1933 Act Registration No. 33-10207
1940 Act Registration No. 811-4904
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 1, 1999
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Pre-Effective Amendment No.
Post-Effective Amendment No. 28
AND/OR
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940
Amendment No. 28
(Check appropriate box or boxes)
IAI INVESTMENT FUNDS III, INC.
(Exact Name of Registrant as Specified in Charter)
3700 U.S. Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
(Address of Principal Executive Offices, Zip Code)
(612) 376-2700
(Registrant's Telephone Number, including Area Code)
Steven G. Lentz, Esq.
3700 U.S. Bank Place
P.O.Box 357
Minneapolis, Minnesota 55440
(Name and Address of Agent for Service)
COPY TO:
Kathleen L. Prudhomme, Esq.
Dorsey & Whitney LLP
220 South Sixth Street
Minneapolis, Minnesota 55402-1498
It is proposed that this filing will become effective (check appropriate box):
X immediately upon filing pursuant to paragraph (b) of Rule 485
---
on (specify date) pursuant to paragraph (b) of Rule 485
---
75 days after filing pursuant to paragraph (a) of Rule 485
---
on December 30, 1998 pursuant to paragraph (a) of Rule 485
---
60 days after filing pursuant to paragraph (a) of Rule 485
---
<PAGE>
PART C
IAI International Fund
series of
IAI Investment Funds III, Inc.
OTHER INFORMATION
Item 23. Exhibits
THE FUNDS ARE FILING OR INCORPORATING BY REFERENCE THE FOLLOWING
EXHIBITS:
(a).1 Articles of Amendment dated 9/23/98 to Amended and Restated
Articles of Incorporation (3)
(a).2 Amended and Restated Articles of Incorporation dated as of
7/26/93 (2)
(b) Bylaws (2)
(c) Instruments Defining Rights of Security Holders - not
applicable
(d).1 Management Agreement dated 4/1/96 (2)
(d).2 Sub-Advisory Agreement dated 1/28/87 (2)
(e).1 Underwriting and Distribution Agreement - not applicable
(e).2 Dealer Sales Agreement (1)
(e).3 Shareholder Services Agreement 5/10/95 (2)
(f) Bonus or Profit Sharing Contracts - not applicable
(g) Custody Agreement dated 8/18/93 (2)
(h) Other Material Contracts - not applicable
(i) Legal Opinion of Dorsey & Whitney LLP *
(j) Consent of KPMG Peat Marwick LLP *
(k) Omitted Financial Statements - not applicable
(l) Initial Capital Agreements - not applicable
(m) Rule 12b-1 Plan - not applicable
(n) Financial Data Schedule - not applicable
(o) Rule 18f-3 Plan - not applicable
- --------------------------
(1) Incorporated by reference to Post-Effective Amendment No. 19 to the
Registrant's Registration Statement on Form N-1A filed with the Commission
on April 1, 1996.
(2) Incorporated by reference to a Post-Effective Amendment No. 21 to the
Registrant's Registration Statement on Form N-1A filed with the Commission
on September 20, 1996.
(3) Incorporated by reference to a Post-Effective Amendment No. 27 to the
Registrant's Registration Statement on Form N-1A filed with the Commission
on December 30, 1998.
* Filed herewith.
Item 24. Persons Controlled by or Under Common Control with the Fund
THE FOLLOWING IS A LIST OF ALL PERSONS DIRECTLY OR INDIRECTLY
CONTROLLED BY OR UNDER COMMON CONTROL WITH THE FUND:
See the section of the Prospectus entitled "Fund Management" and the
section of the Statement of Additional Information entitled "Management" filed
as part of this Registration Statement.
<PAGE>
Item 25. Indemnification
STATE THE GENERAL EFFECT OF ANY CONTRACT, ARRANGEMENTS OR STATUTE UNDER
WHICH ANY DIRECTOR, OFFICER, UNDERWRITER OR AFFILIATED PERSON OF THE FUND IS
INSURED OR INDEMNIFIED AGAINST ANY LIABILITY INCURRED IN THEIR OFFICIAL
CAPACITY, OTHER THAN INSURANCE PROVIDED BY ANY DIRECTOR, OFFICER, AFFILIATED
PERSON, OR UNDERWRITER FOR THEIR OWN PROTECTION.
Incorporated by reference to Post-Effective Amendment to Registrant's
Registration Statement on Form N-1A filed on May 22, 1996.
Item 26. Business and Other Connections of the Investment Adviser
DESCRIBE ANY OTHER BUSINESS, PROFESSION, VOCATION OR EMPLOYMENT OF A
SUBSTANTIAL NATURE THAT EACH INVESTMENT ADVISER, AND EACH DIRECTOR, OFFICER OR
PARTNER OF THE ADVISER, IS OR HAS BEEN ENGAGED WITHIN THE LAST TWO FISCAL YEARS
FOR HIS OR HER OWN ACCOUNT OR IN THE CAPACITY OF DIRECTOR, OFFICER, EMPLOYEE,
PARTNER OR TRUSTEE.
Information on the business of Investment Advisers, Inc. ("IAI") is
described in the Prospectus section "Management" and in Part B of this
Registration Statement in the section "Management."
The following senior officers and directors of IAI are not listed in
the Statement of Additional Information:
Other Business/Employment
Name Position with Adviser During Past Two Years
- ---- -----------------------------------------------
Iain D. Cheyne Chairman/Director None
Stephen C. Coleman Senior Vice President None
Larry Ray Hill Executive Vice President None
Kevin McKendry Director None
Peter Phillips Director None
James S. Sorenson Senior Vice President None
John Caravello Director Senior Vice President, Lloyds
Bank, New York, NY since 1980.
Certain of the officers and directors of IAI also serve as officers and
directors of IAI International Ltd. The address of IAI International is 10 Fleet
Place, London, EC4M 7RH, England. Both IAI and IAI International's ultimate
corporate parent is Lloyds TSB Group plc, a publicly-held financial services
organization based in London, England. The senior officers and directors of IAI
International are Hillary J. Fane, Deputy Chief Investment Officer and Iain D.
Cheyne, Director.
Certain of the officers and directors of IAI also serve as officers and
directors of IAI Trust Company, a wholly-owned subsidiary of IAI. The address of
IAI Trust Company is 3600 U.S. Bank Place, Minneapolis, Minnesota 55402. John A.
Alexander is the President and a Director of IAI Trust Company.
Item 27. Principal Underwriters
(a) STATE THE NAME OF EACH INVESTMENT COMPANY (OTHER THAN THE FUND) FOR WHICH
EACH PRINCIPAL UNDERWRITER CURRENTLY DISTRIBUTING THE FUND'S SECURITIES ALSO
ACTS AS A PRINCIPAL UNDERWRITER, DEPOSITOR, OR INVESTMENT ADVISER.
Not applicable.
<PAGE>
(b) PROVIDE THE INFORMATION REQUIRED BY THE FOLLOWING TABLE FOR EACH DIRECTOR,
OFFICER, OR PARTNER OF EACH PRINCIPAL UNDERWRITER NAMED IN RESPONSE TO ITEM 20.
Not applicable.
(c) PROVIDE THE INFORMATION REQUIRED BY THE FOLLOWING TABLE FOR ALL COMMISSIONS
AND OTHER COMPENSATION RECEIVED, DIRECTLY OR INDIRECTLY, FROM THE FUND DURING
THE LAST FISCAL YEAR BY EACH PRINCIPAL UNDERWRITER WHO IS NOT AN AFFILIATED
PERSON OF THE FUND OR ANY AFFILIATED PERSON OF AN AFFILIATED PERSON.
Not applicable.
Item 28. Location of Accounts and Records
STATE THE NAME AND ADDRESS OF EACH PERSON MAINTAINING PHYSICAL
POSSESSION OF EACH ACCOUNT, BOOK, OR OTHER DOCUMENT REQUIRED TO BE MAINTAINED BY
SECTION 31(a) AND THE RULES UNDER THAT SECTION.
The Custodian for Registrant is Norwest Bank Minnesota, N.A., Norwest
Center, Sixth & Marquette, Minneapolis, Minnesota 55479. The Custodian maintains
records of all cash transactions of Registrant. All other books and records of
Registrant's investment portfolios are maintained by IAI. IAI also acts as
Registrant's transfer agent and dividend disbursing agent, at 601 Second Avenue
South, P.O. Bos 357, Minneapolis, Minnesota 55402.
Item 29. Management Services
PROVIDE A SUMMARY OF THE SUBSTANTIVE PROVISIONS OF ANY
MANAGEMENT-RELATED SERVICE CONTRACT NOT DISCUSSED IN PART A OR B, DISCLOSING THE
PARTIES TO THE CONTRACT AND THE TOTAL AMOUNT PAID AND BY WHOM FOR THE FUND FOR
THE LAST THREE FISCAL YEARS.
Not applicable.
Item 30. Undertakings
(a) IN INITIAL REGISTRATION STATEMENTS FILED UNDER THE SECURITIES ACT,
PROVIDE AN UNDERTAKING TO FILE AN AMENDMENT TO THE REGISTRATION
STATEMENT WITH CERTIFIED FINANCIAL STATEMENTS SHOWING THE INITIAL
CAPITAL RECEIVED BEFORE ACCEPTING SUBSCRIPTIONS FROM MORE THAN 25
PERSONS IF THE FUND INTENDS TO RAISE ITS INITIAL CAPITAL UNDER SECTION
14(a)(3).
Not applicable.
(b) Each recipient of a prospectus of any series of the Registrant may
request the latest Annual Report of such series, and such Annual
Report will be furnished by the Registrant without charge.
<PAGE>
IAI Investment Funds III, Inc.
3700 U.S. Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Ladies and Gentlemen:
We have acted as counsel to IAI Investment Funds III, Inc., a
Minnesota corporation (the "Fund"), in connection with a Registration Statement
on Form N-1A (File No. 33-10207) (the "Registration Statement") relating to the
sale by the Fund of an indefinite number of shares of the Fund's Series A common
stock, each with a par value of $.01 per share (the "Shares").
We have examined such documents and have reviewed such
questions of law as we have considered necessary and appropriate for the
purposes of our opinions set forth below. In rendering our opinions set forth
below, we have assumed the authenticity of all documents submitted to us as
originals, the genuineness of all signatures and the conformity to authentic
originals of all documents submitted to us as copies. We have also assumed the
legal capacity for all purposes relevant hereto of all natural persons and, with
respect to all parties to agreements or instruments relevant hereto other than
the Fund, that such parties had the requisite power and authority (corporate or
otherwise) to execute, deliver and perform such agreements or instruments, that
such agreements or instruments have been duly authorized by all requisite action
(corporate or otherwise), executed and delivered by such parties and that such
agreements or instruments are the valid, binding and enforceable obligations of
such parties. As to questions of fact material to our opinions, we have relied
upon certificates of officers of the Fund and of public officials. We have also
assumed that the Shares will be issued and sold as described in the Registration
Statement.
Based on the foregoing, we are of the opinion that the Shares
have been duly authorized by all requisite corporate action and, upon issuance,
delivery and payment therefore as described in the Registration Statement, will
be validly issued, fully paid and nonassessable.
Our opinions expressed above are limited to the laws of the
State of Minnesota.
<PAGE>
We hereby consent to the filing of this opinion as an exhibit
to the Registration Statement, and to the reference to our firm under the
caption "Legal Counsel" in the Statement of Additional Information constituting
part of the Registration Statement.
Dated: February 26, 1999
Very truly yours,
/s/ DORSEY & WHITNEY LLP
KLP
<PAGE>
Independent Auditors' Consent
The Board of Directors
IAI Investment Funds III, Inc.:
We consent to the use of our report incorporated herein by reference and to the
reference to our Firm under the heading "FINANCIAL HIGHLIGHTS" in Part A of the
Registration Statement.
/s/ KPMG Peat Marwick LLP
Minneapolis, Minnesota
February 23, 1999
<PAGE>
IAI MUTUAL FUNDS
IAI INTERNATIONAL FUND
PROSPECTUS March 1, 1999
As with all mutual funds, the Securities and Exchange Commission has not
approved or disapproved the shares of this Fund, or determined if the
information in this prospectus is accurate or complete. Any statement to the
contrary is a criminal offense.
P.O. BOX 357
MINNEAPOLIS, MINNESOTA 55440
TELEPHONE 1-612-376-2700
1-800-945-3863
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Fund Summary............................................................................................ 1
Objectives......................................................................................... 1
Principal Investment Strategies.................................................................... 1
Principal Risks.................................................................................... 1
Fund Performance................................................................................... 2
Fees and Expenses.................................................................................. 3
Buying and Selling Shares............................................................................... 4
How to Buy Shares.................................................................................. 4
How to Sell Shares................................................................................. 6
Exchange Privilege................................................................................. 8
Authorized Telephone Trading....................................................................... 9
Statements and Confirmations....................................................................... 9
Shareholder Reports................................................................................ 9
Dividends and Capital Gains Distributions............................................................... 9
Taxes................................................................................................... 10
Taxes on Distributions............................................................................. 10
Taxes on Transactions.............................................................................. 10
Fund Management......................................................................................... 11
Investment Adviser................................................................................. 11
Sub-Adviser........................................................................................ 11
Portfolio Manager.................................................................................. 11
More Information on Investment Strategies and Risks..................................................... 11
Investment Strategies.............................................................................. 11
Temporary Investments.............................................................................. 12
Portfolio Turnover................................................................................. 12
Principal Risks.................................................................................... 12
Financial Highlights.................................................................................... 15
For More Information about IAI International Fund....................................................... 16
</TABLE>
<PAGE>
FUND SUMMARY
This section briefly describes the objectives, principal investment strategies
and principal risks of IAI International Fund (the "Fund"). It also provides you
with information on how the Fund has performed and on Fund expenses. For further
information on the Fund, please read the section entitled "More Information on
Investment Strategies and Risks."
OBJECTIVES
The Fund's primary objective is capital appreciation. As a secondary objective,
the Fund seeks current income, principally from dividends.
PRINCIPAL INVESTMENT STRATEGIES
The Fund invests principally (at least 65% of its total assets) in equity of
non-United States issuers which appear to have the potential for above-average
capital appreciation. The Fund will generally invest in securities of mid- and
large-capitalization companies with market capitalizations of $1 billion or
more. However, the Fund may invest up to 20% of its net assets in companies with
market capitalizations of less than $1 billion.
Although the Fund is not required to maintain any particular geographical mix of
its investments, under normal market conditions the Fund invests primarily in
countries that are represented on the Morgan Stanley Capital International
Europe, Australia, Far East ("EAFE") Index. The EAFE Index currently includes
companies representing the stock markets of 14 European countries, Australia,
New Zealand, Japan, Hong Kong and Singapore. The Fund may invest in developing
countries, but will limit its investment in developing countries which are not
included in the EAFE Index to 15% of its total assets.
The Fund's investment process is driven primarily by security selection, with
the Fund's sub-adviser concentrating on securities that it believes have
investment values greater than their market prices. Country analysis is utilized
to set broad guidelines for country allocation and as a means of risk control.
The Fund may engage in foreign currency hedging transactions, such as forward
foreign currency exchange contracts and currency financial futures and options.
Currency hedging may be used for defensive reasons and to reduce portfolio
volatility.
PRINCIPAL RISKS
The principal risks that could adversely affect the value of the Fund's shares
and the total return on your investment include:
o RISKS OF EQUITY SECURITIES. Equity securities may decline
significantly in price over short or extended periods of time. Price
changes may occur in the market as a whole or they may occur in only a
particular company, industry or sector of the market.
o RISKS OF FOREIGN INVESTING. Investing in foreign securities typically
involves risks not associated with U.S. investing. As a result, the
Fund's shares may be more volatile than shares of mutual funds which
invest principally in domestic securities. The Fund is not designed to
be a complete investment program. Risks of foreign investing include
the risk that the Fund may experience a decline in net asset value
resulting from changes in exchange rates between the United States
dollar and foreign currencies, the risk of adverse political and
economic developments, and the possibility of expropriation,
nationalization or confiscatory taxation or limitations on the removal
of Fund assets.
1
<PAGE>
o RISKS OF INVESTING IN DEVELOPING COUNTRIES. The risks of foreign
investing are particularly significant in developing countries. Many
investments in developing countries can be considered speculative, and
the price of securities and value of currencies can be much more
volatile than in the more developed markets.
o RISKS OF VALUE STOCKS. The Fund looks for undervalued securities with
appraised investment values greater than their market prices. These
securities can remain undervalued for years. There is a risk that their
prices will never reach what the Fund's sub-adviser believes is the
securities' true value, or that their prices will go down.
O RISKS OF INVESTING IN SMALL COMPANIES. Investing in small companies
involves greater risk than is customarily associated with investments
in larger, more established companies. Small companies are more likely
than larger companies to have limited product lines, markets or
financial resources, or to depend on a small, inexperienced management
group. The securities of small companies may have limited market
stability and may be subject to more abrupt or erratic market movements
than securities of larger, more established companies or the market
averages in general.
O RISKS OF FOREIGN CURRENCY HEDGING TRANSACTIONS. Attempts by the Fund
to minimize the effects of currency fluctuations through the use of
foreign currency hedging transactions may not be successful or the
Fund's hedging transactions may limit the Fund's ability to take
advantage of a favorable change in the value of foreign currencies.
You can lose money by investing in the Fund. An investment in the Fund is NOT a
deposit of any bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency.
FUND PERFORMANCE
The bar chart and table below provide you with information on the Fund's
volatility and performance. The bar chart shows you how performance of the
Fund's shares has varied from year to year. The table compares the Fund's
performance over different time periods to that of a broad measure of market
performance. Remember, how the Fund has performed in the past is not necessarily
an indication of how it will perform in the future.
ANNUAL TOTAL RETURNS AS OF 12/31 EACH YEAR
[BAR CHART]
1989 18.40%
1990 -13.10%
1991 16.60%
1992 -6.30%
1993 39.50%
1994 0.46%
1995 9.10%
1996 8.43%
1997 -4.19%
1998 1.83%
BEST QUARTER: Quarter ending March 31, 1998 11.35%
WORST QUARTER: Quarter ending September 30, 1990 (14.16)%
2
<PAGE>
AVERAGE ANNUAL TOTAL RETURNS AS OF 12/31/98
ONE YEAR FIVE YEARS TEN YEARS
INTERNATIONAL FUND 1.83% 3.00% 6.15%
MORGAN STANLEY CAPITAL
INTERNATIONAL EUROPE,
AUSTRALIA, FAR EAST INDEX* 20.33% 9.50% 5.86%
- ------------------------------
* An unmanaged index including approximately 1,027 companies representing the
stock markets of approximately 14 European countries, Australia, New
Zealand, Japan, Hong Kong and Singapore.
FEES AND EXPENSES
As an investor, you pay certain fees and expenses if you buy and hold shares of
the Fund. Shareholder fees are fees you pay directly when buying or selling
shares. Annual fund operating expenses are deducted from Fund assets. The
figures presented in the accompanying table are based on expenses during the
fiscal period from February 1 to October 31, 1998.
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
Maximum Sales Charge (Load) None
Imposed on Purchases
Maximum Deferred Sales Charge (Load) None
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE
DEDUCTED FROM FUND ASSETS)
(as a % of average net assets)
Management Fees 1.70%
Distribution and Service (12b-1) Fees None
Other Expenses 0.06%
Total Annual Fund Operating Expenses 1.76%
EXAMPLE
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds. It assumes that you invest
$10,000 in the Fund for the time periods indicated, that your investment has a
5% return each year and that the Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 year $ 179
3 years $ 554
5 years $ 954
10 years $ 2,073
3
<PAGE>
BUYING AND SELLING SHARES
HOW TO BUY SHARES
You may purchase fund shares either directly through the Fund or through certain
securities dealers. These dealers have the responsibility to promptly transmit
orders and may charge a processing fee.
MINIMUM INVESTMENTS
The Fund is a member of the IAI Family of Funds, a family of mutual funds
advised by Investment Advisers, Inc. ("IAI"). The minimum initial investment to
establish an account with the IAI Family of Funds is $5,000 for a retail account
and $2,000 for an IRA account. In each case, your initial investment may be
allocated in any way you wish among the Fund and other funds in the IAI Family
of Funds, so long as no less than $1,000 is allocated to any one fund. Once you
have met the account minimum, subsequent purchases can be made for as little as
$100.
You may satisfy the minimum investment requirement for retail accounts by
participating in the STAR Program. This requires an initial investment of $1,000
in any one fund in the IAI Family of Funds and a commitment to invest an
aggregate of $5,000 within 24 months. If you do not keep this commitment, IAI
has the right to redeem your shares. Contact the Fund if you would like a STAR
Program application.
DETERMINING YOUR PURCHASE PRICE
Your purchase price will be equal to the Fund's net asset value ("NAV") per
share next calculated after your order is placed in proper form. No sales load
or commission is charged when you purchase shares. NAV is determined as of the
close of regular trading on the New York Stock Exchange each day the exchange is
open.
The Fund's NAV per share 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 values
investments for which market quotations are readily available at market value.
It values short-term investments maturing within 60 days at amortized cost,
which approximates market value. It values all other investments and assets at
their fair value.
The Fund translates prices for its investments quoted in foreign currencies into
U.S. dollars at current exchange rates. As a result, changes in the value of
those currencies in relation to the U.S. dollar will affect the Fund's NAV.
Because foreign markets may be open at different times than the New York Stock
Exchange, the value of the Fund's shares may change on days when shareholders
are not able to buy or sell them. If events materially affecting the values of
the Fund's foreign investments occur between the close of foreign markets and
the close of regular trading on the New York Stock Exchange, these investments
will be valued at their fair value by the Fund's Board of Directors or its
delegates.
INVESTING BY MAIL
To invest by mail, send a completed, signed application and a check payable to
"IAI Funds" to the following address:
IAI Mutual Funds
601 2nd Avenue South
Suite 3600
Minneapolis, Minnesota 55402
4
<PAGE>
Third party checks will not be accepted for initial account investments. After
the Fund receives your completed purchase order, your account will be credited
with the number of full and fractional shares that can be purchased at the next
determined net asset value.
For assistance in completing the application, please contact IAI Shareholder
Services at 1-800-945-3863.
INVESTING BY WIRE
If you have an account with a commercial bank that is a member of the Federal
Reserve System, you may purchase shares by requesting your bank to wire funds
to:
Norwest Bank Minnesota
ABA Number: 091000019
IAI Mutual Funds Account Number: 6355002264
For further credit to: (name of shareholder)
IAI Account Number: (your account number)
NOTE: PLEASE SPECIFY THE FUND'S NAME
If you are purchasing by wire for a new account, you must do the following
before you wire funds:
o call IAI Shareholder Services at 1-800-945-3863 to advise them of
your investment;
o obtain an account number, instructions and an application form; and
o complete the application and send it to the Fund.
Your completed application must be received by the Fund before your wire is
sent.
Before initiating any subsequent wires, please call IAI Shareholder Services and
advise them of your name, account number and the name of the bank transmitting
the federal funds.
Wire orders will be accepted only on days when your bank, the Fund, the Fund's
transfer agent and Norwest Bank Minnesota are open for business. A wired
purchase will be considered made when the wired amount is received and the
purchase is accepted by the Fund. The Fund must receive payment before the close
of business for the purchase to be credited to your account on that day.
Otherwise, your purchase will be processed the next business day. The Fund may
reject your wire order if it does not contain the required information stated
above. If the Fund rejects your wire order, your money will be returned
promptly, less any costs incurred by the Fund or its transfer agent in rejecting
the order. You must pay any charges assessed by your bank for the wire service.
Any delays that may occur in wiring federal funds, including delays in
processing by the banks, are not the responsibility of the Fund or the Fund's
transfer agent.
RETIREMENT PLANS
Shares of the Fund may be an appropriate investment for various retirement
plans. If you would like information about establishing an Individual Retirement
Account or other retirement plan, please call IAI Shareholder Services at
1-800-945-3863.
All retirement plans involve a long-term commitment of assets and are subject to
various legal requirements and restrictions. You are urged to consult an
attorney or tax adviser before establishing such a plan.
5
<PAGE>
AUTOMATIC INVESTMENT PLAN
You may arrange to make regular investments of $100 or more each month through
automatic deductions from your checking or savings account. To participate in
this program, simply complete the Automatic Investment Plan portion of your
application and return it to the Fund. You will receive quarterly confirmations
of all transactions and dividends under the Plan.
If you wish to change or terminate your participation in the Automatic
Investment Plan you must provide the Fund with written notice. Your instructions
must be received by 10 days prior to the date the change or termination is to
take place.
HOW TO SELL SHARES
You may redeem your shares on any day the New York Stock Exchange is open. Your
redemption price will be the net asset value of your shares next determined
after your redemption request is received in proper form by the Fund.
BY MAIL
If your redeem by mail, your redemption price will be based on the next net
asset value per share which is determined following receipt by the Fund of your
written redemption request in the form shown below (and a properly endorsed
stock certificate if one has been issued).
To redeem by mail, send a written request to the Fund at the following address:
IAI Mutual Funds
601 Second Avenue South
Suite 3600
Minneapolis, Minnesota 55402
Your request should include the following information:
o name of the Fund,
o account number,
o dollar amount or number of shares to be redeemed,
o name on the account, and
o signatures of all registered account owners.
If you hold certificates for your shares, they must be included with your
request. They must be endorsed on the back with the signature of the person
whose name appears on the certificate and must be signature guaranteed.
Signatures on your written request must be guaranteed if :
o you would like the proceeds from the sale to be paid to someone
other than the shareholder of record, or
o you have changed your address over the telephone within the last 15
calendar days.
6
<PAGE>
A signature guarantee assures that a signature is genuine and protects
shareholders from unauthorized account transfers. Banks, savings and loan
associations, trust companies, credit unions, broker-dealers and member firms of
a national securities exchange may guarantee signatures. NOTARIZATION BY A
NOTARY PUBLIC IS NOT ACCEPTED.
If Fund 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 redemption request.
To redeem money from your IRA account, an IRA Distribution Form must be
completed and returned to IAI. To receive a copy of the form, please call IAI
Shareholder Services at 1-800-945-3863.
BY PHONE
You may redeem shares by phone, subject to the following conditions:
o You must have completed the Authorized Telephone Trading section of
the account application.
o Your telephone instructions must be accompanied by your PIN.
o Telephonic redemptions are limited to $50,000.
o Redemption proceeds must be made payable to the owner(s) of record
and delivered to the address of record.
o Telephone redemptions are not permitted for IRAs.
For assistance, please contact IAI Shareholder Services at 1-800-945-3863.
PAYMENT OF REDEMPTION PROCEEDS
BY WIRE. When you redeem by telephone, you may have the proceeds wired to your
bank account if you provided the required information at the time you opened
your account. Wire redemption requests will only be processed on days your bank,
the Fund, the Fund's transfer agent and Norwest Bank Minnesota are open for
business. If you choose to have your redemption proceeds wired to your bank,
please note the following:
o A minimum amount of $1,000 is required to wire redemption proceeds.
o Proceeds will be wired on the next business day after your redemption
request.
o Your account will be charged a fee of $10 each time redemption
proceeds are wired to your bank. Your bank may also charge you a fee
for receiving a wire.
To add the ability to receive proceeds by wire to your account, or to change
existing bank account information, please submit a letter of instruction,
including your bank information and with a signature guarantee, to:
IAI Shareholder Services
P.O. Box 357
Minneapolis, Minnesota 55440-0357
BY CHECK. Normally the Fund will mail payment for shares redeemed on the
business day following the receipt of your redemption request, although payment
may be made as late as seven days after your request. However, the Fund will not
send redemption proceeds until checks (including certified checks, cashiers
checks or automatic investment credits) received in payment for shares have
cleared. This may take up to 15 days from the date of purchase.
7
<PAGE>
INVOLUNTARY REDEMPTIONS
If your account balance falls below $500 as a result of selling or exchanging
shares, the Fund has the right to redeem your shares and send you the proceeds.
Before redeeming your account, the Fund will mail you a notice of its intention
to redeem, which will give you an opportunity to make an additional investment.
If you do not increase the value of your account to at least $500 within six
months of the date the notice was mailed, the Fund may redeem your account.
SYSTEMATIC CASH WITHDRAWAL PLAN
The Fund has a Systematic Cash Withdrawal Plan under which you may automatically
redeem a fixed dollar amount of Fund shares on either a monthly or quarterly
basis. Under the Systematic Cash Withdrawal Plan:
o Automatic redemptions must be for $100 or more.
o Shares will be redeemed at the net asset value determined on the 15th
of the applicable month (or the next business day).
o All income dividends and capital gains distributions must be
reinvested in Fund shares.
o Confirmations of all transactions and distributions will be sent to
you quarterly.
Plan application forms are available through the Funds. If you would like
assistance in completing the application, contact IAI Shareholder Services at
1-800-945-3863.
EXCHANGE PRIVILEGE
You may exchange your Fund shares for shares of another fund in the IAI Family
of Funds if you satisfy that Fund's purchase requirements. There currently is no
fee to exchange shares.
The Fund generally limits exchanges to four per year. This limit may be modified
for certain retirement plan accounts and for those participating in the
Automatic Exchange Plan described below. The Fund may change or cancel its
exchange privilege at any time.
When you exchange your Fund shares for shares of another fund in the IAI Family
of Funds the exchange is considered a sale of your Fund shares for federal
income tax purposes, and you may have a taxable capital gain or loss.
You may exchange shares by notifying the Fund in writing or, if you have
authorized the Fund to accept telephone instructions, by telephone. See "How to
Sell Shares -- By Telephone."
AUTOMATIC EXCHANGE PLAN
You may arrange to make regular exchanges of $100 or more between any of the
funds in the IAI Family of Funds on a monthly basis. Please note the following
about automatic exchanges:
o If you wish to participate in the Plan, you must complete the
Automatic Exchange Plan portion of your IAI Mutual Fund application.
o Exchanges will take place at the net asset value determined on the
fifth day of each month (or the next business day).
8
<PAGE>
o If you participate in the Automatic Exchange Plan you will receive
quarterly confirmations of all transactions and dividends.
o You may not close an account through the Automatic Exchange Plan.
AUTHORIZED TELEPHONE TRADING
As discussed above, you may exchange and redeem shares by telephone if you have
completed the Authorized Telephone Trading section of the IAI Mutual Fund
application. You will be provided with a personal identification number ("PIN")
that must accompany any instructions by phone. Telephone redemptions are not
permitted for IRAs.
Address changes may also be made over the telephone, provided the request is
accompanied by your PIN. During the 15 calendar days following an address change
by telephone, you may only redeem shares in your account with a signature
guaranteed letter of instruction.
The Fund and its agents will not be responsible for any losses that may result
from acting on telephone instructions that they reasonably believe to be
genuine. The Fund will follow reasonable procedures to confirm that instructions
received by telephone are genuine. These procedures include tape recording all
redemption and exchange requests and requiring that they be accompanied by your
PIN number.
STATEMENTS AND CONFIRMATIONS
Whenever you buy or sell shares of the Fund, IAI will send you a confirmation
statement showing how many shares you bought or sold and at what price. You will
also receive an account statement quarterly and a consolidated transaction
statement annually. Please review carefully all of the information relating to
transactions on your statements and confirmations to ensure that your
instructions were acted on properly. Please notify the Fund immediately in
writing if there is an error. If you do not provide the Fund with notice of an
error within 60 days of non-automatic transactions, or within 60 days of the
date of your consolidated quarterly statement in the case of automatic
transactions, you will be deemed to have ratified the transaction.
SHAREHOLDER REPORTS
Shareholder reports will be sent to you semi-annually. These reports contain
financial information about the Fund, including a list of investment securities
held. To reduce the volume of mail you receive, only one copy of Fund reports
may be mailed to your household (same surname and address). Please call IAI
Shareholder Services at 1-800-945-3863 if you wish to receive additional
shareholder reports.
DIVIDEND AND CAPITAL GAINS DISTRIBUTIONS
The Fund pays dividends from net investment income semi-annually and distributes
any realized capital gains annually.
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
are automatically reinvested in additional shares of the Fund;
capital gains reinvestment -- your capital gain distributions will be
automatically reinvested, but your income dividends will be paid in
cash; or
9
<PAGE>
cash -- your income dividends and capital gain distributions will be
paid in cash.
If you elect to receive distributions in cash, they can be sent to you by 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.
If you do not select an option when you open your account, the Fund will
automatically reinvest all distributions in additional Fund shares.
The Fund also has a Directed Dividend service which allows you to invest your
dividends and/or capital gain distributions into another IAI Mutual Fund.
Contact IAI Shareholder Services at 1-800-945-3863 for details.
Prior to purchasing shares of the Fund, you should consider the impact of
dividend or capital gains distributions which are expected to be announced, or
which have been announced but not paid. If you purchase shares shortly before
the record date for such a distribution, you will pay the full price for the
shares and then receive a portion of that price back shortly thereafter as a
taxable distribution.
TAXES
Some of the common tax consequences of investing in the Fund are discussed
below. More information about taxes is in the Statement of Additional
Information. Because everyone's tax situation is unique, be sure to consult with
your tax adviser.
TAXES ON DISTRIBUTIONS
The Fund pays its shareholders distributions from its net investment income and
any net capital gains that it has realized. For most investors, these
distributions will be taxable, whether paid in cash or reinvested (unless your
investment is in an IRA or other tax-advantaged account).
Distributions paid from the Fund's net investment income are taxable as ordinary
income. Distributions paid from the Fund's long-term capital gains are taxable
as long-term gains, regardless of how long you have held your shares. The Fund's
distributions are expected to consist primarily of capital gains.
The Fund may be required to pay withholding and other taxes imposed by foreign
countries. If the Fund has more than 50% of its total assets invested in
securities of foreign corporations at the end of its taxable year, it may make
an election that will permit you either to claim a foreign tax credit with
respect to foreign taxes paid by the Fund or to deduct those amounts as an
itemized deduction on your tax return. If the Fund makes this election, you will
be notified and provided with sufficient information to calculate the amount you
may deduct as foreign taxes paid or your foreign tax credit.
TAXES ON TRANSACTIONS
The sale or exchange of Fund shares will be a taxable event for you and may
result in a capital gain or loss. The gain or loss will be considered long-term
if you have held your shares for more than one year. A gain or loss on shares
held for one year or less is considered short-term and is taxed at the same
rates as ordinary income.
Information about the tax status of each year's distributions will be mailed
annually.
10
<PAGE>
FUND MANAGEMENT
INVESTMENT ADVISER
Investment Advisers, Inc. ("IAI") is the Fund's investment adviser. IAI, which
has been in the investment advisory business since 1947, 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.
IAI is located at 601 Second Avenue South, Suite 3600, Minneapolis, Minnesota
55402.
The Fund has entered into a Management Agreement with IAI under which IAI
provides the Fund with investment advisory services and is responsible for
managing the Fund's business affairs, subject to the authority of the Board of
Directors. IAI also is responsible under the Management Agreement for providing
or arranging for the provision of all required administrative, stock transfer,
redemption, dividend disbursing, accounting and shareholder services. The
Management Agreement requires IAI to pay all of the Fund's operating expenses,
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. The Fund pays IAI an annual fee
under the Management Agreement. During its most recent fiscal year, the Fund
paid IAI a management fee equal to 1.70% of the Fund's average daily net assets,
on an annual basis. Because IAI is paying the Fund's operating expenses, this
fee represents the Fund's total expenses, excluding interest expense of 0.06%,
for the fiscal year.
SUB-ADVISER
IAI has retained IAI International to act as the Fund's sub-adviser, and pays to
IAI International a portion of its management fee. IAI International is based in
London and maintains a United States representative office with the same address
as IAI.
PORTFOLIO MANAGER
Hilary Fane has had responsibility for the Fund's investments in securities of
foreign issuers since February 1999. Ms. Fane is IAI International's Deputy
Chief Investment Officer, Director of European Investments, and a member of its
Board of Directors. Ms. Fane has served as a portfolio manager since joining IAI
International in 1985.
MORE INFORMATION ON
INVESTMENT STRATEGIES AND RISKS
INVESTMENT STRATEGIES
The principal investment strategies of the Fund are described above under "Fund
Summary," and in more detail below. These are the strategies that IAI believes
are most likely to be important in trying to achieve the Fund's objectives. Of
course, there is no guarantee that the Fund will achieve its objectives.
Although not considered principal strategies, you should be aware that the Fund
may also use strategies and invest in securities that are not described below,
but that are described in the Statement of Additional Information.
The Fund invests primarily in equity securities of non-United States issuers,
including common stocks, preferred stocks and securities convertible into common
stock. In addition, the Fund may invest in securities representing underlying
international securities, such as American Depositary Receipts, European
Depositary Receipts and Global Depositary Receipts. As a holder of a depositary
receipt, the Fund may bear a portion of the additional costs involved in holding
the underlying securities with a depository. The Fund also may invest in shares
of
11
<PAGE>
closed-end investment companies that invest in foreign securities. This may be
the most practical means by which the Fund can invest in certain countries. As a
shareholder in an investment company, the Fund would bear its share of the
investment company's expenses, while continuing to pay its own expenses.
The Fund's investment process is driven primarily by security selection. IAI
conducts extensive primary research on companies worldwide. IAI narrows this
universe of securities by concentrating on those which it believes exhibit
superior value characteristics. These stocks then are evaluated on the basis of
the quality of the company's management, the stock's competitive position both
domestically and internationally, and its potential for cash flow and dividend
growth. IAI uses a dividend discount model which takes these factors into
consideration to produce an appraisal of a company's investment value. This
value is then compared with the market price of the company's stock. IAI looks
for undervalued stocks with appraised investment values greater than their
market prices. IAI generally will buy a stock when its price is at 80% or less
of its appraised value, and sell it when its price is at 110% of its appraised
value. IAI may also sell a stock for other reasons, such as additional
information discovered as a result of ongoing research on the company, or
disappointing performance of the stock.
Country analysis is utilized to set broad guidelines for country allocation and
as a means of risk control. Normally, at least four different foreign economies
will be represented in the Fund's portfolio. From time to time, however, the
Fund may invest 25% or more of its total assets in the economies of Japan, the
United Kingdom, France and/or Germany. In allocating assets among the various
markets throughout the world, the Fund considers such factors as prospects for
relative economic growth between foreign countries, expected levels of inflation
and interest rates, government policies influencing business conditions, the
range of individual investment opportunities available to international
investors, and other pertinent financial, tax, social, political and national
factors, all in relation to the prevailing prices of securities in each country
or region.
TEMPORARY DEFENSIVE INVESTMENTS
In an attempt to respond to adverse market, economic, political or other
conditions, the Fund may temporarily invest without limit in cash or cash
equivalents (in U.S. dollars or foreign currencies) and short-term securities,
including money market securities. Being invested in these securities may keep
the Fund from participating in a market upswing and prevent the Fund from
achieving its investment objectives.
PORTFOLIO TURNOVER
The Fund may dispose of securities whenever it appears advisable, without regard
to the length of time they have been held. As a result, the Fund may, from time
to time, have an annual portfolio turnover rate of over 100%. Trading of
securities may produce capital gains, which are taxable to shareholders when
distributed. Active trading may also increase the amount of commissions or
mark-ups to broker-dealers that the Fund pays when it buys and sells securities.
The "Financial Highlights" section of this prospectus shows the Fund's
historical portfolio turnover rate.
PRINCIPAL RISKS
The principal risks of investing in the Fund are described above under "Fund
Summary." More information about Fund risks is presented below.
o MARKET RISK. The value of a company's stock may be affected by changes in
financial markets that are relatively unrelated to the company itself, such as
changes in interest rates, changes in general economic conditions, changes in
investor perceptions of the market, or the outlook for overall corporate
profitability.
o SECTOR RISK. The stocks of companies within a certain industry or sector of
the economy can perform differently from the overall stock market. This could be
due to such factors as increased production costs or changes in the regulatory
or competitive environment.
12
<PAGE>
o COMPANY RISK. The value of a company's stock may fall as a result of factors
directly relating to that company, such as changes in corporate profitability
due to the success or failure of specific products or management strategies.
o RISKS OF FOREIGN INVESTING. Investing in foreign securities typically involves
risks not associated with U.S. investing. These risks include:
CURRENCY RISK. Because the Fund invests in securities denominated in
currencies other than the U.S. dollar, the Fund may be affected
favorably or unfavorably by changes in currency exchange rates. Changes
in exchange rates will affect the Fund's net asset value, the value of
dividends and interest earned, and gains and losses realized on the
sale of securities. Attempts by the Fund to minimize the effects of
currency fluctuations through the use of foreign currency hedging
transactions may not be successful or the Fund's hedging transactions
may cause the Fund to be unable to take advantage of a favorable change
in the value of foreign currencies.
INFORMATION RISK. There may be less publicly available information
about foreign securities and issuers than is available about domestic
securities and issuers. In addition, foreign companies are not subject
to uniform accounting, auditing and financial reporting standards,
practices and requirements comparable to those which apply to domestic
companies.
FOREIGN SECURITIES MARKET RISK. The foreign securities markets of many
countries in which the Fund invests may be smaller, less liquid and
subject to greater price volatility than those in the United States. In
addition, there may be delays in the settlement of foreign security
transactions. Securities traded on foreign exchanges may be subject to
further risks due to the possibility of permanent or temporary
termination of trading, and greater spreads between bid and asked
prices for securities. In addition, there is generally less
governmental supervision and regulation of foreign stock exchanges.
Brokerage commissions, custody services and other costs relating to
investment in foreign countries are generally more expensive than in
the United States.
RISK OF INVESTMENT RESTRICTIONS. Some countries, particularly
developing countries, restrict to varying degrees foreign investment in
their securities markets. 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.
FOREIGN TAX RISK. The Fund's income from foreign 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 countries. To the
extent foreign income taxes are paid by the Fund, U.S. shareholders may
be entitled to a credit or deduction for U.S. tax purposes. See "Taxes"
above.
POLITICAL AND ECONOMIC RISK. International investing is subject to the
risk of political, social or economic instability in the country of the
issuer of a security, the difficulty of predicting international trade
patterns, the possibility of the imposition of exchange controls,
expropriation, limits on removal of currency or other assets and
nationalization of assets.
o RISKS OF INVESTING IN DEVELOPING COUNTRIES. The risks of foreign investing are
particularly significant in developing countries. The economies of many
developing countries continue to experience significant problems, including high
inflation rates, high interest rates, large external debt and continuing trade
deficits, and are characterized by extreme poverty, high unemployment and a
significant dependence on limited industries. Many developing countries have
experienced substantial, and in some periods extremely high, rates of inflation
for many years. Inflation and rapid fluctuations in inflation rates have had and
may continue to have very negative effects on the economies and securities
markets of certain developing countries. The governments of many developing
countries have exercised and continue to exercise a significant influence over
many aspects of the private sector. Government actions concerning the economy
could have a significant effect on market conditions and prices
13
<PAGE>
and/or yields of securities in which the Fund invests. Finally, currency risk is
also increased in developing countries. Many of the currencies of developing
countries have experienced steady devaluations relative to the U.S. dollar, and
major devaluations have historically occurred in certain countries. These
devaluations could have a detrimental impact on the Fund. Some developing
countries also may have managed currencies which are not free floating against
the U.S. dollar. In addition, there is a risk that certain developing countries
may restrict the free conversion of their currencies into other currencies.
Further, the currencies of certain developing countries may not be internally
traded.
O RISKS OF INVESTING IN SMALL COMPANIES. Investing in small companies involves
greater risk than is customarily associated with investments in larger, more
established companies. Small companies are more likely than larger companies to
have limited product lines, markets or financial resources, or to depend on a
small, inexperienced management group. The securities of small companies are
often traded over-the-counter and may not be traded in volumes typical on a
national securities exchange. Consequently, the securities of small companies
may have limited market stability and may be subject to more abrupt or erratic
market movements than securities of larger, more established companies or the
market averages in general.
O RISKS OF MAKING SIGNIFICANT INVESTMENTS IN A SINGLE COUNTRY. The Fund may
invest more than 25% of its total assets in the economies of Japan, the United
Kingdom, France and/or Germany. If the Fund concentrates its investments in one
of these countries, it will be particularly affected by political and economic
conditions and developments in that country.
O EURO CONVERSION. On January 1, 1999, the European Union introduced a single
currency, the Euro, which was adopted as the common legal currency for
participating member countries. Existing sovereign currencies of the
participating countries will remain legal tender in those countries, as
denominations of the Euro, until January 1, 2002. Participating countries are
Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the
Netherlands, Portugal and Spain.
Whether the Euro conversion will materially affect the Fund's performance is
uncertain. The Fund may be affected by the Euro's impact on the business or
financial condition of European issuers held by the Fund. The ongoing process of
establishing the Euro may result in market volatility. In addition, the
transition to the Euro and the elimination of currency risk among participating
countries may change the economic environment and behavior of investors,
particularly in European markets. To the extent the Fund holds non-U.S. dollar
(Euro or other) denominated securities, it will still be exposed to currency
risk due to fluctuations in those currencies versus the U.S. dollar.
O YEAR 2000 ISSUES. The investment advisory, transfer agency and administrative
services provided to the Fund by IAI depend on the smooth functioning of its
computer systems. Many computer software systems in use today cannot distinguish
the year 2000 from the year 1900 because of the way dates are encoded and
calculated. That failure could have a negative impact on handling securities
trades, pricing and account services. IAI has been actively working on necessary
changes to its computer systems to deal with the year 2000 and expects that its
systems will be adapted in time for that event, although there cannot be
assurance of success. IAI is working with third parties to assess the adequacy
of their compliance efforts and is developing contingency plans intended to
assure that third-party noncompliance will not materially affect IAI's
operations. Companies, organizations, governmental entities and markets in which
the Fund invests will be affected by the Year 2000 issue, but at this time the
Fund cannot predict the degree of impact. To the extent the effect is negative,
the Fund's returns could be adversely affected.
14
<PAGE>
FINANCIAL HIGHLIGHTS
The table that follows presents performance information about the Fund. This
information is intended to help you understand the Fund's financial performance
for the past five years. Some of this information reflects financial results for
a single Fund share. The total returns in the table represent the rate that you
would have earned or lost on an investment in the Fund, assuming you reinvested
all of your dividends and distributions. This information has been audited by
KPMG Peat Marwick LLP, independent auditors, whose report, along with the Fund's
financial statements, is included in the Fund's annual report, which is
available upon request.
<TABLE>
<CAPTION>
Period from Period from
February 1, 1998 April 1, 1994 Year ended
to October 31, Years ended January 31, to January 31, March 31,
1998**** 1998 1997 1996 1995*** 1994
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
Beginning of period $ 10.26 $ 12.11 $ 13.24 $ 12.06 $ 13.45 $ 11.22
------------------------------------------------------------------------------------
OPERATIONS
Net investment income 0.10 0.20 0.24 0.19 0.11 0.06
Net realized and unrealized
gains (losses) (0.52) (0.34) 0.08 2.17 (0.62) 2.56
------------------------------------------------------------------------------------
TOTAL FROM OPERATIONS (0.42) (0.14) 0.32 2.36 (0.51) 2.62
------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (0.03) (0.32) (0.28) (0.16) -- (0.34)
Net realized gains -- (1.39) (1.17) (1.02) (0.88) (0.05)
------------------------------------------------------------------------------------
TOTAL DISTRIBUTIONS (0.03) (1.71) (1.45) (1.18) (0.88) (0.39)
------------------------------------------------------------------------------------
NET ASSET VALUE
End of period $ 9.81 $ 10.26 $ 12.11 $ 13.24 $ 12.06 $ 13.45
------------------------------------------------------------------------------------
Total investment return* (4.15%) (1.04%) 2.39% 20.15% (4.14%) 23.85%
Net assets at end of period
(000's omitted) $35,116 $63,349 $116,191 $151,663 $136,474 $134,796
RATIOS
Expenses to average net
assets (including interest
expense) 1.76%** 1.67% 1.65% 1.66% 1.72%** 1.74%
Expenses to average net
assets (excluding interest
expense) 1.70%** 1.67% 1.65% 1.66% 1.72%** 1.74%
Net investment income to
average net assets 1.28%** 1.42% 1.56% 1.12% 1.04%** 0.87%
Portfolio turnover rate
(excluding short-term
securities) 50.2% 76.4% 32.1% 39.2% 27.6% 50.9%
</TABLE>
- --------------------
* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of all distributions at
net asset value.
** Annualized.
*** Reflects fiscal year end change from March 31 to January 31
**** Reflects fiscal year end change from January 31 to October 31.
15
<PAGE>
FOR MORE INFORMATION ABOUT IAI INTERNATIONAL FUND
The Fund's statement of additional information ("SAI") and annual and
semi-annual reports to shareholders include additional information about the
Fund. The SAI provides more details about the Fund and its policies. A current
SAI is on file with the Securities and Exchange Commission (SEC) and is
incorporated into this prospectus by reference (which means that it is legally
considered part of this prospectus). Additional information about the Fund's
investments is available in the Fund's annual and semiannual reports to
shareholders. In the Fund's annual report, you will find a discussion of the
market conditions and investment strategies that significantly affected the
Fund's performance during its last fiscal year. You may obtain free copies of
these materials by calling the Fund toll-free at 1-800-945-3863.
You may also obtain copies by visiting the SEC's Public Reference Room in
Washington, DC or by sending your request and a duplicating fee to the SEC's
Public Reference Section, Washington, DC 20549-6009. For more information, call
1-800-SEC-0330.
Information about the Fund is also available on the Internet. Text-only versions
of Fund documents can be viewed online or downloaded from the SEC's Internet
site at http://www.sec.gov.
SEC file number: 811-4904
16
<PAGE>
IAI INTERNATIONAL FUND
A SERIES OF
IAI INVESTMENT FUNDS III, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED MARCH 1, 1999
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. THIS
STATEMENT OF ADDITIONAL INFORMATION RELATES TO A PROSPECTUS FOR IAI
INTERNATIONAL FUND (THE "FUND") DATED MARCH 1, 1999, AND SHOULD BE READ IN
CONJUNCTION THEREWITH. THE FINANCIAL STATEMENTS INCLUDED AS PART OF THE FUND'S
ANNUAL REPORT TO SHAREHOLDERS FOR THE FISCAL PERIOD ENDED OCTOBER 31, 1998 ARE
INCORPORATED BY REFERENCE INTO THIS STATEMENT OF ADDITIONAL INFORMATION. COPIES
OF THE FUND'S PROSPECTUS AND/OR ANNUAL REPORT ARE AVAILABLE, WITHOUT CHARGE, BY
WRITING OR CALLING THE FUND, P.O. BOX 357, MINNEAPOLIS, MINNESOTA 55440
(TELEPHONE NUMBER 1-612-376-2700 OR 1-800-945-3863).
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND STRATEGIES..................................................................... 1
INVESTMENT RESTRICTIONS................................................................................. 13
INVESTMENT PERFORMANCE.................................................................................. 15
MANAGEMENT.............................................................................................. 17
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT................................................. 21
LEGAL COUNSEL........................................................................................... 21
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE...................................................... 21
CAPITAL STOCK........................................................................................... 22
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES..................................................... 23
NET ASSET VALUE AND PUBLIC OFFERING PRICE............................................................... 23
PURCHASES AND REDEMPTIONS OF SHARES..................................................................... 23
TAX STATUS.............................................................................................. 24
LIMITATION OF DIRECTOR LIABILITY........................................................................ 26
FINANCIAL STATEMENTS.................................................................................... 27
APPENDIX A - RATINGS OF DEBT SECURITIES................................................................. A-1
</TABLE>
<PAGE>
INVESTMENT OBJECTIVES AND STRATEGIES
IAI International Fund ("International Fund" or the "Fund") is a
diversified series of an open-end, management investment company. The investment
objectives and principal investment strategies of the Fund are discussed in the
Prospectus under "Fund Summary" and "More Information on Investment Strategies
and Risks." 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
strategies will be successful, or that its investment objective will be
attained. Certain of the Fund's principal investment strategies are discussed in
more detail below. In addition, the Fund may also use strategies and invest in
securities that are not described in the Prospectus, but that are described
below.
DEBT SECURITIES
Under normal market conditions, the Fund invests at least 65% of the
value of its total assets in equity securities of non-United States issuers.
However, the Fund may invest up to 35% of its total assets in cash, cash
equivalents, bonds and other debt securities of both United States and foreign
issuers when the anticipated total return from debt securities exceeds the
anticipated total return from equity securities. Such securities include:
(a) Bonds and other fixed income securities of United States issuers
which are rated within the four highest grades ("investment grade") by Moody's
Investors Service, Inc. ("Moody's") (Aaa, As, A or Baa) or Standard & Poor's
Corporation ("S&P") (AAA, AA, A or BBB). Securities rated Baa by Moody's are
considered medium grade obligations which lack outstanding investment
characteristics and in fact have speculative characteristics as well. Securities
rated BBB by S&P are regarded as having an adequate capacity to pay principal
and interest.
(b) Corporate notes, bonds and other debt securities (such as
Eurocurrency instruments) of non-United States issuers judged as being
equivalent in repayment security to investment grade domestic obligations by
Investment Advisers, Inc. ("IAI"), the Fund's investment adviser and manager, or
IAI International Limited, the subadviser to the Fund (hereinafter, references
to IAI shall include IAI International Limited where appropriate); provided,
however, that no more than 35% of the Fund's portfolio will be invested in
foreign corporate debt securities with maturities of greater than one year at
the time of investment.
(c) United States dollars or securities with maturities of one year or
less of, or guaranteed by, the United States Government, its agencies and
instrumentalities.
(d) Foreign currencies or securities of, or guaranteed by, foreign
governments or the agencies or instrumentalities of foreign governments, or
securities issued by supranational agencies (such as the World Bank) that are
equivalent in repayment security to investment grade domestic obligations,
provided that not more than 35% of the Fund's portfolio will be invested in
foreign government obligations having a maturity of greater than one year from
the date of investment.
(e) Short-term debt instruments of domestic and foreign issuers such as
commercial paper, bank certificates of deposit, bankers' acceptances, and
repurchase agreements for such securities (provided that the Fund will not
invest in foreign repurchase agreements and provided further that the Fund may
not invest more than 10% of its total assets in domestic repurchase agreements
and may invest in such repurchase agreements for defensive purposes only). The
commercial paper purchased by International Fund will consist only of (i)
obligations rated either Prime-2 or better by Moody's or A-2 or better by S&P,
or (ii) unrated or foreign obligations issued by companies considered by IAI to
offer equivalent repayment security.
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If a security held by the Fund is downgraded to below investment grade
(or, in the case of an unrated security, if IAI determines that the security's
credit quality is no longer equivalent to that of an investment grade
obligation), the Fund may return the security if IAI determines it would be in
the Fund's best interest, provided that in no event will more than 5% of the
Fund's net assets be invested in debt securities rated lower than investment
grade, or if unrated, deemed by IAI to be of equivalent quality.
TEMPORARY DEFENSIVE INVESTMENTS
The Fund reserves the right, as a temporary defensive measure, when
economic, political or other adverse market conditions require immediate action
to avoid losses, 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 of
the type set forth in paragraph (e) above.
DEPOSITARY RECEIPTS
The Fund may invest in the securities of foreign issuers in the form of
sponsored and unsponsored American Depositary Receipts (ADRs), European
Depositary Receipts (EDRs), Global Depositary Receipts (GDRs) or other
securities convertible into securities of foreign issuers. Generally, such
securities evidence ownership of and may be converted into securities issued by
a foreign corporation. The issuers of unsponsored depository receipts are not
obligated to disclose material information in the United States, and therefore,
there may not be a correlation between such information and the market value of
such securities.
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. Agreements implemented
under the Brady Plan to date are the result of negotiations between debtor
nations and their creditors. As a result, the financial packages offered by each
country differ. Many Brady Bonds are collateralized by U.S. Treasury zero-coupon
securities having similar maturities. Upon a default of such a Brady Bond,
bondholders would receive principal repayment, but only at maturity. Certain
Brady Bonds also include a partial guaranty of interest on a "rolling" basis.
Collateral is deposited by the Brady-issuing government with New York Federal
Reserve in amounts generally covering 12 to 18 months of interest payments. If
the collateral must be utilized for interest payments, the Brady government is
not required to replace it. Thus, bondholders are still subject to sovereign
risk (the credit risk of the issuing nation) with respect to the remaining
interest payments. The Fund will only invest in Brady Bonds which meet the
rating requirements set forth above for investments in debt securities.
There are many influences on the Brady Bond market. These include: (a)
developments in the issuing country, resulting in increased or decreased
sovereign risk, (b) developments in the U.S. Treasury market, which will have an
impact both directly, due to the price of the underlying collateral, and
indirectly, because of relative returns, and (c) regional developments. As a
result, Brady Bonds are generally more volatile than comparable sovereign
Eurobonds.
ZERO COUPON SECURITIES
The Fund may invest in zero coupon obligations of the U.S. Government
or its agencies, tax exempt issuers and corporate issuers, including rights to
stripped coupon and principal payments ("STRIPS"). Zero coupon bonds do not make
regular interest payments; rather, they are sold at a discount from face value.
Principal and accreted discount (representing interest accrued but not paid) are
paid at maturity. STRIPS are debt securities that are stripped of their interest
after the securities are issued, but otherwise are comparable to zero coupon
bonds. The market values of STRIPS and zero coupon bonds generally fluctuate in
response to changes in interest rates to a greater degree than do
interest-paying securities of comparable term and quality.
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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.
CLOSED-END INVESTMENT COMPANIES
A number of countries have authorized the formation of closed-end
investment companies to facilitate indirect foreign investment in their capital
markets. 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.
REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreements relating to the securities
in which it may invest. A repurchase agreement, which is functionally equivalent
to a loan by the Fund, involves the purchase of securities by the Fund 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 the
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.
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REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements as a form of
borrowing. 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 segregate appropriate
liquid assets to cover its obligation under the agreement. The Fund will enter
into reverse repurchase agreements only with parties whose creditworthiness has
been found satisfactory by IAI. 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 does not currently intend to invest more than 5% of its net assets in
reverse repurchase agreements.
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities.
However, certain restricted securities that are not registered for sale to the
general public and that can be resold to institutional investors may be
considered liquid pursuant to guidelines adopted by the Board of Directors. In
the case of a Rule 144A Security, such security is deemed to be liquid if:
(1) IAI reasonably expects to be able to resell the security to a
qualified institutional buyer, as defined in paragraph (a)(1) of Rule 144A, who
is aware of the Fund's reliance upon Rule 144A in selling the security without
registration, as required by paragraph (d)(2) of Rule 144A;
(2) the Rule 144A Security is not (a) of the same class as securities
listed on any national securities exchange or quoted in NASDAQ as determined
under paragraph (d)(3)(i) of Rule 144A, or (b) a security of a registered
investment company (other than a closed-end investment company); and
(3) the issuer (a) is a foreign government eligible to register
securities under Schedule B of the Securities Act of 1933, (b) is a company that
files periodic reports under the Securities Act of 1934 on Forms 8-K, 10-Q, 10-K
or 20-F or provides information under Rule 12g3-2(b) thereunder, or (c) has
agreed in writing to provide the holder and any prospective purchaser of the
Rule 144A Security with reasonably current financial information as required
under paragraph (d)(4)(i) of Rule 144A.
Other securities are deemed to be liquid if IAI determines that the
security can be disposed of within seven days in the ordinary course of business
at approximately the amount at which the Fund has valued the instrument for
purposes of calculating the Fund's net asset value. In making this
determination, IAI will consider such factors as may be relevant to the Fund's
ability to dispose of the security, including but not limited to, the following
factors (none of which, standing alone, would necessarily be determinative):
1. the frequency of trades and quotes for the security;
2. the number of dealers willing to purchase or sell the security
and the number of potential purchasers;
3. dealer undertakings to make a market in the security; and
4. the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the
method of soliciting offers and the mechanics of transfer).
It is not possible to predict with assurance the maintenance of an
institutional trading market for such securities and the liquidity of the Fund's
investments could be impaired if trading declines.
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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 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.
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.
ADJUSTING INVESTMENT EXPOSURE
In order to hedge against various market risks other than currency
risk, to manage the effective maturity or duration of the Fund's portfolio or to
enhance potential gain, the Fund may purchase and sell exchange-listed and
over-the-counter put and call options on securities, fixed-income indices and
other financial instruments, purchase and sell financial futures contracts and
options thereon, and enter into various interest rate transactions such as
swaps. However, the Fund has not entered into such transactions in the past, and
does not anticipate doing so to any significant extent during the current fiscal
year. In any event, no more than 5% of the Fund's assets will be committed to
techniques and instruments entered into for non-hedging purposes.
SWAP AGREEMENTS. The Fund may enter into 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 the
Fund's investment objectives and policies.
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.
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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, the 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 segregate appropriate liquid assets 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 the 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 the 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.
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.
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, the
Fund may be entitled to return of margin owed to it only in proportion to the
amount received by the FCM's other customers, potentially resulting in losses to
the Fund.
The Fund will file 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.
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The above limitations on the Fund's investments in futures contracts
and options, and the 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
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 Fund's portfolio, after taking into account unrealized
profits and unrealized losses on any such contracts it has entered into; and,
provided further, that in the case of an option that is in-the-money, such
amount may be excluded in computing such five percent.
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 (i.e., sells) a put
option, it takes the opposite side of the transaction from the option's
purchaser. In return for receipt of the premium, the Fund assumes the obligation
to pay the strike price for the option's underlying instrument if the other
party to the option chooses to exercise it. 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, the 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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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 the 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. Although the Fund intends
to purchase and sell options and futures only on exchanges or board of trade
where there appears to be an active secondary market, 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 segregate appropriate liquid assets in the amount
prescribed. These securities will be marked to market daily to assure that
coverage requirements are met. 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.
ECONOMIES OF JAPAN, THE UNITED KINGDOM, GERMANY AND FRANCE
As discussed in the Prospectus, the Fund may from time to time invest
more than 25% of its total assets in the economies of Japan, the United Kingdom,
Germany and France. This section includes a general discussion of these
economies.
JAPAN. Japan is politically organized as a democratic, parliamentary
republic and has a population of approximately 122 million. The Japanese economy
is heavily industrial and export-oriented. Although Japan is dependent upon
foreign economies for raw materials, Japan's balance of payments in recent years
has been strong and positive.
Japan has eight stock exchanges located throughout the country, but
over 80% of all trading is conducted on the Tokyo Stock Exchange.
Prices of stocks listed on the Japanese stock exchange are quoted
continuously during regular business hours. Trading commissions are at fixed
scale rates which vary by the type and the value of the transaction, but can be
negotiable for large transactions.
Securities in Japan are denominated and quoted in yen. Yen are fully
convertible and transferable based on floating exchange rates into all
currencies, without administrative or legal restrictions, for both nonresidents
and residents of Japan.
UNITED KINGDOM. The United Kingdom is a constitutional monarchy and
consists of England, Scotland, Wales and Northern Ireland. The population of the
United Kingdom is approximately 57 million. Industry in the United Kingdom is
predominantly owned in the private sector except for certain state owned
entities in the transportation and energy industries.
The financial center of the United Kingdom is London, which is also the
location of the London Stock Exchange. In October of 1986, stock exchange
commission rates were deregulated and stock exchange membership was opened up to
limited companies and to non-residents of the United Kingdom. Additionally, the
Financial Services Act (the "FSA") substantially restructured the U.K.
securities laws and deregulated the London Stock Exchange's own rules. FSA
created a new regulatory body known as the Securities and Investments Board (the
"SIB"), which has the power to delegate certain of its functions to various
self-regulatory organizations, of which the London Stock Exchange is one. Under
the FSA structure, the London Stock Exchange will continue to be largely
self-regulating with fundamentally the same types of self-regulatory rules in
effect prior to FSA.
Stock prices are continuously quoted during business hours on the
London Stock Exchange, and are negotiable, but have formalized for institutions.
Trading commissions in the U.K. are negotiable.
Securities in the United Kingdom are denominated and quoted in "pounds
sterling". Pounds sterling are fully convertible and transferable based on
floating exchange rates into all currencies, without administrative or legal
restrictions, for both non-residents and residents of the United Kingdom.
10
<PAGE>
GERMANY. Germany is a federated republic with a population of
approximately 80 million and a democratic parliamentary form of government. The
German economy is organized primarily on the basis of private sector ownership,
with the state exerting major influence through ownership in certain sectors,
including transportation, communication and energy. Unification of West Germany
with the formerly communist controlled East Germany took place in 1990.
Industrial activity makes the largest contribution to the German gross
national product. Although only 5% of German businesses are large-scale
enterprises, such large-scale businesses account for over half of industrial
production and employ over half the industrial labor force. Trading volume,
therefore, tends to concentrate on relatively few companies with both large
capitalizations and broad stock ownership. Historically the German economy has
been strongly export oriented. Privatization of formerly state owned enterprise
in what was once East Germany is in progress, but will make little difference to
the predominance of large scale businesses in overall industrial activity and
the stock market.
German equity securities trade predominantly on the country's eight
independent local stock exchanges, the Frankfurt exchange accounting for 70% of
turnover. Subject to the provisions of pertinent securities law, mainly the
Stock Exchange Law of 1896, as amended, the council, management and other
executive organs of the stock exchanges constitute self-administering and
self-regulatory bodies. The "Working Group of German Stock Exchanges"
headquartered in Frankfurt, of which all eight stock exchanges are members,
addresses all policy and administrative questions of national and international
character.
Prices for active stocks, including those for larger companies, are
quoted continuously during stock exchange hours. Less actively traded stocks are
quoted only once a day. Equity shares are normally fully-paid and
non-assessable.
Orders for stock executed for large customers on the stock exchanges
are negotiable. A federal stock exchange turnover tax, ranging up to 0.25%, is
levied on all securities transactions other than those between banks acting as
principal. Nonresidents such as the Fund are charged half these rates.
German equity securities have been denominated in Deutchemarks.
Deutchemarks are fully convertible and transferable into all currencies, without
administrative or legal restrictions, for both nonresidents and residents of
Germany. On January 1, 1999, however, Germany, along with ten other member
countries of the European Union, adopted the Euro as its legal currency.
FRANCE. France is a republic with a population of approximately 58
million and a democratic parliamentary form of government. France is one of the
four West European trillion-dollar economies and the leading agricultural
producer in Western Europe. Largely self-sufficient in agricultural products,
France is a major exporter of wheat and dairy products. The agriculture sector
generates slightly more than 2% of France's gross domestic product, the
industrial sector generates approximately one-quarter of GDP, and the growing
services sector has become crucial to the economy, generating over 70% of GDP.
Following stagnation and recession in 1991-93, French GDP expanded 2.4% in 1994
and in 1995, but only 1.3% in 1996. Persistently high unemployment (12.7% in
1996) still poses a major problem for the government.
The center of the French market is the Paris stock exchange (the
Bourse) (local exchanges were closed in 1990), which listed 862 companies with a
total capitalization of 4.1 trillion French francs (50% of GDP) in 1997. In
1996, a new electronic trading floor called the "Nouveau Marche" was created in
which new companies, especially smaller ones with an emphasis on growth and
technology, can raise start-up capital. A financial futures market, the "Marche
a Terme des Instruments Financiers," commonly known as the MATIF, trades
standard contracts on interest rates, short- and long-term bonds, stock market
indices and commodities. It has established linkages with its German and Swiss
counterparts as well as with the Chicago Mercantile Exchange. An options
exchange, the "Marche des Options Negociables de Paris (MONEP)," was established
in September 1987. These markets operate under the auspices of the Societe des
Bourses Francaises (SBF).
11
<PAGE>
France has one of the world's most open financial markets. According to
unofficial estimates, foreigners held approximately one-third of the capital of
publicly traded companies at the end of 1996. U.S. investment in France is
subject to the provisions of the Convention on Establishment between the United
States and France, which was signed in 1959 and is still in force. Some of the
rights it provides to U.S. nationals and companies include (a) the right to
receive the best treatment accorded to either domestic nationals and companies
or third country nationals and companies with respect to transferring funds
between France and the U.S., and (b) the requirement that property may only be
expropriated for a public purpose and that payment must be just, realizable, and
prompt.
French equity securities have been denominated in French francs. Francs
are fully convertible and transferable into all currencies, without
administrative or legal restrictions, for both nonresidents and residents of
France. On January 1, 1999, however, France, along with ten other member
countries of the European Union, adopted the Euro as its legal currency.
ADDITIONAL RISK CONSIDERATIONS
Investors should consider carefully the substantial risks involved with
respect to investing in securities of companies and governments of foreign
nations, which are in addition to the usual risks inherent in domestic
investments. Such risks are heightened with respect to investments in developing
countries. There may be less publicly available information about foreign
companies comparable to the reports and ratings published about companies in the
United States. Foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards, and auditing practices
and requirements may not be comparable to those applicable to United States
companies. Foreign markets typically have substantially less volume than the New
York Stock Exchange and securities of some foreign companies are less liquid and
more volatile than securities of comparable United States companies. Commission
rates in foreign countries, which are generally fixed rather than subject to
negotiation as in the United States, are likely to be higher. In many foreign
countries there is less government supervision and regulation of stock
exchanges, brokers and listed companies than in the United States.
Investments in developing countries may be subject to potentially
higher risks than investments in developed countries. These risks include (i)
less social, political and economic stability; (ii) the small current size of
the markets for such securities and the currently low or nonexistent volume of
trading, which may result in a lack of liquidity and in greater price
volatility; (iii) certain national policies which may restrict the Fund's
investment opportunities, including restrictions on investment in issuers or
industries deemed sensitive to national interests; (iv) foreign taxation; (v)
the absence of developed structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the limited
development and recent emergence, in certain countries, of a capital market
structure or market-oriented economy; and (vii) the possibility that recent
favorable economic developments in certain countries may be slowed or reversed
by unanticipated political or social events in such countries.
Despite the dissolution of the Soviet Union, the Communist Party may
continue to exercise a significant role in certain (particularly Eastern
European) countries. To the extent of the Communist Party's influence,
investments in such countries will involve risks of nationalization,
expropriation and confiscatory taxation. The communist governments of a number
of such countries expropriated large amounts of private property in the past, in
many cases without adequate compensation, and there can be no assurance that
such expropriation will not occur in the future. In the event of such
expropriation, the Fund could lose a substantial portion of any investments it
has made in the affected countries. Further, no accounting standards exist in
many developing countries. Finally, even though certain currencies may be
convertible into U.S. dollars, the conversion rates may be artificial to the
actual market values and may be adverse to Fund shareholders.
Certain countries, which do not have market economies, are
characterized by an absence of developed legal structures governing private and
foreign investments and private property. Certain countries require governmental
approval prior to investments by foreign persons, or limit the amount of
investment by foreign persons in a particular company, or limit the investment
of foreign persons to only a specific class of securities of a company that may
have less advantageous terms than securities of the company available for
purchase by nationals.
12
<PAGE>
Authoritarian governments in certain countries may require that a
governmental or quasi-governmental authority 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.
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.
INVESTMENT RESTRICTIONS
The Fund is subject to certain policies and restrictions which, along
with the Fund's investment objective, 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").
13
<PAGE>
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.
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).
For purposes of applying this restriction, "commodities" shall be
deemed to include commodity contracts.
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.
14
<PAGE>
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.
14. 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 strategies set forth in the
Prospectus, or any restriction set forth above under "Investment Restrictions"
which involves a maximum percentage of securities or assets (other than
Restriction 4) shall not be considered to be violated unless an excess over the
percentage occurs immediately after an acquisition of securities or utilization
of assets and results therefrom.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of portfolio securities owned by the Fund during
the same fiscal year. "Portfolio securities" for purposes of this calculation do
not include securities with a maturity date of less than twelve (12) months from
the date of investment. A 100% portfolio turnover rate would occur, for example,
if the lesser of the value of purchases or sales of portfolio securities for a
particular year were equal to the average monthly value of the portfolio
securities owned during such year. The Fund's historical portfolio turnover
rates are set forth in the Prospectus section "Financial Highlights".
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the Fund may refer to
monthly, quarterly, yearly, cumulative and average annual total returns. 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:
15
<PAGE>
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
The Fund's cumulative total return from the Fund's inception on April
23, 1987 through October 31, 1998 was 89.61%.
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:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of
the period of a hypothetical $1,000
payment made at the beginning of such
period.
The average annual total returns of the Fund for the one, five and ten
year periods ended October 31, 1998 were (5.31)%, 3.06% and 6.08%, respectively.
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
16
<PAGE>
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; and (ix) the performance of U.S. government and
corporate bonds, notes and bills. (The purpose of these comparisons would be to
illustrate historical trends in different market sectors so as to allow
potential investors to compare different investment strategies.); (2) the
Consumer Price Index (measure for inflation) may be used to assess the real rate
of return from an investment in 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.
MANAGEMENT
Under Minnesota law, the Fund's Board of Directors is generally responsible for
the overall operation and management of the Funds.
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>
Madeline Betsch 56 Director Currently retired; until April 1994, was Executive
19 South 1st Street Vice President, Director of Client Services, of
Minneapolis, Minnesota 55401 CME-KHBB Advertising since May 1985, and prior
thereto was a Vice President with Campbell-Mithun,
Inc. (advertising agency) since February 1977.
W. William Hodgson 74 Director Currently retired; served as information manager
1698 Dodd Road for the North Central Home Office of the
Mendota Heights, Minnesota 55118 Prudential Insurance Company of America from 1961
until 1984.
George R. Long 68 Director Chairman of Mayfield Corp. (financial consultants
29 Las Brisas Way and venture capitalists) since 1973.
Naples, Florida 33963
J. Peter Thompson 67 Director Grain farmer in southwestern Minnesota since
Route 1 1974. Prior to that, Mr. Thompson was employed by
Mountain Lake, Minnesota 56159 Paine Webber, Jackson & Curtis, Incorporated, (a
diversified financial services concern), most
recently as Senior Vice President and General
Partner.
</TABLE>
17
<PAGE>
<TABLE>
<S> <C> <C> <C>
Charles H. Withers 72 Director Currently retired; was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980.
Rochester, Minnesota 55903
John A. Alexander 42 President Chief Operating Officer of IAI since 1998. Prior
601 Second Avenue South to that time, Mr. Alexander served in various
P.O. Box 357 senior management capacities of Lloyds Bank plc
Minneapolis, Minnesota 55440 since 1984.
David Koehler 61 Vice Independent training and marketing consultant from
601 Second Avenue South President 1993 to current. Prior to that time, Mr. Koehler
P.O. Box 357 was a partner at IAI Venture Capital Group.
Minneapolis, Minnesota 55440
Paul H. Perseke 33 Treasurer Vice President of IAI. Prior to joining IAI in
601 Second Avenue South 1996, Mr. Perseke served as Vice President and
P.O. Box 357 Manager of Finance and Planning at Dain Rauscher
Minneapolis, Minnesota 55440 Corporation from 1991 to 1996.
Michael J. Radmer 53 Secretary Partner of Dorsey & Whitney LLP, a Minnesota based
220 South Sixth Street law firm which acts as General Counsel to the Fund.
Minneapolis, Minnesota 55402
</TABLE>
Each of the directors and executive officers of the Fund, other than
Mr. Koehler, also serves in the same capacity for each of the 14 other mutual
funds for which IAI serves as investment adviser (the "IAI Mutual Funds").
No compensation is paid by the Fund to any officer other than David
Koehler. 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. Each 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.
<TABLE>
<CAPTION>
Compensation Aggregate Compensation
from from the 15
Name of Person, Position International Fund* IAI Mutual Funds**
------------------------ ------------------- ----------------------
<S> <C> <C>
David Koehler - Vice President $656 $26,250
Betsch, Madeline - Director $1,260 $37,200
Hodgson, W. William - Director $1,260 $37,200
Long, George R. - Director $1,177 $37,200
Thompson, J. Peter - Director $1,266 $37,200
Withers, Charles H. - Director $1,177 $37,200
</TABLE>
- -------------------------
* For the fiscal year ended October 31, 1998.
** For the calendar year ended December 31, 1998; excludes expenses
incurred in connection with attending meetings
18
<PAGE>
Effective February 1998, the directors have agreed that the position of
Board Chair shall rotate from director to director.
The Fund's Board of Directors 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.
MANAGEMENT AGREEMENT
Effective April 1, 1996, pursuant to a Management Agreement between the
Fund and IAI, IAI 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 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 will also
reimburse the Fund for paying qualifying third parties 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 1.70%
For the next $100 - $250 million 1.45%
For the next $250 - $500 million 1.30%
Above $500 million 1.30%
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.
19
<PAGE>
The following table contains relevant information concerning fees the
Fund paid under the Management Agreement for the indicated periods:
<TABLE>
<CAPTION>
Net Assets
Period of Fund Management Fee IAI Waiver*
------ ---------- -------------- -----------
<S> <C> <C> <C>
Period 2/1/98 to 10/31/98 $35,116,423 $548,928 $6,871
Period 2/1/97 to 1/31/98 $63,348,647 $1,750,757 $11,961
Period 4/1/96 to 1/31/97 $116,191,236 $1,743,676 $8,225
</TABLE>
*Resulting from IAI's reduction of its Management Fee in the amount
representing the Fund's payment of directors' fees and expenses.
The Management Agreement will terminate automatically in the event of
its assignment. In addition, the 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 on 60 days' notice to the Fund. The Management 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 Management Agreement or interested
persons of such parties cast in person at a meeting called for the purpose of
voting on such approval.
IAI's ultimate corporate parent is 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.
SUBADVISORY AGREEMENT
Under the Subadvisory Agreement, as amended, between IAI International
Ltd. and IAI dated January 28, 1987, 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 Annual Fee
---------------- ----------
For the first $100 million 1/2 of 1.00%
For the next $100 million 1/2 of .85%
For the next $100 million 1/2 of .75%
Above $300 million 1/2 of .70%
The following table contains relevant information concerning the fees
IAI paid IAI International under the Subadvisory Agreement for the indicated
periods:
Period Subadvisory Fee
------ ---------------
Period 2/1/98 to 10/31/98 $162,733
Period 2/1/97 to 1/31/98 $524,177
Period 2/1/96 to 1/31/97 $615,967
20
<PAGE>
PRIOR AGREEMENT
Effective March 31, 1996, the Investment Advisory Agreement between the
Fund and IAI (the "Prior Agreement") terminated and was replaced by the
Management Agreement described above.
Under the Prior Agreement, International Fund had agreed to pay IAI a
monthly fee of 1.00% per year of International Fund's average month-end net
assets for the first $100,000,000 in assets, 0.85% for the next $100,000,000 in
assets, 0.75% for the next $100,000,000 in assets, and 0.70% for assets above
$300,000,000.
The following table contains relevant information concerning fees the
Fund paid under the Prior Agreement:
Period Advisory Fee
------ ------------
Period 2/1/96 to 3/1/96 $223,539
FYE 1/31/96 $1,368,001
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
The custodian for the Fund is Norwest Bank Minnesota, N.A. Norwest
Center, Sixth and Marquette, Minneapolis, MN 55479.
IAI acts as the Fund's transfer agent, dividend disbursing agent and
IRA Custodian, at P.O. Box 357, Minneapolis, Minnesota 55440.
LEGAL COUNSEL
Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis, Minnesota
55402, acts as General Counsel to the Fund.
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
IAI selects and (where applicable) negotiates commissions with the
brokers who execute the transactions for the 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.
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 a
managed fund or managed account investing in common stocks would primarily
benefit managed funds and accounts investing in common stocks.
21
<PAGE>
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 Conduct 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.
The following table shows brokerage commissions paid by the Fund during
the indicated periods. During these periods, a percentage of commissions were
paid to brokerage firms that provided research services to IAI, although the
provision of such services was not necessarily a factor in the placement of all
such business with such firms.
<TABLE>
<CAPTION>
Percentage of
Commissions to
Brokers
Amount of Commissions Providing Research
--------------------- ------------------
Period Ended Year Ended Year Ended Year Ended Period Ended
October 31, January 31, January 31, January 31, October 31,
1998 1998 1997 1996 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C>
$204,276 $ 549,653 $ 512,536 $ 373,502 42.20%
</TABLE>
CAPITAL STOCK
The Fund, which was created on April 23, 1987, is a separate portfolio
of IAI Investment Funds III, Inc., a Minnesota corporation created on September
16, 1986, whose shares of common stock are currently issued in a single series
(Series A). The investment portfolio represented by Series A common shares is
referred to as "IAI International Fund." On June 25, 1993, International 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."
Each share of the series is entitled to participate pro rata in any
dividends and other distributions of such series and all shares of the series
have equal rights in the event of liquidation of that series. The Board of
Directors of IAI Investment Funds III, Inc., is empowered under the Articles of
Incorporation of such company to issue other series of the company's common
stock without shareholder approval. IAI Investment Funds III, Inc., has
authorized 10,000,000,000 shares of $.01 par value common stock to be issued as
Series A common shares. As of October 31, 1998, the Fund had 3,578,772 shares
outstanding.
22
<PAGE>
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of January 29, 1999, no person was a record holder or, to the
knowledge of the Fund, beneficial owner of more than 5% of the outstanding
shares of the Fund, except as set forth in the following table:
<TABLE>
<CAPTION>
Name and Address of Shareholder Number of Shares Percent of Class
- ------------------------------- ---------------- ----------------
<S> <C> <C>
Hawaiian Trust Company Limited Agent for FSM 390,318.911 13.52
National Government FBO VAP State
P.O. Box 1930 - Honolulu, HI 96805-1930
US Bank WA Custodian FBO Polaris Industries 220,826.046 7.65
LP 401K
P.O. Box 64010 - Saint Paul, MN 55164-0010
Olcoba Company 175,480.637 6.08
Attn: Trust Mutual Fund Specialist
P.O. Box 1000 - Minneapolis, MN 55480
Charles Schwab & Co., Inc. 314,223.989 10.89
SPL Custody A/C for Excl Bnft of Cust
Attn: Mutual Funds Dept - Int Rein
101 Montgomery Street - San Francisco, CA 94104
</TABLE>
In addition, as of January 29, 1999, the Fund's officers and directors
as a group owned less than 1% of the Fund's outstanding shares.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The portfolio securities in which the Fund invests fluctuate in value,
and hence the Fund's 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 a Fund is not determined, on the following national holidays: New
Year's Day, Presidents' Day, Martin Luther King, Jr. Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
On October 31, 1998, the net asset value and public offering price per
share of the Fund was calculated as follows:
NAV = Net Assets ($35,116,423) = $9.81
----------------------------------
Shares Outstanding (3,578,772)
PURCHASES AND REDEMPTION OF SHARES
The Fund has authorized one or more brokers to accept on its behalf
purchase and redemption orders and such brokers are authorized to designate
other intermediaries to accept purchase and redemption orders on the Fund's
behalf. The Fund will be deemed to have received a purchase or redemption order
when an authorized broker or, if applicable, a broker's authorized designee,
accepts the order. In such circumstances, customer orders will be priced at the
Fund's net asset value next computed after they are accepted by an authorized
broker or the broker's authorized designee.
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 Mutual 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.
23
<PAGE>
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 the 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, Fund shares may be redeemed in
exchange for readily marketable securities held by the 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 Fund qualified during its last taxable year, and intends to qualify
during its current taxable year, as a regulated investment company under
Subchapter M of the Internal Revenue Code. If the Fund so qualifies, it will not
be subject to federal income taxes that it distributes to its shareholders.
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 generally 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. If Fund shares
are sold or otherwise disposed of one year or less after the date of
acquisition, the gain or loss will be short-term. Short-term capital gain is
taxed at the same rates as ordinary income.
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
a Fund shareholder to supply the Fund with such shareholder's taxpayer
identification number, and the failure of a Fund shareholder who is otherwise
exempt from withholding to properly document such shareholder's status as an
exempt recipient. Additionally, distributions may be subject to state and local
income taxes, and the treatment thereunder may differ from the federal income
tax consequences discussed above.
Under the Code, 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.
24
<PAGE>
Some of the investment practices that may be employed by the Fund
(i.e., buying and selling options and futures contracts, entering into currency
exchange contracts or swap agreements, purchasing indexed securities, and
selling securities short) will be subject to special provisions that, among
other things, may defer the use of certain losses of the Fund, affect the
holding period of the securities held by the Fund and, particularly in the case
of transactions in or with respect to foreign currencies, affect the character
of the gains or losses realized. These provisions may also require the Fund to
mark-to-market some of the positions in its portfolio (i.e., treat them as
closed out) or to accrue original discount, both of which may cause the Fund to
recognize income without receiving cash with which to make distributions in
amounts necessary to satisfy the distribution requirements for qualification as
a regulated investment company and for avoiding income and excise taxes.
Accordingly, in order to make the required distributions, the Fund may be
required to borrow or liquidate securities. The Fund will monitor its
transactions and may make certain elections in order to mitigate the effect of
these rules and prevent disqualification of the Fund as a regulated investment
company.
The Fund may be subject to U.S. taxes resulting from holdings in a
passive foreign investment company ("PFIC"). A foreign corporation is a PFIC
when 75% or more of its gross income for the taxable year is "passive income" or
50% or more of the average value of its assets consists of assets that produce
or are held for the production of "passive income". If the Fund invests in a
PFIC, it may be subject to income tax and an interest charge on certain
dividends and capital gains earned from that investment, regardless of whether
such income and gains are distributed to shareholders. In addition, if the Fund
sells shares of a PFIC, any capital gain on the sale will be deemed to be
ordinary income regardless of how long the Fund has held the investment.
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.
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.
25
<PAGE>
If the Fund is liable for foreign taxes, it expects to meet the
requirements of the Code for passing through to its shareholders foreign taxes
paid, but there can be no assurance that a Fund will be able to do so. Under the
Code, if more than 50% of the value of 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 non-controlled foreign corporation pursuant to Section
902 of the Code; and (iv) other income not specifically categorized. Of these
categories, a substantial part of Fund income is likely to constitute passive
income. However, in the absence of specific regulatory guidance on the
application of the income categories, the 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.
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 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).
26
<PAGE>
Minnesota law does not eliminate the duty of "care" imposed upon a
director. It only authorizes a corporation to eliminate monetary liability for
violations of that duty. Minnesota law, further, does not permit elimination or
limitation of liability of "officers" of the corporation for breach of their
duties as officers (including the liability of directors who serve as officers
for breach of their duties as officers.) Minnesota law does not permit
elimination or limitation of the availability of equitable relief, such as
injunctive or rescissionary relief. Further, Minnesota law does not permit
elimination or limitation of a director's liability under the Securities Act of
1933 or the Securities Exchange Act of 1934, and it is uncertain whether and to
what extent the elimination of monetary liability would extend to violations of
duties imposed on directors by the Investment Company Act of 1940 and the rules
and regulations adopted under such Act.
FINANCIAL STATEMENTS
The financial statements included as part of the Fund's Annual Report
to Shareholders for the fiscal period ended October 31, 1998, are incorporated
herein by reference. Such Annual Report may be obtained by shareholders on
request from the Fund at no additional charge.
27
<PAGE>
APPENDIX A - RATINGS OF DEBT SECURITIES
RATINGS BY MOODY'S
CORPORATE BONDS
Aaa. Bonds rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa. Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group, they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
A. Bonds rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa. Bonds rated Baa are considered medium grade obligations;
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate, and thereby
not well safeguarded during other good and bad times over the future.
Uncertainty of position 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.
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
A-1
<PAGE>
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates that the
issue ranks in the lower end of its generic rating category. With respect to
municipal securities, those bonds in the Aa, A, Baa, Ba, and B groups which
Moody's believes possess the strongest investment attributes are designated by
the symbols Aa1, A1, Baa1, Ba1, and B1.
COMMERCIAL PAPER
Moody's employs the following three designations, all judged
to be investment grade, to indicate the relative repayment capacity of rated
issuers:
Prime - 1 Superior ability for repayment of senior
short-term debt obligations
Prime - 2 Strong ability for repayment of senior
short-term debt obligations
Prime - 3 Acceptable ability for repayment of senior
short-term debt obligations
If an issuer represents to Moody's that its Commercial Paper
obligations are supported by the credit of another entity or entities, Moody's,
in assigning ratings to such issuers, evaluates the financial strength of the
indicated affiliated corporations, commercial banks, insurance companies,
foreign governments, or other entities, but only as one factor in the total
rating assessment.
RATINGS BY S&P
CORPORATE BONDS
AAA. Debt rated AAA has the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest
and repay principal and differs from the higher rated issues only in small
degree.
A. Debt rated A has a strong capacity to pay interest and
repay principal although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in higher-rated
categories.
BBB. Debt rated BBB is regarded as having an adequate capacity
to pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
BB. Debt rated BB has less near-term vulnerability to default
than other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payments.
B. Debt rated B has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal repayments.
Adverse business, financial, or economic conditions will likely impair capacity
or willingness to pay interest and repay principal. The B rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied BB-rating.
CCC. Debt rated CCC has a currently identifiable vulnerability
to default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of
A-2
<PAGE>
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
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and
the Investment Company Act of 1940, the Registrant certifies that it meets all
of the requirements for effectiveness of this Registration Statement on Form
N-1A pursuant to Rule 485(b) under the Securities Act of 1933 and has duly
caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Minneapolis and State of
Minnesota on the 1st day of March, 1999.
IAI INVESTMENT FUNDS III, INC.
(Registrant)
By
------------------------------------
John A. Alexander, President
Pursuant to the requirements of the Securities Act of 1933,
this Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated:
- ------------------------------ President (principal March 1, 1999
John A. Alexander executive officer)
- ------------------------------ Treasurer (principal March 1, 1999
Paul H. Perseke financial and accounting officer)
Madeline Betsch * Director
W. William Hodgson * Director
George R. Long * Director
J. Peter Thompson * Director
Charles H. Withers * Director
*By March 1, 1999
-----------------------------------------
William C. Joas, Attorney-in-Fact
* Registrant's directors executing Powers of Attorney dated August 18, 1993,
filed with the Commission on June 28, 1994.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that is meets all of
the requirements for effectiveness of this Registration Statement on Form N-1A
pursuant to Rule 485(b) under the Securities Act of 1933 and has duly casued
this Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Minneapolis and State of Minnesota on
the 1st day of March, 1999.
IAI INVESTMENT FUNDS III, INC.
(Registrant)
By /s/ John A. Alexander
-------------------------------------
John A. Alexander, President
Pursuant to the requirements of the Securities Act of 1933,
this Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated:
/s/ John A. Alexander President (principal March 1, 1999
- ------------------------------- executive officer)
John A. Alexander
/s/ Paul H. Perseke Treasurer (principal financial March 1, 1999
- ------------------------------- and accounting officer)
Paul H. Perseke
Madeline Betsch * Director
W. William Hodgson * Director
George R. Long * Director
J. Peter Thompson * Director
Charles H. Withers * Director
*By /s/ William C. Joas March 1, 1999
----------------------------------------
William C. Joas, Attorney-in-Fact
* Registrant's directors executing Powers of Attorney dated August 18, 1993,
filed with the Commission on June 28, 1994.
