<PAGE>
MITCHELL HUTCHINS SERIES TRUST
1285 Avenue of the Americas
New York, New York 10019
Mitchell Hutchins Series Trust ("Fund") is a professionally managed, open-end
investment company that offers shares in the Portfolios listed below. All the
Portfolios except Strategic Income Portfolio are diversified, and each has its
own investment objective and policies. Class I shares of each Portfolio are
offered only to insurance company separate accounts that fund benefits under
variable annuity contracts and/or variable life insurance contracts
("Contracts"). Strategic Income Portfolio and Tactical Allocation Portfolio
are newly organized and have no operating histories.
* STRATEGIC INCOME PORTFOLIO strategically allocates its investments among
three bond market categories: U.S. government and investment grade
corporate bonds; U.S. high yield, high risk corporate bonds; and foreign
and emerging market bonds.
* GROWTH AND INCOME PORTFOLIO invests primarily in dividend-paying equity
securities believed to have the potential for rapid earnings growth.
* TACTICAL ALLOCATION PORTFOLIO follows a disciplined investment strategy
that allocates its assets between common stocks and U.S. Treasury notes
or U.S. Treasury bills.
This Prospectus concisely sets forth information about the Fund that a
prospective investor should know before investing. Investors are advised to
read this Prospectus and the applicable Contract prospectus and retain them
for future reference. A Statement of Additional Information dated May 1, 1998,
as revised December 18, 1998 (which is incorporated by reference herein) has
been filed with the Securities and Exchange Commission ("SEC" or
"Commission"). The Statement of Additional Information can be obtained without
charge and further inquiries can be made by contacting the Fund or by calling
toll free 1-800-986-0088. In addition, the Commission maintains a website
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference and other information regarding registrants
that file electronically with the Commission.
STRATEGIC INCOME PORTFOLIO MAY INVEST WITHOUT LIMIT IN HIGH YIELD, HIGH RISK
BONDS, COMMONLY KNOWN AS "JUNK BONDS." BONDS OF THIS TYPE ARE CONSIDERED
SPECULATIVE WITH RESPECT TO THE PAYMENT OF INTEREST AND RETURN OF PRINCIPAL.
INVESTORS SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED WITH INVESTMENTS IN
THESE FUNDS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
The date of this Prospectus is May 1, 1998, as revised December 18, 1998.
MH 1
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TABLE OF CONTENTS
<TABLE>
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PAGE
<S> <C>
Financial Highlights...................................................... MH 3
Offering of Fund Shares................................................... MH 4
Investment Objectives and Policies........................................ MH 4
Description of Securities, Related Risks and Investment Techniques........ MH 7
Purchases, Redemptions and Exchanges...................................... MH 17
Dividends, Other Distributions and Federal Income Tax..................... MH 17
Valuation of Shares....................................................... MH 18
Management................................................................ MH 19
General Information....................................................... MH 22
Appendix.................................................................. MH 23
</TABLE>
MH 2
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FINANCIAL HIGHLIGHTS
The tables below provide data and ratios for one Class H share of Growth and
Income Portfolio during the periods shown. Growth and Income Portfolio had no
Class I shares outstanding during the periods shown. Strategic Income
Portfolio and Tactical Allocation Portfolio are newly organized and had no
operations during the periods shown. This information is supplemented by the
financial statements, accompanying notes and the report of Ernst & Young LLP,
independent auditors, which appear in the Fund's Annual Report to Shareholders
for the fiscal year ended December 31, 1997, and are incorporated by reference
into the Statement of Additional Information. The financial statements and
notes, as well as the information in the tables appearing below relating to
each of the five years in the period ended December 31, 1997, have been
audited by Ernst & Young LLP. The information appearing below for periods
prior to the year ended December 31, 1993 also has been audited by Ernst &
Young LLP, whose reports thereon were unqualified. Further information about
the performance of Growth and Income Portfolio's Class H shares is also
included in the Annual Report to Shareholders, which may be obtained without
charge by calling 1-800-986-0088.
The information shown below for Growth and Income Portfolio's Class H shares
should not be considered indicative of the results the Class I shares would
have achieved had they been outstanding during these periods. The Portfolios'
Class H shares are not subject to any distribution fees. Because Class I
shares will be subject to a distribution fee at the annual rate of 0.25% of
each Portfolio's average daily net assets attributable to Class I shares, the
ongoing expenses for Class I shares of a Portfolio will be higher than those
for its Class H shares, and the investment returns for Class I shares are
expected to be lower than those for Class H shares of the same Portfolio.
The financial highlights information pertains to Growth and Income Portfolio
and does not reflect charges related to the separate accounts that fund the
Contracts. You should refer to the appropriate Contract prospectus for
additional information regarding such charges.
<TABLE>
<CAPTION>
GROWTH AND INCOME PORTFOLIO
-----------------------------------------------------------------
FOR THE YEARS ENDED FOR THE PERIOD
DECEMBER 31, JANUARY 2, 1992+
---------------------------------------------- TO DECEMBER 31,
1997 1996 1995 1994 1993 1992
------- ------- ------- ------- ------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Net asset value,
beginning of period.... $ 12.27 $ 11.83 $ 9.16 $ 9.87 $ 10.26 $ 10.00
------- ------- ------- ------- ------- -------
Net investment income... 0.10 0.06 0.10 0.10 0.16 0.08
Net realized and
unrealized gains
(losses) from
investments............ 3.88 2.53 2.70 (0.71) (0.39) 0.26
------- ------- ------- ------- ------- -------
Net increase (decrease)
from investment
operations............. 3.98 2.59 2.80 (0.61) (0.23) 0.34
------- ------- ------- ------- ------- -------
Dividends from net
investment income...... (0.10) (0.06) (0.10) (0.10) (0.16) (0.08)
Distributions from net
realized gains from
investments............ (2.46) (2.09) (0.03) -- -- --
------- ------- ------- ------- ------- -------
Total dividends and
other distributions.... (2.56) (2.15) (0.13) (0.10) (0.16) (0.08)
------- ------- ------- ------- ------- -------
Net asset value, end of
period................. $ 13.69 $ 12.27 $ 11.83 $ 9.16 $ 9.87 $ 10.26
======= ======= ======= ======= ======= =======
Total investment return
(1).................... 32.45% 22.12 % 30.52 % (6.18)% (2.26)% 3.40 %
======= ======= ======= ======= ======= =======
Ratios/Supplemental
Data:
Net assets, end of
period (000's)......... $18,493 $14,520 $14,797 $12,872 $16,281 $20,037
Expenses to average net
assets................. 1.04% 1.58 % 1.37 % 1.35 % 1.12 % 1.29 %*
Net investment income to
average net assets..... 0.71% 0.49 % 0.94 % 1.06 % 1.37 % 1.21 %*
Portfolio turnover rate. 92% 99 % 134 % 150 % 52 % 14 %
Average commission rate
paid (2)............... $0.0599 $0.0598 -- -- -- --
</TABLE>
- -------
* Annualized
+ Commencement of operations
(1) Total investment return is calculated assuming a $1,000 investment on the
first day of each period reported, reinvestment of all dividends and other
distributions, if any, at net asset value on the payable dates, and a sale
at net asset value on the last day of each period reported. The figures do
not include additional Contract level charges; results would be lower if
such charges were included. Total investment return for periods of less
than one year has not been annualized.
(2) Effective for fiscal years beginning on or after September 1, 1995, the
Portfolio is required to disclose the average commission rate paid per
share of common stock investments purchased or sold.
MH 3
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OFFERING OF FUND SHARES
The Fund is a professionally managed mutual fund that offers Class I shares of
the Portfolios listed on the cover page and described in greater detail below.
Shares of each Portfolio are offered only to insurance company separate
accounts that fund benefits under variable annuity contracts and/or variable
life insurance contracts (collectively, "Contracts") issued by those insurance
companies. An insurance company separate account's interest is limited to the
Portfolio(s) in which the separate account invests. Not all Portfolios may be
available for all Contracts funded by a particular insurance company separate
account. Fees and charges imposed by a separate account, however, will affect
the actual return to the holder of a Contract. A separate account may also
impose certain restrictions or limitations on the allocation of purchase
payments or Contract value to one or more Portfolios. Prospective investors
should consult the applicable Contract prospectus for information regarding
fees and expenses of the Contract and separate account and any applicable
restrictions or limitations.
Each Portfolio offers Class I shares, and the shares are sold and redeemed at
net asset value. Class I shares are offered to insurance company separate
accounts where the related insurance company receives payments from the Fund
for its services in connection with the distribution of the Portfolios' Class
I shares. The Portfolios' Class I shares are subject to a distribution fee at
the annual rate of 0.25% of net assets attributable to the Class I shares. As
a result, Class I shares have higher ongoing expenses than Class H shares.
Shares of the Portfolios may serve as the underlying investments for separate
accounts of unaffiliated insurance companies ("shared funding") as well as for
both annuity and life insurance Contracts ("mixed funding"). Due to
differences in tax treatment or other considerations, the interests of various
Contract owners might at some time be in conflict. The Fund currently does not
foresee any such conflict. However, the Fund's board of trustees ("board")
intends to monitor events to identify any material irreconcilable conflict
that may arise and to determine what action, if any, should be taken in
response to such conflict. If such a conflict were to occur, one or more
insurance companies' separate accounts might be required to withdraw its
investments in one or more Portfolios. This might force a Portfolio to sell
securities at disadvantageous prices.
The separate accounts that purchase shares of the Portfolios are the
shareholders of the Portfolios--not the individual Contract owners. However,
the insurance company separate accounts may pass through voting rights to the
individual contract owners.
INVESTMENT OBJECTIVES AND POLICIES
Each Portfolio represents a segregated, separately managed portfolio of
securities with its own investment objective and its own investment policies.
There can be no assurance that any Portfolio's investment objective will be
met. Strategic Income Portfolio is managed as a non-diversified investment
company; the other Portfolios are all managed as diversified investment
companies.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly owned
asset management subsidiary of PaineWebber Incorporated ("PaineWebber"),
provides investment advisory and administrative services to the Fund.
STRATEGIC INCOME PORTFOLIO has a primary investment objective of high current
income and a secondary investment objective of capital appreciation. This
Portfolio strategically allocates its investments among three distinct bond
market categories: (1) U.S. government and investment grade corporate bonds,
including mortgage- and asset-backed securities; (2) U.S. high yield,
MH 4
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high risk corporate bonds, including convertible bonds, and preferred stock;
and (3) foreign and emerging market bonds. A portion of the Portfolio's assets
normally is invested in each of these investment sectors. However, the
Portfolio has the flexibility at any time to invest all or substantially all
of its assets in any one sector. The Portfolio may invest without limit in
bonds rated below investment grade (commonly known as "junk bonds"), including
high yield, high risk bonds that are rated as low as D by Standard & Poor's, a
division of The McGraw-Hill Companies, Inc. ("S&P") or C by Moody's Investors
Service Inc. ("Moody's"). The foreign and emerging market bonds in which the
Portfolio may invest include: (1) government bonds, including Brady bonds and
other sovereign debt, and bonds issued by multinational institutions such as
the International Bank for Reconstruction and Development and the
International Monetary Fund; (2) corporate bonds and preferred stock issued by
entities located in foreign countries or denominated in or indexed to foreign
currencies; and (3) interests in securitized or reconstructed foreign loans,
bonds or preferred stock. The Portfolio may invest without limit in securities
of issuers located in any country in the world, including both industrialized
and emerging market countries. The Portfolio generally is not restricted in
the portion of its assets that may be invested in a single country or region,
but the Portfolio's assets normally are invested in issuers located in at
least three countries. No more than 25% of the Portfolio's total assets are
invested in securities issued or guaranteed by any single foreign government.
The Portfolio may invest in foreign and emerging market bonds that do not meet
any minimum credit rating standard or that are unrated. The Portfolio may
invest up to 10% of its total assets in preferred stock of U.S. and foreign
issuers. It also may acquire equity securities when attached to bonds or as
part of a unit including bonds or in connection with a conversion or exchange
of bonds. The Portfolio may invest without limit in certificates of deposit
issued by banks and savings associations and in banker's acceptances. The
Portfolio also may invest in loan participations and assignments, zero coupon
bonds or other securities issued with original issue discount and payment-in-
kind securities. The Portfolio may invest up to 15% of its net assets in
illiquid securities.
Mitchell Hutchins believes that Strategic Income Portfolio's strategy of
sector allocation should be less risky than investing in only one sector of
the bond market. Data from the Lehman Aggregate Bond Index, the Salomon
Brothers High Yield Index, the Merrill Lynch High Yield Index and the Salomon
Brothers World Government Bond Index indicate that these sectors are not
closely correlated. If successful, the Portfolio's strategy should enable it
to achieve a higher level of investment return than if it invested exclusively
in any one investment or allocated a fixed proportion of its assets to each
investment sector. The Portfolio is, however, more dependent on the ability of
Mitchell Hutchins to evaluate successfully the relative values of the
Portfolio's three investment sectors that is the case with a fund that does
not seek to adjust market sector allocations over time.
Strategic Income Portfolio is "non-diversified" as that term is defined in the
Investment Company Act of 1940 ("1940 Act"). That term and the associated
risks are described under "Description of Securities, Related Risks and
Investment Techniques--Risks--Non-Diversified Status" below.
GROWTH AND INCOME PORTFOLIO has an investment objective of current income and
capital growth. This Portfolio, under normal circumstances, invests at least
65% of its total assets in dividend-paying equity securities believed by
Mitchell Hutchins to have the potential for rapid earnings growth. In seeking
to balance capital growth with current income, Mitchell Hutchins follows a
disciplined investment process that relies on its Equity Research Team and its
proprietary Factor Valuation Model. The Model screens a universe of small- to-
large-capitalization companies in ten different business sectors. The Model
identifies undervalued companies with strong earnings momentum that rank well
in terms of value, momentum and economic
MH 5
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sensitivity. The Team takes a closer look at those equity securities that rank
in the top 20% of the Model's universe based on value and momentum. The equity
securities ranking in the top 20% of the Model's universe are screened twice a
month. The Team also applies traditional fundamental analysis and may speak to
the management of these companies, as well as those of their competitors.
Mitchell Hutchins places the team's findings in the context of Mitchell
Hutchins' economic forecast in deciding whether to purchase or sell equity
securities for the Portfolio.
The Portfolio may invest up to 35% of its total assets in equity securities
not meeting these selection criteria, as well as in U.S. government bonds,
corporate bonds and money market instruments, including up to 10% of its total
assets in convertible securities rated below investment grade but no lower
than B by S&P or Moody's, comparably rated by another nationally recognized
statistical rating organization ("NRSRO") or, if unrated, determined by
Mitchell Hutchins to be of comparable quality. Securities rated below
investment grade are commonly known as "junk bonds." The Portfolio may invest
up to 25% of its total assets in U.S. dollar-denominated equity securities and
bonds of foreign issuers that are traded on recognized U.S. exchanges or in
the U.S. over-the-counter ("OTC") market. The Portfolio may invest in bonds
for purposes of seeking capital appreciation when, for example, Mitchell
Hutchins anticipates that market interest rates may decline or credit factors
or ratings affecting particular issuers may improve. The Portfolio may invest
up to 10% of its net assets in illiquid securities.
TACTICAL ALLOCATION PORTFOLIO has an investment objective of total return,
consisting of long-term capital appreciation and current income. The Portfolio
seeks to achieve its objective by using the Tactical Allocation Model, a
systematic investment strategy that allocates its investments between an
equity portion designed to track the performance of the S&P 500 Composite
Stock Price Index ("S&P 500 Index") and a fixed income portion that generally
will be comprised of either five-year U.S. Treasury notes or 30-day U.S.
Treasury bills. The Portfolio seeks to achieve total return during all
economic and financial market cycles, with lower volatility than that of the
S&P 500 Index. Mitchell Hutchins allocates the Portfolio's assets based on the
Model's quantitative assessment of the projected rates of return for each
asset class. The Model attempts to track the S&P 500 Index in periods of
strongly positive market performance but attempts to take a more defensive
posture by reallocating assets to bonds or cash when the Model signals a
potential bear market, prolonged downturn in stock prices or significant loss
in value.
The basic premise of the Tactical Allocation Model is that investors accept
the risk of owning stocks, measured as volatility of return, because they
expect a return advantage. This expected return advantage of owning stocks is
called the equity risk premium ("ERP"). The Model projects the stock market's
expected ERP based on several factors, including the current price of stocks
and their expected future dividends and the yield-to-maturity of the one-year
U.S. Treasury bill. When the stock market's ERP is high, the Model signals the
Portfolio to invest 100% in stocks. Conversely, when the ERP decreases below
certain threshold levels, the Model signals the Portfolio to reduce its
exposure to stocks. The Model can recommend stock allocations of 100%, 75%,
50%, 25% or 0%.
If the Tactical Allocation Model recommends a stock allocation of less than
100%, the Model also recommends a fixed income allocation for the remainder of
the Portfolio's assets. The Model will recommend either bonds (five-year
Treasury notes) or cash (30-day U.S. Treasury bills), but not both. To make
this determination, the Model calculates the risk premium available for the
notes. This bond risk premium ("BRP") is calculated based on the yield-to-
maturity of the five-year U.S. Treasury note and the one-year U.S. Treasury
bill.
MH 6
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Tactical Allocation Portfolio deviates from the recommendations of the
Tactical Allocation Model only to the extent necessary to
. Maintain an amount in cash, not expected to exceed 2% of its total assets
under normal market conditions, to pay Portfolio operating expenses,
dividends and other distributions on its shares and to meet anticipated
redemptions of shares;
. Qualify as a regulated investment company for federal income tax
purposes; and
. Meet the diversification requirements imposed by the Internal Revenue
Code on segregated asset accounts used to fund variable annuity and/or
life insurance contracts, which means, among other things, that the
Portfolio may not invest more than 55% of its total assets in U.S.
Treasury obligations.
As a result, if the Tactical Allocation Model recommends more than a 50%
allocation to bonds or cash, Tactical Allocation Portfolio must invest a
portion of its assets in bonds or money market instruments that are not U.S.
Treasury obligations and, even if the Model does not recommend an allocation
to cash, the Portfolio still may hold cash.
In its stock portion, Tactical Allocation Portfolio attempts to duplicate,
before the deduction of operating expenses, the investment results of the S&P
500 Index. Securities in the S&P 500 Index are selected, and may change from
time to time, based on a statistical analysis of such factors as the issuer's
market capitalization (the S&P 500 Index emphasizes large capitalization
stocks), the security's trading activity and its adequacy as a representative
of stocks in a particular industry section. The Portfolio's investment results
for its stock portion will not be identical to those of the S&P 500 Index.
Deviations from the performance of the S&P 500 Index may result from purchases
and redemptions of Portfolio shares that may occur daily, as well as from
expenses borne by the Portfolio. Instead, the Portfolio attempts to achieve a
correlation of at least 0.95 between the performance of the Portfolio's stock
portion, before the deduction of operating expenses, and that of the S&P 500
Index (a correlation of 1.00 would mean that the net asset value of the stock
portion increased or decreased in exactly the same proportion as changes in
the S&P 500 Index).
Asset reallocations are made on the first business day of each month. In
addition to any reallocation of assets directed by the Tactical Allocation
Model, any material amounts resulting from appreciation or receipt of
dividends, other distributions, interest payments and proceeds from securities
maturing in each of the asset classes are reallocated (or "rebalanced") to the
extent practicable to establish the Model's recommended asset allocation mix.
Tactical Allocation Portfolio is subject to the risk that the Tactical
Allocation Model may not correctly predict the appropriate times to shift the
Portfolio's assets from one type of investment to another. Also, in following
its asset allocation strategy, the Portfolio may not achieve as high a level
of either capital appreciation or current income as a fund that has only one
of those objectives as its primary objective.
The Portfolio may invest up to 15% of its net assets in illiquid securities.
DESCRIPTION OF SECURITIES, RELATED RISKS AND INVESTMENT TECHNIQUES
DESCRIPTION OF SECURITIES
EQUITY SECURITIES include common stocks, most preferred stocks and securities
that are convertible into them, including common stock purchase warrants and
rights, equity interests in trusts, partnerships, joint ventures or similar
enterprises and depository receipts. Common stocks, the most familiar type,
represent an equity (ownership) interest in a corporation.
MH 7
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Preferred stock has certain fixed-income features, like a bond, but is
actually equity in a company, like common stock. Depository receipts typically
are issued by banks or trust companies and evidence ownership of underlying
equity securities.
BONDS are fixed or variable rate debt obligations, including notes, debentures
and similar instruments and securities. Mortgage- and asset-backed securities
are types of bonds and income-producing, non-convertible preferred stocks may
be treated as bonds for investment purposes. Corporations, governments and
other issuers use bonds to borrow money from investors. The issuer pays the
investor a fixed or variable rate of interest and must repay the amount
borrowed at or before maturity. Bonds have varying degrees of investment risk
and varying levels of sensitivity to changes in interest rates.
U.S. GOVERNMENT BONDS include direct obligations of the U.S. government (such
as U.S. Treasury bills, notes and bonds) and obligations issued or guaranteed
by the U.S. government, its agencies or its instrumentalities. U.S. government
bonds also include mortgage-backed securities issued or guaranteed by
government agencies or government-sponsored enterprises. Other U.S. government
bonds may be backed by the full faith and credit of the U.S. government or
supported primarily or solely by the creditworthiness of the government-
related issuer, such as the Resolution Funding Corporation, the Student Loan
Marketing Association, the Federal Home Loan Banks and the Tennessee Valley
Authority.
CORPORATE BONDS are bonds issued by corporations, banks, partnerships, trusts
or other non-governmental entities.
MONEY MARKET INSTRUMENTS are high grade debt obligations with maturities of 13
months or less and include government obligations, obligations of banks
(including certificates of deposit, bankers' acceptances, time deposits and
similar obligations), commercial paper and other short-term bonds of corporate
and other non-governmental issuers, including variable rate and floating rate
securities, participation interests and repurchase agreements secured by any
of these instruments.
MORTGAGE- AND ASSET-BACKED SECURITIES are bonds backed by specific types of
assets. Mortgage-backed securities represent direct or indirect interests in
pools of underlying mortgage loans that are secured by real property. U.S.
government mortgage-backed securities are issued or guaranteed as to principal
and interest (but not as to market value) by the Government National Mortgage
Association, Fannie Mae (also known as the Federal National Mortgage
Association) and Freddie Mac (also known as the Federal Home Loan Mortgage
Corporation) or other government-sponsored entities. Other domestic mortgage-
backed securities are sponsored or issued by private entities, including
investment banking firms and mortgage originators. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate.
Mortgage-backed securities may be composed of one or more classes and may be
structured either as pass-through securities or collateralized debt
obligations. Multiple-class mortgage-backed securities are referred to in this
Prospectus as "CMOs." Some CMOs are directly supported by other CMOs, which in
turn are supported by mortgage pools. Investors typically receive payments out
of the interest and principal on the underlying mortgages. The portions of
these payments that investors receive, as well as the priority of their rights
to receive payments, are determined by the specific terms of the CMO class.
CMOs involve special risks and evaluating them requires special knowledge.
MH 8
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Other asset-backed securities are similar to mortgage-backed securities,
except that the underlying assets are different. These underlying assets may
be nearly any type of financial asset or receivable, such as motor vehicle
installment sales contracts, home equity loans, leases of various types of
real and personal property and receivables from credit cards.
CONVERTIBLE SECURITIES include bonds, preferred stock or other securities that
may be converted into or exchanged for a prescribed amount of common stock of
the same or a different issuer within a particular period of time at a
specified price or formula. A convertible security entitles the holder to
receive interest paid or accrued on debt or dividends paid on preferred stock
until the convertible security matures or is redeemed, converted or exchanged.
Convertible securities have unique investment characteristics in that they
generally (1) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (2) are less subject to fluctuation in
value than the underlying stock because they have fixed income
characteristics, and (3) provide the potential for capital appreciation if the
market price of the underlying common stock increases. While no securities
investment is without some risk, investments in convertible securities
generally entail less risk than the issuer's common stock, although the extent
to which such risk is reduced depends in large measure upon the degree to
which the convertible security sells above its value as a fixed income
security.
LOAN PARTICIPATIONS AND ASSIGNMENTS are investments in fixed and floating rate
loans arranged through private negotiations with a U.S. or foreign borrower.
These investments normally are participations in or assignments of all or a
portion of loans made by banks. Participations typically will result in a
Portfolio's having a contractual relationship only with the lender, not with
the borrower. In a participation, a Portfolio is entitled to receive payments
of principal, interest and any loan fees by the lender only when and if these
fees are received. Also, the Portfolio may not directly benefit from any
collateral supporting the underlying loan. As a result, the Portfolio assumes
the credit risk of both the borrower and the lender that is selling the
participation. If the lender becomes insolvent, the Portfolio may be treated
as a general creditor of the lender and may not benefit from any set-off
between the lender and the borrower. In a loan assignment, a Portfolio is
entitled to receive payments directly from the borrower and, therefore, does
not depend on the selling bank to pass these payments on to the Portfolio.
CURRENCY-LINKED INVESTMENTS are bonds that are indexed to specific foreign
currency exchange rates. The principal amount of these bonds may be adjusted
up or down (but not below zero) at maturity to reflect changes in the exchange
rate between two currencies. A Portfolio may experience loss of principal due
to these adjustments.
RELATED RISKS
EQUITY SECURITIES. While past performance does not guarantee future results,
equity securities historically have provided the greatest long-term growth
potential in a company. However, their prices generally fluctuate more than
other securities and reflect changes in a company's financial condition and in
overall market and economic conditions. Common stocks generally represent the
riskiest investment in a company. It is possible that a Portfolio may
experience a substantial or complete loss on an individual equity investment.
BONDS. Bonds are subject to interest rate risk and credit risk. Interest rate
risk is the risk that interest rates will rise and bond prices will fall,
lowering the value of a Portfolio's investments in bonds. In general, bonds
having longer durations are more sensitive to interest rate changes than are
bonds with shorter durations. "Duration" is a measure of the expected life of
a fixed income security on a present value basis. Credit risk is the risk the
issuer or guarantor may be
MH 9
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unable or unwilling to pay interest or repay principal on the bond. This can
be affected by many factors, including adverse changes in the issuer's own
financial condition or in economic conditions.
CREDIT RATINGS; BONDS RATED BELOW INVESTMENT GRADE. Credit ratings attempt to
evaluate the safety of principal and interest payments, but they do not
evaluate the volatility of the security's value or its liquidity and do not
guarantee the performance of the issuer. Rating agencies may fail to make
timely changes in credit ratings in response to subsequent events, so that an
issuer's current financial condition may be better or worse than the rating
indicates. There is a risk that rating agencies may downgrade bonds, which
normally would lower their value and liquidity.
Investment grade bonds are rated in one of the four highest rating categories
by S&P or Moody's or comparably rated by another nationally recognized rating
agency. Moody's considers bonds rated Baa (its lowest investment grade rating)
to have speculative characteristics. This means that changes in economic
conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than is the case for higher-
rated bonds. Bonds rated D by S&P are in payment default or such rating is
assigned upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized. Bonds rated C by Moody's
are in the lowest rated class and can be regarded as having extremely poor
prospects of attaining any real investment standing. References to rated bonds
in this Prospectus include bonds that are not rated by an NRSRO but that
Mitchell Hutchins determines to be of comparable quality.
High yield, high risk bonds are rated below investment grade and are commonly
referred to as "junk bonds."A Portfolio's investments in these lower rated
bonds entail greater risk than its investments in investment grade bonds. High
yield, high risk bonds generally offer a higher current yield than that
available for higher grade issues, but they are considered predominantly
speculative with respect to the issuer's ability to pay interest and repay
principal and may involve major risk exposure to adverse market conditions.
They are especially subject to adverse changes in general economic conditions
and in the industries in which the issuers are engaged, to changes in the
financial condition of the issuers and to price fluctuations in response to
changes in interest rates. During an economic downturn or period of rising
interest rates, their issuers may experience financial stress that adversely
affects their ability to pay interest and repay principal and may increase the
possibility of default. In addition, such issuers may not have more
traditional methods of financing available to them and may be unable to repay
debt at maturity by refinancing. The risk of loss due to default by such
issuers is significantly greater because lower rated bonds are frequently
unsecured by collateral and will not receive payment until more senior claims
are paid in full. The market for these bonds is thinner and less active, which
may limit a Portfolio's ability to sell them at fair value in response to
changes in the economy or financial markets.
MORTGAGE- AND ASSET-BACKED SECURITIES. The yield characteristics of mortgage-
and asset-backed securities differ from those of traditional bonds. Among the
major differences are that interest and principal payments are made more
frequently (usually monthly) and that principal may be prepaid at any time.
When interest rates go down and homeowners refinance their mortgages,
mortgage-backed securities may be paid off more quickly than investors expect.
When interest rates rise, mortgage-backed securities may be paid off more
slowly than originally expected. Changes in the rate or "speed" of these
prepayments can cause the value of mortgage-backed securities to fluctuate
rapidly.
Because of prepayments, mortgage-backed securities may benefit less than other
bonds from declining interest rates. Reinvestments of prepayments may occur at
lower interest rates than the original investment, thus adversely affecting a
Portfolio's yield. Actual prepayment
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experience may cause the yield of a mortgage-backed security to differ from
what was assumed when a Portfolio purchased the security.
CMO classes may be specially structured in a manner that provides any of a
wide variety of investment characteristics, such as yield, effective maturity
and interest rate sensitivity. As market conditions change, however, and
especially during periods of rapid or unanticipated changes in market interest
rates, the attractiveness of the CMO classes and the ability of the structure
to provide the anticipated investment characteristics may be significantly
reduced. These changes can result in volatility in the market value, and in
some instances reduced liquidity, of the CMO class.
Certain classes of CMOs are structured in a manner that makes them extremely
sensitive to changes in prepayment rates. Interest-only ("IO") and principal-
only ("PO") classes are examples of this. IOs are entitled to receive all or a
portion of the interest, but none (or only a nominal amount) of the principal
payments, from the underlying mortgage assets. If the mortgage assets
underlying an IO experience greater than anticipated principal prepayments,
then the total amount of interest payments allocable to the IO class, and
therefore the yield to investors, generally will be reduced. In some
instances, an investor in an IO may fail to recoup all of his or her initial
investment, even if the security is government-issued or guaranteed or
considered to be of the highest quality, or is rated AAA or the equivalent.
Conversely, PO classes are entitled to receive all or a portion of the
principal payments, but none of the interest, from the underlying mortgage
assets. PO classes are purchased at substantial discounts from par, and the
yield to investors will be reduced if principal payments are slower than
expected. Some IOs and POs, as well as other CMO classes, are structured to
have special protections against the effects of prepayments. These structural
protections, however, normally are effective only within certain ranges of
prepayment rates and thus will not protect investors in all circumstances.
Inverse floating rate CMO classes also may be extremely volatile. These
classes pay interest at a rate that decreases when a specified index of market
rates increases.
The market for privately issued mortgage-backed securities is smaller and less
liquid than the market for U.S. government mortgage-backed securities. Foreign
mortgage-backed securities markets are substantially smaller than U.S.
markets, but have been established in several countries, including Germany,
Denmark, Sweden, Canada and Australia, and may be developed elsewhere. Foreign
mortgage-backed securities generally are structured differently than domestic
mortgage-backed securities, but they normally present substantially similar
risks.
During 1994, the value and liquidity of many mortgage-backed securities
declined sharply due primarily to increases in interest rates. There can be no
assurance that such declines will not recur. The market value of certain
mortgage-backed securities, including IO and PO classes of mortgage-backed
securities and inverse floating rate securities, can be extremely volatile and
these securities may become illiquid. Mitchell Hutchins seeks to manage
Strategic Income Portfolio's investments in mortgage-backed securities so that
the volatility of its portfolio, taken as a whole, is consistent with the
Portfolio's investment objective. If market interest rates or other factors
that affect the volatility of securities held by the Portfolio change in ways
that Mitchell Hutchins does not anticipate, the Portfolio's ability to meet
its investment objective may be reduced.
FOREIGN SECURITIES. Investing in foreign securities involves more risks than
investing in securities of U.S. companies. Their value is subject to economic
and political developments in the countries where the companies operate and to
changes in foreign currency values. Values may also be affected by foreign tax
laws, changes in foreign economic or monetary policies, exchange control
regulations and regulations involving prohibitions on the repatriation of
foreign currencies. Investments in foreign countries could be affected by
other factors not
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present in the United States, including expropriation, confiscatory taxation,
lack of uniform accounting and auditing standards and potential difficulties
in enforcing contractual obligations. Transactions in foreign securities may
be subject to less efficient settlement practices, including extended
clearance and settlement periods.
In general, less information may be available about foreign companies than
about U.S. companies, and foreign companies are generally not subject to the
same accounting, auditing and financial reporting standards as are U.S.
companies. Foreign securities markets may be less liquid and subject to less
regulation than the U.S. securities markets. The costs of investing outside
the United States frequently are higher than those in the United States. These
costs include relatively higher brokerage commissions and foreign custody
expenses.
SOVEREIGN DEBT, BRADY BONDS AND STRUCTURED FOREIGN INVESTMENTS. Sovereign debt
includes bonds that are issued or guaranteed by foreign governments or their
agencies, instrumentalities or political subdivisions or by foreign central
banks. Sovereign debt also may be issued by quasi-governmental entities that
are owned by foreign governments but are not backed by their full faith and
credit or general taxing powers. The issuer of the debt or the governmental
authorities that control the repayment of the debt may be unable or unwilling
to pay interest or repay principal when due in accordance with the terms of
such debt, and a Portfolio may have limited legal recourse in the event of
default. Political conditions, especially a sovereign entity's willingness to
meet the terms of its debt obligations, are of considerable significance.
Foreign government securities also include debt obligations of supranational
entities such as international organizations designated or supported by
governmental entities to promote reconstruction or development, international
banking institutions and related government agencies.
Brady bonds are sovereign debt securities issued under a 1989 plan (named for
former Secretary of the Treasury Nicholas F. Brady) that allows emerging
market countries to restructure their outstanding debt to U.S. and other
banks. Although Brady Bonds are collateralized by U.S. government securities,
payment of interest and repayment of principal is not guaranteed by the U.S.
government.
Strategic Income Portfolio may invest in structured foreign investments. These
are securities backed by or representing interests in underlying securities or
instruments, such as commercial bank loans, Brady bonds or preferred stock.
The cash flow on these underlying instruments may be reapportioned among
several classes of the structured foreign investments so that the classes may
have different maturities, payment priorities and interest rate provisions.
Strategic Income Portfolio receives interest and principal payments on
structured foreign investments only to the extent that the underlying
instruments produce sufficient cash flow.
INVESTING IN EMERGING MARKETS. Investing in securities issued by companies
located in emerging markets involves additional risks. These countries
typically have economic and political systems that are relatively less mature,
and can be expected to be less stable, than those of developed countries.
Emerging market countries may have policies that restrict investment by
foreigners in those countries, and there is a risk of government expropriation
or nationalization of private property. Similarly, for debt issued by
governments of emerging market countries, there is the risk that the issuer of
the debt or the governmental authorities that control the repayment of the
debt may be unable or unwilling to pay interest or repay principal when due in
accordance with the terms of the debt, and Strategic Income Portfolio may have
limited legal recourse in the event of default. The possibility of low or
nonexistent trading volume in the securities of companies in emerging markets
may also result in a lack of liquidity and in price volatility. Issuers in
emerging markets typically are subject to a greater degree of change in
earnings and business prospects than are companies in developed markets.
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Emerging markets include formerly communist countries of Eastern Europe, the
Commonwealth of Independent States (formerly the Soviet Union), and the
People's Republic of China. Upon the accession to power of communist regimes
approximately 50 to 80 years ago, the governments of a number of these
countries expropriated a large amount of property. The claims of many property
owners against these governments were never finally settled. There can be no
assurance that Strategic Income Portfolio's investments in these countries, if
any, would not also be expropriated, nationalized or otherwise confiscated, in
which case the Portfolio could lose its entire investment in the country
involved. In addition, any change in the leadership or policies of these
countries may halt the expansion of or reverse the liberalization of foreign
investment policies now occurring. Hong Kong reverted to Chinese
administration on July 1, 1997. The long-term effects of this reversion are
not known at this time. However, the Portfolio's investments in Hong Kong may
now be subject to the same or similar risks as any investment in China.
CURRENCY RISK. Currency risk is the risk that changes in foreign exchange
rates may reduce the U.S. dollar value of Strategic Income Portfolio's foreign
investments. The Portfolio's share value may change significantly when
investments are denominated in foreign currencies. Generally, currency
exchange rates are determined by supply and demand in the foreign exchange
markets and the relative merits of investments in different countries.
Currency exchange rates can also be affected by the intervention of the U.S.
and foreign governments or central banks, the imposition of currency controls,
currency devaluation policies, speculation or other political or economic
developments inside and outside the United States.
DERIVATIVES. Some of the instruments in which the Portfolios may invest may be
referred to as "derivatives," because their value depends on (or "derives"
from) the value of an underlying asset, reference rate or index. These
instruments include options, futures contracts, forward currency contracts,
swap agreements and similar instruments. There is limited consensus as to what
constitutes a "derivative" security. However, in Mitchell Hutchins' view,
derivative securities also include "stripped" securities, specially structured
types of mortgage- and asset-backed securities, such as IOs, POs or inverse
floaters, and dollar-denominated securities whose value is linked to foreign
currencies. The market value of derivative instruments and securities
sometimes is more volatile than that of other investments, and each type of
derivative instrument may pose its own special risks. Mitchell Hutchins takes
these risks into account in its management of the Portfolios.
COUNTERPARTIES. The Portfolios may be exposed to the risk of financial failure
or insolvency of another party. To help lessen those risks, Mitchell Hutchins,
subject to the supervision of the board, monitors and evaluates the
creditworthiness of the parties with which each Portfolio does business.
RISKS OF ZERO COUPON, OID AND PIK SECURITIES. Zero coupon securities are
Treasury bills, notes and bonds that have been stripped of their unmatured
interest coupons and receipts or certificates representing interests in such
stripped debt obligations and coupons. A zero coupon security pays no cash
interest to its holder prior to maturity. The buyer of a zero coupon security
receives a rate of return from the gradual appreciation of the security that
occurs because it will be redeemed at face value on a specified maturity date.
Federal tax law requires that the holder of a zero coupon security and other
securities issued with original issue discount ("OID") include in gross income
each year the OID that accrues on the security for the year.
Because zero coupon securities bear no interest, they usually trade at a
substantial discount from their face or par value and they are generally more
sensitive to changes in interest rates than other bonds. This means that when
interest rates fall, the value of zero coupon securities rises more rapidly
than bonds paying interest on a current basis. However, when interest rates
rise, their value falls more dramatically.
MH 13
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Interest or dividends on payment in kind ("PIK") securities are paid in
additional securities. PIK securities often trade at a discount from their
face or par value and also are subject to greater fluctuations in market value
in response to changing interest rates than comparable securities that pay
interest or dividends in cash.
TREASURY INFLATION PROTECTION SECURITIES. Treasury bonds include Treasury
Inflation Protection Securities ("TIPS"), which are Treasury bonds on which
the principal value is adjusted daily in accordance with changes in the
Consumer Price Index. Interest on TIPS is payable semiannually on the adjusted
principal value. The principal value of TIPS would decline during periods of
deflation, but the principal amount payable at maturity would not be less than
the original par amount. If inflation is lower than expected while a Portfolio
holds TIPS, the Portfolio may earn less on the TIPS than it would on
conventional Treasury bonds. Any increase in the principal value of TIPS is
taxable in the year the increase occurs, even though holders do not receive
cash representing the increase at that time.
NON-DIVERSIFIED STATUS. Strategic Income Portfolio is "non-diversified" as
that term is defined in the 1940 Act. This means, in general, that more than
5% of the total assets of the Portfolio may be invested in securities of one
issuer (including a foreign government), but only if, at the close of each
quarter of the Portfolio's taxable year, the aggregate amount of such holdings
does not exceed 50% of the value of its total assets and no more than 25% of
the value of its total assets is invested in the securities of a single
issuer. When the Portfolio's portfolio is comprised of securities of a smaller
number of issuers than if it were "diversified," the Portfolio will be subject
to greater risk because changes in the financial condition or market
assessment of a single issuer may have a greater effect on the Portfolio's
total return and the price of its shares.
YEAR 2000 RISKS. Like other mutual funds, financial and business organizations
around the world, each Portfolio could be adversely affected if the computer
systems used by Mitchell Hutchins or other service providers and entities with
computer systems that are linked to Portfolio records do not properly process
and calculate date-related information and data from and after January 1,
2000. This is commonly known as the "Year 2000 Issue." Mitchell Hutchins is
taking steps that it believes are reasonably designed to address the Year 2000
Issue with respect to the computer systems that it uses and to obtain
satisfactory assurances that comparable steps are being taken by each
Portfolio's other, major service providers. However, there can be no assurance
that these steps will be sufficient to avoid any adverse impact on the
Portfolios.
INVESTMENT TECHNIQUES AND STRATEGIES
HEDGING AND OTHER STRATEGIES USING DERIVATIVE INSTRUMENTS. Each Portfolio may
use certain instruments and strategies designed to reduce the overall risk of
its investments ("hedge"), enhance income or realize gains (including
reallocating exposure to different asset classes). Use of these derivatives
solely to enhance income or realize gains may be considered a form of
speculation. These strategies involve derivative instruments, including
options (both exchange-traded and OTC) and futures contracts. Strategic Income
Portfolio may use derivative instruments, including forward currency
contracts, to hedge exposure to currency risks. Strategic Income Portfolio
also may use interest rate swaps and similar contracts to preserve a return or
spread on a particular investment or portion of their portfolios or to protect
against an increase in the price of securities that the Portfolio anticipates
purchasing at a later date or to manage the Portfolio's duration. New
financial products and risk management techniques continue to be developed and
may be used by a Portfolio if consistent with its investment objective and
policies. The Statement of Additional Information contains further information
on these derivative instruments and related strategies.
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The Portfolios might not use any derivative instruments or strategies, and
there can be no assurance that using them will succeed. If Mitchell Hutchins
is incorrect in its judgment on market values, interest rates or other
economic factors in using a derivative instrument or strategy, a Portfolio may
have lower net income or a net loss on the investment. Each of these
strategies involves certain risks, which include:
. the fact that the skills needed to implement a strategy using derivative
instruments or strategies are different from those needed to select
securities for the Portfolios;
. the possibility of imperfect correlation, or even no correlation, between
price movements of derivative instruments used in hedging strategies and
price movements of the securities or currencies being hedged;
. possible constraints placed on a Portfolio's ability to purchase or sell
portfolio investments at advantageous times due to the need for the
Portfolio to maintain "cover" or to segregate securities; and
. the possibility that a Portfolio is unable to close out or liquidate its
hedged position.
DURATION. Duration is a measure of the expected life of a bond on a present
value basis. Duration incorporates a bond's yield, coupon interest payments,
final maturity and call features into one measure and is one of the
fundamental tools used in portfolio selection and yield curve positioning for
the Portfolios that invest in bonds. Duration takes the length of the time
intervals between the present time and the time that the interest and
principal payments are scheduled or, in the case of a callable bond, expected
to be made, and weights them by the present values of the cash to be received
at each future point in time. For any bond with interest payments occurring
prior to the payment of principal, duration is always less than maturity.
Duration allows Mitchell Hutchins to make certain predictions as to the effect
that changes in the level of interest rates will have on the value of a
Portfolio's investments. For example when the level of interest rates
increases by 1%, the value of a fixed income security having a positive
duration of three years generally will decrease by approximately 3%. Thus, if
the duration of a Portfolio's investments is calculated at three years, the
investments normally would be expected to change in value by approximately 3%
for every 1% change in the level of interest rates. However, various factors,
such as changes in anticipated prepayment rates, qualitative considerations
and market supply and demand, can cause particular securities to respond
somewhat differently to changes in interest rates than indicated in the above
example. Moreover, in the case of mortgage-backed and other complex
securities, duration calculations are estimates and are not precise. This is
particularly true during periods of market volatility. Accordingly, the net
asset value of a Portfolio's investments may vary in relation to interest
rates by a greater or lesser percentage than indicated in the above example.
LENDING OF PORTFOLIO SECURITIES. Each Portfolio may lend its securities to
qualified broker-dealers or institutional investors in an amount up to 33 1/3%
of its total assets. Lending securities enables a Portfolio to earn additional
income, but could result in a loss or delay in recovering those securities.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each Portfolio may purchase
securities on a "when-issued" basis or may purchase or sell securities for
delayed delivery. In when-issued or delayed delivery transactions, delivery of
the securities occurs beyond normal settlement periods, but a Portfolio would
not pay for such securities or start earning interest on them until they are
delivered. However, when a Portfolio purchases securities on a when-issued or
delayed delivery basis, it immediately assumes the risks of ownership,
including the risk of price fluctuation.
REPURCHASE AGREEMENTS. Each Portfolio may enter into repurchase agreements.
Repurchase agreements are transactions in which a Portfolio purchases
securities from a bank or
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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. Repurchase agreements carry certain
risks not associated with direct investments in securities, including possible
decline in the market value of the underlying securities and delays and costs
to a Portfolio if the other party to the repurchase agreement becomes
insolvent. Each Portfolio intends to enter into repurchase agreements only
with banks and dealers in transactions believed by Mitchell Hutchins to
present minimal credit risks in accordance with guidelines established by the
board.
BORROWINGS, REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS. Each Portfolio may
borrow money for temporary purposes, but not in excess of the percentage of
its total assets indicated below:
<TABLE>
<S> <C>
Strategic Income Portfolio....... 33 1/3%
Growth and Income Portfolio...... 10%
Tactical Allocation Portfolio.... 33 1/3%
</TABLE>
Strategic Income Portfolio may invest in "arbitraged" reverse repurchase
transactions and "arbitraged" dollar rolls. In a dollar roll, the Portfolio
sells mortgage-backed or other securities for delivery on the next regular
settlement date and, simultaneously, contracts to purchase substantially
identical securities for delivery on a later settlement date. In a reverse
repurchase agreement, the Portfolio sells securities to a bank or dealer and
agrees to repurchase them on demand or on a specified future date and at a
specified price. In "arbitraged" transactions, the Portfolio maintains an
offsetting position in cash or in U.S. government or investment grade bonds
that mature on or before the settlement date of the related dollar roll or
reverse repurchase agreement. Mitchell Hutchins believes that these
"arbitraged" transactions do not present the risks that are normally
associated with leverage. The other Portfolios may each invest up to 5% of its
total assets in reverse repurchase agreements. These dollar rolls and reverse
repurchase transactions are subject to each Portfolio's limitation on
borrowings.
TEMPORARY DEFENSIVE POSITIONS; CASH RESERVES. When Mitchell Hutchins believes
that unusual market or economic circumstances warrant a defensive posture, a
Portfolio may temporarily commit all or any portion of its assets to cash or
money market instruments of U.S. issuers (and foreign issuers for Strategic
Income Portfolio). Each Portfolio may invest up to 35% of its total assets in
cash or money market instruments of U.S. issuers (and foreign issuers for
Strategic Income Portfolio) for liquidity purposes or pending investment in
other securities. Each Portfolio also may reinvest cash collateral from
securities lending in money market instruments, and reinvestment of such cash
collateral is not subject to this 35% limitation.
ILLIQUID SECURITIES. Each Portfolio may invest up to 10% or 15% of its net
assets in illiquid securities, including certain cover for OTC options and
securities whose disposition is restricted under the federal securities laws,
other than those Mitchell Hutchins has determined to be liquid pursuant to
guidelines established by the board. For Strategic Income Portfolio to the
extent that securities are freely tradeable in the country in which they are
principally traded, they are not considered illiquid even if they are not
freely tradeable in the United States. Each Portfolio may invest in restricted
securities that are eligible for resale to qualified institutional buyers
pursuant to SEC Rule 144A, but a Portfolio will not consider those securities
to be illiquid if Mitchell Hutchins determines them to be liquid in accordance
with procedures approved by the board. The lack of a liquid secondary market
for illiquid securities may make it more difficult for a Portfolio to assign a
value to those securities for purposes of valuing its investments and
calculating its net asset value.
PORTFOLIO TURNOVER. Portfolio turnover rates may vary greatly from year to
year and will not be a limiting factor when Mitchell Hutchins deems portfolio
changes appropriate. A higher turnover
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rate may involve correspondingly greater transaction costs, which will be
borne directly by the affected Portfolio and may increase the potential for
short-term capital gains.
OTHER INFORMATION. Each Portfolio's investment objective and certain
investment limitations, as described in the Statement of Additional
Information, are fundamental policies that may not be changed without
shareholder approval. All other investment policies may be changed by the
board without shareholder approval.
New types of mortgage- and asset-backed securities, derivative instruments,
hedging strategies and risk management techniques are developed and marketed
from time to time. Each Portfolio may invest in these securities and
instruments and use these strategies and techniques to the extent consistent
with its investment objective and limitations and with regulatory and tax
considerations.
PURCHASES, REDEMPTIONS AND EXCHANGES
Insurance company separate accounts may purchase and redeem Class I shares of
the Portfolios at net asset value without paying any sales or redemption
charges. Proceeds from redemptions of shares in any of the Portfolios will be
paid on or before the seventh day following the request for redemption by a
Contract holder.
A separate account may exchange shares of one Portfolio for shares of the same
class in another Portfolio at their relative net asset values per share,
provided that both Portfolios are offered by the separate account.
The Fund and Mitchell Hutchins reserve the right to reject any purchase order
and to suspend the offering of a Portfolio's shares for a period of time.
DIVIDENDS, OTHER DISTRIBUTIONS AND FEDERAL INCOME TAX
DIVIDENDS AND OTHER DISTRIBUTIONS. Each Portfolio pays an annual dividend from
its net investment income and net short-term capital gain (the excess of gains
from the sale or exchange of capital assets held for not more than one year
over losses therefrom) and, for Strategic Income Portfolio, net gains from
foreign currency transactions, if any. Each Portfolio also distributes
annually substantially all of its net capital gain (the excess of net long-
term capital gain over net short-term capital loss), if any.
Dividends and other distributions paid on each class of shares of a Portfolio
are calculated at the same time and in the same manner.
Dividends and other distributions from a Portfolio are paid in additional
shares of that Portfolio at net asset value per share, unless the Fund's
transfer agent is instructed otherwise. See the applicable Contract prospectus
for information regarding the federal income tax treatment of distributions to
the insurance company separate accounts.
FEDERAL INCOME TAX. Each Portfolio intends to qualify or continue to qualify
for treatment as a regulated investment company under Subchapter M of the
Internal Revenue Code so that it will not have to pay federal income tax on
that part of its investment company taxable income and net capital gain that
it distributes to its shareholders. Investment company taxable income
generally consists of net investment income, net gains from certain foreign
currency transactions and net short-term capital gain.
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Dividends and other distributions declared by a Portfolio in October, November
or December of any year and payable to shareholders of record on a date in any
of those months will be deemed to have been paid by the Portfolio and received
by the shareholders on December 31 of that year if the distributions are paid
by the Portfolio during the succeeding January.
Portfolio shares are offered only to insurance company separate accounts that
fund the Contracts. Under the Internal Revenue Code, no tax is imposed on an
insurance company with respect to income of a qualifying separate account
properly allocable to the value of eligible variable annuity or variable life
insurance contracts. See the applicable Contract prospectus for a discussion
of the federal income tax status of (1) the insurance company separate
accounts that purchase and hold shares of the Portfolios and (2) the holders
of Contracts funded through those separate accounts.
Each Portfolio intends to comply or continue to comply with the
diversification requirements imposed on it by section 817(h) of the Internal
Revenue Code and the regulations thereunder. These requirements, which are in
addition to the diversification requirements imposed on the Portfolios by the
1940 Act and Subchapter M, place certain limitations on the assets of each
insurance company account--and, because section 817(h) and those regulations
treat the assets of each Portfolio as assets of the related separate account,
of each Portfolio--that may be invested in securities of a single issuer.
Specifically, the regulations provide that, except as permitted by the "safe
harbor" described below, as of the end of each calendar quarter or within 30
days thereafter no more than 55% of the total assets of a Portfolio may be
represented by any one investment, no more than 70% by any two investments, no
more than 80% by any three investments and no more than 90% by any four
investments. For this purpose, all securities of the same issuer are
considered a single investment, and each U.S. government agency and
instrumentality is considered a separate issuer. Section 817(h) provides, as a
safe harbor, that a separate account will be treated as being adequately
diversified if the diversification requirements under Subchapter M are
satisfied and no more than 55% of the value of the separate account's total
assets are cash and cash items, government securities and securities of other
regulated investment companies. Failure of a Portfolio to satisfy the section
817(h) requirements would result in taxation of the insurance company issuing
the Contracts and treatment of the Contract holders other than as described in
the applicable Contract prospectus.
The foregoing is only a summary of some of the important federal income tax
considerations generally affecting the Portfolios and their shareholders; see
the Statement of Additional Information for a more detailed discussion.
Prospective shareholders are urged to consult their tax advisers.
VALUATION OF SHARES
The net asset value of each Portfolio's shares fluctuates and is determined
separately for each class as of the close of regular trading on the New York
Stock Exchange ("NYSE") (currently 4:00 p.m., Eastern time) on each Business
Day. A "Business Day" is any day, Monday through Friday, on which the NYSE is
open for business. For each Portfolio net asset value per share is computed by
dividing the value of the securities held by the Portfolio plus any cash or
other assets minus all liabilities by the total number of Portfolio shares
outstanding. Each Portfolio values its assets based on the current market
value where market quotations are readily available. If such value cannot be
established, the assets are valued at fair value as determined in good faith
by or under the direction of the board. The amortized cost method of valuation
generally is used to value debt obligations with 60 days or less remaining to
maturity, unless the board determines that this does not represent fair value.
All investments denominated in
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foreign currency are valued daily in U.S. dollars on the basis of the then-
prevailing exchange rates. It should be recognized that judgment plays a
greater role in valuing thinly traded and lower rated debt securities because
there is less reliable, objective data available.
MANAGEMENT
The board, as part of its overall management responsibility, oversees various
organizations responsible for each Portfolio's day-to-day management. Mitchell
Hutchins, the investment adviser and administrator for each Portfolio, makes
and implements all investment decisions and supervises all aspects of the
operations of all the Portfolios.
In accordance with procedures adopted by the board, brokerage transactions for
the Portfolios may be conducted through PaineWebber or its affiliates and the
Portfolios may pay fees, including fees calculated as a percentage of
earnings, to PaineWebber for its services as lending agent in their portfolio
securities lending programs. Personnel of Mitchell Hutchins may engage in
securities transactions for their own accounts pursuant to each firm's code of
ethics, which establishes procedures for personal investing and restricts
certain transactions.
For advisory and administrative services, the Fund pays Mitchell Hutchins a
fee, computed daily and paid monthly, at the annual rates set forth below for
each Portfolio. The Portfolios also incur other expenses in their operations,
such as custody and transfer agency fees, brokerage commissions, professional
fees, expenses of board and shareholder meetings, fees and expenses relating
to the registration of their shares, taxes and governmental fees, fees and
expenses of trustees, costs of obtaining insurance, expenses of printing and
distributing shareholder materials, organizational expenses and extraordinary
expenses, including costs or losses in any litigation. For Growth and Income
Portfolio (the only portfolio that had operations during the fiscal year ended
December 31, 1997), total expenses for its Class H shares, stated as a
percentage of average net assets, were as set forth below. Total expenses for
Class I shares are expected to be higher because of the 0.25% distribution fee
borne by those shares.
<TABLE>
<CAPTION>
ANNUAL EXPENSES
ANNUAL RATE AS A PERCENTAGE
OF ADVISORY FEE OF EACH
AS A PERCENTAGE PORTFOLIO'S
OF EACH PORTFOLIO'S AVERAGE
PORTFOLIO AVERAGE NET ASSETS NET ASSETS
- --------- ------------------- ---------------
<S> <C> <C>
Strategic Income Portfolio 0.75% n/a
Growth and Income Portfolio 0.70 1.04%
Tactical Allocation Portfolio 0.50 n/a
</TABLE>
Mitchell Hutchins is located at 1285 Avenue of the Americas, New York, New
York 10019. It is a wholly owned asset management subsidiary of PaineWebber,
which is in turn wholly owned by Paine Webber Group Inc., a publicly owned
financial services holding company. At March 31, 1998 Mitchell Hutchins was
adviser or sub-adviser to 31 investment companies with 68 separate portfolios
and aggregate assets of approximately $39.9 billion.
Mark A. Tincher is primarily responsible for the day-to-day management of
Growth and Income Portfolio. Mr. Tincher is a managing director and chief
investment officer of equities of Mitchell Hutchins, responsible for
overseeing the management of equity investments. Prior to joining Mitchell
Hutchins in March 1995, Mr. Tincher worked for Chase Manhattan Private Bank,
where he was vice president and directed the U.S. funds management and equity
research area.
MH 19
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At Chase since 1988, Mr. Tincher oversaw the management of all Chase equity
funds (the Vista Funds and Trust Investment Funds). Mr. Tincher has held his
Growth and Income Portfolio responsibilities since April 1995.
T. Kirkham Barneby is responsible for the asset allocation decisions and the
day-to-day management of Tactical Allocation Portfolio. Mr. Barneby is a
managing director and chief investment officer--quantitative investments of
Mitchell Hutchins. Mr. Barneby rejoined Mitchell Hutchins in 1994, after being
with Vantage Global Management for one year. During the eight years that Mr.
Barneby was previously with Mitchell Hutchins, he was a senior vice president
responsible for quantitative management and asset allocation models.
Mr. Barneby has held his Tactical Allocation Portfolio responsibilities since
its inception.
Dennis L. McCauley is Strategic Income Portfolio's allocation manager.
Mr. McCauley is a managing director and chief investment officer--fixed income
of Mitchell Hutchins responsible for overseeing all active fixed income
investments, including domestic and global taxable and tax-exempt mutual
funds. Prior to joining Mitchell Hutchins in 1994, Mr. McCauley worked for IBM
Corporation, where he was director of fixed income investments responsible for
developing and managing investment strategy for all fixed income and cash
management investments of IBM's pension fund and self-insured medical funds.
Mr. McCauley has also served as vice president of IBM Credit Corporation's
mutual funds and as a member of the Retirement Fund Investment Committee.
Nirmal Singh, Craig Varrelman and James Keegan assist Mr. McCauley in managing
Strategic Income Portfolio. Messrs. Singh, Varrelman and Keegan share
responsibility for the U.S. government and investment grade securities sector
of Strategic Income Portfolio. Messrs. Singh, Varrelman and Keegan are senior
vice presidents of Mitchell Hutchins. Prior to joining Mitchell Hutchins in
1993, Mr. Singh was with Merrill Lynch Asset Management, Inc., where he was a
member of the portfolio management team. From 1990 to 1993, Mr. Singh was a
senior portfolio manager at Nomura Mortgage Fund Management Corporation. Mr.
Varrelman has been with Mitchell Hutchins as a portfolio manager since 1988
and manages fixed income portfolios with an emphasis on U.S. government
securities. Prior to joining Mitchell Hutchins in March 1996, Mr. Keegan was a
director with Merrion Group, L.P. From 1987 to 1994, he was a vice president
of global investment management of Bankers Trust Company.
Thomas J. Libassi, a senior vice president of Mitchell Hutchins, is the sector
manager responsible for the day-to-day management of Strategic Income
Portfolio's U.S. high yield, high risk securities. Prior to May 1994, Mr.
Libassi was a vice president of Keystone Custodian Funds Inc. with portfolio
management responsibility for approximately $900 million in assets primarily
invested in high yield, high risk bonds. Mr. Libassi has held his day-to-day
portfolio management responsibilities for the Portfolio since its inception.
Stuart Waugh is the sector manager responsible for the day-to-day management
of Strategic Income Portfolio's foreign and emerging market bonds. Mr. Waugh
is a vice president of Mitchell Hutchins Series Trust and a managing director
of Mitchell Hutchins responsible for global fixed income investments. He has
been with Mitchell Hutchins since 1983. Mr. Waugh is a Chartered Financial
Analyst.
Messrs. Keegan, Libassi, McCauley, Singh, Varrelman and Waugh have held their
Strategic Income Portfolio responsibilities since its inception.
DISTRIBUTION ARRANGEMENTS FOR CLASS I SHARES
Mitchell Hutchins is the distributor of each Portfolio's Class I shares. Under
a distribution plan adopted with respect to the Class I shares ("Class I
Plan"), each Portfolio pays Mitchell Hutchins
MH 20
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monthly distribution fees at the annual rate of 0.25% of the average daily net
assets attributable to that Portfolio's Class I shares. Under the Class I
Plan, Mitchell Hutchins uses the distribution fees to pay insurance companies
whose separate accounts purchase Class I shares for distribution-related
services that the insurance companies provide with respect to those Class I
shares. These distribution-related services include (1) the printing and
mailing of Fund prospectuses, statements of additional information, related
supplements and shareholder reports to current and prospective Contract
owners, (2) the development and preparation of sales material, including sales
literature, relating to Class I shares, (3) materials and activities intended
to educate and train insurance company sales personnel concerning the
Portfolios and Class I shares, (4) obtaining information and providing
explanations to Contract owners concerning the Portfolios; (5) compensating
insurance company sales personnel with respect to services that result in the
sale or retention of Class I shares; (6) providing personal services and/or
account maintenance to Contract owners with respect to insurance company
separate accounts that hold Class I shares; and (7) financing other activities
that the board determines are primarily intended to result in the sale of
Class I shares.
The Class I Plan and the related distribution contract specify that the
distribution fees paid to Mitchell Hutchins are not reimbursement for specific
expenses incurred. Therefore, even if Mitchell Hutchins' expenses exceed the
distribution fees it receives, the Portfolios will not be obligated to pay
more than those fees. On the other hand, if Mitchell Hutchins' expenses are
less than such fees, it will retain its full fees and realize a profit.
Expenses in excess of distribution fees received or accrued through the
termination date of the Class I Plan will be Mitchell Hutchins' sole
responsibility and not that of the Portfolios. The board reviews the Class I
Plan and Mitchell Hutchins' corresponding expenses annually.
MH 21
<PAGE>
GENERAL INFORMATION
The Fund is registered with the SEC as an open-end management investment
company and was organized as a business trust under the laws of the
Commonwealth of Massachusetts by Declaration of Trust dated November 21, 1986.
The Fund commenced operations as an investment company on May 4, 1987. The
trustees have authority to issue an unlimited number of shares of beneficial
interest of separate series, par value $.001 per share. Shares of 13 series
are authorized.
Shares of each Portfolio are divided into two classes, designated Class H and
Class I shares. A share of each class represents an identical interest in the
respective Portfolio's investment portfolio and has the same rights,
privileges and preferences. However, each class may differ with respect to
distribution fees, if any, other expenses allocable exclusively to each class,
voting rights on matters exclusively affecting that class, and its exchange
privilege, if any. The different expenses applicable to the different classes
of shares of the Portfolios will affect the performance of those classes.
Each share of a Portfolio is entitled to participate equally in dividends,
other distributions and the proceeds of any liquidation of that Portfolio.
However, due to the differing expenses of the classes, dividends on Class H
and Class I shares will differ.
Shareholders of the Fund are entitled to one vote for each full shares held
and fractional votes for fractional shares. Voting rights are not cumulative
and, as a result, the holders of more than 50% of all the shares may elect all
of the Fund's board members. The shares of a Portfolio will be voted together,
except that only the shareholders of a class may vote on matters affecting
only that class, such as the terms of the Class I Plan. The shares of each
Portfolio will be voted separately, except when an aggregate vote of all the
shares of the Fund is required by law.
The Fund does not hold annual meetings of shareholders. There normally will be
no meetings of shareholders to elect trustees unless fewer than a majority of
the trustees holding office have been elected by shareholders. Shareholders of
record of no less than two-thirds of the outstanding shares of the Fund may
remove a trustee by votes cast in person or by proxy at a meeting called for
that purpose. The trustees are required to call a meeting of shareholders for
the purpose of voting upon the question of removal of any trustee when so
requested in writing by the shareholders of record of not less than 10% of the
Fund's outstanding shares.
CUSTODIAN AND TRANSFER AGENT. State Street Bank and Trust Company, One
Heritage Drive, North Quincy, Massachusetts 02171, is custodian of the assets
of the Portfolios. The custodian employs foreign sub-custodians approved by
the board to provide custody of the foreign assets of the Portfolios that
invest outside the United States. PFPC Inc., a subsidiary of PNC Bank, N.A.,
whose principal business address is 400 Bellevue Parkway, Wilmington, Delaware
19809, is the Fund's transfer and dividend disbursing agent.
CONFIRMATIONS AND STATEMENTS. Shareholders receive confirmations of purchases
and redemptions of Portfolio shares. Monthly statements sent to each separate
account report that account's Portfolio activity.
MH 22
<PAGE>
APPENDIX
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 (or supporting institutions) have a superior
ability for repayment of senior short-term debt 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 (or supporting institutions) have a strong ability for
repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity is maintained.
Issuers rated Prime-3 (or supporting institutions) have an acceptable ability
for repayment of senior short-term 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 may require 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.
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market. Ratings
are graded into several categories, ranging from "A-1" for the highest quality
obligations to "D" for the lowest. These categories are as follows: A-1. This
highest rating category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation. A-2. Capacity
for timely payment on issues with this designation is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
A-3. Issues carrying this designation have adequate capacity for timely
payment. They are, however, 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 speculative capacity for timely payment.
C. This rating is assigned to short-term debt obligations with a doubtful
capacity for payment. D. Debt rated "D" is in payment default. The "D" rating
category is used when interest payments or principal payments are not made on
the date due, even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period.
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
AAA. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
a "gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues;
AA. Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities; A. Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper
MH 23
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medium grade obligations. Factors giving security to principal and interest
are considered adequate but elements may be present which suggest a
susceptibility to impairment sometime in the future; BAA. Bonds which are
rated Baa are considered as medium grade obligations, i.e., they are neither
highly protected nor poorly secured. Interest payments and principal security
appear adequate for the present but certain protective elements may be lacking
or may be characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have speculative
characteristics as well; BA. Bonds which are rated Ba are judged to have
speculative elements; their future cannot be considered as well assured. Often
the protection of interest and principal payments my 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. Bonds which are
rated 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. Bonds which are rated
Caa are of poor standing. Such issues may be in default or there may be
present elements of danger with respect to principal or interest; CA. Bonds
which are rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings; C.
Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: Moody's 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.
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
issues only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances
and economic conditions than debt in higher rated categories, however, the
obligor's capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters;
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity to meet its financial commitment on the obligation; BB,
B, CCC, CC, C, D. Obligations rated BB, B, CCC,CC and C are regarded, as
having significant speculative characteristics. BB indicates the least degree
of speculation and C the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major risk exposures to adverse conditions.
"BB" An obligation rated "BB" is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
"B" An obligation rated "B' is more vulnerable to nonpayment than obligations
rated "BB", but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet
its financial commitment on the obligation.
MH 24
<PAGE>
"CCC" An obligation rated "CCC" is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
"CC" An obligation rated "CC" is currently highly vulnerable to nonpayment.
"C" The "C" rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on the
obligation are being continued.
"D" An obligation rated "D" is in payment default. The "D" rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired unless S&P believes that such payments
will be made during such grace period. The "D" rating also will be used upon
the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
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.
MH 25
