMATION..............................25
PURCHASES AND REDEMPTIONS IN KIND .......................................26
TAX STATUS...............................................................26
LIMITATION OF DIRECTOR LIABILITY.........................................29
APPENDIX A - RATINGS OF DEBT SECURITIES..................................A-1
</TABLE>
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<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and policies of IAI Latin America Fund ("the
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 are subject to various risks. There can be no
guarantee against loss resulting from an investment in the Fund, and there can
be no assurance that the Fund's investment policies will be successful, or that
its investment objective will be attained. Certain of the investment practices
of the Fund are further explained below.
REPURCHASE AGREEMENTS
The 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. The 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 the 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, the 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, the 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, the Fund could suffer a
loss.
REVERSE REPURCHASE AGREEMENTS
The Fund may invest in reverse repurchase agreements. In a reverse
repurchase agreement, the 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, the 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 the Fund's assets and may be
viewed as a form of leverage. The Fund will enter into reverse repurchase
agreements only with parties whose creditworthiness has been found satisfactory
by Investment Advisers, Inc. ("IAI"), the Fund's investment adviser and manager
or IAI International Limited (hereinafter references to IAI shall include IAI
International Limited where appropriate), the subadviser to the Fund. Presently,
the Fund does not intend to invest more than 5% of its net assets in reverse
repurchase agreements.
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 Fund will endeavor to
achieve the most favorable net results on its portfolio transactions. There is
generally less government supervision and regulation of foreign stock exchanges,
brokers and listed companies than in the United States.
-3-
<PAGE>
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 Fund, 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 the 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
The 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. The 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, the Fund may have to sell other assets,
rather than such illiquid securities, at a time which is not advantageous.
LENDING PORTFOLIO SECURITIES
In order to generate additional income, the Fund 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, the 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 Fund's Board of
Directors. The Fund 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, the 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 the Fund an amount
equivalent to any dividends or interest paid on the securities and the 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 the Fund may be reduced by finders' fees paid to broker-dealers and related
expenses. Presently, the Fund does not intend to lend more than 5% of its net
assets to broker-dealers, banks, or other financial borrowers of securities.
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 the
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. The 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.
-4-
<PAGE>
Swap agreements will tend to shift the Fund's investment exposure from one
type of investment to another. For example, if the Fund agrees to exchange
payments in dollars for payments in foreign currency, the swap agreement would
tend to decrease the Fund's exposure to U.S. interest rates and increase its
exposure to foreign currency and interest rates. Depending on how they are used,
swap agreements may increase or decrease the overall volatility of the 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 the Fund. If a swap agreement calls for
payments by the 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. The
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.
The Fund will maintain appropriate liquid assets in a segregated custodial
account to cover its current obligations under swap agreements. If the 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 the Fund's accrued
obligations under the swap agreement over the accrued amount such Fund is
entitled to receive under the agreement. If the 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.
Presently, the Fund does not intend to invest more than 5% of its net assets in
Swap Agreements.
INDEXED SECURITIES
The 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 the Fund's investment policies, depending
on the individual characteristics of the securities. Indexed securities may be
more volatile than the underlying instruments. Presently, the Fund does not
intend to invest more than 5% of its net assets in indexed securities.
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<PAGE>
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS
The 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. The Fund intends to comply
with Section 4.5 of the regulations under the Commodity Exchange Act, which
limits the extent to which the Fund can commit assets to initial margin deposits
and option premiums.
The above limitations on the 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. With respect to positions in commodity futures or
commodity option contracts which do not come within the meaning and intent of a
bona fide hedging in the CFTC rules, the aggregate initial margin and premiums
required to establish such positions will not exceed five percent of the
liquidation value of the qualifying entity's portfolio, after taking into
account unrealized profits and unrealized losses on any such contracts it has
entered into; and, providing further, that in the case of an option that is
in-the-money, the in-the-money amount may be excluded in computing such five
percent.
FUTURES CONTRACTS
When the Fund purchases a futures contract, it agrees to purchase a
specified underlying instrument at a specified future date. When the Fund sells
a futures contract, it agrees to sell the underlying instrument at a specified
future date. The price at which the purchase and sale will take place is fixed
when the 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 the Fund's exposure to positive and
negative price fluctuations in the underlying instrument, much as if it had
purchased the underlying instrument directly. When the 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 the Fund's investment limitations. In the
event of the bankruptcy of an FCM that holds margin on behalf of the 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
the Fund.
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<PAGE>
PURCHASING PUT AND CALL OPTIONS
By purchasing a put option, the 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, the 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. The 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, the Fund will lose the entire premium it paid. If the Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. The 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).
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 the 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 the Fund would be required to make
margin payments to an FCM as described above for futures contracts. The 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 the 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 the 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.
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<PAGE>
COMBINED POSITIONS
The 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, the 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 the 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 the 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 daily price fluctuation
limits or trading halts. The 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 the 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 the 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 the Fund to continue to hold a position until delivery
or expiration regardless of changes in its value. As a result, the 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 the 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.
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<PAGE>
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS
The 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 the Fund's assets could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
NO RATING CRITERIA FOR DEBT SECURITIES
The Fund has established no rating criteria for the debt securities in
which it may invest. Therefore, the 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.
The 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 the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
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 the
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.
SPECIAL CONSIDERATIONS AFFECTING LATIN AMERICA
Latin America is a region rich in natural resources such as oil,
copper, tin, silver, iron ore, forestry, fishing, livestock, and agriculture.
The region has a large population (over 300 million) representing a large
domestic market. The region has been transitional over the last five years from
the stagnant 1980s which were characterized by poor economic policies, higher
international interest rates, and limited access to new foreign capital.
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<PAGE>
High inflation and low economic growth have given way to stable
manageable inflation rates and higher economic growth. Changes in political
leadership, the implementation of market-oriented economic policies, such as
privatization, trade reform and monetary reform have been among the recent steps
taken to modernize the Latin American economies and to regenerate growth in the
region. Various trade agreements have also been formed within the region such as
the Andean Pact, Mercosur and NAFTA. The largest of these is NAFTA, which was
implemented on January 1, 1994.
Latin American equity markets can be extremely volatile and in the past
have shown little correlation with the U.S. market. Currencies are typically
weak, but most are now relatively free floating, and it is not unusual for the
currencies to undergo wide fluctuations in value over short periods of time due
to changes in the market.
Mexico's economy has been transformed significantly over the last 6-7
years. In the past few years, the government has sold the telephone company, the
major steel companies, the banks and many others. The major state ownership
remaining is in the oil sector and the electricity sector. The U.S. is Mexico's
major trading partner, accounting for two-thirds of its exports and imports. The
government in consultation with international economic agencies, is implementing
programs to stabilize the economy and foster growth. For example, Mexico, the
U.S. and Canada implemented the North American Free Trade Agreement. This
cooperation has resulted in increased trade and reduced barriers and is expected
to result in continued GDP growth.
In the early 1980s, Mexico experienced a foreign debt crisis. By 1987,
foreign debt had reached prohibitive levels, accounting for 90 to 95 percent of
GDP. By the end of 1994, a large current account deficit, fueled in part by
expansionary policy, and the burden of its large national debt forced the
Mexican government to devalue the peso, triggering a severe crisis of
confidence. Both the crisis and measures taken to stabilize the economy since,
have led to severely reduced domestic demand, which has been only partially
offset by positive trade-related activity.
Brazil entered the 1990s with declining real growth, runaway inflation, an
unserviceable foreign debt of $122 billion, and a lack of policy direction. Over
the past two years, Brazil was able to stabilize its domestic economy through a
process of balancing the government budget, the privatization of state
enterprises, deregulation and reduction of red tape and introducing greater
competition in the domestic business environment. Inflation has been reduced to
about 3% a month from 50% a month since mid-1994. A major long-run strength is
Brazil's natural resources. Iron ore, bauxite, tin, gold, and forestry products
make up some of Brazil's basic natural resource base, which includes some of the
largest mineral reserves in the world. In terms of population, Brazil is the
sixth-largest in the world with about 155 million people and represents a huge
domestic market.
Chile, like Brazil, is endowed with considerable mineral resources, in
particular copper. Economic reform has been ongoing in Chile for at least 15
years, but political democracy has only recently returned to Chile.
Privatization of the public sector beginning in the early 1980s has bolstered
the equity market. A well organized pension system has created a long-term
domestic investor base.
Argentina is strong in wheat production and other foodstuffs and
livestock ranching. A well-educated and skilled population boasts one of the
highest literacy rates in the region. The country has been ravaged by decades of
extremely high inflation and political instability. Thanks to structural
reforms, the revitalized Argentine economy has been among the top three fastest
growing economies in the world over the last three years. The newly created
Argentine economic institutions have integrated the country with the rest of the
world, leaving the state to concentrate on its essential functions.
Privatization is ongoing and should reduce the amount of external debt
outstanding. The markets for labor, capital and goods and services has been
deregulated. Nearly all non-tariff barriers and export taxes have been
eliminated, the tariff structure simplified and tariffs sharply reduced.
Venezuela has substantial oil reserves. External debt is being
re-negotiated, and the government is implementing economic reform in order to
reduce the size of the public sector. Internal gasoline prices, which are
one-third those of international prices, are being increased in order to reduce
subsidies. Plans for privatization and exchange and interest rate liberalization
are examples of recently introduced reforms.
-10-
<PAGE>
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 Latin
American 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 Latin American 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.
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 the 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, the 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.
The 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 the Fund changes 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 the Fund from transferring cash
out of the country, withhold portions of interest and dividends at the source,
or impose other taxes, with respect to the Fund's investments in securities of
issuers of that country. Although the 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.
-11-
<PAGE>
The 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 the 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 the 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 the Fund's portfolio securities in foreign countries and/or with
securities depositories will be at the risk of the shareholders.
The 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. The 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 the 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, the 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 the 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 the Fund and may be changed by the Board of Directors without
shareholder approval.
The 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 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.
For purposes of applying this restriction, the Fund will not purchase
securities, as defined above, such that 25% or more of the value of the Fund's
total assets are invested in the securities of companies whose principal
business activities are in the same industry.
-12-
<PAGE>
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.
To the extent the Fund engages in reverse repurchase agreements, because
such transactions are considered borrowing, reverse repurchase agreements are
included in the 33-1/3% limitation.
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.
For purposes of applying this restriction, the Fund will not sell
securities short except to the extent that it contemporaneously owns or has the
right to obtain, at no added cost, securities identical to those sold 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.
-13-
<PAGE>
14. The Fund may not invest more than 15% of its net assets 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. With respect to Restriction 14, the Fund is
under a continuing obligation to ensure that it does not violate the maximum
percentage either by acquisition or by virtue of a decrease in the value of the
Fund's liquid assets.
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.
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the 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:
-14-
<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.
In advertising and sales literature, the 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 the Fund. The comparison of the Fund to an alternative investment
should be made with consideration of differences in features and expected
performance. The Fund may also note its mention in newspapers, magazines, or
other media from time to time. However, the Fund assumes no responsibility for
the accuracy of such data.
For example, (1) the 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 the 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 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; (vii) the IFC Investable
Latin American Index (an unmanaged index of Latin American Equity securities
based on market capitalization) and (viii) 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 the 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 the Fund or the general economic business,
investment, or financial environment in which the Fund operates; (4) the effect
of tax-deferred compounding on the 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 the
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 the Fund invests
may be compared to relevant indices or surveys (e.g., S&P Industry Surveys) in
order to evaluate the Fund's historical performance or current or potential
value with respect to the particular industry or sector.
-15-
<PAGE>
MANAGEMENT
The names, addresses, positions and principal occupations of the directors and
executive officers of the Fund are given below.
<TABLE>
<CAPTION>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
<S> <C> <C> <C>
Noel P. Rahn* 57 Chairman of the Noel P. Rahn has been Chief Executive Officer
3700 First Bank Place Board and a Director of IAI since 1974. Mr. Rahn is
P.O. Box 357 also Chairman of the other IAI Mutual Funds.
Minneapolis, Minnesota 55440
Richard E. Struthers* 44 President, Director Richard E. Struthers is Executive Vice
3700 First Bank Place President and a Director of IAI and has served
P.O. Box 357 IAI in many capacities since 1979. Mr.
Minneapolis, Minnesota 55440 Struthers is also President of the other IAI
Mutual Funds.
Madeline Betsch 54 Director Madeline Betsch, until April 1994, was
19 South 1st Street Executive Vice President, Director of Client
Minneapolis, Minnesota 55401 Services, of CME-KHBB Advertising since May
1985, and prior thereto was a Vice President
with Campbell-Mithun, Inc. (advertising
agency) since February 1977. Ms. Betsch is
currently retired.
W. William Hodgson 71 Director W. William Hodgson served as information
1698 Dodd Road manager for the North Central Home Office of
Mendota Heights, Minnesota 55118 the Prudential Insurance Company of America
from 1961 until 1984; he is currently retired.
George R. Long 66 Director George R. Long serves as Director of Pacific
29 Las Brisas Way Industries and has been Chairman of Mayfield
Naples, Florida 33963 International (financial consultants and
venture capitalists) since 1973.
J. Peter Thompson 65 Director J. Peter Thompson has been a grain farmer in
Route 1 southwestern Minnesota since 1974. Prior to
Mountain Lake, Minnesota 56159 that, Mr. Thompson was employed by Paine
Webber, Jackson & Curtis, Incorporated,(a diversified
financial services concern), most recently as Senior Vice
President and General Partner.
Charles H. Withers 69 Director Charles H. Withers was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980; he is currently
Rochester, Minnesota 55903 retired.
-16-
<PAGE>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Archie C. Black, III 34 Treasurer Archie C. Black has been a Senior Vice President and
3700 First Bank Place Chief Financial Officer of IAI since 1992and prior
P.O. Box 357 thereto was Vice President and Controller since joining
IAI in 1987. Mr. Black is also Treasurer of the other
IAI Mutual Funds.
William C. Joas 33 Secretary William C. Joas is a Vice President of IAI and
3700 First Bank Place has served as an attorney for IAI since 1990.
P.O. Box 357 Mr. Joas is also Secretary of the other IAI
Minneapolis, Minnesota 55440 Mutual Funds.
Nigel Hart 29 Vice President, Nigel Hart is a Fund Manager of IAI
3700 First Bank Place Investments International. Prior to joining IAI in 1991,
P.O. Box 357 Mr. Hart served as an equity investment
Minneapolis, Minnesota 55440 analyst with Commercial Union Asset Management
(a diversified financial services concern).
Kirk Gove 34 Vice President, Kirk Gove is a Vice President of IAI. Prior
3700 First Bank Place Marketing to joining IAI in 1992, Mr. Gove served as an
P.O. Box 357 Associate Vice President of Dain Bosworth,
Minneapolis, Minnesota 55440 Incorporated (a diversified financial services
concern). Mr. Gove is also Vice President,
Marketing of the other IAI Mutual Funds.
Susan J. Haedt 34 Vice President, Susan J. Haedt is a Vice President of IAI and
3700 First Bank Place Director of Director of Mutual Fund Operations. Prior to
P.O. Box 357 Mutual Fund joining IAI in 1992, Ms. Haedt served as a
Minneapolis, Minnesota 55440 Operations Senior Manager at KPMG Peat Marwick LLP (an
international tax, accounting and consulting
firm). Ms. Haedt is also Vice President,
Director of Operations of the other IAI Mutual
Funds.
</TABLE>
* Directors of the Fund who are interested persons (as that term is defined by
the Investment Company Act of 1940) of IAI and the Fund.
The Fund has agreed to reduced initial subscription requirements for
employees and directors of the 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 the Fund to any of its officers. As of
January 1, 1996, directors who are not affiliated with IAI receive from the IAI
Mutual Funds a $15,000 annual retainer, $2,500 for each Board meeting attended,
$3,600 for each Audit Committee meeting attended (as applicable) and $1,800 for
each Securities Valuation Committee meeting attended. The Fund will pay its pro
rata share of these fees based on its net assets. Such unaffiliated directors
also are reimbursed for expenses incurred in connection with attending meetings.
-17-
<PAGE>
<TABLE>
<CAPTION>
Aggregate Projected Aggregate
1995 Compensation 1996 Compensation
Name of Person, Position from the IAI Mutual Funds* from the IAI Mutual Funds**
------------------------ ------------------------------ ------------------------------
<S> <C> <C>
Betsch, Madeline - Director $28,725 $32,200
Hodgson, W. William - Director $28,725 $32,200
Long, George R. - Director $27,725 $32,200
Thompson, J. Peter - Director $28,725 $32,200
Withers, Charles H. - Director $27,725 $32,200
</TABLE>
- -------------------------
* For the calendar year ended December 31, 1995 and includes 18 Funds.
** For the calendar year ended December 31, 1996 and includes 20
Funds; provided that a director misses no meetings; excludes
expenses incurred in connection with attending meetings.
The Board of Directors for the Fund has approved a Code of Ethics. The
Code permits access persons to engage in personal securities transactions
subject to certain policies and procedures. Such procedures prohibit certain
persons from acquiring of any securities in an initial public offering. In
addition, 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 is required to
certify annually that they have read and understood the Code of Ethics. An
annual report is provided to the Fund's Board of Directors summarizing existing
procedures and changes, identifying material violations and recommending any
changes needed.
IAI, the Fund's investment adviser, and IAI International Ltd., the Fund's
investment subadvisor, are affiliates of the 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 Lloyds TSB Group, plc ("Lloyds TSB"),
a publicly-held financial services organization headquartered in London,
England. Lloyds TSB is one of the largest personal and corporate financial
services groups in the United Kingdom, engaged in a wide range of activities
including commercial and retail banking. The principal offices of Lloyds TSB are
located at St. George's House, 6 - 8 Eastcheap, London, EC3M 1LL.
HISTORY
The Fund is a separate portfolio of IAI Investment Funds III, Inc., a
Minnesota corporation whose shares of common stock are currently issued in three
series (Series A through C). On June 25, 1993, the Fund's shareholders approved
amended and restated Articles of Incorporation which provided that the
registered investment company whose corporate name had been IAI International
Fund, Inc. be renamed IAI Investment Funds III, Inc. The investment portfolio
represented by Series C common shares is referred to as "IAI Latin America
Fund."
-18-
<PAGE>
MANAGEMENT AGREEMENT
Pursuant to a Management Agreement between the Fund and IAI, IAI has
agreed to provide the 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 and, in connection therewith, IAI has the sole authority and
responsibility to make and execute investment decisions for the Fund within the
framework of the Fund's investment policies, subject to review by the directors
of the Fund. In addition, IAI has agreed to provide or arrange for the provision
of all required administrative, stock transfer, redemption, dividend disbursing,
accounting, and shareholder services including, without limitation, the
following: (1) the maintenance of the Fund's accounts, books and records; (2)
the calculations of the daily net asset value in accordance with the Fund's
current 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 the Fund; (5) the maintenance of
stock registry records; (6) the processing of requested account registration
changes, stock certificate issuances and redemption requests; (7) the
administration of payments and dividends and distributions declared by the Fund;
(8) answering shareholder questions, (9) providing reports and other information
and (10) other services designed to maintain shareholder accounts. IAI may also
pay qualifying broker-dealers, financial institutions and other entities that
provide such services. In return for these services, the Fund has agreed to pay
IAI an annual fee as a percentage of the Fund's average daily net assets as set
forth below:
Daily Net Assets Fee IAI Receives Annually
---------------- -------------------------
For the first $100 million 3.00%
For the next $100 - $250 million 2.95%
For the next $250 - $500 million 2.75%
Above $500 million 2.65%
Until March 1, 1998, IAI has voluntarily agreed to waive its fee in excess of
2.00% of the Fund's average daily net assets.
Under the Management Agreement, except for 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 the Fund, taxes and extraordinary
expenses, IAI has agreed to pay all of the Fund's other costs and expenses,
including, for example, costs incurred in the purchase and sale of assets,
taxes, charges of the custodian of the 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, insurance premiums, and costs of
attending investment conferences. The Management Agreement further provides that
IAI will either reimburse the Fund for the fees and expenses it pays to
directors who are not "interested persons" of the Fund or reduce its fee by an
equivalent amount. IAI is not liable for any loss suffered by the Fund in the
absence of willful misfeasance, bad faith or negligence in the performance of
its duties and obligations.
Under the Subadvisory Agreement between IAI International Ltd. and IAI,
IAI has delegated to IAI International Ltd. the sole authority and
responsibility to make and execute investment decisions for the Fund within the
framework of the Fund's investment policies, subject to review by IAI and the
directors of the Fund. Under the Subadvisory Agreement, IAI has agreed to pay
IAI International Ltd. an annual fee as a percentage of the Fund's average daily
net assets as set forth below:
Daily Net Assets Fee IAI Int'l Receives Annually
---------------- -------------------------------
For the first $100 million .9375%
For the next $100 - $250 million .8875%
For the next $250 - $500 million .6875%
Above $500 million .5875%
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Until March 1, 1998, IAI International has voluntarily agreed to waive its fee
in excess of .625% of the Fund's average daily net assets.
DURATION OF AGREEMENTS
Each of the Management Agreement and the Subadvisory Agreement will
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
the Fund or by vote of a majority of the 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.
CUSTODIAL SERVICE
The custodian for the Fund 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 the Fund 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 the Fund's 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.
Austria Credit Austalt Bankverein
Bangladesh Standard Chartered Bank
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 Citibank, N.A./Cititrust Columbia S.A.
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Cyprus Barclays Bank PLC
Czech Republic ING Bank
Denmark Den Danske Banke
Finland Merita Bank
France Banque Indosuez
Germany Dresdner Bank, A.G.
Ghana Barclays Bank of Ghana
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
Kenya Barclays Bank Kenya
Korea Standard Chartered Bank
Luxembourg Banque Bruxelles Lambert
Malaysia Oversea Chinese Banking Corporation
Mauritius Hong Kong and Shanghai Bank Corporation
Mexico Citibank, N.A., Mexico City Branch
Morocco Banque Commerciale du Maroc
Netherlands ABN Amro Bank
New Zealand Bank of New Zealand
Norway Den Norske Bank
Pakistan Standard Chartered Bank
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Papua New Guinea Australia and New Zealand Banking Group
Peru Citibank N.A., Lima Branch
Philippines Hong Kong & Shanghai Banking Corp. Ltd.
Poland Citibank Poland, 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.
Swaziland Barclays Bank of Swaziland
Sweden Svenska Handelsbanken
Switzerland Bank Leu Ltd.
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
Zambia Barclays Bank of Zambia
Zimbabwe Barclays Bank of Zimbabwe
DEPOSITORIES
-----------
Argentina Caja de Valores
Australia Clearing House Electronic Subregister System
Austria Wertpapiersammelbank
Belgium Caisse Interprofessionelle de Depot et de Titres
Botswana Stock Exchange Talisman System
Brazil Bolsa de Valores de Sao Paulo
Bolsa de Valores de Rio de Janeiro
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Canada The Canadian Depository for Securities
China Shangai Stock Exchange
Czech Republic Center for Securities (SCP)
Denmark Vaerdipapircentralen
France SICOVAM (Societe Interprofessionelle la
Compensacion des Valuers Mobilieres)
Societe de Compensacion des Marches
Conditionnels
Chambre de Compensation des Instruments
Financiers de Paris
Germany Deutscher Kassenverein AG
Greece Central Clearing Office of Athens Stock Exchange
Hong Kong Hong Kong Securities Clearing Company
Ireland Stock Exchange Talisman System
Israel SECH
Italy Monte Titoli, S.p.A
Japan Japan Securities Depository Center
Korea The Korean Central Depository
Malaysia The Malaysian Central Depository
Mexico Instituto para el Deposito de Valores
Morocco Casablanca Stock Exchange
Netherlands NECIGEF (Nederlands Centraal Institut
voor Giraal Effectenverkeer B.V.
New Zealand Austraclear New Zealand System
Norway Verdipapirsentralen
Pakistan The Karachi Stock Exchange Clearinghouse
Papua New Guinea Clearing House Electronic Subregister System
Poland National Depository of Securities
Portugal Lisbon Stock Exchange (SICOB system)
Oporto Stock Exchange (CAMBIUM system)
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<PAGE>
Singapore Central Depository Pte Ltd.
South Africa Central Depository (Pty) Ltd.
Spain Servicio de Compensacion y Liquidacion de Valores
Sri Lanka Central Depository System Piri Ltd.
Sweden Vardepapperscentralen
Switzerland SEGA (Schweizerische Effekten Giro A.G.)
Taiwan Taiwan Securities Depository Co.
Thailand Share Depository Center
United Kingdom Stock Exchange Talisman System
Zimbabwe 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 the Fund, IAI seeks the most favorable net price consistent with the best
execution.
Generally, however, the 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, the
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 the 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 the Fund pays higher than the lowest commission
rates available. Some investment companies enter into arrangements under which a
broker-dealer agrees to pay the cost of certain products or services (not
including research services) in exchange for fund brokerage ("brokerage/service
arrangements"). Under a typical brokerage/service arrangement, a broker agrees
to pay a fund's custodian fees or transfer agent fees and, in exchange, the fund
agrees to direct a minimum amount of brokerage to the broker. IAI does not
intend to enter into such brokerage/service arrangements on behalf of the Fund.
Some investment companies enter into arrangements that provide for specified or
reasonably ascertainable fee reductions in exchange for the use of fund assets
("expense offset agreements"). Under such expense offset agreements, expenses
are reduced by foregoing income rather than by re-characterizing them as capital
items. For example, a fund may have a "compensating balance" agreement with its
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custodian under which the custodian reduces its fees if the fund maintains cash
or deposits with the custodian in non-interest bearing accounts. IAI does not
intend to enter into expense offset agreements involving assets of the Fund.
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 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 the Fund's brokerage
business to any broker-dealers for brokerage and research services. However, IAI
will authorize the 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 the 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 the Fund and such accounts. The
simultaneous purchase or sale of the same securities by the Fund and other
accounts may have detrimental effects on the Fund, as they may affect the price
paid or received by the Fund or the size of the position obtainable by the 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 the Fund as a factor in
the selection of broker-dealers to execute the Fund's securities transactions.
CAPITAL STOCK
The Fund is a separate portfolio of IAI Investment Funds III, Inc., a
Minnesota corporation whose shares of common stock are currently issued in three
series (Series A through C). 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 C common shares. The investment portfolio represented by such shares is
referred to as IAI Latin America Fund.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The portfolio securities in which the Fund invests fluctuate in value,
and hence, for the Fund, the net asset value per share also fluctuates.
The net asset value per share of the 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 the 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.
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<PAGE>
SPECIAL REDEMPTION AND EXCHANGE INFORMATION
In general, shares of the Fund may be exchanged or redeemed at net asset
value. However, shares of the Fund held for less than one year are redeemable at
a price equal to 98% of the then current net asset value per share or such
higher percentage of current net asset value per share that represents the then
current net asset value minus an amount equal to 2% of the cost of the shares.
This 2% discount, referred to in the Prospectus and this Statement of Additional
Information as a redemption fee, directly affects the amount a shareholder who
is subject to the discount receives upon exchange or redemption. It is intended
to encourage long-term investment in the Fund, to avoid transaction and other
expenses caused by early redemptions and to facilitate portfolio management. The
fee is not a deferred sales charge, is not a commission paid to IAI or it
subsidiaries, and does not directly benefit IAI. The Fund reserves the right to
modify the terms of or terminate this fee at any time.
The redemption fee will not be applied to (a) a redemption of shares
resulting from an investment decision by IAI for an investment advisory client;
(b) a redemption of shares held in certain retirement plans, including 401(k)
plans and 403(b) plans (however, this fee waiver does not apply to IRA and
SEP-IRA accounts), (c) a redemption of any shares of the Fund outstanding for
one year or more, (d) a redemption of reinvestment shares (i.e., shares
purchased through the reinvestment of dividends or capital gains distributions
paid by the Fund), or (e) a redemption of shares by the Fund upon exercise of
its right to liquidate accounts (i) falling below the minimum account size by
reason of shareholder redemptions or (ii) when the shareholder has failed to
provide tax identification information. For this purpose and without regard to
the shares actually redeemed, shares will be redeemed as follows: first,
reinvestment shares; second, purchased shares held one year or more; and third,
purchased shares held for less than one year.
PURCHASES AND REDEMPTIONS IN KIND
In extraordinary circumstances, Fund shares may be purchased for cash or in
exchange for securities which are permissible investments of a Fund subject to
IAI's discretion and its determination that the securities are acceptable.
Securities accepted in exchange will be valued on the basis of market
quotations, or if market quotations are not available, by a method that IAI
believes accurately reflects fair value. In addition, securities accepted in
exchange are required to be liquid securities that are not restricted as to
transfer. Also in extraordinary circumstances, if a shareholder so desires, and
IAI so agrees, Fund shares may be redeemed in exchange for securities held by a
Fund. Securities redeemed in exchange will be valued on the basis of market
quotations, or if market quotations are not available, by a method that IAI
believes accurately reflects fair value.
TAX STATUS
The tax status of the Fund and the distributions of the Fund is
summarized in the Prospectus under "Dividends, Distributions and Tax Status."
Because it is expected that no portion of the net investment income of
the Fund will derive from dividends from domestic corporations, it is probable
that no portion of the dividends paid by the Fund 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.
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<PAGE>
Ordinarily, distributions and redemption proceeds earned by Fund
shareholders are not subject to withholding of federal income tax. However, the
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
the Fund shareholder to supply the Fund with such shareholder's taxpayer
identification number, and the failure of the 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, the 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,
the Fund generally must declare dividends by the end of each calendar year
representing 98% of the 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 the 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 the 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 the 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 the 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 the 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, the 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 the Fund's
taxable year. All or part of any loss realized by the Fund on any closing of a
futures contract may be deferred until all of the 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, the 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, the 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 the Fund's principal business of investing in
stocks or securities (or options and futures 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 the 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 the 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 the 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 the Fund to engage in such short-term
transactions in limited circumstances. Any gains realized by the Fund as a
result of the constructive sales of futures contracts held by the 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 the
Fund has held the futures contracts at the end of the year.
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Under the Code, dividends of net investment income received from the
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 the 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 the 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 the Fund will constitute such interests, and the
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 the 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 the Fund for
distributions to shareholders.
If the 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 the Fund will be able to do so. Under
the Code, if more than 50% of the value of the Fund's total assets at the close
of its taxable year consist of stock or securities of foreign corporations, the
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 the 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 the Fund's
taxable year whether the foreign taxes paid by the 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. The 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 Code; and (iv) other income not specifically categorized. Of these
categories, a substantial part of the 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 Fund's Prospectus and this
Statement of Additional Information.
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LIMITATION OF DIRECTOR LIABILITY
Under Minnesota law, the 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 Fund has no financial statements at this time. Such financial
statements will be included in the Fund's 1997 Annual Report to shareholders.
Such Annual Report, when available, may be obtained by shareholdres on request
from the Fund at no charge.
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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
characterizes 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 some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis of condition.
-A1-
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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
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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.
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.
A-2
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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.
COMMERCIAL PAPER
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
