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MAY 1, 1997,
AS REVISED JANUARY 30, 1998
GROWTH AND INCOME PORTFOLIO
A SERIES OF
MITCHELL HUTCHINS SERIES TRUST
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
Growth and Income Portfolio is a diversified series of Mitchell Hutchins
Series Trust ("Fund"), a professionally managed mutual fund. Shares of the
Portfolio are offered only to insurance company separate accounts ("Accounts")
that fund benefits under certain variable contracts ("Contracts"). Advisory
and administrative services are provided to the Fund by Mitchell Hutchins
Asset Management Inc. ("Mitchell Hutchins"), a wholly owned subsidiary of
PaineWebber Incorporated ("PaineWebber"). The Portfolio seeks current income
and capital growth and invests primarily in dividend-paying equity securities
believed by Mitchell Hutchins to have the potential for rapid earnings growth.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the Fund's current Prospectus, dated May 1,
1997, as revised January 30, 1998. A copy of the Prospectus may be obtained by
contacting the Fund at 1-800-647-1568.
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TABLE OF CONTENTS
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PAGE
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Investment Policies and Limitations........................................ 3
Hedging and Related Strategies............................................. 7
Trustees and Officers...................................................... 12
Investment Advisory Services............................................... 19
Portfolio Transactions..................................................... 20
Additional Purchase and Redemption Information............................. 22
Valuation of Shares........................................................ 22
Taxes...................................................................... 23
Other Information.......................................................... 24
Financial Statements....................................................... 25
Description of Commercial Paper and Bond Ratings........................... 25
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INVESTMENT POLICIES AND LIMITATIONS
The following supplements the information contained in the Fund's Prospectus
concerning Growth and Income Portfolio's investment policies and limitations.
Except as otherwise indicated in the Prospectus or the Statement of Additional
Information, there are no policy limitations on the Portfolio's ability to use
the investments or techniques discussed in these documents.
SPECIAL CONSIDERATIONS RELATING TO FOREIGN SECURITIES. As noted in the
Prospectus, Growth and Income Portfolio may invest in U.S. dollar-denominated
securities of foreign issuers. Many of these foreign securities are not
registered with the Securities and Exchange Commission ("SEC"), nor are the
issuers thereof subject to its reporting requirements. Accordingly, there may
be less publicly available information concerning foreign issuers of
securities held by the Portfolio than is available concerning U.S. companies.
Foreign companies are not generally subject to uniform accounting, auditing
and financial reporting standards or to other regulatory requirements
comparable to those applicable to U.S. companies.
Growth and Income Portfolio may invest in foreign securities by purchasing
American Depositary Receipts ("ADRs"). Generally, ADRs, in registered form,
are denominated in U.S. dollars and are designed for use in the U.S.
securities markets. ADRs are receipts typically issued by a U.S. bank or trust
company evidencing ownership of the underlying securities. For purposes of the
Portfolio's investment policies, ADRs are deemed to have the same
classification as the underlying securities they represent. Thus, an ADR
evidencing ownership of common stock will be treated as common stock. ADRs are
publicly traded on exchanges or over-the-counter ("OTC") in the United States
and are issued through "sponsored" or "unsponsored" arrangements. In a
sponsored ADR arrangement, the foreign issuer assumes the obligation to pay
some or all of the depositary's transaction fees, whereas under an unsponsored
arrangement, the foreign issuer assumes no obligations and the depositary's
transaction fees are paid directly by the ADR holders. In addition, less
information is available in the United States about an unsponsored ADR than
about a sponsored ADR.
Investment income on certain foreign securities in which Growth and Income
Portfolio may invest may be subject to foreign withholding or other taxes that
could reduce the return on these securities. Tax treaties between the United
States and foreign countries, however, may reduce or eliminate the amount of
foreign taxes to which the Portfolio would be subject.
ILLIQUID SECURITIES. Growth and Income Portfolio may invest up to 10% of its
net assets in illiquid securities. The term "illiquid securities" for this
purpose means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Portfolio
has valued the securities and includes, among other things, purchased over-
the-counter ("OTC") options, repurchase agreements maturing in more than seven
days and restricted securities other than those securities Mitchell Hutchins
has determined are liquid pursuant to guidelines established by the Fund's
board of trustees. The assets used as cover for OTC options written by the
Portfolio will be considered illiquid unless the OTC options are sold to
qualified dealers who agree that the Portfolio may repurchase any OTC option
it writes at a maximum price to be calculated by a formula set forth in the
option agreement. The cover for an OTC option written subject to this
procedure will be considered illiquid only to the extent that the maximum
repurchase price under the option formula exceeds the intrinsic value of the
option. Illiquid restricted securities may be sold only in privately
negotiated transactions or in public offerings with respect to which a
registration statement is in effect under the Securities Act of 1933 ("1933
Act"). Where registration is required, the Portfolio may be obligated to pay
all or part of the registration expenses and a considerable period may elapse
between the time of the decision to sell and the time it may be permitted to
sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the Portfolio might obtain
a less favorable price than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and
notes. These instruments are often restricted securities because the
securities are sold in transactions not requiring registration. Institutional
investors generally will not seek to sell these instruments to the general
public, but instead will often depend either on an efficient
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institutional market in which such unregistered securities can be readily
resold or on an issuer's ability to honor a demand for repayment. Therefore,
the fact that there are contractual or legal restrictions on resale to the
general public or certain institutions is not dispositive of the liquidity of
such investments.
Rule 144A under the 1933 Act establishes a "safe harbor" from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted
securities have developed as a result of Rule 144A, providing both readily
ascertainable values for restricted securities and the ability to liquidate an
investment to satisfy share redemption orders. Such markets might include
automated systems for the trading, clearance and settlement of unregistered
securities of domestic and foreign issuers, such as the PORTAL System
sponsored by the National Association of Securities Dealers, Inc. An
insufficient number of qualified buyers interested in purchasing Rule 144A-
eligible restricted securities held by Growth and Income Portfolio, however,
could affect adversely the marketability of such portfolio securities and the
Portfolio might be unable to dispose of such securities promptly or at
favorable prices.
The Fund's board of trustees (sometimes referred to as the "board") has
delegated the function of making day-to-day determinations of liquidity to
Mitchell Hutchins, pursuant to guidelines approved by the board. Mitchell
Hutchins takes into account a number of factors in reaching liquidity
decisions, including but not limited to (1) the frequency of trades for the
security, (2) the number of dealers that make quotes for the security, (3) the
number of dealers that have undertaken to make a market in the security, (4)
the number of other potential purchasers and (5) the nature of the security
and how trading is effected (e.g., the time needed to sell the security, how
bids are solicited and the mechanics of transfer). Mitchell Hutchins monitors
the liquidity of restricted securities in Growth and Income Portfolio and
reports periodically on such decisions to the board of trustees.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which
Growth and Income Portfolio purchases securities from a bank or recognized
securities dealer and simultaneously commits to resell the securities to the
bank or dealer at an agreed-upon date or upon demand and at a price reflecting
a market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. The Portfolio maintains custody of the underlying
securities prior to their repurchase; thus, the obligation of the bank or
dealer to pay the repurchase price on the date agreed to is, in effect,
secured by such securities. If the value of these securities is less than the
repurchase price, plus any agreed-upon additional amount, the other party to
the agreement must provide additional collateral so that at all times the
collateral is at least equal to the repurchase price plus any agreed-upon
additional amount. The difference between the total amount to be received upon
repurchase of the securities and the price that was paid by the Portfolio upon
their acquisition is accrued as interest and included in the Portfolio's net
investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to Growth and Income Portfolio
if the other party to a repurchase agreement becomes insolvent. The Portfolio
intends to enter into repurchase agreements only with banks and dealers in
transactions believed by Mitchell Hutchins to present minimum credit risks in
accordance with guidelines established by the Fund's board of trustees.
Mitchell Hutchins will review and monitor the creditworthiness of those
institutions under the board's general supervision.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. A security purchased on a when-
issued or delayed delivery basis is recorded as an asset on the commitment
date and is subject to changes in market value, generally based upon changes
in the level of interest rates. Thus, fluctuation in the value of the security
from the time of the commitment date will affect Growth and Income Portfolio's
net asset value. When the Portfolio commits to purchase securities on a when-
issued or delayed delivery basis, its custodian segregates assets to cover the
amount of the commitment. See "Investment Policies and Limitations--Segregated
Accounts." The Portfolio purchases when-issued securities only with the
intention of taking delivery, but may sell the right to acquire the security
prior to delivery if Mitchell Hutchins deems it advantageous to do so, which
may result in a capital gain or loss to the Portfolio.
LENDING OF PORTFOLIO SECURITIES. As indicated in the Prospectus, Growth and
Income Portfolio is authorized to lend up to 33 1/3% of its total assets. The
Portfolio may lend its portfolio securities to broker-dealers
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or institutional investors that Mitchell Hutchins deems qualified, but only
when the borrower maintains acceptable collateral with the Portfolio's
custodian, marked to market daily, in an amount at least equal to the market
value of the securities loaned, plus accrued interest and dividends.
Acceptable collateral is limited to cash, U.S. government securities and
irrevocable letters of credit that meet certain guidelines established by
Mitchell Hutchins. In determining whether to lend securities to a particular
broker-dealer or institutional investor, Mitchell Hutchins will consider, and
during the period of the loan will monitor, all relevant facts and
circumstances, including the creditworthiness of the borrower. The Portfolio
will retain authority to terminate any loans at any time. The Portfolio may
pay reasonable administrative and custodial fees in connection with a loan and
may pay a negotiated portion of the interest earned on the cash or money
market instruments held as collateral to the borrower or placing broker. The
Portfolio will receive reasonable interest on the loan or a flat fee from the
borrower and amounts equivalent to any dividends, interest or other
distributions on the securities loaned. The Portfolio will regain record
ownership of loaned securities to exercise beneficial rights, such as voting
and subscription rights and rights to dividends, interest or other
distributions, when regaining such rights is considered to be in the
Portfolio's interest.
SHORT SALES "AGAINST THE BOX". Growth and Income Portfolio may engage in
short sales of securities it owns or has the right to acquire at no added cost
through conversion or exchange of other securities it owns (short sales
"against the box"). To make delivery to the purchaser in a short sale, the
executing broker borrows the securities being sold short on behalf of the
Portfolio, and the Portfolio is obligated to replace the securities borrowed
at a date in the future. When the Portfolio sells short, it will establish a
margin account with the broker effecting the short sale, and will deposit
collateral with the broker. In addition, the Portfolio will maintain with its
custodian, in a segregated account, the securities that could be used to cover
the short sale. The Portfolio will incur transaction costs, including interest
expense, in connection with opening, maintaining and closing short sales
against the box. The Portfolio does not intend to have obligations under short
sales that at any time during the coming year exceed 5% of the Portfolio's net
assets.
Growth and Income Portfolio might make a short sale "against the box" in
order to hedge against market risks when Mitchell Hutchins believes that the
price of a security may decline, thereby causing a decline in the value of a
security owned by the Portfolio or a security convertible into or exchangeable
for a security owned by the Portfolio. In such case, any loss in the
Portfolio's long position after the short sale should be reduced by a gain in
the short position. Conversely, any gain in the long position should be
reduced by a loss in the short position. The extent to which gains or losses
in the long position are reduced will depend upon the amount of the securities
sold short relative to the amount of the securities the Portfolio owns, either
directly or indirectly, and in the case where the Portfolio owns convertible
securities, changes in the investment values or conversion premiums of such
securities.
SEGREGATED ACCOUNTS. When Growth and Income Portfolio enters into certain
transactions that involve obligations to make future payments to third
parties, including reverse repurchase agreements or the purchase of securities
on a when-issued or delayed delivery basis, the Portfolio will maintain with
an approved custodian in a segregated account cash or liquid securities,
marked to market daily, in an amount at least equal to the Portfolio's
obligation or commitment under such transactions. As described below under
"Hedging and Related Strategies," segregated accounts may also be required in
connection with certain transactions involving options or futures contracts.
INVESTMENT LIMITATIONS. Growth and Income Portfolio will not:
(1) purchase any security if, as a result of that purchase, 25% or more
of the Portfolio's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities or to municipal
securities.
(2) issue senior securities or borrow money, except as permitted under
the Investment Company Act of 1940 ("1940 Act") and then not in excess of
33 1/3% of the Portfolio's total assets (including the amount of the senior
securities issued but reduced by any liabilities not constituting senior
securities) at the time of the issuance or borrowing, except that the
Portfolio may borrow up to an additional 5% of its total assets (not
including the amount borrowed) for temporary or emergency purposes.
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(3) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investments in government
obligations, commercial paper, certificates of deposit, bankers'
acceptances or similar instruments will not be considered the making of a
loan.
(4) engage in the business of underwriting securities of other issuers,
except to the extent that the Portfolio might be considered an underwriter
under the federal securities laws in connection with its disposition of
portfolio securities.
(5) purchase or sell real estate, except that investments in securities
of issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Portfolio may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to hold
real estate acquired by reason of such enforcement until that real estate
can be liquidated in an orderly manner.
(6) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Portfolio may purchase,
sell or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
(7) purchase securities of any one issuer if, as a result, more than 5%
of the Portfolio's total assets would be invested in securities of that
issuer or the Portfolio would own or hold more than 10% of the outstanding
voting securities of that issuer, except that up to 25% of the Portfolio's
total assets may be invested without regard to this limitation, and except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies and instrumentalities or to securities
issued by other investment companies.
The following interpretation applies to, but is not a part of, this
fundamental limitation: Mortgage- and asset-backed securities will not be
considered to have been issued by the same issuer by reason of the securities
having the same sponsor, and mortgage- and asset-backed securities issued by a
finance or other special purpose subsidiary that are not guaranteed by the
parent company will be considered to be issued by a separate issuer from the
parent company.
The foregoing fundamental investment limitations cannot be changed with
respect to Growth and Income Portfolio without the affirmative vote of the
lesser of (a) more than 50% of the outstanding shares of the Portfolio or (b)
67% or more of the Portfolio's shares present at a meeting of its shareholders
if more than 50% of the outstanding shares of the Portfolio are represented at
the meeting in person or by proxy. If a percentage restriction is adhered to
at the time of an investment or transaction, a later change in percentage
resulting from a change in values of portfolio securities or amount of total
assets will not be considered a violation of any of the foregoing limitations.
The following investment restrictions are not fundamental and may be changed
by the vote of the board without shareholder approval. Growth and Income
Portfolio will not:
(1) hold assets of any issuers, at the end of any calendar quarter (or
within 30 days thereafter), to the extent such holdings would cause the
Portfolio to fail to comply with the diversification requirements imposed
by section 817(h) of the Internal Revenue Code and the Treasury regulations
issued thereunder on segregated asset accounts used to fund variable
annuity contracts.
(2) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Portfolio may
make margin deposits in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(3) engage in short sales of securities or maintain a short position,
except that the Portfolio may (a) sell short "against the box" and (b)
maintain short positions in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
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(4) purchase securities of other investment companies, except to the
extent permitted by the 1940 Act and except that this limitation does not
apply to securities received or acquired as dividends, through offers of
exchange, or as a result of reorganization, consolidation, or merger.
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
HEDGING AND RELATED STRATEGIES USING DERIVATIVE CONTRACTS
As discussed in the Prospectus, Mitchell Hutchins may use a variety of
financial instruments ("Strategic Instruments"), including certain options,
futures contracts (sometimes referred to as "futures") and options on futures
contracts, to attempt to hedge Growth and Income Portfolio's investments. The
Portfolio may enter into transactions using one or more types of Strategic
Instruments under which the full value of its portfolio is at risk. Under
normal circumstances, however, the Portfolio's use of these instruments will
place at risk a much smaller portion of its assets. The particular Strategic
Instruments used by the Portfolio are described below.
OPTIONS ON EQUITY AND DEBT SECURITIES--A call option is a short-term
contract pursuant to which the purchaser of the option, in return for a
premium, has the right to buy the security or currency underlying the option
at a specified price at any time during the term of the option. The writer of
the call option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to deliver the underlying security or
currency against payment of the exercise price. A put option is a similar
contract that gives its purchaser, in return for a premium, the right to sell
the underlying security or currency at a specified price during the option
term. The writer of the put option, who receives the premium, has the
obligation, upon exercise of the option during the option term, to buy the
underlying security or currency at the exercise price.
OPTIONS ON STOCK INDEXES--A stock index assigns relative values to the
stocks included in the index and fluctuates with changes in the market values
of those stocks. A stock index option operates in the same way as a more
traditional stock option, except that exercise of a stock index option is
effected with cash payment and does not involve delivery of securities. Thus,
upon exercise of a stock index option, the purchaser will realize, and the
writer will pay, an amount based on the difference between the exercise price
and the closing price of the stock index.
STOCK INDEX FUTURES CONTRACTS--A stock index futures contract is a bilateral
agreement pursuant to which one party agrees to accept, and the other party
agrees to make, delivery of an amount of cash equal to a specified dollar
amount times the difference between the stock index value at the close of
trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the stocks comprising the index is
made. Generally, contracts are closed out prior to the expiration date of the
contract.
INTEREST RATE FUTURES CONTRACTS--Interest rate futures contracts are
bilateral agreements pursuant to which one party agrees to make, and the other
party agrees to accept, delivery of a specified type of debt security at a
specified future time and at a specified price. Although such futures
contracts by their terms call for actual delivery or acceptance of debt
securities, in most cases the contracts are closed out before the settlement
date without the making or taking of delivery.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities or currency, except that an option on a futures contract
gives the purchaser the right, in return for the premium, to assume a position
in a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a security
or currency, at a specified price at any time during the option term. Upon
exercise of the option, the delivery of the futures position to the holder of
the option will be accompanied by delivery of the accumulated balance that
represents the amount by which the market price of the futures contract
exceeds, in the case of a call, or is less than, in the case of a put, the
exercise price of the option on the future. The writer of an option, upon
exercise, will assume a short position in the case of a call and a long
position in the case of a put.
GENERAL DESCRIPTION OF HEDGING STRATEGIES. Hedging strategies can be broadly
categorized as "short hedges" and "long hedges." A short hedge is a purchase
or sale of a Strategic Instrument intended partially or fully to offset
potential declines in the value of one or more investments held by Growth and
Income Portfolio.
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Thus, in a short hedge the Portfolio takes a position in a Strategic
Instrument whose price is expected to move in the opposite direction of the
price of the investment being hedged. For example, the Portfolio might
purchase a put option on a security to hedge against a potential decline in
the value of that security. If the price of the security declined below the
exercise price of the put, the Portfolio could exercise the put and thus limit
its loss below the exercise price to the premium paid plus transaction costs.
In the alternative, because the value of the put option can be expected to
increase as the value of the underlying security declines, the Portfolio might
be able to close out the put option and realize a gain to offset the decline
in the value of the security.
Conversely, a long hedge is a purchase or sale of a Strategic Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that Growth and Income Portfolio intends to
acquire. Thus, in a long hedge the Portfolio takes a position in a Strategic
Instrument whose price is expected to move in the same direction as the price
of the prospective investment being hedged. For example, the Portfolio might
purchase a call option on a security it intends to purchase in order to hedge
against an increase in the cost of the security. If the price of the security
increased above the exercise price of the call, the Portfolio could exercise
the call and thus limit its acquisition cost to the exercise price plus the
premium paid and transaction costs. Alternatively, the Portfolio might be able
to offset the price increase by closing out an appreciated call option and
realizing a gain.
Growth and Income Portfolio may purchase and write (sell) covered straddles
on securities and stock indices. A long straddle is a combination of a call
and a put option purchased on the same security or on the same futures
contract, where the exercise price of the put is equal to the exercise price
of the call. The Portfolio might enter into a long straddle when Mitchell
Hutchins believes it likely that interest rates will be more volatile during
the term of the option than the option pricing implies. A short straddle is a
combination of a call and a put written on the same security where the
exercise price of the put is equal to the exercise price of the call. The
Portfolio might enter into a short straddle when Mitchell Hutchins believes it
unlikely that interest rates will be as volatile during the term of the option
as the option pricing implies.
Strategic Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that Growth and
Income Portfolio owns or intends to acquire. Strategic Instruments on stock
indices, in contrast, generally are used to hedge against price movements in
broad equity market sectors in which the Portfolio has invested or expects to
invest. Strategic Instruments on debt securities may be used to hedge either
individual securities or broad fixed income market sectors.
Income strategies include the writing of covered options to obtain the
related option premiums. Return strategies include the use of Strategic
Instruments to increase or reduce Growth and Income Portfolio's exposure to an
asset class without buying or selling the underlying instruments.
The use of Strategic Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ("CFTC"). In addition, Growth and
Income Portfolio's ability to use Strategic Instruments will be limited by tax
considerations. See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins expects to discover additional opportunities in
connection with options, future contracts and other hedging strategies. These
new opportunities may become available as Mitchell Hutchins develops new
techniques, as regulatory authorities broaden the range of permitted
transactions and as new options and futures contracts or other techniques are
developed. Mitchell Hutchins may utilize these opportunities to the extent
that they are consistent with Growth and Income Portfolio's investment
objective and permitted by the Portfolio's investment limitations and
applicable regulatory authorities. The Fund's Prospectus or Statement of
Additional Information will be supplemented to the extent that new products or
techniques involve materially different risks than those described below or in
the Prospectus.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVES CONTRACTS. The use of
Strategic Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Strategic Instruments are described in
the sections that follow.
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(1) Successful use of most Strategic Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities and
interest rate markets, which requires different skills than predicting
changes in the prices of individual securities. While Mitchell Hutchins is
experienced in the use of Strategic Instruments, there can be no assurance
that any particular strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Strategic Instrument and price movements of the
investments being hedged. For example, if the value of a Strategic
Instrument used in a short hedge increased by less than the decline in
value of the hedged investment, the hedge would not be fully successful.
Such a lack of correlation might occur due to factors unrelated to the
value of the investments being hedged, such as speculative or other
pressures on the markets in which Strategic Instruments are traded. The
effectiveness of hedges using Strategic Instruments on indices will depend
on the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements
in the investments being hedged. However, hedging strategies can also
reduce opportunity for gain by offsetting the positive effect of favorable
price movements in the hedged investments. For example, if Growth and
Income Portfolio entered into a short hedge because Mitchell Hutchins
projected a decline in the price of a security held by the Portfolio, and
the price of that security increased instead, the gain from that increase
might be wholly or partially offset by a decline in the price of the
Strategic Instrument. Moreover, if the price of the Strategic Instrument
declined by more than the increase in the price of the security, the
Portfolio could suffer a loss. In either such case, the Portfolio would
have been in a better position had it not hedged at all.
(4) As described below, Growth and Income Portfolio might be required to
maintain assets as "cover," maintain segregated accounts or make margin
payments when it takes positions in Strategic Instruments involving
obligations to third parties (i.e., Strategic Instruments other than
purchased options). If the Portfolio was unable to close out its positions
in such Strategic Instruments, it might be required to continue to maintain
such assets or accounts or make such payments until the position expired or
matured. These requirements might impair the Portfolio's ability to sell a
portfolio security or make an investment at a time when it would otherwise
be favorable to do so, or require that the Portfolio sell a portfolio
security at a disadvantageous time. The Portfolio's ability to close out a
position in a Strategic Instrument prior to expiration or maturity depends
on the existence of a liquid secondary market or, in the absence of such a
market, the ability and willingness of a contra party to enter into a
transaction closing out the position. Therefore, there is no assurance that
any position can be closed out at a time and price that is favorable to the
Portfolio.
COVER FOR STRATEGIES USING DERIVATIVES CONTRACTS. Transactions using
Strategic Instruments, other than purchased options, expose Growth and Income
Portfolio to an obligation to another party. The Portfolio will not enter into
any such transactions unless it owns either (1) an offsetting ("covered")
position in securities or other options or futures contracts or (2) cash and
liquid securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. The Portfolio
will comply with SEC guidelines regarding cover for such transactions and
will, if the guidelines so require, set aside cash or liquid securities in a
segregated account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Strategic Instrument is open, unless they
are replaced with similar assets. As a result, the commitment of a large
portion of Growth and Income Portfolio's assets to cover or segregated
accounts could impede portfolio management or the Portfolio's ability to meet
redemption requests or other current obligations.
OPTIONS. Growth and Income Portfolio may purchase put and call options, and
write (sell) covered put and call options, on equity and debt securities. The
Portfolio may purchase put and call options and write (sell) covered call
options on stock indices. The purchase of call options may serve as a long
hedge, and the purchase of put options may serve as a short hedge. Writing
covered put or call options can enable the Portfolio to enhance income by
reason of the premiums paid by the purchasers of such options. Writing covered
put options serves as
9
<PAGE>
a limited long hedge because increases in the value of the hedged instrument
would be offset to the extent of the premium received for writing the option.
However, if the market price of the security underlying a covered put option
declines to less than the exercise price of the option, minus the premium
received, the Portfolio would expect to suffer a loss. Writing covered call
options serves as a limited short hedge, because declines in the value of the
hedged investment would be offset to the extent of the premium received for
writing the option. However, if the security appreciates to a price higher
than the exercise price of the call option, it can be expected that the option
will be exercised and the Portfolio will be obligated to sell the security at
less than its market value. The securities or other assets used as cover for
OTC options written by the Portfolio would be considered illiquid to the
extent described under "Investment Policies and Restrictions--Illiquid
Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration
dates of up to nine months. Options that expire unexercised have no value.
Growth and Income Portfolio may effectively terminate its right or
obligation under an option by entering into a closing transaction. For
example, the Portfolio may terminate its obligation under a call option that
it had written by purchasing an identical call option; this is known as a
closing purchase transaction. Conversely, the Portfolio may terminate a
position in a put or call option it had purchased by writing an identical put
or call option; this is known as a closing sale transaction.
Growth and Income Portfolio may purchase or write both exchange-traded and
OTC options. Currently, many options on equity securities are exchange-traded.
Exchange markets for options on debt securities exist but are relatively new,
and these instruments are primarily traded on the OTC market. Exchange-traded
options in the United States are issued by a clearing organization affiliated
with the exchange on which the option is listed which, in effect, guarantees
completion of every exchange-traded option transaction. In contrast, OTC
options are contracts between the Portfolio and its contra party (usually a
securities dealer or a bank) with no clearing organization guarantee. Thus,
when the Portfolio purchases or writes an OTC option, it relies on the contra
party to make or take delivery of the underlying investment upon exercise of
the option. Failure by the contra party to do so would result in the loss of
any premium paid by the Portfolio as well as the loss of any expected benefits
of the transaction. A Portfolio will enter into OTC option transactions only
with contra parties that have a net worth of at least $20 million.
Generally, the OTC debt options used by Growth and Income Portfolio are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option.
Growth and Income Portfolio's ability to establish and close out positions
in exchange-listed options depends on the existence of a liquid market. The
Portfolio intends to purchase or write only those exchange-traded options for
which there appears to be a liquid secondary market. However, there can be no
assurance that such a market will exist at any particular time. Closing
transactions can be made for OTC options only by negotiating directly with the
contra party, or by a transaction in the secondary market if any such market
exists. Although the Portfolio will enter into OTC options only with contra
parties that are expected to be capable of entering into closing transactions
with the Portfolio, there is no assurance that the Portfolio will in fact be
able to close out an OTC option position at a favorable price prior to
expiration. In the event of insolvency of the contra party, the Portfolio
might be unable to close out an OTC option position at any time prior to its
expiration.
If Growth and Income Portfolio were unable to effect a closing transaction
for an option it had purchased, it would have to exercise the option to
realize any profit. The inability to enter into a closing purchase transaction
for a covered call option written by the Portfolio could cause material losses
because the Portfolio would be unable to sell the investment used as cover for
the written option until the option expires or is exercised.
10
<PAGE>
LIMITATIONS ON THE USE OF OPTIONS. Growth and Income Portfolio's use of
options is governed by the following guidelines, which can be changed by the
board without shareholder vote:
(1) The Portfolio may purchase a put or call option, including any
straddles or spreads, only if the value of its premium, when aggregated
with the premiums on all other options held by the Portfolio, does not
exceed 5% of the Portfolio's total assets.
(2) The aggregate value of securities underlying put options written by
the Portfolio, determined as of the date the put options are written, will
not exceed 50% of the Portfolio's net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock or bond indices and options on
futures contracts) purchased by the Portfolio that are held at any time
will not exceed 20% of the Portfolio's net assets.
FUTURES. The purchase of futures or call options thereon can serve as a long
hedge, and the sale of futures or the purchase of put options thereon can
serve as a short hedge. Writing covered call options on futures contracts can
serve as a limited short hedge, using a strategy similar to that used for
writing covered call options on securities and indices.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract Growth and Income Portfolio is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash, obligations of the United States or obligations fully guaranteed as
to principal and interest by the United States, in an amount generally equal
to 10% or less of the contract value. Margin must also be deposited when
writing an option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin on
futures contracts does not represent a borrowing, but rather is in the nature
of a performance bond or good-faith deposit that is returned to the Portfolio
at the termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility,
the Portfolio may be required by an exchange to increase the level of its
initial margin payment, and initial margin requirements might be increased
generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Portfolio's obligations to or from a
futures broker. When Growth and Income Portfolio purchases an option on a
future, the premium paid plus transaction costs is all that is at risk. In
contrast, when the Portfolio purchases or sells a futures contract or writes a
call option thereon, it is subject to daily variation margin calls that could
be substantial in the event of adverse price movements. If the Portfolio has
insufficient cash to meet daily variation margin requirements, it might need
to sell securities at a time when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to
the instrument held or written. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. Growth and Income Portfolio intends to enter into futures transactions
only on exchanges or boards of trade where there appears to be a liquid
secondary market. However, there can be no assurance that such a market will
exist for a particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If Growth and Income Portfolio were unable to liquidate a futures or related
options position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The
11
<PAGE>
Portfolio would continue to be subject to market risk with respect to the
position. In addition, except in the case of purchased options, the Portfolio
would continue to be required to make daily variation margin payments and
might be required to maintain the position being hedged by the future or
option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might
be increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. Growth and Income
Portfolio's use of futures is governed by the following guidelines, which can
be changed by the board without shareholder vote.
(1) To the extent the Portfolio enters into futures contracts or options
on futures contracts traded on a commodities exchange that are not for bona
fide hedging purposes (as defined by the CFTC), the aggregate initial
margin and premiums on those positions (excluding the amount by which
options are "in-the-money") may not exceed 5% of the Portfolio's net
assets.
(2) The aggregate premiums on all options (including options on
securities and stock indices and options on futures contracts) purchased by
the Portfolio that are held at any time will not exceed 20% of the
Portfolio's net assets.
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by a Portfolio will not exceed 5% of the
Portfolio's total assets.
TRUSTEES AND OFFICERS
The trustees and executive officers of the Fund, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
Margo N. Alexander**; 50 Trustee and President Mrs. Alexander is presi-
dent, chief executive of-
ficer and a director of
Mitchell Hutchins (since
January 1995) and an ex-
ecutive vice president
and director of
PaineWebber. Mrs. Alexan-
der is president and a
director or trustee of 29
investment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Richard Q. Armstrong; 62 Trustee Mr. Armstrong is chairman
78 West Brother Drive and principal of RQA En-
Greenwich, CT 06830 terprises (management
consulting firm) (since
April 1991 and principal
occupation since March
1995). Mr. Armstrong is
also a director of Hi Lo
Automotive, Inc. He was
chairman of the board,
chief executive
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
officer and co-owner of
Adirondack Beverages
(producer and distribu-
tor of soft drinks and
sparkling/still waters)
(October 1993-March
1995). He was a partner
of The New England Con-
sulting Group (manage-
ment consulting firm)
(December 1992-September
1993). He was managing
director of LVMH U.S.
Corporation (U.S. sub-
sidiary of the French
luxury goods conglomer-
ate, Luis Vuitton Moet
Hennessey Corporation)
(1987-1991) and chairman
of its wine and spirits
subsidiary, Schieffelin
& Somerset Company
(1987-1991). Mr. Arm-
strong is a director or
trustee of 28 investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
E. Garrett Bewkes, Jr.**; 71 Trustee and Chairman Mr. Bewkes is a director
of the Board of of Paine Webber Group
Trustees Inc. ("PW Group") (hold-
ing company of
PaineWebber and Mitchell
Hutchins). Prior to De-
cember 1995, he was a
consultant to PW Group.
Prior to 1988, he was
chairman of the board,
president and chief ex-
ecutive officer of Amer-
ican Bakeries
Company. Mr. Bewkes is
also a director of In-
terstate Bakeries Corpo-
ration and NaPro
BioTherapeutics, Inc.
Mr. Bewkes is a director
or trustee of 29 invest-
ment companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Richard R. Burt; 50 Trustee Mr. Burt is chairman of
1275 Pennsylvania Avenue, IEP Advisors, Inc. (in-
N.W. ternational investments
Washington, D.C. 20004 and consulting firm)
(since March 1994) and a
partner of McKinsey &
Company (management con-
sulting firm) (since
1991). He is also a di-
rector of American Pub-
lishing Company and
Archer-Daniels-Midland
Co. (agricultural com-
modities). He was the
chief negotiator in the
Strategic Arms Reduction
Talks with the former
Soviet Union (1989-1991)
and the U.S. Ambassador
to the Federal Republic
of Germany (1985-1989).
Mr. Burt is a director
or trustee of 28 invest-
ment companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Mary C. Farrell**; 48 Trustee Ms. Farrell is a managing
director, senior
investment strategist
and member of
the Investment Policy
Committee of
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
PaineWebber. Ms.
Farrell joined
PaineWebber in 1982.
She is a member of the
Financial Women's Asso-
ciation and Women's
Economic Roundtable and
appears as a regular
panelist on Wall $treet
Week with Louis
Rukeyser. She also
serves on the Board of
Overseers of New York
University's Stern
School of Business. Ms.
Farrell is a director
or trustee of 28 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
Meyer Feldberg; 55 Trustee Mr. Feldberg is Dean and
Columbia University Professor of Management
101 Uris Hall of the Graduate School
New York, New York 10027 of Business, Columbia
University. Prior to
1989, he was president
of the Illinois Insti-
tute of Technology.
Dean Feldberg is also a
director of K-III Com-
munications Corpora-
tion, Federated Depart-
ment Stores, Inc., and
Revlon, Inc. Dean
Feldberg is a director
or trustee of 28 in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves
as investment adviser.
George W. Gowen; 68 Trustee Mr. Gowen is a partner
666 Third Avenue in the law firm of Dun-
New York, New York 10017 nington, Bartholow &
Miller. Prior to May
1994 he was a partner
in the law firm of Fry-
er, Ross & Gowen.
Mr. Gowen is also a di-
rector of Columbia Real
Estate Investments,
Inc. Mr. Gowen is a di-
rector or trustee of 28
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Frederic V. Malek; 61 Trustee Mr. Malek is chairman of
1455 Pennsylvania Avenue, N.W. Thayer Capital Partners
Suite 350 (merchant bank). From
Washington, D.C. 20004 January 1992 to Novem-
ber 1992 he was cam-
paign manager of Bush-
Quayle '92. From 1990
to 1992, he was vice
chairman and, from 1989
to 1990, he was presi-
dent of Northwest Air-
lines Inc., NWA Inc.
(holding company of
Northwest Airlines
Inc.) and Wings Hold-
ings Inc. (holding com-
pany of NWA Inc.).
Prior to 1989, he was
employed by the
Marriott Corporation
(hotels, restaurants,
airline catering and
contract feeding),
where he most recently
was an executive vice
president and president
of Marriott Hotels and
Resorts. Mr. Malek is
also a director of
American Management
Systems, Inc. (man-
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
agement consulting and
computer related ser-
vices), Automatic Data
Processing, Inc., CB
Commercial Group, Inc.
(real estate services),
Choice Hotels Interna-
tional (hotel and hotel
franchising), FPL Group,
Inc. (electric servic-
es), Integra, Inc. (bio-
medical), Manor Care,
Inc. (health care), Na-
tional Education Corpo-
ration and Northwest
Airlines Inc. Mr. Malek
is a director or trustee
of 28 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
Carl W. Schafer; 62 Trustee Mr. Schafer is president
P.O. Box 1164 of the Atlantic Founda-
Princeton, NJ 08542 tion (charitable founda-
tion supporting mainly
oceanographic explora-
tion and research). He
is a director of Roadway
Express, Inc. (truck-
ing), The Guardian Group
of Mutual Funds, Evans
Systems, Inc. (motor fu-
els, convenience store
and diversified compa-
ny), Electronic Clearing
House, Inc. (financial
transactions process-
ing), Wainoco Oil Corpo-
ration and Nutraceutix
Inc. (biotechnology com-
pany). Prior to January
1993, he was chairman of
the Investment Advisory
Committee of the Howard
Hughes Medical
Institute. Mr. Schafer
is a director or trustee
of 28 investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
T. Kirkham Barneby; 51 Vice President Mr. Barneby is a managing
director and chief in-
vestment officer--quan-
titative investment of
Mitchell Hutchins. Prior
to September 1994, he
was a senior vice presi-
dent at Vantage Global
Management. Prior to
June 1993, he was a se-
nior vice president at
Mitchell Hutchins.
Mr. Barneby is a vice
president of five in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Ellen R. Harris; 51 Vice President Ms. Harris is a managing
director and a portfolio
manager of Mitchell
Hutchins. Ms. Harris is
a vice president of two
investment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
James F. Keegan; 37 Vice President Mr. Keegan is a senior
vice president and a
portfolio manager of
Mitchell Hutchins. Prior
to March 1996, he was
director of fixed
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
income strategy and research
of Merrion Group, L.P. From
1987 to 1994, he was a vice
president of global invest-
ment management of Bankers
Trust. Mr. Keegan is a vice
president of three invest-
ment companies for which
Mitchell Hutchins or
PaineWebber serves as in-
vestment adviser.
Dennis McCauley; 51 Vice President Mr. McCauley is a managing
director and chief invest-
ment officer--fixed income
of Mitchell Hutchins. Prior
to December 1994, he was di-
rector of fixed income
investments of IBM Corpora-
tion. Mr. McCauley is a vice
president of 18 investment
companies for which Mitchell
Hutchins or PaineWebber
serves as investment advis-
er.
Ann E. Moran; 40 Vice President and Ms. Moran is a vice president
Assistant Treasurer and a manager of the mutual
fund finance division of
Mitchell Hutchins. Ms. Moran
is a vice president and as-
sistant treasurer of 29 in-
vestment companies for which
Mitchell Hutchins or
PaineWebber serves as in-
vestment adviser.
Dianne E. O'Donnell; 45 Vice President and Ms. O'Donnell is a senior
Secretary vice president and deputy
general counsel of Mitchell
Hutchins. Ms. O'Donnell is a
vice pres-ident and secre-
tary of 28 investment compa-
nies and vice president and
assistant secretary of one
investment company for which
Mitchell Hutchins or
PaineWebber serves as in-
vestment adviser.
Emil Polito; 37 Vice President Mr. Polito is a senior vice
president and director of
operations and control for
Mitchell Hutchins. From
March 1991 to September 1993
he was director of the Mu-
tual Funds Sales Support and
Service Center for Mitchell
Hutchins and PaineWebber.
Mr. Polito is a vice presi-
dent of 29 investment compa-
nies for which Mitchell
Hutchins or PaineWeb-ber
serves as investment advis-
er.
Susan Ryan; 37 Vice President Ms. Ryan is a senior vice
president and a portfolio
manager of Mitchell Hutchins
and has been with Mitchell
Hutchins since 1982.
Ms. Ryan is a vice president
of five investment companies
for which Mitchell Hutchins
or PaineWebber serves as in-
vestment adviser.
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
Victoria E. Schonfeld; 47 Vice President Ms. Schonfeld is a managing
director and general coun-
sel of Mitchell Hutchins.
Prior to May 1994, she was
a partner in the law firm
of Arnold & Porter.
Ms. Schonfeld is a vice
president of 28 investment
companies and a vice pres-
ident and secretary of one
investment company for
which Mitchell Hutchins or
PaineWebber serves as in-
vestment adviser.
Paul H. Schubert; 35 Vice President and Mr. Schubert is a first
Treasurer vice president and the di-
rector of the mutual fund
finance division of Mitch-
ell Hutchins. From August
1992 to August 1994, he
was a vice president at
BlackRock Financial Man-
agement L.P. Mr. Schubert
is a vice president and
treasurer of 29 investment
companies for which Mitch-
ell Hutchins or
PaineWebber serves as in-
vestment adviser.
Nirmal Singh; 41 Vice President Mr. Singh is a senior vice
president and a portfolio
manager of Mitchell
Hutchins. Prior to 1993,
he was a member of
the portfolio management
team at Merrill Lynch As-
set Management, Inc. Mr.
Singh is a vice president
of four investment compa-
nies for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
Barney A. Taglialatela; 36 Vice President and Mr. Taglialatela is a vice
Assistant Treasurer president and a manager of
the mutual fund finance
division of Mitchell
Hutchins. Prior to Febru-
ary 1995, he was a manager
of the mutual fund finance
division of Kidder Peabody
Asset Management, Inc. Mr.
Taglialatela is a vice
president and assistant
treasurer of 29 investment
companies for which Mitch-
ell Hutchins or
PaineWebber serves as in-
vestment adviser.
Mark A. Tincher; 42 Vice President Mr. Tincher is a managing
director and chief invest-
ment officer--equities of
Mitchell Hutchins. Prior
to March 1995, he was a
vice president and di-
rected the U.S. funds man-
agement and equity re-
search areas of Chase Man-
hattan Private Bank. Mr.
Tincher is a vice presi-
dent of 13 investment com-
panies for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
Craig M. Varrelman; 39 Vice President Mr. Varrelman is a senior vice
president and a portfolio man-
ager of Mitchell Hutchins. Mr.
Varrelman is a vice president
of four investment companies
for which Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
Stuart Waugh; 42 Vice President Mr. Waugh is a managing direc-
tor and a portfolio manager of
Mitchell Hutchins responsible
for global fixed income in-
vestments and currency trad-
ing. Mr. Waugh is a vice pres-
ident of five investment com-
panies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Keith A. Weller; 36 Vice President and Mr. Weller is a first vice
Assistant Secretary president and associate gen-
eral counsel of Mitchell
Hutchins. Prior to May 1995,
he was an attorney in private
practice. Mr. Weller is a vice
president and assistant secre-
tary of 28 investment compa-
nies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Ian W. Williams; 40 Vice President and Mr. Williams is a vice presi-
Assistant Treasurer dent and a manager of the mu-
tual fund finance division of
Mitchell Hutchins. Mr. Wil-
liams is a vice president and
assistant treasurer of 29 in-
vestment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
- --------
*Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
**Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of the
Fund as defined in the 1940 Act by virtue of their positions with Mitchell
Hutchins, PaineWebber and/or PW Group.
The Fund pays trustees who are not "interested persons" of the Fund $500
annually for each series and $150 for each board meeting and for each separate
meeting of a board committee. The Fund presently has 13 series, including
Growth and Income Portfolio, and thus pays each such trustee $4,500 annually,
plus any additional amounts due for board or committee meetings. Each chairman
of the audit and contract review committees of individual funds within the
PaineWebber fund complex receives additional compensation aggregating $15,000
annually from the relevant funds. All trustees are reimbursed for any expenses
incurred in attending meetings. Because Mitchell Hutchins performs
substantially all of the services necessary for the operation of the Fund, the
Fund requires no employees. No officer, director or employee of Mitchell
Hutchins or PaineWebber receives any compensation from the Fund for acting as
a trustee or officer.
18
<PAGE>
The table below includes certain information relating to the compensation of
the Fund's current trustees who held office with the Fund or other PaineWebber
funds during the fiscal year ended December 31, 1997.
COMPENSATION TABLE+
<TABLE>
<CAPTION>
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE FUND AND
NAME OF PERSON, POSITION FROM THE FUND * THE FUND COMPLEX**
------------------------ --------------- ------------------
<S> <C> <C>
Richard Q. Armstrong,
Trustee................................... $12,600 $94,885
Richard R. Burt,
Trustee................................... 11,250 87,085
Meyer Feldberg,
Trustee................................... 12,600 117,853
George W. Gowen,
Trustee................................... 14,209 101,567
Frederic V. Malek,
Trustee................................... 12,600 95,845
Carl W. Schafer,
Trustee................................... 12,600 94,885
</TABLE>
- --------
+ Only independent members of the board of trustees are compensated by the
Fund and identified above; trustees who are "interested persons," as
defined by the 1940 Act, do not receive compensation.
* Represents fees paid to each trustee during the fiscal year ended December
31, 1997.
** Represents total compensation paid to each trustee by the fund complex
during the twelve months ended December 31, 1997; no fund within the
complex has a bonus, pension, profit sharing or retirement plan.
INVESTMENT ADVISORY SERVICES
Mitchell Hutchins acts as the investment adviser and administrator of Growth
and Income Portfolio pursuant to a contract with the Fund dated April 21, 1988
as supplemented by a Fee Agreement dated December 30, 1991 ("Advisory
Contract"). Under the Advisory Contract, the Fund pays Mitchell Hutchins a fee
at the annual rate of 0.70% for the Portfolio, computed daily and payable
monthly.
During the fiscal years ended December 31, 1996, 1995 and 1994, Mitchell
Hutchins earned (or accrued) advisory fees (net of any waivers) in the amount
of $111,599, $94,315 and $93,915, respectively, for Growth and Income
Portfolio.
Under a Sub-Advisory Contract dated May 26, 1994, Mitchell Hutchins
Institutional Investors Inc. served as sub-adviser to Growth and Income
Portfolio until April 3, 1995 and was paid (or accrued) by Mitchell Hutchins
(not the Portfolio) sub-advisory fees of $7,400 and $27,400 for the fiscal
years ended December 31, 1995 and December 31, 1994, respectively.
Under the terms of the Advisory Contract, each series (including Growth and
Income Portfolio) bears all expenses incurred in its operation that are not
specifically assumed by Mitchell Hutchins. General expenses of the Fund not
readily identifiable as belonging to one of the series are allocated among all
the series by or under the direction of the board in such manner as the board
determines to be fair and equitable. Expenses borne by each series include,
but are not limited to, the following (or the series' allocated share of the
following): (1) the cost (including brokerage commissions, if any) of
securities purchased or sold by the series and any losses incurred in
connection therewith; (2) fees payable to and expenses incurred on behalf of
the series by Mitchell Hutchins; (3) organizational expenses; (4) filing fees
and expenses relating to the registration and qualification of the Fund or the
shares of a series under federal and state securities laws and maintenance of
such registrations and qualifications; (5) fees and salaries payable to the
trustees who are not "interested persons" of the Fund or Mitchell Hutchins;
(6) all expenses incurred in connection with the trustees' services, including
travel
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expenses; (7) taxes (including any income or franchise taxes) and governmental
fees; (8) costs of any liability, uncollectible items of deposit and other
insurance and fidelity bonds; (9) any costs, expenses or losses arising out of
a liability of or claim for damages or other relief asserted against the Fund
or series for violation of any law; (10) legal, accounting and auditing
expenses, including legal fees of special counsel for the trustees who are not
interested persons of the Fund; (11) charges of custodians, transfer agents
and other agents; (12) costs of preparing share certificates, if any; (13)
expenses of setting in type and printing prospectuses and supplements thereto,
statements of additional information and supplements thereto, reports and
proxy materials for existing shareholders and costs of mailing such materials
to shareholders; (14) any extraordinary expenses (including fees and
disbursements of counsel) incurred by the Fund or series; (15) fees, voluntary
assessments and other expenses incurred in connection with membership in
investment company organizations; (16) costs of mailing and tabulating proxies
and costs of meetings of shareholders, the board and any committees thereof;
(17) the cost of investment company literature and other publications provided
to the trustees and officers; and (18) costs of mailing, stationery and
communications equipment.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder.
The Advisory Contract terminates automatically upon assignment and is
terminable at any time without penalty by the Fund's board of trustees or by
vote of the holders of a majority of Growth and Income Portfolio's outstanding
voting securities on 60 days' written notice to Mitchell Hutchins or by
Mitchell Hutchins on 60 days' written notice to the Fund.
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of the PaineWebber funds and other Mitchell Hutchins' advisory
accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition, the code of ethics puts restrictions on the timing of
personal investing in relation to trades by PaineWebber funds and other
Mitchell Hutchins advisory clients.
PORTFOLIO TRANSACTIONS
Subject to policies established by the board, Mitchell Hutchins is
responsible for the execution of portfolio transactions and the allocation of
brokerage transactions for Growth and Income Portfolio. In executing portfolio
transactions, Mitchell Hutchins seeks to obtain the best net results for the
Portfolio taking into account such factors as the price (including the
applicable brokerage commission or dealer spread), size of the order,
difficulty of execution and operational facilities of the firm involved.
Prices paid to dealers in principal transactions through which most debt
securities and some equity securities are traded generally include a "spread,"
which is the difference between the prices at which the dealer is willing to
purchase and sell a specific security at that time. The Portfolio may invest
in securities traded in the OTC markets and will engage primarily in
transactions with the dealers who make markets in such securities, unless a
better price or execution could be obtained by using a broker. While Mitchell
Hutchins generally seeks reasonably competitive commission rates, payment of
the lowest commission is not necessarily consistent with obtaining the best
net results. During the fiscal years ended December 31, 1996, 1995 and 1994,
the Portfolio paid brokerage commissions in the amount of $31,792, $34,846 and
$45,863, respectively.
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The Fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Fund contemplates that,
consistent with the policy of obtaining the best net results, a substantial
amount of Growth and Income Portfolio's brokerage transactions may be
conducted through Mitchell Hutchins or its affiliates, including PaineWebber.
The board has adopted procedures in conformity with Rule 17e-1 under the 1940
Act to ensure that all brokerage commissions paid to Mitchell Hutchins or its
affiliates are fair and reasonable. Specific provisions included in the
Advisory Contract authorize Mitchell Hutchins and any of its affiliates that
is a member of a national securities exchange to effect securities
transactions for the Portfolios on such exchange and to retain compensation in
connection with such transactions. Any such transactions will be effected and
related compensation paid in accordance with applicable SEC regulations.
During the fiscal years ended December 31, 1996, 1995 and 1994, the Portfolio
paid to PaineWebber brokerage commissions in the amounts of $852, $1,400 and
$1,817, respectively. The $852 in brokerage commissions paid by Growth and
Income Portfolio to PaineWebber during the fiscal year ended December 31, 1996
represented 2.68% of the aggregate brokerage commissions it paid and 0.14% of
the aggregate dollar amount of transactions involving the payment of
commissions.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs") who receive brokerage commissions for their services. The
Fund's procedures in selecting FCMs to execute the Portfolios' transactions in
futures contracts, including procedures permitting the use of Mitchell
Hutchins and its affiliates, are similar to those in effect with respect to
brokerage transactions in securities.
Consistent with the interest of Growth and Income Portfolio and subject to
the review of the board. Mitchell Hutchins may cause the Portfolio to purchase
and sell portfolio securities from and to brokers who provide the Portfolio
with research, analysis, advice and similar services. In return for such
services, the Portfolio may pay to those brokers a higher commission than may
be charged by other brokers, provided that Mitchell Hutchins determines in
good faith that such commission is reasonable in terms either of that
particular transaction or of the overall responsibility of Mitchell Hutchins
to the Portfolio and its other clients and that the total commissions paid by
the Portfolio will be reasonable in relation to the benefits to the Portfolio
over the long term. During the fiscal year ended December 31, 1996, the
Portfolio directed $3,968,857 in portfolio transactions to brokers chosen
because they provide research and analysis, for which the Portfolio paid
$5,400 in brokerage commissions.
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with these transactions,
Mitchell Hutchins will not purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
attributed to the services provided by the executing dealer. Moreover,
Mitchell Hutchins will not enter into any explicit soft dollar arrangements
relating to principal transactions and will not receive in principal
transactions the types of services which could be purchased for hard dollars.
Mitchell Hutchins may engage in agency transactions in OTC equity and debt
securities in return for research and execution services. These transactions
are entered into only in compliance with procedures ensuring that the
transaction (including commissions) is at least as favorable as it would have
been if effected directly with a market-maker that did not provide research or
execution services. These procedures include Mitchell Hutchins receiving
multiple quotes from dealers before executing the transaction on an agency
basis.
Information and research received from such brokers and dealers will be in
addition to, and not in lieu of, the services required to be performed by
Mitchell Hutchins under the Advisory Contract. Research services furnished by
brokers or dealers through which or with which Growth and Income Portfolio
effects securities transactions may be used by Mitchell Hutchins in advising
other funds or accounts and, conversely, research services furnished to
Mitchell Hutchins in connection with these other funds or accounts may be used
in advising the Portfolio.
Investment decisions for Growth and Income Portfolio and for other
investment accounts managed by Mitchell Hutchins are made independently of
each other in light of differing considerations for the various accounts.
However, the same investment decision may occasionally be made for the
Portfolio and one or more of such accounts. In such cases, simultaneous
transactions are inevitable. Purchases or sales are then averaged as
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to price and allocated between the Portfolio and such other account(s) as to
amount according to a formula deemed equitable to the Portfolio and such
account(s). While in some cases this practice could have a detrimental effect
upon the price or value of the security as far as the Portfolio is concerned,
or upon its ability to complete its entire order, in other cases it is
believed that coordination and the ability to participate in volume
transactions will be beneficial to the Portfolio.
Growth and Income Portfolio will not purchase securities that are offered in
underwritings in which Mitchell Hutchins, or any of its affiliates is a member
of the underwriting or selling group, except pursuant to procedures adopted by
the Fund's board of trustees pursuant to Rule 10f-3 under the 1940 Act. Among
other things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be
at not more than the public offering price prior to the end of the first
business day after the date of the public offering and that Mitchell Hutchins
or any of its affiliates not participate in or benefit from the sale to the
Fund.
PORTFOLIO TURNOVER. The turnover rate may vary greatly from year to year for
Growth and Income Portfolio and will not be a limiting factor when Mitchell
Hutchins deems portfolio changes appropriate. The annual portfolio turnover
rate is calculated by dividing the lesser of the Portfolio's annual sales or
purchases of portfolio securities (exclusive of purchases or sales of
securities whose maturities at the time of acquisition were one year or less)
by the monthly average value of the securities except short-term securities in
the Portfolio during the year. For the fiscal years ended December 31, 1996
and December 31, 1995, the portfolio turnover rates were 99% and 134%,
respectively.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Accounts purchase and redeem shares of Growth and Income Portfolio on
each day on which the New York Stock Exchange ("NYSE") is open for trading
("Business Day") based on, among other things, the amount of premium payments
to be invested and surrendered and transfer requests to be effected on that
day pursuant to the Contracts. Currently, the NYSE is closed on the observance
of New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Such purchases and redemptions of the shares of the Portfolio are effected at
its net asset value per share determined as of the close of regular trading
(currently 4:00 p.m., Eastern time) on the NYSE on that Business Day. Payment
for redemptions are made by the Fund within seven days thereafter. No fee is
charged the separate accounts when they purchase or redeem Portfolio shares.
The Fund may suspend redemption privileges of shares of Growth and Income
Portfolio or postpone the date of payment during any period (1) when the NYSE
is closed or trading on the NYSE is restricted as determined by the SEC, (2)
when an emergency exists, as defined by the SEC, that makes it not reasonably
practicable for the Fund to dispose of securities owned by it or fairly to
determine the value of its assets or (3) as the SEC may otherwise permit. The
redemption price may be more or less than the shareholder's cost, depending on
the market value of the Portfolio's securities at the time.
VALUATION OF SHARES
Growth and Income Portfolio determines its net asset value as of the close
of regular trading (currently 4:00 p.m., Eastern time) on the NYSE on each
Monday through Friday when the NYSE is open.
Securities that are listed on U.S. stock exchanges are valued at the last
sale price on the day the securities are being valued or, lacking any sales on
such day, at the last available bid price. In cases where securities are
traded on more than one exchange, the securities are generally valued on the
exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on the Nasdaq Stock Market ("Nasdaq") are
valued at the last available sale price listed on Nasdaq at 4:00 p.m., Eastern
time; other OTC securities are valued at the last available bid price prior to
the time of valuation.
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When market quotations are readily available, Growth and Income Portfolio's
debt securities are valued based upon market quotations, provided such
quotations adequately reflect, in the judgment of Mitchell Hutchins, the fair
value of the securities. The amortized cost method of valuation generally is
used with respect to debt obligations with 60 days or less remaining to
maturity unless the board determines that this does not represent fair value.
When market quotations for options and futures positions held by the Portfolio
are readily available, those positions are valued based upon such quotations.
Market quotations are not generally available for options traded in the OTC
market. When market quotations for options and futures positions, or any other
securities or assets of the Portfolio, are not available, they are valued at
fair value as determined in good faith by or under the direction of the board.
When practicable, such determinations are based upon appraisals received from
a pricing service using a computerized matrix system or appraisals derived
from information concerning the security or similar securities received from
recognized dealers in those securities.
In determining the approximate market value of portfolio investments, the
Fund may employ outside organizations, which may use a matrix or formula
method that takes into consideration market indices, matrices, yield curves
and other specific adjustments. This may result in the securities being valued
at a price different from the price that would have been determined had the
matrix or formula method not been used. All cash, receivables and current
payables are carried at their face value. Other assets, if any, are valued at
fair value as determined in good faith by or under the direction of the board.
TAXES
Shares of Growth and Income Portfolio are offered only to Accounts that fund
benefits under the Contracts. See the applicable Contract prospectus for a
discussion of the special taxation of insurance companies with respect to such
Accounts and of the Contract holders.
Growth and Income Portfolio is treated as a separate corporation for federal
income tax purposes. In order to continue to qualify for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code, the
Portfolio must distribute to its shareholders for each taxable year at least
90% of its investment company taxable income (consisting generally of net
investment income and net short-term capital gain) ("Distribution
Requirement") and must meet several additional requirements. With respect to
the Portfolio, these requirements include the following: (1) the Portfolio
must derive at least 90% of its gross income each taxable year from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of securities or other income (including gains from options
or futures) derived with respect to its business of investing in securities
("Income Requirement"); (2) at the close of each quarter of the Portfolio's
taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs and other securities, with these other securities limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value
of the Portfolio's total assets and that does not represent more than 10% of
the issuer's outstanding voting securities; and (3) at the close of each
quarter of the Portfolio's taxable year, not more than 25% of the value of its
total assets may be invested in securities (other than U.S. government
securities or the securities of other RICs) of any one issuer.
As noted in the Prospectus, Growth and Income Portfolio must, and intends to
continue to, comply with the diversification requirements imposed by section
817(h) of the Internal Revenue Code and the regulations thereunder. These
requirements, which are in addition to the diversification requirements
mentioned above, place certain limitations on the proportion of the
Portfolio's assets that may be represented by any single investment (which
includes all securities of the same issuer). For these purposes, each U.S.
government agency or instrumentality is treated as a separate issuer.
The use of hedging and related strategies, such as selling (writing) and
purchasing options and futures contracts, involves complex rules that will
determine for income tax purposes the character and timing of recognition of
the gains and losses Growth and Income Portfolio realizes in connection
therewith. Gains from
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options and futures derived by the Portfolio with respect to its business of
investing in securities will qualify as permissible income under the Income
Requirement.
Growth and Income Portfolio may invest in the stock of "passive foreign
investment companies" ("PFICs"). A PFIC is a foreign corporation--other than a
"controlled foreign corporation" (i.e., a foreign corporation in which, on any
day during its taxable year, more than 50% of the total voting power of all
voting stock therein or the total value of all stock therein is owned,
directly, indirectly, or constructively, by "U.S. shareholders," defined as
U.S. persons that individually own, directly, indirectly, or constructively,
at least 10% of that voting power) as to which the Portfolio is a U.S.
shareholder--that, in general, meets either of the following tests: (1) at
least 75% of its gross income is passive or (2) an average of at least 50% of
its assets produce, or are held for the production of, passive income. Under
certain circumstances, the Portfolio will be subject to federal income tax on
a portion of any "excess distribution" received on the stock of a PFIC or of
any gain on disposition of such stock (collectively "PFIC income"), plus
interest thereon, even if the Portfolio distributes the PFIC income as a
taxable dividend to its shareholders. The balance of the PFIC income will be
included in the Portfolio's investment company taxable income and,
accordingly, will not be taxable to it to the extent that income is
distributed to its shareholders.
If Growth and Income Portfolio invests in a PFIC and elects to treat the
PFIC as a "qualified electing fund" ("QEF"), then in lieu of the foregoing tax
and interest obligation, the Portfolio would be required to include in income
each year its pro rata share of the QEF's annual ordinary earnings and net
capital gain (the excess of net long-term capital gain over net short-term
capital loss)--which likely would have to be distributed to the Portfolio's
shareholders to satisfy the Distribution Requirement and avoid imposition of
the Excise Tax--even if those earnings and gain were not distributed to the
Portfolio by the QEF. In most instances it will be very difficult, if not
impossible, to make this election because of certain requirements thereof.
Growth and Income Portfolio may elect to "mark-to-market" its stock in any
PFIC. "Marking-to-market," in this context, means including in ordinary income
each taxable year the excess, if any of the fair market value of a PFIC's
stock over the Portfolio's adjusted basis therein as of the end of that year.
Pursuant to the election, the Portfolio also would be allowed to deduct (as an
ordinary, not capital, loss) the excess, if any, of its adjusted basis in PFIC
stock over the fair market value thereof as of the taxable year-end, but only
to the extent of any net mark-to-market gains with respect to that stock
included by the Portfolio for prior taxable years. The Portfolio's adjusted
basis in each PFIC's stock with respect to which it makes this election will
be adjusted to reflect the amounts of income included and deductions taken
under the election. Regulations proposed in 1992 would provide a similar
election with respect to the stock of certain PFICs.
The foregoing is only a general summary of some of the important federal
income tax considerations generally affecting Growth and Income Portfolio and
its shareholders. No attempt is made to present a complete explanation of the
federal tax treatment of the Portfolio's activities, and this discussion is
not intended as a substitute for careful tax planning. Accordingly, potential
investors are urged to consult their own tax advisers for more detailed
information and for information regarding any state, local or foreign taxes
applicable to the Portfolio and to dividends and other distributions
therefrom.
OTHER INFORMATION
Prior to November 12, 1997, the name of the Fund was "PaineWebber Series
Trust." Prior to August 14, 1995, Growth and Income Portfolio's name was
"Dividend Growth Portfolio."
The Fund is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Fund or
Growth and Income Portfolio. However, the Fund's Declaration of Trust
disclaims shareholder liability for acts or obligations of the Fund or the
Portfolio and requires that notice of such disclaimer be given in each note,
bond, contract, instrument, certificate or undertaking made or issued by the
trustees or by any
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officers or officer by or on behalf of the Fund, the trustees or any of them
in connection with the Fund. The Declaration of Trust provides for
indemnification from Fund or Portfolio property, as appropriate, for all
losses and expenses of any shareholder held personally liable for the
obligations of the Fund or Portfolio. Thus, the risk of a shareholder's
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund or Portfolio itself would be unable to meet
its obligations, a possibility that Mitchell Hutchins believes is remote and
not material. Upon payment of any liability incurred by a shareholder of a
Portfolio, the shareholder paying such liability will be entitled to
reimbursement from the general assets of the Portfolio. The board intends to
conduct the operations of the Fund so as to avoid, as far as possible,
ultimate liability of the shareholders for liabilities of the Fund and the
Portfolio.
More than 99% of the outstanding shares of Growth and Income Portfolio is,
at the date of this Statement of Additional Information, owned by American
Republic Variable Annuity Account, a segregated investment account of American
Republic Insurance Company, American Benefit Variable Annuity Account, a
segregated investment account of American Benefit Life Insurance Company, and
PaineWebber Life Variable Annuity Account, a segregated investment account of
PaineWebber Life Insurance Company.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the Fund.
Kirkpatrick & Lockhart LLP also acts as counsel to Mitchell Hutchins and
PaineWebber in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Fund.
FINANCIAL STATEMENTS
The Fund's Annual Report to shareholders for the fiscal year ended December
31, 1996 is a separate document supplied with this Statement of Additional
Information, and the financial statements, accompanying notes and report of
independent auditors appearing therein are incorporated by reference in this
Statement of Additional Information.
DESCRIPTION OF COMMERCIAL PAPER AND BOND RATINGS
COMMERCIAL PAPER RATINGS. Moody's employs the designation "Prime-1," "Prime-
2" and "Prime-3" to indicate the repayment capacity of issuers of commercial
paper. Issuers rated Prime-1 have a superior capacity for repayment of short-
term promissory obligations. Prime-1 repayment capacity will normally be
evidenced by the following characteristics: leading market positions in well-
established industries; high rates of return on funds employed; conservative
capitalization structures with moderate reliance on debt and ample asset
protection; broad margins in earnings coverage of fixed financial charges and
high internal cash generation; well-established access to a range of financial
markets and assured sources of alternate liquidity. Issuers rated Prime-2 have
a strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternate liquidity is
maintained. Issuers rated Prime-3 have an acceptable capacity for repayment of
short-term promissory obligations. The effect of industry characteristics and
market composition may be more pronounced. Variability in earnings and
profitability may result in changes in the level of debt protection
measurements and the requirement for relatively high financial leverage.
Adequate alternate liquidity is maintained. Not Prime. Issuers assigned this
rating do not fall within any of the Prime rating categories.
S&P's ratings of commercial paper are graded into four categories ranging
from "A" for the highest quality obligations to "D" for the lowest. A--Issues
assigned this highest rating are regarded as having the greatest capacity for
timely payment. Issues in this category are delineated with numbers 1, 2, and
3 to indicate the
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relative degree of 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 denoted
with a plus (+) sign designation. A-2--Capacity for timely payments on issues
with this designation is strong. However, the relative degree of safety is not
as high as for issues designated "A-1." A-3--Issues carrying this designation
have a satisfactory capacity for timely payment. They are, however, somewhat
more vulnerable to the adverse effects of changes in circumstances than
obligations carrying the higher designations. B--Issues rated B are regarded
as having only an adequate capacity for timely payment. However, such capacity
may be damaged by changing conditions or short-term adversities. C--This
rating is assigned to short-term debt obligations with a doubtful capacity for
payment. D--This rating indicates that the issue is either in default or is
expected to be in default upon maturity.
CORPORATE DEBT SECURITIES. Moody's rates the long-term debt securities
issued by various entities from "Aaa" to "D". Aaa--Best quality. These
securities 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--High quality by all standards. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities,
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--Upper medium grade obligations. These bonds
possess many favorable investment attributes. 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--
Medium grade obligations. 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--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 both good and bad times over the future. Uncertainty of position
characterizes bonds in this class. B--Generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small. Caa--Poor standing. Such issues may be in default or there may be
present elements of danger with respect to principal or interest. Ca--
Obligations which are speculative in a high degree. Such issues are often in
default or have other marked shortcomings. C--Lowest rated class of bonds;
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's may apply numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system.
The modifier 1 indicates that the security ranks in the higher end of its
generic rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates that the issue ranks in the lower end of its generic
rating category.
S&P also rates the long-term debt securities of various entities in
categories ranging from "AAA" to "D" according to quality. AAA--Highest grade.
Capacity to pay interest and repay principal extremely strong. AA--High grade.
Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from AAA issues only in a small degree. A--Have a strong capacity
to pay interest and repay principal, although they are somewhat more
susceptible to the adverse effects of changes in circumstances and economic
conditions. BBB--Regarded as having adequate capacity to pay interest and
repay principal. Whereas these bonds normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal than
for debt in higher rated categories. BB, B, CCC, CC, C--Regarded, on balance,
as predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation.
While such debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to adverse
conditions. CI--Reserved for income
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bonds on which no interest is being paid. D--In default, and payment of
interest and/or repayment of principal is in arrears.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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