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MAY 1, 1998
GROWTH AND INCOME PORTFOLIO
A SERIES OF
MITCHELL HUTCHINS SERIES TRUST
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
Growth and Income Portfolio ("Portfolio") is a diversified series of
Mitchell Hutchins Series Trust ("Fund"), a professionally managed, open-end
investment company. Shares of the Portfolio are offered only to insurance
company separate accounts that fund benefits under certain variable annuity
contracts and/or variable life insurance contracts (collectively,
"Contracts"). Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a
wholly owned asset management subsidiary of PaineWebber Incorporated
("PaineWebber"), serves as investment adviser and administrator of the
Portfolio.
This Statement of Additional Information is not a prospectus and should be
read only in conjunction with the Fund's current Prospectus, dated May 1,
1998. A copy of the Prospectus may be obtained by contacting the Fund or your
PaineWebber investment executive or by calling toll free 1-800-986-0088.
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TABLE OF CONTENTS
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Investment Policies and Limitations........................................ 3
Hedging and Related Strategies Using Derivative Instruments................ 9
Trustees and Officers; Principal Holders of Securities..................... 15
Investment Advisory Services............................................... 23
Portfolio Transactions..................................................... 24
Additional Purchase and Redemption Information............................. 25
Valuation of Shares........................................................ 26
Taxes...................................................................... 26
Other Information.......................................................... 28
Financial Statements....................................................... 28
Appendix .................................................................. 29
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INVESTMENT POLICIES AND LIMITATIONS
The following supplements the information contained in the Prospectus
concerning the investment policies and limitations of Growth and Income
Portfolio. Except as otherwise indicated in the Prospectus or the Statement of
Additional Information, there are no policy limitations on the Portfolio's
ability to use the investments or techniques discussed in these documents.
RISK CONSIDERATIONS RELATING TO FOREIGN SECURITIES. Growth and Income
Portfolio may invest in U.S. dollar denominated securities of foreign issuers.
Securities of foreign issuers may not be registered with the Securities and
Exchange Commission ("SEC"), and the issuers thereof may not be subject to its
reporting requirements. Accordingly, there may be less publicly available
information concerning foreign issuers of securities held by the Portfolio
than is available concerning U.S. companies. Foreign companies are not
generally subject to uniform accounting, auditing and financial reporting
standards or to other regulatory requirements comparable to those applicable
to U.S. companies.
Growth and Income Portfolio may invest in foreign securities by purchasing
American Depository Receipts ("ADRs"). ADRs are receipts typically issued by a
U.S. bank or trust company evidencing ownership of the underlying securities.
They are generally in registered form, are denominated in U.S. dollars and are
designed for use in the U.S. securities markets. For purposes of the
Portfolio's investment policies, ADRs, are deemed to have the same
classification as the underlying securities they represent. Thus, an ADR,
evidencing ownership of common stock will be treated as common stock. ADRs are
publicly traded on exchanges or over-the-counter ("OTC") in the United States
and are issued through "sponsored" or "unsponsored" arrangements. In a
sponsored ADR arrangement, the foreign issuer assumes the obligation to pay
some or all of the depositary's transaction fees, whereas under an unsponsored
arrangement, the foreign issuer assumes no obligations and the depositary's
transaction fees are paid directly by the ADR holders. In addition, less
information is available in the United States about an unsponsored ADR than
about a sponsored ADR.
Investment income on certain foreign securities in which Growth and Income
Portfolio may invest may be subject to foreign withholding on interest and/or
dividends or other taxes that could reduce the return on these securities. Tax
treaties between the United States and foreign countries, however, may reduce
or eliminate the amount of foreign taxes to which the Portfolio would be
subject.
MONEY MARKET INVESTMENTS. The money market investments of Growth and Income
Portfolio include, among other things, (1) securities issued or guaranteed by
the U.S. government or one of its agencies or instrumentalities, (2) debt
obligations of banks, savings and loan institutions, insurance companies and
mortgage bankers, (3) commercial paper and notes, including those with
variable and floating rates of interest, (4) debt obligations of foreign
branches of U.S. banks, U.S. branches of foreign banks, and foreign branches
of foreign banks, (5) debt obligations issued or guaranteed by one or more
foreign governments or any of their foreign political subdivisions, agencies
or instrumentalities, including obligations of supranational entities, (6)
debt securities issued by foreign issuers, (7) repurchase agreements and (8)
other investment companies that invest exclusively in money market
instruments.
YIELD FACTORS AND RATINGS. Moody's Investors Service, Inc. ("Moody's"),
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"), and
other nationally recognized statistical rating organizations ("NRSROs") are
private services that provide ratings of the credit quality of debt
obligations in which Growth and Income Portfolio may invest. A description of
the ratings assigned to debt obligations by S&P and Moody's is included in the
Appendix to this Statement of Additional Information.
Growth and Income Portfolio may use these ratings in determining whether to
purchase, sell or hold a security. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
debt obligations with the same maturity, interest rate and rating may have
different market prices. Also, rating agencies may fail to make timely changes
in credit ratings in response to subsequent events so that an issuer's current
financial condition may be better or worse than the rating indicates. The
rating assigned to a
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security by a NRSRO does not reflect an assessment of the volatility of the
security's market value or of the liquidity of an investment in the security.
Subsequent to its purchase by the Portfolio, an issue of debt obligations may
cease to be rated or its rating may be reduced below the minimum rating
required for purchase by the Portfolio.
In addition to ratings assigned to individual bond issues, Mitchell Hutchins
will analyze interest rate trends and developments that may affect individual
issuers, including factors such as liquidity, profitability and asset quality.
The yields on debt securities in which Growth and Income Portfolio invests are
dependent on a variety of factors, including general money market conditions,
general conditions in the bond market, the financial condition of the issuer,
the size of the offering, the maturity of the obligation and its rating. There
is a wide variation in the quality of bonds, both within a particular
classification and between classifications. An issuer's obligations under its
bonds are subject to the provisions of bankruptcy, insolvency and other laws
affecting the rights and remedies of bond holders or other creditors of an
issuer; litigation or other conditions may also adversely affect the power or
ability of issuers to meet their obligations for the payment of interest and
principal on their bonds.
Debt securities rated Ba or lower by Moody's, BB or lower by S&P, comparably
rated by another NRSRO or determined by Mitchell Hutchins to be of comparable
quality are below investment grade, are deemed by those agencies to be
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal and may involve major risk exposure to adverse
conditions. Lower rated debt securities generally offer a higher current yield
than that available for investment grade issues, but they involve higher
risks, in that they 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 periods of economic downturn or
rising interest rates, highly leveraged issuers may experience financial
stress which could adversely affect their ability to make payments of interest
and principal and 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 such
securities frequently are unsecured and subordinated to the prior payment of
senior indebtedness.
The market for lower rated debt securities, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. In the past, the prices of many lower
rated debt securities declined substantially, reflecting an expectation that
many issuers of such securities might experience financial difficulties. As a
result, the yields on lower rated debt securities rose dramatically. However,
such higher yields did not reflect the value of the income stream that holders
of such securities expected, but rather the risk that holders of such
securities could lose a substantial portion of their value as a result of the
issuers' financial restructuring or defaults. There can be no assurance that
such declines will not recur. The market for lower rated debt issues generally
is thinner or less active than that for higher quality securities, which may
limit Growth and Income Portfolio's ability to sell such securities at fair
value in response to changes in the economy or financial markets. Adverse
publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the values and liquidity of lower rated
securities, especially in a thinly traded market.
CONVERTIBLE SECURITIES. Before conversion, convertible securities have
characteristics similar to non-convertible debt securities in that they
ordinarily provide a stable stream of income with generally higher yields than
those of common stocks in the same or similar issuers. Convertible securities
rank senior to common stock in a corporation's capital structure but are
usually subordinated to comparable non-convertible securities.
The value of a convertible security is a function of its "investment value"
(determined by its yield comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and
its "conversion value" (the security's worth, at market value, if converted
into the underlying
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common stock). The investment value of a convertible security is influenced by
changes in interest rates, with investment value declining as interest rates
increase and increasing as interest rates decline. The credit standing of the
issuer and other factors also may have an effect on the convertible security's
investment value. The conversion value of a convertible security is determined
by the market price of the underlying common stock. If the conversion value is
low relative to the investment value, the price of the convertible security is
governed principally by its investment value, and generally the conversion
value decreases as the convertible security approaches maturity. To the extent
the market price of the underlying common stock approaches or exceeds the
conversion price, the price of the convertible security will be increasingly
influenced by its conversion value. In addition, a convertible security
generally will sell at a premium over its conversion value, determined by the
extent to which investors place value on the right to acquire the underlying
common stock while holding a fixed income security.
A convertible security may be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by Growth and Income Portfolio is
called for redemption, the Portfolio will be required to permit the issuer to
redeem the security, convert it into the underlying common stock or sell it to
a third party. The Portfolio may hold any equity securities it acquires upon
conversion.
WARRANTS. Warrants are securities permitting but not obligating their holder
to subscribe for other securities or commodities. Warrants do not carry with
them the right to dividends or voting rights with respect to the securities
that they entitle their holder to purchase, and they do not represent any
rights in the assets of the issuer. As a result, warrants may be considered
more speculative than certain other types of investments. In addition, the
value of a warrant does not necessarily change with the value of the
underlying securities, and a warrant ceases to have value if it is not
exercised prior to its expiration date.
ILLIQUID SECURITIES. Growth and Income Portfolio may invest up to 10% of its
net assets in illiquid securities. The term "illiquid securities" for this
purpose means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Portfolio
has valued the securities and includes, among other things, purchased OTC
options, repurchase agreements maturing in more than seven days and restricted
securities other than those securities Mitchell Hutchins has determined are
liquid pursuant to guidelines established by the Fund's board of trustees
(sometimes referred to as the "board"). The assets used as cover for OTC
options written by the Portfolio will be considered illiquid unless the OTC
options are sold to qualified dealers who agree that the Portfolio may
repurchase any OTC options it writes at a maximum price to be calculated by a
formula set forth in the option agreements. The cover for an OTC option
written subject to this procedure will be considered illiquid only to the
extent that the maximum repurchase price under the option formula exceeds the
intrinsic value of the option. To the extent the Portfolio invests in illiquid
securities, it may not be able to readily liquidate such investments and may
have to sell other investments if necessary to raise cash to meet its
obligations. Where registration is required, the Portfolio may be obligated to
pay all or part of the registration expenses and a considerable period may
elapse between the time of the decision to sell and the time it may be
permitted to sell a security under an effective registration statement. If,
during such a period, adverse market conditions were to develop, the Portfolio
might obtain a less favorable price than prevailed when it decided to sell.
Restricted securities are not registered under the Securities Act of 1933
("1933 Act") and may be sold only in privately negotiated or other exempted
transactions or after a 1933 Act registration statement has become effective.
However, not all restricted securities are illiquid. A large institutional
market has developed for many U.S. and foreign securities that are not
registered under the 1933 Act. Institutional investors generally will not seek
to sell these instruments to the general public, but instead will often depend
either on an efficient institutional market in which such unregistered
securities can be readily resold or on an issuer's ability to honor a demand
for repayment. Therefore, the fact that there are contractual or legal
restrictions on resale to the general public or certain institutions is not
dispositive of the liquidity of such investments.
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Institutional markets for restricted securities have developed as a result
of Rule 144A, which establishes a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers. Such markets include automated systems for the trading,
clearance and settlement of unregistered securities of domestic and foreign
issuers, such as the PORTAL System sponsored by the National Association of
Securities Dealers, Inc. An insufficient number of qualified buyers interested
in purchasing Rule 144A-eligible restricted securities held by Growth and
Income Portfolio, however, could affect adversely the marketability of such
securities and the Portfolio might be unable to dispose of the securities
promptly or at favorable prices.
The board has delegated the function of making day-to-day determinations of
liquidity to Mitchell Hutchins, pursuant to guidelines approved by the board.
Mitchell Hutchins takes into account a number of factors in reaching liquidity
decisions, including but not limited to (1) the frequency of trades for the
security, (2) the number of dealers that make quotes for the security, (3) the
number of dealers that have undertaken to make a market in the security, (4)
the number of other potential purchasers and (5) the nature of the security
and how trading is effected (e.g., the time needed to sell the security, how
bids are solicited and the mechanics of transfer). Mitchell Hutchins monitors
the liquidity of restricted securities in Growth and Income Portfolio and
reports periodically on such decisions to the board.
REPURCHASE AGREEMENTS. Repurchase agreements are transactions in which
Growth and Income Portfolio purchases securities from a bank or recognized
securities dealer and simultaneously commits to resell the securities to the
bank or dealer at an agreed-upon date or upon demand and at a price reflecting
a market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. The Portfolio maintains custody of the underlying
securities prior to their repurchase; thus, the obligation of the bank or
dealer to pay the repurchase price on the date agreed to is, in effect,
secured by such securities. If the value of these securities is less than the
repurchase price, plus any agreed-upon additional amount, the other party to
the agreement must provide additional collateral so that at all times the
collateral is at least equal to the repurchase price plus any agreed-upon
additional amount. The difference between the total amount to be received upon
repurchase of the securities and the price that was paid by the Portfolio upon
their acquisition is accrued as interest and included in the Portfolio's net
investment income. Repurchase agreements carry certain risks not associated
with direct investments in securities, including possible declines in the
market value of the underlying securities and delays and costs to a Portfolio
if the other party to a repurchase agreement becomes insolvent.
Growth and Income Portfolio intends to enter into repurchase agreements only
with banks and dealers in transactions believed by Mitchell Hutchins to
present minimum credit risks in accordance with guidelines established by the
board. Mitchell Hutchins reviews and monitors the creditworthiness of those
institutions under the board's general supervision.
REVERSE REPURCHASE AGREEMENTS. Growth and Income Portfolio may engage in
reverse repurchase agreements up to an aggregate value of 5% of its total
assets. Such transactions involve the sale of securities held by the Portfolio
subject to its agreement to repurchase the securities at an agreed-upon date
or upon demand and at a price reflecting a market rate of interest. Such
transactions are considered to be borrowings and may be entered into only for
temporary purposes. While a reverse repurchase agreement is outstanding, the
Portfolio's custodian segregates assets to cover the amount of its obligations
under the reverse repurchase agreement. See "Investment Policies and
Restrictions--Segregated Accounts."
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. A security purchased on a when-
issued or delayed delivery basis is recorded as an asset on the commitment
date and is subject to changes in market value, generally based upon changes
in the level of interest rates. Thus, fluctuation in the value of the security
from the time of the commitment date will affect Growth and Income Portfolio's
net asset value. When the Portfolio commits to purchase securities on a when-
issued or delayed delivery basis, its custodian segregates assets to cover the
amount of the commitment. See "Investment Policies and Limitations--Segregated
Accounts." The Portfolio purchases when-issued securities only with the
intention of taking delivery, but may sell the right to acquire the
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security prior to delivery if Mitchell Hutchins deems it advantageous to do
so, which may result in a capital gain or loss to the Portfolio.
LENDING OF PORTFOLIO SECURITIES. Growth and Income Portfolio is authorized
to lend portfolio securities valued at up to 33 1/3% of its total assets to
broker-dealers or institutional investors that Mitchell Hutchins deems
qualified, but only when the borrower maintains acceptable collateral with the
Portfolio's custodian, marked to market daily, in an amount at least equal to
the market value of the securities loaned, plus accrued interest and
dividends. Acceptable collateral is limited to cash, U.S. government
securities and irrevocable letters of credit that meet certain guidelines
established by Mitchell Hutchins. The Portfolio may reinvest any cash
collateral in money market investments or other short-term liquid investments.
In determining whether to lend securities to a particular broker-dealer or
institutional investor, Mitchell Hutchins will consider, and during the period
of the loan will monitor, all relevant facts and circumstances, including the
creditworthiness of the borrower. The Portfolio will retain authority to
terminate any of its loans at any time. The Portfolio may pay reasonable fees
in connection with a loan and may pay a negotiated portion of the interest
earned on the reinvestment of cash held as collateral to the borrower or
placing broker. The Portfolio will receive reasonable interest on a loan or a
flat fee from the borrower and amounts equivalent to any dividends, interest
or other distributions on the securities loaned. The Portfolio will regain
record ownership of loaned securities to exercise beneficial rights, such as
voting and subscription rights and rights to dividends, interest or other
distributions, when regaining such rights is considered to be in the
Portfolio's interest.
Pursuant to procedures adopted by the board governing Growth and Income
Portfolio's securities lending program, the board has approved retention of
PaineWebber to serve as lending agent for the Portfolio. The board also has
authorized the payment of fees (including fees calculated as a percentage of
invested cash collateral) to PaineWebber for these services. The board
periodically reviews all portfolio securities loan transactions for which
PaineWebber acted as lending agent.
SHORT SALES "AGAINST THE BOX". Growth and Income Portfolio may engage in
short sales of securities it owns or has the right to acquire at no added cost
through conversion or exchange of other securities it owns (short sales
"against the box"). To make delivery to the purchaser in a short sale, the
executing broker borrows the securities being sold short on behalf of the
Portfolio, and the Portfolio is obligated to replace the securities borrowed
at a date in the future. When the Portfolio sells short, it establishes a
margin account with the broker effecting the short sale, and deposits
collateral with the broker. In addition, the Portfolio maintains with its
custodian, in a segregated account, the securities that could be used to cover
the short sale. The Portfolio will incur transaction costs, including interest
expense, in connection with opening, maintaining and closing short sales
against the box.
Growth and Income Portfolio might make a short sale "against the box" in
order to hedge against market risks when Mitchell Hutchins believes that the
price of a security may decline, thereby causing a decline in the value of a
security owned by the Portfolio or a security convertible into or exchangeable
for a security owned by the Portfolio. In such case, any loss in the
Portfolio's long position after the short sale should be reduced by a
corresponding gain in the short position. Conversely, any gain in the long
position after the short sale should be reduced by a corresponding loss in the
short position. The extent to which gains or losses in the long position are
reduced will depend upon the amount of the securities sold short relative to
the amount of the securities the Portfolio owns, either directly or
indirectly, and in the case where the Portfolio owns convertible securities,
changes in the investment values or conversion premiums of such securities.
Growth and Income Portfolio currently does not intend to have obligations
under short sales that at any time during the coming year exceed 5% of its net
assets.
SEGREGATED ACCOUNTS. When Growth and Income Portfolio enters into certain
transactions that involve obligations to make future payments to third
parties, including reverse repurchase agreements or the purchase of securities
on a when-issued or delayed delivery basis, the Portfolio will maintain with
its custodian in a segregated account cash or liquid securities, marked to
market daily, in an amount at least equal to the Portfolio's
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obligation or commitment under such transactions. As described below under
"Hedging and Related Strategies Using Derivative Instruments," segregated
accounts may also be required in connection with certain transactions
involving options or futures contracts.
INVESTMENT LIMITATIONS.
Growth and Income Portfolio will not:
(1) purchase any security if, as a result of that purchase, 25% or more
of the Portfolio's total assets would be invested in securities of issuers
having their principal business activities in the same industry, except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies or instrumentalities or to municipal
securities.
(2) issue senior securities or borrow money, except as permitted under
the 1940 Act and then not in excess of 33 1/3% of the Portfolio's total
assets (including the amount of the senior securities issued but reduced by
any liabilities not constituting senior securities) at the time of the
issuance or borrowing, except that the Portfolio may borrow up to an
additional 5% of its total assets (not including the amount borrowed) for
temporary or emergency purposes.
(3) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investments in government
obligations, commercial paper, certificates of deposit, bankers'
acceptances or similar instruments will not be considered the making of a
loan.
(4) engage in the business of underwriting securities of other issuers,
except to the extent that the Portfolio might be considered an underwriter
under the federal securities laws in connection with its disposition of
portfolio securities.
(5) purchase or sell real estate, except that investments in securities
of issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by
interests in real estate are not subject to this limitation, and except
that the Portfolio may exercise rights under agreements relating to such
securities, including the right to enforce security interests and to hold
real estate acquired by reason of such enforcement until that real estate
can be liquidated in an orderly manner.
(6) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Portfolio may purchase,
sell or enter into financial options and futures, forward and spot currency
contracts, swap transactions and other financial contracts or derivative
instruments.
(7) purchase securities of any one issuer if, as a result, more than 5%
of the Portfolio's total assets would be invested in securities of that
issuer or the Portfolio would own or hold more than 10% of the outstanding
voting securities of that issuer, except that up to 25% of the Portfolio's
total assets may be invested without regard to this limitation, and except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies and instrumentalities or to securities
issued by other investment companies.
The foregoing fundamental investment limitations cannot be changed for
Growth and Income Portfolio without the affirmative vote of the lesser of
(a) more than 50% of the outstanding shares of the Portfolio or (b) 67% or
more of the Portfolio's shares present at a meeting of its shareholders if
more than 50% of the outstanding shares of the Portfolio are represented at
the meeting in person or by proxy. If a percentage restriction is adhered
to at the time of an investment or transaction, a later change in
percentage resulting from a change in values of portfolio securities or
amount of total assets will not be considered a violation of any of the
foregoing limitations.
The following investment restrictions may be changed by the board without
shareholder approval. Growth and Income Portfolio will not:
(1) hold assets of any issuers, at the end of any calendar quarter (or
within 30 days thereafter), to the extent such holdings would cause the
Portfolio to fail to comply with the diversification requirements
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imposed by section 817(h) of the Internal Revenue Code and the Treasury
regulations issued thereunder on segregated asset accounts used to fund
variable annuity and/or variable life insurance contracts.
(2) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Portfolio may
make margin deposits in connection with its use of financial options and
futures, forward and spot currency contracts, swap transactions and other
financial contracts or derivative instruments.
(3) engage in short sales of securities or maintain a short position,
except that the Portfolio may (a) sell short "against the box" and (b)
maintain short positions in connection with its use of financial options
and futures, forward and spot currency contracts, swap transactions and
other financial contracts or derivative instruments.
(4) purchase securities of other investment companies, except to the
extent permitted by the Investment Company Act of 1940 ("1940 Act") and
except that this limitation does not apply to securities received or
acquired as dividends, through offers of exchange, or as a result of
reorganization, consolidation, or merger.
(5) purchase portfolio securities while borrowings in excess of 5% of its
total assets are outstanding.
HEDGING AND RELATED STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS. As discussed in the
Prospectus, Mitchell Hutchins may use a variety of financial instruments
("Derivative Instruments"), including certain options, futures contracts
(sometimes referred to as "futures") and options on futures contracts, to
attempt to hedge Growth and Income Portfolio's investments or attempt to
enhance the Portfolio's income or realize gains. The Portfolio may enter into
transactions using one or more types of Derivative Instruments under which the
full value of its portfolio is at risk. Under normal circumstances, however,
the Portfolio's use of these instruments will place at risk a much smaller
portion of its assets. The particular Derivative Instruments used by the
Portfolio are described below.
OPTIONS ON EQUITY AND DEBT SECURITIES--A call option is a short-term
contract pursuant to which the purchaser of the option, in return for a
premium, has the right to buy the security or currency underlying the option
at a specified price at any time during the term of the option. The writer of
the call option, who receives the premium, has the obligation, upon exercise
of the option during the option term, to deliver the underlying security
against payment of the exercise price. A put option is a similar contract that
gives its purchaser, in return for a premium, the right to sell the underlying
security at a specified price during the option term. The writer of the put
option, who receives the premium, has the obligation, upon exercise of the
option during the option term, to buy the underlying security at the exercise
price.
OPTIONS ON STOCK INDICES--A stock index assigns relative values to the
stocks included in the index and fluctuates with changes in the market values
of those stocks. A stock index option operates in the same way as a more
traditional stock option, except that exercise of a stock index option is
effected with cash payment and does not involve delivery of securities. Thus,
upon exercise of a stock index option, the purchaser will realize, and the
writer will pay, an amount based on the difference between the exercise price
and the closing price of the stock index.
STOCK INDEX FUTURES CONTRACTS--A stock index futures contract is a bilateral
agreement pursuant to which one party agrees to accept, and the other party
agrees to make, delivery of an amount of cash equal to a specified dollar
amount times the difference between the stock index value at the close of
trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the stocks comprising the index is
made. Generally, contracts are closed out prior to the expiration date of the
contract.
INTEREST RATE FUTURES CONTRACTS--Interest rate futures contracts are
bilateral agreements pursuant to which one party agrees to make, and the other
party agrees to accept, delivery of a specified type of debt security at a
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specified future time and at a specified price. Although such futures
contracts by their terms call for actual delivery or acceptance of debt
securities, in most cases the contracts are closed out before the settlement
date without the making or taking of delivery.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities, except that an option on a futures contract gives the
purchaser the right, in return for the premium, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security, at a
specified price at any time during the option term. Upon exercise of the
option, the delivery of the futures position to the holder of the option will
be accompanied by delivery of the accumulated balance that represents the
amount by which the market price of the futures contract exceeds, in the case
of a call, or is less than, in the case of a put, the exercise price of the
option on the future. The writer of an option, upon exercise, will assume a
short position in the case of a call and a long position in the case of a put.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS. Hedging
strategies can be broadly categorized as "short hedges" and "long hedges." A
short hedge is a purchase or sale of a Derivative Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held by Growth and Income Portfolio. Thus, in a short hedge the
Portfolio takes a position in a Derivative Instrument whose price is expected
to move in the opposite direction of the price of the investment being hedged.
For example, the Portfolio might purchase a put option on a security to hedge
against a potential decline in the value of that security. If the price of the
security declined below the exercise price of the put, the Portfolio could
exercise the put and thus limit its loss below the exercise price to the
premium paid plus transaction costs. In the alternative, because the value of
the put option can be expected to increase as the value of the underlying
security declines, the Portfolio might be able to close out the put option and
realize a gain to offset the decline in the value of the security.
Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that Growth and Income Portfolio intends to
acquire. Thus, in a long hedge the Portfolio takes a position in a Derivative
Instrument whose price is expected to move in the same direction as the price
of the prospective investment being hedged. For example, the Portfolio might
purchase a call option on a security it intends to purchase in order to hedge
against an increase in the cost of the security. If the price of the security
increased above the exercise price of the call, the Portfolio could exercise
the call and thus limit its acquisition cost to the exercise price plus the
premium paid and transaction costs. Alternatively, the Portfolio might be able
to offset the price increase by closing out an appreciated call option and
realizing a gain.
Growth and Income Portfolio may purchase and write (sell) covered straddles
on securities and stock indices. A long straddle is a combination of a call
and a put option purchased on the same security or on the same futures
contract, where the exercise price of the put is equal to the exercise price
of the call. The Portfolio might enter into a long straddle when Mitchell
Hutchins believes it likely that interest rates will be more volatile during
the term of the option than the option pricing implies. A short straddle is a
combination of a call and a put written on the same security where the
exercise price of the put is equal to the exercise price of the call. The
Portfolio might enter into a short straddle when Mitchell Hutchins believes it
unlikely that interest rates will be as volatile during the term of the option
as the option pricing implies.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that Growth and
Income Portfolio owns or intends to acquire. Derivative Instruments on stock
indices, in contrast, generally are used to hedge against price movements in
broad equity market sectors in which the Portfolio has invested or expects to
invest. Derivative Instruments on debt securities may be used to hedge either
individual securities or broad fixed income market sectors.
Income strategies include the writing of covered options to obtain the
related option premiums. Return strategies include the use of Derivative
Instruments to increase or reduce Growth and Income Portfolio's exposure to an
asset class without buying or selling the underlying instruments.
10
<PAGE>
The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, Growth and
Income Portfolio's ability to use Derivative Instruments will be limited by
tax considerations. See "Taxes."
In addition to the products, strategies and risks described below and in the
Prospectus, Mitchell Hutchins may discover additional opportunities in
connection with Derivative Instruments and with hedging, income and gain
strategies. These new opportunities may become available as regulatory
authorities broaden the range of permitted transactions and as new Derivative
Instruments and techniques are developed. Mitchell Hutchins may utilize these
opportunities to the extent that they are consistent with Growth and Income
Portfolio's investment objective and permitted by the Portfolio's investment
limitations and applicable regulatory authorities. The Fund's Prospectus or
this Statement of Additional Information will be supplemented to the extent
that new products or techniques involve materially different risks than those
described below or in the Prospectus.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVES INSTRUMENTS. The use of
Derivative Instruments involves special considerations and risks, as described
below. Risks pertaining to particular Derivative Instruments are described in
the sections that follow.
(1) Successful use of most Derivative Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities and
interest rate markets, which requires different skills than predicting
changes in the prices of individual securities. While Mitchell Hutchins is
experienced in the use of Derivative Instruments, there can be no assurance
that any particular strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative
Instrument used in a short hedge increased by less than the decline in
value of the hedged investment, the hedge would not be fully successful.
Such a lack of correlation might occur due to factors affecting the markets
on which Derivative Instruments are traded rather than the value of the
investments being hedged. The effectiveness of hedges using Derivative
Instruments on indices will depend on the degree of correlation between
price movements in the index and price movements in the securities being
hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements
in the investments being hedged. However, hedging strategies can also
reduce opportunity for gain by offsetting the positive effect of favorable
price movements in the hedged investments. For example, if Growth and
Income Portfolio entered into a short hedge because Mitchell Hutchins
projected a decline in the price of a security held by the Portfolio, and
the price of that security increased instead, the gain from that increase
might be wholly or partially offset by a decline in the price of the
Derivative Instrument. Moreover, if the price of the Derivative Instrument
declined by more than the increase in the price of the security, the
Portfolio could suffer a loss. In either such case, the Portfolio would
have been in a better position had it not hedged at all.
(4) As described below, Growth and Income Portfolio might be required to
maintain assets as "cover," maintain segregated accounts or make margin
payments when it takes positions in Derivative Instruments involving
obligations to third parties (i.e., Derivative Instruments other than
purchased options). If the Portfolio were unable to close out its positions
in such Derivative Instruments, it might be required to continue to
maintain such assets or accounts or make such payments until the position
expired or matured. These requirements might impair the Portfolio's ability
to sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Portfolio sell a
portfolio security at a disadvantageous time. The Portfolio's ability to
close out a position in a Derivative Instrument prior to expiration or
maturity depends on the existence of a liquid secondary market or, in the
absence of such a market, the ability and willingness of a counterparty to
enter into a transaction closing out the position. Therefore, there is no
assurance that any position can be closed out at a time and price that is
favorable to the Portfolio.
11
<PAGE>
COVER FOR STRATEGIES USING DERIVATIVES INSTRUMENTS. Transactions using
Derivative Instruments, other than purchased options, expose Growth and Income
Portfolio to an obligation to another party. The Portfolio will not enter into
any such transactions unless it owns either (1) an offsetting ("covered")
position in securities or other options or futures contracts or (2) cash and
liquid securities, with a value sufficient at all times to cover its potential
obligations to the extent not covered as provided in (1) above. The Portfolio
will comply with SEC guidelines regarding cover for such transactions and
will, if the guidelines so require, set aside cash or liquid securities in a
segregated account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they
are replaced with similar assets. As a result, committing a large portion of
Growth and Income Portfolio's assets to cover positions or to segregated
accounts could impede portfolio management or the Portfolio's ability to meet
redemption requests or other current obligations.
OPTIONS. Growth and Income Portfolio may purchase put and call options, and
write (sell) covered put and call options, on equity and debt securities. The
Portfolio that may use options may purchase put and call options and write
(sell) covered call options on stock indices. The purchase of call options may
serve as a long hedge, and the purchase of put options may serve as a short
hedge. In addition, the Portfolio may purchase options to enhance return by
increasing or reducing its exposure to an asset class without purchasing or
selling the underlying securities. Writing covered put or call options can
enable the Portfolio to enhance income by reason of the premiums paid by the
purchasers of such options. Writing covered put options serves as a limited
long hedge because increases in the value of the hedged instrument would be
offset to the extent of the premium received for writing the option. However,
if the market price of the security underlying a covered put option declines
to less than the exercise price of the option, minus the premium received, the
Portfolio would expect to suffer a loss. Writing covered call options serves
as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing
the option. However, if the security appreciates to a price higher than the
exercise price of the call option, it can be expected that the option will be
exercised and the Portfolio will be obligated to sell the security at less
than its market value. The securities or other assets used as cover for OTC
options written by the Portfolio would be considered illiquid to the extent
described under "Investment Policies and Restrictions--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration
dates of up to nine months. Options that expire unexercised have no value.
Growth and Income Portfolio may effectively terminate its right or
obligation under an option by entering into a closing transaction. For
example, the Portfolio may terminate its obligation under a call option that
it had written by purchasing an identical call option; this is known as a
closing purchase transaction. Conversely, the Portfolio may terminate a
position in a put or call option it had purchased by writing an identical put
or call option; this is known as a closing sale transaction. Closing
transactions permit the Portfolio to realize profits or limit losses on an
option position prior to its exercise or expiration.
Growth and Income Portfolio may purchase or write both exchange-traded and
OTC options. Currently, many options on equity securities are exchange-traded.
Exchange markets for options on debt securities and foreign currencies exist
but are relatively new, and these instruments are primarily traded on the OTC
market. Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction.
In contrast, OTC options are contracts between the Portfolio and its
counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when the Portfolio purchases or writes an OTC
option, it relies on the counterparty to make or take delivery of the
underlying investment upon exercise of the option. Failure by the counterparty
to do so would result in the loss of any premium paid by the Portfolio as well
as the loss of any expected benefits of the transaction.
12
<PAGE>
Generally, the OTC debt options used by Growth and Income Portfolio are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option.
Growth and Income Portfolio's ability to establish and close out positions
in exchange-listed options depends on the existence of a liquid market. The
Portfolio intends to purchase or write only those exchange-traded options for
which there appears to be a liquid secondary market. However, there can be no
assurance that such a market will exist at any particular time. Closing
transactions can be made for OTC options only by negotiating directly with the
counterparty, or by a transaction in the secondary market if any such market
exists. Although the Portfolio will enter into OTC options only with
counterparties that are expected to be capable of entering into closing
transactions with the Portfolio, there is no assurance that the Portfolio will
in fact be able to close out an OTC option position at a favorable price prior
to expiration. In the event of insolvency of the counterparty, the Portfolio
might be unable to close out an OTC option position at any time prior to its
expiration.
If Growth and Income Portfolio were unable to effect a closing transaction
for an option it had purchased, it would have to exercise the option to
realize any profit. The inability to enter into a closing purchase transaction
for a covered call option written by the Portfolio could cause material losses
because the Portfolio would be unable to sell the investment used as cover for
the written option until the option expires or is exercised.
Growth and Income Portfolio may purchase and write put and call options on
indices in much the same manner as the more traditional options discussed
above, except the index options may serve as a hedge against overall
fluctuations in a securities market (or market sector) rather than anticipated
increases or decreases in the value of a particular security.
LIMITATIONS ON THE USE OF OPTIONS. Growth and Income Portfolio's use of
options is governed by the following guidelines, which can be changed by the
board without shareholder vote:
(1) The Portfolio may purchase a put or call option, including any
straddle or spread, only if the value of its premium, when aggregated with
the premiums on all other options held by the Portfolio, does not exceed 5%
of the Portfolio's total assets.
(2) The aggregate value of securities underlying put options written by
the Portfolio, determined as of the date the put options are written, will
not exceed 50% of its net assets.
(3) The aggregate premiums paid on all options (including options on
securities, foreign currencies and stock or bond indices and options on
futures contracts) purchased by the Portfolio that are held at any time
will not exceed 20% of its net assets.
FUTURES. The purchase of futures or call options thereon can serve as a long
hedge, and the sale of futures or the purchase of put options thereon can
serve as a short hedge. Writing covered call options on futures contracts can
serve as a limited short hedge, using a strategy similar to that used for
writing covered call options on securities and indices. In addition, Growth
and Income Portfolio may purchase or sell futures contracts or purchase
options thereon to enhance return by increasing or reducing exposure to an
asset class without purchasing or selling the underlying securities.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract Growth and Income Portfolio is required to
deposit "initial margin" in an amount generally equal to 10% or less of the
contract value. Margin must also be deposited when writing an option on a
futures contract, in accordance with applicable exchange rules. Unlike margin
in securities transactions, initial margin on futures contracts does not
represent a borrowing, but rather is in the nature of a performance bond or
good-faith deposit that is returned to the Portfolio at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, the Portfolio may be
required by an exchange to increase the level of its initial margin payment,
and initial margin requirements might be increased generally in the future by
regulatory action.
13
<PAGE>
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of Growth and Income Portfolio's obligations to
or from a futures broker. When the Portfolio purchases an option on a future,
the premium paid plus transaction costs is all that is at risk. In contrast,
when the Portfolio purchases or sells a futures contract or writes a call
option thereon, it is subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If the Portfolio has
insufficient cash to meet daily variation margin requirements, it might need
to sell securities at a time when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to
the instrument held or written. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. Growth and Income Portfolio intends to enter into futures transactions
only on exchanges or boards of trade where there appears to be a liquid
secondary market. However, there can be no assurance that such a market will
exist for a particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits on
the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If Growth and Income Portfolio were unable to liquidate a futures or related
options position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Portfolio
would continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Portfolio would
continue to be required to make daily variation margin payments and might be
required to maintain the position being hedged by the future or option or to
maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and related options
markets are subject to daily variation margin calls and might be compelled to
liquidate futures or related options positions whose prices are moving
unfavorably to avoid being subject to further calls. These liquidations could
increase price volatility of the instruments and distort the normal price
relationship between the futures or options and the investments being hedged.
Also, because initial margin deposit requirements in the futures market are
less onerous than margin requirements in the securities markets, there might
be increased participation by speculators in the futures markets. This
participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets
involving arbitrage, "program trading" and other investment strategies might
result in temporary price distortions.
LIMITATIONS ON THE USE OF FUTURES AND RELATED OPTIONS. Growth and Income
Portfolio's use of futures is governed by the following guidelines, which can
be changed by the board without shareholder vote.
(1) To the extent the Portfolio enters into futures contracts or options
on futures contracts that are not for bona fide hedging purposes (as
defined by the CFTC), the aggregate initial margin and premiums on those
positions (excluding the amount by which options are "in-the-money") may
not exceed 5% of its net assets.
(2) The aggregate premiums on all options (including options on
securities and stock indices and options on futures contracts) purchased by
the Portfolio that are held at any time will not exceed 20% of its net
assets.
14
<PAGE>
(3) The aggregate margin deposits on all futures contracts and options
thereon held at any time by the Portfolio will not exceed 5% of its total
assets.
TRUSTEES AND OFFICERS; PRINCIPAL HOLDERS OF SECURITIES
The trustees and executive officers of the Fund, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
Margo N. Alexander**; 51 Trustee and President Mrs. Alexander is presi-
dent, chief executive
officer and a director
of Mitchell Hutchins
(since January 1995) and
an executive vice presi-
dent and director of
PaineWebber (since March
1984). Mrs. Alexander is
president and a director
or trustee of 30 invest-
ment companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Richard Q. Armstrong; 62 Trustee Mr. Armstrong is chairman
78 West Brother Drive and principal of RQA En-
Greenwich, CT 06830 terprises (management
consulting firm) (since
April 1991 and principal
occupation since March
1995). Mr. Armstrong is
also a director of Hi Lo
Automotive, Inc. He was
chairman of the board,
chief executive officer
and co-owner of Adiron-
dack Beverages (producer
and distributor of soft
drinks and
sparkling/still waters)
(October 1993-March
1995). He was a partner
of The New England Con-
sulting Group (manage-
ment consulting firm)
(December 1992-September
1993). He was managing
director of LVMH U.S.
Corporation (U.S. sub-
sidiary of the French
luxury goods conglomer-
ate, Louis Vuitton Moet
Hennessey Corporation)
(1987-1991) and chairman
of its wine and spirits
subsidiary, Schieffelin
& Somerset Company
(1987-1991). Mr. Arm-
strong is a director or
trustee of 29 investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
E. Garrett Bewkes, Jr.**; 71 Trustee and Chairman Mr. Bewkes is a director
of the Board of of Paine Webber Group
Trustees Inc. ("PW Group") (hold-
ing company of
PaineWebber and Mitchell
Hutchins). Prior to De-
cember 1995, he was a
consultant to PW Group.
Prior to 1988, he was
chairman of the board,
president and chief ex-
ecutive officer of Amer-
ican Bakeries Company.
Mr. Bewkes is also a di-
rector of Interstate
Bakeries Corporation and
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
NaPro BioTherapeutics,
Inc. Mr. Bewkes is a di-
rector or trustee of 30
investment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Richard R. Burt; 51 Trustee Mr. Burt is chairman of
1275 Pennsylvania Avenue, IEP Advisors, Inc. (in-
N.W. ternational investments
Washington, D.C. 20004 and consulting firm)
(since March 1994) and a
partner of McKinsey &
Company (management con-
sulting firm) (since
1991). He is also a di-
rector of American Pub-
lishing Company and Ar-
cher-Daniels-Midland Co.
(agricultural commodi-
ties). He was the chief
negotiator in the Stra-
tegic Arms Reduction
Talks with the former
Soviet Union (1989-1991)
and the U.S. Ambassador
to the Federal Republic
of Germany (1985-1989).
Mr. Burt is a director
or trustee of 29 invest-
ment companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Mary C. Farrell**; 48 Trustee Ms. Farrell is a managing
director, senior
investment strategist
and member of the In-
vestment Policy Commit-
tee of PaineWebber. Ms.
Farrell joined
PaineWebber in 1982. She
is a member of the Fi-
nancial Women's Associa-
tion and Women's Eco-
nomic Roundtable and ap-
pears as a regular pan-
elist on Wall $treet
Week with Louis
Rukeyser. She also
serves on the Board of
Overseers of New York
University's Stern
School of Business. Ms.
Farrell is a director or
trustee of 29 investment
companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Meyer Feldberg; 56 Trustee Mr. Feldberg is Dean and
Columbia University Professor of Management
101 Uris Hall of the Graduate School
New York, New York 10027 of Business, Columbia
University. Prior to
1989, he was president
of the Illinois Insti-
tute of Technology. Dean
Feldberg is also a di-
rector of K-III Communi-
cations Corporation,
Federated Department
Stores Inc., and Revlon,
Inc. Dean Feldberg is a
director or trustee of
29 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
George W. Gowen; 68 Trustee Mr. Gowen is a partner
666 Third Avenue in the law firm of Dun-
New York, New York 10017 nington, Bartholow &
Miller. Prior to May
1994 he was a partner
in the law firm of Fry-
er, Ross & Gowen.
Mr. Gowen is also a di-
rector of Columbia Real
Estate Investments,
Inc. Mr. Gowen is a di-
rector or trustee of 29
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Frederic V. Malek; 61 Trustee Mr. Malek is Chairman of
1455 Pennsylvania Avenue, N.W. Thayer Capital Partners
Suite 350 (merchant bank). From
Washington, D.C. 20004 January 1992 to Novem-
ber 1992 he was cam-
paign manager of Bush-
Quayle '92. From 1990
to 1992, he was vice
chairman and, from 1989
to 1990, he was presi-
dent of Northwest Air-
lines Inc., NWA Inc.
(holding company of
Northwest Airlines
Inc.) and Wings Hold-
ings Inc. (holding com-
pany of NWA Inc.).
Prior to 1989, he was
employed by the
Marriott Corporation
(hotels, restaurants,
airline catering and
contract feeding),
where he most recently
was an executive vice
president and president
of Marriott Hotels and
Resorts. Mr. Malek is
also a director of
American Management
Systems, Inc. (manage-
ment consulting and
computer related ser-
vices), Automatic Data
Processing, Inc., CB
Commercial Group, Inc.
(real estate services),
Choice Hotels Interna-
tional (hotel and hotel
franchising), FPL
Group, Inc. (electric
services), Integra,
Inc. (bio-medical),
Manor Care, Inc.
(health care), National
Education Corporation
and Northwest Airlines
Inc. Mr. Malek is a di-
rector or trustee of 29
investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Carl W. Schafer; 62 Trustee Mr. Schafer is president
66 Witherspoon Street #1100 of the Atlantic Founda-
Princeton, NJ 08542 tion (charitable foun-
dation supporting
mainly oceanographic
exploration and re-
search). He is a direc-
tor of Roadway Express,
Inc. (trucking), The
Guardian Group of Mu-
tual Funds, Evans Sys-
tems, Inc. (motor fu-
els, convenience store
and diversified compa-
ny), Electronic Clear-
ing House, Inc. (finan-
cial transactions
processing), Wainoco
Oil Corporation and
Nutraceutix, Inc. (bio-
technology company).
Prior to January 1993,
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
he was chairman of the
Investment Advisory Com-
mittee of the Howard
Hughes Medical Insti-
tute. Mr. Schafer is a
director or trustee of
29 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
T. Kirkham Barneby; 51 Vice President Mr. Barneby is a managing
director and chief in-
vestment officer--quan-
titative investment of
Mitchell Hutchins. Prior
to September 1994, he
was a senior vice presi-
dent at Vantage Global
Management. Prior to
June 1993, he was a se-
nior vice president at
Mitchell Hutchins.
Mr. Barneby is a vice
president of six invest-
ment companies for which
Mitchell Hutchins or
PaineWebber serves as
investment adviser.
Ellen R. Harris; 51 Vice President Ms. Harris is a managing
director and a portfolio
manager of Mitchell
Hutchins. Ms. Harris is
a vice president of two
investment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Donald R. Jones; 37 Vice President Mr. Jones is a first vice
president and a portfo-
lio manager of Mitchell
Hutchins. Prior to Feb-
ruary 1996, he was a
vice president in the
asset management group
of First Fidelity Ban-
corporation. Mr. Jones
is a vice president of
two investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
James F. Keegan; 37 Vice President Mr. Keegan is a senior
vice president and a
portfolio manager of
Mitchell Hutchins. Prior
to March 1996, he was
director of fixed income
strategy and research of
Merrion Group, L.P. From
1987 to 1994, he was a
vice president of global
investment management of
Bankers Trust.
Mr. Keegan is a vice
president of three in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Thomas J. Libassi; 39 Vice President Mr. Libassi is a senior
vice president and a
portfolio manager of
Mitchell Hutchins. Prior
to May 1994, he was a
vice president of Key-
stone Custodian Funds
Inc. with portfolio man-
agement responsibility.
Mr. Libassi is a vice
president of five in-
vestment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
Dennis McCauley; 51 Vice President Mr. McCauley is a manag-
ing director and chief
investment officer--
fixed income of Mitchell
Hutchins. Prior to De-
cember 1994, he was di-
rector of fixed income
investments of IBM Cor-
poration. Mr. McCauley
is a vice president of
20 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
Ann E. Moran; 40 Vice President and Ms. Moran is a vice pres-
Assistant Treasurer ident and a manager of
the mutual fund finance
division of Mitchell
Hutchins. Ms. Moran is a
vice president and as-
sistant treasurer of 30
investment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Dianne E. O'Donnell; 45 Vice President and Ms. O'Donnell is a senior
Secretary vice president and dep-
uty general counsel of
Mitchell Hutchins. Ms.
O'Donnell is a vice
pres- ident and secre-
tary of 29 investment
companies and vice pres-
ident and assistant sec-
retary of one investment
company for which Mitch-
ell Hutchins or
PaineWebber serves as
investment adviser.
Emil Polito; 37 Vice President Mr. Polito is a senior
vice president and di-
rector of operations and
control for Mitchell
Hutchins. From March
1991 to September 1993
he was director of
the mutual funds sales
support and service cen-
ter for Mitchell
Hutchins and
PaineWebber. Mr. Polito
is a vice president of
30 investment companies
for which Mitchell
Hutchins or PaineWebber
serves as investment
adviser.
Susan Ryan; 37 Vice President Ms. Ryan is a senior vice
president and portfolio
manager of Mitchell
Hutchins and has been
with Mitchell Hutchins
since 1982. Ms. Ryan is
a vice president of five
investment companies for
which Mitchell Hutchins
or PaineWebber serves as
investment adviser.
Victoria E. Schonfeld; 47 Vice President Ms. Schonfeld is a manag-
ing director and general
counsel of Mitchell
Hutchins. Prior to May
1994, she was a partner
in the law firm of Ar-
nold & Porter. Ms.
Schonfeld is a vice
president of 29 invest-
ment companies and a
vice president and sec-
retary of one invest-
</TABLE>
19
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
ment company for which
Mitchell Hutchins or
PaineWebber serves as in-
vestment adviser.
Paul H. Schubert; 35 Vice President and Mr. Schubert is a first
Treasurer vice president and the di-
rector of the mutual fund
finance division of Mitch-
ell Hutchins. From August
1992 to August 1994, he
was a vice president at
BlackRock Financial Man-
agement L.P. Mr. Schubert
is a vice president and
treasurer of 30 investment
companies for which Mitch-
ell Hutchins or
PaineWebber serves as in-
vestment adviser.
Nirmal Singh; 42 Vice President Mr. Singh is a senior vice
president and portfolio
manager of Mitchell
Hutchins. Prior to 1993,
he was a member of
the portfolio management
team at Merrill Lynch As-
set Management, Inc.
Mr. Singh is a vice presi-
dent of four investment
companies for which Mitch-
ell Hutchins or
PaineWebber serves as in-
vestment adviser.
Barney A. Taglialatela; 37 Vice President and Mr. Taglialatela is a vice
Assistant Treasurer president and a manager of
the mutual fund finance
division of Mitchell
Hutchins. Prior to Febru-
ary 1995, he was a manager
of the mutual fund finance
division of Kidder Peabody
Asset Management, Inc. Mr.
Taglialatela is a vice
president and assistant
treasurer of 30 investment
companies for which Mitch-
ell Hutchins or
PaineWebber serves as in-
vestment adviser.
Mark A. Tincher; 42 Vice President Mr. Tincher is a managing
director and chief invest-
ment officer--equities of
Mitchell Hutchins. Prior
to March 1995, he was a
vice president and di-
rected the U.S. funds man-
agement and equity re-
search areas of Chase Man-
hattan Private Bank. Mr.
Tincher is a vice presi-
dent of 13 investment com-
panies for which Mitchell
Hutchins or PaineWebber
serves as investment ad-
viser.
Craig M. Varrelman; 39 Vice President Mr. Varrelman is a senior
vice president and a port-
folio manager of Mitchell
Hutchins. Mr. Varrelman is
a vice president of four
investment companies for
which Mitchell Hutchins or
PaineWebber serves as in-
vestment adviser.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
BUSINESS EXPERIENCE
NAME AND ADDRESS*; AGE POSITION WITH THE FUND AND OTHER DIRECTORSHIPS
---------------------- ---------------------- -----------------------
<C> <C> <S>
Stuart Waugh; 43 Vice President Mr. Waugh is a managing direc-
tor and a portfolio manager of
Mitchell Hutchins responsible
for global fixed income in-
vestments and currency trad-
ing. Mr. Waugh is a vice pres-
ident of five investment com-
panies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Keith A. Weller; 36 Vice President and Mr. Weller is a first vice
Assistant Secretary president and associate gen-
eral counsel of Mitchell
Hutchins. Prior to May 1995,
he was an attorney in private
practice. Mr. Weller is a vice
president and assistant secre-
tary of 29 investment compa-
nies for which Mitchell
Hutchins or PaineWebber serves
as investment adviser.
Ian W. Williams; 40 Vice President and Mr. Williams is a vice presi-
Assistant Treasurer dent and a manager of the mu-
tual fund finance division of
Mitchell Hutchins. Mr. Wil-
liams is a vice president and
assistant treasurer of 30 in-
vestment companies for which
Mitchell Hutchins or
PaineWebber serves as invest-
ment adviser.
</TABLE>
- --------
*Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
**Mrs. Alexander, Mr. Bewkes and Ms. Farrell are "interested persons" of the
Fund as defined in the 1940 Act by virtue of their positions with Mitchell
Hutchins, PaineWebber and/or PW Group.
The Fund pays trustees who are not "interested persons" of the Fund $500
annually for each of its Portfolios and $150 for each board meeting and for
each separate meeting of a board committee with respect to a Portfolio. The
Fund presently has 13 Portfolios, including Growth and Income Portfolio, and
thus pays each such trustee $6,500 annually, plus any additional amounts due
for board or committee meetings. Each chairman of the audit and contract
review committees of individual funds within the PaineWebber fund complex
receives additional compensation aggregating $15,000 annually from the
relevant funds. All trustees are reimbursed for any expenses incurred in
attending meetings. Because Mitchell Hutchins performs substantially all of
the services necessary for the operation of the Fund and its Portfolios, the
Fund requires no employees. No officer, director or employee of Mitchell
Hutchins or PaineWebber receives any compensation from the Fund for acting as
a trustee or officer.
21
<PAGE>
The table below includes certain information relating to the compensation of
the Fund's current trustees who held office with the Fund or other PaineWebber
funds during the fiscal year ended December 31, 1997.
COMPENSATION TABLE+
<TABLE>
<CAPTION>
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE FUND AND
NAME OF PERSON, POSITION FROM THE FUND* THE FUND COMPLEX**
------------------------ -------------- ------------------
<S> <C> <C>
Richard Q. Armstrong,
Trustee.................................... $12,600 $ 94,885
Richard R. Burt,
Trustee.................................... 11,250 87,085
Meyer Feldberg,
Trustee.................................... 12,600 117,853
George W. Gowen,
Trustee.................................... 14,209 101,567
Frederic V. Malek,
Trustee.................................... 12,600 95,845
Carl W. Schafer,
Trustee.................................... 12,600 94,885
</TABLE>
- --------
+ Only independent members of the board of trustees are compensated by the
Fund and identified above; trustees who are "interested persons," as
defined by the 1940 Act, do not receive compensation.
* Represents fees paid to each trustee during the fiscal year ended December
31, 1997.
** Represents total compensation paid to each trustee by the fund complex
during the twelve months ended December 31, 1997; no fund within the
complex has a bonus, pension, profit sharing or retirement plan.
PRINCIPAL HOLDERS OF SECURITIES
The following shareholders are shown in the Fund's records as owning more
than 5% of the Class H shares of Growth and Income Portfolio as of April 17,
1998, as indicated below:
<TABLE>
<CAPTION>
NUMBER AND PERCENTAGE OF
SHARES BENEFICIALLY
NAME OF SHAREHOLDER OWNED AS OF APRIL 17, 1998
- ------------------- --------------------------
<S> <C>
PaineWebber Life Variable Annuity Account .......... 1,085,239.293 (67%)
American Republic Variable Annuity Account ......... 497,135.089 (31%)
Keyport Benefit Variable Annuity Account..... ...... 36,847.486 (2%)
</TABLE>
PaineWebber Life Variable Annuity Account is a segregated investment account
of PaineWebber Life Insurance Company, 1200 Harbor Blvd., Weehawken, New
Jersey 07087. American Republic Variable Annuity Account is a segregated
investment account of American Republic Insurance Company, 601 6th Avenue, Des
Moines, Iowa 50309. Keyport Benefit Variable Annuity Account (formerly,
American Benefit Variable Annuity Account) is a segregated investment account
of Keyport Benefit Life Insurance Company (formerly, American Benefit Life
Insurance Company), 100 Manhattanville Rd., Purchase, New York 10577. Keyport
Benefit Life Insurance Company is a wholly owned subsidiary of Keyport Life
Insurance Company, 125 High Street, Boston, Massachusetts 02110-2712.
22
<PAGE>
INVESTMENT ADVISORY SERVICES
Mitchell Hutchins acts as the investment adviser and administrator of Growth
and Income Portfolio pursuant to a contract with the Fund dated April 21, 1988
as supplemented by a Fee Agreement dated December 30, 1991 ("Advisory
Contract"). Under the Advisory Contract, the Fund pays Mitchell Hutchins a fee
at the annual rate of 0.70% of the Portfolio's average net assets, computed
daily and payable monthly.
During the fiscal years ended December 31, 1997, 1996 and 1995 Mitchell
Hutchins earned (or accrued) advisory fees in the amount of $138,089, $111,599
and $94,315, respectively for Growth and Income Portfolio. Under a Sub-
Advisory Contract dated May 26, 1994, Mitchell Hutchins Institutional
Investors Inc. served as sub-adviser to Growth and Income Portfolio until
April 3, 1995 and was paid (or accrued) by Mitchell Hutchins (not the
Portfolio) sub-advisory fees of $7,400 for the fiscal year ended December 31,
1995.
Under the terms of the Advisory Contract, each Portfolio (including Growth
and Income Portfolio) bears all expenses incurred in its operation that are
not specifically assumed by Mitchell Hutchins. General expenses of the Fund
not readily identifiable as belonging to one of the Portfolios are allocated
among the Portfolios by or under the direction of the board in such manner as
the board determines to be fair and equitable. Expenses borne by each
Portfolio include, but are not limited to, the following (or the Portfolio's
allocated share of the following): (1) the cost (including brokerage
commissions, if any) of securities purchased or sold by the Portfolio and any
losses incurred in connection therewith; (2) fees payable to and expenses
incurred on behalf of the Portfolio by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the Fund or the shares of a Portfolio under federal and state
securities laws and maintenance of such registrations and qualifications; (5)
fees and salaries payable to the trustees who are not "interested persons" of
the Fund or Mitchell Hutchins; (6) all expenses incurred in connection with
the trustees' services, including travel expenses; (7) taxes (including any
income or franchise taxes) and governmental fees; (8) costs of any liability,
uncollectible items of deposit and other insurance and fidelity bonds; (9) any
costs, expenses or losses arising out of a liability of or claim for damages
or other relief asserted against the Fund or Portfolio for violation of any
law; (10) legal, accounting and auditing expenses, including legal fees of
special counsel for the trustees who are not interested persons of the Fund;
(11) charges of custodians, transfer agents and other agents; (12) costs of
preparing share certificates, if any; (13) expenses of setting in type and
printing prospectuses and supplements thereto, statements of additional
information and supplements thereto, reports and proxy materials for existing
shareholders and costs of mailing such materials to shareholders; (14) any
extraordinary expenses (including fees and disbursements of counsel) incurred
by the Fund or Portfolio; (15) fees, voluntary assessments and other expenses
incurred in connection with membership in investment company organizations;
(16) costs of mailing and tabulating proxies and costs of meetings of
shareholders, the board and any committees thereof; (17) the cost of
investment company literature and other publications provided to the trustees
and officers; and (18) costs of mailing, stationery and communications
equipment.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part
of Mitchell Hutchins in the performance of its duties or from reckless
disregard of its duties and obligations thereunder.
The Advisory Contract terminates automatically upon assignment and is
terminable at any time without penalty by the board or by vote of the holders
of a majority of Growth and Income Portfolio's outstanding voting securities
on 60 days' written notice to Mitchell Hutchins or by Mitchell Hutchins on 60
days' written notice to the Fund.
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of the PaineWebber funds and other Mitchell Hutchins' advisory
accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in
23
<PAGE>
initial public offerings generally are prohibited. In addition, the code of
ethics puts restrictions on the timing of personal investing in relation to
trades by PaineWebber funds and other Mitchell Hutchins advisory clients.
Subsequent to August 1, 1997, PFPC Inc., the Fund's transfer agent ("PFPC"),
(not the Fund), pays PaineWebber for certain transfer agency related services
that PFPC has delegated to PaineWebber.
PORTFOLIO TRANSACTIONS
Subject to policies established by the board, Mitchell Hutchins is
responsible for the execution of portfolio transactions and the allocation of
brokerage transactions for Growth and Income Portfolio. In executing portfolio
transactions, Mitchell Hutchins seeks to obtain the best net results for the
Portfolio taking into account such factors as the price (including the
applicable brokerage commission or dealer spread), size of the order,
difficulty of execution and operational facilities of the firm involved. While
Mitchell Hutchins generally seeks reasonably competitive commission rates,
payment of the lowest commission is not necessarily consistent with obtaining
the best net results. Prices paid to dealers in principal transactions through
which most debt securities and some equity securities are traded generally
include a "spread," which is the difference between the prices at which the
dealer is willing to purchase and sell a specific security at that time. The
Portfolio may invest in securities traded in the OTC markets and will engage
primarily in transactions with the dealers who make markets in such
securities, unless a better price or execution could be obtained by using a
broker. During the fiscal years ended December 31, 1997, 1996 and 1995 the
Portfolio paid brokerage commissions in the amount of $39,178, $31,792 and
$34,846, respectively.
The Fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Fund contemplates that,
consistent with the policy of obtaining the best net results, a substantial
amount of Growth and Income Portfolio's brokerage transactions may be
conducted through Mitchell Hutchins or its affiliates, including PaineWebber.
The board has adopted procedures in conformity with Rule 17e-1 under the 1940
Act to ensure that all brokerage commissions paid to Mitchell Hutchins or its
affiliates are fair and reasonable. Specific provisions included in the
Advisory Contract authorize Mitchell Hutchins and any of its affiliates that
is a member of a national securities exchange to effect securities
transactions for the Portfolio on such exchange and to retain compensation in
connection with such transactions. Any such transactions will be effected and
related compensation paid in accordance with applicable SEC regulations.
During the fiscal years ended December 31, 1997, 1996 and 1995, the Portfolio
paid to PaineWebber brokerage commissions in the amounts of $558, $852 and
$1,400, respectively. The $558 in brokerage commissions paid by Growth and
Income Portfolio to PaineWebber during the fiscal year ended December 31, 1997
represented 1.42% of the aggregate brokerage commissions paid by that
Portfolio and 1.12% of the aggregate dollar amount of transactions involving
the payment of commissions.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs") who receive brokerage commissions for their services. The
Fund's procedures in selecting FCMs to execute the Portfolio's transactions in
futures contracts, including procedures permitting the use of Mitchell
Hutchins and its affiliates, are similar to those in effect with respect to
brokerage transactions in securities.
Consistent with the interest of Growth and Income Portfolio and subject to
the review of the board, Mitchell Hutchins may cause the Portfolio to purchase
and sell portfolio securities from and to brokers who provide the Portfolio
with research, analysis, advice and similar services. In return for such
services, the Portfolio may pay to those brokers a higher commission than may
be charged by other brokers, provided that Mitchell Hutchins determines in
good faith that such commission is reasonable in terms either of that
particular transaction or of the overall responsibility of Mitchell Hutchins
to the Portfolio and its other clients and that the total commissions paid by
the Portfolio will be reasonable in relation to the benefits to the Portfolio
over the long term. During the fiscal year ended December 31, 1997, the
Portfolio directed $3,272,033 in portfolio transactions to brokers chosen
because they provide research and analysis, for which the Portfolio paid
$3,843 in brokerage commissions.
24
<PAGE>
For purchases or sales with broker-dealer firms that act as principal,
Mitchell Hutchins seeks best execution. Although Mitchell Hutchins may receive
certain research or execution services in connection with these transactions,
Mitchell Hutchins will not purchase securities at a higher price or sell
securities at a lower price than would otherwise be paid if no weight was
attributed to the services provided by the executing dealer. Moreover,
Mitchell Hutchins will not enter into any explicit soft dollar arrangements
relating to principal transactions and will not receive in principal
transactions the types of services which could be purchased for hard dollars.
Mitchell Hutchins may engage in agency transactions in OTC equity and debt
securities in return for research and execution services. These transactions
are entered into only in compliance with procedures ensuring that the
transaction (including commissions) is at least as favorable as it would have
been if effected directly with a market-maker that did not provide research or
execution services. These procedures include Mitchell Hutchins receiving
multiple quotes from dealers before executing the transaction on an agency
basis.
Information and research received from such brokers and dealers will be in
addition to, and not in lieu of, the services required to be performed by
Mitchell Hutchins under the Advisory Contract. Research services furnished by
brokers or dealers through which or with which Growth and Income Portfolio
effect securities transactions may be used by Mitchell Hutchins in advising
other funds or accounts and, conversely, research services furnished to
Mitchell Hutchins in connection with these other funds or accounts may be used
in advising the Portfolio.
Investment decisions for Growth and Income Portfolio and for other
investment accounts managed by Mitchell Hutchins are made independently of
each other in light of differing considerations for the various accounts.
However, the same investment decision may occasionally be made for the
Portfolio and one or more of such accounts. In such cases, simultaneous
transactions are inevitable. Purchases or sales are then averaged as to price
and allocated between the Portfolio and such other account(s) as to amount
according to a formula deemed equitable to the Portfolio and such account(s).
While in some cases this practice could have a detrimental effect upon the
price or value of the security as far as the Portfolio is concerned, or upon
its ability to complete its entire order, in other cases it is believed that
coordination and the ability to participate in volume transactions will be
beneficial to the Portfolio.
Growth and Income Portfolio will not purchase securities that are offered in
underwritings in which Mitchell Hutchins or any of its affiliates is a member
of the underwriting or selling group, except pursuant to procedures adopted by
the board pursuant to Rule 10f-3 under the 1940 Act. Among other things, these
procedures require that the commission or spread paid in connection with such
a purchase be reasonable and fair, that the purchase be at not more than the
public offering price prior to the end of the first business day after the
date of the public offering and that Mitchell Hutchins, or any affiliate
thereof not participate in or benefit from the sale to the Portfolio.
PORTFOLIO TURNOVER. The turnover rate may vary greatly from year to year for
Growth and Income Portfolio and will not be a limiting factor when Mitchell
Hutchins deems portfolio changes appropriate. The annual portfolio turnover
rate is calculated by dividing the lesser of the Portfolio's annual sales or
purchases of portfolio securities (exclusive of purchases or sales of
securities whose maturities at the time of acquisition were one year or less)
by the monthly average value of the securities except short-term securities in
the Portfolio during the year. For the fiscal years ended December 31, 1997
and December 31, 1996, the portfolio turnover rates for the Portfolio were 92%
and 99%, respectively.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The insurance company separate accounts purchase and redeem shares of Growth
and Income Portfolio on each day on which the New York Stock Exchange ("NYSE")
is open for trading ("Business Day") based on, among other things, the amount
of premium payments to be invested and surrendered and transfer requests to be
effected on that day pursuant to the variable contracts. Currently, the NYSE
is closed on the observance of New Year's Day, Martin Luther King, Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day. Such purchases and redemptions of the
shares of the Portfolio
25
<PAGE>
are effected at their respective net asset values per share determined as of
the close of regular trading (currently 4:00 p.m., Eastern time) on the NYSE
on that Business Day. Payment for redemptions are made by the Fund within
seven days thereafter. No fee is charged the separate accounts when they
purchase or redeem Portfolio shares.
The Fund may suspend redemption privileges of shares of Growth and Income
Portfolio or postpone the date of payment during any period (1) when the NYSE
is closed or trading on the NYSE is restricted as determined by the SEC, (2)
when an emergency exists, as defined by the SEC, that makes it not reasonably
practicable for the Fund to dispose of securities owned by it or fairly to
determine the value of its assets or (3) as the SEC may otherwise permit. The
redemption price may be more or less than the shareholder's cost, depending on
the market value of the Portfolio's securities at the time.
VALUATION OF SHARES
Growth and Income Portfolio determines its net asset value as of the close
of regular trading (currently 4:00 p.m., Eastern time) on the NYSE on each
Monday through Friday when the NYSE is open.
Securities that are listed on U.S. stock exchanges are valued at the last
sale price on the day the securities are being valued or, lacking any sales on
such day, at the last available bid price. In cases where securities are
traded on more than one exchange, the securities are generally valued on the
exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on the Nasdaq Stock Market ("Nasdaq") are
valued at the last available sale price listed on Nasdaq at 4:00 p.m., Eastern
time; other OTC securities are valued at the last available bid price prior to
the time of valuation.
When market quotations are readily available, the debt securities of Growth
and Income Portfolio are valued based upon market quotations, provided such
quotations adequately reflect, in the judgment of Mitchell Hutchins, the fair
value of the securities. The amortized cost method of valuation generally is
used with respect to debt obligations with 60 days or less remaining to
maturity unless the board determines that this does not represent fair value.
When market quotations for options and futures positions held by the Portfolio
are readily available, those positions are valued based upon such quotations.
Market quotations are not generally available for options traded in the OTC
market. When market quotations for options and futures positions, or any other
securities or assets of the Portfolio, are not available, they are valued at
fair value as determined in good faith by or under the direction of the board.
When practicable, such determinations are based upon appraisals received from
a pricing service using a computerized matrix system or appraisals derived
from information concerning the security or similar securities received from
recognized dealers in those securities. In valuing thinly traded securities
and lower rated corporate bonds, it should be recognized that judgment often
plays a greater role than is the case with respect to securities for which a
broader range of dealer quotations and last-sale information is available.
TAXES
Shares of Growth and Income Portfolio are offered only to insurance company
separate accounts that fund benefits under the Contracts. See the applicable
Contract prospectus for a discussion of the special taxation of insurance
companies with respect to such accounts and of the Contract holders.
Growth and Income Portfolio is treated as a separate corporation for federal
income tax purposes. In order to continue to qualify for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code, the
Portfolio must distribute to its shareholders for each taxable year at least
90% of its investment company taxable income (consisting generally of net
investment income and net short-term capital gain, ("Distribution
Requirement") and must meet several additional requirements. With respect to
the Portfolio, these requirements include the following: (1) the Portfolio
must derive at least 90% of its gross income each taxable year from dividends,
interest, payments with respect to securities loans and gains from the sale or
other
26
<PAGE>
disposition of securities or other income (including gains from options or
futures derived with respect to its business of investing in securities
("Income Requirement"); (2) at the close of each quarter of the Portfolio's
taxable year, at least 50% of the value of its total assets must be
represented by cash and cash items, U.S. government securities, securities of
other RICs and other securities, with these other securities limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value
of the Portfolio's total assets and that does not represent more than 10% of
the issuer's outstanding voting securities; and (3) at the close of each
quarter of the Portfolio's taxable year, not more than 25% of the value of its
total assets may be invested in securities (other than U.S. government
securities or the securities of other RICs) of any one issuer.
As noted in the Prospectus, Growth and Income Portfolio intends to 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
mentioned above, place certain limitations on the proportion of the
Portfolio's assets that may be represented by any single investment (which
includes all securities of the same issuer). For these purposes, each U.S.
government agency or instrumentality is treated as a separate issuer.
The use of hedging and related strategies, such as selling (writing) and
purchasing options and futures contracts, involves complex rules that will
determine for income tax purposes the amount, character and timing of
recognition of the gains and losses Growth and Income Portfolio realizes in
connection therewith. Gains from the options and futures derived by the
Portfolio with respect to its business of investing in securities will qualify
as permissible income under the Income Requirement.
Growth and Income Portfolio may invest in the stock of "passive foreign
investment companies" ("PFICs"). A PFIC is a foreign corporation--other than a
"controlled foreign corporation" (i.e., a foreign corporation in which, on any
day during its taxable year, more than 50% of the total voting power of all
voting stock therein or the total value of all stock therein is owned,
directly, indirectly, or constructively, by "U.S. shareholders," defined as
U.S. persons that individually own, directly, indirectly, or constructively,
at least 10% of that voting power) as to which the Portfolio is a U.S.
shareholder--that, in general, meets either of the following tests: (1) at
least 75% of its gross income is passive or (2) an average of at least 50% of
its assets produce, or are held for the production of, passive income. Under
certain circumstances, the Portfolio will be subject to federal income tax on
a portion of any "excess distribution" received on the stock of a PFIC or of
any gain from disposition of such stock (collectively "PFIC income"), plus
interest thereon, even if the Portfolio distributes the PFIC income as a
taxable dividend to its shareholders. The balance of the PFIC income will be
included in the Portfolio's investment company taxable income and,
accordingly, will not be taxable to it to the extent that income is
distributed to its shareholders.
If Growth and Income Portfolio invests in a PFIC and elects to treat the
PFIC as a "qualified electing fund" ("QEF"), then in lieu of the foregoing tax
and interest obligation, the Portfolio would be required to include in income
each year its pro rata share of the QEF's annual ordinary earnings and net
capital gain (the excess of net long-term capital gain over net short-term
capital loss)--which most likely would have to be distributed to the
Portfolio's shareholders to satisfy the Distribution Requirement--even if
those earnings and gain were not distributed to the Portfolio by the QEF. In
most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
Growth and Income Portfolio may elect to "mark-to-market" its stock in any
PFIC. "Marking-to-market," in this context, means including in ordinary income
each taxable year the excess, if any, of the fair market value of a PFIC's
stock over the Portfolio's adjusted basis therein as of the end of that year.
Pursuant to the election, the Portfolio also would be allowed to deduct (as an
ordinary, not capital, loss) the excess, if any, of its adjusted basis in PFIC
stock over the fair market value thereof as of the taxable year-end, but only
to the extent of any net mark-to-market gains with respect to that stock
included by the Portfolio for prior taxable years. The Portfolio's adjusted
basis in each PFIC's stock with respect to which it makes this election will
be adjusted to reflect the amounts of income included and deductions taken
under the election. Regulations proposed in 1992 would provide a similar
election with respect to the stock of certain PFICs.
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If Growth and Income Portfolio has an "appreciated financial position"--
generally, an interest (including an interest through an option, future or
short sale) with respect to any stock, debt instrument (other than "straight
debt"), or partnership interest the fair market value of which exceeds its
adjusted basis--and enters into a "constructive sale" of the same or
substantially similar property, the Portfolio will be treated as having made
an actual sale thereof, with the result that gain will be recognized at that
time. A constructive sale generally consists of a short sale, an offsetting
notional principal contract, or futures or forward contract entered into by
the Portfolio or a related person with respect to the same or substantially
similar property. In addition, if the appreciated financial position is itself
a short sale or such a contract, acquisition of the underlying property or
substantially similar property will be deemed a constructive sale.
The foregoing is only a general summary of some of the important federal
income tax considerations generally affecting Growth and Income Portfolio and
its shareholders. No attempt is made to present a complete explanation of the
federal tax treatment of the Portfolio's activities, and this discussion is
not intended as a substitute for careful tax planning. Accordingly, potential
investors are urged to consult their own tax advisers for more detailed
information and for information regarding any state, local or foreign taxes
applicable to the Portfolio and to dividends and other distributions
therefrom.
OTHER INFORMATION
Prior to August 14, 1995, the name of Growth and Income Portfolio was
"Dividend Growth Portfolio." Prior to November 19, 1997, the Fund was known as
"PaineWebber Series Trust."
The Fund is an entity of the type commonly known as a "Massachusetts
business trust." Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Fund or
Growth and Income Portfolio. However, the Fund's Declaration of Trust
disclaims shareholder liability for acts or obligations of the Fund or the
Portfolio and requires that notice of such disclaimer be given in each note,
bond, contract, instrument, certificate or undertaking made or issued by the
trustees or by any officers or officer by or on behalf of the Fund, the
trustees or any of them in connection with the Fund. The Declaration of Trust
provides for indemnification from Fund or Portfolio property, as appropriate,
for all losses and expenses of any shareholder held personally liable for the
obligations of the Fund or Portfolio. Thus, the risk of a shareholder's
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund or Portfolio itself would be unable to meet
its obligations, a possibility that Mitchell Hutchins believes is remote and
not material. Upon payment of any liability incurred by a shareholder of a
Portfolio, the shareholder paying such liability will be entitled to
reimbursement from the general assets of the Portfolio. The board intends to
conduct the operations of the Fund so as to avoid, as far as possible,
ultimate liability of the shareholders for liabilities of the Fund and the
Portfolio.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C. 20036-1800, serves as counsel to the Fund.
Kirkpatrick & Lockhart LLP also acts as counsel to Mitchell Hutchins and
PaineWebber in connection with other matters.
AUDITORS. Ernst & Young LLP, 787 Seventh Avenue, New York, New York 10019,
serves as independent auditors for the Fund.
FINANCIAL STATEMENTS
The Fund's Annual Report to shareholders for the fiscal year ended December
31, 1997 is a separate document supplied with this Statement of Additional
Information, and the financial statements, accompanying notes and report of
independent auditors appearing therein with respect to Growth and Income
Portfolio are incorporated by reference in this Statement of Additional
Information.
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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 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
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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.
"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.
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