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Statement of Additional Information Dated February 3, 1997
as revised and supplemented through June 9, 1997
STEIN ROE INVESTMENT TRUST
Suite 3200, One South Wacker Drive, Chicago, Illinois 60606
800-338-2550
Stein Roe Emerging Markets Fund
This Statement of Additional Information is not a
prospectus, but provides additional information that should be
read in conjunction with the Fund's prospectus dated February 3,
1997, and any supplements thereto ("Prospectus"). The Prospectus
may be obtained at no charge by telephoning 800-338-2550.
TABLE OF CONTENTS
Page
General Information and History.............................2
Investment Policies.........................................3
Special Considerations......................................3
Portfolio Investments and Strategies........................7
Investment Restrictions....................................24
Additional Investment Considerations.......................27
Purchases and Redemptions..................................28
Management.................................................29
Principal Shareholders.....................................33
Investment Advisory Services...............................33
Distributor................................................35
Transfer Agent.............................................36
Custodian..................................................36
Independent Public Accountants.............................37
Portfolio Transactions.....................................37
Additional Income Tax Considerations.......................38
Investment Performance.....................................39
Appendix--Ratings..........................................43
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GENERAL INFORMATION AND HISTORY
Stein Roe Emerging Markets Fund (the "Fund") is a series of
the Stein Roe Investment Trust (the "Trust"). Each series of the
Trust represents shares of beneficial interest in a separate
portfolio of securities and other assets, with its own objectives
and policies. On February 1, 1996, the name of the Trust was
changed from SteinRoe Investment Trust to Stein Roe Investment
Trust.
Stein Roe & Farnham Incorporated (the "Adviser") provides
investment advisory and administrative services to the Fund
through its Global Capital Management division.
As of the date of this Statement of Additional Information,
ten series of the Trust are authorized and outstanding. Each
share of a series, without par value, is entitled to participate
pro rata in any dividends and other distributions declared by the
Board on shares of that series, and all shares of a series have
equal rights in the event of liquidation of that series. Each
whole share (or fractional share) outstanding on the record date
established in accordance with the By-Laws shall be entitled to a
number of votes on any matter on which it is entitled to vote
equal to the net asset value of the share (or fractional share)
in United States dollars determined at the close of business on
the record date (for example, a share having a net asset value of
$10.50 would be entitled to 10.5 votes). As a business trust,
the Trust is not required to hold annual shareholder meetings.
However, special meetings may be called for purposes such as
electing or removing trustees, changing fundamental policies, or
approving an investment advisory contract. If requested to do so
by the holders of at least 10% of the Trust's outstanding shares,
the Trust will call a special meeting for the purpose of voting
upon the question of removal of a trustee or trustees and will
assist in the communications with other shareholders as if the
Trust were subject to Section 16(c) of the Investment Company Act
of 1940. All shares of all series of the Trust are voted
together in the election of trustees. On any other matter
submitted to a vote of shareholders, shares are voted in the
aggregate and not by individual series, except that shares are
voted by individual series when required by the Investment
Company Act of 1940 or other applicable law, or when the Board of
Trustees determines that the matter affects only the interests of
one or more series, in which case shareholders of the unaffected
series are not entitled to vote on such matters.
Special Considerations Regarding Master Fund/Feeder Fund
Structure
The Fund may in the future seek to achieve its objective by
pooling its assets with assets of other investment companies for
investment in another investment company having the same
investment objective and substantially the same investment
policies as the Fund. The purpose of such an arrangement is to
achieve greater operational efficiencies and reduce costs. The
Adviser is expected to manage any such mutual fund in which a
Fund would invest. Such investment would be subject to
determination by the trustees that it was in the best interests
of the Fund and its shareholders, and shareholders would receive
advance notice of any such change.
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INVESTMENT POLICIES
In pursuing its objective, the Fund will invest as described
below and may employ the investment techniques described in the
Prospectus and under Portfolio Investments and Strategies in this
Statement of Additional Information. The Fund's investment
objective is non-fundamental and may be changed by the Board of
Trustees without the approval of a "majority of the outstanding
voting securities" /1/ of the Fund.
The Fund's investment objective is to seek capital
appreciation primarily through investing in companies in emerging
markets. Under normal markets conditions, the Fund will invest
at least 65% of its total assets (taken at market value) in
equity securities of emerging market issuers. The Fund does not
intend to concentrate investments in any particular industry. In
addition, there is no limitation on the amount the Fund can
invest in a specific country or region of the world. However,
the Fund intends to diversify its investment among several
countries.
The Fund is intended for long-term investors and not for
short-term trading purposes. It should not be considered a
complete investment program. Many investments in emerging
markets can be considered speculative, and the value of those
investments can be more volatile than is typical in more
developed foreign markets.
The Fund considers "emerging markets" to include any country
that is defined as an emerging or developing country by (i) the
World Bank, (ii) the International Finance Corporation or (iii)
the United Nations or its authorities. The Fund's investments
will include, but are not limited to, securities of companies
located within countries in Asia, Africa, Latin America and
certain parts of Europe. The Fund considers an issuer to be an
"emerging markets issuer" if:
- - the issuer is organized under the laws of an emerging market
country;
the principal securities trading market for the issuer's
securities is in an emerging market country;
- - the issuer derives at least 50% of its revenue from goods
produced or services rendered in emerging market countries; or
- - at least 50% of the issuer's assets are located in emerging
market countries.
SPECIAL CONSIDERATIONS
Foreign Investing
The Fund invests primarily in foreign securities (including
emerging market securities), which may entail a greater degree of
risk (including risks relating to exchange rate fluctuations, tax
provisions, or expropriation of assets) than investment in
securities of domestic issuers. The Fund may also purchase
foreign securities in the form of American Depositary Receipts
(ADRs), European Depositary Receipts
- -------------------
/1/ A "majority of the outstanding voting securities" means the
approval of the lesser of (i) 67% or more of the shares at a
meeting if the holders of more than 50% of the outstanding shares
of the Fund are present or represented by proxy or (ii) more than
50% of the outstanding shares of the Fund.
- -------------------
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(EDRs), or other securities representing underlying shares of
foreign issuers. Positions in these securities are not
necessarily denominated in the same currency as the common stocks
into which they may be converted. ADRs are receipts typically
issued by an American bank or trust company evidencing ownership
of the underlying securities. EDRs are European receipts
evidencing a similar arrangement. Generally, ADRs, in registered
form, are designed for the U.S. securities markets and EDRs, in
bearer form, are designed for use in European securities markets.
The Fund may invest in sponsored or unsponsored ADRs. In the
case of an unsponsored ADR, the Fund is likely to bear its
proportionate share of the expenses of the depositary and it may
have greater difficulty in receiving shareholder communications
than it would have with a sponsored ADR.
With respect to portfolio securities that are issued by
foreign issuers or denominated in foreign currencies, the Fund's
investment performance is affected by the strength or weakness of
the U.S. dollar against these currencies. For example, if the
dollar falls in value relative to the Japanese yen, the dollar
value of a yen-denominated stock held in the portfolio will rise
even though the price of the stock remains unchanged.
Conversely, if the dollar rises in value relative to the yen, the
dollar value of the yen-denominated stock will fall. (See
discussion of transaction hedging and portfolio hedging under
Portfolio Investments and Strategies--Currency Exchange
Transactions.)
Investors should understand and consider carefully the risks
involved in foreign investing. Investing in foreign securities,
positions in which are generally denominated in foreign
currencies, and utilization of forward foreign currency exchange
contracts involve certain considerations comprising both risks
and opportunities not typically associated with investing in U.S.
securities. These considerations include: fluctuations in
exchange rates of foreign currencies; possible imposition of
exchange control regulation or currency restrictions that would
prevent cash from being brought back to the United States; less
public information with respect to issuers of securities; less
governmental supervision of stock exchanges, securities brokers,
and issuers of securities; lack of uniform accounting, auditing,
and financial reporting standards; lack of uniform settlement
periods and trading practices; less liquidity and frequently
greater price volatility in foreign markets than in the United
States; possible imposition of foreign taxes; possible investment
in securities of companies in developing as well as developed
countries; and sometimes less advantageous legal, operational,
and financial protections applicable to foreign sub-custodial
arrangements. The risks are greater for emerging market
countries.
Investing in Emerging Markets
Investments in emerging markets securities include special
risks in addition to those generally associated with foreign
investing. Many investments in emerging markets can be
considered speculative, and the value of those investments can be
more volatile than in more developed foreign markets. This
difference reflects the greater uncertainties of investing in
less established markets and economies. Emerging markets also
have different clearance and settlement procedures, and in
certain markets there have been times when settlements have not
kept pace with the volume of securities transactions, making it
difficult to conduct such transactions.
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Delays in settlement could result in temporary periods when a
portion of the assets of the Fund is uninvested and no return is
earned thereon. The inability of the Fund to make intended
security purchases due to settlement problems could cause the
Fund to miss attractive investment opportunities. Inability to
dispose of portfolio securities due to settlement problems could
result either in losses to the Fund due to subsequent declines in
the value of those securities or, if the Fund has entered into a
contract to sell a security, in possible liability to the
purchaser. Costs associated with transactions in emerging
markets securities are typically higher than costs associated
with transactions in U.S. securities. Such transactions also
involve additional costs for the purchase or sale of foreign
currency.
Certain foreign markets (including emerging markets) may
require governmental approval for the repatriation of investment
income, capital or the proceeds of sales of securities by foreign
investors. In addition, if a deterioration occurs in an emerging
market's balance of payments or for other reasons, a country
could impose temporary restrictions on foreign capital
remittances. The Fund could be adversely affected by delays in,
or a refusal to grant, required governmental approval for
repatriation of capital, as well as by the application to the
Fund of any restrictions on investments.
The risk also exists that an emergency situation may arise
in one or more emerging markets. As a result, trading of
securities may cease or may be substantially curtailed and prices
for the Fund's securities in such markets may not be readily
available. The Fund may suspend redemption of its shares for any
period during which an emergency exists, as determined by the
Securities and Exchange Commission (the "SEC"). Accordingly, if
the Fund believes that appropriate circumstances exist, it will
promptly apply to the SEC for a determination that such an
emergency is present. During the period commencing from the
Fund's identification of such condition until the date of the SEC
action, the Fund's securities in the affected markets will be
valued at fair value determined in good faith by or under the
direction of the Trust's Board of Trustees.
Volume and liquidity in most foreign markets are lower than
in the U.S. Fixed commissions on foreign securities exchanges
are generally higher than negotiated commissions on U.S.
exchanges, although the Fund endeavors to achieve the most
favorable net results on its portfolio transactions. There is
generally less government supervision and regulation of business
and industry practices, securities exchanges, brokers, dealers
and listed companies than in the U.S. Mail service between the
U.S. and foreign countries may be slower or less reliable than
within the U.S., thus increasing the risk of delayed settlements
of portfolio transactions or loss of certificates for portfolio
securities. In addition, with respect to certain emerging
markets, there is the possibility of expropriation or
confiscatory taxation, political or social instability, or
diplomatic developments which could affect the Fund's investments
in those countries. Moreover, individual emerging market
economies may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product,
rate of inflation, capital reinvestment, resource self-
sufficiency and balance of payments position.
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Income from securities held by the Fund could be reduced by
a withholding tax on the source or other taxes imposed by the
emerging market countries in which the Fund invests. The Fund's
net asset value may also be affected by changes in the rates of
methods or taxation applicable to the Fund or to entities in
which the Fund has invested. The Adviser will consider the cost
of any taxes in determining whether to acquire any particular
investments, but can provide no assurance that the taxes will not
be subject to change.
Many emerging markets have experienced substantial rates of
inflation for many years. Inflation and rapid fluctuations in
inflation rates have had and may continue to have adverse effects
on the economies and securities markets of certain emerging
market countries. In an attempt to control inflation, wage and
price controls have been imposed in certain countries. Of these
countries, some, in recent years, have begun to control inflation
through prudent economic policies.
Emerging market governmental issuers are among the largest
debtors to commercial banks, foreign governments, international
financial organizations and other financial institutions.
Certain emerging market governmental issuers have not been able
to make payments of interest or principal on debt obligations as
those payments have come due. Obligations arising from past
restructuring agreements may affect the economic performance and
political and social stability of those issuers.
Governments of many emerging market countries have exercised
and continue to exercise substantial influence over many aspects
of the private sector through ownership or control of many
companies, including some of the largest in any given country.
As a result, government actions in the future could have a
significant effect on economic conditions in emerging markets,
which in turn, may adversely affect companies in the private
sector, general market conditions and prices and yields of
certain of the securities in the Fund's portfolio.
Expropriation, confiscatory taxation, nationalization, political,
economic or social instability or other similar developments have
occurred frequently over the history of certain emerging markets
and could adversely affect the Fund's assets should these
conditions recur.
The ability of emerging market country governmental issuers
to make timely payments on their obligations is likely to be
influenced strongly by the issuer's balance of payments,
including export performance, and its access to international
credits and investments. An emerging market whose exports are
concentrated in a few commodities could be vulnerable to a
decline in the international prices of one or more of those
commodities. Increased protectionism on the part of an emerging
market's trading partners could also adversely affect the
country's exports and diminish its trade account surplus, if any.
To the extent that emerging markets receive payment for their
exports in currencies other than dollars or non-emerging market
currencies, their ability to make debt payments denominated in
dollars or non-emerging market currencies could be affected.
Another factor bearing on the ability of an emerging market
country to repay debt obligations is the level of international
reserves of the country. Fluctuations in the level of these
reserves affect the amount of foreign exchange readily available
for
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external debt payments and thus could have a bearing on the
capacity of emerging market countries to make payments on these
debt obligations.
To the extent that an emerging market country cannot
generate a trade surplus, it must depend on continuing loans from
foreign governments, multilateral organizations or private
commercial banks, aid payments from foreign governments and on
inflows of foreign investment. The access of emerging markets to
these forms of external funding may not be certain, and a
withdrawal of external funding could adversely affect the
capacity of emerging market country governmental issuers to make
payments on their obligations. In addition, the cost of
servicing emerging market debt obligations can be affected by a
change in international interest rates since the majority of
these obligations carry interest rates that are adjusted
periodically based upon international rates.
PORTFOLIO INVESTMENTS AND STRATEGIES
Medium- and Lower-Quality Debt Securities
The Fund may invest in medium- and lower-quality debt
securities. Medium-quality debt securities, although considered
investment grade, have some speculative characteristics. Lower-
quality securities, commonly referred to as "junk bonds," are
those rated below the fourth highest rating category or those of
comparable quality.
Investment in medium- and lower-quality debt securities
involves greater investment risk, including the possibility of
issuer default or bankruptcy. The Fund will diversify its
holdings among a number of issuers to help minimize this risk.
An economic downturn could severely disrupt this market and
adversely affect the value of outstanding bonds and the ability
of the issuers to repay principal and interest. In addition,
lower-quality bonds are less sensitive to interest rate changes
than higher-quality instruments and generally are more sensitive
to adverse economic changes or individual corporate developments.
During a period of adverse economic changes, including a period
of rising interest rates, issuers of such bonds may experience
difficulty in servicing their principal and interest payment
obligations.
Lower-quality debt securities are obligations of issuers
that are considered predominantly speculative with respect to the
issuer's capacity to pay interest and repay principal according
to the terms of the obligation. These securities carry greater
investment risk, including the possibility of issuer default and
bankruptcy, and are commonly referred to as "junk bonds." The
lowest rating assigned by Moody's is for bonds that can be
regarded as having extremely poor prospects of ever attaining any
real investment standing.
Achievement of the investment objective will be more
dependent on the Adviser's credit analysis than would be the case
if the Fund were investing in higher-quality debt securities.
Since the ratings of rating services (which evaluate the safety
of principal and interest payments, not market risks) are used
only as preliminary indicators of investment quality, the Adviser
employs its own credit research and
<PAGE> 8
analysis, from which it has developed a proprietary credit rating
system based upon comparative credit analyses of issuers within
the same industry. These analyses may take into consideration
such quantitative factors as an issuer's present and potential
liability, profitability, internal capability to generate funds,
debt/equity ratio and debt servicing capabilities, and such
qualitative factors as an assessment of management, industry
characteristics, accounting methodology, and foreign business
exposure.
Medium- and lower-quality debt securities tend to be less
marketable than higher-quality debt securities because the market
for them is less broad. The market for unrated debt securities
is even narrower. During periods of thin trading in these
markets, the spread between bid and asked prices is likely to
increase significantly, and the Fund may have greater difficulty
selling its portfolio securities. The market value of these
securities and their liquidity may be affected by adverse
publicity and investor perceptions.
Derivatives
Consistent with its objective, the Fund may invest in a
broad array of financial instruments and securities, including
conventional exchange-traded and non-exchange-traded options,
futures contracts, futures options, forward contracts, securities
collateralized by underlying pools of mortgages or other
receivables, floating rate instruments, and other instruments
that securitize assets of various types ("Derivatives"). In each
case, the value of the instrument or security is "derived" from
the performance of an underlying asset or a "benchmark" such as a
security index, an interest rate, or a currency.
Derivatives are most often used to manage investment risk or
to create an investment position indirectly because it is more
efficient or less costly than direct investment that cannot be
readily established directly due to portfolio size, cash
availability, or other factors. They also may be used in an
effort to enhance portfolio returns.
The successful use of Derivatives depends on the Adviser's
ability to correctly predict changes in the levels and directions
of movements in currency exchange rates, security prices,
interest rates and other market factors affecting the Derivative
itself or the value of the underlying asset or benchmark. In
addition, correlations in the performance of an underlying asset
to a Derivative may not be well established. Finally, privately
negotiated and over-the-counter Derivatives may not be as well
regulated and may be less marketable than exchange-traded
Derivatives.
The Fund does not currently intend to invest more than 5% of
its net assets in any type of Derivative.
Defensive Investments
When the Adviser considers a temporary defensive position
advisable, the Fund may invest, without limitation, in high-
quality fixed income securities or hold assets in cash or cash
equivalents.
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Foreign Securities
Currency Exchange Transactions. Currency exchange
transactions may be conducted either on a spot (i.e., cash) basis
at the spot rate for purchasing or selling currency prevailing in
the foreign exchange market or through forward currency exchange
contracts ("forward contracts"). Forward contracts are
contractual agreements to purchase or sell a specified currency
at a specified future date (or within a specified time period)
and price set at the time of the contract. Forward contracts are
usually entered into with banks and broker-dealers, are not
exchange traded, and are usually for less than one year, but may
be renewed.
The Fund's foreign currency exchange transactions are
limited to transaction hedging and portfolio hedging involving
either specific transactions or portfolio positions, except to
the extent described below under "Synthetic Foreign Money Market
Positions." Transaction hedging is the purchase or sale of
forward contracts with respect to specific receivables or
payables of the Fund arising in connection with the purchase and
sale of its portfolio securities. Portfolio hedging is the use
of forward contracts with respect to portfolio security positions
denominated or quoted in a particular foreign currency.
Portfolio hedging allows the Fund to limit or reduce its exposure
in a foreign currency by entering into a forward contract to sell
such foreign currency (or another foreign currency that acts as a
proxy for that currency) at a future date for a price payable in
U.S. dollars so that the value of the foreign-denominated
portfolio securities can be approximately matched by a foreign-
denominated liability. The Fund may not engage in portfolio
hedging with respect to the currency of a particular country to
an extent greater than the aggregate market value (at the time of
making such sale) of the securities held in its portfolio
denominated or quoted in that particular currency, except that
the Fund may hedge all or part of its foreign currency exposure
through the use of a basket of currencies or a proxy currency
where such currencies or currency act as an effective proxy for
other currencies. In such a case, the Fund may enter into a
forward contract where the amount of the foreign currency to be
sold exceeds the value of the securities denominated in such
currency. The use of this basket hedging technique may be more
efficient and economical than entering into separate forward
contracts for each currency held in the Fund. The Fund may not
engage in "speculative" currency exchange transactions.
At the maturity of a forward contract to deliver a
particular currency, the Fund may either sell the portfolio
security related to such contract and make delivery of the
currency, or it may retain the security and either acquire the
currency on the spot market or terminate its contractual
obligation to deliver the currency by purchasing an offsetting
contract with the same currency trader obligating it to purchase
on the same maturity date the same amount of the currency.
It is impossible to forecast with absolute precision the
market value of portfolio securities at the expiration of a
forward contract. Accordingly, it may be necessary for the Fund
to purchase additional currency on the spot market (and bear the
expense of such purchase) if the market value of the security is
less than the amount of currency the Fund is obligated to deliver
and if a decision is made to sell the security and make delivery
of the currency. Conversely, it may be necessary to sell on
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the spot market some of the currency received upon the sale of
the portfolio security if its market value exceeds the amount of
currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss to
the extent that there has been movement in forward contract
prices. If the Fund engages in an offsetting transaction, it may
subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period
between the Fund's entering into a forward contract for the sale
of a currency and the date it enters into an offsetting contract
for the purchase of the currency, the Fund will realize a gain to
the extent the price of the currency it has agreed to sell
exceeds the price of the currency it has agreed to purchase.
Should forward prices increase, the Fund will suffer a loss to
the extent the price of the currency it has agreed to purchase
exceeds the price of the currency it has agreed to sell. A
default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase
or sale of currency, if any, at the current market price.
Hedging against a decline in the value of a currency does
not eliminate fluctuations in the prices of portfolio securities
or prevent losses if the prices of such securities decline. Such
transactions also preclude the opportunity for gain if the value
of the hedged currency should rise. Moreover, it may not be
possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to
sell the currency at a price above the devaluation level it
anticipates. The cost to the Fund of engaging in currency
exchange transactions varies with such factors as the currency
involved, the length of the contract period, and prevailing
market conditions. Since currency exchange transactions are
usually conducted on a principal basis, no fees or commissions
are involved.
Synthetic Foreign Money Market Positions. The Fund may
invest in money market instruments denominated in foreign
currencies. In addition to, or in lieu of, such direct
investment, the Fund may construct a synthetic foreign money
market position by (a) purchasing a money market instrument
denominated in one currency, generally U.S. dollars, and (b)
concurrently entering into a forward contract to deliver a
corresponding amount of that currency in exchange for a different
currency on a future date and at a specified rate of exchange.
For example, a synthetic money market position in Japanese yen
could be constructed by purchasing a U.S. dollar money market
instrument, and entering concurrently into a forward contract to
deliver a corresponding amount of U.S. dollars in exchange for
Japanese yen on a specified date and at a specified rate of
exchange. Because of the availability of a variety of highly
liquid short-term U.S. dollar money market instruments, a
synthetic money market position utilizing such U.S. dollar
instruments may offer greater liquidity than direct investment in
foreign currency money market instruments. The result of a
direct investment in a foreign currency and a concurrent
construction of a synthetic position in such foreign currency, in
terms of both income yield and gain or loss from changes in
currency exchange rates, in general should be similar, but would
not be identical because the components of the alternative
investments would not be identical. Except to the extent a
synthetic foreign money market position consists of a money
market instrument denominated in a foreign currency, the
synthetic foreign money market position shall not be deemed a
<PAGE> 11
"foreign security" for purposes of the policy that, under normal
conditions, the Fund will invest at least 65% of its total assets
in foreign securities.
Brady Bonds
The Fund may invest in "Brady Bonds," which are debt
securities issued under the framework of the Brady Plan as a
mechanism for debtor countries to restructure their outstanding
bank loans. Most "Brady Bonds" have their principal
collateralized by zero coupon U.S. Treasury bonds. Brady Bonds
have been issued only in recent years, and, accordingly, do not
have a long payment history.
U.S. dollar-denominated, collateralized Brady Bonds, which
may be fixed rate par bonds or floating rate discount bonds, are
generally collateralized in full as to principal due at maturity
by U.S. Treasury zero coupon obligations which have the same
maturity as the Brady Bonds. Interest payments on these Brady
Bonds generally are collateralized by cash or securities in an
amount that, in the case of fixed rate bonds, is equal to at
least one year of rolling interest payments or, in the case of
floating rate bonds, initially is equal to at least one year's
rolling interest payments based on the applicable interest rate
at the time and is adjusted at regular intervals thereafter.
Certain Brady Bonds are entitled to "value recovery payments" in
certain circumstances, which in effect constitute supplemental
interest payments but generally are not collateralized. Brady
Bonds are often viewed as having three or four valuation
components: (i) the collateralized repayment of principal at
final maturity; (ii) the collateralized interest payments; (iii)
the uncollateralized interest payments; and (iv) any
uncollateralized repayment of principal at maturity (these
uncollateralized amounts constitute the "residual risk"). In the
event of a default with respect to collateralized Brady Bonds as
a result of which the payment obligations of the issuer are
accelerated, the U.S. Treasury zero coupon obligations held as
collateral for the payment of principal will not be distributed
to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held to the scheduled
maturity of the defaulted Brady Bonds by the collateral agent, at
which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady
Bonds in the normal course. In addition, in light of the
residual risk of the Brady Bonds and, among other factors, the
history of defaults with respect to commercial bank loans by
public and private entities of countries issuing Brady Bonds,
investments in Brady Bonds will be viewed as speculative.
Sovereign Debt Obligations
The Fund may purchase sovereign debt instruments issued or
guaranteed by foreign governments or their agencies, including
debt of emerging market countries. Sovereign debt of emerging
market countries may involve a high degree of risk, and may be in
default or present the risk of default. Governmental entities
responsible for repayment of the debt may be unable or unwilling
to repay principal and interest when due, and may require
renegotiation or rescheduling of debt payments. In addition,
prospects for repayment of principal and interest may depend on
political as well as economic factors.
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Lending of Portfolio Securities
Subject to restriction (5) under Investment Restrictions in
this Statement of Additional Information, the Fund may lend its
portfolio securities to broker-dealers and banks. Any such loan
must be continuously secured by collateral in cash or cash
equivalents maintained on a current basis in an amount at least
equal to the market value of the securities loaned by the Fund.
The Fund would continue to receive the equivalent of the interest
or dividends paid by the issuer on the securities loaned, and
would also receive an additional return that may be in the form
of a fixed fee or a percentage of the collateral. The Fund would
have the right to call the loan and obtain the securities loaned
at any time on notice of not more than five business days. The
Fund would not have the right to vote the securities during the
existence of the loan but would call the loan to permit voting of
the securities if, in the Adviser's judgment, a material event
requiring a shareholder vote would otherwise occur before the
loan was repaid. In the event of bankruptcy or other default of
the borrower, the Fund could experience both delays in
liquidating the loan collateral or recovering the loaned
securities and losses, including (a) possible decline in the
value of the collateral or in the value of the securities loaned
during the period while the Fund seeks to enforce its rights
thereto, (b) possible subnormal levels of income and lack of
access to income during this period, and (c) expenses of
enforcing its rights.
Repurchase Agreements
The Fund may invest in repurchase agreements, provided that
it will not invest more than 15% of net assets in repurchase
agreements maturing in more than seven days and any other
illiquid securities. A repurchase agreement is a sale of
securities to the Fund in which the seller agrees to repurchase
the securities at a higher price, which includes an amount
representing interest on the purchase price, within a specified
time. In the event of bankruptcy of the seller, the Fund could
experience both losses and delays in liquidating its collateral.
Structured Notes
Structured Notes are Derivatives on which the amount of
principal repayment and or interest payments is based upon the
movement of one or more factors. These factors include, but are
not limited to, currency exchange rates, interest rates (such as
the prime lending rate and the London Interbank Offered Rate
("LIBOR")), stock indices such as the S&P 500 Index and the price
fluctuations of a particular security. In some cases, the impact
of the movements of these factors may increase or decrease
through the use of multipliers or deflators. The use of
Structured Notes allows the Fund to tailor its investments to the
specific risks and returns the Adviser wishes to accept while
avoiding or reducing certain other risks.
When-Issued and Delayed-Delivery Securities; Reverse Repurchase
Agreements
The Fund may purchase securities on a when-issued or
delayed-delivery basis. Although the payment and interest terms
of these securities are established at the time the Fund enters
into the commitment, the securities may be delivered and paid for
a month or more after the date of purchase, when their value may
have
<PAGE> 13
changed. The Fund makes such commitments only with the intention
of actually acquiring the securities, but may sell the securities
before settlement date if the Adviser deems it advisable for
investment reasons. The Fund may utilize spot and forward
foreign currency exchange transactions to reduce the risk
inherent in fluctuations in the exchange rate between one
currency and another when securities are purchased or sold on a
when-issued or delayed-delivery basis.
The Fund may enter into reverse repurchase agreements with
banks and securities dealers. A reverse repurchase agreement is
a repurchase agreement in which the Fund is the seller of, rather
than the investor in, securities and agrees to repurchase them at
an agreed-upon time and price. Use of a reverse repurchase
agreement may be preferable to a regular sale and later
repurchase of securities because it avoids certain market risks
and transaction costs.
At the time the Fund enters into a binding obligation to
purchase securities on a when-issued basis or enters into a
reverse repurchase agreement, liquid assets (cash, U.S.
Government securities or other "high-grade" debt obligations) of
the Fund having a value at least as great as the purchase price
of the securities to be purchased will be segregated on the books
of the Fund and held by the custodian throughout the period of
the obligation. The use of these investment strategies, as well
as borrowing under a line of credit as described below, may
increase net asset value fluctuation.
Convertible Securities
By investing in convertible securities, the Fund obtains the
right to benefit from the capital appreciation potential in the
underlying stock upon exercise of the conversion right, while
earning higher current income than would be available if the
stock were purchased directly. In determining whether to
purchase a convertible, the Adviser will consider substantially
the same criteria that would be considered in purchasing the
underlying stock. While convertible securities purchased by the
Fund are frequently rated investment grade, the Fund also may
purchase unrated securities or securities rated below investment
grade if the securities meet the Adviser's other investment
criteria. Convertible securities rated below investment grade
(a) tend to be more sensitive to interest rate and economic
changes, (b) may be obligations of issuers who are less
creditworthy than issuers of higher quality convertible
securities, and (c) may be more thinly traded due to such
securities being less well known to investors than either common
stock or conventional debt securities. As a result, the
Adviser's own investment research and analysis tends to be more
important in the purchase of such securities than other factors.
Short Sales Against the Box
The Fund may sell securities short against the box; that is
enter into short sales of securities that it currently owns or
has the right to acquire through the conversion or exchange of
other securities that it owns at no additional cost. The Fund
may make short sales of securities only if at all times when a
short position is open the Fund owns at least an equal amount of
such securities or securities convertible into or exchangeable
for securities of the same issue as, and equal in amount to, the
securities sold short, at no additional cost.
<PAGE> 14
In a short sale against the box, a Fund does not deliver
from its portfolio the securities sold. Instead, the Fund
borrows the securities sold short from a broker-dealer through
which the short sale is executed, and the broker-dealer delivers
such securities, on behalf of the Fund, to the purchaser of such
securities. The Fund is required to pay to the broker-dealer the
amount of any dividends paid on shares sold short. Finally, to
secure its obligations to deliver to such broker-dealer the
securities sold short, the Fund must deposit and continuously
maintain in a separate account with its custodian an equivalent
amount of the securities sold short or securities convertible
into or exchangeable for such securities at no additional cost.
The Fund is said to have a short position in the securities sold
until it delivers to the broker-dealer the securities sold. The
Fund may close out a short position by purchasing on the open
market and delivering to the broker-dealer an equal amount of the
securities sold short, rather than by delivering portfolio
securities.
Short sales may protect the Fund against the risk of losses
in the value of its portfolio securities because any unrealized
losses with respect to such portfolio securities should be wholly
or partially offset by a corresponding gain the short position.
However, any potential gains in such portfolio securities should
be wholly or partially offset by a corresponding loss in the
short position. The extent to which such gains or losses are
offset will depend upon the amount of securities sold relative to
the amount the Fund owns, either directly or indirectly, and, in
the case where the Fund owns convertible securities, changes in
the conversion premium.
Short sale transactions involve certain risks. If the price
of the security sold short increases between the time of the
short sale and the time the Fund replaces the borrowed security,
the Fund will incur a loss and if the price declines during this
period, the Fund will realize a short-term capital gain. Any
realized short-term capital gain will be decreased, and any
incurred loss increased, by the amount of transaction costs and
any premium, dividend or interest which the Fund may have to pay
in connection with such short sale. Certain provisions of the
Internal Revenue Code may limit the degree to which the Fund is
able to enter into short sales. There is no limitation on the
amount of the Fund's assets that, in the aggregate, may be
deposited as collateral for the obligation to replace securities
borrowed to effect short sales and allocated to segregated
accounts in connection with short sales. The Fund does not
currently expect that more than 5% of its total assets would be
involved in short sales against the box.
Closed-End Investment Companies
The Fund may also invest in closed-end investment companies
investing primarily in the emerging markets. To the extent the
Fund invests in such closed-end investment companies,
shareholders will incur certain duplicate fees and expenses.
Such closed-end investment company investments will generally
only be made when market access or liquidity restricts direct
investment in the market.
Rule 144A Securities
The Fund may purchase securities that have been privately
placed but that are eligible for purchase and sale under Rule
144A under the 1933 Act. That Rule
<PAGE> 15
permits certain qualified institutional buyers, such as the Fund,
to trade in privately placed securities that have not been
registered for sale under the 1933 Act. The Adviser, under the
supervision of the Board of Trustees, will consider whether
securities purchased under Rule 144A are illiquid and thus
subject to the Fund's restriction of investing no more than 15%
of its net assets in illiquid securities. A determination of
whether a Rule 144A security is liquid or not is a question of
fact. In making this determination, the Adviser will consider
the trading markets for the specific security, taking into
account the unregistered nature of a Rule 144A security. In
addition, the Adviser could consider the (1) frequency of trades
and quotes, (2) number of dealers and potential purchasers, (3)
dealer undertakings to make a market, and (4) nature of the
security and of marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers, and the
mechanics of transfer). The liquidity of Rule 144A securities
would be monitored and, if as a result of changed conditions, it
is determined that a Rule 144A security is no longer liquid, the
Fund's holdings of illiquid securities would be reviewed to
determine what, if any, steps are required to assure that the
Fund does not invest more than 15% of its assets in illiquid
securities. Investing in Rule 144A securities could have the
effect of increasing the amount of the Fund's assets invested in
illiquid securities if qualified institutional buyers are
unwilling to purchase such securities. The Fund does not expect
to invest as much as 5% of its total assets in Rule 144A
securities that have not been deemed to be liquid by the Adviser.
(See restriction (m) under Investment Restrictions.)
Swaps, Caps, Floors and Collars
The Fund may enter into swaps and may purchase or sell
related caps, floors and collars. The Fund would enter into
these transactions primarily to preserve a return or spread on a
particular investment or portion of its portfolio, to protect
against currency fluctuations, as a duration management technique
or to protect against any increase in the price of securities the
Fund anticipates purchasing at a later date. The Fund intends to
use these techniques as hedges and not as speculative investments
and will not sell interest rate income stream the Fund may be
obligated to pay.
A swap agreement is generally individually negotiated and
structured to include exposure to a variety of different types of
investments or market factors. Depending on its structure, a
swap agreement may increase or decrease the Fund's exposure to
changes in the value of an index of securities in which the Fund
might invest, the value of a particular security or group of
securities, or foreign currency values. Swap agreements can take
many different forms and are known by a variety of names. The
Fund may enter into any form of swap agreement if the Adviser
determines it is consistent with the Fund's investment objective
and policies.
A swap agreement tends to shift the Fund's investment
exposure from one type of investment to another. For example, if
the Fund agrees to exchange payments in dollars at a fixed rate
for payments in a foreign currency the amount of which is
determined by movements of a foreign securities index, the swap
agreement would tend to increase the Fund's exposure to foreign
stock market movements and foreign currencies. Depending on how
it is used, a swap agreement may
<PAGE> 16
increase or decrease the overall volatility of the Fund's
investments and its net asset value.
The performance of a swap agreement is determined by the
change in the specific currency, market index, security, or other
factors that determine the amounts of payments due to and from
the Fund. If a swap agreement calls for payments by the Fund,
the Fund must be prepared to make such payments when due. If the
counterparty's creditworthiness declines, the value of a swap
agreement would be likely to decline, potentially resulting in a
loss. The Fund will not enter into any swap, cap, floor or
collar transaction unless, at the time of entering into such
transaction, the unsecured long-term debt of the counterparty,
combined with any credit enhancements, is rated at least A by
Standard & Poor's Corporation or Moody's or has an equivalent
rating from a nationally recognized statistical rating
organization or is determined to be of equivalent credit quality
by the Adviser.
The purchase of a cap entitles the purchaser to receive
payments on a notional principal amount from the party selling
the cap to the extent that a specified index exceeds a
predetermined interest rate or amount. The purchase of a floor
entitles the purchaser to receive payments on a notional
principal amount from the party selling such floor to the extent
that a specified index falls below a predetermined interest rate
or amount. A collar is a combination of a cap and floor that
preserves a certain return within a predetermined range of
interest rates or values.
At the time the Fund enters into swap arrangements or
purchases or sells caps, floors or collars, liquid assets of the
Fund having a value at least as great as the commitment
underlying the obligations will be segregated on the books of the
Fund and held by the custodian throughout the period of the
obligation.
Eurodollar Instruments
The Fund may make investments in Eurodollar instruments.
Eurodollar instruments are U.S. dollar-denominated futures
contracts or options thereon which are linked to LIBOR, although
foreign currency-denominated instruments are available from time
to time. Eurodollar future contracts enable purchasers to obtain
a fixed rate for the lending of funds and sellers to obtain a
fixed rate for borrowings. The Fund might use Eurodollar futures
contracts and options thereon to hedge against changes in LIBOR,
to which many interest rate swaps and fixed income instruments
are linked.
Line of Credit
Subject to restriction (6) under Investment Restrictions in
this Statement of Additional Information, the Fund may establish
and maintain a line of credit with a major bank in order to
permit borrowing on a temporary basis to meet share redemption
requests in circumstances in which temporary borrowing may be
preferable to liquidation of portfolio securities.
<PAGE> 17
Interfund Borrowing and Lending Program
Pursuant to an exemptive order issued by the Securities and
Exchange Commission, the Fund has received permission to lend
money to, and borrow money from, other mutual funds advised by
the Adviser. The Fund will borrow through the program when
borrowing is necessary and appropriate and the costs are equal to
or lower than the costs of bank loans.
Portfolio Turnover
Although the Fund does not purchase securities with a view
to rapid turnover, there are no limitations on the length of time
that portfolio securities must be held. Accordingly, the
portfolio turnover rate may vary significantly from year to year,
but is not expected to exceed 100% under normal market
conditions. Portfolio turnover can occur for a number of reasons
such as general conditions in the securities markets, more
favorable investment opportunities in other securities, or other
factors relating to the desirability of holding or changing a
portfolio investment. Because of the Fund's flexibility of
investment and emphasis on growth of capital, it may have greater
portfolio turnover than that of mutual funds that have primary
objectives of income or maintenance of a balanced investment
position. A high rate of portfolio turnover in the Fund, if it
should occur, would result in increased transaction expense,
which must be borne by the Fund. High portfolio turnover may
also result in the realization of capital gains or losses and, to
the extent net short-term capital gains are realized, any
distributions resulting from such gains will be considered
ordinary income for federal income tax purposes. (See Risks and
Investment Considerations and Distributions and Income Taxes in
the Prospectus, and Additional Income Tax Considerations in this
Statement of Additional Information.)
Options on Securities and Indexes
The Fund may purchase and sell put options and call options
on securities, indexes or foreign currencies in standardized
contracts traded on recognized securities exchanges, boards of
trade, or similar entities, or quoted on Nasdaq. The Fund may
purchase agreements, sometimes called cash puts, that may
accompany the purchase of a new issue of bonds from a dealer.
An option on a security (or index) is a contract that gives
the purchaser (holder) of the option, in return for a premium,
the right to buy from (call) or sell to (put) the seller (writer)
of the option the security underlying the option (or the cash
value of the index) at a specified exercise price at any time
during the term of the option (normally not exceeding nine
months). The writer of an option on an individual security or on
a foreign currency has the obligation upon exercise of the option
to deliver the underlying security or foreign currency upon
payment of the exercise price or to pay the exercise price upon
delivery of the underlying security or foreign currency. Upon
exercise, the writer of an option on an index is obligated to pay
the difference between the cash value of the index and the
exercise price multiplied by the specified multiplier for the
index option. (An index is designed to reflect specified facets
of a particular financial or securities market, a specific group
of financial instruments or securities, or certain economic
indicators.)
<PAGE> 18
The Fund will write call options and put options only if
they are "covered." For example, in the case of a call option on
a security, the option is "covered" if the Fund owns the security
underlying the call or has an absolute and immediate right to
acquire that security without additional cash consideration (or,
if additional cash consideration is required, cash or cash
equivalents in such amount are held in a segregated account by
its custodian) upon conversion or exchange of other securities
held in its portfolio.
If an option written by the Fund expires, the Fund realizes
a capital gain equal to the premium received at the time the
option was written. If an option purchased by the Fund expires,
the Fund realizes a capital loss equal to the premium paid.
Prior to the earlier of exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option
of the same series (type, exchange, underlying security or index,
exercise price, and expiration). There can be no assurance,
however, that a closing purchase or sale transaction can be
effected when the Fund desires.
The Fund will realize a capital gain from a closing purchase
transaction if the cost of the closing option is less than the
premium received from writing the option, or, if it is more, the
Fund will realize a capital loss. If the premium received from a
closing sale transaction is more than the premium paid to
purchase the option, the Fund will realize a capital gain or, if
it is less, the Fund will realize a capital loss. The principal
factors affecting the market value of a put or a call option
include supply and demand, interest rates, the current market
price of the underlying security or index in relation to the
exercise price of the option, the volatility of the underlying
security or index, and the time remaining until the expiration
date.
A put or call option purchased by the Fund is an asset of
the Fund, valued initially at the premium paid for the option.
The premium received for an option written by the Fund is
recorded as a deferred credit. The value of an option purchased
or written is marked-to-market daily and is valued at the closing
price on the exchange on which it is traded or, if not traded on
an exchange or no closing price is available, at the mean between
the last bid and asked prices.
Risks Associated with Options. There are several risks
associated with transactions in options. For example, there are
significant differences between the securities markets, the
currency markets, and the options markets that could result in an
imperfect correlation between these markets, causing a given
transaction not to achieve its objectives. A decision as to
whether, when and how to use options involves the exercise of
skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or
unexpected events.
There can be no assurance that a liquid market will exist
when the Fund seeks to close out an option position. If the Fund
were unable to close out an option that it had purchased on a
security, it would have to exercise the option in order to
realize any profit or the option would expire and become
worthless. If the Fund were unable to close out a covered call
option that it had written on a security, it would not
<PAGE> 19
be able to sell the underlying security until the option expired.
As the writer of a covered call option on a security, the Fund
foregoes, during the option's life, the opportunity to profit
from increases in the market value of the security covering the
call option above the sum of the premium and the exercise price
of the call.
If trading were suspended in an option purchased or written
by the Fund, the Fund would not be able to close out the option.
If restrictions on exercise were imposed, the Fund might be
unable to exercise an option it has purchased.
Futures Contracts and Options on Futures Contracts
The Fund may use interest rate futures contracts, index
futures contracts, and foreign currency futures contracts. An
interest rate, index or foreign currency futures contract
provides for the future sale by one party and purchase by another
party of a specified quantity of a financial instrument or the
cash value of an index /2/ at a specified price and time. A
public market exists in futures contracts covering a number of
indexes (including, but not limited to: the Standard & Poor's 500
Index, the Value Line Composite Index, and the New York Stock
Exchange Composite Index) as well as financial instruments
(including, but not limited to: U.S. Treasury bonds, U.S.
Treasury notes, Eurodollar certificates of deposit, and foreign
currencies). Other index and financial instrument futures
contracts are available and it is expected that additional
futures contracts will be developed and traded.
The Fund may purchase and write call and put futures
options. Futures options possess many of the same
characteristics as options on securities, indexes and foreign
currencies (discussed above). A futures option gives the holder
the right, in return for the premium paid, to assume a long
position (call) or short position (put) in a futures contract at
a specified exercise price at any time during the period of the
option. Upon exercise of a call option, the holder acquires a
long position in the futures contract and the writer is assigned
the opposite short position. In the case of a put option, the
opposite is true. The Fund might, for example, use futures
contracts to hedge against or gain exposure to fluctuations in
the general level of stock prices, anticipated changes in
interest rates or currency fluctuations that might adversely
affect either the value of the Fund's securities or the price of
the securities that the Fund intends to purchase. Although other
techniques could be used to reduce or increase the Fund's
exposure to stock price, interest rate and currency fluctuations,
the Fund may be able to achieve its exposure more effectively and
perhaps at a lower cost by using futures contracts and futures
options.
The Fund will only enter into futures contracts and futures
options that are standardized and traded on an exchange, board of
trade, or similar entity, or quoted on an automated quotation
system.
- --------------
/2/ A futures contract on an index is an agreement pursuant to
which two parties agree to take or more delivery of an amount of
cash equal to the difference between the value of the index at
the close of the last trading day of the contract and the price
at which the index contract was originally written. Although the
value of a securities index is a function of the value of certain
specified securities, no physical delivery of those securities is
made.
- --------------
<PAGE> 20
The success of any futures transaction depends on the
Adviser correctly predicting changes in the level and direction
of stock prices, interest rates, currency exchange rates and
other factors. Should those predictions be incorrect, the Fund's
return might have been better had the transaction not been
attempted; however, in the absence of the ability to use futures
contracts, the Adviser might have taken portfolio actions in
anticipation of the same market movements with similar investment
results but, presumably, at greater transaction costs.
When a purchase or sale of a futures contract is made by the
Fund, the Fund is required to deposit with its custodian (or
broker, if legally permitted) a specified amount of cash or U.S.
Government securities or other securities acceptable to the
broker ("initial margin"). The margin required for a futures
contract is set by the exchange on which the contract is traded
and may be modified during the term of the contract. The initial
margin is in the nature of a performance bond or good faith
deposit on the futures contract, which is returned to the Fund
upon termination of the contract, assuming all contractual
obligations have been satisfied. The Fund expects to earn
interest income on its initial margin deposits. A futures
contract held by the Fund is valued daily at the official
settlement price of the exchange on which it is traded. Each day
the Fund pays or receives cash, called "variation margin," equal
to the daily change in value of the futures contract. This
process is known as "marking-to-market." Variation margin paid
or received by the Fund does not represent a borrowing or loan by
the Fund but is instead settlement between the Fund and the
broker of the amount one would owe the other if the futures
contract had expired at the close of the previous day. In
computing daily net asset value, the Fund will mark-to-market its
open futures positions.
The Fund is also required to deposit and maintain margin
with respect to put and call options on futures contracts written
by it. Such margin deposits will vary depending on the nature of
the underlying futures contract (and the related initial margin
requirements), the current market value of the option, and other
futures positions held by the Fund.
Although some futures contracts call for making or taking
delivery of the underlying securities, usually these obligations
are closed out prior to delivery by offsetting purchases or sales
of matching futures contracts (same exchange, underlying security
or index, and delivery month). If an offsetting purchase price
is less than the original sale price, the Fund realizes a capital
gain, or if it is more, the Fund realizes a capital loss.
Conversely, if an offsetting sale price is more than the original
purchase price, the Fund realizes a capital gain, or if it is
less, the Fund realizes a capital loss. The transaction costs
must also be included in these calculations.
Risks Associated with Futures
There are several risks associated with the use of futures
contracts and futures options. A purchase or sale of a futures
contract may result in losses in excess of the amount invested in
the futures contract. In trying to increase or reduce market
exposure, there can be no guarantee that there will be a
correlation between price movements in the futures contract and
in the portfolio exposure sought. In addition, there are
significant differences between the securities and futures
markets that
<PAGE> 21
could result in an imperfect correlation between the markets,
causing a given transaction not to achieve its objectives. The
degree of imperfection of correlation depends on circumstances
such as: variations in speculative market demand for futures,
futures options and the related securities, including technical
influences in futures and futures options trading and differences
between the securities markets and the securities underlying the
standard contracts available for trading. For example, in the
case of index futures contracts, the composition of the index,
including the issuers and the weighting of each issue, may differ
from the composition of the Fund's portfolio, and, in the case of
interest rate futures contracts, the interest rate levels,
maturities, and creditworthiness of the issues underlying the
futures contract may differ from the financial instruments held
in the Fund's portfolio. A decision as to whether, when and how
to use futures contracts involves the exercise of skill and
judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or
unexpected stock price or interest rate trends.
Futures exchanges may limit the amount of fluctuation
permitted in certain futures contract prices during a single
trading day. The daily limit establishes the maximum amount that
the price of a futures contract may vary either up or down from
the previous day's settlement price at the end of the current
trading session. Once the daily limit has been reached in a
futures contract subject to the limit, no more trades may be made
on that day at a price beyond that limit. The daily limit
governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may
work to prevent the liquidation of unfavorable positions. For
example, futures prices have occasionally moved to the daily
limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial
losses. Stock index futures contracts are not normally subject
to such daily price change limitations.
There can be no assurance that a liquid market will exist at
a time when the Fund seeks to close out a futures or futures
option position. The Fund would be exposed to possible loss on
the position during the interval of inability to close, and would
continue to be required to meet margin requirements until the
position is closed. In addition, many of the contracts discussed
above are relatively new instruments without a significant
trading history. As a result, there can be no assurance that an
active secondary market will develop or continue to exist.
Limitations on Options and Futures
If other options, futures contracts, or futures options of
types other than those described herein are traded in the future,
the Fund may also use those investment vehicles, provided the
Board of Trustees determines that their use is consistent with
the Fund's investment objective.
The Fund will not enter into a futures contract or purchase
an option thereon if, immediately thereafter, the initial margin
deposits for futures contracts held by the Fund plus premiums
paid by it for open futures option positions, less the
<PAGE> 22
amount by which any such positions are "in-the-money," /3/ would
exceed 5% of the Fund's total assets.
When purchasing a futures contract or writing a put option
on a futures contract, the Fund must maintain with its custodian
(or broker, if legally permitted) cash or cash equivalents
(including any margin) equal to the market value of such
contract. When writing a call option on a futures contract, the
Fund similarly will maintain with its custodian cash or cash
equivalents (including any margin) equal to the amount by which
such option is in-the-money until the option expires or is closed
out by the Fund.
The Fund may not maintain open short positions in futures
contracts, call options written on futures contracts or call
options written on indexes if, in the aggregate, the market value
of all such open positions exceeds the current value of the
securities in its portfolio, plus or minus unrealized gains and
losses on the open positions, adjusted for the historical
relative volatility of the relationship between the portfolio and
the positions. For this purpose, to the extent the Fund has
written call options on specific securities in its portfolio, the
value of those securities will be deducted from the current
market value of the securities portfolio.
In order to comply with Commodity Futures Trading Commission
Regulation 4.5 and thereby avoid being deemed a "commodity pool
operator," the Fund will use commodity futures or commodity
options contracts solely for bona fide hedging purposes within
the meaning and intent of Regulation 1.3(z), or, with respect to
positions in commodity futures and commodity options contracts
that do not come within the meaning and intent of 1.3(z), the
aggregate initial margin and premiums required to establish such
positions will not exceed 5% of the fair market value of the
assets of the Fund, after taking into account unrealized profits
and unrealized losses on any such contracts it has entered into
in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount (as defined in Section
190.01(x) of the Commission Regulations) may be excluded in
computing such 5%.
Taxation of Options and Futures
If the Fund exercises a call or put option that it holds,
the premium paid for the option is added to the cost basis of the
security purchased (call) or deducted from the proceeds of the
security sold (put). For cash settlement options and futures
options exercised by the Fund, the difference between the cash
received at exercise and the premium paid is a capital gain or
loss.
If a call or put option written by the Fund is exercised,
the premium is included in the proceeds of the sale of the
underlying security (call) or reduces the cost basis of the
security purchased (put). For cash settlement options and
futures options written by the Fund, the difference between the
cash paid at exercise and the premium received is a capital gain
or loss.
- ------------
/3/ A call option is "in-the-money" if the value of the futures
contract that is the subject to the option exceeds the exercise
price A put option is "in-the-money" if the exercise price
exceeds the value of the futures contract that is the subject of
the option.
- ------------
<PAGE> 23
Entry into a closing purchase transaction will result in
capital gain or loss. If an option written by the Fund was in-
the-money at the time it was written and the security covering
the option was held for more than the long-term holding period
prior to the writing of the option, any loss realized as a result
of a closing purchase transaction will be long-term. The holding
period of the securities covering an in-the-money option will not
include the period of time the option is outstanding.
If the Fund writes an equity call option /4/ other than a
"qualified covered call option," as defined in the Internal
Revenue Code, any loss on such option transaction, to the extent
it does not exceed the unrealized gains on the securities
covering the option, may be subject to deferral until the
securities covering the option have been sold.
A futures contract held until delivery results in capital
gain or loss equal to the difference between the price at which
the futures contract was entered into and the settlement price on
the earlier of delivery notice date or expiration date. If the
Fund delivers securities under a futures contract, the Fund also
realizes a capital gain or loss on those securities.
For federal income tax purposes, the Fund generally is
required to recognize as income for each taxable year its net
unrealized gains and losses as of the end of the year on futures,
futures options and non-equity options positions ("year-end mark-
to-market"). Generally, any gain or loss recognized with respect
to such positions (either by year-end mark-to-market or by actual
closing of the positions) is considered to be 60% long-term and
40% short-term, without regard to the holding periods of the
contracts. However, in the case of positions classified as part
of a "mixed straddle," the recognition of losses on certain
positions (including options, futures and futures options
positions, the related securities and certain successor positions
thereto) may be deferred to a later taxable year. Sale of
futures contracts or writing of call options (or futures call
options) or buying put options (or futures put options) that are
intended to hedge against a change in the value of securities
held by the Fund: (1) will affect the holding period of the
hedged securities; and (2) may cause unrealized gain or loss on
such securities to be recognized upon entry into the hedge.
If the Fund were to enter into a short index future, short
index futures option or short index option position and the
Fund's portfolio were deemed to "mimic" the performance of the
index underlying such contract, the option or futures contract
position and the Fund's stock positions would be deemed to be
positions in a mixed straddle, subject to the above-mentioned
loss deferral rules.
In order for the Fund to continue to qualify for federal
income tax treatment as a regulated investment company, at least
90% of its gross income for a taxable year must be derived from
qualifying income; i.e., dividends, interest, income
- -----------
/4/ An equity option is defined to mean any option to buy or sell
stock, and any other option the value of which is determined by
reference to an index of stocks of the type that is ineligible to
be traded on a commodity futures exchange (e.g., an option
contract on a sub-index based on the price of nine hotel-casino
stocks). The definition of equity option excludes options on
broad-based stock indexes (such as the Standard & Poor's 500
index).
- -----------
<PAGE> 24
derived from loans of securities, and gains from the sale of
securities or foreign currencies, or other income (including but
not limited to gains from options, futures, or forward
contracts). In addition, gains realized on the sale or other
disposition of securities held for less than three months must be
limited to less than 30% of the Fund's annual gross income. Any
net gain realized from futures (or futures options) contracts
will be considered gain from the sale of securities and therefore
be qualifying income for purposes of the 90% requirement. In
order to avoid realizing excessive gains on securities held less
than three months, the Fund may be required to defer the closing
out of certain positions beyond the time when it would otherwise
be advantageous to do so.
The Fund distributes to shareholders annually any net
capital gains that have been recognized for federal income tax
purposes (including year-end mark-to-market gains) on options and
futures transactions. Such distributions are combined with
distributions of capital gains realized on the Fund's other
investments, and shareholders are advised of the nature of the
payments.
INVESTMENT RESTRICTIONS
The Fund operates under the following investment
restrictions. The Fund may not:
(1) with respect to 75% of its total assets, invest more
than 5% of its total assets, taken at market value at the time of
a particular purchase, in the securities of a single issuer,
except for securities issued or guaranteed by the U.S.
Government, or any of its agencies or instrumentalities or
repurchase agreements for such securities and except that all or
substantially all of the assets of the Fund may be invested in
another registered investment company having the same investment
objective and substantially similar investment policies as the
Fund;
(2) acquire more than 10%, taken at the time of a particular
purchase, of the outstanding voting securities of any one issuer,
except that all or substantially all of the assets of the Fund
may be invested in another registered investment company having
the same investment objective and substantially similar
investment policies as the Fund;
(3) act as an underwriter of securities, except insofar as
it may be deemed an underwriter for purposes of the Securities
Act of 1933 on disposition of securities acquired subject to
legal or contractual restrictions on resale, except that all or
substantially all of the assets of the Fund may be invested in
another registered investment company having the same investment
objective and substantially similar investment policies as the
Fund;
(4) purchase or sell real estate (although it may purchase
securities secured by real estate or interests therein, or
securities issued by companies which invest in real estate or
interests therein), commodities, or commodity contracts, except
that it may enter into (a) futures and options on futures and (b)
forward contracts;
<PAGE> 25
(5) make loans, although it may (a) lend portfolio
securities and participate in an interfund lending program with
other Stein Roe Funds and Portfolios provided that no such loan
may be made if, as a result, the aggregate of such loans would
exceed 33 1/3% of the value of its total assets (taken at market
value at the time of such loans); (b) purchase money market
instruments and enter into repurchase agreements; and (c) acquire
publicly distributed or privately placed debt securities;
(6) borrow except that it may (a) borrow for non-
leveraging, temporary or emergency purposes, (b) engage in
reverse repurchase agreements and make other borrowings, provided
that the combination of (a) and (b) shall not exceed 33 1/3% of
the value of its total assets (including the amount borrowed)
less liabilities (other than borrowings) or such other percentage
permitted by law, and (c) enter into futures and options
transactions; it may borrow from banks, other Stein Roe Funds and
Portfolios, and other persons to the extent permitted by
applicable law;
(7) invest in a security if more than 25% of its total
assets (taken at market value at the time of a particular
purchase) would be invested in the securities of issuers in any
particular industry, /5/ except that this restriction does not
apply to securities issued or guaranteed by the U.S. Government
or its agencies or instrumentalities and except that all or
substantially all of the assets of the Fund may be invested in
another registered investment company having the same investment
objective and substantially similar investment policies as the
Fund; or
(8) issue any senior security except to the extent permitted
under the Investment Company Act of 1940.
The above restrictions are fundamental policies and may not
be changed without the approval of a "majority of the outstanding
voting securities," as defined above. The Fund is also subject
to the following non-fundamental restrictions and policies, which
may be changed by the Board of Trustees. None of the following
restrictions shall prevent the Fund from investing all or
substantially all of its assets in another investment company
having the same investment objective and substantially the same
investment policies as the Fund. The Fund may not:
(a) invest in any of the following: (i) interests in oil,
gas, or other mineral leases or exploration or development
programs (except readily marketable securities, including but not
limited to master limited partnership interests, that may
represent indirect interests in oil, gas, or other mineral
exploration or development programs); (ii) puts, calls,
straddles, spreads, or any combination thereof (except that it
may enter into transactions in options, futures, and options on
futures); (iii) shares of other open-end investment companies,
except in connection with a merger, consolidation, acquisition,
or reorganization; and (iv) limited partnerships in real estate
unless they are readily marketable;
(b) invest in companies for the purpose of exercising
control or management;
- --------------
/5/ For purposes of this investment restriction, the Fund uses
industry classifications contained in Morgan Stanley Capital
International Perspective, which is published by Morgan Stanley,
an international investment banking and brokerage firm.
- --------------
<PAGE> 26
(c) purchase more than 3% of the stock of another investment
company or purchase stock of other investment companies equal to
more than 5% of its total assets (valued at time of purchase) in
the case of any one other investment company and 10% of such
assets (valued at time of purchase) in the case of all other
investment companies in the aggregate; any such purchases are to
be made in the open market where no profit to a sponsor or dealer
results from the purchase, other than the customary broker's
commission, except for securities acquired as part of a merger,
consolidation or acquisition of assets;
(d) purchase or hold securities of an issuer if 5% of the
securities of such issuer are owned by those officers, trustees,
or directors of the Trust or of its investment adviser, who each
own beneficially more than 1/2 of 1% of the securities of that
issuer;
(e) mortgage, pledge, or hypothecate its assets, except as
may be necessary in connection with permitted borrowings or in
connection with options, futures, and options on futures;
(f) invest more than 5% of its net assets (valued at time of
purchase) in warrants, nor more than 2% of its net assets in
warrants that are not listed on the New York or American Stock
Exchange or a recognized foreign exchange;
(g) write an option on a security unless the option is
issued by the Options Clearing Corporation, an exchange, or
similar entity;
(h) buy or sell an option on a security, a futures contract,
or an option on a futures contract unless the option, the futures
contract, or the option on the futures contract is offered
through the facilities of a recognized securities association or
listed on a recognized exchange or similar entity;
(i) purchase a put or call option if the aggregate premiums
paid for all put and call options exceed 20% of its net assets
(less the amount by which any such positions are in-the-money),
excluding put and call options purchased as closing transactions;
(j) purchase securities on margin (except for use of short-
term credits as are necessary for the clearance of transactions),
or sell securities short unless (i) it owns or has the right to
obtain securities equivalent in kind and amount to those sold
short at no added cost or (ii) the securities sold are "when
issued" or "when distributed" securities which it expects to
receive in a recapitalization, reorganization, or other exchange
for securities it contemporaneously owns or has the right to
obtain and provided that transactions in options, futures, and
options on futures are not treated as short sales;
(k) invest more than 5% of its total assets (taken at
market value at the time of a particular investment) in
securities of issuers (other than issuers of federal agency
obligations or securities issued or guaranteed by any foreign
country or asset-backed securities) that, together with any
predecessors or unconditional guarantors, have been in continuous
operation for less than three years ("unseasoned issuers");
<PAGE> 27
(l) invest more than 10% of its total assets (taken at
market value at the time of a particular investment) in
restricted securities, other than securities eligible for resale
pursuant to Rule 144A under the Securities Act of 1933;
(m) invest more than 15% of its total assets (taken at
market value at the time of a particular investment) in
restricted securities and securities of unseasoned issuers;
(n) invest more than 15% of its net assets (taken at market
value at the time of a particular investment) in illiquid
securities, including repurchase agreements maturing in more than
seven days.
Notwithstanding the foregoing investment restrictions, the
Fund may purchase securities pursuant to the exercise of
subscription rights, subject to the condition that such purchase
will not result in the Fund's ceasing to be a diversified
investment company. Far Eastern and European corporations
frequently issue additional capital stock by means of
subscription rights offerings to existing shareholders at a price
substantially below the market price of the shares. The failure
to exercise such rights would result in the Fund's interest in
the issuing company being diluted. The market for such rights is
not well developed in all cases and, accordingly, the Fund may
not always realize full value on the sale of rights. The
exception applies in cases where the limits set forth in the
investment restrictions would otherwise be exceeded by exercising
rights or would have already been exceeded as a result of
fluctuations in the market value of the Fund's portfolio
securities with the result that the Fund would be forced either
to sell securities at a time when it might not otherwise have
done so, to forego exercising the rights.
ADDITIONAL INVESTMENT CONSIDERATIONS
The Adviser seeks to provide superior long-term investment
results through a disciplined, research-intensive approach to
investment selection and prudent risk management. In working to
build wealth for generations it has been guided by three primary
objectives which it believes are the foundation of a successful
investment program. These objectives are preservation of
capital, limited volatility through managed risk, and consistent
above-average returns as appropriate for the particular client or
managed account. Because every investor's needs are different,
Stein Roe mutual funds are designed to accommodate different
investment objectives, risk tolerance levels, and time horizons.
In selecting a mutual fund, investors should ask the following
questions:
What are my investment goals?
It is important to a choose a fund that has investment objectives
compatible with your investment goals.
What is my investment time frame?
If you have a short investment time frame (e.g., less than three
years), a mutual fund that seeks to provide a stable share price,
such as a money market fund, or one that seeks capital
preservation as one of its objectives may be appropriate. If you
have a
<PAGE> 28
longer investment time frame, you may seek to maximize your
investment returns by investing in a mutual fund that offers
greater yield or appreciation potential in exchange for greater
investment risk.
What is my tolerance for risk?
All investments, including those in mutual funds, have risks
which will vary depending on investment objective and security
type. However, mutual funds seek to reduce risk through
professional investment management and portfolio diversification.
In general, equity mutual funds emphasize long-term capital
appreciation and tend to have more volatile net asset values than
bond or money market mutual funds. Although there is no
guarantee that they will be able to maintain a stable net asset
value of $1.00 per share, money market funds emphasize safety of
principal and liquidity, but tend to offer lower income potential
than bond funds. Bond funds tend to offer higher income
potential than money market funds but tend to have greater risk
of principal and yield volatility.
In addition, the Adviser believes that investment in a high
yield fund provides an opportunity to diversify an investment
portfolio because the economic factors that affect the
performance of high-yield, high-risk debt securities differ from
those that affect the performance of higher quality debt
securities or equity securities.
PURCHASES AND REDEMPTIONS
Purchases and redemptions are discussed in the Prospectus
under the headings How to Purchase Shares, How to Redeem Shares,
Net Asset Value, and Shareholder Services, and that information
is incorporated herein by reference. The Prospectus discloses
that you may purchase (or redeem) shares through investment
dealers, banks, or other institutions. It is the responsibility
of any such institution to establish procedures insuring the
prompt transmission to the Trust of any such purchase order.
The Fund's net asset value is determined on days on which
the New York Stock Exchange (the "NYSE") is open for trading.
The NYSE is regularly closed on Saturdays and Sundays and on New
Year's Day, the third Monday in February, Good Friday, the last
Monday in May, Independence Day, Labor Day, Thanksgiving, and
Christmas. If one of these holidays falls on a Saturday or
Sunday, the NYSE will be closed on the preceding Friday or the
following Monday, respectively. Net asset value will not be
determined on days when the NYSE is closed unless, in the
judgment of the Board of Trustees, net asset value of the Fund
should be determined on any such day, in which case the
determination will be made at 3:00 p.m., Chicago time.
The Trust intends to pay all redemptions in cash and is
obligated to redeem shares solely in cash up to the lesser of
$250,000 or one percent of the net assets of the Trust during any
90-day period for any one shareholder. However, redemptions in
excess of such limit may be paid wholly or partly by a
distribution in kind of
<PAGE> 29
securities. If redemptions were made in kind, the redeeming
shareholders might incur transaction costs in selling the
securities received in the redemptions.
Due to the relatively high cost of maintaining smaller
accounts, the Trust reserves the right to redeem shares in any
account for their then-current value (which will be promptly paid
to the investor) if at any time the shares in the account do not
have a value of at least $1,000. An investor will be notified
that the value of his account is less than that minimum and
allowed at least 30 days to bring the value of the account up to
at least $1,000 before the redemption is processed. The
Agreement and Declaration of Trust also authorizes the Trust to
redeem shares under certain other circumstances as may be
specified by the Board of Trustees.
The Trust reserves the right to suspend or postpone
redemptions of shares of the Fund during any period when: (a)
trading on the NYSE is restricted, as determined by the SEC, or
the NYSE is closed for other than customary weekend and holiday
closings; (b) the SEC has by order permitted such suspension; or
(c) an emergency, as determined by the SEC, exists, making
disposal of portfolio securities or valuation of net assets of
the Fund not reasonably practicable.
MANAGEMENT
The following table sets forth certain information with
respect to the trustees and officers of the Trust:
<TABLE>
<CAPTION>
POSITION(S) HELD PRINCIPAL OCCUPATION(S)
NAME AGE WITH THE TRUST DURING PAST FIVE YEARS
<S> <C> <C> <C>
Gary A. Anetsberger 41 Senior Vice-President Chief financial officer of the Mutual Funds
division of Stein Roe & Farnham Incorporated (the
"Adviser"); senior vice president of the Adviser
since April, 1996; vice president of the Adviser
prior thereto
Timothy K. Armour 48 President; Trustee President of the Mutual Funds division of the Adviser
(1)(2) and director of the Adviser
Jilaine Hummel Bauer 41 Executive Vice-President; General counsel and secretary of the Adviser since
Secretary November, 1995; senior vice president of the Adviser
since April, 1992
Bruno Bertocci 42 Vice-President Vice president of Colonial Management Associates,
Inc. since January, 1996; senior vice president of
the Adviser since May, 1995; global equity portfolio
manager with Rockefeller & Co. prior thereto
Kenneth L. Block (3) 77 Trustee Chairman emeritus of A. T. Kearney, Inc. (international
management consultants)
William W. Boyd 70 Trustee Chairman and director of Sterling Plumbing Group, Inc.
(2)(3) (manufacturer of plumbing products)
David P. Brady 33 Vice-President Vice president of the Adviser since November, 1995;
portfolio manager for the Adviser since 1993; equity
investment analyst, State Farm Mutual Automobile
Insurance Company prior thereto
<PAGE> 30
Thomas W. Butch 40 Executive Vice-President Senior vice president of the Adviser since September,
1994; first vice president, corporate communications,
of Mellon Bank Corporation prior thereto
Daniel K. Cantor 37 Vice-President Senior vice president of the Adviser
Lindsay Cook (1) 45 Trustee Executive vice president of Liberty Financial Companies,
Inc. (the indirect parent of the Adviser) since March,
1997; senior vice president prior thereto
Philip J. Crosley 50 Vice-President Senior vice president of the Adviser since February,
1996; Vice President, Institutional Sales-Advisor
Sales, Invesco Funds Group prior thereto
E. Bruce Dunn 63 Vice-President Senior vice president of the Adviser
Erik P. Gustafson 33 Vice-President Senior portfolio manager of the Adviser; senior vice
president of the Adviser since April, 1996; vice
president of the Adviser from May, 1994 to April,
1996; associate of the Adviser prior thereto
Douglas A. Hacker(3) 41 Trustee Senior vice president and chief financial officer,
United Airlines, since July, 1994; senior vice
president, finance, United Airlines, February,
1993 to July, 1994; vice president, American
Airlines prior thereto
David P. Harris 32 Vice-President Vice president of Colonial Management Associates, Inc.
since January, 1996; vice president of the Adviser
since May, 1995; global equity portfolio manager with
Rockefeller & Co. prior thereto
Harvey B. Hirschhorn 47 Vice-President Executive vice president, senior portfolio manager,
and chief economist and investment strategist of the
Adviser; director of research of the Adviser, 1991 to 1995
Janet Langford Kelly 39 Trustee Senior vice president, secretary and general counsel of
(30 Sara Lee Corporation (branded, packaged, consumer-products
manufacturer), since 1995; partner of Sidley & Austin
(law firm) prior thereto
Eric S. Maddix 33 Vice-President Vice president of the Adviser since November, 1995;
portfolio manager or research assistant for the Adviser
since 1987
Lynn C. Maddox 56 Vice-President Senior vice president of the Adviser
Anne E. Marcel 39 Vice-President Vice president of the Adviser since April, 1996;
manager, Mutual Fund Sales & Services of the Adviser
since October, 1994; supervisor of the Counselor
Department of the Adviser from October, 1992 to
October, 1994; vice president of Selected Financial
Services prior thereto
Arthur J. McQueen 39 Vice-President Senior vice president of the Adviser
<PAGE> 31
Francis W. Morley(3) 77 Trustee Chairman of Employer Plan Administrators and
Consultants Co. (designer, administrator, and
communicator of employee benefit plans)
Charles R. Nelson(3) 54 Trustee Van Voorhis Professor of Political Economy, Department
of Economics of the University of Washington
Nicolette D. Parrish 47 Vice-President; Senior compliance administrator and assistant secretary
Assistant Secretary of the Adviser since November, 1995; senior legal
assistant for the Adviser prior thereto
Judith E. Perrie 29 Treasurer Compliance manager for the Adviser's Mutual Funds
division since April, 1997; tax manager, Strong
Capital Management, Inc. (investment advisory firm)
since June 1996; associate with Strong's corporate
tax department prior thereto
Richard B. Peterson 56 Vice-President Senior vice president of the Adviser
Cynthia A. Prah 34 Vice-President Manager of shareholder transaction processing for the
Adviser
Sharon R. Robertson 35 Controller Accounting manager for the Adviser's Mutual Funds division
Janet B. Rysz 41 Assistant Secretary Senior compliance administrator and assistant secretary
of the Adviser
Gloria J. Santella 39 Vice-President Senior vice president of the Adviser since November,
1995; vice president of the Adviser prior thereto
Thomas P. Sorbo 36 Vice-President Senior vice president of the Adviser since January,
1994; vice president of the Adviser from September,
1992 to December, 1993; associate of Travelers
Insurance Company prior thereto
Thomas C. Theobald 60 Trustee Managing director, William Blair Capital Partners
(3) (private equity fund) since 1994; chief executive officer
and chairman of the Board of Directors of Continental
Bank Corporation, 1987-1994
Heidi J. Walter 29 Vice-President Legal counsel for the Adviser since March, 1995;
associate with Beeler Schad & Diamond, PC (law firm)
prior thereto
Stacy H. Winick 32 Vice-President Senior legal counsel for the Adviser since October,
1996; associate of Bell, Boyd & Lloyd (law firm), June,
1993 to September, 1996; associate of Debevoise &
Plimpton (law firm) prior thereto
Hans P. Ziegler 56 Executive Vice-President Chief executive officer of the Adviser since May, 1994;
president of the Investment Counsel division of the
Adviser from July, 1993 to June, 1994; president and
chief executive officer, Pitcairn Financial Management
Group prior thereto
Margaret O. Zwick 30 Assistant Treasurer Accounting manager for the Adviser since April 1997;
compliance manager from August 1995 to April 1997;
compliance accountant, January 1995 to July 1995;
section manager, January 1994 to January 1995;
supervisor prior thereto
<FN>
______________________________
<PAGE> 32
(1) Trustee who is an "interested person" of the Trust and of the
Adviser, as defined in the Investment Company Act of 1940.
(2) Member of the Executive Committee of the Board of Trustees,
which is authorized to exercise all powers of the Board with
certain statutory exceptions.
(3) Member of the Audit Committee of the Board, which makes
recommendations to the Board regarding the selection of
auditors and confers with the auditors regarding the scope
and results of the audit.
</TABLE>
Certain of the trustees and officers of the Trust are
trustees or officers of other investment companies managed by the
Adviser. Mr. Armour, Ms. Bauer, Mr. Cook, and Ms. Walter are
vice presidents of the Fund's distributor, Liberty Securities
Corporation. The address of Mr. Block is 11 Woodley Road,
Winnetka, Illinois 60093; that of Mr. Boyd is 2900 Golf Road,
Rolling Meadows, Illinois 60008; that of Mr. Cook is 600 Atlantic
Avenue, Boston, Massachusetts 02210; that of Mr. Hacker is P.O.
Box 66100, Chicago, IL 60666; that of Ms. Kelly is Three First
National Plaza, Chicago, Illinois 60602; that of Mr. Morley is 20
North Wacker Drive, Suite 2275, Chicago, Illinois 60606; that of
Mr. Nelson is Department of Economics, University of Washington,
Seattle, Washington 98195; that of Mr. Theobald is Suite 3300,
222 West Adams Street, Chicago, IL 60606; that of Messrs.
Bertocci, Cantor, and Harris is 1330 Avenue of the Americas, New
York, New York 10019; and that of the other officers is One South
Wacker Drive, Chicago, Illinois 60606.
Officers and trustees affiliated with the Adviser serve
without any compensation from the Trust. In compensation for
their services to the Trust, trustees who are not "interested
persons" of the Trust or the Adviser are paid an annual retainer
of $8,000 (divided equally among the series of the Trust) plus an
attendance fee from each series for each meeting of the Board or
standing committee thereof attended at which business for that
series is conducted. The attendance fees (other than for a
Nominating Committee or Compensation Committee meeting) are based
on each series' net assets as of the preceding December 31. For
a series with net assets of less than $50 million, the fee is $50
per meeting; with $51 to $250 million, the fee is $200 per
meeting; with $251 million to $500 million, $350; with $501
million to $750 million, $500; with $751 million to $1 billion,
$650; and with over $1 billion in net assets, $800. For a series
participating in the master fund/feeder fund structure, the
trustees' attendance fees are paid solely by the master
portfolio. Each non-interested trustee also receives $500 from
the Trust for attending each meeting of the Nominating Committee
or Compensation Committee. The Trust has no retirement or
pension plan. The following table sets forth compensation paid
by the Trust during the fiscal year ended September 30, 1996 to
each of the trustees:
Aggregate Total Compensation
Compensation from the
Name of Trustee from the Trust Stein Roe Fund Complex
------------------ --------------- ----------------------
Timothy K. Armour -0- -0-
Lindsay Cook -0- -0-
Janet Langford Kelly -0- -0-
Douglas A. Hacker $ 4,700 $11,650
Thomas C. Theobald 4,700 11,650
Kenneth L. Block 35,750 81,817
William W. Boyd 37,750 88,317
Francis W. Morley 35,750 82,017
Charles R. Nelson 37,750 88,317
<PAGE> 33
Gordon R. Worley 36,150 82,217
_______________
* During this period, the Stein Roe Fund Complex consisted of
the six series of Stein Roe Income Trust, four series of Stein
Roe Municipal Trust, eight series of Investment Trust, and one
series of SR&F Base Trust. Messrs. Hacker and Theobald were
elected trustees on June 18, 1996; Mr. Worley retired as a
trustee on December 31, 1996; and Ms. Kelly became a trustee
on January 1, 1997.
PRINCIPAL SHAREHOLDERS
As of June 9, 1997, the only person known by the Trust own
of record or "beneficially" 5% or more of the outstanding shares
of the Fund within the definition of that term as contained in
Rule 13d-3 under the Securities Exchange Act of 1934 was as
follows:
Approximate Percentage of
Name and Address Outstanding Shares Held
- ----------------- -------------------------
Keyport Life Insurance Company 8.3%
125 High Street
Boston, MA 02110
INVESTMENT ADVISORY SERVICES
Stein Roe & Farnham Incorporated, the Fund's investment
adviser, is a wholly owned subsidiary of SteinRoe Services Inc.
("SSI"), the Fund's transfer agent, which is a wholly owned
subsidiary of Liberty Financial Companies, Inc. ("Liberty
Financial"), which is a majority owned subsidiary of LFC
Holdings, Inc., which is a wholly owned subsidiary of Liberty
Mutual Equity Corporation, which is a wholly owned subsidiary of
Liberty Mutual Insurance Company. Liberty Mutual Insurance
Company is a mutual insurance company, principally in the
property/casualty insurance field, organized under the laws of
Massachusetts in 1912.
The directors of the Adviser are Kenneth R. Leibler, Harold
W. Cogger, C. Allen Merritt, Jr., Timothy K. Armour, and Hans P.
Ziegler. Mr. Leibler is President and Chief Executive Officer of
Liberty Financial; Mr. Cogger is Executive Vice President of
Liberty Financial; Mr. Merritt is Executive Vice President and
Treasurer of Liberty Financial; Mr. Armour is President of the
Adviser's Mutual Funds division; and Mr. Ziegler is Chief
Executive Officer of the Adviser. The business address of
Messrs. Leibler, Cogger, and Merritt is Federal Reserve Plaza,
Boston, Massachusetts 02210; and that of Messrs. Armour, and
Ziegler is One South Wacker Drive, Chicago, Illinois 60606.
The Adviser and its predecessor have been providing
investment advisory services since 1932. The Adviser acts as
investment adviser to wealthy individuals, trustees, pension and
profit sharing plans, charitable organizations, and other
institutional investors. As of December 31, 1996, the Adviser
managed over $26.7 billion in assets: over $8 billion in equities
and over $18.7 billion in fixed income securities (including $1.6
billion in municipal securities). The $26.7 billion in managed
assets included over $7.5 billion held by open-end mutual funds
managed by the Adviser (approximately 16% of the mutual fund
assets were held by clients of the Adviser). These mutual funds
were owned by over 227,000 shareholders. The $7.5 billion in
mutual fund assets included over $743 million in over 47,000 IRA
accounts. In
<PAGE> 34
managing those assets, the Adviser utilizes a proprietary
computer-based information system that maintains and regularly
updates information for approximately 6,500 companies. The
Adviser also monitors over 1,400 issues via a proprietary credit
analysis system. At December 31, 1996, the Adviser employed 19
research analysts and 55 account managers. The average
investment-related experience of these individuals was 22 years.
Stein Roe Counselor [service mark] and Stein Roe Personal
Counselor [service mark]are professional investment advisory
services offered to Fund shareholders. Each is designed to help
shareholders construct Fund investment portfolios to suit their
individual needs. Based on information shareholders provide
about their financial circumstances, goals, and objectives in
response to a questionnaire, the Adviser's investment
professionals create customized portfolio recommendations for
investments in the Fund and other mutual funds managed by the
Adviser. Shareholders participating in Stein Roe Counselor
[service mark] are free to self direct their investments while
considering the Adviser's recommendations; shareholders
participating in Stein Roe Personal Counselor [service mark]
enjoy the added benefit of having the Adviser implement portfolio
recommendations automatically for a fee of 1% or less, depending
on the size of their portfolios. In addition to reviewing
shareholders' circumstances, goals, and objectives periodically
and updating portfolio recommendations to reflect any changes,
the shareholders who participate in these programs are assigned a
dedicated Counselor [service mark] representative. Other
distinctive services include specially designed account
statements with portfolio performance and transaction data,
newsletters, and regular investment, economic, and market
updates. A $50,000 minimum investment is required to participate
in either program.
Please refer to the description of the Adviser,
administrative agreement, management agreement, fees, expense
limitation, and transfer agency services under Fee Table and
Management of the Fund in the Prospectus, which is incorporated
herein by reference.
The Adviser provides office space and executive and other
personnel to the Fund and bears any sales or promotional
expenses. The Fund pays all expenses other than those paid by
the Adviser, including but not limited to printing and postage
charges and securities registration and custodian fees and
expenses incidental to its organization.
The administrative agreement provides that the Adviser shall
reimburse the Fund to the extent that total annual expenses of
the Fund (including fees paid to the Adviser, but excluding
taxes, interest, brokers' commissions and other normal charges
incident to the purchase and sale of portfolio securities and
expenses of litigation to the extent permitted under applicable
state law) exceed the applicable limits prescribed by any state
in which shares of the Fund are being offered for sale to the
public; provided, however, that the Adviser shall not be required
to reimburse the Fund an amount in excess of the management fee
from the Fund for such year. In addition, in the interest of
further limiting expenses of the Fund, the Adviser may
voluntarily waive its management fee and/or absorb certain
expenses for the Fund, as described under Fee Table in the
Prospectus. Any such reimbursement will enhance the yield of the
Fund.
<PAGE> 35
The management agreement also provides that neither the
Adviser nor any of its directors, officers, stockholders (or
partners of stockholders), agents, or employees shall have any
liability to the Trust or any shareholder of the Trust for any
error of judgment, mistake of law or any loss arising out of any
investment, or for any other act or omission in the performance
by the Adviser of its duties under the agreement, except for
liability resulting from willful misfeasance, bad faith or gross
negligence on their part in the performance of its duties or from
reckless disregard by it of its obligations and duties under the
agreement.
Any expenses that are attributable solely to the
organization, operation, or business of the Fund shall be paid
solely out of the Fund's assets. Any expenses incurred by the
Trust that are not solely attributable to a particular series are
apportioned in such manner as the Adviser determines is fair and
appropriate, unless otherwise specified by the Board of Trustees.
Bookkeeping and Accounting Agreement
Pursuant to a separate agreement with the Trust, the Adviser
receives a fee for performing certain bookkeeping and accounting
services for the Fund. For these services, the Adviser receives
an annual fee of $25,000 per series plus .0025 of 1% of average
net assets over $50 million. During the fiscal years ended
September 30, 1995 and 1996, the Adviser received aggregate fees
of $192,479 and $265,246, respectively, from Investment Trust for
services performed under this Agreement.
DISTRIBUTOR
Shares of the Fund are distributed by Liberty Securities
Corporation ("LSC") under a Distribution Agreement as described
under Management of the Fund in the Prospectus, which is
incorporated herein by reference. The Distribution Agreement
continues in effect from year to year, provided such continuance
is approved annually (i) by a majority of the trustees or by a
majority of the outstanding voting securities of the Trust, and
(ii) by a majority of the trustees who are not parties to the
Agreement or interested persons of any such party. The Trust has
agreed to pay all expenses in connection with registration of its
shares with the Securities and Exchange Commission and auditing
and filing fees in connection with registration of its shares
under the various state blue sky laws and assumes the cost of
preparation of prospectuses and other expenses.
As agent, LSC offers shares of the Fund to investors in
states where the shares are qualified for sale, at net asset
value, without sales commissions or other sales load to the
investor. In addition, no sales commission or "12b-1" payment is
paid by the Fund. LSC offers the Fund's shares only on a best-
efforts basis.
TRANSFER AGENT
SSI performs certain transfer agency services for the Trust,
as described under Management of the Fund in the Prospectus. For
performing these services, SSI receives from the Fund a fee based
on an annual rate of .22 of 1% of average net assets.
<PAGE> 36
The Trust believes the charges by SSI to the Fund are comparable
to those of other companies performing similar services. (See
Investment Advisory Services.)
CUSTODIAN
State Street Bank and Trust Company (the "Bank"), 225
Franklin Street, Boston, Massachusetts 02101, is the custodian
for the Trust. It is responsible for holding all securities and
cash of the Fund, receiving and paying for securities purchased,
delivering against payment securities sold, receiving and
collecting income from investments, making all payments covering
expenses of the Fund, and performing other administrative duties,
all as directed by authorized persons. The custodian does not
exercise any supervisory function in such matters as purchase and
sale of portfolio securities, payment of dividends, or payment of
expenses of the Fund.
Portfolio securities purchased in the U.S. are maintained in
the custody of the Bank or of other domestic banks or
depositories. Portfolio securities purchased outside of the U.S.
are maintained in the custody of foreign banks and trust
companies that are members of the Bank's Global Custody Network
and foreign depositories ("foreign sub-custodians"). Each of the
domestic and foreign custodial institutions holding portfolio
securities has been approved by the Board of Trustees in
accordance with regulations under the Investment Company Act of
1940.
The Board of Trustees reviews, at least annually, whether it
is in the best interest of the Fund and its shareholders to
maintain Fund assets in each of the countries in which the Fund
invests with particular foreign sub-custodians in such countries,
pursuant to contracts between such respective foreign sub-
custodians and the Bank. The review includes an assessment of
the risks of holding Fund assets in any such country (including
risks of expropriation or imposition of exchange controls), the
operational capability and reliability of each such foreign sub-
custodian, and the impact of local laws on each such custody
arrangement. The Board of Trustees is aided in its review by the
Bank, which has assembled the network of foreign sub-custodians
utilized by the Fund, as well as by the Adviser and counsel.
However, with respect to foreign sub-custodians, there can be no
assurance that the Fund, and the value of its shares, will not be
adversely affected by acts of foreign governments, financial or
operational difficulties of the foreign sub-custodians,
difficulties and costs of obtaining jurisdiction over, or
enforcing judgments against, the foreign sub-custodians, or
application of foreign law to the Fund's foreign sub-custodial
arrangements. Accordingly, an investor should recognize that the
non-investment risks involved in holding assets abroad are
greater than those associated with investing in the United
States.
The Fund may invest in obligations of the custodian and may
purchase or sell securities from or to the custodian.
INDEPENDENT PUBLIC ACCOUNTANTS
The independent public accountants for the Trust are Arthur
Andersen LLP, 33 West Monroe Street, Chicago, Illinois 60603.
The accountants audit and report on
<PAGE> 37
the Fund's annual financial statements, review certain regulatory
reports and the Fund's federal income tax returns, and perform
other professional accounting, auditing, tax and advisory
services when engaged to do so by the Trust.
PORTFOLIO TRANSACTIONS
The Adviser places the orders for the purchase and sale of
the Fund's portfolio securities and options and futures
contracts. The Adviser's overriding objective in effecting
portfolio transactions is to seek to obtain the best combination
of price and execution. The best net price, giving effect to
brokerage commissions, if any, and other transaction costs,
normally is an important factor in this decision, but a number of
other judgmental factors may also enter into the decision. These
include: the Adviser's knowledge of negotiated commission rates
currently available and other current transaction costs; the
nature of the security being traded; the size of the transaction;
the desired timing of the trade; the activity existing and
expected in the market for the particular security;
confidentiality; the execution, clearance and settlement
capabilities of the broker or dealer selected and others which
are considered; the Adviser's knowledge of the financial
stability of the broker or dealer selected and such other brokers
or dealers; and the Adviser's knowledge of actual or apparent
operational problems of any broker or dealer. Recognizing the
value of these factors, the Fund may pay a brokerage commission
in excess of that which another broker or dealer may have charged
for effecting the same transaction. Evaluations of the
reasonableness of brokerage commissions, based on the foregoing
factors, are made on an ongoing basis by the Adviser's staff
while effecting portfolio transactions. The general level of
brokerage commissions paid is reviewed by the Adviser, and
reports are made annually to the Board of Trustees.
With respect to issues of securities involving brokerage
commissions, when more than one broker or dealer is believed to
be capable of providing the best combination of price and
execution with respect to a particular portfolio transaction for
the Fund, the Adviser often selects a broker or dealer that has
furnished it with research products or services such as research
reports, subscriptions to financial publications and research
compilations, compilations of securities prices, earnings,
dividends, and similar data, and computer data bases, quotation
equipment and services, research-oriented computer software and
services, and services of economic and other consultants.
Selection of brokers or dealers is not made pursuant to an
agreement or understanding with any of the brokers or dealers;
however, the Adviser uses an internal allocation procedure to
identify those brokers or dealers who provide it with research
products or services and the amount of research products or
services they provide, and endeavors to direct sufficient
commissions generated by its clients' accounts in the aggregate,
including the Fund, to such brokers or dealers to ensure the
continued receipt of research products or services the Adviser
feels are useful. In certain instances, the Adviser may receive
from brokers and dealers products or services that are used both
as investment research and for administrative, marketing, or
other non-research purposes. In such instances, the Adviser will
make a good faith effort to determine the relative proportions of
such products or services which may be considered as investment
research. The portion of the costs of such products or services
attributable to research usage may be defrayed by the Adviser
(without prior agreement or understanding, as noted above)
through
<PAGE> 38
brokerage commissions generated by transactions by clients
(including the Fund), while the portion of the costs attributable
to non-research usage of such products or services is paid by the
Adviser in cash. No person acting on behalf of the Fund is
authorized, in recognition of the value of research products or
services, to pay a commission in excess of that which another
broker or dealer might have charged for effecting the same
transaction. The Adviser may also receive research in connection
with selling concessions and designations in fixed price
offerings in which the Fund participates. Research products or
services furnished by brokers and dealers may be used in
servicing any or all of the clients of the Adviser and not all
such research products or services are used in connection with
the management of the Fund.
With respect to the Fund's purchases and sales of portfolio
securities transacted with a broker or dealer on a net basis, the
Adviser may also consider the part, if any, played by the broker
or dealer in bringing the security involved to the Adviser's
attention, including investment research related to the security
and provided to the Fund.
The Trust has arranged for its custodian to act as a
soliciting dealer to accept any fees available to the custodian
as a soliciting dealer in connection with any tender offer for
Fund portfolio securities. The custodian will credit any such
fees received against its custodial fees. In addition, the Board
of Trustees has reviewed the legal developments pertaining to and
the practicability of attempting to recapture underwriting
discounts or selling concessions when portfolio securities are
purchased in underwritten offerings. The Board of Trustees has
been advised by counsel that recapture in foreign securities
underwritings is permitted and has directed the Adviser to
attempt to recapture to the extent consistent with best price and
execution.
ADDITIONAL INCOME TAX CONSIDERATIONS
The Fund intends to comply with the special provisions of
the Internal Revenue Code that relieve it of federal income tax
to the extent of its net investment income and capital gains
currently distributed to shareholders.
Because dividend and capital gain distributions reduce net
asset value, a shareholder who purchases shares shortly before a
record date will, in effect, receive a return of a portion of his
investment in such distribution. The distribution would
nonetheless be taxable to him, even if the net asset value of
shares were reduced below his cost. However, for federal income
tax purposes the shareholder's original cost would continue as
his tax basis.
The Fund expects that less than 100% of its dividends will
qualify for the deduction for dividends received by corporate
shareholders.
To the extent the Fund invests in foreign securities, it may
be subject to withholding and other taxes imposed by foreign
countries. Tax treaties between certain countries and the United
States may reduce or eliminate such taxes. Investors may be
entitled to claim U.S. foreign tax credits with respect to such
taxes, subject to certain provisions and limitations contained in
the Code. Specifically, if more than 50%
<PAGE> 39
of the Fund's total assets at the close of any fiscal year
consist of stock or securities of foreign corporations, the Fund
may file an election with the Internal Revenue Service pursuant
to which shareholders of the Fund will be required to (i) include
in ordinary gross income (in addition to taxable dividends
actually received) their pro rata shares of foreign income taxes
paid by the Fund even though not actually received, (ii) treat
such respective pro rata shares as foreign income taxes paid by
them, and (iii) deduct such pro rata shares in computing their
taxable incomes, or, alternatively, use them as foreign tax
credits, subject to applicable limitations, against their United
States income taxes. Shareholders who do not itemize deductions
for federal income tax purposes will not, however, be able to
deduct their pro rata portion of foreign taxes paid by the Fund,
although such shareholders will be required to include their
share of such taxes in gross income. Shareholders who claim a
foreign tax credit may be required to treat a portion of
dividends received from the Fund as separate category income for
purposes of computing the limitations on the foreign tax credit
available to such shareholders. Tax-exempt shareholders will not
ordinarily benefit from this election relating to foreign taxes.
Each year, the Fund will notify shareholders of the amount of (i)
each shareholder's pro rata share of foreign income taxes paid by
the Fund and (ii) the portion of Fund dividends which represents
income from each foreign country, if the Fund qualifies to pass
along such credit.
Passive Foreign Investment Companies. The Fund may purchase
the securities of certain foreign investment funds or trusts
called passive foreign investment companies ("PFICs"). In
addition to bearing their proportionate share of the Fund's
expenses (management fees and operating expenses), shareholders
will also indirectly bear similar expenses of PFICs. Capital
gains on the sale of PFIC holdings will be deemed to be ordinary
income regardless of how long the Fund holds its investment. In
addition, the Fund may be subject to corporate income tax and an
interest charge on certain dividends and capital gains earned
from PFICs, regardless of whether such income and gains are
distributed to shareholders.
In accordance with tax regulations, the Fund intends to
treat PFICs as sold on the last day of the Fund's fiscal year and
recognize any gains for tax purposes at that time; losses will
not be recognized. Such gains will be considered ordinary income
which the Fund will be required to distribute even though it has
not sold the security and received cash to pay such
distributions.
INVESTMENT PERFORMANCE
The Fund may quote certain total return figures from time to
time. A "Total Return" on a per share basis is the amount of
dividends distributed per share plus or minus the change in the
net asset value per share for a period. A "Total Return
Percentage" may be calculated by dividing the value of a share at
the end of a period by the value of the share at the beginning of
the period and subtracting one. For a given period, an "Average
Annual Total Return" may be computed by finding the average
annual compounded rate that would equate a hypothetical initial
amount invested of $1,000 to the ending redeemable value.
n
Average Annual Total Return is computed as follows: ERV = P(1+T)
<PAGE> 40
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the period at the
end of the period (or fractional portion thereof).
Investment performance figures assume reinvestment of all
dividends and distributions and do not take into account any
federal, state, or local income taxes which shareholders must pay
on a current basis. They are not necessarily indicative of
future results. The performance of the Fund is a result of
conditions in the securities markets, portfolio management, and
operating expenses. Although investment performance information
is useful in reviewing the Fund's performance and in providing
some basis for comparison with other investment alternatives, it
should not be used for comparison with other investments using
different reinvestment assumptions or time periods.
In advertising and sales literature, the Fund may compare
its performance with that of other mutual funds, indexes or
averages of other mutual funds, indexes of related financial
assets or data, and other competing investment and deposit
products available from or through other financial institutions.
The composition of these indexes or averages differs from that of
the Fund. Comparison of the Fund to an alternative investment
should be made with consideration of differences in features and
expected performance.
All of the indexes and averages noted below will be obtained
from the indicated sources or reporting services, which the Fund
believes to be generally accurate. The Fund may also note its
mention or recognition in newspapers, magazines, or other media
from time to time. However, the Fund assumes no responsibility
for the accuracy of such data. Newspapers and magazines which
might mention the Fund include, but are not limited to, the
following:
Architectural Digest
Arizona Republic
Atlanta Constitution
Associated Press
Barron's
Bloomberg
Boston Herald
Business Week
Chicago Tribune
Chicago Sun-Times
Cleveland Plain Dealer
CNBC
CNN
Crain's Chicago Business
Consumer Reports
Consumer Digest
Dow Jones Newswire
Fee Advisor
Financial Planning
Financial World
Forbes
Fortune
Fund Action
Fund Decoder
Gourmet
Individual Investor
Investment Adviser
Investment Dealers' Digest
Investor's Business Daily
Kiplinger's Personal Finance Magazine
Knight-Ridder
Lipper Analytical Services
Los Angeles Times
Louis Rukeyser's Wall Street
Money
Morningstar
<PAGE> 41
Mutual Fund Market News
Mutual Fund News Service
Mutual Funds Magazine
Newsweek
The New York Times
No-Load Fund Investor
Pension World
Pensions and Investment
Personal Investor
Physicians Financial News
Jane Bryant Quinn (syndicated column)
The San Francisco Chronicle
Securities Industry Daily
Smart Money
Smithsonian
Strategic Insight
Time
Travel & Leisure
USA Today
U.S. News & World Report
Value Line
The Wall Street Journal
The Washington Post
Working Women
Worth
Your Money
The Fund may compare its performance to the Consumer Price
Index (All Urban), a widely recognized measure of inflation.
The Fund's performance may be compared to the following
indexes or averages:
Dow-Jones Industrial Average New York Stock Exchange Composite Index
Standard & Poor's 500 Stock Index American Stock Exchange Composite Index
Standard & Poor's 400 Industrials Nasdaq Composite
Wilshire 5000 Nasdaq Industrials
(These indexes are widely (These indexes generally reflect the
ecognized indicators of general performance of stocks traded in the
U.S. stock market results.) indicated markets.)
EAFE Index Financial Times Actuaries World Index
(Ex-U.S.)
Morgan Stanley Capital Morgan Stanley Capital International
International World Index Emerging Markets Global Index
(These indexes are widely recognized
indicators of the international markets)
In addition, the Fund may compare performance to the indices
indicated below:
Lipper International & Global Funds Average
Lipper General Equity Funds Average
Lipper Equity Funds Average
Lipper International Fund Index
(The Lipper averages are unweighted averages of total return
performance as classified, calculated, and published by Lipper.)
Morningstar International Stock Average
Morningstar U.S. Diversified Average
Morningstar Equity Fund Average
Morningstar Hybrid Fund Average
Morningstar All Equity Funds Average
Morningstar General Equity Average*
*Includes Morningstar Aggressive Growth, Growth, Balanced, Equity
Income, and Growth & Income Averages.
<PAGE> 42
The Lipper International Fund index reflects the net asset
value weighted return of the ten largest international funds.
The Lipper, and Morningstar averages are unweighted averages
of total return performance of mutual funds as classified,
calculated, and published by these independent services that
monitor the performance of mutual funds. The Fund may also use
comparative performance as computed in a ranking by Lipper or
category averages and rankings provided by another independent
service. Should Lipper or another service reclassify the Fund to
a different category or develop (and place the Fund into) a new
category, the Fund may compare its performance or ranking with
those of other funds in the newly assigned category, as published
by the service.
The Fund may also cite its rating, recognition, or other
mention by Morningstar or any other entity. Morningstar's rating
system is based on risk-adjusted total return performance and is
expressed in a star-rating format. The risk-adjusted number is
computed by subtracting a fund's risk score (which is a function
of the fund's monthly returns less the 3-month T-bill return)
from its load-adjusted total return score. This numerical score
is then translated into rating categories, with the top 10%
labeled five star, the next 22.5% labeled four star, the next 35%
labeled three star, the next 22.5% labeled two star, and the
bottom 10% one star. A high rating reflects either above-average
returns or below-average risk, or both.
Of course, past performance is not indicative of future
results.
____________________________
To illustrate the historical returns on various types of
financial assets, the Fund may use historical data provided by
Ibbotson Associates, Inc. ("Ibbotson"), a Chicago-based
investment firm. Ibbotson constructs (or obtains) very long-term
(since 1926) total return data (including, for example, total
return indexes, total return percentages, average annual total
returns and standard deviations of such returns) for the
following asset types:
Common stocks
Small company stocks
Long-term corporate bonds
Long-term government bonds
Intermediate-term government bonds
U.S. Treasury bills
Consumer Price Index
The Fund may also use hypothetical returns to be used as an
example in a mix of asset allocation strategies. One such
example is reflected in the chart below, which shows the effect
of tax deferral on a hypothetical investment. This chart assumes
that an investor invested $2,000 a year on January 1, for any
specified period, in both a Tax-Deferred Investment and a Taxable
Investment, that both investments earn either 6%, 8% or 10%
compounded annually, and that the investor withdrew the entire
amount at the end of the period. (A tax rate of 39.6% is applied
annually to the Taxable Investment and on the withdrawal of
earnings on the Tax-Deferred Investment.)
<PAGE> 43
TAX-DEFERRED INVESTMENT VS. TAXABLE INVESTMENT
INTEREST RATE 6% 8% 10% 6% 8% 10%
Compounding
Years Tax-Deferred Investment Taxable Investment
30 $124,992 $171,554 $242,340 $109,197 $135,346 $168,852
25 90,053 115,177 150,484 82,067 97,780 117,014
20 62,943 75,543 91,947 59,362 68,109 78,351
15 41,684 47,304 54,099 40,358 44,675 49,514
10 24,797 26,820 29,098 24,453 26,165 28,006
5 11,178 11,613 12,072 11,141 11,546 11,965
1 2,072 2,096 2,121 2,072 2,096 2,121
Dollar Cost Averaging. Dollar cost averaging is an
investment strategy that requires investing a fixed amount of
money in Fund shares at set intervals. This allows you to
purchase more shares when prices are low and fewer shares when
prices are high. Over time, this tends to lower your average
cost per share.
Like any investment strategy, dollar cost averaging can't
guarantee a profit or protect against losses in a steadily
declining market. Dollar cost averaging involves uninterrupted
investing regardless of share price and therefore may not be
appropriate for every investor.
From time to time, the Fund may offer in its advertising and
sales literature to send an investment strategy guide, a tax
guide, or other supplemental information to investors and
shareholders. It may also mention the Stein Roe Counselor
[service mark] and the Stein Roe Personal Counselor [service
mark] programs and asset allocation and other investment
strategies.
APPENDIX--RATINGS
RATINGS IN GENERAL
A rating of a rating service represents the service's
opinion as to the credit quality of the security being rated.
However, the ratings are general and are not absolute standards
of quality or guarantees as to the creditworthiness of an issuer.
Consequently, the Adviser believes that the quality of debt
securities in which the Fund invests should be continuously
reviewed and that individual analysts give different weightings
to the various factors involved in credit analysis. A rating is
not a recommendation to purchase, sell or hold a security because
it does not take into account market value or suitability for a
particular investor. When a security has received a rating from
more than one service, each rating should be evaluated
independently. Ratings are based on current information
furnished by the issuer or
obtained by the rating services from other sources which they
consider reliable. Ratings may be changed, suspended or
withdrawn as a result of changes in or unavailability of such
information, or for other reasons.
The following is a description of the characteristics of
ratings of corporate debt securities used by Moody's Investors
Service, Inc. ("Moody's") and Standard & Poor's Corporation
("S&P").
<PAGE> 44
RATINGS BY MOODY'S
Aaa. Bonds rated Aaa are judged to be the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a
large or an exceptionally stable margin and principal is secure.
Although the various protective elements are likely to change,
such changes as can be visualized are more unlikely to impair the
fundamentally strong position of such bonds.
Aa. Bonds rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than
the best bonds because margins of protection may not be as large
as in Aaa bonds 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
bonds.
A. Bonds rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations.
Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a
susceptibility to impairment sometime in the future.
Baa. Bonds rated Baa are considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may be
very moderate and thereby not well safeguarded during both good
and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. 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.
NOTE: Moody's applies 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.
<PAGE> 45
RATINGS BY S&P
AAA. Debt rated AAA has the highest rating. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and
repay principal and differs from the highest rated issues only in
small degree.
A. Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
debt in higher rated categories.
BBB. Debt rated BBB is regarded as having an adequate capacity
to pay interest and repay principal. Whereas it normally
exhibits adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead to a
weakened capacity to pay interest and repay principal for debt in
this category than for debt in higher rated categories.
BB, B, CCC, CC, and C. Debt rated BB, B, CCC, CC, or C is
regarded, on balance, as predominantly speculative with respect
to capacity to pay interest and repay principal in accordance
with the terms of the obligation. BB indicates the lowest degree
of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or
major risk exposures to adverse conditions.
C1. This rating is reserved for income bonds on which no
interest is being paid.
D. Debt rated D is in default, and payment of interest and/or
repayment of principal is in arrears. The D rating is also used
upon the filing of a bankruptcy petition if debt service payments
are jeopardized.
NOTES:
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. Foreign debt is rated on the same basis
as domestic debt measuring the creditworthiness of the issuer;
ratings of foreign debt do not take into account currency
exchange and related uncertainties.
The "r" is attached to highlight derivative, hybrid, and certain
other obligations that S&P believes may experience high
volatility or high variability in expected returns due to non-
credit risks. Examples of such obligations are: securities whose
principal or interest return is indexed to equities, commodities,
or currencies; certain swaps and options; and interest only and
principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will
exhibit no volatility or variability in total return.
