TARGET/UNITED FUNDS, INC.
6300 Lamar Avenue
P. O. Box 29217
Shawnee Mission, Kansas 66201-9217
913-236-2000
888-WADDELL
May 1, 2000
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information (the "SAI") is not a prospectus.
Investors should read this SAI in conjunction with the prospectus (the
"Prospectus") of Target/United Funds, Inc. (the "Fund") dated May 1, 2000, which
may be obtained by request to the Fund or Waddell & Reed, Inc. at the address or
telephone number shown above.
TABLE OF CONTENTS
Performance Information ..................................... 2
Investment Strategies, Policies and Practices................ 5
Investment Management and Other Services .................... 50
Net Asset Value ............................................. 54
Directors and Officers ...................................... 57
Purchases and Redemptions ................................... 63
Shareholder Communications .................................. 64
Taxes ....................................................... 64
Dividends and Distributions ................................. 70
Portfolio Transactions and Brokerage ........................ 70
Other Information ........................................... 74
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Appendix A .................................................. 76
Financial Statements ........................................ 85
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Target/United Funds, Inc. is a mutual fund; an investment that pools
shareholders' money and invests it toward a specified goal. In technical terms,
the Fund is an open-end, diversified management company organized as a Maryland
corporation on December 2, 1986. The Fund sells its shares only to the separate
accounts of Participating Insurance Companies to fund certain variable life
insurance policies and variable annuity contracts ("Policies").
PERFORMANCE INFORMATION
From time to time, advertisements and sales materials for one or more of
the Portfolios may include total return information, yield information and/or
performance rankings. Performance data will be accompanied by or used in
calculating performance data for the respective separate accounts that invest in
the Portfolio.
Total Return
The following relates to each Portfolio other than Money Market Portfolio.
Total return is the overall change in the value of an investment over a given
period of time. An average annual total return quotation is computed by finding
the average annual compounded rates of return over the one-, five-, and ten-year
periods that would equate the initial amount invested to the ending redeemable
value. Total return is calculated by assuming an initial $1,000 investment. No
sales charge is required to be paid by the Participating Insurance Companies for
purchase of shares. All dividends and distributions are assumed to be paid in
shares at their at net asset value ("NAV") as of the day the dividend or
distribution is paid. The formula used to calculate the total return is:
P(1 + T)^n = ERV
Where : P = $1,000 initial payment
T = Average annual total return
n = Number of years
ERV = Ending redeemable value of the $1,000
investment for the periods shown.
The average annual total return quotations as of December 31, 1999, which
is the most recent balance sheet included in this SAI, for the periods shown
were as follows:
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One-year Five-year Ten-year
period from period from Period from
1-1-99 to 1-1-95 to 1-1-90 to
12-31-99 12-31-99 12-31-99
----------- ----------- -----------
Asset Strategy Portfolio 22.96% 11.52%*
Balanced Portfolio 10.14% 14.39% 12.52%**
Bond Portfolio -1.44% 7.69% 7.45%
Growth Portfolio 34.35% 26.47% 19.38%
High Income Portfolio 4.22% 10.00% 10.29%
Income Portfolio 12.52% 22.06% 17.26%***
International Portfolio 65.58% 26.15% 22.81%**
Limited-Term Bond Portfolio 1.74% 6.58% 5.84%**
Science and Technology Portfolio 174.66% 75.31%****
Small Cap Portfolio 52.23% 26.09% 26.88%**
*Period from May 1, 1995, commencement of operations, to December 31, 1999.
**Period from May 3, 1994, commencement of operations, to December 31, 1999.
***Period from July 16, 1991, commencement of operations, to December 31,
1999.
****Period from April 4, 1997, commencement of operations, to December 31,
1999.
Unaveraged or cumulative total return may also be quoted. Such total
return data reflects the change in value of an investment over a stated period
of time. Cumulative total returns will be calculated according to the formula
indicated above but without averaging the rate for the number of years in the
period. The Fund may also provide non-standardized performance information.
Yield
The following relates to Bond Portfolio, High Income Portfolio and
Limited-Term Bond Portfolio. A yield quoted for a Portfolio is computed by
dividing the net investment income per share earned during the period for which
the yield is shown by the maximum offering price per share on the last day of
that period according to the following formula:
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Yield = 2((((a-b)/cd)+1)^6 -1)
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the maximum offering price per share on the last day
of the period.
The yield computed according to the formula for the 30-day period ended on
December 31, 1999, the date of the most recent balance sheet included in this
SAI, is as follows:
Bond Portfolio 6.54%
High Income Portfolio 8.49%
Limited-Term Bond Portfolio 7.66%
The following relates to Money Market Portfolio. There are two methods by
which Money Market Portfolio's yield for a specified time is calculated. The
first method, which results in an amount referred to as the "current yield,"
assumes an account containing exactly one share at the beginning of the period.
The NAV of this share will be $1.00 except under extraordinary circumstances.
The net change in the value of the account during the period is then determined
by subtracting this beginning value from the value of the account at the end of
the period which will include all dividends accrued; however, capital changes
are excluded from the calculation, i.e., realized gains and losses from the sale
of securities and unrealized appreciation and depreciation. However, so that the
change will not reflect the capital changes to be excluded, the dividends used
in the yield computation may not be the same as the dividends actually declared,
as certain realized gains and losses and, under unusual circumstances,
unrealized gains and losses (see "Purchases and Redemptions"), will be taken
into account in the calculation of dividends actually declared. Instead, the
dividends used in the yield calculation will be those which would have been
declared if the capital changes had not affected the dividends.
This net change in the account value is then divided by the value of the
account at the beginning of the period (i.e., normally $1.00 as discussed above)
and the resulting figure (referred to as the "base period return") is then
annualized by multiplying it by 365 and dividing it by the number of days in the
period with the resulting current yield figure carried to at least the nearest
hundredth of one percent.
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The second method results in a figure referred to as the "effective
yield." This represents an annualization of the current yield with dividends
reinvested daily. Effective yield is calculated by compounding the base period
return by adding 1, raising the sum to a power equal to 365 divided by 7, and
subtracting 1 from the result and rounding the result to the nearest hundredth
of one percent according to the following formula:
EFFECTIVE YIELD = [(BASE PERIOD RETURN + 1)]^365/7 -1
The Money Market Portfolio's current yield as calculated above for the
seven days ended December 31, 1999, the date of the most recent balance sheet
included in this SAI, was 6.03% and its effective yield calculated for the same
period was 6.21%.
Performance Rankings and Other Information
The following relates to each of the Portfolios. From time to time,
advertisements and information furnished to present or prospective Policyholders
may include performance rankings as published by recognized independent mutual
fund statistical services such as Lipper Analytical Services, Inc., or by
publications of general interest such as Forbes, Money, The Wall Street Journal,
Business Week, Barron's, Fortune or Morningstar Mutual Fund Values. A
Portfolio's performance may also be compared to that of other selected mutual
funds or recognized market indicators such as the Standard & Poor's 500
Composite Stock Price Index and the Dow Jones Industrial Average. Performance
information may be quoted numerically or presented in a table, graph or other
illustration. In connection with a ranking, the Fund may provide additional
information, such as the particular category to which it related, the number of
funds in the category, the criteria upon which the ranking is based, and the
effect of sales charges, fee waivers and/or expense reimbursements.
Performance information for a Portfolio may be accompanied by information
about market conditions and other factors that affected the Portfolio's
performance for the period(s) shown.
Change in yields primarily reflect different interest rates received by a
Portfolio as its portfolio securities change. Yield is also affected by
portfolio quality, portfolio maturity, type of securities held and operating
expense ratio.
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All performance information included in advertisements or sales material
is historical in nature and is not intended to represent or guarantee future
results. The value of a Portfolio's shares when redeemed may be more or less
than their original cost.
INVESTMENT STRATEGIES, POLICIES AND PRACTICES
This SAI supplements the information contained in the Prospectus and
contains more detailed information about the investment strategies and policies
the Fund's investment manager, Waddell & Reed Investment Management Company (the
"Manager"), may employ and the types of instruments in which a Portfolio may
invest, in pursuit of a Portfolio's goal(s). A summary of the risks associated
with these instrument types and investment practices is included as well.
The Manager might not buy all of these instruments or use all of these
techniques, or use them to the full extent permitted by a Portfolio's investment
policies and restrictions. The Manager buys an instrument or uses a technique
only if it believes that doing so will help a Portfolio achieve its goal(s). See
"Investment Restrictions" for a listing of the fundamental and non-fundamental
(e.g., operating) investment restrictions and policies of the Portfolios.
Asset Strategy Portfolio
Asset Strategy Portfolio allocates its assets among the following classes,
or types, of investments:
The short-term class includes all types of domestic and foreign securities
and money market instruments with remaining maturities of three years or less.
The Manager will seek to maximize total return within the short-term asset class
by taking advantage of yield differentials between different instruments,
issuers, and currencies. Short-term instruments may include corporate debt
securities, such as commercial paper and notes; U.S. Government securities or
securities issued by foreign governments or their agencies or instrumentalities;
bank deposits and other financial institution obligations; repurchase agreements
involving any type of security; and other similar short-term instruments. These
instruments may be denominated in U.S. dollars or foreign currency.
The bond class includes all varieties of domestic and foreign fixed-income
securities with maturities greater than three years. The Manager seeks to
maximize total return within the bond class by adjusting the Portfolio's
investments in securities with
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different credit qualities, maturities, and coupon or dividend rates, and by
seeking to take advantage of yield differentials between securities. Securities
in this class may include bonds, notes, adjustable-rate preferred stocks,
convertible bonds, mortgage-related and asset-backed securities, domestic and
foreign government and government agency securities, zero coupon securities, and
other intermediate and long-term securities. As with the short-term class, these
securities may be denominated in U.S. dollars or foreign currency. The Portfolio
may also invest in lower-quality, high-yield debt securities. The Portfolio may
not invest more than 35% of its total assets in these securities.
The stock class includes domestic and foreign equity securities of all
types (other than adjustable-rate preferred stocks, which are included in the
bond class). The Manager seeks to maximize total return within this asset class
by actively allocating assets to industry sectors expected to benefit from major
trends, and to individual stocks that the Manager believes to have superior
growth potential and/or value potential. Securities in the stock class may
include common stocks, fixed-rate preferred stocks (including convertible
preferred stocks), warrants, rights, depository receipts, securities of
closed-end investment companies, and other equity securities issued by companies
of any size, located world-wide.
The Manager intends to take advantage of yield differentials by
considering the purchase or sale of instruments when differentials on spreads
between various grades and maturities of such instruments approach extreme
levels relative to long-term norms.
In making asset allocation decisions, the Manager typically evaluates
projections of risk, market conditions, economic conditions, volatility, yields,
and returns.
The ability of Asset Strategy Portfolio to purchase and hold precious
metals such as gold, silver and platinum may allow it to benefit from a
potential increase in the price of precious metals or stability in the price of
such metals at a time when the value of securities may be declining. For
example, during periods of declining stock prices, the price of gold may
increase or remain stable, while the value of the stock market may be subject to
a general decline.
Precious metals prices are affected by various factors, such as economic
conditions, political events and monetary policies. As a result, the price of
gold, silver or platinum may fluctuate widely. The sole source of return to
Asset Strategy Portfolio from such investments will be gains realized on sales;
a negative return will be realized if the metal is sold at a loss.
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Investments in precious metals do not provide a yield. Asset Strategy
Portfolio's direct investment in precious metals may be limited by tax
considerations. See "Taxes" below.
High Income Portfolio
High Income Portfolio may invest in certain high-yield, high-risk,
non-investment grade debt securities (commonly referred to as "junk bonds"). The
market for such securities may differ from that for investment grade debt
securities. See the discussion below for information about the risks associated
with non-investment grade debt securities. See Appendix A to this SAI for a
description of bond ratings.
Money Market Portfolio
Money Market Portfolio may invest in the money market obligations and
instruments listed below. Under Rule 2a-7 ("Rule 2a-7") of the Investment
Company Act of 1940, as amended (the "1940 Act"), investments are limited to
those that are U.S. dollar denominated and that are rated in one of the two
highest rating categories by the requisite nationally recognized statistical
rating organization(s) ("NRSRO(s)"), as defined in Rule 2a-7, or are comparable
unrated securities. See Appendix A to this SAI for a description of some of
these ratings. In general, Rule 2a-7 also limits investments in securities of
any one issuer (except securities issued or guaranteed by the U.S. Government or
its agencies or instrumentalities ("U.S. Government securities")) to no more
than 5% of the Portfolio's total assets. Investments in securities rated in the
second highest rating category by the requisite NRSRO(s) or comparable unrated
securities are limited to no more than 5% of the Portfolio's total assets, with
investments in such securities of any one issuer (except U.S. Government
securities) being limited to the greater of one percent of the Portfolio's total
assets or $1,000,000. Under Rule 2a-7, the Portfolio may only invest in
securities with a remaining maturity of not more than 397 calendar days, as
further described in the Rule.
(1) U.S. Government Securities: See "U.S. Government Securities."
(2) Bank Obligations and Instruments Secured Thereby: Subject to the
limitations described above, time deposits, certificates of deposit, bankers'
acceptances and other bank obligations if they are obligations of a bank subject
to regulation by the U.S. Government (including obligations issued by foreign
branches of these banks) or obligations issued by a foreign bank having total
assets equal to at least U.S.
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$500,000,000, and instruments secured by any such obligation. A "bank" includes
commercial banks and savings and loan associations. Time deposits are monies
kept on deposit with U.S. banks or other U.S. financial institutions for a
stated period of time at a fixed rate of interest. At present, bank time
deposits are not considered by the Board of Directors or the Manager, to be
readily marketable. There may be penalties for the early withdrawal of such time
deposits, in which case, the yield of these investments will be reduced.
(3) Commercial Paper Obligations Including Variable Amount Master Demand
Notes: Commercial paper rated as described above. See Appendix A to this SAI for
a description of some of these ratings. A variable amount master demand note
represents a borrowing arrangement under a letter agreement between a commercial
paper issuer and an institutional investor.
(4) Corporate Debt Obligations: Corporate debt obligations if they are
rated as described above. See Appendix A to this SAI for a description of some
of these bond ratings.
(5) Canadian Government Obligations: Obligations of, or obligations
guaranteed by, the Government of Canada, a Province of Canada or any agency,
instrumentality or political subdivision of that Government or any Province. The
Portfolio will not invest in Canadian Government obligations if more than 10% of
the value of its total assets would then be so invested, subject to the
diversification requirements applicable to the Money Market Portfolio.
(6) Certain Other Obligations: Obligations other than those listed in (1)
through (5) (such as municipal obligations) only if any such other obligation is
guaranteed as to principal and interest by either a bank or a corporation whose
securities the Portfolio is eligible to hold under the Rule.
The value of the obligations and instruments in which the Portfolio
invests will fluctuate depending in large part on changes in prevailing interest
rates. If these rates go up after the Portfolio buys an obligation or
instrument, its value may go down; if these rates go down, its value may go up.
Changes in interest rates will be more quickly reflected in the yield of a
portfolio of short-term obligations than in the yield of a portfolio of
long-term obligations.
Securities - General
The main types of securities in which the Portfolios may invest include
common stock, preferred stock, debt securities and convertible securities.
Although common stocks and other equity
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securities have a history of long-term growth in value, their prices tend to
fluctuate in the short term, particularly those of smaller companies. The equity
securities in which a Portfolio (other than Money Market Portfolio) invests may
include preferred stock that converts into common stock. Each of the Portfolios
(other than Money Market Portfolio) may invest in preferred stock rated in any
rating category of the established rating services or, if unrated, judged by the
Manager to be of equivalent quality. Debt securities have varying levels of
sensitivity to changes in interest rates and varying degrees of quality. As a
general matter, however, when interest rates rise, the values of fixed-rate
securities fall and, conversely, when interest rates fall, the values of
fixed-rate debt securities rise. Similarly, long-term bonds are generally more
sensitive to interest rate changes than short-term bonds.
Lower quality debt securities (commonly called "junk bonds") are
considered to be speculative and involve greater risk of default or price
changes due to changes in the issuer's creditworthiness. The market prices of
these securities may fluctuate more than high-quality securities and may decline
significantly in periods of general economic difficulty. The market for
lower-rated debt securities may be thinner and less active than that for
higher-rated debt securities, which can adversely affect the prices at which the
former are sold. Adverse publicity and changing investor perceptions may
decrease the values and liquidity of lower-rated debt securities, especially in
a thinly traded market. Valuation becomes more difficult and judgment plays a
greater role in valuing lower-rated debt securities than with respect to
securities for which more external sources of quotations and last sale
information are available. Since the risk of default is higher for lower-rated
debt securities, the Manager's research and credit analysis are an especially
important part of managing securities of this type held by a Portfolio. The
Manager continuously monitors the issuers of lower-rated debt securities in each
portfolio in an attempt to determine if the issuers will have sufficient cash
flow and profits to meet required principal and interest payments. The Fund may
choose, at its expense or in conjunction with others, to pursue litigation or
otherwise exercise its rights as a security holder to seek to protect the
interests of security holders if it determines this to be in the best interest
of the shareholders of the affected Portfolio(s).
Subject to its investment restrictions, a Portfolio (other than Money
Market Portfolio) may invest in debt securities rated in any rating category of
the established rating services, including securities rated in the lowest
category (securities rated D by Standard & Poor's ("S&P") and C by Moody's
Investors Service, Inc. ("MIS")). Debt securities rated D
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by S&P or C by MIS are in payment default or are regarded as having extremely
poor prospects of ever attaining any real investment standing. Debt securities
rated at least BBB by S&P or Baa by MIS are considered to be investment grade
debt securities. Securities rated BBB or Baa may have speculative
characteristics. In addition, a Portfolio will treat unrated securities judged
by the Manager to be of equivalent quality to a rated security as having that
rating.
While credit ratings are only one factor the Manager relies on in
evaluating high-yield debt securities, certain risks are associated with credit
ratings. Credit ratings evaluate the safety of principal and interest payments,
not market value risk. Credit ratings for individual securities may change from
time to time, and a Portfolio may retain a portfolio security whose rating has
been changed.
Each of the Portfolios (other than Money Market Portfolio) may purchase
debt securities whose principal amount at maturity is dependent upon the
performance of a specified equity security. The issuer of such debt securities,
typically an investment banking firm, is unaffiliated with the issuer of the
equity security to whose performance the debt security is linked. Equity-linked
debt securities differ from ordinary debt securities in that the principal
amount received at maturity is not fixed, but is based on the price of the
linked equity security at the time the debt security matures. The performance of
equity-linked debt securities depends primarily on the performance of the linked
equity security and may also be influenced by interest rate changes. In
addition, although the debt securities are typically adjusted for diluting
events such as stock splits, stock dividends and certain other events affecting
the market value of the linked equity security, the debt securities are not
adjusted for subsequent issuances of the linked equity security for cash. Such
an issuance could adversely affect the price of the debt security. In addition
to the equity risk relating to the linked equity security, such debt securities
are also subject to credit risk with regard to the issuer of the debt security.
In general, however, such debt securities are less volatile than the equity
securities to which they are linked.
Each of the Portfolios (other than Money Market Portfolio) may invest in
convertible securities. A convertible security is a bond, debenture, note,
preferred stock or other security that may be converted into or exchanged for a
prescribed amount of common stock of the same or different issuer within a
particular period of time at a specified price or formula. Convertible
securities generally have higher yields than common stocks of the same or
similar issuers, but lower yields than comparable nonconvertible securities, are
less subject to fluctuation in value than the
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underlying stock because they have fixed income characteristics, and provide the
potential for capital appreciation if the market price of the underlying common
stock increases.
The value of a convertible security is influenced by changes in interest
rates, with investment value declining as interest rates increase and increasing
as interest rates decline. The credit standing of the issuer and other factors
also may have an effect on the convertible security's investment value.
The Portfolios (other than Money Market Portfolio) may also invest in a
type of convertible preferred stock that pays a cumulative, fixed dividend that
is senior to, and expected to be in excess of, the dividends paid on the common
stock of the issuer. At the mandatory conversion date, the preferred stock is
converted into not more than one share of the issuer's common stock at the "call
price" that was established at the time the preferred stock was issued. If the
price per share of the related common stock on the mandatory conversion date is
less than the call price, the holder of the preferred stock will nonetheless
receive only one share of common stock for each share of preferred stock (plus
cash in the amount of any accrued but unpaid dividends). At any time prior to
the mandatory conversion date, the issuer may redeem the preferred stock upon
issuing to the holder a number of shares of common stock equal to the call price
of the preferred stock in effect on the date of redemption divided by the market
value of the common stock, with such market value typically determined one or
two trading days prior to the date notice of redemption is given. The issuer
must also pay the holder of the preferred stock cash in an amount equal to any
accrued but unpaid dividends on the preferred stock. This convertible preferred
stock is subject to the same market risk as the common stock of the issuer,
except to the extent that such risk is mitigated by the higher dividend paid on
the preferred stock. The opportunity for equity appreciation afforded by an
investment in such convertible preferred stock, however, is limited, because in
the event the market value of the issuer's common stock increases to or above
the call price of the preferred stock, the issuer may (and would be expected to)
call the preferred stock for redemption at the call price. This convertible
preferred stock is also subject to credit risk with regard to the ability of the
issuer to pay the dividend established upon issuance of the preferred stock.
Generally, convertible preferred stock is less volatile than the related common
stock of the issuer.
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Specific Securities and Investment Practices
U.S. Government Securities
U.S. Government securities are high quality debt instruments issued or
guaranteed as to principal or interest by the U.S. Treasury or an agency or
instrumentality of the U.S. Government. These securities include Treasury Bills
(which mature within one year of the date they are issued), Treasury Notes
(which have maturities of one to ten years) and Treasury Bonds (which generally
have maturities of more than 10 years). All such Treasury securities are backed
by the full faith and credit of the United States.
U.S. Government agencies and instrumentalities that issue or guarantee
securities include, but are not limited to, the Federal Housing Administration,
Fannie Mae (also known as the Federal National Mortgage Association), Farmers
Home Administration, Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association ("Ginnie Mae"), General
Services Administration, Central Bank for Cooperatives, Federal Home Loan Banks,
Federal Home Loan Mortgage Corporation ("Freddie Mac"), Farm Credit Banks,
Maritime Administration, the Tennessee Valley Authority, the Resolution Funding
Corporation and the Student Loan Marketing Association.
Securities issued or guaranteed by U.S. Government agencies and
instrumentalities are not always supported by the full faith and credit of the
United States. Some, such as securities issued by the Federal Home Loan Banks,
are backed by the right of the agency or instrumentality to borrow from the
Treasury. Others, such as securities issued by Fannie Mae, are supported only by
the credit of the instrumentality and by a pool of mortgage assets. If the
securities are not backed by the full faith and credit of the United States, the
owner of the securities must look principally to the agency issuing the
obligation for repayment and may not be able to assert a claim against the
United States in the event that the agency or instrumentality does not meet its
commitment.
U.S. Government securities may include mortgage-backed securities issued
by U.S. Government agencies or instrumentalities including, but not limited to,
Ginnie Mae, Freddie Mac and Fannie Mae. These mortgage-backed securities include
pass-through securities, participation certificates and collateralized mortgage
obligations. See "Mortgage-Backed and Asset-Backed Securities." Timely payment
of principal and interest on Ginnie Mae pass-throughs is guaranteed by the full
faith and credit of the United States. Freddie Mac and Fannie Mae are both
instrumentalities of the U.S. Government, but their obligations are not backed
by the
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full faith and credit of the United States. It is possible that the availability
and the marketability (i.e., liquidity) of the securities discussed in this
section could be adversely affected by actions of the U.S. Government to tighten
the availability of its credit.
Money Market Instruments
Money market instruments are high-quality, short-term debt instruments
that present minimal credit risk. They may include U.S. Government securities,
commercial paper and other short-term corporate obligations, and certificates of
deposit and other financial institution obligations. These instruments may carry
fixed or variable interest rates.
Bank Deposits
Among the other debt securities in which the Portfolios may invest are
deposits in banks (represented by certificates of deposit or other evidence of
deposit issued by such banks) of varying maturities. The Federal Deposit
Insurance Corporation insures the principal of certain such deposits, currently
to the extent of $100,000 per bank. Bank deposits are not marketable, and a
Portfolio may invest in them only within the 10% limit mentioned below under
"Investment Restrictions and Limitations" (15% limit for Asset Strategy
Portfolio) unless such obligations are payable at principal amount plus accrued
interest on demand or within seven days after demand.
Zero Coupon Securities
Zero coupon securities are debt obligations that do not entitle the holder
to any periodic payment of interest prior to maturity or that specify a future
date when the securities begin to pay current interest; instead, they are sold
at a deep discount from their face value and are redeemed at face value when
they mature. Because zero coupon securities do not pay current income, their
prices can be very volatile when interest rates change and generally are subject
to greater price fluctuations in response to changing interest rates than prices
of comparable maturities that make current distributions of interest in cash.
A Portfolio may invest in zero coupon securities that are "stripped" U.S.
Treasury notes and bonds, zero coupon bonds of corporate issuers and other
securities that are issued with original issue discount ("OID"). The Federal tax
law requires that a holder of a security with OID accrue a ratable portion of
the OID on the security as income each year, even though the holder may receive
no interest payment on the security during the year. Accordingly, although a
Portfolio will receive no payments
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on its zero coupon securities prior to their maturity or disposition, it will
have current income attributable to those securities and includable in the
dividends paid to its shareholders. Those dividends will be paid from a
Portfolio's cash assets or by liquidation of portfolio securities, if necessary,
at a time when a Portfolio otherwise might not have done so.
A broker-dealer creates a derivative zero by separating the interest and
principal components of a U.S. Treasury security and selling them as two
individual securities. CATS (Certificates of Accrual on Treasury Securities),
TIGRs (Treasury Investment Growth Receipts), and TRs (Treasury Receipts) are
examples of derivative zeros.
A Federal Reserve Bank creates STRIPS (Separate Trading of Registered
Interest and Principal of Securities) by separating the interest and principal
components of an outstanding U.S. Treasury bond and selling them as individual
securities. Bonds issued by the Resolution Funding Corporation (REFCORP) and the
Financing Corporation (FICO) can also be separated in this fashion. Original
issue zeros are zero coupon securities originally issued by the U.S. Government,
a government agency, or a corporation in zero coupon form.
Municipal Obligations
Municipal obligations are issued by a wide range of state and local
governments, agencies and authorities for various purposes. The two main kinds
of municipal bonds are "general obligation" bonds and "revenue" bonds. In
"general obligation" bonds, the issuer has pledged its full faith, credit and
taxing power for the payment of principal and interest. "Revenue" bonds are
payable only from specific sources; these may include revenues from a particular
facility or class of facilities or special tax or other revenue source.
Industrial development bonds are revenue bonds issued by or on behalf of public
authorities to obtain funds to finance privately operated facilities. Their
credit quality is generally dependent on the credit standing of the company
involved.
Mortgage-Backed and Asset-Backed Securities
Mortgage-Backed Securities. Mortgage-backed securities represent direct or
indirect participations in, or are secured by and payable from, mortgage loans
secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. Multi-class pass-through
securities and collateralized mortgage obligations are collectively referred to
in this SAI as "CMOs." Some CMOs are
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directly supported by other CMOs, which in turn are supported by mortgage pools.
Investors typically receive payments out of the interest and principal on the
underlying mortgages. The portions of the payments that investors receive, as
well as the priority of their rights to receive payments, are determined by the
specific terms of the CMO class.
The U.S. Government mortgage-backed securities in which the Portfolios may
invest include mortgage-backed securities issued or guaranteed as to the payment
of principal and interest (but not as to market value) by Ginnie Mae, Fannie Mae
or Freddie Mac. Other mortgage-backed securities are issued by private issuers,
generally originators of and investors in mortgage loans, including savings
associations, mortgage bankers, commercial banks, investment bankers and special
purpose entities. Payments of principal and interest (but not the market value)
of such private mortgage-backed securities may be supported by pools of mortgage
loans or other mortgage-backed securities that are guaranteed, directly or
indirectly, by the U.S. Government or one of its agencies or instrumentalities,
or they may be issued without any government guarantee of the underlying
mortgage assets but with some form of non-government credit enhancement. These
credit enhancements do not protect investors from changes in market value.
The Portfolios may purchase mortgage-backed securities issued by both
government and non-government entities such as banks, mortgage lenders or other
financial institutions. Other types of mortgage-backed securities will likely be
developed in the future, and a Portfolio may invest in them if the Manager
determines they are consistent with the Portfolio's goal(s) and investment
policies.
Stripped Mortgage-Backed Securities. Stripped mortgage-backed securities
are created when a U.S. Government agency or a financial institution separates
the interest and principal components of a mortgage-backed security and sells
them as individual securities. The holder of the "principal-only" security
("PO") receives the principal payments made by the underlying mortgage-backed
security, while the holder of the "interest-only" security ("IO") receives
interest payments from the same underlying security.
For example, interest-only ("IO") classes are entitled to receive all or a
portion of the interest, but none (or only a nominal amount) of the principal
payments, from the underlying mortgage assets. If the mortgage assets underlying
an IO experience greater than anticipated principal prepayments, then the total
amount of interest allocable to the IO class, and therefore the yield to
investors, generally will be reduced. In
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some instances, an investor in an IO may fail to recoup all of the investor's
initial investment, even if the security is guaranteed by the government or
considered to be of the highest quality. Conversely, principal-only ("PO")
classes are entitled to receive all or a portion of the principal payments, but
none of the interest, from the underlying mortgage assets. PO classes are
purchased at substantial discounts from par, and the yield to investors will be
reduced if principal payments are slower than expected. IOs, POs and other CMOs
involve special risks, and evaluating them requires special knowledge.
Asset-Backed Securities. Asset-backed securities have structural
characteristics similar to mortgage-backed securities, as discussed above.
However, the underlying assets are not first lien mortgage loans or interests
therein, but include assets such as motor vehicle installment sales contracts,
other installment sale contracts, home equity loans, leases of various types of
real and personal property and receivables from revolving credit (credit card)
agreements. Such assets are securitized through the use of trusts or special
purpose corporations. Payments or distributions of principal and interest may be
guaranteed up to a certain amount and for a certain time period by a letter of
credit or pool insurance policy issued by a financial institution unaffiliated
with the issuer, or other credit enhancements may be present. The value of
asset-backed securities may also depend on the creditworthiness of the servicing
agent for the loan pool, the originator of the loans or the financial
institution providing the credit enhancement.
Special Characteristics of Mortgage-Backed and Asset-Backed Securities.
The yield characteristics of mortgage-backed and asset-backed securities differ
from those of traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other obligations generally may be prepaid at any time. Prepayments on a pool
of mortgage loans are influenced by a variety of economic, geographic, social
and other factors, including changes in mortgagors' housing needs, job
transfers, unemployment, mortgagors' net equity in the mortgaged properties and
servicing decisions. Generally, however, prepayments on fixed-rate mortgage
loans will increase during a period of falling interest rates and decrease
during a period of rising interest rates. Similar factors apply to prepayments
on asset-backed securities, but the receivables underlying asset-backed
securities generally are of a shorter maturity and thus are likely to experience
substantial prepayments. Such securities, however, often provide that for a
specified time period the issuers will replace receivables in the pool that are
repaid with comparable obligations. If the issuer is unable to do so, repayment
of
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principal on the asset-backed securities may commence at an earlier date.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificate holders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are purchased
or traded in the secondary market at a premium or discount. In addition, there
is normally some delay between the time the issuer receives mortgage payments
from the servicer and the time the issuer makes the payments on the
mortgage-backed securities, and this delay reduces the effective yield to the
holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice has been to assume that prepayments on pools of
fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of average
life determined for each pool. In periods of declining interest rates, the rate
of prepayment tends to increase, thereby shortening the actual average life of a
pool of mortgage-related securities. Conversely, in periods of rising interest
rates, the rate of prepayment tends to decrease, thereby lengthening the actual
average life of the pool. Changes in the rate or "speed" of these prepayments
can cause the value of the mortgage-backed securities to fluctuate rapidly.
However, these effects may not be present, or may differ in degree, if the
mortgage loans in the pools have adjustable interest rates or other special
payment terms, such as a prepayment charge. Actual prepayment experience may
cause the yield of mortgage-backed securities to differ from the assumed average
life yield.
The market for privately issued mortgage-backed and asset-backed
securities is smaller and less liquid than the market for U.S. Government
mortgage-backed securities. CMO classes may be specifically structured in a
manner that provides any of a wide variety of investment characteristics, such
as yield, effective maturity and interest rate sensitivity. As market conditions
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change, however, and especially during periods of rapid or unanticipated changes
in market interest rates, the attractiveness of some CMO classes and the ability
of the structure to provide the anticipated investment characteristics may be
reduced. These changes can result in volatility in the market value and, in some
instances, reduced liquidity of the CMO class.
Variable or Floating Rate Instruments
Variable or floating rate instruments (including notes purchased directly
from issuers) bear variable or floating interest rates and may carry rights that
permit holders to demand payment of the unpaid principal balance plus accrued
interest from the issuers or certain financial intermediaries on dates prior to
their stated maturities. Floating rate securities have interest rates that
change whenever there is a change in a designated base rate, while variable rate
instruments provide for a specified periodic adjustment in the interest rate.
These formulas are designed to result in a market value for the instrument that
approximates its par value.
Indexed Securities
Each Portfolio (other than Money Market Portfolio) may purchase securities
whose prices are indexed to the prices of other securities, securities indices,
currencies, precious metals or other commodities, or other financial indicators,
subject to its operating policy regarding derivative instruments and subject, in
the case of Money Market Portfolio only, to the requirements of Rule 2a-7.
Indexed securities typically, but not always, are debt securities or deposits
whose value at maturity or coupon rate is determined by reference to a specific
instrument or statistic. The performance of indexed securities depends to a
great extent on the performance of the security, currency or other instrument to
which they are indexed and may also be influenced by interest rate changes in
the United States and abroad. At the same time, indexed securities are subject
to the credit risks associated with the issuer of the security and their values
may decline substantially if the issuer's creditworthiness deteriorates. Indexed
securities may be more volatile than the underlying investments.
Gold-indexed securities, for example, typically provide for a maturity
value that depends on the price of gold, resulting in a security whose price
tends to rise and fall together with gold prices. Currency-indexed securities
typically are short-term to intermediate-term debt securities whose maturity
values or interest rates are determined by reference to the values of one or
more specified foreign currencies, and may offer higher yields than U.S.
dollar-denominated securities of equivalent issuers.
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Currency-indexed securities may be positively or negatively indexed; that is,
their maturity value may increase when the specified currency value increases,
resulting in a security that performs similarly to a foreign-denominated
instrument, or their maturity value may decline when foreign currencies
increase, resulting in a security whose price characteristics are similar to a
put on the underlying currency. Currency-indexed securities may also have prices
that depend on the values of a number of different foreign currencies relative
to each other.
Recent issuers of indexed securities have included banks, corporations,
and certain U.S. government agencies. The Manager will use its judgment in
determining whether indexed securities should be treated as short-term
instruments, bonds, stocks, or as a separate asset class for purposes of Asset
Strategy Portfolio's investment allocations, depending on the individual
characteristics of the securities. Certain indexed securities that are not
traded on an established market may be deemed illiquid.
Foreign Securities and Currencies
All Portfolios, other than Limited-Term Bond, may invest in the securities
of foreign issuers, including depository receipts.
In general, depository receipts are securities convertible into and
evidencing ownership of securities of foreign corporate issuers, although
depository receipts may not necessarily be denominated in the same currency as
the securities into which they may be converted. American Depository Receipts,
in registered form, are dollar-denominated receipts typically issued by a U.S.
bank or trust company evidencing ownership of the underlying securities.
International depository receipts and European depository receipts, in bearer
form, are foreign receipts evidencing a similar arrangement and are designed for
use by non-U.S. investors and traders in non-U.S. markets. Global depository
receipts are more recently developed receipts designed to facilitate the trading
of foreign issuers by U.S. and non-U.S. investors and traders.
The Manager believes that there are investment opportunities as well as
risks in investing in foreign securities. Individual foreign economies may
differ favorably or unfavorably from the U.S. economy or each other in such
matters as gross national product, rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payments position. Individual foreign
companies may also differ favorably or unfavorably from domestic companies in
the same industry. Foreign currencies may be stronger or weaker than the U.S.
dollar or than each other. Thus,
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the value of securities denominated in or indexed to foreign currencies, and of
dividends and interest from such securities, can change significantly when
foreign currencies strengthen or weaken relative to the U.S. dollar. The Manager
believes that a Portfolio's ability to invest assets abroad might enable it to
take advantage of these differences and strengths where they are favorable.
However, foreign securities and foreign currencies involve additional
significant risks, apart from the risks inherent in U.S. investments. Foreign
securities markets generally have less trading volume and less liquidity than
U.S. markets, and prices on some foreign markets can be highly volatile. Many
foreign countries lack uniform accounting and disclosure standards comparable to
those applicable to U.S. companies, and it may be more difficult to obtain
reliable information regarding an issuer's financial conditions and operations.
In addition, the costs of foreign investing, including withholding taxes,
brokerage commissions and custodial costs, are generally higher than for U.S.
investments.
Foreign markets may offer less protection to investors than U.S. markets.
Foreign issuers, brokers and securities markets may be subject to less
government supervision. Foreign security trading practices, including those
involving the release of assets in advance of payment, may involve increased
risks in the event of a failed trade or the insolvency of a broker-dealer, and
may involve substantial delays. It may also be difficult to enforce legal rights
in foreign countries.
Investing abroad also involves different political and economic risks.
Foreign investments may be affected by actions of foreign governments adverse to
the interests of U.S. investors, including the possibility of expropriation or
nationalization of assets, confiscatory taxation, restrictions on U.S.
investment or on the ability to repatriate assets or convert currency into U.S.
dollars, or other government intervention. There may be greater possibility of
default by foreign governments or government-sponsored enterprises. Investments
in foreign countries also involve a risk of local political, economic, or social
instability, military action or unrest, or adverse diplomatic developments.
These is no assurance that the Manager will be able to anticipate these
potential events or counter their effects.
The considerations noted above generally are intensified in developing
countries. A developing country is a nation that, in the Manager's opinion, is
likely to experience long-term gross domestic product growth above that expected
to occur in the United States, the United Kingdom, France, Germany, Italy, Japan
and Canada. Developing countries may have relatively unstable
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governments, economies based on only a few industries and securities markets
that trade a small number of securities.
Certain foreign securities impose restrictions on transfer within the
United States or to U.S. persons. Although securities subject to transfer
restrictions may be marketable abroad, they may be less liquid than foreign
securities of the same class that are not subject to such restrictions.
Certain of the Portfolios could also be adversely affected by the
conversion of certain European currencies into the euro. This conversion, which
is underway, is scheduled to be completed in 2002. However, problems with the
conversion process and delays could increase volatility in world capital markets
and affect European capital markets in particular.
Each of the Portfolios (other than Money Market Portfolio and Limited-Term
Bond Portfolio) may also purchase and sell foreign currency and invest in
foreign currency deposits.
Currency conversion involves dealer spreads and other costs, although
commissions are not usually charged. See "Options, Futures Contracts and Other
Strategies -- Forward Currency Contracts."
Investments in obligations of domestic branches of foreign banks will not
be considered to be foreign securities if the Manager has determined that the
nature and extent of federal and state regulation and supervision of the branch
in question is substantially equivalent to federal or state chartered domestic
banks doing business in the same jurisdiction.
The only foreign securities in which Money Market Portfolio may invest are
Canadian Government obligations, foreign bank obligations and obligations of
foreign branches of domestic banks, all of which must be U.S.
dollar-denominated.
Restricted Securities
Each of the Portfolios may invest in restricted securities. Restricted
securities are securities that are subject to legal or contractual restrictions
on resale. However, restricted securities generally can be sold in privately
negotiated transactions, pursuant to an exemption from registration under the
Securities Act of 1933, as amended, or in a registered public offering. Where
registration is required, a Portfolio may be obligated to pay all or part of the
registration expense and a considerable period may elapse between the time it
decides to seek registration and the time the Portfolio may be permitted to sell
a security under an effective registration statement. If, during
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such a period, adverse market conditions were to develop, a Portfolio might
obtain a less favorable price than prevailed when it decided to seek
registration of the security.
There are risks associated with investment in restricted securities in
that there can be no assurance of a ready market for resale. Also, the
contractual restrictions on resale might prevent a Portfolio from reselling the
securities at a time when such sale would be desirable. Restricted securities in
which a Portfolio seeks to invest need not be listed or admitted to trading on a
foreign or domestic exchange and may be less liquid than listed securities.
Certain restricted securities, for example Rule 144A securities, may be
determined to be liquid in accordance with guidelines adopted by the Board of
Directors. See "Illiquid Investments."
Investment Company Securities
Asset Strategy Portfolio, Balanced Portfolio, International Portfolio,
Science and Technology Portfolio and Small Cap Portfolio may buy shares of
closed-end investment companies (i.e., those that do not redeem their shares).
Asset Strategy Portfolio may buy shares of open-end investment companies. As a
shareholder in an investment company, a Portfolio would bear its pro rata share
of that investment company's expenses, which could result in duplication of
certain fees, including management and administrative fees.
Lending Securities
Securities loans may be made on a short-term or long-term basis for the
purpose of increasing a Portfolio's income. If a Portfolio lends securities, the
borrower pays the Portfolio an amount equal to the dividends or interest on the
securities that the Portfolio would have received if it had not lent the
securities. The Portfolio also receives additional compensation. Under a
Portfolio's current securities lending procedures, the Portfolio may lend
securities only to broker-dealers and financial institutions deemed creditworthy
by the Manager.
Any securities loans that a Portfolio makes must be collateralized in
accordance with applicable regulatory requirements (the "Guidelines"). At the
time of each loan, a Portfolio must receive collateral equal to no less than
100% of the market value of the securities loaned. Under the present Guidelines,
the collateral must consist of cash or U.S. Government securities or bank
letters of credit, at least equal in value to the market value of the securities
lent on each day that the loan
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is outstanding. If the market value of the lent securities exceeds the value of
the collateral, the borrower must add more collateral so that it at least equals
the market value of the securities lent. If the market value of the securities
decreases, the borrower is entitled to return of the excess collateral.
There are two methods of receiving compensation for making loans. The
first is to receive a negotiated loan fee from the borrower. This method is
available for all three types of collateral. The second method, which is not
available when letters of credit are used as collateral, is for a Portfolio to
receive interest on the investment of the cash collateral or to receive interest
on the U.S. Government securities used as collateral. Part of the interest
received in either case may be shared with the borrower.
The letters of credit that a Portfolio may accept as collateral are
agreements by banks (other than the borrowers of the Portfolio's securities),
entered into at the request of the borrower and for its account and risk, under
which the banks are obligated to pay to the Portfolio, while the letter is in
effect, amounts demanded by the Portfolio if the demand meets the terms of the
letter. The Portfolio's right to make this demand secures the borrower's
obligations to it. The terms of any such letters and the creditworthiness of the
banks providing them (which might include the Portfolio's custodian bank) must
be satisfactory to the Portfolio.
The Portfolios will make loans only under rules of the New York Stock
Exchange ("NYSE"), which presently require the borrower to give the securities
back to the Portfolio within five business days after the Portfolio gives notice
to do so. If a Portfolio loses its voting rights on securities loaned, it will
have the securities returned to it in time to vote them if a material event
affecting the investment is to be voted on. A Portfolio may pay reasonable
finder's, administrative and custodian fees in connection with loans of
securities.
Some, but not all, of these rules are necessary to meet requirements of
certain laws relating to securities loans. These rules will not be changed
unless the change is permitted under these requirements. These requirements do
not cover the present rules, which may be changed without shareholder vote, as
to: (i) whom securities may be loaned; (ii) the investment of cash collateral;
or (iii) voting rights.
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There may be risks of delay in receiving additional collateral from the
borrower if the market value of the securities loaned increases, as well as
risks of delay in recovering the securities loaned or even loss of rights in the
collateral should the borrower fail financially.
Repurchase Agreements
Each of the Portfolios may purchase securities subject to repurchase
agreements, subject to its limitation on investment in illiquid investments. See
"Investment Restrictions and Limitations." A repurchase agreement is an
instrument under which a Portfolio purchases a security and the seller (normally
a commercial bank or broker-dealer) agrees, at the time of purchase, that it
will repurchase the security at a specified time and price. The amount by which
the resale price is greater than the purchase price reflects an agreed-upon
market interest rate effective for the period of the agreement. The return on
the securities subject to the repurchase agreement may be more or less than the
return on the repurchase agreement.
The majority of repurchase agreements in which a Portfolio will engage are
overnight transactions, and the delivery pursuant to the resale typically will
occur within one to five days of the purchase. The primary risk is that a
Portfolio may suffer a loss if the seller fails to pay the agreed-upon amount on
the delivery date and that amount is greater than the resale price of the
underlying securities and other collateral held by the Portfolio. In the event
of bankruptcy or other default by the seller, there may be possible delays and
expenses in liquidating the underlying securities or other collateral, decline
in their value or loss of interest. The return on such collateral may be more or
less than that from the repurchase agreement. A Portfolio's repurchase
agreements will be structured so as to fully collateralize the loans. In other
words, the value of the underlying securities, which will be held by the
Portfolio's custodian bank or by a third party that qualifies as a custodian
under section 17(f) of the 1940 Act, is and, during the entire term of the
agreement, remains at least equal to the value of the loan, including the
accrued interest earned thereon.
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Repurchase agreements are entered into only with those entities approved by the
Manager.
Loans and Other Direct Debt Instruments
Direct debt instruments are interests in amounts owed by a corporate,
governmental, or other borrower to lenders or lending syndicates (loans and loan
participations), to suppliers of goods or services (trade claims or other
receivables), or to other parties. Asset Strategy Portfolio may invest in direct
debt instruments, subject to its policies regarding the quality of debt
securities.
Purchasers of loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the borrower for payment of principal and
interest. Direct debt instruments may not be rated by any nationally recognized
rating service. If Asset Strategy Portfolio does not receive scheduled interest
or principal payments on such indebtedness, the Portfolio's share price and
yield could be adversely affected. Loans that are fully secured offer the
Portfolio more protections than an unsecured loan in the event of non-payment of
scheduled interest or principal. However, there is no assurance that the
liquidation of collateral from a secured loan would satisfy the borrower's
obligation, or that the collateral could be liquidated. Indebtedness of
borrowers whose creditworthiness is poor involves substantially greater risks,
and may be highly speculative. Borrowers that are in bankruptcy or restructuring
may never pay off their indebtedness, or may pay only a small fraction of the
amount owed. Direct indebtedness of developing countries also involves a risk
that the governmental entities responsible for the repayment of the debt may be
unable, or unwilling, to pay interest and principal when due.
Investments in loans through direct assignment of a financial
institution's interests with respect to a loan may involve additional risks to
the Portfolio. For example, if a loan is foreclosed, the Portfolio could become
part owner of any collateral, and would bear the costs and liabilities
associated with owning and disposing of the collateral. Direct debt instruments
may also involve a risk of insolvency of the lending bank or other intermediary.
Direct debt instruments that are not in the form of securities may offer less
legal protection to the Portfolio in the event of fraud or misrepresentation. In
the absence of definitive regulatory guidance, the Portfolio relies on the
Manager's research in an attempt to avoid situations where fraud or
misrepresentation could adversely affect the Portfolio.
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A loan is often administered by a bank or other financial institution that
acts as agent for all holders. The agent administers the terms of the loan, as
specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Portfolio has direct recourse against the borrower, it may
have to rely on the agent to apply appropriate credit remedies against a
borrower. If assets held by the agent for the benefit of the Portfolio were
determined to be subject to the claims of the agent's general creditors, the
Portfolio might incur certain costs and delays in realizing payment on the loan
or loan participation and could suffer a loss of principal or interest.
Investments in direct debt instruments may entail less legal protection
for the Portfolio. Direct indebtedness purchased by the Portfolio may include
letters of credit, revolving credit facilities, or other standby financing
commitments obligating the Portfolio to pay additional cash on demand. These
commitments may have the effect of requiring the Portfolio to increase its
investment in a borrower at a time when it would not otherwise have done so,
even if the borrower's condition makes it unlikely that the amount will ever be
repaid. The Portfolio will set aside appropriate liquid assets in a segregated
custodial account to cover its potential obligations under standby financing
commitments.
For purposes of the limitations on the amount of total assets that Asset
Strategy Portfolio will invest in any one issuer or in issuers within the same
industry, the Portfolio generally will treat the borrower as the "issuer" of
indebtedness held by the Portfolio. In the case of loan participations where a
bank or other lending institution serves as financial intermediary between the
Portfolio and the borrower, if the participation does not shift to the Portfolio
the direct debtor-creditor relationship with the borrower, Securities and
Exchange Commission ("SEC") interpretations require the Portfolio, in
appropriate circumstances, to treat both the lending bank or other lending
institution and the borrower as "issuers" for these purposes. Treating a
financial intermediary as an issuer of indebtedness may restrict the Portfolio's
ability to invest in indebtedness related to a single financial intermediary, or
a group of intermediaries engaged in the same industry, even if the underlying
borrowers represent many different companies and industries.
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When-Issued and Delayed-Delivery Transactions
Each Portfolio may purchase securities in which it may invest on a
when-issued or delayed-delivery basis or sell them on a delayed-delivery basis.
In either case, payment and delivery for the securities take place at a future
date. The securities so purchased or sold by a Portfolio are subject to market
fluctuation; their value may be less or more when delivered than the purchase
price paid or received. When purchasing securities on a when-issued or
delayed-delivery basis, a Portfolio assumes the rights and risks of ownership,
including the risk of price and yield fluctuations. No interest accrues to a
Portfolio until delivery and payment are completed. When a Portfolio makes a
commitment to purchase securities on a when-issued or delayed-delivery basis, it
will record the transaction and thereafter reflect the value of the securities
in determining its NAV per share. When a Portfolio sells a security on a
delayed-delivery basis, the Portfolio does not participate in further gains or
losses with respect to the security. When a Portfolio makes a commitment to sell
securities on a delayed basis, it will record the transaction and thereafter
value the securities at the sales price in determining the Portfolio's NAV per
share. If the other party to a delayed-delivery transaction fails to deliver or
pay for the securities, the Portfolios could miss a favorable price or yield
opportunity, or could suffer a loss.
Ordinarily, a Portfolio purchases securities on a when-issued or
delayed-delivery basis with the intention of actually taking delivery of the
securities. However, before the securities are delivered and before it has paid
for them (the "settlement date"), a Portfolio may sell the securities if the
Manager decided it was advisable to do so for investment reasons. The Portfolio
will hold aside or segregate cash or other securities, other than those
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purchased on a when-issued or delayed-delivery basis, at least equal in value to
the amount it will have to pay on the settlement date; these other securities
may, however, be sold at or before the settlement date to pay the purchase price
of the when-issued or delayed-delivery securities.
Warrants and Rights
Each Portfolio (other than Money Market Portfolio) may invest in warrants
and rights. Warrants are options to purchase equity securities at specific
prices valid for a specific period of time. Their prices do not necessarily move
parallel to the prices of the underlying securities. Rights are similar to
warrants but normally have a shorter duration and are distributed directly by
the issuer to its shareholders. Warrants and rights have no voting rights,
receive no dividends and have no rights with respect to the assets of the
issuer. Warrants and rights are highly volatile and, therefore, more susceptible
to a sharp decline in value than the underlying security might be. They are also
generally less liquid than an investment in the underlying shares.
Illiquid Investments
Illiquid investments are investments that cannot be sold or disposed of in
the ordinary course of business within seven days at approximately the price at
which they are valued. Investments currently considered to be illiquid include:
(i) repurchase agreements not terminable within seven days;
(ii) securities for which market quotations are not readily available;
(iii) over-the-counter ("OTC") options and their underlying collateral;
(iv) bank deposits, unless they are payable at principal amount plus
accrued interest on demand or within seven days after demand;
(v) restricted securities not determined to be liquid pursuant to
guidelines established by or under the direction of the Funds' Board
of Directors;
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(vi) non-government stripped fixed-rate mortgage-backed securities;
(vii) securities involved in swap, cap, floor and collar transactions; and
(viii) direct debt instruments.
The assets used as cover for OTC options written by a Portfolio will be
considered illiquid unless the OTC options are sold to qualified dealers who
agree that the Portfolio may repurchase any OTC option it writes at a maximum
price to be calculated by a formula set forth in the option agreement. The cover
for an OTC option written subject to this procedure would be considered illiquid
only to the extent that the maximum repurchase price under the formula exceeds
the intrinsic value of the option.
If through a change in values, net assets, or other circumstances, a
Portfolio were in a position where more than 10% of its net assets (15% with
respect to Asset Strategy Portfolio) were invested in illiquid securities, it
would seek to take appropriate steps to protect liquidity.
Options, Futures Contracts and Other Strategies
General. The Manager may use certain options, futures contracts (sometimes
referred to as "futures"), options on futures contracts, forward currency
contracts, swaps, caps, floors, collars, indexed securities and other derivative
instruments (collectively, "Financial Instruments") to attempt to enhance a
Portfolio's income or yield or to attempt to hedge a Portfolio's investments.
The strategies described below may be
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used in an attempt to manage a Portfolio's foreign currency exposure as well as
other risks of a Portfolio's investments that can affect fluctuation in its NAV.
Generally, a Portfolio (other than Money Market Portfolio) may purchase
and sell any type of Financial Instrument. However, as an operating policy, a
Portfolio will only purchase or sell a Financial Instrument if the Portfolio is
authorized to invest in the type of asset by which the return on, or value of,
the Financial Instrument is primarily measured. Since each Portfolio (other than
Money Market Portfolio and Limited-Term Bond Portfolio) is authorized to invest
generally in foreign securities, each such Portfolio may purchase and sell
foreign currency derivatives.
Hedging strategies can be broadly categorized as "short hedges" and "long
hedges." A short hedge is a purchase or sale of a Financial Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held in a Portfolio's portfolio. Thus, in a short hedge, a Portfolio
takes a position in a Financial Instrument whose price is expected to move in
the opposite direction of the price of the investment being hedged.
Conversely, a long hedge is a purchase or sale of a Financial Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that a Portfolio intends to acquire. Thus, in a
long hedge, a Portfolio takes a position in a Financial Instrument whose price
is expected to move in the same direction as the price of the prospective
investment being hedged. A long hedge is sometimes referred to as an
anticipatory hedge. In an anticipatory hedge transaction, a Portfolio does not
own a corresponding security and, therefore, the transaction does not relate to
a security the Portfolio owns. Rather, it relates to a security that the
Portfolio intends to acquire. If a Portfolio does not complete the hedge by
purchasing the security it anticipated purchasing, the effect on the Portfolio's
portfolio is the same as if the transaction were entered into for speculative
purposes.
Financial Instruments on securities generally are used to attempt to hedge
against price movements in one or more particular securities positions that a
Portfolio owns or intends to acquire. Financial Instruments on indices, in
contrast, generally are used to attempt to hedge against price movements in
market sectors in which a Portfolio has invested or expects to invest. Financial
Instruments on debt securities may be used to hedge either individual securities
or broad debt market sectors.
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The use of Financial Instruments is subject to applicable regulations of
the SEC, the several exchanges on which they are traded and the Commodity
Futures Trading Commission (the "CFTC"). In addition, a Portfolio's ability to
use Financial Instruments will be limited by tax considerations. See "Taxes."
In addition to the Financial Instruments, strategies and risks described
below, the Manager expects to discover additional opportunities in connection
with Financial Instruments and other similar or related techniques. These new
opportunities may become available as the Manager develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
Financial Instruments or other techniques are developed. The Manager may utilize
these opportunities to the extent that they are consistent with a Portfolio's
goal(s) and permitted by a Portfolio's investment limitations and applicable
regulatory authorities. The Portfolios might not use any of these strategies,
and there can be no assurance that any strategy used will succeed. The
Portfolios' Prospectus or SAI will be supplemented to the extent that new
products or techniques involve materially different risks than those described
below or in the Prospectus.
Special Risks. The use of Financial Instruments involves special
considerations and risks, certain of which are described below. In general these
techniques may increase the volatility of a Portfolio and may involve a small
investment of cash relative to the magnitude of the risk assumed. Risks
pertaining to particular Financial Instruments are described in the sections
that follow and use of Financial Instruments could result in a loss, regardless
of whether the intent was to reduce risk or increase return.
(1) Successful use of most Financial Instruments depends upon the
Manager's ability to predict movements of the overall securities, currency and
interest rate markets, which requires different skills than predicting changes
in the prices of individual securities. There can be no assurance that any
particular strategy will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Financial Instrument and price movements of the investments
being hedged. For example, if the value of a Financial Instrument used in a
short hedge increased by less than the decline in value of the hedged
investment, the hedge would not be fully successful. Such a lack of correlation
might occur due to factors unrelated to the value of the investments being
hedged, such as speculative or other pressures on the markets in which Financial
Instruments are traded. The effectiveness of hedges using Financial Instruments
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on indices will depend on the degree of correlation between price movements in
the index and price movements in the securities being hedged.
Because there are a limited number of types of exchange-traded options and
futures contracts, it is likely that the standardized contracts available will
not match a Portfolio's current or anticipated investments exactly. A Portfolio
may invest in options and futures contracts based on securities with different
issuers, maturities or other characteristics from the securities in which it
typically invests, which involves a risk that the options or futures position
will not track the performance of the Portfolio's other investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match a Portfolio's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. A Portfolio may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in a Portfolio's options or futures
positions are poorly correlated with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
(3) If successful, the above-discussed strategies can reduce risk of loss
by wholly or partially offsetting the negative effect of unfavorable price
movements. However, such strategies can also reduce opportunity for gain by
offsetting the positive effect of favorable price movements. For example, if a
Portfolio entered into a short hedge because the Manager projected a decline in
the price of a security in the Portfolio's portfolio, and the price of that
security increased instead, the gain from that increase might be wholly or
partially offset by a decline in the price of the Financial Instrument.
Moreover, if the price of the Financial Instrument declined by more than the
increase in the price of the security, the Portfolio could suffer a loss. In
either such case, the Portfolio would have been in a better position had it not
attempted to hedge at all.
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(4) As described below, a Portfolio might be required to maintain assets
as "cover," maintain segregated accounts or make margin payments when it takes
positions in Financial Instruments involving obligations to third parties (i.e.,
Financial Instruments other than purchased options). If a Portfolio were unable
to close out its positions in such Financial Instruments, it might be required
to continue to maintain such assets or accounts or make such payments until the
position expired or matured. These requirements might impair a Portfolio's
ability to sell a portfolio security or make an investment at a time when it
would otherwise be favorable to do so, or require that a Portfolio sell a
portfolio security at a disadvantageous time.
(5) A Portfolio's ability to close out a position in a Financial
Instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the other party to the transaction (the "counterparty") to enter
into a transaction closing out the position. Therefore, there is no assurance
that any position can be closed out at a time and price that is favorable to the
Portfolio.
Cover. Transactions using Financial Instruments, other than purchased
options, expose a Portfolio to an obligation to another party. A Portfolio will
not enter into any such transactions unless it owns either (1) an offsetting
("covered") position in securities, currencies, or other options, futures
contracts or forward contracts, or (2) cash and liquid assets with a value,
marked-to-market daily, sufficient to cover its potential obligations to the
extent not covered as provided in (1) above. Each Portfolio will comply with SEC
guidelines regarding cover for these instruments and will, if the guidelines so
require, set aside cash or liquid assets in an account with its custodian in the
prescribed amount as determined daily.
Assets used as cover or held in an account cannot be sold while the
position in the corresponding Financial Instrument is open, unless they are
replaced with other appropriate assets. As a result, the commitment of a large
portion of a Portfolio's assets to cover or to accounts could impede portfolio
management or the Portfolio's ability to meet redemption requests or other
current obligations.
Options. A call option gives the purchaser the right to buy, and obligates
the writer to sell, the underlying investment at the agreed-upon price during
the option period. A put option gives the purchaser the right to sell, and
obligates the writer to buy, the underlying investment at the agreed-upon price
during the option period. Purchasers of options pay an amount, known as a
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premium, to the option writer in exchange for the right under the option
contract.
The purchase of call options can serve as a long hedge, and the purchase
of put options can serve as a short hedge. Writing put or call options can
enable a Portfolio to enhance income or yield by reason of the premiums paid by
the purchasers of such options. However, if the market price of the security
underlying a put option declines to less than the exercise price of the option,
minus the premium received, the Portfolio would expect to suffer a loss.
Writing call options can serve as a limited short hedge, because declines
in the value of the hedged investment would be offset to the extent of the
premium received for writing the option. However, if the security or currency
appreciates to a price higher than the exercise price of the call option, it can
be expected that the option will be exercised and the Portfolio will be
obligated to sell the security or currency at less than its market value. If the
call option is an OTC option, the securities or other assets used as cover would
be considered illiquid to the extent described under "Illiquid Investments."
Writing put options can serve as a limited long hedge because increases in
the value of the hedged investment would be offset to the extent of the premium
received for writing the option. However, if the security or currency
depreciates to a price lower than the exercise price of the put option, it can
be expected that the put option will be exercised and a Portfolio will be
obligated to purchase the security or currency at more than its market value. If
the put option is an OTC option, the securities or other assets used as cover
would be considered illiquid to the extent described under "Illiquid
Investments."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options that expire unexercised have
no value.
A Portfolio may effectively terminate its right or obligation under an
option by entering into a closing transaction. For example, a Portfolio may
terminate its obligation under a call or put option that it had written by
purchasing an identical call or put option; this is known as a closing purchase
transaction. Conversely, a Portfolio may terminate a position in a put or call
option it had purchased by writing an identical put or call option; this is
known as a closing sale transaction. Closing
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transactions permit a Portfolio to realize profits or limit losses on an option
position prior to its exercise or expiration.
A type of put that a Portfolio may purchase is an "optional delivery
standby commitment," which is entered into by parties selling debt securities to
a Portfolio. An optional delivery standby commitment gives a Portfolio the right
to sell the security back to the seller on specified terms. This right is
provided as an inducement to purchase the security.
Risks of Options on Securities. Options offer large amounts of leverage,
which will result in a Portfolio's NAV being more sensitive to changes in the
value of the related instrument. A Portfolio may purchase or write both
exchange-traded and OTC options. Exchange-traded options in the United States
are issued by a clearing organization affiliated with the exchange on which the
option is listed that, in effect, guarantees completion of every exchange-traded
option transaction. In contrast, OTC options are contracts between a Portfolio
and its counterparty (usually a securities dealer or a bank) with no clearing
organization guarantee. Thus, when a Portfolio purchases an OTC option, it
relies on the counterparty from whom it purchased the option to make or take
delivery of the underlying investment upon exercise of the option. Failure by
the counterparty to do so would result in the loss of any premium paid by the
Portfolio as well as the loss of any expected benefit of the transaction.
A Portfolio's ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid market. However,
there can be no assurance that such a market will exist at any particular time.
Closing transactions can be made for OTC options only by negotiating directly
with the counterparty, or by a transaction in the secondary market if any such
market exists. There can be no assurance that a Portfolio will in fact be able
to close out an OTC option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, a Portfolio might be unable to
close out an OTC option position at any time prior to its expiration.
If a Portfolio were unable to effect a closing transaction for an option
it had purchased, it would have to exercise the option to realize any profit.
The inability to enter into a closing purchase transaction for a covered call
option written by a Portfolio could cause material losses because the Portfolio
would be unable to sell the investment used as cover for the written option
until the option expires or is exercised.
Options on Indices. Puts and calls on indices are similar to puts and
calls on securities or futures contracts except that all
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settlements are in cash and gain or loss depends on changes in the index in
question rather than on price movements in individual securities or futures
contracts. When a Portfolio writes a call on an index, it receives a premium and
agrees that, prior to the expiration date, the purchaser of the call, upon
exercise of the call, will receive from the Portfolio an amount of cash if the
closing level of the index upon which the call is based is greater than the
exercise price of the call. The amount of cash is equal to the difference
between the closing price of the index and the exercise price of the call times
a specified multiple ("multiplier"), which determines the total dollar value for
each point of such difference. When a Portfolio buys a call on an index, it pays
a premium and has the same rights as to such call as are indicated above. When a
Portfolio buys a put on an index, it pays a premium and has the right, prior to
the expiration date, to require the seller of the put, upon the Portfolio's
exercise of the put, to deliver to the Portfolio an amount of cash if the
closing level of the index upon which the put is based is less than the exercise
price of the put, which amount of cash is determined by the multiplier, as
described above for calls. When a Portfolio writes a put on an index, it
receives a premium and the purchaser of the put has the right, prior to the
expiration date, to require the Portfolio to deliver to it an amount of cash
equal to the difference between the closing level of the index and the exercise
price times the multiplier if the closing level is less than the exercise price.
Risks of Options on Indices. The risks of investment in options on indices
may be greater than options on securities. Because index options are settled in
cash, when a Portfolio writes a call on an index it cannot provide in advance
for its potential settlement obligations by acquiring and holding the underlying
securities. A Portfolio can offset some of the risk of writing a call index
option by holding a diversified portfolio of securities similar to those on
which the underlying index is based. However, a Portfolio cannot, as a practical
matter, acquire and hold a portfolio containing exactly the same securities as
underlie the index and, as a result, bears a risk that the value of the
securities held will vary from the value of the index.
Even if a Portfolio could assemble a portfolio that exactly reproduced the
composition of the underlying index, it still would not be fully covered from a
risk standpoint because of the "timing risk" inherent in writing index options.
When an index option is exercised, the amount of cash that the holder is
entitled to receive is determined by the difference between the exercise price
and the closing index level on the date when the option is exercised. As with
other kinds of options, a Portfolio as the call writer will not learn that the
Portfolio has been assigned until the next business day at the earliest. The
time lag between
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exercise and notice of assignment poses no risk for the writer of a covered call
on a specific underlying security, such as common stock, because there the
writer's obligation is to deliver the underlying security, not to pay its value
as of a fixed time in the past. So long as the writer already owns the
underlying security, it can satisfy its settlement obligations by simply
delivering it, and the risk that its value may have declined since the exercise
date is borne by the exercising holder. In contrast, even if the writer of an
index call holds securities that exactly match the composition of the underlying
index, it will not be able to satisfy its assignment obligations by delivering
those securities against payment of the exercise price. Instead, it will be
required to pay cash in an amount based on the closing index value on the
exercise date. By the time it learns that it has been assigned, the index may
have declined, with a corresponding decline in the value of its portfolio. This
"timing risk" is an inherent limitation on the ability of index call writers to
cover their risk exposure by holding securities positions.
If a Portfolio has purchased an index option and exercises it before the
closing index value for that day is available, it runs the risk that the level
of the underlying index may subsequently change. If such a change causes the
exercised option to fall out-of-the-money, the Portfolio will be required to pay
the difference between the closing index value and the exercise price of the
option (times the applicable multiplier) to the assigned writer.
OTC Options. Unlike exchange-traded options, which are standardized with
respect to the underlying instrument, expiration date, contract size and strike
price, the terms of OTC options (options not traded on exchanges) generally are
established through negotiation with the other party to the option contract.
While this type of arrangement allows a Portfolio great flexibility to tailor
the option to its needs, OTC options generally involve greater risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
Generally, OTC foreign currency options used by a Portfolio are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option.
Futures Contracts and Options on Futures Contracts. The purchase of
futures or call options on futures can serve as a long hedge, and the sale of
futures or the purchase of put options on futures can serve as a short hedge.
Writing call options on futures contracts can serve as a limited short hedge,
using a
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strategy similar to that used for writing call options on securities or indices.
Similarly, writing put options on futures contracts can serve as a limited long
hedge. Futures contracts and options on futures contracts can also be purchased
and sold to attempt to enhance income or yield.
In addition, futures strategies can be used to manage the average duration
of a Portfolio's fixed-income portfolio. If the Manager wishes to shorten the
average duration of a Portfolio's fixed-income portfolio, the Portfolio may sell
a debt futures contract or a call option thereon, or purchase a put option on
that futures contract. If the Manager wishes to lengthen the average duration of
a Portfolio's fixed-income portfolio, the Portfolio may buy a debt futures
contract or a call option thereon, or sell a put option thereon.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract a Portfolio is required to deposit "initial
margin" in an amount generally equal to 10% or less of the contract value.
Margin must also be deposited when writing a call or put option on a futures
contract, in accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts does not represent
a borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to the Portfolio at the termination of the transaction
if all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, the Portfolio may be required by an exchange
to increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking-to-market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Portfolio's obligations to or from a
futures broker. When a Portfolio purchases an option on a future, the premium
paid plus transaction costs is all that is at risk. In contrast, when a
Portfolio purchases or sells a futures contract or writes a call or put option
thereon, it is subject to daily variation margin calls that could be substantial
in the event of adverse price movements. If the Portfolio has insufficient cash
to meet daily variation margin requirements, it might need to sell securities at
a time when such sales are disadvantageous.
Purchasers and sellers of futures contracts and options on futures can
enter into offsetting closing transactions, similar to closing transactions in
options, by selling or purchasing, respectively, an instrument identical to the
instrument purchased
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or sold. Positions in futures and options on futures may be closed only on an
exchange or board of trade that provides a secondary market. However, there can
be no assurance that a liquid secondary market will exist for a particular
contract at any particular time. In such event, it may not be possible to close
a futures contract or options position.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a futures contract or an option on a futures
contract can vary from the previous day's settlement price; once that limit is
reached, no trades may be made that day at a price beyond the limit. Daily price
limits do not limit potential losses because prices could move to the daily
limit for several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If a Portfolio were unable to liquidate a futures contract or an option on
a futures position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Portfolio
would continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Portfolio would continue
to be required to make daily variation margin payments and might be required to
maintain the position being hedged by the futures contract or option or to
maintain cash or liquid assets in an account.
Risks of Futures Contracts and Options Thereon. The ordinary spreads
between prices in the cash and futures markets (including the options on futures
market), due to differences in the natures of those markets, are subject to the
following factors, which may create distortions. First, all participants in the
futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal relationship between the cash and futures markets. Second, the liquidity
of the futures market depends on participants entering into offsetting
transactions rather than making or taking delivery. To the extent participants
decide to make or take delivery, liquidity in the futures market could be
reduced, thus producing distortion. Third, from the point of view of
speculators, the deposit requirements in the futures market are less onerous
than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may cause temporary price
distortions. Due to the possibility of distortion, a correct forecast of general
interest rate,
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currency exchange rate or stock market trends by the Manager may still not
result in a successful transaction. The Manager may be incorrect in its
expectations as to the extent of various interest rate, currency exchange rate
or stock market movements or the time span within which the movements take
place.
Index Futures. The risk of imperfect correlation between movements in the
price of an index future and movements in the price of the securities that are
the subject of the hedge increases as the composition of a Portfolio's portfolio
diverges from the securities included in the applicable index. The price of the
index futures may move more than or less than the price of the securities being
hedged. If the price of the index futures moves less than the price of the
securities that are the subject of the hedge, the hedge will not be fully
effective but, if the price of the securities being hedged has moved in an
unfavorable direction, the Portfolio would be in a better position than if it
had not hedged at all. If the price of the securities being hedged has moved in
a favorable direction, this advantage will be partially offset by the futures
contract. If the price of the futures contract moves more than the price of the
securities, a Portfolio will experience either a loss or a gain on the futures
contract that will not be completely offset by movements in the price of the
securities that are the subject of the hedge. To compensate for the imperfect
correlation of movements in the price of the securities being hedged and
movements in the price of the index futures, a Portfolio may buy or sell index
futures in a greater dollar amount than the dollar amount of the securities
being hedged if the historical volatility of the prices of such securities being
hedged is more than the historical volatility of the prices of the securities
included in the index. It is also possible that, where a Portfolio has sold
index futures contracts to hedge against decline in the market, the market may
advance and the value of the securities held in the portfolio may decline. If
this occurred, a Portfolio would lose money on the futures contract and also
experience a decline in value of its portfolio securities. However, while this
could occur for a very brief period or to a very small degree, over time the
value of a diversified portfolio of securities will tend to move in the same
direction as the market indices on which the futures contracts are based.
Where index futures are purchased to hedge against a possible increase in
the price of securities before a Portfolio is able to invest in them in an
orderly fashion, it is possible that the market may decline instead. If the
Portfolio then concludes not to invest in them at that time because of concern
as to possible further market decline or for other reasons, it will realize a
loss on the futures contract that is not offset by a reduction in the price of
the securities it had anticipated purchasing.
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Foreign Currency Hedging Strategies--Special Considerations. Each
Portfolio (other than Money Market Portfolio and Limited-Term Bond Portfolio)
may use options and futures contracts on foreign currencies (including the
Euro), as described above, and forward currency contracts, as described below,
to attempt to hedge against movements in the values of the foreign currencies in
which the Portfolio's securities are denominated or to attempt to enhance income
or yield. Currency hedges can protect against price movements in a security that
a Portfolio owns or intends to acquire that are attributable to changes in the
value of the currency in which it is denominated. Such hedges do not, however,
protect against price movements in the securities that are attributable to other
causes.
Each of these Portfolios might seek to hedge against changes in the value
of a particular currency when no Financial Instruments on that currency are
available or such Financial Instruments are more expensive than certain other
Financial Instruments. In such cases, a Portfolio may seek to hedge against
price movements in that currency by entering into transactions using Financial
Instruments on another currency or a basket of currencies, the values of which
the Manager believes will have a high degree of positive correlation to the
value of the currency being hedged. The risk that movements in the price of the
Financial Instrument will not correlate perfectly with movements in the price of
the currency subject to the hedging transaction is magnified when this strategy
is used.
The value of Financial Instruments on foreign currencies depends on the
value of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Financial
Instruments, a Portfolio could be disadvantaged by having to deal in the odd lot
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market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Financial Instruments until they reopen.
Settlement of transactions involving foreign currencies might be required
to take place within the country issuing the underlying currency. Thus, a
Portfolio might be required to accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
Forward Currency Contracts. Each Portfolio (other than Money Market
Portfolio and Limited-Term Bond Portfolio) may enter into forward currency
contracts to purchase or sell foreign currencies for a fixed amount of U.S.
dollars or another foreign currency. A forward currency contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days (term) from the date of the forward currency
contract agreed upon by the parties, at a price set at the time of the forward
currency contract. These forward currency contracts are traded directly between
currency traders (usually large commercial banks) and their customers.
Such transactions may serve as long hedges; for example, a Portfolio may
purchase a forward currency contract to lock in the U.S. dollar price of a
security denominated in a foreign currency that the Portfolio intends to
acquire. Forward currency contract transactions may also serve as short hedges;
for example, a Portfolio may sell a forward currency contract to lock in the
U.S. dollar equivalent of the proceeds from the anticipated sale of a security,
dividend or interest payment denominated in a foreign currency.
Each of these Portfolios may also use forward currency contracts to hedge
against a decline in the value of existing
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investments denominated in foreign currency. For example, if a Portfolio owned
securities denominated in euros, it could enter into a forward currency contract
to sell euros in return for U.S. dollars to hedge against possible declines in
the euro's value. Such a hedge, sometimes referred to as a "position hedge,"
would tend to offset both positive and negative currency fluctuations, but would
not offset changes in security values caused by other factors. Each of these
Portfolios could also hedge the position by selling another currency expected to
perform similarly to the euro. This type of hedge, sometimes referred to as a
"proxy hedge," could offer advantages in terms of cost, yield, or efficiency,
but generally would not hedge currency exposure as effectively as a simple hedge
into U.S. dollars. Proxy hedges may result in losses if the currency used to
hedge does not perform similarly to the currency in which the hedged securities
are denominated.
Each of these Portfolios also may use forward currency contracts to
attempt to enhance income or yield. A Portfolio could use forward currency
contracts to increase its exposure to foreign currencies that the Manager
believes might rise in value relative to the U.S. dollar, or shift its exposure
to foreign currency fluctuations from one country to another. For example, if a
Portfolio owned securities denominated in a foreign currency and the Manager
believed that currency would decline relative to another currency, it might
enter into a forward currency contract to sell an appropriate amount of the
first foreign currency, with payment to be made in the second foreign currency.
The cost to a Portfolio of engaging in forward currency contracts varies
with factors such as the currency involved, the length of the contract period
and the market conditions then prevailing. Because forward currency contracts
are usually entered into on a principal basis, no fees or commissions are
involved. When a Portfolio enters into a forward currency contract, it relies on
the counterparty to make or take delivery of the underlying currency at the
maturity of the contract. Failure by the counterparty to do so would result in
the loss of any expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures contracts, by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can be
no assurance that a Portfolio will in fact be able to close out a forward
currency contract at a
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favorable price prior to maturity. In addition, in the event of insolvency of
the counterparty, a Portfolio might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Portfolio would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in securities denominated in the
foreign currency or to maintain cash or liquid assets in an account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the forward
currency contract has been established. Thus, a Portfolio might need to purchase
or sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts. The projection of
short-term currency market movements is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain.
Normally, consideration of the prospect for currency parities will be
incorporated into the longer term investment decisions made with regard to
overall diversification strategies. However, the Manager believes that it is
important to have the flexibility to enter into such forward currency contracts
when it determines that the best interests of a Portfolio will be served.
Successful use of forward currency contracts depends on the Manager's
skill in analyzing and predicting currency values. Forward currency contracts
may substantially change a Portfolio's exposure to changes in currency exchange
rates and could result in losses to a Portfolio if currencies do not perform as
the Manager anticipates. There is no assurance that the Manager's use of forward
currency contracts will be advantageous to a Portfolio or that the Manager will
hedge at an appropriate time.
Combined Positions. A Portfolio may purchase and write options in
combination with each other, or in combination with futures or forward
contracts, to adjust the risk and return characteristics of its overall
position. For example, a Portfolio may purchase a put option and write a call
option on the same underlying instrument, in order to construct a combined
position whose risk and return characteristics are similar to selling a futures
contract. Another possible combined position would involve writing a call option
at one strike price and buying a call option at a lower price, in order to
reduce the risk of the written call option in the event of a substantial price
increase. Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
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Turnover. A Portfolio's options and futures activities may affect its
turnover rate and brokerage commission payments. The exercise of calls or puts
written by a Portfolio, and the sale or purchase of futures contracts, may cause
it to sell or purchase related investments, thus increasing its turnover rate.
Once a Portfolio has received an exercise notice on an option it has written, it
cannot effect a closing transaction in order to terminate its obligation under
the option and must deliver or receive the underlying securities at the exercise
price. The exercise of puts purchased by a Portfolio may also cause the sale of
related investments, also increasing turnover; although such exercise is within
a Portfolio's control, holding a protective put might cause it to sell the
related investments for reasons that would not exist in the absence of the put.
A Portfolio will pay a brokerage commission each time it buys or sells a put or
call or purchases or sells a futures contract. Such commissions may be higher
than those that would apply to direct purchases or sales.
Swaps, Caps, Floors and Collars. Each of the Portfolios (other than Money
Market Portfolio) may enter into swaps, caps, floors and collars to preserve a
return or a spread on a particular investment or portion of its portfolio, to
protect against any increase in the price of securities a Portfolio anticipates
purchasing at a later date or to attempt to enhance yield. Swaps involve the
exchange by a Portfolio with another party of their respective commitments to
pay or receive cash flows on a notional principal amount, e.g., an exchange of
floating rate payments for fixed-rate payments. The purchase of a cap entitles
the purchaser, to the extent that a specified index exceeds a predetermined
value, to receive payments on a notional principal amount from the party selling
the cap. The purchase of a floor entitles the purchaser, to the extent that a
specified index falls below a predetermined value, to receive payments on a
notional principal amount from the party selling the floor. A collar combines
elements of buying a cap and selling a floor.
Swap agreements, including caps, floors and collars, can be individually
negotiated and structured to include exposure to a variety of different types of
investments or market factors. Depending on their structure, swap agreements may
increase or decrease the overall volatility of a Portfolio's investments and its
share price and yield because, and to the extent, these agreements affect a
Portfolio's exposure to long- or short-term interest rates (in the United States
or abroad), foreign currency values, mortgage-backed security values, corporate
borrowing rates, or other factors such as security prices or inflation rates.
Swap agreements will tend to shift a Portfolio's investment exposure from
one type of investment to another. For example, if
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a Portfolio agrees to exchange payments in U.S. dollars for payments in foreign
currency, the swap agreement would tend to decrease the Portfolio's exposure to
U.S. interest rates and increase its exposure to foreign currency and interest
rates. Caps and floors have an effect similar to buying or writing options.
The creditworthiness of firms with which a Portfolio enters into swaps,
caps, floors or collars will be monitored by the Manager in accordance with
procedures adopted by the Fund's Board of Directors. If a firm's
creditworthiness declines, the value of the agreement would be likely to
decline, potentially resulting in losses. If a default occurs by the other party
to such transaction, a Portfolio will have contractual remedies pursuant to the
agreements related to the transaction.
The net amount of the excess, if any, of a Portfolio's obligations over
its entitlements with respect to each swap will be accrued on a daily basis and
an amount of cash or liquid assets having an aggregate NAV at least equal to the
accrued excess will be maintained in an account with the Portfolio's custodian
that satisfies the requirements of the 1940 Act. Each Portfolio will also
establish and maintain such account with respect to its total obligations under
any swaps that are not entered into on a net basis and with respect to any caps
or floors that are written by the Portfolio. The Manager and the Portfolios
believe that such obligations do not constitute senior securities under the 1940
Act and, accordingly, will not treat them as being subject to a Portfolio's
borrowing restrictions. The position of the SEC is that assets involved in swap
transactions are illiquid and are, therefore, subject to the limitations on
investing in illiquid securities.
Borrowing
Each of the Portfolios, other than Small Cap Portfolio, may borrow money,
but only from banks and for emergency or extraordinary purposes. Small Cap
Portfolio may borrow money, only from banks, to purchase securities and only to
the extent that the value of its assets, less its liabilities other than
borrowings, is equal to at least 300% of all borrowings including the proposed
borrowing. If a Portfolio does borrow, its share price may be subject to greater
fluctuation until the borrowing is paid off.
Investment Restrictions and Limitations
Certain of the Portfolios' investment restrictions and other limitations
are described in this SAI. The following are each Portfolio's, other than Asset
Strategy Portfolio, fundamental
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investment limitations set forth in their entirety, which cannot be changed
without shareholder approval. For this purpose, shareholder approval means the
approval, at a meeting of Portfolio shareholders, by the lesser of (1) the
holders of 67% or more of the Portfolio's shares represented at the meeting, if
more than 50% of the Portfolio's outstanding shares are present in person or by
proxy or (2) more than 50% of the Portfolio's outstanding shares. A Portfolio
(other than Asset Strategy Portfolio) may not:
(i) Issue senior securities (except that each Portfolio may borrow money
as described below);
(ii) Purchase or sell physical commodities; however, this policy shall
not prevent a Portfolio other than Money Market Portfolio from
purchasing and selling foreign currency, futures contracts, options,
forward contracts, swaps, caps, floors, collars and other financial
instruments;
(iii) Buy real estate or any nonliquid interests in real estate investment
trusts;
(iv) Make loans, except loans of portfolio securities to the extent
allowed, and in accordance with the requirements, under the 1940
Act, and a Portfolio may buy debt securities and other obligations
consistent with its goal(s) and its other investment policies and
restrictions;
(v) Invest for the purpose of exercising control or management of other
companies;
(vi) Sell securities short (unless, for a Portfolio other than Money
Market Portfolio, it owns or has the right to obtain securities
equivalent in kind and amount to the securities sold short) or
purchase securities on margin, except that, for a Portfolio other
than Money Market Portfolio, (1) this policy does not prevent the
Portfolio from entering into short positions in foreign currency,
futures contracts, options, forward contracts, swaps, caps, floors,
collars and other financial instruments, (2) the Portfolio may
obtain such short-term credits as are necessary for the clearance of
transactions, and (3) the Portfolio may make margin payments in
connection with futures contracts, options, forward contracts,
swaps, caps, floors, collars and other financial instruments;
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(vii) Engage in the underwriting of securities, except insofar as it may
be deemed an underwriter in selling shares of a Portfolio and
except as it may be deemed such in the sale of restricted
securities;
(viii) Except for Small Cap Portfolio (see "Borrowing"), borrow money
except from banks as a temporary measure or for extraordinary or
emergency purposes and not for investment purposes, and only up to
5% of the value of a Portfolio's total assets; or
(ix) With respect to 75% of its total assets, purchase securities of any
one issuer (other than cash items and "Government securities" as
defined in the 1940 Act), if immediately after and as a result of
such purchase, (a) the value of the holdings of the Portfolio in
the securities of such issuer exceeds 5% of the value of the
Portfolio's total assets, or (b) the Portfolio owns more than 10%
of the outstanding voting securities of such issuer; or, except for
Money Market Portfolio, buy a security if more than 25% of its
assets would then be invested in securities of companies in any one
industry (U.S. Government securities are not included in this
restriction); provided, however, that Science and Technology
Portfolio may invest more than 25% of its assets in securities of
companies in the science and technology industries.
As additional fundamental policies of Money Market Portfolio that may not
be changed without shareholder approval, Money Market Portfolio may not:
(i) Engage in arbitrage transactions;
(ii) Pledge, mortgage or hypothecate assets as security for indebtedness
except to secure permitted borrowings; or
(iii) Buy a security if more than 25% of its assets would then be
invested in securities of companies in any one industry (U.S.
Government securities and bank obligations and instruments are not
included in this restriction).
The following are fundamental policies of Asset Strategy Portfolio and may
not be changed without shareholder approval. Asset Strategy Portfolio may not:
(i) With respect to 75% of the Portfolio's total assets, purchase the
securities of any issuer (other than obligations issued or
guaranteed by the United States
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government, or any of its agencies or instrumentalities) if, as a
result thereof, (a) more than 5% of the Portfolio's total assets
would be invested in the securities of such issuer, or (b) the
Portfolio would hold more than 10% of the outstanding voting
securities of such issuer;
(ii) Issue bonds or any other class of securities preferred over shares
of the Portfolio in respect of the Portfolio's assets or earnings,
provided that the Portfolio may issue additional classes of shares
in accordance with the Fund's Articles of Incorporation;
(iii) Sell securities short (unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold
short) or purchase securities on margin, except that (1) this policy
does not prevent the Portfolio from entering into short positions in
foreign currency, futures contracts, options, forward contracts,
swaps, caps, floors, collars and other financial instruments, (2)
the Portfolio may obtain such short-term credits as are necessary
for the clearance of transactions, and (3) the Portfolio may make
margin payments in connection with futures contracts, options,
forward contracts, swaps, caps, floors, collars and other financial
instruments;
(iv) Borrow money, except that the Portfolio may borrow money for
emergency or extraordinary purposes (not for leveraging or
investment) in an amount not exceeding 33 1/3% of the value of its
total assets (less liabilities other than borrowings). Any
borrowings that come to exceed 33 1/3% of the value of the
Portfolio's total assets by reason of a decline in net assets will
be reduced within three days to the extent necessary to comply with
the 33 1/3% limitation. For purposes of this limitation, "three
days" means three days, exclusive of Sundays and holidays;
(v) Underwrite securities issued by others, except to the extent that
the Portfolio may be deemed to be an underwriter within the meaning
of the Securities Act of 1933 in the disposition of restricted
securities;
(vi) Purchase the securities of any issuer (other than obligations issued
or guaranteed by the United States government or any of its agencies
or instrumentalities) if, as a result, more than 25% of the
Portfolio's total assets (taken at current value) would be invested
in the
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securities of issuers having their principal business activities in
the same industry;
(vii) Invest in real estate limited partnerships or purchase or sell real
estate unless acquired as a result of ownership of securities (but
this shall not prevent the Portfolio from purchasing and selling
securities issued by companies or other entities or investment
vehicles that deal in real estate or interests therein, nor shall
this prevent the Portfolio from purchasing interests in pools of
real estate mortgage loans);
(viii) Purchase or sell physical commodities, except that the Portfolio
may purchase and sell precious metals for temporary, defensive
purposes; however, this policy shall not prevent the Portfolio from
purchasing and selling foreign currency, futures contracts,
options, forward contracts, swaps, caps, floors, collars and other
financial instruments; or
(ix) Make loans, except (a) by lending portfolio securities to the
extent allowed, and in accordance with the requirements, under the
1940 Act; (b) through the purchase of debt securities and other
obligations consistent with its goal and other investment policies
and restrictions; and (c) by engaging in repurchase agreements with
respect to portfolio securities.
The following investment restrictions are not fundamental and may be
changed by the Fund's Board of Directors without approval of the shareholders of
the affected Portfolios:
(i) At least 65% of each of Bond Portfolio's and Limited-Term Bond
Portfolio's total assets will be invested during normal market
conditions in bonds, and at least 65% of High Income Portfolio's
total assets will be invested during normal market conditions to
seek a high level of current income. Bond Portfolio may not
purchase any securities other than debt securities if, as a result
of such purchase, more than 10% of its total assets would be
invested in non-debt securities. This 10% limit does not include a
non-debt security held as a result of a conversion of a debt
security or exercise of a warrant;
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(ii) At least 65% of Small Cap Portfolio's total assets will be invested
during normal market conditions in companies whose market
capitalizations are within the range of capitalizations of companies
included in the Lipper, Inc. Small Cap Category at the time the
securities are acquired by the Portfolio;
(iii) At least 25% of Balanced Portfolio's total assets will be invested
during normal market conditions in fixed-income senior securities;
(iv) At least 80% of International Portfolio's total assets will be
invested during normal market conditions in foreign securities.
International Portfolio may not purchase a foreign security if, as a
result of such purchase, more than 75% of its total assets would be
invested in issuers of that foreign country. International Portfolio
currently intends to have at least 65% of its total assets invested
in issuers of at least three different foreign countries;
(v) Each of Balanced Portfolio, Growth Portfolio, Income Portfolio,
International Portfolio, Limited-Term Bond Portfolio, Science and
Technology Portfolio and Small Cap Portfolio does not currently
intend to invest in non-investment grade debt securities if, as a
result of such investment, more than 5% of its total assets would
consist of such investments. Asset Strategy Portfolio may not invest
more than 35% of its total assets in non-investment grade debt
securities;
(vi) Money Market Portfolio may not purchase the securities of any one
issuer (other than U.S. Government securities) if, as a result of
such purchase, more than 5% of its total assets would be invested in
the securities of any one issuer, as determined in accordance with
Rule 2a-7. Money Market Portfolio may not invest more than 5% of its
total assets in securities rated in the second highest rating
category by the requisite rating organization(s) or comparable
unrated securities, with investments in such securities of any one
issuer (except U.S. Government securities) limited to the greater of
1% of the Portfolio's total assets or $1,000,000, as determined in
accordance with Rule 2a-7;
(vii) High Income Portfolio may not purchase a common stock if, as a
result, more than 20% of its total assets would be invested in
common stocks. This 20% limit includes
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common stocks acquired on conversion of convertible securities, on
exercise of warrants or call options or in any other voluntary
manner. The Portfolio does not currently intend to invest more than
10% of its total assets in non-dividend paying common stocks;
(viii) Subject to the diversification requirements of Rule 2a-7, Money
Market Portfolio may invest up to 10% of its total assets in
Canadian Government obligations. Money Market Portfolio may not
invest more than 25% of its total assets in a combination of
Canadian Government obligations and foreign bank obligations;
(ix) Asset Strategy Portfolio currently intends to limit its investments
in foreign securities, under normal market conditions, to no more
than 50% of its total assets;
(x) Each of Bond Portfolio, Growth Portfolio, High Income Portfolio,
Income Portfolio, Science and Technology Portfolio and Small Cap
Portfolio may not invest more than 20% of its total assets in
foreign securities. Balanced Portfolio may purchase an unlimited
amount of foreign securities; however, the Portfolio intends to
have less than 10% of its total assets invested in foreign
securities;
(xi) Each Portfolio may not purchase a security if, as a result, more
than 10% (15% for Asset Strategy Portfolio) of its net assets would
consist of illiquid investments;
(xii) Each of Balanced Portfolio, International Portfolio, Small Cap
Portfolio and Science and Technology Portfolio may invest up to 10%
of its total assets in shares of investment companies that do not
redeem their shares if the Portfolio buys these shares in a regular
transaction in the open market or acquires them as part of a
reorganization, consolidation or merger; however, these Portfolios
do not currently intend to invest more than 5% of their respective
total assets in such securities. Asset Strategy Portfolio does not
currently intend to purchase shares of investment companies that do
not redeem their shares except in a regular transaction in the open
market and if, as a result, no more than 10% of its total assets
would be invested in such shares. Asset Strategy Portfolio does not
currently intend to purchase shares of open-end investment
companies;
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(xiii) Each of Asset Strategy Portfolio, International Portfolio and
Limited-Term Bond Portfolio does not currently intend to purchase
the securities of any issuer (other than securities issued or
guaranteed by domestic or foreign governments or political
subdivisions thereof) if, as a result, more than 5% of its total
assets would be invested in the securities of business enterprises
that, including predecessors, have a record of less than three
years of continuous operation. This restriction does not apply to
any obligations issued or guaranteed by the U.S. government or a
state or local government authority, or their respective
instrumentalities, or to collateralized mortgage obligations,
other mortgage-related securities, asset-backed securities,
indexed securities or OTC derivative instruments;
(xiv) A Portfolio may not participate on a joint, or a joint and
several, basis in any trading account in any securities (but this
does not prohibit the "bunching" of orders for the sale or
purchase of Portfolio securities with any other Portfolio or with
other advisory accounts of the Manager or any of its affiliates to
reduce brokerage commissions or otherwise to achieve best
execution);
(xv) Asset Strategy Portfolio does not currently intend to lend assets
other than securities to other parties, except by acquiring loans,
loan participations, or other forms of direct debt instruments.
This limitation does not apply to purchases of debt securities or
to repurchase agreements;
(xvi) Asset Strategy Portfolio does not currently intend to invest in
oil, gas, or other mineral exploration or development programs or
leases;
(xvii) Asset Strategy Portfolio will not purchase any security while
borrowings representing more than 5% of its total assets are
outstanding;
(xviii) Asset Strategy Portfolio does not currently intend to invest in
money-market instruments rated below the highest rating category
by S&P or MIS, or judged by the Manager to be of equivalent
quality; provided, however, that the Portfolio may invest in
money-market instruments rated below the highest rating category
by S&P or MIS if such instrument is subject to a letter of credit
or similar unconditional credit enhancement which is rated A-1 by
S&P or Prime 1 by MIS;
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(xix) Other than Asset Strategy Portfolio and Money Market Portfolio,
none of the other Portfolios may pledge its assets in connection
with any permitted borrowings; however, this policy does not
prevent a Portfolio from pledging its assets in connection with
its purchase and sale of futures contracts, options, forward
contracts, swaps, caps, floors, collars and other financial
instruments;
(xx) Money Market Portfolio will not invest in any security whose
interest rate or principal amount to be repaid, or timing of
payments, varies or floats with the value of a foreign currency,
the rate of interest payable on foreign currency borrowings, or
with any interest rate or index expressed in a currency other than
U.S. dollars;
(xxi) For Limited-Term Bond Portfolio, the maturity of collateralized
mortgage obligations and other asset-backed securities will be
deemed to be the estimated average life of such securities, as
determined in accordance with certain prescribed models or
formulas. The maturity of other debt securities will be deemed to
be the earlier of the call date or the maturity date, whichever is
appropriate;
(xxii) Limited-Term Bond Portfolio may only invest in U.S. dollar
denominated securities; and
(xxiii) To the extent that a Portfolio enters into futures contracts,
options on futures contracts or options on foreign currencies
traded on a CFTC-regulated exchange, in each case other than for
bona fide hedging purposes (as defined by the CFTC), the aggregate
initial margin and premiums required to establish those positions
(excluding the amount by which options are "in-the-money" at the
time of purchase) will not exceed 5% of the liquidation value of
the Portfolio, after taking into account unrealized profits and
unrealized losses on any contracts the Portfolio has entered into.
(In general, a call option on a futures contract is "in-the-money"
if the value of the underlying futures contract is exceeded by the
strike price of the put.) This policy does not limit to 5% the
percentage of a Portfolio's total assets that are at risk in
futures contracts, options on futures contracts and currency
options.
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An investment policy or limitation that states a maximum percentage of a
Portfolio's assets that may be so invested or prescribes quality standards is
typically applied immediately after, and based on, the Portfolio's acquisition
of an asset. Accordingly, a subsequent change in the asset's value, net assets,
or other circumstances will not be considered when determining whether the
investment complies with the Portfolio's investment policies and limitations.
Portfolio Turnover
A Portfolio turnover rate is, in general, the percentage computed by
taking the lesser of purchases or sales of portfolio securities for a year and
dividing it by the monthly average of the market value of such securities during
the year, excluding certain short-term securities. A Portfolio's turnover rate
may vary greatly from year to year as well as within a particular year.
The portfolio turnover rates for the fiscal years ended December 31,
1999 and December 31, 1998 for each of the Portfolios then in existence were as
follows:
1999 1998
---- ----
Asset Strategy Portfolio 179.63% 189.02%
Balanced Portfolio 62.90 54.62
Bond Portfolio 47.27 32.75
Growth Portfolio 65.82 75.58
High Income Portfolio 87.84 63.64
Income Portfolio 70.20 62.84
International Portfolio 118.71 88.84
Limited-Term Bond Portfolio 22.81 47.11
Money Market Portfolio 0.00 0.00
Science and Technology Portfolio 47.36 64.72
Small Cap Portfolio 130.99 177.32
The high portfolio turnover rate for Asset Strategy Portfolio,
International Portfolio and Small Cap Portfolio was due to the active management
of each Portfolio and the volatility of the stock market during this period. A
high turnover rate will increase transaction costs and commission costs that
will be borne by the Portfolio and may generate taxable income or loss. Because
short-term securities are generally excluded from
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computation of the turnover rate, a rate is not computed for Money Market
Portfolio.
INVESTMENT MANAGEMENT AND OTHER SERVICES
The Management Agreement
The Fund has an Investment Management Agreement (the "Management
Agreement") with Waddell & Reed, Inc. On January 8, 1992, subject to the
authority of the Fund's Board of Directors, Waddell & Reed, Inc. assigned the
Management Agreement and all related investment management duties (and related
professional staff) to the Manager, a wholly owned subsidiary of Waddell & Reed,
Inc. Under the Management Agreement, the Manager is employed to supervise the
investments of each Portfolio and provide investment advice to each Portfolio.
The address of the Manager and Waddell & Reed, Inc. is 6300 Lamar Avenue, P. O.
Box 29217, Shawnee Mission, Kansas 66201-9217. Waddell & Reed, Inc. is the
Fund's distributor.
The Management Agreement permits the Manager or an affiliate of the
Manager to enter into a separate agreement for accounting services ("Accounting
Services Agreement") with the Fund. The Management Agreement contains detailed
provisions as to the matters to be considered by the Fund's Directors prior to
approving any Accounting Services Agreement.
Waddell & Reed Financial, Inc.
The Manager is a wholly owned subsidiary of Waddell & Reed, Inc. Waddell &
Reed, Inc. is a wholly owned subsidiary of Waddell & Reed Financial Services,
Inc., a holding company which is a wholly owned subsidiary of Waddell & Reed
Financial, Inc., a publicly held company. The address of these companies is 6300
Lamar Avenue, P.O. Box 29217, Shawnee Mission, KS 66201-9217.
Waddell & Reed, Inc. and its predecessors served as investment manager to
the Fund and to each of the registered investment companies in the United Group
of Mutual Funds, except United Asset Strategy Fund, Inc., since 1940 or the
company's inception date, whichever was later, until January 8, 1992, when it
assigned its duties as investment manager for these funds (and the related
professional staff) to the Manager. The Manager has also served as investment
manager for Waddell & Reed Funds, Inc. since its inception in September 1992,
United Asset Strategy Fund, Inc. since it commenced operations in March 1995,
United Small Cap Fund, Inc. since it commenced operations in
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October 1999 and United Tax-Managed Equity Fund, Inc. since it commenced
operations in March 2000. Waddell & Reed, Inc. serves as distributor for
Policies for which the Fund is the underlying investment vehicle and as
underwriter for the investment companies in the United Group of Mutual Funds and
Waddell & Reed Funds, Inc.
Accounting Services
Under the Accounting Services Agreement entered into between the Fund and
Waddell & Reed Services Company (the "Agent"), a subsidiary of Waddell & Reed,
Inc., the Agent provides the Fund with bookkeeping and accounting services and
assistance including maintenance of the Fund's records, pricing of the
Portfolios' shares, preparation of prospectuses for existing shareholders,
preparation of proxy statements and certain shareholder reports. A new
Accounting Services Agreement, or amendments to an existing one, may be approved
by the Fund's Board of Directors without shareholder approval.
Payments by the Fund for Management and Accounting Services
Under the Management Agreement, for the Manager's management services, the
Fund pays the Manager a fee as described in the Prospectus. Prior to the
above-described assignment from Waddell & Reed, Inc. to the Manager, all fees
were paid to Waddell & Reed, Inc. The management fees paid to the Manager,
during the last three fiscal years for each Portfolio then in existence were as
follows:
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Periods ended December 31,
--------------------------
1999 1998 1997
---- ---- ----
Asset Strategy Portfolio $ 125,314 $ 91,048 $ 71,899
Balanced Portfolio 664,392 471,708 324,830
Bond Portfolio 593,016 547,604 491,520
Growth Portfolio 6,468,574 4,903,762 4,150,034
High Income Portfolio 778,077 801,018 690,862
Income Portfolio 5,983,548 5,015,935 3,955,628
International Portfolio 1,606,571 1,168,796 799,824
Limited-Term Bond Portfolio 29,161 22,936 21,919
Money Market Portfolio 254,538 223,299 192,321
Science and Technology Portfolio* 738,631 126,390 27,836
Small Cap Portfolio 1,771,481 1,395,302 1,018,984
*Science and Technology Portfolio began operations April 4, 1997.
The Fund accrues and pays this fee daily.
Under the Accounting Services Agreement, the Fund pays Waddell & Reed
Services Company a fee for accounting services as described in the Prospectus.
Fees paid to the Agent for the last three fiscal years for each Portfolio then
in existence were as follows:
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Periods ended December 31,
--------------------------
1999 1998 1997
---- ---- ----
Asset Strategy Portfolio $10,000 $ 9,167 $ --
Balanced Portfolio 36,667 30,000 25,833
Bond Portfolio 40,000 40,000 30,000
Growth Portfolio 87,500 72,500 67,500
High Income Portfolio 40,000 40,000 38,333
Income Portfolio 85,000 72,500 65,833
International Portfolio 42,500 40,000 35,833
Limited-Term Bond Portfolio -- -- --
Money Market Portfolio 30,000 23,333 20,000
Science and Technology Portfolio* 31,667 11,667 --
Small Cap Portfolio 46,667 40,000 38,333
*Science and Technology Portfolio began operations April 4, 1997.
Pursuant to its voluntary waiver of fees for a Portfolio with assets under
$25 million on any fee accrual and payment date, the manager waived management
fees in the amounts of $65,722 and $14,949 for Asset Strategy Portfolio and
Limited-Term Bond Portfolio for 1999.
Since the Fund pays a management fee for investment supervision and an
accounting services fee for accounting services as discussed above, the Manager
and Waddell & Reed Services Company, respectively, pay all of their own expenses
in providing these services. Waddell & Reed, Inc. and affiliates pay the Fund's
Directors and officers who are affiliated with the Manager and Waddell & Reed,
Inc. The Fund pays the fees and expenses of the Fund's other Directors. The Fund
pays all of its other expenses. These include the costs of printing and mailing
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materials sent to shareholders, audit and outside legal fees, taxes, brokerage
commissions, interest, insurance premiums, fees payable under securities laws
and to the Investment Company Institute, cost of processing and maintaining
shareholder records, cost of systems or services used to price Portfolio
securities and nonrecurring and extraordinary expenses, including litigation and
indemnification relating to litigation.
Service Plan
Under a Service Plan (the "Plan") adopted by the Fund pursuant to Rule
12b-1 under the 1940 Act, each Portfolio may pay Waddell & Reed, Inc. a fee not
to exceed .25% of the Portfolio's average annual net assets, paid monthly, to
compensate Waddell & Reed, Inc. for its costs and expenses in connection with
the provision of personal services to Policyowners and/or maintenance of
Policyowner accounts.
The Plan permits Waddell & Reed, Inc. to be compensated for amounts it
expends in compensating, training and supporting registered financial advisors,
sales managers and/or other appropriate personnel in providing personal services
to Policyowners and/or maintaining Policyowner accounts; increasing services
provided to Policyowners by office personnel; engaging in other activities
useful in providing personal service to Policyowners and/or maintenance of
Policyowner accounts; and in compensating broker-dealers who may regularly sell
Policies, and other third parties, for providing shareholder services and/or
maintaining Policyowner accounts.
The only Directors or interested persons, as defined in the 1940 Act, of
the Fund who have a direct or indirect financial interest in the operation of
the Plan are the officers and Directors who are also officers of either Waddell
& Reed, Inc. or its affiliate(s) or who are shareholders of Waddell & Reed
Financial, Inc., the indirect parent company of Waddell & Reed, Inc. The Plan is
anticipated to benefit each Portfolio and the Policyholders through Waddell &
Reed, Inc.'s activities to provide directly or indirectly, personal services to
the Policyholders and thereby promote the maintenance of their accounts with the
Fund. The Fund anticipates that Policyholders may benefit to the extent that
Waddell & Reed's activities are successful in increasing the assets of the Fund
through reduced redemptions and reducing a Policyholder's share of Fund and
Portfolio expenses. In addition, the Fund anticipates that the revenues from the
Plan will provide Waddell & Reed, Inc. with greater resources to make the
financial commitments necessary to continue to improve the quality and level of
services to the Fund and Policyholders.
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The Plan was approved by the Fund's Board of Directors, including the
Directors who are not interested persons of the Fund and who have no direct or
indirect financial interest in the operations of the Plan or any agreement
referred to in the Plan (hereafter, the "Plan Directors"). The Plan was also
approved as to each Portfolio by the shareholders of the Portfolio.
Among other things, the Plan provides that (i) Waddell & Reed, Inc. will
provide to the Directors of the Fund at least quarterly, and the Directors will
review, a report of amounts expended under the Plan and the purposes for which
such expenditures were made, (ii) the Plan will continue in effect only so long
as it is approved at least annually, and any material amendments thereto will be
effective only if approved, by the Directors including the Plan Directors acting
in person at a meeting called for that purpose, (iii) amounts to be paid by a
Portfolio under the Plan may not be materially increased without the vote of the
holders of a majority of the outstanding shares of the Portfolio, and (iv) while
the Plan remains in effect, the selection and nomination of the Directors who
are Plan Directors will be committed to the discretion of the Plan Directors.
During the fiscal year ended December 31, 1999, each Portfolio paid the
following amount under the Plan:
Asset Strategy Portfolio $ 40,884
Balanced Portfolio 246,777
Bond Portfolio 272,450
Growth Portfolio 2,250,583
High Income Portfolio 294,959
Income Portfolio 2,070,886
International Portfolio 467,843
Limited-Term Bond Portfolio 13,593
Money Market Portfolio 138,656
Science and Technology Portfolio 220,622
Small Cap Portfolio 505,758
Custodial and Auditing Services
The Custodian for each Portfolio is UMB Bank, n.a., 928 Grand Boulevard,
Kansas City, Missouri. In general, the Custodian is responsible for holding the
Portfolios' cash and securities. Deloitte & Touche LLP, 1010 Grand Boulevard,
Kansas City, Missouri, the Fund's independent auditors, audits the Fund's annual
financial statements.
NET ASSET VALUE
The NAV of one of the shares of a Portfolio is the value of the
Portfolio's assets, less liabilities, divided by
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the total number of shares outstanding. For example, if on a particular day a
Portfolio owned securities worth $100 and held cash of $15, the total value of
the assets would be $115. If it had a liability of $5, the NAV would be $110
($115 minus $5). If it had 11 shares outstanding, the NAV of one share would be
$10 ($110 divided by 11).
The NAV per share of each Portfolio is computed on each day that the NYSE
is open for trading as of the later of the close of the regular session of the
NYSE or the close of the regular session of any other securities or commodities
exchange on which an option or future held by a Portfolio is traded. The NYSE
ordinarily closes at 4:00 p.m. Eastern time. The NYSE annually announces the
days on which it will not be open for trading. The most recent announcement
indicates that it will not be open on the following days: New Year's Day, Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving Day and Christmas Day. However, it is possible that
the NYSE may close on other days. The NAV will change every business day, since
the value of the assets and the number of shares outstanding change every
business day.
Under Rule 2a-7, Money Market Portfolio uses the "amortized cost method"
for valuing its portfolio securities provided it meets certain conditions. As a
general matter, the primary conditions imposed under Rule 2a-7 relating to the
Portfolio's investments are that the Portfolio must: (i) not maintain a
dollar-weighted average portfolio maturity in excess of 90 days; (ii) limit its
investments, including repurchase agreements, to those instruments which are
U.S. dollar denominated and which the Fund's Board of Directors determines
present minimal credit risks and which are rated in one of the two highest
rating categories by the requisite NRSRO(s), as defined in Rule 2a-7; or, in the
case of any instrument that is not rated, of comparable quality as determined
under procedures established by and under the general supervision and
responsibility of the Fund's Board of Directors; (iii) limit its investments in
the securities of any one issuer (except U.S. Government securities) to no more
than 5% of its assets; (iv) limit its investments in securities rated in the
second highest rating category by the requisite NRSRO(s) or comparable unrated
securities to no more than 5% of its assets; (v) limit its investments in the
securities of any one issuer which are rated in the second highest rating
category by the requisite NRSRO(s) or comparable unrated securities to the
greater of 1% of its assets or $1,000,000; and (vi) limit its investments to
securities with a remaining maturity of not more than 397 days. Rule 2a-7 sets
forth the method by which the maturity of a security is determined. The
amortized cost method involves valuing an instrument at its cost and thereafter
assuming a
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constant amortization rate to maturity of any discount or premium, and does not
reflect the impact of fluctuating interest rates on the market value of the
security. This method does not take into account unrealized gains or losses.
While the amortized cost method provides some degree of certainty in
valuation, there may be periods during which value, as determined by amortized
cost, is higher or lower than the price the Portfolio would receive if it sold
the instrument. During periods of declining interest rates, the daily yield on
the Portfolio's shares may tend to be higher than a like computation made by a
fund with identical investments utilizing a method of valuation based upon
market prices and estimates of market prices for all of its portfolio
instruments and changing its dividends based on these changing prices. Thus, if
the use of amortized cost by the Portfolio resulted in a lower aggregate
portfolio value on a particular day, a prospective investor in the Portfolio's
shares would be able to obtain a somewhat higher yield than would result from
investment in such a fund, and existing investors in the Portfolio's shares
would receive less investment income. The converse would apply in a period of
rising interest rates.
Under Rule 2a-7, the Fund's Board of Directors must establish procedures
designed to stabilize, to the extent reasonably possible, the Portfolio's price
per share as computed for the purpose of sales and redemptions at $1.00. Such
procedures must include review of the portfolio holdings by the Board of
Directors at such intervals as it may deem appropriate and at such intervals as
are reasonable in light of current market conditions to determine whether the
Portfolio's NAV calculated by using available market quotations (see below)
deviates from the per share value based on amortized cost.
For the purpose of determining whether there is any deviation between the
value of the Portfolio based on amortized cost and that determined on the basis
of available market quotations, if there are readily available market
quotations, investments are valued at the mean between the bid and asked prices.
If such market quotations are not available, the investments will be valued at
their fair value as determined in good faith under procedures established by and
under the general supervision and responsibility of the Fund's Board of
Directors, including being valued at prices based on market quotations for
investments of similar type, yield and duration.
Under Rule 2a-7, if the extent of any deviation between the NAV per share
based upon available market quotations and the NAV per share based on amortized
cost exceeds one-half of 1%, the Board of Directors must promptly
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consider what action, if any, will be initiated. When the Board of Directors
believes that the extent of any deviation may result in material dilution or
other unfair results, it is required to take such action as it deems appropriate
to eliminate or reduce to the extent reasonably practicable such dilution or
unfair results. Such actions could include the sale of portfolio securities
prior to maturity to realize capital gains or losses or to shorten average
portfolio maturity, withholding dividends or payment of distributions from
capital or capital gains, redemptions of shares in kind, or establishing a NAV
per share using available market quotations.
The portfolio securities of the Portfolios (other than Money Market
Portfolio) that are listed or traded on U.S. or foreign stock exchanges are
valued at the last sales price on that day or, lacking any sales on such day, at
the mean of the last bid and asked prices available. In cases where securities
or other instruments are traded on more than one exchange, such securities or
other instruments generally are valued on the exchange designated by the Manager
(under procedures established by and under the general supervision and
responsibility of the Board of Directors) as the primary market. Securities
traded in the OTC market are valued at the mean of the last bid and asked
prices.
Bonds, other than convertible bonds, are valued using a pricing system
provided by a major dealer in bonds. Convertible bonds are valued using this
pricing system only on days when there is no sale reported. Short-term debt
securities held by the Portfolios (other than Money Market Portfolio) are valued
at amortized cost. When market quotations for options and futures positions and
non-exchange traded foreign securities held by a Portfolio are readily
available, those positions and securities will be valued based upon such
quotations. Market quotations generally will not be available for options traded
in the OTC market. Warrants and rights to purchase securities are valued at
market value. When market quotations are not readily available, securities,
options, futures and other assets are valued at fair value as determined in good
faith under procedures established by and under the general supervision and
responsibility of the Board of Directors.
When a Portfolio writes a call or a put option, an amount equal to the
premium received is included in that Portfolio's Statement of Assets and
Liabilities as an asset, and an equivalent deferred credit is included in the
liability section. The deferred credit is "marked-to-market" to reflect the
current market value of the option. If an option a Portfolio wrote is exercised,
the proceeds received on the sale of the related investment are increased by the
amount of the premium that the Portfolio received. If an option written by a
Portfolio expires,
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it has a gain in the amount of the premium; if it enters into a closing
transaction, it will have a gain or loss depending on whether the premium was
more or less than the cost of the closing transaction.
All securities and other assets quoted in foreign currency and forward
currency contracts are valued weekly in U.S. dollars on the basis of the foreign
currency exchange rate prevailing at the time such valuation is determined by
the Portfolio's Custodian. Foreign currency exchange rates are generally
determined prior to the close of the NYSE. Occasionally, events affecting the
value of foreign securities and such exchange rates occur between the time at
which they are determined and the close of the NYSE, which events will not be
reflected in a computation of the Portfolio's NAV. If events materially
affecting the value of such securities or assets or currency exchange rates
occurred during such time period, the securities or assets would be valued at
their fair value as determined in good faith under procedures established by and
under the general supervision and responsibility of the Board of Directors. The
foreign currency exchange transactions of a Portfolio conducted on a spot basis
are valued at the spot rate for purchasing or selling currency prevailing on the
foreign exchange market. Under normal market conditions this rate differs from
the prevailing exchange rate by an amount generally less than one-tenth of one
percent due to the costs of converting from one currency to another.
Optional delivery standby commitments are valued at fair value under the
general supervision and responsibility of the Fund's Board of Directors. They
are accounted for in the same manner as exchange-listed puts.
DIRECTORS AND OFFICERS
The day-to-day affairs of the Fund are handled by outside organizations
selected by the Board of Directors. The Board of Directors has responsibility
for establishing broad corporate policies for the Fund and for overseeing
overall performance of the selected experts. It has the benefit of advice and
reports from independent counsel and independent auditors. The majority of the
Directors are not affiliated with Waddell & Reed, Inc.
The principal occupation during the past five years of each Director and
officer is stated below. Each of the persons listed through and including Mr.
Vogel is a member of the Fund's Board of Directors. The other persons are
officers of the Fund but are not members of the Board of Directors. For purposes
of this section, the term "Fund Complex" includes the Fund, each of the funds in
the United Group of Mutual Funds and Waddell & Reed Funds, Inc.
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Each of the Fund's Directors is also a Director of each of the funds in the Fund
Complex and each of the Fund's officers is also an officer of one or more of the
funds in the Fund Complex.
KEITH A. TUCKER*
Chairman of the Board of Directors of the Fund and each of the other funds
in the Fund Complex; Chairman of the Board of Directors, Chief Executive Officer
and Director of Waddell & Reed Financial, Inc.; President, Chairman of the Board
of Directors and Chief Executive Officer of Waddell & Reed Financial Services,
Inc.; Chairman of the Board of Directors of WRIMCO, Waddell & Reed, Inc. and
Waddell & Reed Services Company; formerly, President of each of the funds in the
Fund Complex; formerly, Chairman of the Board of Directors of Waddell & Reed
Asset Management Company, a former affiliate of Waddell & Reed Financial, Inc.
Date of birth: February 11, 1945.
JAMES M. CONCANNON
950 Docking Road
Topeka, Kansas 66615
Dean and Professor of Law, Washburn University School of Law; Director,
AmVestors CBO II Inc. Date of birth: October 2, 1947.
JOHN A. DILLINGHAM
4040 Northwest Claymont Drive
Kansas City, Missouri 64116
President of JoDill Corp., an agricultural company; President and Director
of Dillingham Enterprises Inc.; formerly, Director and consultant, McDougal
Construction Company; formerly, Instructor at Central Missouri State University;
formerly, Member of the Board of Police Commissioners, Kansas City, Missouri;
formerly, Senior Vice President-Sales and Marketing of Garney Companies, Inc., a
specialty utility contractor. Date of birth: January 9, 1939.
DAVID P. GARDNER
263 West 3rd Avenue
San Mateo, California 94402
Chairman and Chief Executive Officer of George S. and Delores Dor'e Eccles
Foundation; Director of First Security Corp., a bank holding company, and
Director of Fluor Corp., a company with interests in coal; formerly, President
of Hewlett Foundation. Date of birth: March 24, 1933.
LINDA K. GRAVES*
1 South West Cedar Crest Road
Topeka, Kansas 66606
First Lady of Kansas; formerly, Partner of Levy and Craig, P.C., a law
firm. Date of birth: July 29, 1953.
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JOSEPH HARROZ, JR.
125 South Creekdale Drive
Norman, Oklahoma 73072
General Counsel of the Board of Regents at the University of Oklahoma;
Adjunct Professor of Law at the University of Oklahoma College of Law; Managing
Member, Harroz Investments, L.L.C.; formerly, Vice President for Executive
Affairs of the University of Oklahoma; formerly, Attorney with Crowe & Dunlevy,
a law firm. Date of birth: January 17, 1967.
JOHN F. HAYES
20 West 2nd Avenue
P. O. Box 2977
Hutchinson, Kansas 67504-2977
Director of Central Bank and Trust; Director of Central Financial
Corporation; Chairman of the Board of Directors, Gilliland & Hayes, P.A., a law
firm; formerly, President of Gilliland & Hayes, P.A.; formerly, Director of
Central Properties, Inc. Date of birth: December 11, 1919.
ROBERT L. HECHLER*
President and Principal Financial Officer of the Fund and each of the
other funds in the Fund Complex; Executive Vice President, Chief Operating
Officer and Director of Waddell & Reed Financial, Inc.; Vice President, Chief
Operating Officer, Director and Treasurer of Waddell & Reed Financial Services,
Inc.; Executive Vice President, Principal Financial Officer, Director and
Treasurer of WRIMCO; President, Chief Executive Officer, Principal Financial
Officer, Director and Treasurer of Waddell & Reed, Inc.; Director and Treasurer
of Waddell & Reed Services Company; Chairman, Chief Executive Officer, President
and Director of Fiduciary Trust Company of New Hampshire, an affiliate of
Waddell & Reed, Inc.; formerly, Vice President of each of the funds in the Fund
Complex; formerly, Director and Treasurer of Waddell & Reed Asset Management
Company; formerly, President of Waddell & Reed Services Company. Date of birth:
November 12, 1936.
HENRY J. HERRMANN*
Vice President of the Fund and each of the other funds in the Fund
Complex; President, Chief Investment Officer and Director of Waddell & Reed
Financial, Inc.; Vice President, Chief Investment Officer and Director of
Waddell & Reed Financial Services, Inc.; Director of Waddell & Reed, Inc.;
President, Chief Executive Officer, Chief Investment Officer and Director of
WRIMCO; Chairman of the Board of Directors of Austin, Calvert & Flavin, Inc., an
affiliate of WRIMCO; formerly, President, Chief Executive Officer, Chief
Investment Officer and Director of Waddell & Reed Asset Management Company. Date
of birth: December 8, 1942.
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GLENDON E. JOHNSON
13635 Deering Bay Drive
Unit 284
Miami, Florida 33158
Retired; formerly, Director and Chief Executive Officer of John Alden
Financial Corporation and its subsidiaries. Date of birth: February 19, 1924.
WILLIAM T. MORGAN*
928 Glorietta Blvd.
Coronado, California 92118
Retired; formerly, Chairman of the Board of Directors and President of
each of the funds in the Fund Complex then in existence. (Mr. Morgan retired as
Chairman of the Board of Directors and President of the funds in the Fund
Complex then in existence on April 30, 1993); formerly, President, Director and
Chief Executive Officer of WRIMCO and Waddell & Reed, Inc.; formerly, Chairman
of the Board of Directors of Waddell & Reed Services Company. Date of birth:
April 27, 1928.
RONALD C. REIMER
2601 Verona Road
Mission Hills, Kansas 66208
Retired. Co-founder and teacher at Servant Leadership School of Kansas
City; Director and Vice President of Network Rehabilitation Services; Board
Member, Member of Executive Committee and Finance Committee of Truman Medical
Center; formerly, Employment Counselor and Director of McCue-Parker Center. Date
of birth: August 3, 1934.
FRANK J. ROSS, JR.*
700 West 47th Street
Kansas City, Missouri 64112
Shareholder, Polsinelli, White, Vardeman & Shalton, a law firm; Director
of Columbian Bank and Trust. Date of birth: April 9, 1953.
ELEANOR B. SCHWARTZ
1213 West 95th Court, Chartwell 4
Kansas City, Missouri 64114
Professor of Business Administration, University of Missouri-Kansas City;
formerly, Chancellor, University of Missouri-Kansas City. Date of birth: January
1, 1937.
FREDERICK VOGEL III
1805 West Bradley Road
Milwaukee, Wisconsin 53217
Retired. Date of birth: August 7, 1935.
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Daniel C. Schulte
Vice President, Assistant Secretary and General Counsel of the Fund and
each of the other funds in the Fund Complex; Vice President, Secretary and
General Counsel of Waddell & Reed Financial, Inc., Waddell & Reed Financial
Services Company, Waddell & Reed, Inc., WRIMCO and Waddell & Reed Services
Company; formerly, Assistant Secretary of Waddell & Reed Financial, Inc.;
formerly, an attorney with Klenda, Mitchell, Austerman & Zuercher, L.L.C. Date
of birth: December 8, 1965.
Kristen A. Richards
Vice President, Secretary and Associate General Counsel of the Fund and
each of the other funds in the Fund Complex; Vice President and Associate
General Counsel of WRIMCO; formerly, Assistant Secretary of the Fund and each of
the other funds in the Fund Complex; formerly, Compliance Officer of WRIMCO.
Date of birth: December 2, 1967.
Theodore W. Howard
Vice President, Treasurer and Principal Accounting Officer of the Fund and
each of the other funds in the Fund Complex; Vice President of Waddell & Reed
Services Company. Date of birth: July 18, 1942.
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72
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73
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Michael L. Avery
Vice President of the Fund and two other funds in the Fund Complex; Senior
Vice President of the Manager; formerly, Vice President of, and the Director of
Research for, Waddell & Reed Asset Management Company. Date of birth: September
15, 1953.
James C. Cusser
Vice President of the Fund and two other funds in the Fund Complex; Vice
President of the Manager. Date of birth: May 30, 1949.
Thomas A. Mengel
Vice President of the Fund and two other funds in the Fund Complex; Vice
President of the Manager; formerly, President of Sal. Oppenheim jr. & Cie.
Securities, Inc. Date of birth: April 13, 1957.
William M. Nelson
Vice President of the Fund and Vice President of the Manager. Date of
birth: May 18, 1960.
Cynthia P. Prince-Fox
Vice President of the Fund and two other funds in the Fund Complex; Vice
President of the Manager; Vice President and Portfolio Manager for Austin,
Calvert & Flavin, Inc., an affiliate of the Manager; formerly, Vice President
of, and a portfolio manager for, Waddell & Reed Asset Management Company. Date
of birth: January 11, 1959.
Philip J. Sanders
Vice President of the Fund and Vice President of the Manager; formerly
Lead Manager with Tradestreet Investment Associates. Date of birth: October 30,
1959.
Grant P. Sarris
Vice President of the Fund and two other funds in the Fund Complex and
Vice President of the Manager. Date of birth: September 14, 1966.
Mark G. Seferovich
Vice President of the Fund and two other funds in the Fund Complex and Senior
Vice President of the Manager; formerly, Vice President of, and a portfolio
manager for, Waddell & Reed Asset Management Company. Date of birth: April 6,
1947.
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W. Patrick Sterner
Vice President of the Fund and one other fund in the Fund Complex; Vice
President of the Manager; formerly, Vice President of, and a portfolio manager
for, Waddell & Reed Asset Management Company. Date of birth: January 11, 1949.
Mira Stevovich
Vice President and Assistant Treasurer of the Fund and two other funds in
the Fund Complex and Assistant Treasurer of all funds in the Fund Complex; Vice
President of the Manager. Date of birth: July 30, 1953.
Daniel J. Vrabac
Vice President of the Fund and two other funds in the Fund Complex; Vice
President of the Manager; formerly, Vice President of, and a portfolio manager
for, Waddell & Reed Asset Management company. Date of birth: July 24, 1954.
James D. Wineland
Vice President of the Fund and two other funds in the Fund Complex; Senior
Vice President of the Manager; formerly, Vice President of, and a portfolio
manager for, Waddell & Reed Asset Management Company. Date of birth: September
25, 1951.
The address of each person is 6300 Lamar Avenue, P. O. Box 29217, Shawnee
Mission, Kansas 66201-9217 unless a different address is given.
The Directors who may be deemed to be "interested persons", as defined in
the 1940 Act, are indicated as such by an asterisk.
As of January 31, 2000, the Directors and officers as a group owned less
than 1% of the shares of any Portfolio.
The Board of Directors has created an honorary position of Director
Emeritus, whereby, an incumbent Director who has attained the age of 70 may, or
if elected on or after May 31, 1993 and has attained the age of 75 must, resign
his or her position as Director and, unless he or she elects otherwise, will
serve as Director Emeritus provided the Director has served as a
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Director of the Fund for at least five years which need not have been
consecutive. A Director Emeritus receives fees in recognition of his or her past
services whether or not services are rendered in his or her capacity as Director
Emeritus, but he or she has no authority or responsibility with respect to the
management of the Fund. Messrs. Henry L. Bellmon, Jay B. Dillingham, Doyle
Patterson, Ronald K. Richey and Paul S. Wise retired as Directors of the Fund
and of each of the funds in the Fund Complex, and each serves as Director
Emeritus.
The Fund, the funds in the United Group of Mutual Funds and Waddell & Reed
Funds, Inc. pay to each Director, effective October 1, 1999, an annual base fee
of $50,000, plus $3,000 for each meeting of the Board of Directors attended and
effective January 1, 2000, an annual base fee of $52,000 plus $3,250 for each
meeting of the Board of Directors attended, plus reimbursement of expenses for
attending such meeting and $500 for each committee meeting attended which is not
in conjunction with a Board of Directors meeting, other than Directors who are
affiliates of Waddell & Reed, Inc. (Prior to October 1, 1999, the funds in the
United Group, Target/United Funds, Inc. and Waddell & Reed Funds, Inc. paid to
each Director an annual base fee of $48,000 plus $2,500 for each meeting of the
Board of Directors attended.) The fees to the Directors are divided among the
Portfolios, the funds in the United Group and the series of Waddell & Reed
Funds, Inc. based on the Portfolios' relative size.
During the Fund's fiscal year ended December 31, 1999, the Fund's
Directors received the following fees for service as a director:
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COMPENSATION TABLE
Total
Aggregate Compensation
Compensation From Fund
From and Fund
Director Fund Complex*
- -------- ------------ ------------
Robert L. Hechler $ 0 $ 0
Henry J. Herrmann 0 0
Keith A. Tucker 0 0
James M. Concannon 5,987 59,500
John A. Dillingham 5,987 59,500
David P. Gardner 5,735 57,000
Linda K. Graves 5,987 59,500
Joseph Harroz, Jr. 5,987 59,500
John F. Hayes 5,987 59,500
Glendon E. Johnson 6,036 60,000
William T. Morgan 5,987 59,500
Ronald C. Reimer 6,001 59,500
Frank J. Ross, Jr. 5,987 59,500
Eleanor B. Schwartz 6,036 60,000
Frederick Vogel III 6,036 60,000
*No pension or retirement benefits have been accrued as a part of Fund expenses.
PURCHASES AND REDEMPTIONS
The separate accounts of the Participating Insurance Companies place
orders to purchase and redeem shares of each Portfolio based on, among other
things, the amount of premium payments to be invested and the number of
surrender and transfer requests to be effected on any day according to the terms
of the Policies. Shares of a Portfolio are sold at their NAV per share. No sales
charge is paid by the Participating Insurance Company for purchase of shares.
Redemptions will be made at the NAV per share of the Portfolio. Payment is
generally made within seven days after receipt of a proper request to redeem.
The Fund may suspend the right of redemption of shares of any Portfolio and may
postpone payment for any period if any of the following conditions exist: (i)
the NYSE is closed other than customary weekend and holiday closings or trading
on the NYSE is restricted; (ii) the SEC has determined
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that a state of emergency exists which may make payment or transfer not
reasonably practicable; (iii) the SEC has permitted suspension of the right of
redemption of shares for the protection of the shareholders of the Fund; or (iv)
applicable laws and regulations otherwise permit the Fund to suspend payment on
the redemption of shares. Redemptions are ordinarily made in cash but under
extraordinary conditions the Fund's Board of Directors may determine that the
making of cash payments is undesirable. In such case, redemption payments may be
made in Portfolio securities. The redeeming shareholders would incur brokerage
costs in selling such securities. The Fund has elected to be governed by Rule
18f-1 under the 1940 Act, pursuant to which it is obligated to redeem shares
solely in cash up to the lesser of $250,000 or 1% of its NAV during any 90-day
period for any one shareholder.
Should any conflict between Policyowners arise which would require that a
substantial amount of net assets be withdrawn from a Portfolio, orderly
portfolio management could be disrupted to the potential detriment of
Policyowners. The Fund need not accept any purchase order and it may discontinue
offering the shares of any Portfolio.
SHAREHOLDER COMMUNICATIONS
Policyowners will receive from the Participating Insurance Companies
financial statements of the Fund as required under the 1940 Act. Each report
shows the investments owned by the Portfolio and the market values thereof and
provides other information about the Fund and its operations.
TAXES
General
Shares of the Portfolios are offered only to insurance company separate
accounts that fund Policies. See the applicable Policy prospectus for a
discussion of the special taxation of insurance companies with respect to such
accounts and of the Policy holders.
Each Portfolio is treated as a separate corporation for Federal income tax
purposes. Each Portfolio has qualified since inception for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code of 1986, as
amended (the "Code"), so that it is relieved of Federal income tax on that part
of its investment company taxable income (consisting generally of net taxable
investment income, net short-term capital gain and, for
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each Portfolio other than Money Market Portfolio and Limited-Term Bond
Portfolio, net gains from certain foreign currency transactions) that it
distributes to its shareholders. To continue to qualify for treatment as a RIC,
a Portfolio must distribute to its shareholders for each taxable year at least
90% of its investment company taxable income ("Distribution Requirement"), and
must meet several additional requirements. With respect to each Portfolio, these
requirements include the following: (1) the Portfolio must derive at least 90%
of its gross income each taxable year from dividends, interest, payments with
respect to securities loans, and gains from the sale or other disposition of
securities or foreign currencies or other income (including gains from options,
futures contracts or forward contracts) derived with respect to its business of
investing in securities or those currencies ("Income Requirement"); (2) at the
close of each quarter of the Portfolio's taxable year, at least 50% of the value
of its total assets must be represented by cash and cash items, U.S. Government
securities, securities of other RICs and other securities that are limited, in
respect of any one issuer, to an amount that does not exceed 5% of the value of
the Fund's total assets and that does not represent more than 10% of the
issuer's outstanding voting securities ("50% Diversification Requirement"); and
(3) at the close of each quarter of the Portfolio's taxable year, not more than
25% of the value of its total assets may be invested in securities (other than
U.S. Government securities or the securities of other RICs) of any one issuer.
Each Portfolio intends to comply with the diversification requirements
imposed by section 817(h) of the Code and the regulations thereunder. These
requirements, which are in addition to the diversification requirements imposed
on the Portfolios by the 1940 Act and Subchapter M of the Code, place certain
limitations on the assets of each separate account -- and, because section
817(h) and those regulations treat the assets of each Portfolio as assets of the
related separate account, of each Portfolio -- that may be invested in
securities of a single issuer. Specifically, the regulations provide that,
except as permitted by the "safe harbor" described below, as of the end of each
calendar quarter or within 30 days thereafter, no more than 55% of a Portfolio's
total assets may be represented by any one investment, no more than 70% by any
two investments, no more than 80% by any three investments and no more than 90%
by any four investments. For this purpose, all securities of the same issuer are
considered a single investment, and while each U.S. Government agency and
instrumentality is considered a separate issuer, a particular foreign government
and its agencies, instrumentalities and political subdivisions all will be
considered the same issuer. Section 817(h) provides, as a safe harbor, that a
separate account will be treated as being adequately diversified if the
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diversification requirements under Subchapter M are satisfied and no more than
55% of the value of the account's total assets are cash and cash items,
government securities and securities of other RICs. Failure of a Portfolio to
satisfy the section 817(h) requirements would result in taxation of the
Participating Insurance Companies and treatment of the Policyowners other than
as described in the prospectuses for the Policies. If any Portfolio failed to
qualify for treatment as a regulated investment company for any taxable year,
(1) it would be taxed at corporate rates on the full amount of its taxable
income for that year without being able to deduct the distributions it makes to
its shareholders, (2) the shareholders would treat all those distributions,
including distributions of net capital gains (the excess of net long-term
capital gains over net short-term capital losses), as dividends (that is,
ordinary income) to the extent of the Portfolio's earnings and profits, and (3)
most importantly, each insurance company separate account invested therein would
fail to satisfy the diversification requirements of Code section 817(h), with
the result that the variable annuity contracts supported by that account would
no longer be eligible for tax deferral. In addition, the Portfolio could be
required to recognize unrealized gains, pay substantial taxes and interest and
make substantial distributions before requalifying for regulated investment
company treatment.
Dividends and distributions declared by a Portfolio in December of any
year and payable to shareholders of record on a date in that month are deemed to
have been paid by the Portfolio and received by the shareholders on December 31
of that year if they are paid by the Portfolio during the following January.
Each Portfolio will be subject to a nondeductible 4% excise tax ("Excise
Tax") to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gains net
income for the one-year period ending on October 31 of that year, plus certain
other amounts. Each Portfolio may defer into the next calendar year net capital
losses incurred between November 1 and the end of the current calendar year. It
is the Portfolio's policy to make sufficient distributions each year to avoid
imposition of the Excise Tax.
Income from Foreign Securities
Dividends and interest received, and gains realized, by a Portfolio (other
than the Limited-Term Bond Portfolio) may be subject to income, withholding or
other taxes imposed by foreign
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countries and U.S. possessions ("foreign taxes") that would reduce the yield
and/or total return on its securities. Tax conventions between certain countries
and the United States may reduce or eliminate foreign taxes, however, and many
foreign countries do not impose taxes on capital gains in respect of investments
by foreign investors.
Each Portfolio (other than Money Market Portfolio and Limited-Term Bond
Portfolio) may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is any foreign corporation that, in general, meets either of
the following tests: (i) at least 75% of its gross income is passive or (ii) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain circumstances, a Portfolio will be subject to
Federal income tax on a portion of any "excess distribution" received on the
stock of a PFIC or of any gain on disposition of the stock (collectively "PFIC
income"), plus interest thereon, even if the Portfolio distributes the PFIC
income as a taxable dividend to its shareholders. The balance of the PFIC income
will be included in the Portfolio's investment company taxable income and,
accordingly, will not be taxable to it to the extent it distributes that income
to its shareholders.
If a Portfolio invests in a PFIC and elects to treat the PFIC as a
"qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the Portfolio will be required to include in income each
year its pro rata share of the QEF's annual ordinary earnings and net capital
gain -- which probably would have to be distributed by the Portfolio to satisfy
the Distribution Requirement and to avoid imposition of the Excise Tax -- even
if those earnings and gain were not distributed to the Portfolio by the QEF. In
most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
The Portfolio may elect to "mark to market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of a PFIC's stock over
the Portfolio's adjusted basis therein as of the end of that year. Pursuant to
the election, the Portfolio also may deduct (as an ordinary, not
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capital, loss) the excess, if any, of its adjusted basis in PFIC stock over the
fair market value thereof as of the taxable year-end, but only to the extent of
any net mark-to-market gains with respect to that stock included by the
Portfolio for prior taxable years under the election (and under regulations
proposed in 1992 that provided a similar election with respect to the stock of
certain PFICs). The Portfolio's adjusted basis in each PFIC's stock with respect
to which it makes this election will be adjusted to reflect the amounts of
income included and deductions taken under the election.
Foreign Currency Gains and Losses
Gains or losses (i) from the disposition of foreign currencies, including
forward currency contracts, (ii) on the disposition of each debt security
denominated in a foreign currency that are attributable to fluctuations in the
value of the foreign currency between the date of acquisition of the security
and the date of disposition, and (iii) that are attributable to fluctuations in
exchange rates that occur between the time a Portfolio accrues interest,
dividends or other receivables, or expenses or other liabilities, denominated in
a foreign currency and the time the Portfolio actually collects the receivables
or pays the liabilities, generally are treated as ordinary income or loss. These
gains or losses, referred to under the Code as "section 988" gains or losses,
may increase or decrease the amount of a Portfolio's investment company taxable
income to be distributed to its shareholders as ordinary income, rather than
affecting the amount of its net capital gain.
Income from Options, Futures and Forward Currency Contracts and Foreign
Currencies
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures contracts and entering into forward currency
contracts, involves Complex rules that will determine for income tax purposes
the amount, character and timing of recognition of the gains and losses a
Portfolio realizes in connection therewith. Gains from the disposition of
foreign currencies (except certain gains that may be excluded by future
regulations), and gains from options, futures contracts and forward currency
contracts derived by a Portfolio with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement.
Any income a Portfolio earns from writing options is taxed as short-term
capital gains. If a Portfolio enters into a closing purchase transaction, it
will have a short-term capital gain or loss based on the difference between the
premium it receives for
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the option it wrote and the premium it pays for the option it buys. If an option
written by a Portfolio lapses without being exercised, the premium it receives
also will be a short-term capital gain. If such an option is exercised and the
Portfolio thus sells the securities subject to the option, the premium the
Portfolio receives will be added to the exercise price to determine the gain or
loss on the sale.
Certain options, futures contracts and forward currency contracts in which
a Portfolio may invest will be "section 1256 contracts." Section 1256 contracts
held by a Portfolio at the end of its taxable year, other than contracts subject
to a "mixed straddle" election made by the Portfolio, are "marked-to-market"
(that is, treated as sold at that time for their fair market value) for Federal
income tax purposes, with the result that unrealized gains or losses are treated
as though they were realized. Sixty percent of any net gains or losses
recognized on these deemed sales, and 60% of any net realized gains or losses
from any actual sales of section 1256 contracts, are treated as long-term
capital gain or loss, and the balance is treated as short-term capital gain or
loss. Section 1256 contracts also may be marked-to-market for purposes of the
Excise Tax and other purposes. A Portfolio may need to distribute any
mark-to-market gains to its shareholders to satisfy the Distribution Requirement
and/or avoid imposition of the Excise Tax, even though it may not have closed
the transactions and received cash to pay the distributions.
Code section 1092 (dealing with straddles) may also affect the taxation of
options and futures contracts in which a Portfolio may invest. That section
defines a "straddle" as offsetting positions with respect to personal property;
for these purposes, options, futures contracts and forward currency contracts
are personal property. Section 1092 generally provides that any loss from the
disposition of a position in a straddle may be deducted only to the extent the
loss exceeds the unrealized gain on the offsetting position(s) of the straddle.
In addition, these rules may postpone the recognition of loss that would
otherwise be recognized under the mark-to-market rules discussed above. The
regulations under section 1092 also provide certain "wash sale" rules, which
apply to transactions where a position is sold at a loss and a new offsetting
position is acquired within a prescribed period, and "short sale" rules
applicable to straddles. If a Portfolio makes certain elections, the amount,
character and timing of the recognition of gains and losses from the affected
straddle positions will be determined under rules that vary according to the
elections made. Because only a few of the regulations implementing the straddle
rules have been promulgated,
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the tax consequences of straddle transactions to a Portfolio are not entirely
clear.
If a Portfolio has an "appreciated financial position" -- generally, an
interest (including an interest through an option, futures or forward currency
contract or short sale) with respect to any stock, debt instrument (other than
"straight debt") or partnership interest the fair market value of which exceeds
its adjusted basis -- and enters into a "constructive sale" of the position, the
Portfolio will be treated as having made an actual sale thereof, with the result
that gain will be recognized at that time. A constructive sale generally
consists of a short sale, an offsetting notional principal contract or futures
or forward currency contract entered into by a Portfolio or a related person
with respect to the same or substantially identical property. In addition, if
the appreciated financial position is itself a short sale or such a contract,
acquisition of the underlying property or substantially identical property will
be deemed a constructive sale. The foregoing will not apply, however, to any
transaction during any taxable year that otherwise would be treated as a
constructive sale if the transaction is closed within 30 days after the end of
that year and a Portfolio holds the appreciated financial position unhedged for
60 days after that closing (i.e., at no time during that 60-day period is a
Portfolio's risk of loss regarding that position reduced by reason of certain
specified transactions with respect to substantially identical or related
property, such as having an option to sell, being contractually obligated to
sell, making a short sale, or granting an option to buy substantially identical
stock or securities).
Zero Coupon and Payment-in-Kind Securities
As the holder of zero coupon or other securities issued with original
issue discount ("OID"), a Portfolio must include in its income the OID that
accrues on the securities during the taxable year, even if the Portfolio
receives no corresponding payment on the securities during the year. Similarly,
a Portfolio must include in its gross income securities it receives as
"interest" on payment-in-kind securities. Because each Portfolio annually must
distribute substantially all of its investment company taxable income, including
any accrued OID and other non-cash income, in order to satisfy the Distribution
Requirement and to avoid imposition of the Excise Tax, a Portfolio may be
required in a particular year to distribute as a dividend an amount that is
greater than the total amount of cash it actually receives. Those distributions
will be made from a Portfolio's cash assets or from the proceeds of sales of
portfolio securities, if necessary. A Portfolio may realize capital gains or
losses from those sales,
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which would increase or decrease its investment company taxable income and/or
net capital gain.
DIVIDENDS AND DISTRIBUTIONS
It is the Fund's intention to distribute substantially all the net
investment income, if any, of each Portfolio. For dividend purposes, net
investment income of each Portfolio, other than Money Market Portfolio, will
consist of all payments of dividends or interest received by such Portfolio less
the estimated expenses of such Portfolio. Money Market Portfolio's net
investment income for dividend purposes consists of all interest income accrued
on the Portfolio, plus or minus realized gains or losses on portfolio
securities, less the Portfolio's expenses.
Dividends on Money Market Portfolio are declared and paid daily in
additional full and fractional shares. Dividends from investment income of
Growth Portfolio, Bond Portfolio, High Income Portfolio, Income Portfolio,
International Portfolio, Small Cap Portfolio, Balanced Portfolio, Limited-Term
Bond Portfolio, Asset Strategy Portfolio and Science and Technology Portfolio
will usually be declared and paid annually in December in additional full and
fractional shares of that Portfolio. Ordinarily, dividends are paid on shares
starting on the day after they are issued and on shares the day they are
redeemed. Under the amortized cost procedures which pertain to Money Market
Portfolio in certain circumstances dividends of Money Market Portfolio might be
eliminated or reduced.
All net realized long-term or short-term capital gains of the Portfolios,
if any, other than short-term capital gains of Money Market Portfolio, are
declared and distributed annually in December to the shareholders of the
Portfolios to which such gains are attributable.
PORTFOLIO TRANSACTIONS AND BROKERAGE
One of the duties undertaken by the Manager in the Management Agreement is
to arrange for the purchase and sale of securities for the Portfolios. With
respect to Limited-Term Bond Portfolio, Money Market Portfolio and High Income
Portfolio, many purchases are made directly from issuers or from underwriters,
dealers or banks. Purchases from underwriters
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include a commission or concession paid by the issuer to the underwriter.
Purchases from dealers will include the spread between the bid and the asked
prices. Otherwise, transactions in securities other than those for which an
exchange is the primary market are generally effected with dealers acting as
principals or market makers. Brokerage commissions are paid primarily for
effecting transactions in securities traded on an exchange and otherwise only if
it appears likely that a better price or execution can be obtained. The
individuals who manage the Portfolios may manage other advisory accounts with
similar investment objectives. It can be anticipated that the manager will
frequently, yet not always, place concurrent orders for all or most accounts for
which the manager has responsibility or the Manager may otherwise combine orders
for a Portfolio with those of other Portfolios, funds in the United Group and
Waddell & Reed Funds, Inc. and/or other accounts for which it has investment
discretion, including accounts affiliated with the Manager. Under current
written procedures, transactions effected pursuant to such combined orders are
averaged as to price and allocated in accordance with the purchase or sale
orders actually placed for each fund or advisory account, except where the
combined order is not filled completely. In this case, the Manager will
ordinarily allocate the transaction pro rata based on the orders placed, subject
to certain variances provided for in the written procedures. Sharing in large
transactions could affect the price a Portfolio pays or receives or the amount
it buys or sells. As well, a better negotiated commission may be available
through combined orders.
To effect the portfolio transactions of each Portfolio in securities
traded on an exchange, the Manager is authorized to engage broker-dealers
("brokers") which, in its best judgment based on all relevant factors, will
implement the policy of the Portfolio to seek "best execution" (prompt and
reliable execution at the best price obtainable) for reasonable and competitive
commissions. The Manager need not seek competitive commission bidding but is
expected to minimize the commissions paid to the extent consistent with the
interests and policies of the Portfolio. Subject to review by the Board of
Directors, such policies include the selection of brokers which provide
execution and/or research services and other services, including pricing or
quotation services directly or through others ("research and brokerage
services") considered by the Manager to be useful or desirable for its
investment management of the Portfolio and/or the other funds and accounts over
which the Manager has investment discretion.
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Research and brokerage services are, in general, defined by reference to
Section 28(e) of the Securities Exchange Act of 1934 as including (i) advice,
either directly or through publications or writings, as to the value of
securities, the advisability of investing in, purchasing or selling securities
and the availability of securities and purchasers or sellers, (ii) furnishing
analyses and reports, or (iii) effecting securities transactions and performing
functions incidental thereto (such as clearance, settlement and custody).
"Investment discretion" is, in general, defined as having authorization to
determine what securities shall be purchased or sold for an account, or making
those decisions even though someone else has responsibility.
The commissions paid to brokers that provide such research and/or
brokerage services may be higher than the commission another qualified broker
would charge if a good faith determination is made by the Manager that the
commission is reasonable in relation to the research or brokerage services
provided. No allocation of brokerage or principal business is made to provide
any other benefits to the Manager or its affiliates.
The investment research provided by a particular broker may be useful only
to one or more of the other advisory accounts of the Manager and investment
research received for the commissions of those other accounts may be useful both
to a Portfolio and one or more of such other accounts. To the extent that
electronic or other products provided by such brokers to assist the Manager in
making investment management decisions are used for administration or other
non-research purposes, a reasonable allocation of the cost of the product
attributable to its non-research use is made by the Manager.
Such investment research, which may be supplied by a third party at the
request of a broker, includes information on particular companies and industries
as well as market, economic or institutional activity areas. It serves to
broaden the scope and supplement the research activities of the Manager; serves
to make available additional views for consideration and comparisons; and
enables the Manager to obtain market information on the price of securities held
in a Portfolio or being considered for purchase.
The Fund may also use its brokerage to pay for pricing or quotation
services to value securities. The table below sets forth the brokerage
commissions paid during the fiscal years ended December 31, 1999, 1998 and 1997:
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Periods ended December 31,
-------------------------------
1999 1998 1997
---- ---- ----
Asset Strategy Portfolio $ 38,386 $ 16,848 $ 16,930
Balanced Portfolio 128,278 68,705 56,431
Bond Portfolio -- -- --
Growth Portfolio 1,122,733 1,048,968 1,785,220
High Income Portfolio 17,842 5,131 2,998
Income Portfolio 716,229 576,461 421,831
International Portfolio 1,002,125 632,844 597,704
Limited-Term Bond Portfolio -- -- --
Money Market Portfolio -- -- --
Science and Technology Portfolio* 52,993 19,104 8,143
Small Cap Portfolio 275,977 309,983 238,000
---------- ---------- ----------
$3,354,563 $2,678,044 $3,127,257
========== ========== ==========
*Science and Technology Portfolio began operations April 4, 1997.
The next table shows the transactions, other than principal transactions,
which were directed to broker-dealers who provided research services as well as
execution and the brokerage commissions paid for the fiscal year ended December
31, 1999. These transactions were allocated to these broker-dealers by the
internal allocation procedures described above.
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Amount of Brokerage
Transactions Commissions
-------------- --------------
Asset Strategy Portfolio $ 11,398,375 $ 22,361
Balanced Portfolio 68,989,394 103,186
Bond Portfolio -- --
Growth Portfolio 890,003,135 985,610
High Income Portfolio 5,980,162 8,818
Income Portfolio 462,010,618 544,031
International Portfolio 11,717,695 10,819
Limited-Term Bond Portfolio -- --
Money Market Portfolio -- --
Science and Technology Portfolio 13,054,361 15,524
Small Cap Portfolio 46,650,245 124,546
-------------- --------------
$1,509,803,985 $ 1,814,895
============== ==============
As of December 31, 1999, each of the following Portfolios held securities
issued by their respective regular broker-dealers, as follows: Asset Strategy
Portfolio owned Bank of America Corporation securities in the aggregate amount
of $170,637; Balanced Portfolio owned Bank of America Corporation securities in
the aggregate amount of $1,008,217; Bond Portfolio owned Salomon Inc. securities
in the aggregate amount of $1,032,340; Growth Portfolio owned Citigroup Inc.
securities in the aggregate amount of $9,862,344; Growth Portfolio owned Bank of
America Corporation securities in the aggregate amount of $9,033,750; Growth
Portfolio owned Morgan Stanley, Dean Witter, Discover & Co. securities in the
aggregate amount of $9,992,500; Income Portfolio owned Citigroup Inc. securities
in the aggregate amount of $12,926,616; Income Portfolio owned Bank of America
Corporation securities in the aggregate amount of $7,819,212; Limited-Term Bond
Portfolio owned Bank of America Corporation securities in the aggregate amount
of $101,749; and Limited-Term Bond Portfolio owned Salomon Inc. securities in
the aggregate amount of $100,482.
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The Fund, the Manager and Waddell & Reed, Inc. have adopted a Code of
Ethics under Rule 17j-1 of the 1940 Act that permits their respective directors,
officers and employees to invest in securities, including securities that may be
purchased or held by a Fund. The Code of Ethics subjects covered personnel to
certain restrictions that include prohibited activities, pre-clearance
requirements and reporting obligations.
OTHER INFORMATION
Capital Stock
The Fund was incorporated in Maryland on December 2, 1986. Prior to August
31, 1998, the Fund was known as TMK/United Funds, Inc. Capital stock is
currently divided into the following classes which are a type of class
designated a "series" as that term is defined in the Articles of Incorporation
of the Fund: Asset Strategy Portfolio, Balanced Portfolio, Bond Portfolio,
Growth Portfolio, High Income Portfolio, Income Portfolio, International
Portfolio, Limited-Term Bond Portfolio, Money Market Portfolio, Science and
Technology Portfolio and Small Cap Portfolio.
The balance of shares authorized but not divided into classes may be
issued to an existing Portfolio, or to new series having the number of shares
and descriptions, powers, and rights, and the qualifications, limitations, and
restrictions as the Board of Directors may determine. The Board of Directors may
also change the designation of any Portfolio and may increase or decrease the
numbers of shares of any Portfolio but may not decrease the number of shares of
any Portfolio below the number of shares then outstanding.
Each issued and outstanding share in a Portfolio is entitled to
participate equally in dividends and distributions declared by the Portfolio
and, upon liquidation or dissolution, in net assets of such Portfolio remaining
after satisfaction of outstanding liabilities. The shares of each Portfolio when
issued are fully paid and nonassessable.
The Fund does not hold annual meetings of shareholders; however, certain
significant corporate matters, such as the approval of a new investment advisory
agreement or a change in a fundamental investment policy, which require
shareholder approval will be presented to shareholders at a meeting called by
the Board of Directors for such purpose.
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Special meetings of shareholders may be called for any purpose upon
receipt by the Fund of a request in writing signed by shareholders holding not
less than 25% of all shares entitled to vote at such meeting, provided certain
conditions stated in the Bylaws are met. There will normally be no meeting of
the shareholders for the purpose of electing directors until such time as less
than a majority of directors holding office have been elected by shareholders,
at which time the directors then in office will call a shareholders' meeting for
the election of directors. To the extent that Section 16(c) of the 1940 Act
applies to the Fund, the directors are required to call a meeting of
shareholders for the purpose of voting upon the question of removal of any
director when requested in writing to do so by the shareholders of record of not
less than 10% of the Fund's outstanding shares.
Voting Rights
All shares of the Fund have equal voting rights (regardless of the NAV per
share) except that on matters affecting only one Portfolio, only shares of the
respective Portfolio are entitled to vote. The shares do not have cumulative
voting rights. Accordingly, the holders of more than 50% of the shares of the
Fund voting for the election of directors can elect all of the directors of the
Fund if they choose to do so, and in such event the holders of the remaining
shares would not be able to elect any directors.
Matters in which the interests of all the Portfolios are substantially
identical (such as the election of Directors or the approval of independent
public accountants) will be voted on by all shareholders without regard to the
separate Portfolios. Matters that affect all the Portfolios but where the
interests of the Portfolios are not substantially identical (such as approval of
the Investment Management Agreement) will be voted on separately by each
Portfolio. Matters affecting only one Portfolio, such as a change in its
fundamental policies, will be voted on separately by the Portfolio.
Matters requiring separate shareholder voting by a Portfolio shall have
been effectively acted upon with respect to any Portfolio if a majority of the
outstanding voting securities of that Portfolio votes for approval of the
matter, notwithstanding that: (1) the matter has not been approved by a majority
of the outstanding voting securities of any other Series; or (2) the matter has
not been approved by a majority of the outstanding voting securities of the
Fund.
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The phrase "a majority of the outstanding voting securities" of a series
(or of a Fund) means the vote of the lesser of: (1) 67% of the shares of a
series (or the Fund) present at a meeting if the holders of more than 50% of the
outstanding shares are present in person or by proxy; or (2) more than 50% of
the outstanding shares of a series (or a Fund).
To the extent required by law, Policyholders are entitled to give voting
instructions with respect to Fund shares held in the separate accounts of
Participating Insurance Companies. Participating Insurance Companies will vote
the shares in accordance with such instructions unless otherwise legally
required or permitted to act with respect to such instructions.
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APPENDIX A
The following are descriptions of some of the ratings of securities which
the Fund may use. The Fund may also use ratings provided by other nationally
recognized statistical rating organizations in determining the eligibility of
securities for the Portfolios.
DESCRIPTION OF BOND RATINGS
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. An S&P
corporate or municipal bond rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment of creditworthiness may take into consideration obligors such as
guarantors, insurers or lessees.
The debt rating is not a recommendation to purchase, sell or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished to S&P by the
issuer or obtained by S&P from other sources it considers reliable. S&P does not
perform any audit in connection with any ratings and may, on occasion, rely on
unaudited financial information. The ratings may be changed, suspended or
withdrawn as a result of changes in, or unavailability of, such information, or
based on other circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default -- capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with
the terms of the obligation.;.
2. Nature of and provisions of the obligation;
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
A brief description of the applicable S&P rating symbols and their
meanings follow:
AAA -- Debt rated AAA has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
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AA -- Debt rated AA also qualifies as high-quality debt. Capacity to pay
interest and repay principal is very strong, and debt rated AA differs from AAA
issues only in a small degree.
A -- Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB -- Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B, CCC, CC, C -- Debt rated BB, B, CCC, CC and C is regarded as having
predominantly speculative characteristics 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 exposures
to adverse conditions.
BB -- Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B -- Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB or BB- rating.
CCC -- Debt rated CCC has a currently indefinable vulnerability to
default, and is dependent upon favorable business, financial and economic
conditions to meet timely payment of interest and repayment of principal. In the
event of adverse business, financial or economic conditions, it is not likely to
have the capacity to pay interest and repay principal. The CCC rating category
is also used for debt subordinated to senior debt that is assigned an actual or
implied B or B- rating.
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CC -- The rating CC is typically applied to debt subordinated to senior
debt that is assigned an actual or implied CCC rating.
C -- The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC- debt rating. The C rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
CI -- The rating CI is reserved for income bonds on which no interest is
being paid.
D -- Debt rated D is in payment default. It is used when interest payments
or principal payments are not made on a due date even if the applicable grace
period has not expired, unless S&P believes that such payments will be made
during such grace periods. The D rating will also be used upon a filing of a
bankruptcy petition if debt service payments are jeopardized.
Plus (+) or Minus (-) -- To provide more detailed indications of credit
quality, 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.
NR -- Indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
Debt Obligations of issuers outside the United States and its territories
are rated on the same basis as domestic corporate and municipal issues. The
ratings measure the creditworthiness of the obligor but do not take into account
currency exchange and related uncertainties.
Bond Investment Quality Standards: Under present commercial bank
regulations issued by the Comptroller of the Currency, bonds rated in the top
four categories (AAA, AA, A, BBB, commonly known as "Investment Grade" ratings)
are generally regarded as eligible for bank investment. In addition, the Legal
Investment Laws of various states governing legal investments may impose certain
rating or other standards for obligations eligible for investment by savings
banks, trust companies, insurance companies and fiduciaries generally.
Moody's Investors Service, Inc. A brief description of the applicable MIS
rating symbols and their meanings follows:
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Aaa -- Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuations of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A -- Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa -- Bonds which are rated Baa are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Some bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
NOTE: Bonds within the above categories which possess the strongest investment
attributes are designated by the symbol "1" following the rating.
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 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.
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Caa -- Bonds which are rated Caa are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca -- Bonds which are rated Ca represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Description of preferred stock ratings
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. An S&P
preferred stock rating is an assessment of the capacity and willingness of an
issuer to pay preferred stock dividends and any applicable sinking fund
obligations. A preferred stock rating differs from a bond rating inasmuch as it
is assigned to an equity issue, which issue is intrinsically different from, and
subordinated to, a debt issue. Therefore, to reflect this difference, the
preferred stock rating symbol will normally not be higher than the debt rating
symbol assigned to, or that would be assigned to, the senior debt of the same
issuer.
The preferred stock ratings are based on the following considerations:
1. Likelihood of payment - capacity and willingness of the issuer to meet the
timely payment of preferred stock dividends and any applicable sinking
fund requirements in accordance with the terms of the obligation;
2. Nature of, and provisions of, the issue;
3. Relative position of the issue in the event of bankruptcy, reorganization,
or other arrangement under the laws of bankruptcy and other laws affecting
creditors' rights.
AAA -- This is the highest rating that may be assigned by S&P to a
preferred stock issue and indicates an extremely strong capacity to pay the
preferred stock obligations.
AA -- A preferred stock issue rated AA also qualifies as a high-quality
fixed income security. The capacity to pay preferred stock obligations is very
strong, although not as overwhelming as for issues rated AAA.
A -- An issue rated A is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more
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susceptible to the adverse effects of changes in circumstances and economic
conditions.
BBB -- An issue rated BBB is regarded as backed by an adequate capacity to
pay the preferred stock obligations. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to make payments for a preferred
stock in this category than for issues in the 'A' category.
BB, B, CCC -- Preferred stock rated BB, B, and CCC are regarded, on
balance, as predominantly speculative with respect to the issuer's capacity to
pay preferred stock obligations. BB indicates the lowest degree of speculation
and CCC the highest degree of speculation. While such issues will likely have
some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
CC -- The rating CC is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments but that is currently paying.
C -- A preferred stock rated C is a non-paying issue.
D -- A preferred stock rated D is a non-paying issue with the issuer in
default on debt instruments.
NR -- This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
Plus (+) or minus (-) -- To provide more detailed indications of preferred
stock quality, the rating 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.
A preferred stock rating is not a recommendation to purchase, sell, or
hold a security inasmuch as it does not comment as to market price or
suitability for a particular investor. The ratings are based on current
information furnished to S&P by the issuer or obtained by S&P from other sources
it considers reliable. S&P does not perform an audit in connection with any
rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or based on other circumstances.
Moody's Investors Service, Inc. Note: MIS applies numerical modifiers 1, 2
and 3 in each rating classification; the modifier 1
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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.
Preferred stock rating symbols and their definitions are as follows:
aaa -- An issue which is rated aaa is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
aa -- An issue which is rated aa is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance the earnings
and asset protection will remain relatively well-maintained in the foreseeable
future.
a -- An issue which is rated a is considered to be an upper-medium grade
preferred stock. While risks are judged to be somewhat greater than in the aaa
and aa classification, earnings and asset protection are, nevertheless, expected
to be maintained at adequate levels.
baa -- An issue which is rated baa is considered to be a medium-grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
ba -- An issue which is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
b -- An issue which is rated b generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
caa -- An issue which is rated caa is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future status
of payments.
ca -- An issue which is rated ca is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payments.
c -- This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having
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extremely poor prospects of ever attaining any real investment standing.
DESCRIPTION OF COMMERCIAL PAPER RATINGS
S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market. Ratings are
graded into several categories, ranging from A-1 for the highest quality
obligations to D for the lowest. Issuers rated A are further referred to by use
of numbers 1, 2 and 3 to indicate the relative degree of safety. Issues assigned
an A rating (the highest rating) are regarded as having the greatest capacity
for timely payment. An A-1 designation indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted with a plus sign (+) designation. An
A-2 rating indicates that capacity for timely payment is satisfactory; however,
the relative degree of safety is not as high as for issues designated A-1.
Issues rated A-3 have adequate capacity for timely payment; however, they are
more vulnerable to the adverse effects of changes in circumstances than
obligations carrying the higher designations. Issues rated B are regarded as
having only speculative capacity for timely payment. A C rating is assigned to
short-term debt obligations with a doubtful capacity for payment. Debt rated D
is in payment default, which occurs when interest payments or principal payments
are not made on the date due, even if the applicable grace period has not
expired, unless S&P believes that such payments will be made during such grace
period.
MIS commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. MIS employs the designations of Prime 1, Prime 2 and
Prime 3, all judged to be investment grade, to indicate the relative repayment
capacity of rated issuers. Issuers rated Prime 1 have a superior capacity for
repayment of short-term promissory obligations and repayment capacity will
normally be evidenced by (1) leading market positions in well established
industries; (2) high rates of return on funds employed; (3) conservative
capitalization structures with moderate reliance on debt and ample asset
protection; (4) broad margins in earnings coverage of fixed financial charges
and high internal cash generation; and (5) well established access to a range of
financial markets and assured sources of alternate liquidity. Issuers rated
Prime 2 also have a strong capacity for repayment of short-term promissory
obligations as will normally be evidenced by many of the characteristics
described above for Prime 1 issuers, but to a lesser degree. Earnings trends and
coverage ratios, while sound, will be more subject to variation; capitalization
characteristics, while still appropriate, may be
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more affected by external conditions; and ample alternate liquidity is
maintained. Issuers rated Prime 3 have an acceptable capacity for repayment of
short-term promissory obligations, as will normally be evidenced by many of the
characteristics above for Prime 1 issuers, but to a lesser degree. The effect of
industry characteristics and market composition may be more pronounced;
variability in earnings and profitability may result in changes in the level of
debt protection measurements and requirement for relatively high financial
leverage; and adequate alternate liquidity is maintained.
DESCRIPTION OF NOTE RATINGS
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. An S&P
note rating reflects the liquidity factors and market access risks unique to
notes. Notes maturing in 3 years or less will likely receive a note rating.
Notes maturing beyond 3 years will most likely receive a long-term debt rating.
The following criteria will be used in making that assessment.
--Amortization schedule (the larger the final maturity relative to
other maturities, the more likely the issue is to be treated as a
note).
--Source of Payment (the more the issue depends on the market for its
refinancing, the more likely it is to be treated as a note.)
The note rating symbols and definitions are as follows:
SP-1 Strong capacity to pay principal and interest. Issues
determined to possess very strong characteristics are given a
plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over
the term of the notes.
SP-3 Speculative capacity to pay principal and interest.
Moody's Investors Service, Inc. MIS Short-Term Loan Ratings -- MIS ratings
for state and municipal short-term obligations will be designated Moody's
Investment Grade (MIG). This distinction is in recognition of the differences
between short-term credit risk and long-term risk. Factors affecting the
liquidity of the borrower are uppermost in importance in short-term borrowing,
while various factors of major importance in bond risk are of lesser importance
over the short run. Rating symbols and their meanings follow:
MIG 1 -- This designation denotes best quality. There is present strong
protection by established cash flows, superior
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liquidity support or demonstrated broad-based access to the market for
refinancing.
MIG 2 -- This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
MIG 3 -- This designation denotes favorable quality. All security elements
are accounted for but this is lacking the undeniable strength of the preceding
grades. Liquidity and cash flow protection may be narrow and market access for
refinancing is likely to be less well established.
MIG 4 -- This designation denotes adequate quality. Protection commonly
regarded as required of an investment security is present and although not
distinctly or predominantly speculative, there is specific risk.
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