<PAGE>
As filed with the Securities and Exchange Commission on April 24, 1995.
1933 Act File No. 33-12092
1940 Act File No. 811-5029
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No: [ ]
------
Post-Effective Amendment No: 22 [X]
------
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
--------------------------------------------------------------------
Amendment No: 21
-------
LEGG MASON INCOME TRUST, INC.
(Exact Name of Registrant as Specified in Charter)
111 South Calvert Street
Baltimore, Maryland 21202
(Address of Principal Executive Offices)
Registrant's Telephone Number, including Area Code: (410) 539-0000
Copies to:
CHARLES A. BACIGALUPO ARTHUR C. DELIBERT, ESQ.
111 South Calvert Street Kirkpatrick & Lockhart
Baltimore, Maryland 21202 1800 M Street, N.W.
(Name and Address of South Lobby - Ninth Floor
Agent for Service) Washington, D.C. 20036-5891
It is proposed that this filing will become effective:
[___] immediately upon filing pursuant to Rule 485(b)
[_X_] on May 1, 1995 pursuant to Rule 485(b)
[___] 60 days after filing pursuant to Rule 485(a)(i)
[___] on ___________________, 1995 pursuant to Rule 485(a)(i)
<PAGE>
[___] 75 days after filing pursuant to Rule 485(a)(ii)
[___] on ___________________, 1995 pursuant to Rule 485(a)(ii)
If appropriate, check the following box:
[___] This post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
Registrant has filed a declaration pursuant to Rule 24f-2 under the
Investment Company Act of 1940 and filed the notice required by such Rule
for its most recent fiscal year on February 24, 1995.
Page 1 of _______
Exhibit Index begins on page _______
<PAGE>
Legg Mason Income Trust, Inc.
Contents of Registration Statement
This registration statement consists of the following papers and
documents.
Cover Sheet
Table of Contents
Cross Reference Sheets
Legg Mason U. S. Government Intermediate-Term Portfolio - Primary Shares
------------------------------------------------------------------------
Part A - Prospectus
Navigator U.S. Government Intermediate-Term Portfolio
-----------------------------------------------------
Part A - Prospectus
Legg Mason Investment Grade Income Portfolio
--------------------------------------------
Part A - Prospectus
Legg Mason U. S. Government Money Market Portfolio
--------------------------------------------------
Part A - Prospectus
Legg Mason High Yield Portfolio
-------------------------------
Part A - Prospectus
Legg Mason U. S. Government Intermediate-Term Portfolio - Primary Shares
Navigator U.S. Government Intermediate-Term Portfolio
-----------------------------------------------------
Part B - Statement of Additional Information
Legg Mason Investment Grade Income Portfolio
Legg Mason U. S. Government Money Market Portfolio
--------------------------------------------------
Part B - Statement of Additional Information
Legg Mason High Yield Portfolio
-------------------------------
Part B - Statement of Additional Information
Part C - Other Information
Signature Page
Exhibits
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason U. S. Government Intermediate-Term Portfolio - Primary Shares
Form N-1A Cross Reference Sheet
-------------------------------
Part A Item No. Prospectus Caption
--------------- ------------------
1 Cover Page
2 Prospectus Highlights;
Fund Expenses
3 Financial Highlights;
Performance Information
4 The Fund's Investment Objective and Policies;
Description of the Corporation and Its Shares
5 Fund Expenses;
Dividends and Other Distributions;
The Fund's Board of Directors, Manager and
Investment Adviser;
The Fund's Distributor
6 Prospectus Highlights;
Dividends and Other Distributions;
Shareholder Services;
Tax Treatment of Dividends and Other
Distributions;
How Your Shareholder Account Is Maintained;
Description of the Corporation and Its Shares
7 How You Can Invest In the Fund;
How Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined;
The Fund's Distributor;
Investing Through Tax-Deferred Retirement Plans
8 How You Can Redeem Your Fund Shares
9 Not Applicable
<PAGE>
Legg Mason Income Trust, Inc.
Navigator U. S. Government Intermediate-Term Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Part A Item No. Prospectus Caption
--------------- ------------------
1 Cover Page
2 Prospectus Highlights;
Fund Expenses
3 Financial Highlights;
Performance Information
4 The Fund's Investment Objective and Policies;
Description of the Corporation and Its Shares
5 Fund Expenses;
Dividends and Other Distributions;
The Fund's Board of Directors, Manager and
Investment Adviser;
The Fund's Distributor
6 Prospectus Highlights;
Dividends and Other Distributions;
Shareholder Services;
Tax Treatment of Dividends and Other
Distributions;
How Your Shareholder Account Is Maintained;
Description of the Corporation and Its Shares
7 How You Can Invest In the Fund;
How Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined;
The Fund's Distributor;
Investing Through Tax-Deferred Retirement Plans
8 How You Can Redeem Your Fund Shares
9 Not Applicable
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason Investment Grade Income Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Part A Item No. Prospectus Caption
--------------- ------------------
1 Cover Page
2 Prospectus Highlights;
Fund Expenses
3 Financial Highlights;
Performance Information;
4 The Fund's Investment Objective and Policies;
Description of the Corporation and Its Shares
5 Fund Expenses;
Dividends and Other Distributions;
The Fund's Board of Directors, Manager and
Investment Adviser;
The Fund's Distributor
6 Prospectus Highlights;
Dividends and Other Distributions;
Shareholder Services;
Tax Treatment of Dividends;
How Your Shareholder Account Is Maintained;
Description of the Corporation and Its Shares
7 How You Can Invest In the Fund;
How Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined;
The Fund's Distributor;
Investing Through Tax-Deferred Retirement Plans
8 How You Can Redeem Your Fund Shares
9 Not Applicable
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason U. S. Government Money Market Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Part A Item No. Prospectus Caption
--------------- ------------------
1 Cover Page
2 Prospectus Highlights;
Fund Expenses
3 Financial Highlights;
Performance Information
4 The Fund's Investment Objective and Policies;
Description of the Corporation and Its Shares
5 Fund Expenses;
Dividends and Distributions;
The Fund's Board of Directors, Manager and
Investment Adviser;
The Fund's Distributor
6 Prospectus Highlights;
Dividends;
Shareholder Services;
Tax Treatment of Dividends;
How Your Shareholder Account Is Maintained;
Description of the Corporation and Its Shares
7 How You Can Invest In the Fund;
How Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined;
The Fund's Distributor;
Investing Through Tax-Deferred Retirement Plans
8 How You Can Redeem Your Fund Shares
9 Not Applicable
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason High Yield Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Part A Item No. Prospectus Caption
--------------- ------------------
1 Cover Page
2 Prospectus Highlights;
Fund Expenses
3 Performance Information;
Financial Highlights
4 The Fund's Investment Objectives and Policies;
Description of the Corporation and Its Shares;
Other Investment Policies;
Risk Factors
5 Fund Expenses;
Dividends and Distributions;
The Fund's Board of Directors, Manager and
Investment Adviser;
The Fund's Distributor
6 Prospectus Highlights;
Dividends;
Shareholder Services;
Taxes;
How Your Shareholder Account Is Maintained;
Description of the Corporation and Its Shares
7 How You Can Invest In the Fund;
How Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined;
The Fund's Distributor;
Investing Through Tax-Deferred Retirement Plans
8 How You Can Redeem Your Fund Shares
9 Not Applicable
<PAGE>
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason U. S. Government Intermediate-Term Portfolio - Primary Shares
Navigator U.S. Government Intermediate-Term Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Statement of Additional
Part B Item No. Information Caption
--------------- -----------------------
10 Cover Page
11 Table of Contents
12 Not Applicable
13 Additional Information About Investment
Limitations and Policies;
Portfolio Transactions and Brokerage
14 The Corporation's Directors and Officers
15 The Corporation's Directors and Officers
16 Management Agreement;
Investment Advisory Agreement;
The Fund's Distributor;
The Corporation's Independent Accountants;
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent
17 Portfolio Transactions and Brokerage
18 Not Applicable
19 Valuation of Fund Shares;
Additional Purchase and Redemption Information
20 Additional Tax Information;
Tax-Deferred Retirement Plans
21 Portfolio Transactions and Brokerage;
The Fund's Distributor;
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent
22 Performance Information
23 Financial Statements
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason Investment Grade Income Portfolio
Legg Mason U.S. Government Money Market Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Statement of Additional
Part B Item No. Information Caption
--------------- -----------------------
10 Cover Page
11 Table of Contents
12 Not Applicable
13 Additional Information About Investment
Limitations and Policies;
Portfolio Transactions and Brokerage
14 The Corporation's Directors and Officers
15 The Corporation's Directors and Officers
16 Management Agreements;
Investment Advisory Agreements;
The Portfolios' Distributor;
The Corporation's Independent Accountants;
The Portfolios' Custodian and Transfer and
Dividend-Disbursing Agent
17 Portfolio Transactions and Brokerage
18 Not Applicable
19 Valuation of Shares;
Additional Purchase and Redemption Information
20 Additional Tax Information;
Tax-Deferred Retirement Plans
<PAGE>
21 Portfolio Transactions and Brokerage;
The Portfolios' Distributor;
The Portfolios' Custodian and Transfer and
Dividend-Disbursing Agent
22 Performance Information
23 Financial Statements
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason High Yield Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Statement of Additional
Part B Item No. Information Caption
--------------- -----------------------
10 Cover Page
11 Table of Contents
12 Not Applicable
13 Additional Information About Investment
Limitations and Policies;
Portfolio Transactions and Brokerage
14 The Corporation's Directors and Officers
15 The Corporation's Directors and Officers
16 The Fund's Manager;
Investment Advisory Agreement;
The Fund's Distributor;
The Corporation's Independent Accountants;
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent
17 Portfolio Transactions and Brokerage
18 Not Applicable
19 Valuation of Shares;
Additional Purchase and Redemption
Information
20 Additional Tax Information;
Tax-Deferred Retirement Plans
<PAGE>
21 Portfolio Transactions and Brokerage;
The Fund's Distributor;
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent
22 Performance Information
23 Financial Statements
<PAGE>
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Highlights 2
Fund Expenses 3
Financial Highlights 4
Performance Information 5
The Fund's Investment Objective and
Policies 6
How You Can Invest in the Fund 12
How Your Shareholder Account is Maintained 13
How You Can Redeem Your Primary Shares 13
How Net Asset Value Is Determined 14
Dividends and Other Distributions 14
Tax Treatment of Dividends and Other
Distributions 15
Shareholder Services 16
Investing through Tax-Deferred Retirement
Plans 17
The Fund's Board of Directors, Manager and
Investment Adviser 17
The Fund's Distributor 18
Description of the Corporation and its
Shares 19
</TABLE>
ADDRESSES
DISTRIBUTOR:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410(Bullet)539(Bullet)0000 800(Bullet)822(Bullet)5544
TRANSFER AND SHAREHOLDER SERVICING AGENT:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
COUNSEL:
Kirkpatrick & Lockhart
1800 M Street, N.W., Washington, DC 20036
INDEPENDENT ACCOUNTANTS:
Coopers & Lybrand L.L.P.
217 East Redwood Street, Baltimore, Maryland 21202
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS OR THE STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THE PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR
BY THE PRINCIPAL UNDERWRITER IN ANY JURISDICTION IN WHICH SUCH OFFERING
MAY NOT LAWFULLY BE MADE.
(Recycle Logo appears here) PRINTED ON RECYCLED PAPER
LMF-025
PROSPECTUS
MAY 1, 1995
LEGG MASON
U.S.
GOVERNMENT
INTERMEDIATE-
TERM
PORTFOLIO
PRIMARY SHARES
PUTTING YOUR FUTURE FIRST
(Legg Mason Funds Logo appears here)
<PAGE>
THE LEGG MASON U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO -- PRIMARY
SHARES
PROSPECTUS
The Legg Mason U.S. Government Intermediate-Term Portfolio ("Fund") is
a professionally managed portfolio seeking to provide investors with high
current income consistent with prudent investment risk and liquidity
needs. The Fund is a separate portfolio of Legg Mason Income Trust, Inc.
("Corporation"), a diversified open-end management investment company
which currently has four portfolios. In seeking to achieve the Fund's
objective, the Fund's investment adviser, Western Asset Management Company
("Adviser"), under normal circumstances, invests at least 75% of the
Fund's total assets in obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, or instruments secured by
such securities. The Fund expects to maintain an average dollar-weighted
maturity of between three and ten years.
The Adviser believes that shares of the Fund may be appropriate both
for direct investment and for investment in Individual Retirement Accounts
and other qualified retirement plans.
The Primary Class of Shares ("Primary Shares") offered in this
Prospectus is available to all investors except certain institutions (see
page 4). No initial sales charge is payable on purchases, and no
redemption charge is payable on sales, of Primary Shares of the Fund. The
Fund pays management fees to its Manager, Legg Mason Fund Adviser, Inc.
("Manager"), and distribution fees with respect to Primary Shares to its
Distributor, Legg Mason Wood Walker, Incorporated ("Legg Mason"), as
described on pages 17-19 of this Prospectus.
This Prospectus sets forth concisely the information about the Fund
that a prospective investor ought to know before investing. It should be
retained for future reference. A Statement of Additional Information about
the Fund dated May 1, 1995 has been filed with the Securities and Exchange
Commission ("SEC") and, as amended or supplemented from time to time, is
incorporated herein by reference. The Statement of Additional Information
is available without charge upon request from Legg Mason (address and
telephone numbers listed at right).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Dated: May 1, 1995
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
800 (Bullet) 822 (Bullet) 5544
<PAGE>
PROSPECTUS HIGHLIGHTS
THE LEGG MASON U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO-PRIMARY SHARES
The following summary is qualified in its entirety by the more
detailed information appearing in the body of this Prospectus.
FUND TYPE:
The Fund is a separate portfolio of Legg Mason Income Trust, Inc., an
open-end, diversified management investment company. You may purchase or
redeem Primary Shares of the Fund through a brokerage account with Legg
Mason or certain of its affiliates. See "How You Can Invest in the Fund,"
page 12, and "How You Can Redeem Your Primary Shares," page 13.
FUND STARTED:
August 7, 1987
NET ASSETS:
Over $234.8 million as of February 28, 1995
INVESTMENT OBJECTIVE AND POLICIES:
The Fund's investment objective is to obtain high current income
consistent with prudent investment risk and liquidity needs. The Fund
attempts to meet this objective by investing at least 75% of the Fund's
total assets in obligations issued or guaranteed by the U.S. Government,
its agencies or instrumentalities, or instruments secured by such
securities. Of course, there can be no assurance that the Fund will
achieve its objective. The value of the debt instruments held by the Fund,
and thus the net asset value of Fund shares, generally fluctuates
inversely with movements in market interest rates. Certain investment
grade debt securities in which the Fund invests may have speculative
characteristics. The Fund's participation in hedging and option income
strategies also involves certain investment risks and transaction costs.
See "The Fund's Investment Objective and Policies," page 6.
DISTRIBUTOR :
Legg Mason Wood Walker, Incorporated
MANAGER AND ADVISER :
Legg Mason Fund Adviser, Inc. serves as the Fund's manager, and
Western Asset Management Company serves as investment adviser to the Fund.
TRANSFER AND SHAREHOLDER SERVICING AGENT :
Boston Financial Data Services
CUSTODIAN:
State Street Bank and Trust Company
EXCHANGE PRIVILEGE:
All funds in the Legg Mason Family of Funds. See "Exchange Privilege,"
page 16.
DIVIDENDS:
Declared daily and paid monthly.
REINVESTMENT :
All dividends and other distributions are automatically reinvested in
Primary Shares unless cash payments are requested.
INITIAL PURCHASE:
$1,000 minimum, generally.
SUBSEQUENT PURCHASES:
$100 minimum, generally. See "How You Can Invest in the Fund," page
12.
PURCHASE METHODS:
Send bank/personal check or wire federal funds.
PUBLIC OFFERING PRICE PER SHARE:
Net asset value
2
<PAGE>
FUND EXPENSES
The purpose of the following table is to assist an investor in understanding
the various costs and expenses that an investor in Primary Shares of the Fund
will bear directly or indirectly. The expenses and fees set forth in the table
are based on average net assets and annual Fund operating expenses related to
Primary Shares for the year ended December 31, 1994, adjusted for current
expense and fee waiver levels.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum sales charge on purchases or
reinvested dividends None
Redemption and exchange fees None
ANNUAL FUND OPERATING EXPENSES -- PRIMARY
SHARES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Management fees 0.55 %
12b-1 fees 0.50 %
Other expenses 0.14 %
Less: Reimbursement of fees (1) (0.24 )%
Total operating expenses 0.95 %
</TABLE>
(1) The expense ratio for Primary Shares would have been 1.19% had the Fund's
Manager not agreed to reimburse fees. The reimbursement agreement, wherein the
Manager has agreed to continue to reimburse fees and/or assume other expenses to
the extent the expenses attributable to Primary Shares (exclusive of taxes,
interest, brokerage and extraordinary expenses) exceed during any month an
annual rate of 0.95% of average daily net assets (Primary Shares) for such
month, will remain in effect until October 31, 1995, or until net assets reach
$400 million, whichever occurs first, and unless extended will terminate on that
date.
Because the Fund pays a 12b-1 fee with respect to Primary Shares, long-term
shareholders in Primary Shares may pay more in distribution expenses than the
economic equivalent of the maximum front-end sales charge permitted by the
National Association of Securities Dealers, Inc. ("NASD"). For further
information concerning Fund expenses, see "The Fund's Board of Directors,
Manager and Investment Adviser," page 17.
EXAMPLE OF EFFECT OF FUND EXPENSES
The following example illustrates the expenses that you would pay on a
$1,000 investment in Primary Shares over various time periods assuming (1) a 5%
annual rate of return and (2) full redemption at the end of each time period. As
noted in the table above, the Fund charges no redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
<S> <C> <C> <C>
$ 10 $30 $53 $117
</TABLE>
This example assumes that all dividends and other distributions are
reinvested and that the percentage amounts listed under "Annual Fund Operating
Expenses" remain the same over the time periods shown. The above tables and the
assumption in the example of a 5% annual return are required by regulations of
the SEC applicable to all mutual funds. THE ASSUMED 5% ANNUAL RETURN IS NOT A
PREDICTION OF, AND DOES NOT REPRESENT, THE PROJECTED OR ACTUAL PERFORMANCE OF
PRIMARY SHARES. THE ABOVE TABLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE
SHOWN. The actual expenses attributable to Primary Shares will depend upon,
among other things, the level of average net assets, the levels of sales and
redemptions of shares, and the extent to which Primary Shares incur variable
expenses, such as transfer agency costs.
3
<PAGE>
FINANCIAL HIGHLIGHTS
Effective December 1, 1994, the Fund commenced the sale of a second
class of shares, known as Navigator Shares. Navigator Shares are currently
offered for sale only to institutional clients of the Fairfield Group, Inc.
("Fairfield") for investment of their own funds and funds for which they
act in a fiduciary capacity, to clients of Legg Mason Trust Company ("Trust
Company") for which Trust Company exercises discretionary investment
management responsibility, to qualified retirement plans managed on a
discretionary basis and having net assets of at least $200 million, and to
The Legg Mason Profit Sharing Plan and Trust. Navigator Shares pay no 12b-1
distribution fees and may pay lower transfer agency fees. The information
for Primary Shares reflects the 12b-1 fees paid by that Class.
The financial highlights for the period August 7, 1987 (commencement of
operations) to December 31, 1987 and for the years ended December 31, 1988
through 1994 have been derived from financial statements which have been
audited by Coopers & Lybrand L.L.P., independent accountants. The Fund's
financial statements for the year ended December 31, 1994 and the report of
Coopers & Lybrand L.L.P. thereon are included in the Fund's annual report
and are incorporated by reference in the Statement of Additional
Information. The annual report is available to shareholders without charge
by calling your Legg Mason or affiliated investment executive or Legg
Mason's Funds Marketing Department at 800-822-5544.
<TABLE>
<CAPTION>
PRIMARY CLASS
NAVIGATOR CLASS FOR THE YEARS ENDED DECEMBER 31,
1994(1) 1994 1993
<S> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period $9.72 $10.43 $10.70
Net investment income 0.05(3) 0.51(2) 0.53(2)
Net realized and
unrealized gain
(loss) on investments -- (0.71) 0.17
Total from investment
operations 0.05 (0.20) 0.70
Distributions to
shareholders:
Net investment income (0.05) (0.51) (0.53)
Net realized gain on
investments -- -- (0.39)
In excess of net
realized gain on
investments -- -- (0.05)
Net asset value, end of
period $9.72 $ 9.72 $10.43
Total return 0.50%** (1.93)% 6.6%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net
assets:
Expenses 0.4%(3)(double dagger) 0.9%(2)(4) 0.9%(2)(4)
Net investment income 6.4%(3)(double dagger) 5.1%(2) 4.8%(2)
Portfolio turnover rate 315.7% 315.7% 490.2%
Net assets, end of
period (in thousands) $4,024 $231,255 $299,529
</TABLE>
<TABLE>
<CAPTION>
1992 1991 1990 1989
<S> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period $10.77 $10.29 $10.20 $9.79
Net investment income 0.60(2) 0.72(2) 0.78(2) 0.80(2)
Net realized and
unrealized gain
(loss) on investments 0.05 0.70 0.09 0.41
Total from investment
operations 0.65 1.42 0.87 1.21
Distributions to
shareholders:
Net investment income (0.60) (0.72) (0.78) (0.80)
Net realized gain on
investments (0.12) (0.22) -- --
In excess of net
realized gain on
investments -- -- -- --
Net asset value, end of
period $10.70 $10.77 $10.29 $10.20
Total return 6.3% 14.4% 9.1% 12.8%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net
assets:
Expenses 0.9%(2)(4) 0.8%(2)(4) 0.6%(2)(4) 0.8%(2)(4)
Net investment income 5.5%(2) 6.7%(2) 7.7%(2) 7.9%(2)
Portfolio turnover rate 512.6% 642.8% 67.0% 57.3%
Net assets, end of
period (in thousands) $307,320 $211,627 $74,423 $43,051
</TABLE>
<TABLE>
<CAPTION>
AUGUST 7, 1987*
TO
1988 DECEMBER 31, 1987
<S> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period $9.72 $10.00
Net investment income 0.74(2) 0.30(2)
Net realized and
unrealized gain
(loss) on investments (0.12) (0.08)
Total from investment
operations 0.62 0.22
Distributions to
shareholders:
Net investment income (0.74) (0.30)
Net realized gain on
investments (0.01) --
In excess of net
realized gain on
investments -- --
Net asset value, end of
period $9.79 $ 9.92
Total return 6.4% 2.2%**
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net
assets:
Expenses 1.0%(2)(4) 1.0%(2)(4)(double dagger)
Net investment income 7.4%(2) 7.4%(2)(double dagger)
Portfolio turnover rate 132.5% 66.3%(double dagger)
Net assets, end of
period (in thousands) $27,087 $16,617
</TABLE>
* Commencement of operations.
** Not annualized.
(double dagger) Annualized.
(1) For the period December 1, 1994 (commencement of sale of Navigator
Shares) to December 31, 1994.
(2) Net of fees waived and reimbursements made by the manager for expenses
in excess of voluntary expense limitations as follows: 1.0% until
September 10, 1989; 0.5% until March 31, 1990; 0.6% until December 31,
1990; 0.75% until April 30, 1991; 0.8% until December 31, 1991; 0.85%
until August 31, 1992; and 0.95% until October 31, 1995.
(3) Net of fees waived and reimbursements made by the manager for expenses
in excess of voluntary limitation as follows: 0.45% until October 31,
1995.
(4) Includes distribution fee of 0.5%
4
<PAGE>
PERFORMANCE INFORMATION
From time to time the Fund may quote the total return of each class of
shares in advertisements or in reports or other communications to shareholders.
A mutual fund's TOTAL RETURN is a measurement of the overall change in value,
including changes in share price and assuming reinvestment of dividends and
capital gain distributions of an investment in the fund. CUMULATIVE TOTAL RETURN
shows the fund's performance over a specific period of time. AVERAGE ANNUAL
TOTAL RETURN is the average annual compounded return that would have produced
the same cumulative total return if the fund's performance had been constant
over the entire period. Performance figures reflect past performance and are not
intended to indicate future performance. Average annual returns tend to smooth
out variations in the fund's return, so they differ from actual year-by-year
results.
Total returns of Primary Shares as of December 31, 1994 were as follows:
<TABLE>
<CAPTION>
CUMULATIVE AVERAGE ANNUAL
TOTAL RETURN TOTAL RETURN
<S> <C> <C>
One Year -1.93 % -1.93%
Five Years +38.59 +6.75
Life of Fund(dagger) +70.08 +7.43
</TABLE>
(dagger)Fund's inception -- August 7, 1987.
No adjustment has been made for any income taxes payable by shareholders.
The investment return and principal value of an investment in the Fund will
fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost. Returns would have been lower if the Manager had not
waived/reimbursed certain fees and expenses during the fiscal years 1987 through
1994. As of the date of this Prospectus, Navigator Shares have no material
performance record.
The Fund also may advertise its yield or effective yield. Yield reflects net
investment income per share (as defined by applicable SEC regulations) over a
30-day (or one-month) period, expressed as an annualized percentage of net asset
value at the end of the period. The effective yield, although calculated
similarly, will be slightly higher than the yield because it assumes that income
earned from the investment is reinvested (i.e., the compounding effect of
reinvestment). Yield computations differ from other accounting methods and
therefore may differ from dividends actually paid or reported net income.
Further information about the Fund's performance is contained in the Annual
Report to Shareholders, which may be obtained without charge by calling your
Legg Mason or affiliated investment executive or Legg Mason's Funds Marketing
Department at 800-822-5544.
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THE FUND'S INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide investors with high
current income consistent with prudent investment risk and liquidity
needs. The investment objective of the Fund may not be changed without a
vote of Fund shareholders; however, except as otherwise noted, the
investment policies of the Fund described below may be changed by the
Corporation's Board of Directors without a shareholder vote. There can be
no assurance that the Fund's investment objective will be achieved.
At least 75% of the Fund's total assets are, under normal
circumstances, invested in U.S. government securities or instruments
secured by such securities, including repurchase agreements. The Fund
expects to maintain an average dollar-weighted maturity of between three
and ten years. U.S. government securities include: 1) U.S. Treasury
obligations, which differ only in their interest rates, maturities and
times of issuance: U.S. Treasury bills (maturity of one year or less),
U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury bonds
(generally maturities of greater than ten years); and 2) obligations
issued or guaranteed by U.S. government agencies and instrumentalities
which are supported by any of the following: a) the full faith and credit
of the U.S. Government (such as certificates of the Government National
Mortgage Association, "GNMA", b) the right of the issuer to borrow an
amount limited to a specific line of credit from the U.S. Government (such
as obligations of the Federal Home Loan Banks), c) discretionary authority
of the U.S. Treasury to lend to the government agency or instrumentality
(such as the Federal National Mortgage Association), or d) only the credit
of the instrumentality (such as the Student Loan Marketing Association).
In the case of obligations not backed by the full faith and credit of the
Untied States, the Fund must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate
repayment and may not be able to assert a claim against the United States
itself in the event the agency or instrumentality does not meet its
commitments. The U.S. Government does not guarantee the market value of
the Fund's investments or the market value or yield of the Fund's shares,
which will fluctuate with changes in market interest rates. Investments in
mortgage-related securities issued by governmental or government-related
entities, as described on the next page, will be included in the 75%
limitation.
The balance of the Fund, up to 25% of its total assets, normally is
invested in cash, commercial paper and investment grade debt securities
rated within one of the four highest grades assigned by Standard & Poor's
Ratings Group ("S&P") (AAA, AA, A or BBB), Moody's Investors Service, Inc.
("Moody's") (Aaa, Aa, A or Baa), securities comparably rated by another
nationally recognized statistical rating organization, or unrated
securities judged by the Adviser to be of comparable quality. Debt
securities rated Baa are deemed by Moody's to have speculative
characteristics; changes in economic conditions or other circumstances are
more likely to lead to a weakened capacity for the issuers of such
securities to make principal and interest payments than is the case for
high-grade debt securities. A further description of Moody's and S&P's
ratings is included in the Appendix to the Statement of Additional
Information.
The market value of the interest-bearing debt securities held by the
Fund, and therefore the net asset value of Fund shares, is affected by
changes in market interest rates. There is normally an inverse
relationship between the market value of securities sensitive to
prevailing interest rates and actual changes in interest rates; i.e., a
decline in interest rates produces an increase in market value, while an
increase in rates produces a decrease in market value. Moreover, the
longer the remaining maturity of a security, the greater is the effect of
interest rate changes on the market value of such a security. In addition,
changes in the ability of an issuer to make payments of interest and
principal and in the market's perception of an issuer's creditworthiness
also affect the market value of the debt securities of that issuer.
The Fund has adopted certain fundamental investment limitations that,
like its investment objective, may not be changed without the approval of
the Fund's shareholders. A full description of these investment
limitations is included in the Statement of Additional Information.
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Corporate Debt Securities
Among the debt securities in which the Fund may invest are those
issued by corporations. In selecting corporate debt securities for the
Fund, the Adviser reviews and monitors the creditworthiness of each issuer
and issue. Interest rate trends and specific developments which the
Adviser believes may affect individual issuers are also analyzed.
Mortgage-Related Securities
The Fund normally may invest up to 50% of its total assets in
mortgage-related securities, including those issued by the governmental or
government-related entities referred to above. Mortgage-related securities
represent interests in pools of mortgages created by lenders such as
commercial banks, savings and loan institutions, mortgage bankers and
others. Mortgage-related securities may be issued by governmental or
government-related entities or by non-governmental entities such as banks,
savings and loan institutions, private mortgage insurance companies,
mortgage bankers and other secondary market issuers. No more than 25% of
the Fund's total assets normally are invested in mortgage-related
securities issued by non-governmental entities.
Interests in pools of mortgage-related securities differ from other
forms of debt securities which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified
call dates. In contrast, mortgage-related securities provide monthly
payments which consist of interest and, in most cases, principal. In
effect, these payments are a "pass-through" of the monthly payments made
by the individual borrowers on their residential mortgage loans, net of
any fees paid to the issuer or guarantor of such securities. Additional
payments to holders of mortgage-related securities are caused by
repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure, net of fees or costs which may be incurred.
Some mortgage-related securities are described as "modified pass-through."
These securities entitle the holders to receive all interest and principal
payments owed on the mortgages in the pool, net of certain fees,
regardless of whether or not the mortgagors actually make the payments.
The Adviser expects that governmental or private entities may create
new types of mortgage-related securities in response to changes in the
market or changes in government regulation of such securities. As new
types of mortgage-related securities are developed and offered to
investors, the Adviser will, consistent with the investment objective and
policies of the Fund, consider making investments in such new types of
securities.
As prepayment rates of individual pools of mortgage loans vary widely,
it is not possible to predict accurately the average life of a particular
mortgage-related security. Although both government and privately-issued
mortgage-related securities are issued with stated maturities of up to
forty years, unscheduled or early payments of principal and interest on
the underlying mortgages may shorten considerably the securities'
effective maturities. On the other hand, a decrease in the rate of
prepayments may extend the effective maturities of mortgage-related
securities, increasing their sensitivity to changes in market interest
rates. Such a decrease in prepayments may result from an increase in
market interest rates, among other causes. The volume of prepayments of
principal on a pool of mortgages underlying a particular mortgage-related
security will influence the yield of that security, and the principal
returned to the Fund may be reinvested in instruments whose yield may be
higher or lower than that which might have been obtained had such
prepayments not occurred. When interest rates are declining, such
prepayments usually increase, with the result that reinvestment of such
principal prepayments will be at a lower rate than that on the original
mortgage-related security. Increased prepayment of principal may limit the
Fund's ability to realize the appreciation in the value of such securities
that would otherwise accompany declining interest rates. An increase in
mortgage prepayments could cause the Fund to incur a loss on a mortgage-
related security that was purchased at a premium. In determining the
Fund's average maturity, the Adviser must apply certain assumptions and
projections about the maturity and prepayments of mortgage-related
securities; actual prepayment rates may differ.
Government Mortgage-Related Securities
GNMA is the principal federal government guarantor of mortgage-related
securities. GNMA is a wholly owned U.S. government corporation
7
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within the Department of Housing and Urban Development. GNMA pass-through
securities are considered to have a very low risk of default in that (i)
the underlying mortgage loan portfolio is comprised entirely of
government-backed loans and (ii) the timely payment of both principal and
interest on the securities is guaranteed by the full faith and credit of
the U.S. Government -- regardless of whether they have been collected.
GNMA pass-through securities are, however, subject to the same market risk
as comparable debt securities. Therefore, the effective maturity and
market value of the Fund's GNMA securities can be expected to fluctuate in
response to changes in interest rate levels.
Residential mortgage loans are also pooled by the Federal Home Loan
Mortgage Corporation ("FHLMC"). FHLMC is a corporate instrumentality of
the U.S. Government that was created by Congress in 1970 for the purposes
of increasing the availability of mortgage credit for residential housing.
FHLMC issues mortgage participation certificates ("PCs") which represent
interests in mortgages from FHLMC's national portfolio. The mortgage loans
in FHLMC's portfolio are not government backed; rather, the loans are
either uninsured with loan-to-value ratios of 80% or less, or privately
insured if the loan-to-value ratio exceeds 80%. FHLMC, not the U.S.
Government, guarantees the timely payment of interest and ultimate
collection of principal on FHLMC PCs.
The Federal National Mortgage Association ("FNMA") is a
government-sponsored corporation owned entirely by private stockholders.
It is subject to general regulation by the Secretary of Housing and Urban
Development. FNMA purchases residential mortgages from a list of approved
seller/servicers, which include savings and loan associations, savings
banks, commercial banks, credit unions and mortgage bankers. Pass-through
certificates ("FNMA certificates") issued by FNMA are guaranteed as to
timely payment of principal and interest by FNMA, not the U.S. Government.
Privately Issued Mortgage-Related Securities
Mortgage-related securities offered by private issuers include
pass-through securities comprised of pools of conventional residential
mortgage loans; mortgage-backed bonds which are considered to be
obligations of the institution issuing the bonds and are collateralized by
mortgage loans; and bonds and collateralized mortgage obligations ("CMOs")
which are collateralized by mortgage-related securities issued by FHLMC,
FNMA, or GNMA or by pools of conventional mortgages.
CMOs are typically structured with two or more classes or series which
have different maturities and are generally retired in sequence. Each
class of obligations is scheduled to receive periodic interest payments
according to the coupon rate on the obligations. However, all monthly
principal payments and any repayments from the collateral pool are paid
first to the "Class 1" bondholders. The principal payments are such that
the Class 1 obligations are scheduled to be completely repaid no later
than, for example, five years after the offering date. Thereafter, all
payments of principal are allocated to the next most senior class of bonds
until that class of bonds has been fully repaid. Although full payoff of
each class of bonds is contractually required by a certain date, any or
all classes of obligations may be paid off sooner than expected because of
an increase in the payoff speed of the pool.
Mortgage-related securities created by non-governmental issuers
generally offer a higher rate of interest than government and government-
related securities because there are no direct or indirect government
guarantees of payments in the former securities, resulting in higher
risks. However, many issuers or servicers of mortgage-related securities
guarantee timely payment of interest and principal on such securities.
Timely payment of principal may also be supported by various forms of
insurance, including individual loan, title, pool and hazard policies.
There can be no assurance that the private issuers or insurers will be
able to meet their obligations under the relevant guarantees and insurance
policies, and such guarantees and policies often do not cover the full
amount of the pool. Where privately issued securities are collateralized
by securities issued by FHLMC, FNMA or GNMA, the timely payment of
interest and principal is supported by the government-related securities
collateralizing such obligations.
Since the inception of the mortgage-related pass-through security in
1970, the market for these securities has expanded considerably. The size
of the primary issuance market and active participation in the secondary
market by securities dealers
8
<PAGE>
and many types of investors make government and government-related
pass-through pools highly liquid. Private conventional pools of mortgages
(pooled by commercial banks, savings and loan institutions and others with
no relationship to government and government-related entities) have also
achieved broad market acceptance, and consequently an active secondary
market has emerged. However, the market for conventional pools is smaller
and less liquid than the market for the government and government-related
mortgage pools.
The Fund may purchase some mortgage-related securities through private
placements. In such cases, the securities may be considered illiquid and,
if so, will be subject to the Fund's investment limitation that no more
than 10% of its net assets will be invested in illiquid securities.
Asset-Backed Securities
Asset-backed securities are securities that represented direct or
indirect participations in, or are secured by and payable from, assets
such as motor vehicle installment sales contracts, installment loan
contracts, 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 and special purpose
corporations. The value of such securities partly depends on loan
repayments by individuals, which may be adversely affected during general
downturns in the economy. Payments or distributions of principal and
interest on asset-backed securities may be supported by credit
enhancements, such as various forms of cash collateral accounts or letters
of credit. Like mortgage-related securities, asset-backed securities are
subject to the risk of prepayment. The risk that recovery on repossessed
collateral might be unavailable or inadequate to support payments on
asset-backed securities, however, is greater than is the case for
mortgage-backed securities.
Zero Coupon Bonds
Zero coupon bonds are debt obligations which make no fixed interest
payments but instead are issued at a significant discount from face value.
Like other debt securities, the price can also reflect a premium or
discount to the original issue discount reflecting the market's judgment
as to the issuer's creditworthiness, the interest rate or other similar
factors. The discount approximates the total amount of interest the bonds
will accrue and compound over the period until maturity or the first
interest payment date at a rate of interest reflecting the market rate of
the security at the time of issuance. Because zero coupon bonds do not
require the periodic payment of interest, their prices can be very
volatile when market interest rates change.
The original issue discount on zero coupon bonds must be included in
the Fund's income ratably as it accrues. Accordingly, to continue to
qualify for tax treatment as a regulated investment company and to avoid a
certain excise tax, the Fund may be required to distribute as a dividend
an amount that is greater than the total amount of cash it actually
receives. See "Additional Tax Information" in the Statement of Additional
Information. These distributions must be made from the Fund's cash assets
or, if necessary, from the proceeds of sales of portfolio securities. Such
sales could occur at a time which would be disadvantageous to the Fund and
when the Fund would not otherwise choose to dispose of the assets.
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 a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt
or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before conversion,
convertible securities ordinarily provide a stable stream of income with
generally higher yields than those of common stocks of the same or similar
issuers, but lower than the yield on non-convertible debt. Convertible
securities are usually subordinated to comparable-tier non-convertible
securities but rank senior to common stock in a corporation's capital
structure.
The value of a convertible security is a function of (1) its yield in
comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at
market value, if converted into the underlying common stock. Convertible
9
<PAGE>
securities are typically issued by smaller capitalized companies, whose
stock prices may be volatile. The price of a convertible security often
reflects such variations in the price of the underlying common stock in a
way that non-convertible debt does not. A convertible security may be
subject to redemption at the option of the issuer at a price established
in the convertible security's governing instrument, which could have an
adverse effect on the Fund's ability to achieve its investment objective.
The Fund does not intend to exercise conversion rights for any convertible
security it owns and does not intend to hold any security which has been
subject to conversion.
Foreign Securities
The Fund may invest in U.S. dollar-denominated debt securities issued
by foreign companies and governments. The foreign government securities in
which the Fund invests generally consist of obligations supported by
national, state or provincial governments or similar political
subdivisions. The Fund also may invest in debt securities of foreign
"quasi-government agencies," which are issued by entities owned by a
national, state or equivalent government or are obligations of a political
unit that is not backed by the national government's full faith and credit
and general taxing powers.
Investment in foreign securities presents certain risks, including
those resulting from adverse political and economic developments, reduced
availability of public information concerning issuers and the fact that
foreign issuers generally are not subject to uniform accounting, auditing
and financial reporting standards or to other regulatory practices and
requirements comparable to those applicable to domestic issuers. Moreover,
securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. Some foreign
securities are subject to foreign taxes and withholding. Because the
foreign securities in which the Fund invests are U.S. dollar-denominated,
there is no risk of currency fluctuation.
Repurchase Agreements
A repurchase agreement is an agreement under which the Fund acquires
U.S. government obligations from a securities dealer or bank subject to
resale at an agreed-upon price and date. The securities are held for the
Fund by State Street Bank and Trust Company ("State Street"), the Fund's
custodian, as collateral until resold and will be supplemented by
additional collateral if necessary to maintain a total value equal to or
in excess of the value of the repurchase agreement. The Fund bears a risk
of loss in the event that the other party to a repurchase agreement
defaults on its obligations and the Fund is delayed or prevented from
exercising its right to dispose of the collateral securities, which may
decline in value in the interim. The Fund will enter into repurchase
agreements only with financial institutions which the Adviser believes
present minimal risk of default during the term of the agreement based on
guidelines established by the Corporation's Board of Directors. The Fund
will not enter into repurchase agreements of more than seven days'
duration if more than 10% of its total assets would be invested in such
agreements and other illiquid investments.
When-Issued Securities
The Fund may enter into commitments to purchase U.S. government
securities or other securities on a when-issued basis. The Fund may
purchase when-issued securities because such securities are often the more
efficiently priced and have the best liquidity in the bond market. As with
the purchase of all securities, when the Fund purchases securities on a
when-issued basis, it assumes the risks of ownership, including the risk
of price fluctuation, at the time of purchase, not at the time of receipt.
However, the Fund does not have to pay for the obligations until they are
delivered to the Fund, which is normally 7 to 15 days later, but could be
considerably longer in the case of some mortgage-backed securities. To
meet that payment obligation, the Fund will set aside cash or liquid high-
quality debt securities equal to the payment that will be due. Depending
on market conditions, the Fund's when-issued purchases could cause its net
asset value to be more volatile, because they will increase the amount by
which the Fund's total assets, including the value of the when-issued
securities held by the Fund, exceed its net assets. The Fund does not
expect that its commitment to purchase when-issued securities will at any
time exceed, in the aggregate, 20% of its total assets.
10
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Futures and Option Transactions
In an effort to protect against the effect of adverse changes in
interest rates, the Fund may purchase and sell interest rate futures
contracts and may purchase put options on interest rate futures contracts
and debt securities (practices known at "hedging"). A futures contract is
an agreement by the Fund to buy or sell securities at a specified date and
price. The purchase of a put option on a futures contract allows the Fund,
at its option, to enter into a particular futures contract or sell
securities at any time up to the option's expiration date.
The Fund may purchase put options on interest rate futures contracts
or sell interest rate futures contracts (that is, enter into a futures
contract to sell the underlying security) to attempt to reduce the risk of
fluctuations in its share value. The Fund may purchase an interest rate
futures contract (that is, enter into a futures contract to purchase the
underlying security) to attempt to establish more definitely the return on
securities the Fund intends to purchase. The Fund may not use these
instruments for speculation or leverage.
The Fund may seek to enhance its income or hedge the portfolio by
writing (selling) covered call options (i.e., the Fund will own the
underlying instrument while the call is outstanding) and covered put
options (i.e., the Fund will have cash, U.S. government securities or
other high-grade, liquid debt instruments in a segregated account in an
amount not less than the exercise price while the put is outstanding).
The Fund may write call options on securities in its portfolio in an
attempt to realize, through the premium the Fund receives, a greater
current return than would be realized on the securities alone. The Fund
may write put options in an attempt to realize enhanced income when it is
willing to purchase the underlying instrument for its portfolio at the
exercise price. The Fund may also purchase call options for the purpose of
acquiring the underlying instruments for its portfolio. At times, the net
cost of acquiring instruments in this manner (the exercise price of the
call option plus the premium paid) may be less than the cost of acquiring
the instruments directly.
The success of the Fund's hedging activities in reducing risks depends
on many factors, the most significant of which is the Adviser's ability to
predict market interest rate changes correctly. Generally speaking,
selling futures contracts, purchasing put options and writing call options
are strategies designed to protect against falling security prices, and
can limit potential gains if prices rise. Purchasing futures contracts,
purchasing call options and writing put options are strategies whose
return tend to rise and fall together with security prices, and can cause
losses if prices fall. If security prices remain unchanged over time,
option writing strategies tend to be profitable, while option buying
strategies tend to decline in value. However, there may not be perfect
correlation between movements in the price of an option or futures
contract and movements in the price of the underlying security.
The Fund could also be exposed to risks if it could not close out its
futures or options positions because of an illiquid secondary market. The
Adviser attempts to minimize the possible negative effects of these
factors through careful selection and monitoring of the Fund's futures and
options positions. The Adviser is of the opinion that the Fund's
investments in futures transactions will not have a material adverse
effect on the Fund's liquidity or ability to honor redemptions.
The purchase and sale of options and futures contracts involve risks
different from those involved with direct investments in securities, and
also require different skills by the Adviser in managing the Fund's
portfolio. While utilization of options, futures contracts and similar
instruments may be advantageous to the Fund, if the Adviser is not
successful in employing such instruments in managing the Fund's
investments or in predicting interest rate changes, the Fund's performance
will be worse than if the Fund had not made such investments. In addition,
the Fund will pay commissions and other costs in connection with such
investments, which may increase the Fund's expenses and reduce its yield.
A more complete discussion of the possible risks involved in transactions
in options and futures contracts is contained in the Statement of
Additional Information. The Fund's current policy is to limit options and
futures transactions to those described above.
The Fund will not enter into any futures contracts or related options
if the sum of the initial margin deposits on futures contracts and related
11
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options and premiums paid for related options the Fund has purchased would
exceed 5% of the Fund's total assets. The Fund will not purchase futures
contracts or related options if, as a result, more than 33 1/3% of the
Fund's total assets would be so invested.
Portfolio Turnover
For the year ended December 31, 1994, the Fund's portfolio turnover
rate was 315.7% and the Fund anticipates that in the future its portfolio
turnover rate may exceed 300%. The portfolio turnover rate is computed by
dividing the lesser of purchases or sales of securities for the period by
the average value of portfolio securities for that period. Short-term
securities are excluded from the calculation. A portfolio turnover rate in
excess of 100% will involve correspondingly greater transaction costs
which will be borne directly by the Fund. It may also increase the amount
of short-term capital gains, if any, realized by the Fund and will affect
the tax treatment of distributions paid to shareholders because
distributions of net short-term capital gains are taxable as ordinary
income.
HOW YOU CAN INVEST IN THE FUND
You may purchase Primary Shares of the Fund through a brokerage
account with Legg Mason or with an affiliate that has a dealer agreement
with Legg Mason (Legg Mason is a wholly owned subsidiary of Legg Mason,
Inc., a financial services holding company). Your Legg Mason or affiliated
investment executive will be pleased to explain the shareholder services
available from the Fund and answer any questions you may have. Documents
available from your Legg Mason or affiliated investment executive should
be completed if you invest in shares of the Fund through an Individual
Retirement Account ("IRA"), Self-Employed Individual Retirement Plan
("Keogh Plan"), Simplified Employee Pension Plan ("SEP") or other
qualified retirement plan.
The minimum initial investment in Primary Shares for each account,
including investments made by exchange from other Legg Mason funds, is
$1,000, and the minimum investment for each purchase of additional shares
is $100, except as noted below. Initial investments in an IRA account
established on behalf of a nonworking spouse of a shareholder who has an
IRA invested in the Fund require a minimum amount of only $250. Subsequent
investments in an IRA or similar plan also require a minimum amount of
$100. However, once an account is established, the minimum amount for
subsequent investments will be waived if an investment in an IRA or
similar plan will bring the investment for the year to the maximum amount
permitted under the Internal Revenue Code of 1986, as amended ("Code").
For purchases of shares through payroll deduction plans, the Fund's Future
First Systematic Investment Plan and plans involving automatic payment of
funds from financial institutions or automatic investment of dividends
from certain unit investment trusts, minimum initial and subsequent
investments are lower. The Fund may change these minimum amount
requirements at its discretion. You should always furnish your shareholder
account number when making additional purchases of Fund shares.
There are three ways you can invest in Primary Shares of the Fund:
1. THROUGH YOUR LEGG MASON OR AFFILIATED INVESTMENT EXECUTIVE
Shares may be purchased through any Legg Mason or affiliated
investment executive. An investment executive will be pleased to open an
account for you, explain to you the shareholder services available from
the Fund, and answer any questions you may have. After you have
established a Legg Mason or affiliated account, you can order shares from
your investment executive in person, by telephone or by mail.
2. THROUGH THE FUTURE FIRST SYSTEMATIC INVESTMENT PLAN
You may also buy shares through the Future First Systematic Investment
Plan. Under this plan, you may arrange for automatic monthly investments
in the Fund of $50 or more by authorizing Boston Financial Data Services
("BFDS"), the Fund's transfer agent, to prepare a check each month drawn
on your checking account. There is no minimum initial investment. Please
contact any Legg Mason or affiliated investment executive for further
information.
3. THROUGH AUTOMATIC INVESTMENTS
Arrangements may be made with some employers and financial
institutions, such as banks or credit unions, for regular automatic
monthly
12
<PAGE>
investments of $50 or more in shares. In addition, it may be possible for
dividends from certain unit investment trusts to be invested automatically
in shares. Persons interested in establishing such automatic investment
programs should contact the Fund through any Legg Mason or affiliated
investment executive.
Primary Shares purchased on behalf of an IRA, Keogh Plan, SEP or other
qualified retirement plan will be processed at the net asset value next
determined after Legg Mason's Funds Processing receives a check for the
amount of the purchase. Other Primary Share purchases will be processed at
the net asset value next determined after your Legg Mason or affiliated
investment executive has received your order; payment must be made within
five business days to Legg Mason. Beginning in June, 1995, payment must be
made within three business days to Legg Mason. Orders received by your
Legg Mason or affiliated investment executive before the close of business
of the New York Stock Exchange, Inc. ("Exchange") (normally 4:00 p.m.
Eastern time) ("close of the Exchange") on any day the Exchange is open
will be executed at the net asset value determined as of the close of the
Exchange on that day. Orders received by your Legg Mason or affiliated
investment executive after the close of the Exchange or on days the
Exchange is closed will be executed at the net asset value determined as
of the close of the Exchange on the next day the Exchange is open. See
"How Net Asset Value is Determined" on page 14. The Fund reserves the
right to reject any order for shares of the Fund or to suspend the
offering of shares for a period of time.
HOW YOUR SHAREHOLDER ACCOUNT IS MAINTAINED
When you initially purchase shares, a shareholder account is
automatically established for you. Any shares that you purchase or receive
as a distribution will be credited directly to your account at the time of
purchase or receipt. No certificates are issued unless you specifically
request them in writing. Shareholders who elect to receive certificates
can redeem their shares only by mail. Certificates will be issued in full
shares only. No certificates will be issued for shares prior to 15
business days after purchase of such shares by check unless the Fund can
be reasonably assured during that period that payment for the purchase of
such shares has been collected. Shares may not be held in, or transferred
to, an account with any brokerage firm other than Legg Mason or its
affiliates.
HOW YOU CAN REDEEM YOUR PRIMARY SHARES
There are two ways you can redeem your Primary Shares. First, you may
give your Legg Mason or affiliated investment executive an order for
repurchase of your shares. Please have the following information ready
when you call: the number of shares to be redeemed and your shareholder
account number. Second, you may send a written request for redemption to
"Legg Mason U.S. Government Intermediate-Term Portfolio, c/o Legg Mason
Funds Processing, P.O. Box 1476, Baltimore, Maryland 21203-1476."
Requests for redemption in "good order," as described below, received
by your Legg Mason or affiliated investment executive before the close of
the Exchange on any day when the Exchange is open, will be transmitted to
BFDS, transfer agent for the Fund, for redemption at the net asset value
per share determined as of the close of the Exchange on that day. Requests
for redemption received by your Legg Mason or affiliated investment
executive after the close of the Exchange will be executed at the net
asset value determined as of the close of the Exchange on its next trading
day. A redemption request received by your Legg Mason or affiliated
investment executive may be treated as a request for repurchase and, if it
is accepted by Legg Mason, the shares will be purchased at the net asset
value per share determined as of the next close of the Exchange.
Proceeds from your redemption will settle in your Legg Mason brokerage
account two business days after trade date. However, the Fund reserves the
right to take up to seven days to make payment upon redemption if, in the
judgment of the Adviser, the Fund could be adversely affected by immediate
payment. (The Statement of Additional Information describes several other
circumstances in which the date of payment may be postponed or the right
of redemption suspended.) The proceeds of your redemption or repurchase
may be more or less than your original cost. If the shares to be redeemed
or repurchased were paid for by check (including certified or cashier's
checks) within 15 business days of the redemption or
13
<PAGE>
repurchase request, the proceeds may not be disbursed unless the Fund can
be reasonably assured that the check has been collected.
A redemption request will be considered to be received in "good order"
only if:
1. You have indicated in writing the number of Primary Shares to be
redeemed and your shareholder account number;
2. The written request is signed by you and by any co-owner of the
account with exactly the same name or names used in establishing the
account;
3. The written request is accompanied by any certificates representing
the shares that have been issued to you, and you have endorsed the
certificates for transfer or an accompanying stock power exactly as the
name or names appear on the certificates; and
4. The signatures on the written redemption request and on any
certificates for your shares (or an accompanying stock power) have been
guaranteed without qualification by a national bank, a state bank, a
member firm of a principal stock exchange or other entity described in
Rule 17Ad-15 under the Securities Exchange Act of 1934.
Other supporting legal documents may be required from corporations or
other organizations, fiduciaries or persons other than the shareholder of
record making the request for redemption or repurchase. If you have a
question concerning the redemption of shares, contact your Legg Mason or
affiliated investment executive.
The Fund will not be responsible for the authenticity of redemption
instructions received by telephone, provided it follows reasonable
procedures to identify the caller. The Fund may request identifying
information from callers or employ identification numbers. The Fund may be
liable for losses due to unauthorized or fraudulent instructions if it
does not follow reasonable procedures. Telephone redemption privileges are
available automatically to all shareholders unless certificates have been
issued. Shareholders who do not wish to have telephone redemption
privileges should call their Legg Mason or affiliated investment executive
for further instructions.
To redeem your Fund retirement account, a Distribution Request Form
must be completed and returned to Legg Mason Client Services for
processing. This form can be obtained through your Legg Mason or
affiliated investment executive or Legg Mason Client Services in
Baltimore, Maryland.
Because of the relatively high cost of maintaining small accounts, the
Fund may elect to close any account with a current value of less than $500
by redeeming all of the shares in the account and mailing the proceeds to
you. However, the Fund will not redeem accounts that fall below $500
solely as a result of a reduction in net asset value per share. If the
Fund elects to redeem the shares in your account, you will be notified
that your account is below $500 and will be allowed 60 days in which to
make an additional investment in order to avoid having your account
closed.
HOW NET ASSET VALUE IS DETERMINED
Net asset value per share is determined daily, as of the close of the
Exchange, on every day that the Exchange is open, by subtracting the
liabilities attributable to Primary Shares from the total assets
attributable to such shares and dividing the result by the number of
Primary Shares outstanding. Securities owned by the Fund for which market
quotations are readily available are valued at current market value. In
the absence of readily available market quotations, securities are valued
at fair value as determined by the Corporation's Board of Directors.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund declares dividends to holders of Primary Shares out of its
investment company taxable income attributable to those shares, which
consists of net investment income and net short-term capital gain.
Dividends from net investment income are declared daily and paid monthly.
Shareholders begin to earn dividends on their Fund shares as of settlement
date, which is normally the fifth business day after their orders are
placed with their Legg Mason or affiliated investment executive. Beginning
in June, 1995, settlement date will normally be the third business day
after orders are placed with a Legg Mason or affiliated investment
executive. Dividends from net short-term capital gain and distributions of
substantially all net capital gain (the excess of net long-term capital
gain over net short-term capital loss) generally are declared and paid
after the end of the taxable year
14
<PAGE>
in which the gain is realized. A second distribution of net capital gain
may be necessary in some years to avoid imposition of the excise tax
described under the heading "Additional Tax Information" in the Statement
of Additional Information. Dividends and capital gain distributions, if
any, on shares held in an IRA, Keogh Plan, SEP or other qualified
retirement plan and by shareholders maintaining a Systematic Withdrawal
Plan generally are reinvested in Primary Shares on the payment dates.
Other shareholders may elect to:
1. Receive both dividends and capital gain distributions in Primary
Shares;
2. Receive dividends in cash and capital gain distributions in Primary
Shares;
3. Receive dividends in Primary Shares and capital gain distributions
in cash; or
4. Receive both dividends and capital gain distributions in cash.
In certain cases, you may reinvest your dividends and capital gain
distributions in Primary Shares of another Legg Mason fund. Please contact
your Legg Mason or affiliated investment executive for additional
information about this option.
If no election is made, both dividends and capital gain distributions
will be credited to your account in Primary Shares at the net asset value
of the shares determined as of the close of the Exchange on the
reinvestment date. Shares received pursuant to any of the first three
(reinvestment) elections above also will be credited to your account at
that net asset value. If you elect to receive dividends and/or capital
gain distributions in cash, you will be sent a check or will have your
Legg Mason account credited after the payment date. You may elect at any
time to change your option by notifying the Fund in writing at: Legg Mason
U.S. Government Intermediate-Term Portfolio, c/o Legg Mason Funds
Processing, P.O. Box 1476, Baltimore, Maryland 21203-1476. Your election
must be received at least 10 days before the record date in order to be
effective for dividends and capital gain distributions paid to
shareholders as of that date.
TAX TREATMENT OF DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will be relieved of federal
income tax on that part of its investment company taxable income and net
capital gain that is distributed to its shareholders.
Dividends from the Fund's investment company taxable income (whether
paid in cash or reinvested in Primary Shares) are taxable to its
shareholders (other than IRAs, Keogh Plans, SEPs, other qualified
retirement plans and other tax-exempt investors) as ordinary income to the
extent of the Fund's earnings and profits. Distributions of the Fund's net
capital gain (whether paid in cash or reinvested in Primary Shares), when
designated as such, are taxable to those shareholders as long-term capital
gain, regardless of how long they have held their Fund shares.
The Fund sends each shareholder a notice following the end of each
calendar year specifying, among other things, the amounts of all dividends
and capital gain distributions paid (or deemed paid) during that year. The
Fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to any individuals and
certain other noncorporate shareholders who do not provide the Fund with a
certified taxpayer identification number. The Fund also is required to
withhold 31% of all dividends and capital gain distributions payable to
such shareholders who otherwise are subject to backup withholding.
A redemption of Fund shares may result in taxable gain or loss to the
redeeming shareholder, depending on whether the redemption proceeds are
more or less than the shareholder's adjusted basis for the redeemed
shares. An exchange of Fund shares for shares of another Legg Mason fund
generally will have similiar tax consequences. If Fund shares are
purchased within 30 days before or after redeeming other Fund shares
(regardless of class) at a loss, all or part of that loss will not be
deductible and instead will increase the basis of the newly purchased
shares.
A dividend or capital gain distribution paid shortly after shares have
been purchased, although in effect a return of investment, is subject to
federal income tax. Accordingly, an investor should recognize that a
purchase of Fund shares immediately prior to the record date for a
dividend or capital gain distribution could cause the investor to incur
tax liabilities and should not be made
15
<PAGE>
solely for the purpose of receiving the dividend or capital gain
distribution.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting the Fund and its shareholders; see the
Statement of Additional Information for a further discussion. In addition
to federal income tax, you may also be subject to state and local income
taxes on distributions from the Fund, depending on the laws of your home
state and locality, though the portion of the dividends paid by the Fund
attributable to direct U.S. government obligations is not subject to state
and local income taxes in most jurisdictions. The Fund's annual notice to
shareholders regarding the amount of dividends identifies this portion.
Prospective shareholders are urged to consult their tax advisers with
respect to the effects of this investment on their own tax situations.
SHAREHOLDER SERVICES
CONFIRMATIONS AND REPORTS
You will receive from the distributor a confirmation after each
transaction (except a reinvestment of dividends, capital gains and shares
purchased through the Future First Systematic Investment Plan or through
automatic investments). An account statement will be sent to you monthly
unless there has been no activity in the account or you are purchasing
shares through the Future First Systematic Investment Plan or through
automatic investments, in which case an account statement will be sent
quarterly. Reports will be sent to shareholders at least semiannually
showing the Fund's portfolio and other information; the annual report will
contain financial statements audited by the Corporation's independent
accountants.
Shareholder inquiries should be addressed to "Legg Mason U.S.
Government Intermediate-Term Portfolio, c/o Legg Mason Funds Processing,
P.O. Box 1476, Baltimore, Maryland 21203-1476."
SYSTEMATIC WITHDRAWAL PLAN
You may elect to make systematic withdrawals from your Fund account of
a minimum of $50 on a monthly basis if you are purchasing or already own
shares with a net asset value of $5,000 or more. Shareholders should not
purchase shares of the Fund while they are participating in the Systematic
Withdrawal Plan. Please contact your Legg Mason or affiliated investment
executive for further information.
EXCHANGE PRIVILEGE
As a Fund shareholder, you are entitled to exchange your Primary
Shares of the Fund for Primary Shares of the following funds in the Legg
Mason Family of Funds, provided that such shares are eligible for sale in
your state of residence:
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current income
consistent with stability of principal.
Legg Mason Tax Exempt Trust, Inc.
A money market fund seeking high current income exempt from federal
income tax, preservation of capital, and liquidity.
Legg Mason U.S. Government Money Market Portfolio
A money market fund seeking high current income consistent with
liquidity and conservation of principal.
Legg Mason Value Trust, Inc.
A mutual fund seeking long-term growth of capital.
Legg Mason Special Investment Trust, Inc.
A mutual fund seeking capital appreciation by investing principally in
issuers with market capitalizations of less than $2.5 billion.
Legg Mason Total Return Trust, Inc.
A mutual fund seeking capital appreciation and current income in order
to achieve an attractive total investment return consistent with
reasonable risk.
Legg Mason American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Legg Mason Global Equity Trust
A mutual fund seeking maximum long-term total return, by investing in
common stocks of companies located in at least three different countries.
16
<PAGE>
Legg Mason Investment Grade Income Portfolio
A mutual fund seeking a high level of current income, primarily
through investment in a diversified portfolio of investment grade debt
securities.
Legg Mason High Yield Portfolio
A mutual fund primarily seeking a high level of current income and
secondarily, capital appreciation, by investing principally in
lower-rated, fixed-income securities.
Legg Mason Global Government Trust
A mutual fund seeking capital appreciation and current income by
investing principally in debt securities issued or guaranteed by foreign
governments, the U.S. Government, their agencies, instrumentalities and
political subdivisions.
Legg Mason Maryland Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal and Maryland state and local income taxes,
consistent with prudent investment risk and preservation of capital.
Legg Mason Pennsylvania Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax and Pennsylvania personal income
tax, consistent with prudent investment risk and preservation of capital.
Legg Mason Tax-Free Intermediate-Term Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
* Shares of these funds are sold with an initial sales charge.
Investments by exchange into the Legg Mason funds sold without an
initial sales charge are made at the per share net asset value determined
on the same business day as redemption of the Fund shares you wish to
exchange. Investments by exchange into the Legg Mason funds sold with an
initial sales charge are made at the per share net asset value, plus the
applicable sales charge, determined on the same business day as redemption
of the Fund shares you wish to redeem; except that no sales charge will be
imposed upon proceeds from the redemption of Fund shares to be exchanged
that were originally purchased by exchange from a fund on which the same
or higher initial sales charge previously was paid. There is no charge for
the exchange privilege, but the Fund reserves the right to terminate or
limit the exchange privilege of any shareholder who makes more than four
exchanges from the Fund in one calendar year. To obtain further
information concerning the exchange privilege and prospectuses of other
Legg Mason funds, or to make an exchange, please contact your Legg Mason
or affiliated investment executive. To effect an exchange by telephone,
please call your Legg Mason or affiliated investment executive with the
information described in the section "How You Can Redeem Your Primary
Shares," page 13. Please read the prospectus for the other funds carefully
before you invest by exchange. The Fund reserves the right to modify or
terminate the exchange privilege upon 60 days' notice to shareholders.
There is no assurance the money market funds will be able to maintain
a $1.00 share price. None of the funds is insured or guaranteed by the
U.S. Government.
INVESTING THROUGH TAX-DEFERRED RETIREMENT PLANS
An investment in shares of the Fund may be appropriate for IRAs, Keogh
Plans, SEPs and other qualified retirement plans. Investors who are
considering establishing such a plan may wish to consult their attorneys
or other tax advisers with respect to individual tax questions. Your Legg
Mason or affiliated investment executive can make available to you forms
of plans. The option of investing in these plans through regular payroll
deductions may be arranged with Legg Mason and your employer. Additional
information with respect to these plans is available upon request from any
Legg Mason or affiliated investment executive.
THE FUND'S BOARD OF DIRECTORS, MANAGER AND INVESTMENT ADVISER
BOARD OF DIRECTORS
The business and affairs of the Fund are managed under the direction
of the Corporation's Board of Directors.
17
<PAGE>
MANAGER
Pursuant to a management agreement with the Fund ("Management
Agreement"), which was approved by the Corporation's Board of Directors,
Legg Mason Fund Adviser, Inc., a wholly owned subsidiary of Legg Mason,
Inc., serves as the Fund's manager. The Manager manages the non-investment
affairs of the Fund, directs all matters related to the operation of the
Fund and provides office space and administrative staff for the Fund. The
Fund pays the Manager, pursuant to the Management Agreement, a management
fee equal to an annual rate of 0.55% of the Fund's average daily net
assets. The Fund's Manager has agreed that until October 31, 1995 or when
the Fund reaches net assets (Primary Shares) of $400 million, whichever
occurs first, it will continue to reimburse fees and/or assume other
expenses to the extent the Fund's expenses (exclusive of taxes, interest,
brokerage and extraordinary expenses) exceed during any month an annual
rate of 0.95% of the Fund's average daily net assets (Primary Shares) for
such month. After reimbursement by the Manager of certain expenses, the
Fund's total operating expenses for the year ended December 31, 1994 were
0.90% of average daily net assets. Reimbursement by the Manager reduces
Fund expenses and increases its yield and total return.
The Manager acts as investment adviser, manager or consultant to
fifteen investment company portfolios (excluding the Fund) which had
aggregate assets under management of over $3.8 billion as of February 28,
1995. The Manager's address is 111 South Calvert Street, Baltimore,
Maryland 21202.
INVESTMENT ADVISER
Western Asset Management Company, another wholly owned subsidiary of
Legg Mason, Inc., serves as investment adviser to the Fund pursuant to the
terms of an Investment Advisory Agreement with the Manager, which was
approved by the Corporation's Board of Directors. The Adviser manages the
investment and other affairs of the Fund and directs the investments of
the Fund in accordance with its investment objective, policies and
limitations. For these services, the Manager (not the Fund) pays the
Adviser a fee, computed daily and payable monthly, at an annual rate equal
to 40% of the fee received by the Manager, or 0.22% of the Fund's average
daily net assets.
An investment committee has been responsible for the day-to-day
management of the Fund since its inception.
The Adviser also renders investment advice to eleven open-end
investment companies and one closed-end investment company, which together
had aggregate assets under management of approximately $2.3 billion as of
February 28, 1995. The Adviser also renders investment advice to private
accounts with fixed income assets under management of approximately $10.8
billion as of that date. The address of the Adviser is 117 East Colorado
Boulevard, Pasadena, California 91105.
The Adviser has managed fixed income portfolios continuously since its
founding in 1971, and has focused exclusively on such accounts since 1984.
In managing fixed-income portfolios, the Adviser first studies the
range of factors that influence interest rates and develops a long-term
interest rate forecast. It then allocates available funds to those sectors
of the market (for example, government, corporate, or mortgage-backed
securities), which it considers most attractive. Then it selects the
specific issues which it believes represent the best values. All three
decisions are integral parts of the Adviser's portfolio management process
and contribute to its performance record.
THE FUND'S DISTRIBUTOR
Legg Mason is the distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of shares of the Fund, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional information and periodic reports used in
connection with the offering to prospective investors, after the
prospectuses, statements of additional information and reports have been
prepared, set in type and mailed to existing shareholders at the Fund's
expense, and for any supplementary sales literature and advertising costs.
Legg Mason also receives a fee from BFDS for assisting it with its
transfer agent and shareholder
18
<PAGE>
servicing functions. For the year ended December 31, 1994, Legg Mason
received $57,597 for performing such services in connection with this
Fund.
The Board of Directors of the Corporation has adopted a Distribution
and Shareholder Services Plan ("Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940 ("1940 Act"). The Plan provides that as
compensation for Legg Mason's ongoing services to investors in Primary
Shares and its activities and expenses related to the sale and
distribution of Primary Shares, the Fund pays Legg Mason, from the assets
attributable to Primary Shares, an annual distribution fee and an annual
service fee, each of which is equal to 0.25% of the average daily net
assets attributable to Primary Shares. The distribution fee and the
service fee are computed daily and paid monthly. The fees received by Legg
Mason during any year may be more or less than its costs of providing
distribution and shareholder services for Primary Shares.
NASD rules limit the amount of annual distribution fees that may be
charged by mutual funds and impose a ceiling on the cumulative
distribution fees received. The Fund's Plan complies with those rules.
The Chairman, President and Treasurer of the Corporation are employed
by Legg Mason.
DESCRIPTION OF THE CORPORATION AND ITS SHARES
The Corporation is a diversified open-end investment company which was
incorporated in Maryland on April 28, 1987. The Articles of Incorporation
of the Corporation permit the Board of Directors to create additional
series (or portfolios), each of which issues a separate class of shares.
There are currently four portfolios of the Corporation, including the
Fund. While additional series may be created in the future, there is no
intention at this time to form any particular additional series.
The Corporation has authorized one billion shares of common stock, par
value $.001 per share. The Fund currently offers two Classes of Shares --
Class A (known as "Primary Shares") and Navigator Shares. Each Class
represents interests in the same pool of assets of the Fund. A separate
vote is taken by a Class of Shares of the Fund if a matter affects just
that Class of Shares. Each Class of Shares may bear differing
Class-specific expenses. Salespersons and others entitled to receive
compensation for selling or servicing Fund shares may receive more with
respect to one Class than another.
The initial and subsequent investment minimums for Navigator Shares
are $50,000 and $100, respectively. Investments in Navigator Shares may be
made through investment executives of Fairfield Group, Inc., Horsham,
Pennsylvania, or Legg Mason.
The Fund pays no Rule 12b-1 fee with respect to Navigator Shares. The
per share net asset value of Navigator Shares, and dividends and
distributions (if any) paid to Navigator shareholders, are generally
expected to be higher than those of Primary Shares of the Fund, because of
the lower expenses attributable to Navigator Shares. Navigator Shares of
the Fund may be exchanged for the corresponding class of shares of certain
other Legg Mason Funds. Investments by exchange into the other Legg Mason
Funds are made at the per share net asset value, determined on the same
business day as redemption of the Navigator Shares the investors wish to
redeem.
The Board of Directors of the Fund does not anticipate that there will
be any conflicts among the interests of the holders of the different
Classes of Fund Shares. On an ongoing basis, the Board will consider
whether any such conflict exists and, if so, take appropriate action.
Shareholders of the Fund are entitled to one vote per share and
fractional votes for fractional shares held. Voting rights are not
cumulative. All shares of the Fund are fully paid and nonassessable and
have no preemptive or conversion rights.
Shareholder meetings will not be held except where the 1940 Act
requires a shareholder vote on certain matters (including the election of
directors, approval of an advisory contract, and approval of a plan of
distribution pursuant to Rule 12b-1). The Corporation will call a special
meeting of the shareholders at the request of 10% or more of the shares
entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the Fund at 111 South Calvert Street,
Baltimore, Maryland 21202, stating the purpose of the proposed meeting and
the matters to be acted upon.
19
<PAGE>
Prospectus
May 1, 1995
Navigator
U.S. Government
Intermediate-Term
Portfolio
Putting Your Future First
<PAGE>
Table of Contents
Fund Expenses
Financial Highlights
Performance Information
The Fund's Investment Objective and Policies
How to Purchase and Redeem Shares
How Shareholder Accounts are Maintained
How Net Asset Value Is Determined
Dividends and Other Distributions
Tax Treatment of Dividends and Other Distributions
Shareholder Services
The Fund's Board of Directors, Manager and Investment Adviser
The Fund's Distributor
Description of the Corporation and its Shares
Addresses
Distributor:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410-539-0000 800-822-5544
Transfer and Shareholder Servicing Agent:
Boston Financial Data Services
P.O. Box 8000, Boston, MA 02266-8000
Counsel:
Kirkpatrick & Lockhart
1800 M Street, N.W., Washington, DC 20036
Independent Accountants:
Coopers & Lybrand L.L.P.
217 East Redwood Street, Baltimore, Maryland 21202
No person has been authorized to give any information or to make
any representations not contained in this Prospectus or the
Statement of Additional Information in connection with the
offering made by the Prospectus and, if given or made, such
information or representations must not be relied upon as having
been authorized by the Fund or its distributor. The Prospectus
does not constitute an offering by the Fund or by the principal
underwriter in any jurisdiction in which such offering may not
lawfully be made.
LMF - 065A
<PAGE>
Navigator U.S. Government Intermediate-Term Portfolio
Prospectus
Shares of Navigator U.S. Government Intermediate-Term Portfolio
("Navigator Shares") represent a separate class ("Navigator Class") of
interests in the Legg Mason U.S. Government Intermediate-Term Portfolio
("Fund"), a professionally managed portfolio seeking to provide investors
with high current income consistent with prudent investment risk and
liquidity needs. The Fund is a separate portfolio of Legg Mason Income
Trust, Inc. ("Corporation"), a diversified open-end management investment
company which currently has four portfolios. In seeking to achieve the
Fund's objective, the Fund's investment adviser, Western Asset Management
Company ("Adviser"), under normal circumstances, invests at least 75% of
the Fund's total assets in obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, or instruments secured by
such securities. The Fund expects to maintain an average dollar-weighted
maturity of between three and ten years.
The Navigator Class of Shares, described in this Prospectus, is
currently offered for sale only to institutional clients of the Fairfield
Group, Inc. ("Fairfield") for investment of their own funds and funds for
which they act in a fiduciary capacity, to clients of Legg Mason Trust
Company ("Trust Company") for which the Trust Company exercises
discretionary investment management responsibility (such institutional
investors are referred to collectively as "Institutional Clients" and
accounts of such Clients are referred to collectively as "Customer
Accounts"), to qualified retirement plans managed on a discretionary basis
and having net assets of at least $200 million, and to The Legg Mason
Profit Sharing Plan and Trust. Navigator Shares may not be purchased by
individuals directly, but Institutional Clients may purchase shares for
Customer Accounts maintained for individuals.
Navigator Shares are sold and redeemed without any purchase or
redemption charge imposed by the Fund, although Institutional Clients may
charge their Customer Accounts for services provided in connection with
the purchase or redemption of shares. See "How to Purchase and Redeem
Shares." The Fund will pay management fees to Legg Mason Fund Adviser,
Inc., but Navigator Class pays no distribution fees.
MUTUAL FUND SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, ANY BANK OR OTHER DEPOSITORY INSTITUTION.
SHARES ARE NOT INSURED BY THE FDIC, THE FEDERAL RESERVE BOARD, OR ANY
OTHER AGENCY, AND ARE SUBJECT TO INVESTMENT RISK, INCLUDING THE POSSIBLE
LOSS OF THE PRINCIPAL AMOUNT INVESTED.
This Prospectus sets forth concisely the information about the
Fund that a prospective investor ought to know before investing. It should
be retained for future reference. A Statement of Additional Information
about the Fund dated May 1, 1995 has been filed with the Securities and
Exchange Commission ("SEC") and, as amended or supplemented from time to
time, is incorporated herein by reference. The Statement of Additional
Information is available without charge upon request from Legg Mason
(address and telephone numbers listed below).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
<PAGE>
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Dated: May 1, 1995
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410-539-0000
800-822-5544
2
<PAGE>
Fund Expenses
The purpose of the following table is to assist an investor in
understanding the various costs and expenses that an investor in Navigator
Shares will bear directly or indirectly. The expenses and fees set forth
in the table are based on estimated expenses for the first year of
operation of the Navigator Class.
Shareholder Transaction Expenses
Maximum sales charge on purchases or
reinvested dividends None
Redemption and exchange fees None
Annual Fund Operating Expenses -- Navigator Shares
(as a percentage of average net assets)
Management fees(1) 0.33%
12b-1 fees None
Other expenses (estimated) 0.12%
Total operating expenses 0.45%
(1) The expense ratio for Navigator Class would have been 0.67% had the
Fund's Manager not agreed to reimburse management fees and other expenses
pursuant to a voluntary expense limitation. The reimbursement agreement,
wherein the Manager has agreed to continue to reimburse management fees
and/or assume other expenses to the extent the Navigator Class's expenses
(exclusive of taxes, interest, brokerage and extraordinary expenses)
exceed during any month an annual rate of 0.45% of the Fund's average
daily net assets for such month, will remain in effect until October 31,
1995, or until the Fund's net assets reach $400 million, whichever occurs
first, and unless extended will terminate on that date.
For further information concerning Fund expenses, see "The Fund's
Board of Directors, Manager and Investment Adviser," page 19.
Example of Effect of Fund Expenses
The following example illustrates the expenses that you would pay on a
$1,000 investment over various time periods assuming (1) a 5% annual rate
of return and (2) full redemption at the end of each time period. As noted
in the table above, the Fund charges no redemption fees of any kind.
1 Year 3 Years 5 Years 10 Years
$5 $14 $25 $57
This example assumes that all dividends and other distributions
are reinvested and that the percentage amounts listed under Annual Fund
3
<PAGE>
Operating Expenses remain the same over the time periods shown. The above
tables and the assumption in the example of a 5% annual return are
required by regulations of the SEC applicable to all mutual funds. THE
ASSUMED 5% ANNUAL RETURN IS NOT A PREDICTION OF AND DOES NOT REPRESENT THE
PROJECTED OR ACTUAL PERFORMANCE OF NAVIGATOR SHARES. THE ABOVE TABLES
SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES.
Actual expenses may be greater or less than those shown. The actual
expenses attributed to Navigator Shares will depend upon, among other
things, the level of average net assets, the levels of sales and
redemptions of shares, and the extent to which Navigator Shares incur
variable expenses, such as transfer agency costs.
4
<PAGE>
Financial Highlights
Effective December 1, 1994, the Fund commenced the sale of
Navigator Shares. The information shown below for prior periods is for
Primary Shares and reflects 12b-1 fees paid by that class and not by
Navigator Shares.
The financial highlights for the period August 7, 1987
(commencement of operations) to December 31, 1987 and for the years ended
December 31, 1988 through 1994 have been derived from financial statements
which have been audited by Coopers & Lybrand L.L.P., independent
accountants. The Fund's financial statements for the year ended December
31, 1994 and the report of Coopers & Lybrand L.L.P. thereon are included
in the Fund's annual report and are incorporated by reference in the
Statement of Additional Information. The annual report is available to
shareholders without charge by calling an investment executive at
Fairfield or Legg Mason or Legg Mason's Funds Marketing Department at
800-822-5544.
5
<PAGE>
<TABLE>
<CAPTION>
NAVIGATOR PRIMARY
CLASS CLASS
For the Years Ended December 31,
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1/ 2/
1994 1994 1993 1992 1991 1990 1989 1988 8/7/87
to
12/31/87
Per Share
Operating
Per-
formance:
Net
asset
value,
begin-
ning of
period $9.72 $10.43 $10.70 $10.77 $10.29 $10.20 $9.79 $9.92 $10.00
Net
invest-
ment 3/ 4/ 4/ 4/ 4/ 4/ 4/ 4/ 4/
income 0.05 0.51 0.53 0.60 0.72 0.78 0.80 0.74 0.30
Net
realized
and
unrea-
lized
gain
(loss)
on
invest-
ments -- (0.71) 0.17 0.05 0.70 0.09 0.41 (0.12) (0.08)
Total
from
invest-
ment
opera-
tions 0.05 (0.20) 0.70 0.65 1.42 0.87 1.21 0.62 0.22
Distri-
butions
to
share-
holders:
6
<PAGE>
For the Years Ended December 31,
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1/ 2/
1994 1994 1993 1992 1991 1990 1989 1988 8/7/87
to
12/31/87
Net
invest-
ment
income (0.05) (0.51) (0.53) (0.60) (0.72) (0.78) (0.80) (0.74) (0.30)
Net
rea-
lized
gain on
invest-
ments -- -- (0.39) (0.12) (0.22) -- -- (0.01) --
In
excess
of net
rea-
lized
gain on
invest-
ments -- -- (0.05) -- -- -- -- -- --
Net
asset
value,
end of
period $9.72 $9.72 $10.43 $10.70 $10.77 $10.29 $10.20 $9.79 $9.92
Total 5/ 5/
return 0.50% -1.93% 6.6% 6.3% 14.4% 9.1% 12.8% 6.4% 2.2%
Ratios/
Supple-
mental
Data:
Ratios
to
average
net
assets:
Ex-
penses
Net
invest- 3/ 4/ 6/ 4/ 6/ 4/ 6/ 4/ 6/ 4/ 6/ 4/ 6/ 4/ 6/
ment .4% .9% .9% .9% .8% .6% .8% 1.0% 1.0%
income 6.4% 5.1% 4.8% 5.5% 6.7% 7.7% 7.9% 7.4% 7.4%
Port-
folio
turnover 7/
rate 315.7% 315.7% 490.2% 512.6% 642.8% 67.0% 57.3% 132.5% 66.3%
7
<PAGE>
For the Years Ended December 31,
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1/ 2/
1994 1994 1993 1992 1991 1990 1989 1988 8/7/87
to
12/31/87
Net
assets,
end of
period
(in
thou-
sands) $4,024$231,255 $299,529 $307,320 $211,627$74,423 $43,051 $27,087 $16,617
</TABLE>
1/ For the period December 1, 1994 (commencement of operations) to
December 31, 1994.
2/ Commencement of operations.
3/ Net of fees waived and reimbursements made by the manager for expenses
in excess of voluntary limitation as follows: 0.45% until October 31,
1995.
4/ Net of fees waived and reimbursements made by the manager for expenses
in excess of voluntary expense limitations as follows: 1.0% until
September 10, 1989; 0.5% until March 31, 1990; 0.6% until December 31,
1990; 0.75% until April 30, 1991; 0.8% until December 31, 1991; 0.85%
until August 31, 1992; and 0.95% until October 31, 1995.
5/ Not annualized.
6/ Includes distribution fee of 0.5%.
7/ Annualized.
8
<PAGE>
Performance Information
From time to time the Fund may quote the total return of each
class of shares in advertisements or in reports or other communications to
shareholders. A mutual fund's total return is a measurement of the overall
change in value, including changes in share price and assuming
reinvestment of dividends and capital gain distributions of an investment
in the fund. Cumulative total return shows the fund's performance over a
specific period of time. Average annual total return is the average annual
compounded return that would have produced the same cumulative total
return if the fund's performance had been constant over the entire period.
Performance figures reflect past performance and are not intended to
indicate future performance. Average annual returns tend to smooth out
variations in the fund's return, so they differ from actual year-by-year
results.
Total returns of Primary Shares as of December 31, 1994 were as
follows:
Cumulative Average Annual
Total Return Total Return
One Year -1.93% -1.93%
Five Years +38.59% +6.75%
Life of Fund* +70.08% +7.43%
* Fund's inception - August 7, 1987.
No adjustment has been made for any income taxes payable by
shareholders. The investment return and principal value of an investment
in the Fund will fluctuate so that an investor's shares, when redeemed,
may be worth more or less than their original cost. Returns would have
been lower if the Manager had not waived/reimbursed certain fees and
expenses during the fiscal years 1987 through 1994. As of the date of this
prospectus, Navigator Shares have no material performance history.
Because Navigator Shares have lower total expenses, they will generally
have a higher return than Primary Shares.
The Fund also may advertise its yield or effective yield. Yield
reflects net investment income per share (as defined by applicable SEC
regulations) over a 30-day (or one-month) period, expressed as an
annualized percentage of net asset value at the end of the period. The
effective yield, although calculated similarly, will be slightly higher
than the yield because it assumes that income earned from the investment
is reinvested (i.e., the compounding effect of reinvestment). Yield
computations differ from other accounting methods and therefore may differ
from dividends actually paid or reported net income.
Further information about the Fund's performance is contained in
the annual report to shareholders, which may be obtained without charge by
calling an investment executive at Fairfield or Legg Mason or Legg Mason's
Funds Marketing Department at 800-822-5544.
9
<PAGE>
The Fund's Investment Objective and Policies
The investment objective of the Fund is to provide investors with
high current income consistent with prudent investment risk and liquidity
needs. The investment objective of the Fund may not be changed without a
vote of Fund shareholders; however, except as otherwise noted, the
investment policies of the Fund described below may be changed by the
Corporation's Board of Directors without a shareholder vote. There can be
no assurance that the Fund's investment objective will be achieved.
At least 75% of the Fund's total assets are, under normal
circumstances, invested in U.S. government securities or instruments
secured by such securities, including repurchase agreements. The Fund
expects to maintain an average dollar-weighted maturity of between three
and ten years. U.S. government securities include: 1) U.S. Treasury
obligations, which differ only in their interest rates, maturities and
times of issuance: U.S. Treasury bills (maturity of one year or less),
U.S. Treasury notes (maturity of one to ten years) and U.S. Treasury bonds
(generally maturities of greater than ten years); and 2) obligations
issued or guaranteed by U.S. government agencies and instrumentalities
which are supported by any of the following: a) the full faith and credit
of the U.S. Government (such as certificates of the Government National
Mortgage Association ("GNMA"), b) the right of the issuer to borrow an
amount limited to a specific line of credit from the U.S. Government (such
as obligations of the Federal Home Loan Banks), c) discretionary authority
of the U.S. Treasury to lend to the government agency or instrumentality
(such as the Federal National Mortgage Association), or d) only the credit
of the instrumentality (such as the Student Loan Marketing Association).
In the case of obligations not backed by the full faith and credit of the
United States, the Fund must look principally to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate
repayment and may not be able to assert a claim against the United States
itself in the event the agency or instrumentality does not meet its
commitments. The U.S. Government does not guarantee the market value of
the Fund's investments or the market value or yield of the Fund's shares,
which will fluctuate with market interest rates. Investments in
mortgage-related securities issued by governmental or government-related
entities, as described on the next page, will be included in the 75%
limitation.
The balance of the Fund, up to 25% of its total assets, normally
is invested in cash, commercial paper and investment grade debt securities
rated within one of the four highest grades assigned by Standard & Poor's
Ratings Group ("S&P") (AAA, AA, A or BBB), Moody's Investors Service, Inc.
("Moody's") (Aaa, Aa, A or Baa), securities comparably rated by another
nationally recognized statistical rating organization, or unrated
securities judged by the Adviser to be of comparable quality. Debt
securities rated Baa are deemed by Moody's to have speculative
characteristics; changes in economic conditions or other circumstances are
more likely to lead to a weakened capacity for the issuers of such
10
<PAGE>
securities to make principal and interest payments than is the case for
high-grade debt securities. A further description of Moody's and S&P's
ratings is included in the Appendix to the Statement of Additional
Information.
The market value of the interest-bearing debt securities held by
the Fund, and therefore the net asset value of Fund shares, is affected by
changes in market interest rates. There is normally an inverse
relationship between the market value of securities sensitive to
prevailing interest rates and actual changes in interest rates; i.e., a
decline in interest rates produces an increase in market value, while an
increase in rates produces a decrease in market value. Moreover, the
longer the remaining maturity of a security, the greater is the effect of
interest rate changes on the market value of such a security. In addition,
changes in the ability of an issuer to make payments of interest and
principal and in the market's perception of an issuer's creditworthiness
also affect the market value of the debt securities of that issuer.
The Fund has adopted certain fundamental investment limitations
that, like its investment objective, may not be changed without the
approval of the Fund's shareholders. A full description of these
investment limitations is included in the Statement of Additional
Information.
Corporate Debt Securities
Among the debt securities in which the Fund may invest are those
issued by corporations. In selecting corporate debt securities for the
Fund, the Adviser reviews and monitors the creditworthiness of each issuer
and issue. Interest rate trends and specific developments which the
Adviser believes may affect individual issuers are also analyzed.
Mortgage-Related Securities
The Fund normally may invest up to 50% of its total assets in
mortgage-related securities, including those issued by the governmental or
government-related entities referred to above. Mortgage-related securities
represent interests in pools of mortgages created by lenders such as
commercial banks, savings and loan institutions, mortgage bankers and
others. Mortgage-related securities may be issued by governmental or
government-related entities or by non-governmental entities such as banks,
savings and loan institutions, private mortgage insurance companies,
mortgage bankers and other secondary market issuers. No more than 25% of
the Fund's total assets normally are invested in mortgage-related
securities issued by non-governmental entities.
Interests in pools of mortgage-related securities differ from
other forms of debt securities which normally provide for periodic payment
of interest in fixed amounts with principal payments at maturity or
specified call dates. In contrast, mortgage-related securities provide
monthly payments which consist of interest and, in most cases, principal.
In effect, these payments are a "pass-through" of the monthly payments
made by the individual borrowers on their residential mortgage loans, net
of any fees paid to the issuer or guarantor of such securities. Additional
11
<PAGE>
payments to holders of mortgage-related securities are caused by
repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure, net of fees or costs which may be incurred.
Some mortgage-related securities are described as "modified pass-through."
These securities entitle the holders to receive all interest and principal
payments owed on the mortgages in the pool, net of certain fees,
regardless of whether or not the mortgagors actually make the payments.
The Adviser expects that governmental or private entities may
create new types of mortgage-related securities in response to changes in
the market or changes in government regulation of such securities. As new
types of mortgage-related securities are developed and offered to
investors, the Adviser will, consistent with the investment objective and
policies of the Fund, consider making investments in such new types of
securities.
As prepayment rates of individual pools of mortgage loans vary
widely, it is not possible to predict accurately the average life of a
particular mortgage-related security. Although both government and
privately-issued mortgage-related securities are issued with stated
maturities of up to forty years, unscheduled or early payments of
principal and interest on the underlying mortgages may shorten
considerably the securities' effective maturities. On the other hand, a
decrease in the rate of prepayments may extend the effective maturities of
mortgage-related securities, increasing their sensitivity to changes in
market interest rates. Such a decrease in prepayments may result from an
increase in market interest rates, among other causes. The volume of
prepayments of principal on a pool of mortgages underlying a particular
mortgage-related security will influence the yield of that security, and
the principal returned to the Fund may be reinvested in instruments whose
yield may be higher or lower than that which might have been obtained had
such prepayments not occurred. When interest rates are declining, such
prepayments usually increase, with the result that reinvestment of such
principal prepayments will be at a lower rate than that on the original
mortgage-related security. Increased prepayment of principal may limit the
Fund's ability to realize the appreciation in the value of such securities
that would otherwise accompany declining interest rates. An increase in
mortgage prepayments could cause the Fund to incur a loss on a
mortgage-related security that was purchased at a premium. In determining
the Fund's average maturity, the Adviser must apply certain assumptions
and projections about the maturity and prepayment of mortgage-related
securities; actual prepayment rates may differ.
Government Mortgage-Related Securities
GNMA is the principal federal government guarantor of
mortgage-related securities. GNMA is a wholly owned U.S. government
corporation within the Department of Housing and Urban Development. GNMA
pass-through securities are considered to have a very low risk of default
in that (i) the underlying mortgage loan portfolio is comprised entirely
of government-backed loans and (ii) the timely payment of both principal
and interest on the securities is guaranteed by the full faith and credit
of the U.S. Government--regardless of whether they have been collected.
GNMA pass-through securities are, however, subject to the same market risk
12
<PAGE>
as comparable debt securities. Therefore, the effective maturity and
market value of the Fund's GNMA securities can be expected to fluctuate in
response to changes in interest rate levels.
Residential mortgage loans are also pooled by the Federal Home
Loan Mortgage Corporation ("FHLMC"). FHLMC is a corporate instrumentality
of the U.S. Government that was created by Congress in 1970 for the
purpose of increasing the availability of mortgage credit for residential
housing. FHLMC issues mortgage participation certificates ("PCs") which
represent interests in mortgages from FHLMC's national portfolio. The
mortgage loans in FHLMC's portfolio are not government backed; rather, the
loans are either uninsured with loan-to-value ratios of 80% or less, or
privately insured if the loan-to-value ratio exceeds 80%. FHLMC, not the
U.S. Government, guarantees the timely payment of interest and ultimate
collection of principal on FHLMC PCs.
The Federal National Mortgage Association ("FNMA") is a
government-sponsored corporation owned entirely by private stockholders.
It is subject to general regulation by the Secretary of Housing and Urban
Development. FNMA purchases residential mortgages from a list of approved
seller/servicers, which include savings and loan associations, savings
banks, commercial banks, credit unions and mortgage bankers. Pass-through
certificates ("FNMA certificates") issued by FNMA are guaranteed as to
timely payment of principal and interest by FNMA, not the U.S. Government.
Privately Issued Mortgage-Related Securities
Mortgage-related securities offered by private issuers include
pass-through securities comprised of pools of conventional residential
mortgage loans; mortgage-backed bonds which are considered to be
obligations of the institution issuing the bonds and are collateralized by
mortgage loans; and bonds and collateralized mortgage obligations ("CMOs")
which are collateralized by mortgage-related securities issued by FHLMC,
FNMA, or GNMA or by pools of conventional mortgages.
CMOs are typically structured with two or more classes or series
which have different maturities and are generally retired in sequence.
Each class of obligations is scheduled to receive periodic interest
payments according to the coupon rate on the obligations. However, all
monthly principal payments and any prepayments from the collateral pool
are paid first to the "Class 1" bondholders. The principal payments are
such that the Class 1 obligations are scheduled to be completely repaid no
later than, for example, five years after the offering date. Thereafter,
all payments of principal are allocated to the next most senior class of
bonds until that class of bonds has been fully repaid. Although full
payoff of each class of bonds is contractually required by a certain date,
any or all classes of obligations may be paid off sooner than expected
because of an increase in the payoff speed of the pool.
Mortgage-related securities created by non-governmental issuers
generally offer a higher rate of interest than government and
government-related securities because there are no direct or indirect
government guarantees of payments in the former securities, resulting in
higher risks. However, many issuers or servicers of mortgage-related
securities guarantee timely payment of interest and principal on such
securities. Timely payment of principal may also be supported by various
13
<PAGE>
forms of insurance, including individual loan, title, pool and hazard
policies. There can be no assurance that the private issuers or insurers
will be able to meet their obligations under the relevant guarantees and
insurance policies, and such guarantees and policies often do not cover
the full amount of the pool. Where privately issued securities are
collateralized by securities issued by FHLMC, FNMA or GNMA, the timely
payment of interest and principal is supported by the government-related
securities collateralizing such obligations.
Since the inception of the mortgage-related pass-through security
in 1970, the market for these securities has expanded considerably. The
size of the primary issuance market and active participation in the
secondary market by securities dealers and many types of investors make
government and government-related pass-through pools highly liquid.
Private conventional pools of mortgages (pooled by commercial banks,
savings and loan institutions and others with no relationship to
government and government-related entities) have also achieved broad
market acceptance, and consequently an active secondary market has
emerged. However, the market for conventional pools is smaller and less
liquid than the market for the government and government-related mortgage
pools.
The Fund may purchase some mortgage-related securities through
private placements. In such cases, the securities may be considered
illiquid and, if so, will be subject to the Fund's investment limitation
that no more than 10% of its net assets will be invested in illiquid
securities.
Asset-Backed Securities
Asset-backed securities are securities that represent direct or
indirect participations in, or are secured by and payable from, assets
such as motor vehicle installment sales contracts, installment loan
contracts, 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 and special purpose
corporations. The value of such securities partly depends on loan
repayments by individuals, which may be adversely affected during general
downturns in the economy. Payments or distributions of principal and
interest on asset-backed securities may be supported by credit
enhancements, such as various forms of cash collateral accounts or letters
of credit. Like mortgage-related securities, asset-backed securities are
subject to the risk of prepayment. The risk that recovery on repossessed
collateral might be unavailable or inadequate to support payments on
asset-backed securities, however, is greater than is the case for
mortgage-backed securities.
Zero Coupon Bonds
Zero coupon bonds are debt obligations which make no fixed
interest payments but instead are issued at a significant discount from
face value. Like other debt securities, the price can also reflect a
premium or discount to the original issue discount reflecting the market's
14
<PAGE>
judgment as to the issuer's creditworthiness, the interest rate or other
similar factors. The discount approximates the total amount of interest
the bonds will accrue and compound over the period until maturity or the
first interest payment date at a rate of interest reflecting the market
rate of the security at the time of issuance. Because zero coupon bonds do
not require the periodic payment of interest, their prices can be very
volatile when market interest rates change.
The original issue discount on zero coupon bonds must be included
in the Fund's income ratably as it accrues. Accordingly, to continue to
qualify for tax treatment as a regulated investment company and to avoid a
certain excise tax, the Fund may be required to distribute as a dividend
an amount that is greater than the total amount of cash it actually
receives. See "Additional Tax Information" in the Statement of Additional
Information. These distributions must be made from the Fund's cash assets
or, if necessary, from the proceeds of sales of portfolio securities. Such
sales could occur at a time which would be disadvantageous to the Fund and
when the Fund would not otherwise choose to dispose of the assets.
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 a different issuer within
a particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt
or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before conversion,
convertible securities have characteristics similar to non-convertible
debt securities in that they ordinarily provide a stable stream of income
with generally higher yields than those of common stocks of the same or
similar issuers, but lower than the yield on non-convertible debt.
Convertible securities are usually subordinated to comparable-tier
non-convertible securities but rank senior to common stock in a
corporation's capital structure.
The value of a convertible security is a function of (1) its
yield in comparison with the yields of other securities of comparable
maturity and quality that do not have a conversion privilege and (2) its
worth, at market value, if converted into the underlying common stock.
Convertible securities are typically issued by smaller capitalized
companies, whose stock prices may be volatile. The price of a convertible
security often reflects such variations in the price of the underlying
common stock in a way that non-convertible debt does not. A convertible
security may be subject to redemption at the option of the issuer at a
price established in the convertible security's governing instrument which
could have an adverse effect on the Fund's ability to achieve its
investment objective. The Fund does not intend to exercise conversion
rights for any convertible security it owns and does not intend to hold
any security which has been subject to conversion.
Foreign Securities
15
<PAGE>
The Fund may invest in U.S. dollar-denominated debt securities
issued by foreign companies and governments. The foreign government
securities in which the Fund invests generally consist of obligations
supported by national, state or provincial governments or similar
political subdivisions. The Fund also may invest in debt securities of
foreign "quasi-governmental agencies," which are issued by entities owned
by a national, state or equivalent government or are obligations of a
political unit that is not backed by the national government's full faith
and credit and general taxing powers.
Investment in foreign securities presents certain risks,
including those resulting from adverse political and economic
developments, reduced availability of public information concerning
issuers and the fact that foreign issuers generally are not subject to
uniform accounting, auditing and financial reporting standards or to other
regulatory practices and requirements comparable to those applicable to
domestic issuers. Moreover, securities of many foreign issuers may be less
liquid and their prices more volatile than those of comparable domestic
issuers. Some foreign securities are subject to foreign taxes and
withholding. Because the foreign securities in which the Fund invests are
U.S. dollar-denominated, there is no risk of currency fluctuation.
Repurchase Agreements
A repurchase agreement is an agreement under which the Fund
acquires either U.S. government obligations or other high-quality, liquid
debt securities from a securities dealer or bank subject to resale at an
agreed-upon price and date. The securities are held for the Fund by State
Street Bank and Trust Company ("State Street"), the Fund's custodian, as
collateral until resold and will be supplemented by additional collateral
if necessary to maintain a total value equal to or in excess of the value
of the repurchase agreement. The Fund bears a risk of loss in the event
that the other party to a repurchase agreement defaults on its obligations
and the Fund is delayed or prevented from exercising its right to dispose
of the collateral securities, which may decline in value in the interim.
The Fund will enter into repurchase agreements only with financial
institutions which the Adviser believes present minimal risk of default
during the term of the agreement based on guidelines established by the
Corporation's Board of Directors. The Fund will not enter into repurchase
agreements of more than seven days' duration if more than 10% of its total
assets would be invested in such agreements and other illiquid
investments.
When-Issued Securities
The Fund may enter into commitments to purchase U.S. government
securities or other securities on a when-issued basis. The Fund may
purchase when-issued securities because such securities are often the most
efficiently priced and have the best liquidity in the bond market. As with
the purchase of all securities, when the Fund purchases securities on a
when-issued basis, it assumes the risks of ownership, including the risk
of price fluctuation, at the time of purchase, not at the time of receipt.
However, the Fund does not have to pay for the obligations until they are
16
<PAGE>
delivered to the Fund, which is normally 7 to 15 days later, but could be
considerably longer in the case of some mortgage-backed securities. To
meet that payment obligation, the Fund will set aside cash or liquid,
high-quality debt securities equal to the payment that will be due.
Depending on market conditions, the Fund's when-issued purchases could
cause its net asset value to be more volatile, because they will increase
the amount by which the Fund's total assets, including the value of the
when-issued securities held by the Fund, exceed its net assets. The Fund
does not expect that its commitment to purchase when-issued securities
will at any time exceed, in the aggregate, 20% of its total assets.
Futures and Options Transactions
In an effort to protect against the effect of adverse changes in
interest rates, the Fund may purchase and sell interest rate futures
contracts and may purchase put options on interest rate futures contracts
and debt securities (practices known as "hedging"). A futures contract is
an agreement by the Fund to buy or sell securities at a specified date and
price. The purchase of a put option on a futures contract allows the Fund,
at its option, to enter into a particular futures contract to sell
securities at any time up to the option's expiration date.
The Fund may purchase put options on interest rate futures
contracts or sell interest rate futures contracts (that is, enter into a
futures contract to sell the underlying security) to attempt to reduce the
risk of fluctuations in its share value. The Fund may purchase an interest
rate futures contract (that is, enter into a futures contract to purchase
the underlying security) to attempt to establish more definitely the
return on securities the Fund intends to purchase. The Fund may not use
these instruments for speculation or leverage.
The Fund may seek to enhance its income or hedge the portfolio by
writing (selling) covered call options (i.e., the Fund will own the
underlying instrument while the call is outstanding) and covered put
options (i.e., the Fund will have cash, U.S. government securities or
other high-grade, liquid debt instruments in a segregated account in an
amount not less than the exercise price while the put is outstanding).
The Fund may write call options on securities in its portfolio in
an attempt to realize, through the premium the Fund receives, a greater
current return than would be realized on the securities alone. The Fund
may write put options in an attempt to realize enhanced income when it is
willing to purchase the underlying instrument for its portfolio at the
exercise price. The Fund may also purchase call options for the purpose of
acquiring the underlying instruments for its portfolio. At times, the net
cost of acquiring instruments in this manner (the exercise price of the
call option plus the premium paid) may be less than the cost of acquiring
the instruments directly.
The success of the Fund's hedging activities in reducing risks
depends on many factors, the most significant of which is the Adviser's
ability to predict market interest rate changes correctly. Generally
speaking, selling futures contracts, purchasing put options and writing
call options are strategies designed to protect against falling security
prices, and can limit potential gains if prices rise. Purchasing futures
17
<PAGE>
contracts, purchasing call options and writing put options are strategies
whose returns tend to rise and fall together with security prices, and can
cause losses if prices fall. If security prices remain unchanged over
time, option writing strategies tend to be profitable, while option buying
strategies tend to decline in value. However, there may not be perfect
correlation between movements in the price of an option or futures
contract and movements in the price of the underlying security.
The Fund could also be exposed to risks if it could not close out
its futures or options positions because of an illiquid secondary market.
The Adviser attempts to minimize the possible negative effects of these
factors through careful selection and monitoring of the Fund's futures and
options positions. The Adviser is of the opinion that the Fund's
investments in futures transactions will not have a material adverse
effect on the Fund's liquidity or ability to honor redemptions.
The purchase and sale of options and futures contracts involve
risks different from those involved with direct investments in securities,
and also require different skills by the Adviser in managing the Fund's
portfolio. While utilization of options, futures contracts and similar
instruments may be advantageous to the Fund, if the Adviser is not
successful in employing such instruments in managing the Fund's
investments or in predicting interest rate changes, the Fund's performance
will be worse than if the Fund had not made such investments. In addition,
the Fund will pay commissions and other costs in connection with such
investments, which may increase the Fund's expenses and reduce its yield.
A more complete discussion of the possible risks involved in transactions
in options and futures contracts is contained in the Statement of
Additional Information. The Fund's current policy is to limit options and
futures transactions to those described above.
The Fund will not enter into any futures contracts or related
options if the sum of the initial margin deposits on futures contracts and
related options and premiums paid for related options the Fund has
purchased would exceed 5% of the Fund's total assets. The Fund will not
purchase futures contracts or related options if, as a result, more than
33-1/3% of the Fund's total assets would be so invested.
Portfolio Turnover
For the year ended December 31, 1994, the Fund's portfolio
turnover rate was 315.7% and the Fund anticipates that in the future its
portfolio turnover rate may exceed 300%. The portfolio turnover rate is
computed by dividing the lesser of purchases or sales of securities for
the period by the average value of portfolio securities for that period.
Short-term securities are excluded from the calculation. A portfolio
turnover rate in excess of 100% will involve correspondingly greater
transaction costs which will be borne directly by the Fund. It may also
increase the amount of short-term capital gains, if any, realized by the
Fund and will affect the tax treatment of distributions paid to
shareholders because distributions of net short-term capital gains are
taxable as ordinary income.
How to Purchase and Redeem Shares
18
<PAGE>
Institutional Clients of Fairfield Group, Inc. may purchase
Navigator Shares from Fairfield, the principal offices of which are
located at 200 Gibraltar Road, Horsham, Pennsylvania 19044. Other
investors eligible to purchase Navigator Shares may purchase them through
a brokerage account with Legg Mason Wood Walker, Inc. ("Legg Mason").
(Legg Mason and Fairfield are wholly owned subsidiaries of Legg Mason,
Inc., a financial services holding company.)
Purchase of Shares
The minimum investment is $50,000 for the initial purchase of
Navigator Shares and $100 for each subsequent investment. The Fund
reserves the right to change these minimum amounts at its discretion.
Institutional Clients may set different minimums for their Customers'
investments in Accounts invested in Navigator Shares.
Share purchases will be processed at the net asset value next
determined after Legg Mason or Fairfield has received your order; payment
must be made within five business days to the selling organization.
Beginning in June, 1995, payment must be made within three business days
to the selling organization. Orders received by Legg Mason or Fairfield
before the close of regular trading on the New York Stock Exchange, Inc.
("Exchange") (normally 4:00 p.m. Eastern time) ("close of the Exchange")
on any day the Exchange is open will be executed at the net asset value
determined as of the close of the Exchange on that day. Orders received
by Legg Mason or Fairfield after the close of the Exchange or on days the
Exchange is closed will be executed at the net asset value determined as
of the close of the Exchange on the next day the Exchange is open. See
"How Net Asset Value is Determined" on page 16. The Fund reserves the
right to reject any order for shares of the Fund, to suspend the offering
of shares for a period of time, or to waive any minimum investment
requirements.
In addition to Institutional Clients purchasing shares directly
from Fairfield, Navigator Shares may be purchased through procedures
established by Fairfield in connection with requirements of Customer
Accounts of various Institutional Clients.
No sales charge is imposed by the Fund in connection with the
purchase of Navigator Shares. Depending upon the terms of a particular
Customer Account, however, Institutional Clients may charge their
Customers fees for automatic investment and other cash management services
provided in connection with investments in the Fund. Information
concerning these services and any applicable charges will be provided by
the Institutional Clients. This Prospectus should be read by Customers in
connection with any such information received from the Institutional
Clients. Any such fees, charges or other requirements imposed by an
Institutional Client upon its Customers will be in addition to the fees
and requirements described in this Prospectus.
Redemption of Shares
Shares may ordinarily be redeemed by a shareholder via telephone,
in accordance with the procedures described below. However, Customers of
19
<PAGE>
Institutional Clients wishing to redeem shares held in Customer Accounts
at the Institution may redeem only in accordance with instructions and
limitations pertaining to their Account at the Institution.
Fairfield clients can make telephone redemption requests by
calling Fairfield at 1-800-441-3885. Legg Mason clients should call their
investment executives or Legg Mason Funds Processing at 1-800-822-5544.
Callers should have available the number of shares (or dollar amount) to
be redeemed and their account number.
Orders for redemption received by Legg Mason or Fairfield, before
the close of the Exchange on any day when the Exchange is open, will be
transmitted to Boston Financial Data Services ("BFDS"), transfer agent for
the Fund, for redemption at the net asset value per share determined as of
the close of the Exchange on that day. Requests for redemption received by
the transfer agent after the close of the Exchange will be executed at the
net asset value determined as of the close of the Exchange on its next
trading day. A redemption request received by Legg Mason or Fairfield may
be treated as a request for repurchase and, if it is accepted by Legg
Mason, your shares will be purchased at the net asset value per share
determined as of the next close of the Exchange.
Shareholders may have their telephone redemption requests paid by
a direct wire to a domestic commercial bank account previously designated
by the shareholder, or mailed to the name and address in which the
shareholder's account is registered with the Fund. Such payments will
normally be transmitted on the next business day following receipt of a
valid request for redemption. However, the Fund reserves the right to
take up to seven days to make payment upon redemption if, in the judgment
of the Adviser, the Fund could be adversely affected by immediate payment.
(The Statement of Additional Information describes several other
circumstances in which the date of payment may be postponed or the right
of redemption suspended.) The proceeds of your redemption or repurchase
may be more or less than your original cost. If the shares to be redeemed
or repurchased were paid for by check (including certified or cashier's
checks) within 15 business days of the redemption or repurchase request,
the proceeds may not be disbursed unless the Fund can be reasonably
assured that the check has been collected.
The Fund will not be responsible for the authenticity of
redemption instructions received by telephone, provided it follows
reasonable procedures to identify the caller. The Fund may request
identifying information from callers or employ identification numbers. The
Fund may be liable for losses due to unauthorized or fraudulent
instructions if it does not follow reasonable procedures. Telephone
redemption privileges are available automatically to all shareholders
unless certificates have been issued. Shareholders who do not wish to have
telephone redemption privileges should call their investment executive for
further instructions.
Because of the relatively high cost of maintaining small
accounts, the Fund may elect to close any account with a current value of
20
<PAGE>
less than $500 by redeeming all of the shares in the account and mailing
the proceeds to the investor. However, the Fund will not redeem accounts
that fall below $500 solely as a result of a reduction in net asset value
per share. If the Fund elects to redeem the shares in an account, the
shareholder will be notified that the account is below $500 and will be
allowed 60 days in which to make an additional investment in order to
avoid having the account closed.
How Shareholder Accounts are Maintained
A shareholder account is established automatically for each
investor. Any shares the investor purchases or receives as a dividend or
other distribution will be credited directly to the account at the time of
purchase or receipt. No certificates are issued unless the shareholder
specifically requests them in writing. Shareholders who elect to receive
certificates can redeem their shares only by mail. Certificates will be
issued in full shares only. No certificates will be issued for shares
prior to 15 business days after purchase of such shares by check unless
the Fund can be reasonably assured during that period that payment for the
purchase of such shares has been collected. Fund shares may not be held
in, or transferred to, an account with any brokerage firm other than
Fairfield, Legg Mason or their affiliates.
Every shareholder of record will receive a confirmation of each
new share transaction with the Fund, which will also show the total number
of shares being held in safekeeping by the Fund's Transfer Agent for the
account of the shareholder.
Navigator Shares sold to Institutional Clients acting in a
fiduciary, advisory, custodial, or other similar capacity on behalf of
persons maintaining Customer Accounts at Institutional Clients will
normally be held of record by the Institutional Clients. Therefore, in
the context of Institutional Clients, references in this Prospectus to
shareholders mean the Institutional Clients rather than their Customers.
Institutional Clients purchasing or holding Navigator Shares on behalf of
their customers are responsible for the transmission of purchase and
redemption orders (and the delivery of funds) to the Fund on a timely
basis.
How Net Asset Value Is Determined
Net asset value per share is determined daily as of the close of
the Exchange, on every day that the Exchange is open, by subtracting the
liabilities attributable to Navigator Shares from the total assets
attributable to such shares and dividing the result by the number of
Navigator Shares outstanding. Securities owned by the Fund for which
market quotations are readily available are valued at current market
value. In the absence of readily available market quotations, securities
are valued at fair value as determined by the Corporation's Board of
Directors.
Dividends and Other Distributions
21
<PAGE>
The Fund declares dividends to holders of Navigator Shares out of
its investment company taxable income attributable to those shares, which
consists of net investment income and net short-term capital gain.
Dividends from net investment income are declared daily and paid monthly.
Shareholders begin to earn dividends on their Fund shares as of settlement
date, which is normally the fifth business day after their orders are
placed with their investment executive. Beginning in June, 1995,
settlement date will normally be the third business day after orders are
placed with their investment executive. Dividends from net short-term
capital gain and distributions of substantially all net capital gain (the
excess of net long-term capital gain over net short-term capital loss)
generally are declared and paid after the end of the taxable year in which
the gain is realized. A second distribution of net capital gain may be
necessary in some years to avoid imposition of the excise tax described
under the heading "Additional Tax Information" in the Statement of
Additional Information. Shareholders may elect to:
1. Receive both dividends and capital gain distributions in
Navigator Shares of the Fund;
2. Receive dividends in cash and capital gain distributions in
Navigator Shares of the Fund;
3. Receive dividends in Navigator Shares of the Fund and capital
gain distributions in cash; or
4. Receive both dividends and capital gain distributions in cash.
In certain cases, shareholders may reinvest dividends and capital
gain distributions in shares of another Navigator fund. Please contact
your investment executive for additional information on this option.
Qualified retirement plans that obtained Navigator Shares through exchange
generally receive dividends and other distributions in additional shares.
If no election is made, both dividends and other distributions
will be credited to the Institutional Client's account in Navigator Shares
at the net asset value of the shares determined as of the close of the
Exchange on the reinvestment date. Shares received pursuant to any of the
first three (reinvestment) elections above also will be credited to the
account at that net asset value. If an investor elects to receive
dividends or other distributions in cash, a check will be sent. Investors
purchasing through Fairfield may elect at any time to change the
distribution option by notifying the Fund in writing at: Navigator U.S.
Government Intermediate-Term Portfolio, c/o Fairfield Group, Inc., 200
Gibraltar Road, Horsham, Pennsylvania 19044. Those purchasing through
Legg Mason should write to Navigator U.S. Government Intermediate-Term
Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476, Baltimore,
Maryland, 21203-1476. An election must be received at least 10 days
before the record date in order to be effective for dividends and capital
gain distributions paid to shareholders as of that date.
Tax Treatment of Dividends and Other Distributions
22
<PAGE>
The Fund intends to continue to qualify for treatment as a
regulated investment company under the Code so that it will be relieved of
federal income tax on that part of its investment company taxable income
and net capital gain that is distributed to its shareholders.
Dividends from the Fund's investment company taxable income
(whether paid in cash or reinvested in Navigator Shares) are taxable to
its shareholders (other than qualified retirement plans) as ordinary
income to the extent of the Fund's earnings and profits. Distributions of
the Fund's net capital gain (whether paid in cash or reinvested in
Navigator Shares), when designated as such, are taxable to those
shareholders as long-term capital gain, regardless of how long they have
held their Fund shares.
The Fund sends each shareholder a notice following the end of
each calendar year specifying the amounts of all dividends and capital
gain distributions paid (or deemed paid) during that year. The Fund is
required to withhold 31% of all dividends, capital gain distributions and
redemption proceeds payable to any individuals and certain other
noncorporate shareholders who do not provide the Fund with a certified
taxpayer identification number. The Fund also is required to withhold 31%
of all dividends and capital gain distributions payable to such
shareholders who otherwise are subject to backup withholding.
A redemption of Fund shares may result in taxable gain or loss to
the redeeming shareholder, depending on whether the redemption proceeds
are more or less than the shareholder's adjusted basis for the redeemed
shares. An exchange of Fund shares for shares of another Legg Mason fund
will generally have similar tax consequences. If Fund shares are
purchased within 30 days before or after redeeming other Fund shares
(regardless of class) at a loss, all or part of that loss will not be
deductible and instead will increase the basis of the newly purchased
shares.
A dividend or capital gain distribution paid shortly after shares
have been purchased, although in effect a return of investment, is subject
to federal income tax. Accordingly, an investor should recognize that a
purchase of Fund shares immediately prior to the record date for a
dividend or capital gain distribution could cause the investor to incur
tax liabilities and should not be made solely for the purpose of receiving
the dividend or capital gain distribution.
The foregoing is only a summary of some of the important federal
tax considerations generally affecting the Fund and its shareholders; see
the Statement of Additional Information for a further discussion. In
addition to federal income tax, you may also be subject to state and local
income taxes on distributions from the Fund, depending on the laws of your
home state and locality, though the portion of the dividends paid by the
Fund attributable to direct U.S. government obligations is not subject to
state and local income taxes in most jurisdictions. The Fund's annual
23
<PAGE>
notice to shareholders regarding the amount of dividends identifies this
portion. Prospective shareholders are urged to consult their tax advisers
with respect to the effects of this investment on their own tax
situations.
Shareholder Services
Confirmations and Reports
Shareholders will receive from the distributor a confirmation
after each transaction (except a reinvestment of dividends or capital gain
distributions). An account statement will be sent to each shareholder
monthly unless there has been no activity in the account, in which case an
account statement will be sent quarterly. Reports will be sent to
shareholders at least semiannually showing the Fund's portfolio and other
information. The annual report will contain financial statements audited
by the Corporation's independent accountants.
Confirmations for purchases and redemptions of Navigator Shares
made by Institutional Clients acting in a fiduciary, advisory, custodial,
or other similar capacity on behalf of persons maintaining Customer
Accounts at Institutional Clients will be sent to the Institutional
Client. Beneficial ownership of shares by Customer Accounts will be
recorded by the Institutional Client and reflected in the regular account
statements provided by them to their Customers.
Shareholder inquiries should be addressed to "Navigator U.S.
Government Intermediate-Term Portfolio, c/o Legg Mason Funds Processing,
P.O. Box 1476, Baltimore, Maryland 21203-1476" or "c/o Fairfield Group
Inc., 200 Gibraltar Road, Horsham, Pennsylvania 19044."
Exchange Privilege
Holders of Navigator Shares are entitled to exchange them for
Navigator Shares of the following funds, provided the shares to be
acquired are eligible for sale under applicable state securities laws:
Navigator Money Market Fund, Inc. -- Prime Obligations Portfolio
A money market fund seeking to provide as high a level of current
interest income as is consistent with liquidity and relative stability of
principal.
Navigator Tax-Free Money Market Fund, Inc. -- Navigator Tax-Free Money
Market Fund
A money market fund seeking to provide its shareholders with as
high a level of current interest income that is exempt from federal income
taxes as is consistent with liquidity and relative stability of principal.
Navigator Value Trust
A mutual fund seeking long-term growth of capital.
Navigator Special Investment Trust
24
<PAGE>
A mutual fund seeking capital appreciation by investing
principally in issuers with market capitalizations of less than $2.5
billion.
Navigator Total Return Trust
A mutual fund seeking capital appreciation and current income in
order to achieve an attractive total investment return consistent with
reasonable risk.
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current
income consistent with stability of principal.
Investments by exchange into the other Navigator funds are made
at the per share net asset value determined on the same business day as
redemption of the Fund shares you wish to exchange. To obtain further
information concerning the exchange privilege and prospectuses of other
Navigator funds, or to make an exchange, please contact your investment
executive. To effect an exchange by telephone, please call your investment
executive with the information described in the section "How to Purchase
and Redeem Shares," page 13. The Fund reserves the right to modify or
terminate the exchange privilege upon 60 days' notice to shareholders.
There is no assurance that the money market funds will be able to
maintain a $1.00 share price. None of the funds is insured or guaranteed
by the U.S. Government.
The Fund's Board of Directors, Manager and Investment Adviser
Board of Directors
The business and affairs of the Fund are managed under the
direction of the Corporation's Board of Directors.
Manager
Pursuant to a management agreement with the Fund ("Management
Agreement"), which was approved by the Corporation's Board of Directors,
Legg Mason Fund Adviser, Inc., a wholly owned subsidiary of Legg Mason,
Inc., serves as the Fund's manager. The Manager manages the non-investment
affairs of the Fund, directs all matters related to the operation of the
Fund and provides office space and administrative staff for the Fund. The
Fund pays the Manager, pursuant to the Management Agreement, a fee equal
to an annual rate of 0.55% of the Fund's average daily net assets.
The Manager acts as manager, investment adviser or investment
consultant to fifteen investment company portfolios (excluding the Fund)
which had aggregate assets under management of over $3.8 billion as of
February 28, 1995. The Manager's address is 111 South Calvert Street,
Baltimore, Maryland 21202. The Fund's Manager has agreed that until
October 31, 1995 or when the Fund reaches net assets of $400 million,
whichever occurs first, it will continue to reimburse fees and/or assume
other expenses to the extent the Fund's expenses (exclusive of taxes,
25
<PAGE>
interest, brokerage and extraordinary expenses) exceed during any month an
annual rate of 0.45% (Navigator Shares) of the Fund's average daily net
assets for such month.
Investment Adviser
Western Asset Management Company, another wholly owned subsidiary
of Legg Mason, Inc., serves as investment adviser to the Fund pursuant to
the terms of an Investment Advisory Agreement with the Manager, which was
approved by the Corporation's Board of Directors. The Adviser manages the
investment and other affairs of the Fund and directs the investments of
the Fund in accordance with its investment objective, policies and
limitations. For these services, the Manager (not the Fund) pays the
Adviser a fee, computed daily and payable monthly, at an annual rate equal
to 40% of the fee received by the Manager, or 0.22% of the Fund's average
daily net assets.
An investment committee has been responsible for the day-to-day
management of the Fund since its inception.
The Adviser also renders investment advice to eleven open-end
investment companies and one closed-end investment company, which together
had aggregate assets under management of approximately $2.3 billion as of
February 28, 1995. The Adviser also renders investment advice to private
accounts with fixed income assets under management of approximately $10.8
billion as of that date. The address of the Adviser is 117 East Colorado
Boulevard, Pasadena, California 91105.
The Adviser has managed fixed income portfolios continuously
since its founding in 1971, and has focused exclusively on such accounts
since 1984.
In managing fixed-income portfolios, the Adviser first studies
the range of factors that influence interest rates and develops a
long-term interest rate forecast. It then allocates available funds to
those sectors of the market (for example, government, corporate, or
mortgage-backed securities), which it considers most attractive. Then it
selects the specific issues which it believes represent the best values.
All three decisions are integral parts of the Adviser's portfolio
management process and contribute to its performance record.
The Fund's Distributor
Legg Mason is the distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of shares of the Fund, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional information and periodic reports used in
connection with the offering to prospective investors, after the
26
<PAGE>
prospectuses, statements of additional information and reports have been
prepared, set in type and mailed to existing shareholders at the Fund's
expense, and for any supplementary sales literature and advertising costs.
Legg Mason also receives a fee from BFDS for assisting it with
its transfer agent and shareholder servicing functions. For the period
ended December 31, 1994, Legg Mason received $2 for performing such
services in connection with this Fund.
Fairfield Group, Inc., a wholly owned subsidiary of Legg Mason,
Inc., is a registered broker-dealer with principal offices located at 200
Gibraltar Road, Horsham, Pennsylvania 19044. Fairfield sells Navigator
Shares pursuant to a Dealer Agreement with the Fund's Distributor, Legg
Mason. Neither Fairfield nor Legg Mason receives compensation from the
Fund for selling Navigator Shares.
The Chairman, President and Treasurer of the Corporation are
employed by Legg Mason.
Description of the Corporation and its Shares
The Corporation is a diversified open-end investment company
which was incorporated in Maryland on April 28, 1987. The Articles of
Incorporation of the Corporation permit the Board of Directors to create
additional series (or portfolios), each of which issues a separate class
of shares. There are currently four portfolios of the Corporation,
including the Fund. While additional series may be created in the future,
there is no intention at this time to form any particular additional
series.
The Corporation has authorized one billion shares of common
stock, par value $.001 per share. The Fund currently offers two classes of
shares -- Navigator Class and Class A (known as "Primary Shares"). Each
class represents interests in the same pool of assets of the Fund. A
separate vote is taken by a class of shares of the Fund if a matter
affects just that class of shares. Each class of shares may bear
differing class-specific expenses. Salespersons and others entitled to
receive compensation for selling or servicing Fund shares may receive more
with respect to one class than another.
The initial and subsequent investment minimums for Primary Shares
are $1,000 and $100, respectively. Investments in Primary Shares may be
made through a Legg Mason or Affiliated Investment Executive, through the
Future First Systematic Investment Plan or through automatic investment
arrangements.
Holders of Primary Shares bear distribution and service fees
under Rule 12b-1 at the rate of 0.50% of the net assets attributable to
Primary Shares. Investors in Primary Shares may elect to receive
dividends and/or capital gain distributions in cash through the receipt of
a check or a credit to their Legg Mason account. The per share net asset
value of the Navigator Class of Shares, and dividends and distributions
(if any) paid to Navigator shareholders, are generally expected to be
higher than those of Primary Shares of the Fund, because of the lower
expenses attributable to Navigator Shares. The per share net asset value
27
<PAGE>
of the classes of shares will tend to converge, however, immediately after
the payment of ordinary income dividends. Primary Shares of the Fund may
be exchanged for the corresponding class of shares of other Legg Mason
Funds. Investments by exchange into the Legg Mason Funds sold with an
initial sales charge are made at the per share net asset value, plus the
sales charge, determined on the same business day as redemption of the
Fund shares the investors in Primary Shares wish to redeem.
The Fund's Manager has agreed that until October 31, 1995 or when
the Fund reaches net assets of $400 million, whichever occurs first, it
will continue to reimburse management fees and/or assume other expenses to
the extent the expenses of Primary Shares (exclusive of taxes, interest,
brokerage and extraordinary expenses) exceed during any month an annual
rate of 0.95% of the average daily net assets of Primary Shares for such
month. Reimbursement by the Manager reduces Fund expenses and increases
its yield and total return.
The Board of Directors of the Fund does not anticipate that there
will be any conflicts among the interests of the holders of the different
classes of Fund shares. On an ongoing basis, the Board will consider
whether any such conflict exists and, if so, take appropriate action.
Shareholders of the Fund are entitled to one vote per share and
fractional votes for fractional shares held. Voting rights are not
cumulative. All shares of the Fund are fully paid and nonassessable and
have no preemptive or conversion rights.
Shareholder meetings will not be held except where the 1940 Act
requires a shareholder vote on certain matters (including the election of
directors, approval of an advisory contract, and approval of a plan of
distribution pursuant to Rule 12b-1). The Corporation will call a special
meeting of the shareholders at the request of 10% or more of the shares
entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the Fund at 111 South Calvert Street,
Baltimore, Maryland 21202, stating the purpose of the proposed meeting and
the matters to be acted upon.
28
<PAGE>
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Highlights 2
Fund Expenses 3
Financial Highlights 4
Performance Information 5
The Fund's Investment Objective and
Policies 6
How You Can Invest in the Fund 13
How Your Shareholder Account is Maintained 14
How You Can Redeem Your Fund Shares 14
How Net Asset Value is Determined 15
Dividends and Other Distributions 15
Tax Treatment of Dividends and Other
Distributions 16
Shareholder Services 17
Investing through Tax-Deferred Retirement
Plans 18
The Fund's Board of Directors, Manager and
Investment Adviser 18
The Fund's Distributor 19
Description of the Corporation and its
Shares 20
</TABLE>
ADDRESSES
DISTRIBUTOR:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000 800 (Bullet) 822 (Bullet) 5544
TRANSFER AND SHAREHOLDER SERVICING AGENT:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
COUNSEL:
Kirkpatrick & Lockhart
1800 M Street, N.W., Washington, DC 20036
INDEPENDENT ACCOUNTANTS:
Coopers & Lybrand L.L.P.
217 East Redwood Street, Baltimore, Maryland 21202
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS OR THE STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THE PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR
BY THE PRINCIPAL UNDERWRITER IN ANY JURISDICTION IN WHICH SUCH OFFERING
MAY NOT LAWFULLY BE MADE.
PRINTED ON RECYCLED PAPER
LMF-021
PROSPECTUS
MAY 1, 1995
LEGG MASON
INVESTMENT
GRADE
INCOME
PORTFOLIO
PUTTING YOUR FUTURE FIRST
(Logo of Legg Mason appears here)
<PAGE>
THE LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
PROSPECTUS
The Legg Mason Investment Grade Income Portfolio ("Fund") is a
professionally managed portfolio seeking to provide investors with a high
level of current income through investment in a diversified portfolio of
debt securities. The Fund is a separate portfolio of Legg Mason Income
Trust, Inc. ("Corporation"), a diversified open-end management investment
company which currently has four portfolios. In seeking to achieve the
Fund's objective, the Fund's investment adviser, Western Asset Management
Company ("Adviser"), under normal circumstances, invests primarily in debt
securities which the Adviser considers to be of investment grade, i.e.,
securities rated within the four highest grades by Moody's Investors
Service, Inc. or Standard & Poor's Ratings Group, securities comparably
rated by another nationally recognized statistical rating organization, or
unrated securities judged by the Adviser to be of comparable quality.
The Adviser believes that shares of the Fund may be appropriate both
for direct investment and for investment in Individual Retirement Accounts
and other qualified retirement plans.
No initial sales charge is payable on purchases, and no redemption
charge is payable on sales, of shares of the Fund. The Fund pays
management fees to its Manager, Legg Mason Fund Adviser, Inc. ("Manager"),
and distribution fees to its Distributor, Legg Mason Wood Walker,
Incorporated ("Legg Mason"), as described on pages 18 and 19 of this
Prospectus.
This Prospectus sets forth concisely the information about the Fund
that a prospective investor ought to know before investing. It should be
retained for future reference. A Statement of Additional Information about
the Fund dated May 1, 1995 has been filed with the Securities and Exchange
Commission ("SEC") and, as amended or supplemented from time to time, is
incorporated herein by reference. The Statement of Additional Information
is available without charge upon request from Legg Mason (address and
telephone numbers listed below).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Dated: May 1, 1995
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
800 (Bullet) 822 (Bullet) 5544
<PAGE>
PROSPECTUS HIGHLIGHTS
THE LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
The following summary is qualified in its entirety by the more
detailed information appearing in the body of this Prospectus.
FUND TYPE:
The Fund is a separate portfolio of Legg Mason Income Trust, Inc., an
open-end, diversified management investment company. You may purchase or
redeem shares of the Fund through a brokerage account with Legg Mason or
certain of its affiliates. See "How You Can Invest in the Fund," page 13,
and "How You Can Redeem Your Fund Shares," page 14.
FUND STARTED:
August 7, 1987
NET ASSETS:
Over $69.6 million as of February 28, 1995
INVESTMENT OBJECTIVE AND POLICIES:
The Fund's investment objective is to provide investors with a high
level of current income through investment in a diversified portfolio of
debt securities. The Fund attempts to meet its objective primarily through
the purchase of debt securities which the Adviser considers to be of
investment grade. Of course, there can be no assurance that the Fund will
achieve its objective. The value of the debt instruments held by the Fund,
and thus the net asset value of Fund shares, generally fluctuates
inversely with movements in market interest rates. Certain investment
grade debt securities in which the Fund invests may have speculative
characteristics. The Fund may invest up to 25% of its assets in debt
securities rated below investment-grade, commonly known as "junk bonds."
Such securities are considered speculative and involve increased risk
exposure to adverse business and economic conditions. The Fund's
participation in hedging and option income strategies also involves
certain investment risks and transaction costs. See "The Fund's Investment
Objective and Policies," page 6, and "Risks of Lower Rated Debt
Securities," page 9.
DISTRIBUTOR :
Legg Mason Wood Walker, Incorporated
MANAGER AND ADVISER :
Legg Mason Fund Adviser, Inc. serves as the Fund's manager, and
Western Asset Management Company serves as investment adviser to the Fund.
TRANSFER AND SHAREHOLDER SERVICING AGENT :
Boston Financial Data Services
CUSTODIAN:
State Street Bank and Trust Company
EXCHANGE PRIVILEGE:
All funds in the Legg Mason Family of Funds. See "Exchange Privilege,"
page 17.
DIVIDENDS :
Declared daily and paid monthly.
REINVESTMENT :
All dividends and other distributions are automatically reinvested in
Fund shares unless cash payments are requested.
INITIAL PURCHASE:
$1,000 minimum, generally.
SUBSEQUENT PURCHASES:
$100 minimum, generally. See "How You Can Invest in the Fund," page
13.
PURCHASE METHODS:
Send bank/personal check or wire federal funds.
PUBLIC OFFERING PRICE PER SHARE:
Net asset value
2
<PAGE>
FUND EXPENSES
The purpose of the following table is to assist an investor in understanding
the various costs and expenses that an investor in the Fund will bear directly
or indirectly. The expenses and fees set forth in the table are based on average
net assets and annual Fund operating expenses for the year ended December 31,
1994, adjusted for current expense and fee waiver levels.
<TABLE>
<S> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum sales charge on purchases or
reinvested dividends None
Redemption and exchange fees None
ANNUAL FUND OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Management fees 0.60 %
12b-1 fees 0.50 %
Other expenses 0.30 %
Less: Reimbursements(1) (0.50)%
Total operating expenses 0.90 %
</TABLE>
(1) The Fund's expense ratio would have been 1.40% had the Fund's Manager not
agreed to reimburse the Fund for management and distribution fees and other
expenses pursuant to a voluntary expense limitation. The reimbursement
agreement, wherein the Manager has agreed to continue to reimburse the Fund for
management fees and/or assume other expenses to the extent the Fund's expenses
(exclusive of taxes, interest, brokerage and extraordinary expenses) exceed
during any month an annual rate of 0.90% of the Fund's average daily net assets
for such month, will remain in effect until October 31, 1995, or until the
Fund's net assets reach $100 million, whichever occurs first, and unless
extended will terminate on that date.
Because the Fund pays 12b-1 fees, long-term shareholders may pay more in
distribution expenses than the economic equivalent of the maximum front-end
sales charge permitted by the National Association of Securities Dealers, Inc.
("NASD"). For further information concerning Fund expenses, see "The Fund's
Board of Directors, Manager and Investment Adviser," page 18.
EXAMPLE OF EFFECT OF FUND EXPENSES
The following example illustrates the expenses that you would pay on a
$1,000 investment over various time periods assuming (1) a 5% annual rate of
return and (2) full redemption at the end of each time period. As noted in the
table above, the Fund charges no redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
<S> <C> <C> <C>
$9 $29 $50 $111
</TABLE>
This example assumes that all dividends and other distributions are
reinvested and that the percentage amounts listed under "Annual Fund Operating
Expenses" remain the same over the time periods shown. The above tables and the
assumption in the example of a 5% annual return are required by regulations of
the SEC applicable to all mutual funds. THE ASSUMED 5% ANNUAL RETURN IS NOT A
PREDICTION OF, AND DOES NOT REPRESENT, THE FUND'S PROJECTED OR ACTUAL
PERFORMANCE. THE ABOVE TABLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. The
Fund's actual expenses will depend upon, among other things, the level of
average net assets, the levels of sales and redemptions of shares, and the
extent to which the Fund incurs variable expenses, such as transfer agency
costs.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights for the period August 7, 1987 (commencement of
operations) to December 31, 1987 and for the years ended December 31, 1988
through 1994 have been derived from financial statements which have been
audited by Coopers & Lybrand L.L.P., independent accountants. The Fund's
financial statements for the year ended December 31, 1994 and the report of
Coopers & Lybrand L.L.P. thereon are included in the Fund's annual report
and are incorporated by reference in the Statement of Additional
Information. The annual report is available to shareholders without charge
by calling your Legg Mason or affiliated investment executive or Legg
Mason's Funds Marketing Department at 800-822-5544.
<TABLE>
<CAPTION>
AUGUST 7, 1987*
FOR THE YEARS ENDED DECEMBER 31, to
1994 1993 1992 1991 1990 1989 1988 DECEMBER 31, 1987
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period $10.40 $10.71 $10.71 $9.97 $10.29 $9.88 $9.94 $10.00
Net investment income 0.60(1) 0.62(1) 0.66(1) 0.76(1) 0.84(1) 0.82(1) 0.78(1) 0.31(1)
Net realized and unrealized gain
(loss) on investments (1.09) 0.33 0.25 0.77 (0.28) 0.41 (0.035) (0.06)
Total from investment operations (0.49) 0.95 0.91 1.53 0.56 1.23 0.745 0.25
Distributions to shareholders:
Net investment income (0.60) (0.62) (0.66) (0.76) (0.84) (0.82) (0.78) (0.31)
Net realized gain on
investments (0.04) (0.63) (0.25) (0.03) (0.04) -- (0.025) --
In excess of net realized gain
on investments -- (0.01) -- -- -- -- -- --
Net asset value, end of period $9.27 $10.40 $10.71 $10.71 $9.97 $10.29 $9.88 $9.94
Total return (4.8)% 11.2% 6.8% 16.0% 5.8% 13.0% 7.7% 2.6%(4)
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses 0.85%(1)(2) 0.85%(1)(2) 0.85%(1)(2) 0.71%(1)(2) 0.50%(1)(2) 0.82%(1)(2) 1.00%(1)(2) 1.00%(1)(2)(3)
Net investment income 6.1%(1) 5.6%(1) 6.1%(1) 7.3%(1) 8.3%(1) 8.1%(1) 7.7%(1) 7.8%(1)(3)
Portfolio turnover rate 200.1% 348.2% 316.7% 212.5% 54.9% 92.4% 146.3% 72.4%(3)
Net assets, end of period
(in thousands) $66,196 $68,781 $48,033 $36,498 $22,994 $13,891 $9,913 $5,661
</TABLE>
* COMMENCEMENT OF OPERATIONS.
(1) NET OF FEES WAIVED AND REIMBURSEMENTS MADE BY THE MANAGER FOR EXPENSES
IN EXCESS OF VOLUNTARY EXPENSE LIMITATIONS AS FOLLOWS: 1.0% UNTIL
SEPTEMBER 10, 1989; 0.5% UNTIL DECEMBER 31, 1990; 0.65% UNTIL APRIL 30,
1991; 0.7% UNTIL OCTOBER 31, 1991; 0.8% UNTIL DECEMBER 31, 1991; AND
0.90% UNTIL OCTOBER 31, 1995.
(2) INCLUDES DISTRIBUTION FEE OF 0.5%
(3) ANNUALIZED.
(4) NOT ANNUALIZED.
4
<PAGE>
PERFORMANCE INFORMATION
From time to time the Fund may quote its total return in advertisements or
in reports or other communications to shareholders. A mutual fund's TOTAL RETURN
is a measurement of the overall change in value, including changes in share
price and assuming reinvestment of dividends and capital gain distributions of
an investment in the fund. CUMULATIVE TOTAL RETURN shows the fund's performance
over a specific period of time. AVERAGE ANNUAL TOTAL RETURN is the average
annual compounded return that would have produced the same cumulative total
return if the fund's performance had been constant over the entire period.
Performance figures reflect past performance and are not intended to indicate
future performance. Average annual returns tend to smooth out variations in the
fund's return, so they differ from actual year-by-year results.
The Fund's total returns as of December 31, 1994 were as follows:
<TABLE>
<CAPTION>
CUMULATIVE AVERAGE ANNUAL
TOTAL RETURN TOTAL RETURN
<S> <C> <C>
One Year - 4.82% - 4.82%
Five Years +38.71 +6.76
Life of Fund(|) +73.07 +7.69
</TABLE>
(|) Fund's inception -- August 7, 1987.
No adjustment has been made for any income taxes payable by shareholders.
The investment return and principal value of an investment in the Fund will
fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost. Returns would have been lower if the Manager had not
waived/reimbursed certain fees and expenses during the fiscal years 1987 through
1994.
The Fund also may advertise its yield or effective yield. Yield reflects net
investment income per share (as defined by applicable SEC regulations) over a
30-day (or one-month) period, expressed as an annualized percentage of net asset
value at the end of the period. The effective yield, although calculated
similarly, will be slightly higher than the yield because it assumes that income
earned from the investment is reinvested (i.e., the compounding effect of
reinvestment). Yield computations differ from other accounting methods and
therefore may differ from dividends actually paid or reported net income.
Further information about the Fund's performance is contained in the annual
report to shareholders, which may be obtained without charge by calling your
Legg Mason or affiliated investment executive or Legg Mason's Funds Marketing
Department at 800-822-5544.
5
<PAGE>
THE FUND'S INVESTMENT OBJECTIVE AND POLICIES
The investment objective of the Fund is to provide investors with a
high level of current income through investment in a diversified portfolio
of debt securities. In seeking to achieve its objective, the Fund invests
primarily in debt securities which the Adviser considers to be of
investment grade, of which some may be privately placed and some may have
equity features. The investment objective of the Fund may not be changed
without a vote of Fund shareholders; however, except as otherwise noted,
the investment policies of the Fund described below may be changed by the
Corporation's Board of Directors without a shareholder vote. There can be
no assurance that the Fund's investment objective will be attained.
In pursuing its objective, under normal circumstances, the Fund
invests at least 75% of its total assets in the following types of
investment grade interest-bearing debt securities:
(1) debt securities which are rated at the time of purchase within the
four highest grades assigned by Moody's Investors Service, Inc.
("Moody's") (Aaa, Aa, A or Baa) or Standard & Poor's Ratings Group ("S&P")
(AAA, AA, A or BBB), securities comparably rated by another nationally
recognized statistical rating organization ("NRSRO"), or unrated
securities judged by the Adviser to be of comparable quality;
(2) securities of, or guaranteed by, the U.S. Government, its agencies
or instrumentalities; and
(3) commercial paper and other money market instruments which are
rated A-1 or A-2 by S&P or Prime-1 or Prime-2 by Moody's at the date of
investment, securities comparably rated by another NRSRO, or unrated
securities judged by the Adviser to be of comparable quality to securities
which may be purchased under item (1); bank certificates of deposit; and
bankers' acceptances.
The remainder of the Fund's assets, not in excess of 25% of its total
assets, may be invested in: (1) debt securities of issuers which are rated
at the time of purchase below Moody's and S&P's four highest grades, but
rated B or better by Moody's or S&P, securities comparably rated by
another NRSRO, or unrated securities judged by the Adviser to be of
comparable quality; (2) securities which may be convertible into or
exchangeable for, or carry warrants to purchase, common stock or other
equity interests (such securities may offer attractive income
opportunities, and the debt securities of certain issuers may not be
available without such features); and (3) preferred stocks, rated no lower
than Ba by Moody's or, if unrated by Moody's, judged by the Adviser to be
of comparable quality.
The Fund currently invests in debt securities with maturities ranging
from short-term (including overnight) up to forty years and anticipates
that it will continue to do so. The Fund expects to maintain its portfolio
of securities so as to have an average dollar-weighted maturity of between
five and twenty years.
The market value of the interest-bearing debt securities held by the
Fund, and therefore the net asset value of Fund shares, is affected by
changes in market interest rates. There is normally an inverse
relationship between the market value of securities sensitive to
prevailing interest rates and actual changes in interest rates; i.e., a
decline in prevailing market interest rates produces an increase in market
value, while an increase in rates produces a decrease in market value.
Moreover, the longer the remaining maturity of a security, the greater is
the effect of interest rate changes on the market value of such a
security. In addition, changes in the ability of an issuer to make
payments of interest and principal and in the market's perception of an
issuer's creditworthiness also affect the market value of the debt
securities of that issuer.
The Fund has adopted certain fundamental investment limitations that,
like its investment objective, may not be changed without the approval of
the Fund's shareholders. A full description of these investment
limitations is included in the Statement of Additional Information.
Corporate Debt Securities
Among the debt securities in which the Fund may invest are those
issued by corporations. In selecting corporate debt securities for the
Fund, the Adviser reviews and monitors the creditworthiness of each issuer
and issue. Interest rate trends and specific developments which the
Adviser believes may affect individual issuers are also analyzed.
6
<PAGE>
U.S. Government Securities
The U.S. government securities in which the Fund may invest include
direct obligations of the U.S. Treasury (such as Treasury bills, notes and
bonds) and obligations issued by U.S. government agencies and
instrumentalities, including securities that are supported by: (1) the
full faith and credit of the United States (such as Government National
Mortgage Association ("GNMA") certificates); (2) the right of the issuer
to borrow from the U.S. Treasury (such as securities of the Federal Home
Loan Banks); (3) the discretionary authority of the U.S. Treasury to lend
to the issuer (such as Federal National Mortgage Association ("FNMA")
securities); and (4) solely by the creditworthiness of the issuer (such as
Federal Home Loan Mortgage Corporation ("FHLMC") securities). Neither the
U.S. Government nor any of its agencies or instrumentalities guarantees
the market value of the securities they issue. Therefore, the market value
of such securities can be expected to fluctuate in response to changes in
interest rates.
Mortgage-Related Securities
The Fund normally may invest up to 50% of its total assets in
mortgage-related securities. Mortgage-related securities represent
interests in pools of mortgages created by lenders such as commercial
banks, savings and loan institutions, mortgage bankers and others.
Mortgage-related securities may be issued by governmental or government-
related entities or by non-governmental entities such as banks, savings
and loan institutions, private mortgage insurance companies, mortgage
bankers and other secondary market issuers.
Interests in pools of mortgage-related securities differ from other
forms of debt securities which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified
call dates. In contrast, mortgage-related securities provide monthly
payments which consist of interest and, in most cases, principal. In
effect, these payments are a "pass-through" of the monthly payments made
by the individual borrowers on their residential mortgage loans, net of
any fees paid to the issuer or guarantor of such securities. Additional
payments to holders of mortgage-related securities are caused by
repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure, net of fees or costs incurred. Some
mortgage-related securities are described as "modified pass-through."
These securities entitle the holders to receive all interest and principal
payments owed on the mortgages in the pool, net of certain fees,
regardless of whether or not the mortgagors actually make the payments.
The Adviser expects that governmental or private entities may create
new types of mortgage-related securities in response to changes in the
market or changes in government regulation of such securities. As new
types of mortgage-related securities are developed and offered to
investors, the Adviser will, consistent with the investment objective and
policies of the Fund, consider making investments in such new types of
securities.
As prepayment rates of individual pools of mortgage loans vary widely,
it is not possible to predict accurately the average life of a particular
mortgage-related security. Although both government and privately-issued
mortgage-related securities are issued with stated maturities of up to
forty years, unscheduled or early payments of principal and interest on
the underlying mortgages may shorten considerably the securities'
effective maturities. On the other hand, a decrease in the rate of
prepayments may extend the effective maturities of mortgage-related
securities, increasing their sensitivity to changes in market interest
rates. Such a decrease in prepayments may result from an increase in
market interest rates, among other causes. The volume of prepayments of
principal on a pool of mortgages underlying a particular mortgage-related
security will influence the yield of that security, and the principal
returned to the Fund may be reinvested in instruments whose yield may be
higher or lower than that which might have been obtained had such
prepayments not occurred. When interest rates are declining, such
prepayments usually increase, with the result that reinvestment of such
principal prepayments will be at a lower rate than that on the original
mortgage-related security. Increased prepayment of principal may limit the
Fund's ability to realize the appreciation in the value of such securities
that would otherwise accompany declining interest rates. An increase in
mortgage prepayments could cause the Fund to incur a loss on a mortgage-
related security that was purchased at a premium. In determining the
Fund's average maturity, the
7
<PAGE>
Adviser must apply certain assumptions and projections about the maturity
and prepayments of mortgage-related securities; actual prepayment rates
may differ.
Government Mortgage-Related Securities
GNMA is the principal federal government guarantor of mortgage-related
securities. GNMA is a wholly owned U.S. government corporation within the
Department of Housing and Urban Development. GNMA pass-through securities
are considered to have a very low risk of default in that (i) the
underlying mortgage loan portfolio is comprised entirely of
government-backed loans and (ii) the timely payment of both principal and
interest on the securities is guaranteed by the full faith and credit of
the U.S. Government -- regardless of whether they have been collected.
Residential mortgage loans are also pooled by FHLMC. FHLMC is a
corporate instrumentality of the U.S. Government that was created by
Congress in 1970 for the purpose of increasing the availability of
mortgage credit for residential housing. FHLMC issues mortgage
participation certificates ("PCs") which represent interests in mortgages
from FHLMC's national portfolio. The mortgage loans in FHLMC's portfolio
are not government-backed; rather, the loans are either uninsured with
loan-to-value ratios of 80% or less, or privately insured if the
loan-to-value ratio exceeds 80%. FHLMC, not the U.S. Government,
guarantees the timely payment of interest and ultimate collection of
principal on FHLMC PCs.
FNMA is a government-sponsored corporation owned entirely by private
stockholders. It is subject to general regulation by the Secretary of
Housing and Urban Development. FNMA purchases residential mortgages from a
list of approved seller/servicers, which include savings and loan
associations, savings banks, commercial banks, credit unions and mortgage
bankers. Pass-through certificates ("FNMA certificates") issued by FNMA
are guaranteed as to timely payment of principal and interest by FNMA, not
the U.S. Government.
Privately Issued Mortgage-Related Securities
Mortgage-related securities offered by private issuers include
pass-through securities comprised of pools of conventional residential
mortgage loans; mortgage-backed bonds which are considered to be
obligations of the institution issuing the bonds and are collateralized by
mortgage loans; and bonds and collateralized mortgage obligations ("CMOs")
which are collateralized by mortgage-related securities issued by FHLMC,
FNMA or GNMA or by pools of conventional mortgages.
CMOs are typically structured with two or more classes or series which
have different maturities and are generally retired in sequence. Each
class of obligations is scheduled to receive periodic interest payments
according to the coupon rate on the obligations. However, all monthly
principal payments and any prepayments from the collateral pool are paid
first to the "Class 1" bondholders. The principal payments are such that
the Class 1 obligations are scheduled to be completely repaid no later
than, for example, five years after the offering date. Thereafter, all
payments of principal are allocated to the next most senior class of bonds
until that class of bonds has been fully repaid. Although full payoff of
each class of bonds is contractually required by a certain date, any or
all classes of obligations may be paid off sooner than expected because of
an increase in the payoff speed of the pool.
Mortgage-related securities created by non-governmental issuers
generally offer a higher rate of interest than government and government-
related securities because there are no direct or indirect government
guarantees of payments in the former securities, resulting in higher
risks. However, many issuers or servicers of mortgage-related securities
guarantee timely payment of interest and principal on such securities.
Timely payment of principal may also be supported by various forms of
insurance, including individual loan, title, pool and hazard policies.
There can be no assurance that the private issuers or insurers will be
able to meet their obligations under the relevant guarantees and insurance
policies, and such guarantees and policies often do not cover the full
amount of the pool. Where privately issued securities are collateralized
by securities issued by FHLMC, FNMA or GNMA, the timely payment of
interest and principal is supported by the government-related securities
collateralizing such obligations.
Since the inception of the mortgage-related pass-through security in
1970, the market for these securities has expanded considerably. The size
of
8
<PAGE>
the primary issuance market and active participation in the secondary
market by securities dealers and many types of investors make government
and government-related pass-through pools highly liquid. Private
conventional pools of mortgages (pooled by commercial banks, savings and
loan institutions and others with no relationship to government and
government-related entities) have also achieved broad market acceptance,
and consequently an active secondary market has emerged. However, the
market for conventional pools is smaller and less liquid than the market
for the government and government-related mortgage pools.
The Fund may purchase some mortgage-related securities through private
placements. In such cases, the securities may be considered illiquid and,
if so, will be subject to the Fund's investment limitation that no more
than 10% of its net assets will be invested in illiquid securities.
Asset-Backed Securities
Asset-backed securities are securities that represent direct or
indirect participations in, or are secured by and payable from, assets
such as motor vehicle installment sales contracts, installment loan
contracts, 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 and special purpose
corporations. The value of such securities partly depends on loan
repayments by individuals, which may be adversely affected during general
downturns in the economy. Payments or distributions of principal and
interest on asset-backed securities may be supported by credit
enhancements, such as various forms of cash collateral accounts or letters
of credit. Like mortgage-related securities, asset-backed securities are
subject to the risk of prepayment. The risk that recovery on repossessed
collateral might be unavailable or inadequate to support payments on
asset-backed securities, however, is greater than is the case for
mortgage-backed securities.
Risks of Lower Rated Debt Securities
Debt securities rated Baa and preferred stock rated ba are deemed by
Moody's to have speculative characteristics. Generally, lower rated debt
securities offer a higher current yield than that provided by higher grade
issues, but involve higher risks. Debt securities rated B by Moody's
"generally lack characteristics of the desirable investment. Assurance of
interest and principal payments or maintenance of other terms of the
contract over any long period of time may be small." S&P states that 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."
Lower rated debt securities are especially affected by adverse changes
in the industries in which the issuers are engaged and by changes in the
financial condition of the issuers. Highly leveraged issuers may also
experience financial stress during periods of rising interest rates.
The market for lower rated debt securities has expanded rapidly in
recent years, which growth parallelled a long economic expansion. At
certain times in the past, the prices of many lower rated debt securities
have declined, indicating concerns that issuers of such securities might
experience financial difficulties. At those times, the yields on lower
rated debt securities rose dramatically, reflecting the risk that holders
of such securities could lose a substantial portion of their value as a
result of the issuers' financial restructuring or default. There can be no
assurance that such declines will not recur.
The market for lower rated debt securities generally is thinner and
less active than that for higher quality securities, which may limit the
Fund's ability to sell such securities at fair value. Judgment plays a
greater role in pricing such securities than is the case for securities
having more active markets. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may also decrease the values
and liquidity of lower rated securities, especially in a thinly traded
market.
If an investment grade security purchased by the Fund is subsequently
given a rating below investment grade, the Adviser will consider that fact
in determining whether to retain that security in the Fund's portfolio,
but is not required to dispose of it.
9
<PAGE>
The table below provides a summary of ratings assigned to debt
holdings in the Fund's portfolio. These figures are dollar-weighted
averages of month-end portfolio holdings during the fiscal year ended
December 31, 1994, presented as a percentage of total investments. These
percentages are historical and are not necessarily indicative of the
quality of current or future portfolio holdings, which may vary.
<TABLE>
<CAPTION>
MOODY'S S&P
<S> <C> <C> <C>
RATINGS AVERAGE RATINGS AVERAGE
Aaa/Aa/A 60.2% AAA/AA/A 62.9%
Baa 19.5% BBB 22.0%
Ba 13.2% BB 13.8%
B 1.6% B 1.3%
NR 5.5% NR -- %
</TABLE>
There were no debt securities not rated by either Moody's or S&P.
Unrated securities are not necessarily lower-quality securities.
Zero Coupon Bonds
Zero coupon bonds are debt obligations which make no fixed interest
payments but instead are issued at a significant discount from face value.
Like other debt securities, the price can also reflect a premium or
discount to the original issue discount reflecting the market's judgment
as to the issuer's creditworthiness, the interest rate or other similar
factors. The discount approximates the total amount of interest the bonds
will accrue and compound over the period until maturity or the first
interest payment date at a rate of interest reflecting the market rate of
the security at the time of issuance. Because zero coupon bonds do not
require the periodic payment of interest, their prices can be very
volatile when market interest rates change.
The original issue discount on zero coupon bonds must be included in
the Fund's income ratably as it accrues. Accordingly, to continue to
qualify for tax treatment as a regulated investment company and to avoid a
certain excise tax, the Fund may be required to distribute as a dividend
an amount that is greater than the total amount of cash it actually
receives. See "Additional Tax Information" in the Statement of Additional
Information. These distributions must be made from the Fund's cash assets
or, if necessary, from the proceeds of sales of portfolio securities. Such
sales could occur at a time which would be disadvantageous to the Fund and
when the Fund would not otherwise choose to dispose of the assets.
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 a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt
or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before conversion,
convertible securities have characteristics similar to non-convertible
debt securities in that they ordinarily provide a stable stream of income
with generally higher yields than those of common stocks of the same or
similar issuers, but lower than the yield on non-convertible debt.
Convertible securities are usually subordinated to comparable-tier
non-convertible securities but rank senior to common stock in a
corporation's capital structure.
The value of a convertible security is a function of (1) its yield in
comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at
market value, if converted into the underlying common stock. Convertible
securities are typically issued by smaller capitalized companies, whose
stock prices may be volatile. The price of a convertible security often
reflects such variations in the price of the underlying common stock in a
way that non-convertible debt does not. A convertible security may be
subject to redemption at the option of the issuer at a price established
in the convertible security's governing instrument, which could have an
adverse effect on the Fund's ability to achieve its investment objective.
The Fund does not intend to exercise conversion rights for any convertible
security it owns and does not intend to hold any security which has been
subject to conversion.
Foreign Securities
The Fund may invest in U.S. dollar-denominated debt securities issued
by foreign companies and governments. The foreign government securities in
which the Fund invests generally consist of
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obligations supported by national, state or provincial governments or
similar political subdivisions. The Fund also may invest in debt
securities of foreign "quasi-government agencies," which are issued by
entities owned by a national, state or equivalent government or are
obligations of a political unit that is not backed by the national
government's full faith and credit and general taxing powers.
Investment in foreign securities presents certain risks, including
those resulting from adverse political and economic developments, reduced
availability of public information concerning issuers and the fact that
foreign issuers generally are not subject to uniform accounting, auditing
and financial reporting standards or to other regulatory practices and
requirements comparable to those applicable to domestic issuers. Moreover,
securities of many foreign issuers may be less liquid and their prices
more volatile than those of comparable domestic issuers. Some foreign
securities are subject to foreign taxes and withholding. Because the
foreign securities in which the Fund invests are U.S. dollar-denominated,
there is no risk of currency fluctuation.
Repurchase Agreements
A repurchase agreement is an agreement under which the Fund acquires
either U.S. government obligations or other high-quality liquid debt
securities from a securities dealer or bank subject to resale at an
agreed-upon price and date. The securities are held for the Fund by State
Street Bank and Trust Company ("State Street"), the Fund's custodian, as
collateral until resold and will be supplemented by additional collateral
if necessary to maintain a total value equal to or in excess of the value
of the repurchase agreement. The Fund bears a risk of loss in the event
that the other party to a repurchase agreement defaults on its obligations
and the Fund is delayed or prevented from exercising its right to dispose
of the collateral securities, which may decline in value in the interim.
The Fund will enter into repurchase agreements only with financial
institutions which the Adviser believes present minimal risk of default
during the term of the agreement based on guidelines established by the
Corporation's Board of Directors. The Fund will not enter into repurchase
agreements of more than seven days' duration if more than 10% of its total
assets would be invested in such agreements and other illiquid
investments.
When-issued Securities
The Fund may enter into commitments to purchase U.S. government
securities or other securities on a when-issued basis. The Fund may
purchase when-issued securities because such securities are often the most
efficiently priced and have the best liquidity in the bond market. As with
the purchase of all securities, when the Fund purchases securities on a
when-issued basis, it assumes the risks of ownership, including the risk
of price fluctuation, at the time of purchase, not at the time of receipt.
However, the Fund does not have to pay for the obligations until they are
delivered to the Fund, which is normally 7 to 15 days later, but could be
considerably longer in the case of some mortgage-backed securities. To
meet that payment obligation, the Fund will set aside cash or liquid high-
quality debt securities equal to the payment that will be due. Depending
on market conditions, the Fund's when-issued purchases could cause its net
asset value to be more volatile, because they will increase the amount by
which the Fund's total assets, including the value of the when-issued
securities held by the Fund, exceed its net assets. The Fund does not
expect that its commitment to purchase when-issued securities will at any
time exceed, in the aggregate, 20% of total assets.
Futures and Options Transactions
In an effort to protect against the effect of adverse changes in
interest rates, the Fund may purchase and sell interest rate futures
contracts and may purchase put options on interest rate futures contracts
and debt securities (practices known as "hedging"). A futures contract is
an agreement by the Fund to buy or sell securities at a specified date and
price. The purchase of a put option on a futures contract allows the Fund,
at its option, to enter into a particular futures contract to sell
securities at any time up to the option's expiration date.
The Fund may purchase put options on interest rate futures contracts
or sell interest rate
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futures contracts (that is, enter into a futures contract to sell the
underlying security) to attempt to reduce the risk of fluctuations in its
share value. The Fund may purchase an interest rate futures contract (that
is, enter into a futures contract to purchase the underlying security) to
attempt to establish more definitely the return on securities the Fund
intends to purchase. The Fund may not use these instruments for
speculation or leverage.
The Fund may seek to enhance its income or hedge the portfolio by
writing (selling) covered call options (i.e., the Fund will own the
underlying instrument while the call is outstanding) and covered put
options (i.e., the Fund will have cash, U.S. government securities or
other high-grade, liquid debt instruments in a segregated account in an
amount not less than the exercise price while the put is outstanding).
The Fund may write call options on securities in its portfolio in an
attempt to realize, through the premium the Fund receives, a greater
current return than would be realized on the securities alone. The Fund
may write put options in an attempt to realize enhanced income when it is
willing to purchase the underlying instrument for its portfolio at the
exercise price. The Fund may also purchase call options for the purpose of
acquiring the underlying instruments for its portfolio. At times, the net
cost of acquiring instruments in this manner (the exercise price of the
call option plus the premium paid) may be less than the cost of acquiring
the instruments directly.
The success of the Fund's hedging activities in reducing risks depends
on many factors, the most significant of which is the Adviser's ability to
predict market interest rate changes correctly. Generally speaking,
selling futures contracts, purchasing put options and writing call options
are strategies designed to protect against falling security prices, and
can limit potential gains if prices rise. Purchasing futures contracts,
purchasing call options and writing put options are strategies whose
returns tend to rise and fall together with security prices, and can cause
losses if prices fall. If security prices remain unchanged over time,
option writing strategies tend to be profitable, while option buying
strategies tend to decline in value. However, there may not be perfect
correlation between movements in the price of an option or futures
contract and movements in the price of the underlying security.
The Fund could also be exposed to risks if it could not close out its
futures or options positions because of an illiquid secondary market. The
Adviser attempts to minimize the possible negative effects of these
factors through careful selection and monitoring of the Fund's futures and
options positions. The Adviser is of the opinion that the Fund's
investments in futures transactions will not have a material adverse
effect on the Fund's liquidity or ability to honor redemptions.
The purchase and sale of options and futures contracts involve risks
different from those involved with direct investments in securities, and
also require different skills by the Adviser in managing the Fund's
portfolio. While utilization of options, futures contracts and similar
instruments may be advantageous to the Fund, if the Adviser is not
successful in employing such instruments in managing the Fund's
investments or in predicting interest rate changes, the Fund's performance
will be worse than if the Fund had not made such investments. In addition,
the Fund will pay commissions and other costs in connection with such
investments, which may increase the Fund's expenses and reduce its yield.
A more complete discussion of the possible risks involved in transactions
in options and futures contracts is contained in the Statement of
Additional Information. The Fund's current policy is to limit options and
futures transactions to those described above.
The Fund will not enter into any futures contracts or related options
if the sum of the initial margin deposits on futures contracts and related
options and premiums paid for related options the Fund has purchased would
exceed 5% of the Fund's total assets. The Fund will not purchase futures
contracts or related options if, as a result, more than 33 1/3% of the
Fund's total assets would be so invested.
Portfolio Turnover
For the year ended December 31, 1994, the Fund's portfolio turnover
rate was 200.1% and the Fund anticipates that in the future its portfolio
turnover rate may exceed 300%. The portfolio turnover rate is computed by
dividing the lesser of purchases or sales of securities for the period by
the average value of portfolio securities for that
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period. Short-term securities are excluded from the calculation. A
portfolio turnover rate in excess of 100% will involve correspondingly
greater transaction costs which will be borne directly by the Fund. It may
also increase the amount of net short-term capital gains, if any, realized
by the Fund and will affect the tax treatment of distributions paid to
shareholders because distributions of net short-term capital gains are
taxable as ordinary income.
HOW YOU CAN INVEST IN THE FUND
You may purchase shares of the Fund through a brokerage account with
Legg Mason or with an affiliate that has a dealer agreement with Legg
Mason (Legg Mason is a wholly owned subsidiary of Legg Mason, Inc., a
financial services holding company). Your Legg Mason or affiliated
investment executive will be pleased to explain the shareholder services
available from the Fund and answer any questions you may have. Documents
available from your Legg Mason or affiliated investment executive should
be completed if you invest in shares of the Fund through an Individual
Retirement Account ("IRA"), Self-Employed Individual Retirement Plan
("Keogh Plan"), Simplified Employee Pension Plan ("SEP") or other
qualified retirement plan.
The minimum initial investment in the Fund for each account, including
investments made by exchange from other Legg Mason funds, is $1,000, and
the minimum investment for each purchase of additional shares is $100,
except as noted below. Initial investments in an IRA account established
on behalf of a nonworking spouse of a shareholder who has an IRA invested
in the Fund require a minimum amount of only $250. Subsequent investments
in an IRA or similar plan also require a minimum amount of $100. However,
once an account is established, the minimum amount for subsequent
investments will be waived if an investment in an IRA or similar plan will
bring the investment for the year to the maximum amount permitted under
the Internal Revenue Code of 1986, as amended ("Code"). For purchases of
shares through payroll deduction plans, the Fund's Future First Systematic
Investment Plan and plans involving automatic payment of funds from
financial institutions or automatic investment of dividends from certain
unit investment trusts, minimum initial and subsequent investments are
lower. The Fund may change these minimum amount requirements at its
discretion. You should always furnish your shareholder account number when
making additional purchases of Fund shares.
There are three ways you can invest in the Fund:
1. THROUGH YOUR LEGG MASON OR AFFILIATED INVESTMENT EXECUTIVE
Fund shares may be purchased through any Legg Mason or affiliated
investment executive. An investment executive will be pleased to open an
account for you, explain to you the shareholder services available from
the Fund, and answer any questions you may have. After you have
established a Legg Mason or affiliated account, you can order shares of
the Fund from your investment executive in person, by telephone or by
mail.
2. THROUGH THE FUTURE FIRST SYSTEMATIC INVESTMENT PLAN
You may also buy shares in the Fund through the Future First
Systematic Investment Plan. Under this plan, you may arrange for automatic
monthly investments in the Fund of $50 or more by authorizing Boston
Financial Data Services ("BFDS"), the Fund's transfer agent, to prepare a
check each month drawn on your checking account. There is no minimum
initial investment. Please contact any Legg Mason or affiliated investment
executive for further information.
3. THROUGH AUTOMATIC INVESTMENTS
Arrangements may be made with some employers and financial
institutions, such as banks or credit unions, for regular automatic
monthly investments of $50 or more in shares of the Fund. In addition, it
may be possible for dividends from certain unit investment trusts to be
invested automatically in Fund shares. Persons interested in establishing
such automatic investment programs should contact the Fund through any
Legg Mason or affiliated investment executive.
Fund shares purchased on behalf of an IRA, Keogh Plan, SEP or other
qualified retirement plan
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will be processed at the net asset value next determined after Legg
Mason's Funds Processing receives a check for the amount of the purchase.
Other share purchases will be processed at the net asset value next
determined after your Legg Mason or affiliated investment executive has
received your order; payment must be made within five business days to
Legg Mason. Beginning in June, 1995, payment must be made within three
business days to Legg Mason. Orders received by your Legg Mason or
affiliated investment executive before the close of business of the New
York Stock Exchange, Inc. ("Exchange") (normally 4:00 p.m. Eastern time)
("close of the Exchange") on any day the Exchange is open will be executed
at the net asset value determined as of the close of the Exchange on that
day. Orders received by your Legg Mason or affiliated investment executive
after the close of the Exchange or on days the Exchange is closed will be
executed at the net asset value determined as of the close of the Exchange
on the next day the Exchange is open. See "How Net Asset Value is
Determined" on page 15. The Fund reserves the right to reject any order
for shares of the Fund or to suspend the offering of shares for a period
of time.
HOW YOUR SHAREHOLDER ACCOUNT IS MAINTAINED
When you initially purchase Fund shares, a shareholder account is
automatically established for you. Any shares that you purchase or receive
as a distribution will be credited directly to your account at the time of
purchase or receipt. No certificates are issued unless you specifically
request them in writing. Shareholders who elect to receive certificates
can redeem their shares only by mail. Certificates will be issued in full
shares only. No certificates will be issued for shares prior to 15
business days after purchase of such shares by check unless the Fund can
be reasonably assured during that period that payment for the purchase of
such shares has been collected. Fund shares may not be held in, or
transferred to, an account with any brokerage firm other than Legg Mason
or its affiliates.
HOW YOU CAN REDEEM YOUR FUND SHARES
There are two ways you can redeem your Fund shares. First, you may
give your Legg Mason or affiliated investment executive an order for
repurchase of your shares. Please have the following information ready
when you call: the number of shares to be redeemed and your shareholder
account number. Second, you may send a written request for redemption to
"Legg Mason Investment Grade Income Portfolio, c/o Legg Mason Funds
Processing, P.O. Box 1476, Baltimore, Maryland 21203-1476."
Requests for redemption in "good order," as described below, received
by your Legg Mason or affiliated investment executive before the close of
the Exchange on any day when the Exchange is open, will be transmitted to
BFDS, transfer agent for the Fund, for redemption at the net asset value
per share determined as of the close of the Exchange on that day. Requests
for redemption received by your Legg Mason or affiliated investment
executive after the close of the Exchange will be executed at the net
asset value determined as of the close of the Exchange on its next trading
day. A redemption request received by your Legg Mason or affiliated
investment executive may be treated as a request for repurchase and, if it
is accepted by Legg Mason, the shares will be purchased at the net asset
value per share determined as of the next close of the Exchange.
Proceeds from your redemption will settle in your Legg Mason brokerage
account two business days after trade date. However, the Fund reserves the
right to take up to seven days to make payment upon redemption if, in the
judgment of the Adviser, the Fund could be adversely affected by immediate
payment. (The Statement of Additional Information describes several other
circumstances in which the date of payment may be postponed or the right
of redemption suspended.) The proceeds of your redemption or repurchase
may be more or less than your original cost. If the shares to be redeemed
or repurchased were paid for by check (including certified or cashier's
checks) within 15 business days of the redemption or repurchase request,
the proceeds may not be disbursed unless the Fund can be reasonably
assured that the check has been collected.
A redemption request will be considered to be received in "good order"
only if:
1. You have indicated in writing the number of shares to be redeemed
and your shareholder account number;
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2. The written request is signed by you and by any co-owner of the
account with exactly the same name or names used in establishing the
account;
3. The written request is accompanied by any certificates representing
the shares that have been issued to you, and you have endorsed the
certificates for transfer or an accompanying stock power exactly as the
name or names appear on the certificates; and
4. The signatures on the written redemption request and on any
certificates for your shares (or an accompanying stock power) have been
guaranteed without qualification by a national bank, a state bank, a
member firm of a principal stock exchange or other entity described in
Rule 17Ad-15 under the Securities Exchange Act of 1934.
Other supporting legal documents may be required from corporations or
other organizations, fiduciaries or persons other than the shareholder of
record making the request for redemption or repurchase. If you have a
question concerning the redemption of Fund shares, contact your Legg Mason
or affiliated investment executive.
The Fund will not be responsible for the authenticity of redemption
instructions received by telephone, provided it follows reasonable
procedures to identify the caller. The Fund may request identifying
information from callers or employ identification numbers. The Fund may be
liable for losses due to unauthorized or fraudulent instructions if it
does not follow reasonable procedures. Telephone redemption privileges are
available automatically to all shareholders unless certificates have been
issued. Shareholders who do not wish to have telephone redemption
privileges should call their Legg Mason or affiliated investment executive
for further instructions.
To redeem your Fund retirement account, a Distribution Request Form
must be completed and returned to Legg Mason Client Services for
processing. This form can be obtained through your Legg Mason or
affiliated investment executive or Legg Mason Client Services in
Baltimore, Maryland.
Because of the relatively high cost of maintaining small accounts, the
Fund may elect to close any account with a current value of less than $500
by redeeming all of the shares in the account and mailing the proceeds to
you. However, the Fund will not redeem accounts that fall below $500
solely as a result of a reduction in net asset value per share. If the
Fund elects to redeem the shares in your account, you will be notified
that your account is below $500 and will be allowed 60 days in which to
make an additional investment in order to avoid having your account
closed.
HOW NET ASSET VALUE IS DETERMINED
Net asset value per Fund share is determined daily, as of the close of
the Exchange, on every day that the Exchange is open, by subtracting the
Fund's liabilities from its total assets and dividing the result by the
number of shares outstanding. Securities owned by the Fund for which
market quotations are readily available are valued at current market
value. In the absence of readily available market quotations, securities
are valued at fair value as determined by the Corporation's Board of
Directors.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund declares dividends to its shareholders out of its investment
company taxable income, which consists of net investment income and net
short-term capital gain. Dividends from net investment income are declared
daily and paid monthly. Shareholders begin to earn dividends on their Fund
shares as of settlement date, which is normally the fifth business day
after their orders are placed with their Legg Mason or affiliated
investment executive. Beginning in June, 1995, settlement date will
normally be the third business day after orders are placed with a Legg
Mason or affiliated investment executive. Dividends from net short-term
capital gain and distributions of substantially all net capital gain (the
excess of net long-term capital gain over net short-term capital loss)
generally are declared and paid after the end of the taxable year in which
the gain is realized. A second distribution of net capital gain may be
necessary in some years to avoid imposition of the excise tax described
under the heading "Additional Tax Information" in the Statement of
Additional Information. Dividends and capital gain distributions, if any,
on shares held in an IRA, Keogh Plan, SEP or
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<PAGE>
other qualified retirement plan and by shareholders maintaining a
Systematic Withdrawal Plan generally are reinvested in Fund shares on the
payment dates. Other shareholders may elect to:
1. Receive both dividends and capital gain distributions in Fund
shares;
2. Receive dividends in cash and capital gain distributions in Fund
shares;
3. Receive dividends in Fund shares and capital gain distributions in
cash; or
4. Receive both dividends and capital gain distributions in cash.
In certain cases, you may reinvest your dividends and capital gain
distributions in shares of another Legg Mason fund. Please contact your
Legg Mason or affiliated investment executive for additional information
about this option.
If no election is made, both dividends and capital gain distributions
will be credited to your account in Fund shares at the net asset value of
the shares determined as of the close of the Exchange on the reinvestment
date. Shares received pursuant to any of the first three (reinvestment)
elections above also will be credited to your account at that net asset
value. If you elect to receive dividends and/or capital gain distributions
in cash, you will be sent a check or will have your Legg Mason account
credited after the payment date. You may elect at any time to change your
option by notifying the Fund in writing at: Legg Mason Investment Grade
Income Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476,
Baltimore, Maryland 21203-1476. Your election must be received at least 10
days before the record date in order to be effective for dividends and
capital gain distributions paid to shareholders as of that date.
TAX TREATMENT OF DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will be relieved of federal
income tax on that part of its investment company taxable income and net
capital gain that is distributed to its shareholders.
Dividends from the Fund's investment company taxable income (whether
paid in cash or reinvested in Fund shares) are taxable to its shareholders
(other than IRAs, Keogh Plans, SEPs, other qualified retirement plans and
other tax-exempt investors) as ordinary income to the extent of the Fund's
earnings and profits. Distributions of the Fund's net capital gain
(whether paid in cash or reinvested in Fund shares), when designated as
such, are taxable to those shareholders as long-term capital gain,
regardless of how long they have held their Fund shares.
The Fund sends each shareholder a notice following the end of each
calendar year specifying, among other things, the amounts of all dividends
and capital gain distributions paid (or deemed paid) during that year. The
Fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to any individuals and
certain other noncorporate shareholders who do not provide the Fund with a
certified taxpayer identification number. The Fund also is required to
withhold 31% of all dividends and capital gain distributions payable to
such shareholders who otherwise are subject to backup withholding.
A redemption of Fund shares may result in taxable gain or loss to the
redeeming shareholder, depending on whether the redemption proceeds are
more or less than the shareholder's adjusted basis for the redeemed
shares. An exchange of Fund shares for shares of any other Legg Mason fund
generally will have similar tax consequences. If Fund shares are purchased
within 30 days before or after redeeming other Fund shares at a loss, all
or part of that loss will not be deductible and instead will increase the
basis of the newly purchased shares.
A dividend or capital gain distribution paid shortly after shares have
been purchased, although in effect a return of investment, is subject to
federal income tax. Accordingly, an investor should recognize that a
purchase of Fund shares immediately prior to the record date for a
dividend or capital gain distribution could cause the investor to incur
tax liabilities and should not be made solely for the purpose of receiving
the dividend or capital gain distribution.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting the Fund and its shareholders; see the
Statement of Additional Information for a further discussion. In addition
to federal income tax, you may also be subject to state and local income
taxes
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<PAGE>
on distributions from the Fund, depending on the laws of your home state
and locality, though the portion of the dividends paid by the Fund
attributable to direct U.S. government obligations is not subject to state
and local income taxes in most jurisdictions. The Fund's annual notice to
shareholders regarding the amount of dividends identifies this portion.
Prospective shareholders are urged to consult their tax advisers with
respect to the effects of this investment on their own tax situations.
SHAREHOLDER SERVICES
CONFIRMATIONS AND REPORTS
You will receive from the distributor a confirmation after each
transaction (except a reinvestment of dividends, capital gains and shares
purchased through the Future First Systematic Investment Plan or through
automatic investments). An account statement will be sent to you monthly
unless there has been no activity in the account or you are purchasing
shares through the Future First Systematic Investment Plan or through
automatic investments, in which case an account statement will be sent
quarterly. Reports will be sent to shareholders at least semiannually
showing the Fund's portfolio and other information; the annual report will
contain financial statements audited by the Corporation's independent
accountants.
Shareholder inquiries should be addressed to "Legg Mason Investment
Grade Income Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476,
Baltimore, Maryland 21203-1476."
SYSTEMATIC WITHDRAWAL PLAN
You may elect to make systematic withdrawals from your Fund account of
a minimum of $50 on a monthly basis if you are purchasing or already own
shares with a net asset value of $5,000 or more. Shareholders should not
purchase shares of the Fund while they are participating in the Systematic
Withdrawal Plan. Please contact your Legg Mason or affiliated investment
executive for further information.
EXCHANGE PRIVILEGE
As a Fund shareholder, you are entitled to exchange your shares of the
Fund for shares of the following funds in the Legg Mason Family of Funds,
provided that such shares are eligible for sale in your state of
residence:
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current income
consistent with stability of principal.
Legg Mason Tax Exempt Trust, Inc.
A money market fund seeking high current income exempt from federal
income tax, preservation of capital, and liquidity.
Legg Mason U.S. Government Money Market Portfolio
A money market fund seeking high current income consistent with
liquidity and conservation of principal.
Legg Mason Value Trust, Inc.
A mutual fund seeking long-term growth of capital.
Legg Mason Special Investment Trust, Inc.
A mutual fund seeking capital appreciation by investing principally in
issuers with market capitalizations of less than $2.5 billion.
Legg Mason Total Return Trust, Inc.
A mutual fund seeking capital appreciation and current income in order
to achieve an attractive total investment return consistent with
reasonable risk.
Legg Mason American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Legg Mason Global Equity Trust
A mutual fund seeking maximum long-term total return, by investing in
common stocks of companies located in at least three different countries.
Legg Mason U.S. Government Intermediate-Term Portfolio
A mutual fund seeking high current income consistent with prudent
investment risk and liquidity needs, primarily by investing in debt
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<PAGE>
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, while maintaining an average dollar-weighted maturity
of between three and ten years.
Legg Mason High Yield Portfolio
A mutual fund primarily seeking a high level of current income and
secondarily, capital appreciation, by investing principally in
lower-rated, fixed-income securities.
Legg Mason Global Government Trust
A mutual fund seeking capital appreciation and current income by
investing principally in debt securities issued or guaranteed by foreign
governments, the U.S. Government, their agencies, instrumentalities and
political subdivisions.
Legg Mason Maryland Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal and Maryland state and local income taxes,
consistent with prudent investment risk and preservation of capital.
Legg Mason Pennsylvania Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax and Pennsylvania personal income
tax, consistent with prudent investment risk and preservation of capital.
Legg Mason Tax-Free Intermediate-Term Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
* Shares of these funds are sold with an initial sales charge.
Investments by exchange into the Legg Mason funds sold without an
initial sales charge are made at the per share net asset value determined
on the same business day as redemption of the Fund shares you wish to
exchange. Investments by exchange into the Legg Mason funds sold with an
initial sales charge are made at the per share net asset value, plus the
applicable sales charge, determined on the same business day as redemption
of the Fund shares you wish to redeem; except that no sales charge will be
imposed upon proceeds from the redemption of Fund shares to be exchanged
that were originally purchased by exchange from a fund on which the same
or higher initial sales charge previously was paid. There is no charge for
the exchange privilege, but the Fund reserves the right to terminate or
limit the exchange privilege of any shareholder who makes more than four
exchanges from the Fund in one calendar year. To obtain further
information concerning the exchange privilege and prospectuses of other
Legg Mason funds, or to make an exchange, please contact your Legg Mason
or affiliated investment executive. To effect an exchange by telephone,
please call your Legg Mason or affiliated investment executive with the
information described in the section "How You Can Redeem Your Fund
Shares," page 14. Please read the prospectus for the other funds carefully
before you invest by exchange. The Fund reserves the right to modify or
terminate the exchange privilege upon 60 days' notice to shareholders.
There is no assurance the money market funds will be able to maintain
a $1.00 share price. None of the funds is insured or guaranteed by the
U.S. Government.
INVESTING THROUGH TAX-DEFERRED RETIREMENT PLANS
An investment in shares of the Fund may be appropriate for IRAs, Keogh
Plans, SEPs and other qualified retirement plans. Investors who are
considering establishing such a plan may wish to consult their attorneys
or tax advisers with respect to individual tax questions. Your Legg Mason
or affiliated investment executive can make available to you forms of
plans. The option of investing in these plans through regular payroll
deductions may be arranged with Legg Mason and your employer. Additional
information with respect to these plans is available upon request from any
Legg Mason or affiliated investment executive.
THE FUND'S BOARD OF DIRECTORS, MANAGER AND INVESTMENT ADVISER
BOARD OF DIRECTORS
The business and affairs of the Fund are managed under the direction
of the Corporation's Board of Directors.
18
<PAGE>
MANAGER
Pursuant to a management agreement with the Fund ("Management
Agreement"), which was approved by the Corporation's Board of Directors,
Legg Mason Fund Adviser, Inc., a wholly owned subsidiary of Legg Mason,
Inc., serves as the Fund's manager. The Manager manages the non-investment
affairs of the Fund, directs all matters related to the operation of the
Fund and provides office space and administrative staff for the Fund. The
Fund pays the Manager, pursuant to the Management Agreement, a management
fee equal to an annual rate of 0.60% of the Fund's average daily net
assets. The Fund's Manager has agreed that until October 31, 1995 or when
the Fund reaches net assets of $100 million, whichever occurs first, it
will continue to reimburse fees and/or assume other expenses to the extent
the Fund's expenses (exclusive of taxes, interest, brokerage and
extraordinary expenses) exceed during any month an annual rate of 0.90% of
the Fund's average daily net assets for such month. After reimbursement by
the Manager of certain expenses, the Fund's total operating expenses for
the year ended December 31, 1994 were 0.85% of average daily net assets.
Reimbursement by the Manager reduces Fund expenses and increases its yield
and total return.
The Manager acts as investment adviser, manager, or consultant to
fifteen investment company portfolios (excluding the Fund) which had
aggregate assets under management of over $4.0 billion as of February 28,
1995. The Manager's address is 111 South Calvert Street, Baltimore,
Maryland 21202.
INVESTMENT ADVISER
Western Asset Management Company, another wholly owned subsidiary of
Legg Mason, Inc., serves as investment adviser to the Fund pursuant to the
terms of an Investment Advisory Agreement with the Manager, which was
approved by the Corporation's Board of Directors. The Adviser manages the
investment and other affairs of the Fund and directs the investments of
the Fund in accordance with its investment objective, policies and
limitations. For these services, the Manager (not the Fund) pays the
Adviser a fee, computed daily and payable monthly, at an annual rate equal
to 40% of the fee received by the Manager, or 0.24% of the Fund's average
daily net assets.
An investment committee has been responsible for the day-to-day
management of the Fund since its inception.
The Adviser also renders investment advice to eleven open-end
investment companies and one closed-end investment company, which together
had aggregate assets under management of approximately $2.5 billion as of
February 28, 1995. The Adviser also renders investment advice to private
accounts with fixed income assets under management of approximately $10.8
billion as of that date. The address of the Adviser is 117 East Colorado
Boulevard, Pasadena, California 91105.
The Adviser has managed fixed income portfolios continuously since its
founding in 1971, and has focused exclusively on such accounts since 1984.
In managing fixed-income portfolios, the Adviser first studies the
range of factors that influence interest rates and develops a long-term
interest rate forecast. It then allocates available funds to those sectors
of the market (for example, government, corporate, or mortgage-backed
securities), which it considers most attractive. Then it selects the
specific issues which it believes represent the best values. All three
decisions are integral parts of the Adviser's portfolio management process
and contribute to its performance record.
THE FUND'S DISTRIBUTOR
Legg Mason is the distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of shares of the Fund, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional information and periodic reports used in
connection with the offering to prospective investors, after the
prospectuses, statements of additional information and reports have been
prepared, set in type and mailed to existing shareholders at the Fund's
expense, and for any supplementary sales literature and advertising costs.
Legg Mason also receives a fee from BFDS for assisting it with its
transfer agent and shareholder servicing functions. For the year ended
December
19
<PAGE>
31, 1994, Legg Mason received $19,980 for performing such services in
connection with this Fund.
The Board of Directors of the Corporation has adopted a Distribution
and Shareholder Services Plan ("Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940 ("1940 Act"). The Plan provides that as
compensation for Legg Mason's ongoing services to shareholders and its
activities and expenses related to the sale and distribution of Fund
shares, the Fund pays Legg Mason an annual distribution fee and an annual
service fee, each of which is equal to 0.25% of the Fund's average daily
net assets. The distribution fee and the service fee are calculated daily
and paid monthly. The fees received by Legg Mason during any year may be
more or less than its cost of providing distribution and shareholder
services to the Fund.
NASD rules limit the amount of annual distribution fees that may be
charged by mutual funds and impose a ceiling on the cumulative
distribution fees received. The Fund's Plan complies with those rules.
The Chairman, President and Treasurer of the Corporation are employed
by Legg Mason.
DESCRIPTION OF THE CORPORATION AND ITS SHARES
The Corporation is a diversified open-end investment company which was
incorporated in Maryland on April 28, 1987. The Articles of Incorporation
of the Corporation permit the Board of Directors to create additional
series (or portfolios), each of which issues a separate class of shares.
There are currently four portfolios of the Corporation, including the
Fund. While additional series may be created in the future, there is no
intention at this time to form any particular additional series.
The Corporation has authorized one billion shares of common stock, par
value $.001 per share. Shareholders of each portfolio of the Corporation
are entitled to one vote per share and fractional votes for fractional
shares held. However, shareholders of the Fund vote separately on certain
matters affecting it. For example, a change in investment policy for the
Fund would be voted upon only by its shareholders. Voting rights are not
cumulative. All shares of the Corporation are fully paid and
non-assessable and have no preemptive or conversion rights.
Shareholder meetings will not be held except where the 1940 Act
requires a shareholder vote on certain matters (including the election of
directors, approval of an advisory contract, and approval of a plan of
distribution pursuant to Rule 12b-1). The Corporation will call a special
meeting of the shareholders at the request of 10% or more of the shares
entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the Fund at 111 South Calvert Street,
Baltimore, Maryland 21202, stating the purpose of the proposed meeting and
the matters to be acted upon.
20
<PAGE>
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Highlights 2
Fund Expenses 3
Financial Highlights 4
Performance Information 5
The Fund's Investment Objective and
Policies 6
How You Can Invest in the Fund 7
How Your Shareholder Account is Maintained 8
How You Can Redeem Your Fund Shares 8
How Net Asset Value is Determined 10
Dividends 10
Tax Treatment of Dividends 10
Shareholder Services 11
Investing through Tax-Deferred Retirement
Plans 13
The Fund's Board of Directors, Manager and
Investment Adviser 13
The Fund's Distributor 13
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent 14
Description of the Corporation and its
Shares 14
</TABLE>
ADDRESSES
DISTRIBUTOR:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000 800 (Bullet) 822 (Bullet) 5544
TRANSFER AND SHAREHOLDER SERVICING AGENT:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
COUNSEL:
Kirkpatrick & Lockhart
1800 M Street, N.W., Washington, DC 20036
INDEPENDENT ACCOUNTANTS:
Coopers & Lybrand L.L.P.
217 East Redwood Street, Baltimore, Maryland 21202
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS OR THE STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THE PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR
BY THE PRINCIPAL UNDERWRITER IN ANY JURISDICTION IN WHICH SUCH OFFERING
MAY NOT LAWFULLY BE MADE.
(Recycle Logo appears here) PRINTED ON RECYCLED PAPER
LMF-019
PROSPECTUS
MAY 1, 1995
LEGG MASON
U.S.
GOVERNMENT
MONEY MARKET
PORTFOLIO
PUTTING YOUR FUTURE FIRST
(Legg Mason Funds Logo appears here)
<PAGE>
THE LEGG MASON U.S. GOVER NMENT MONEY MARKET PORTFOLIO
PROSPECTUS
The Legg Mason U.S. Government Money Market Portfolio ("Fund") is a
professionally managed portfolio seeking high current income consistent
with liquidity and conservation of principal. The Fund is a separate
portfolio of Legg Mason Income Trust, Inc. ("Corporation"), a diversified
open-end investment company which currently has four portfolios. In
seeking to achieve the Fund's objective, the Fund's investment adviser,
Western Asset Management Company ("Adviser"), invests the Fund's assets in
debt obligations issued or guaranteed by the U.S. Government, its agencies
or instrumentalities, and in repurchase agreements secured by such
instruments. The Fund attempts to stabilize the value of its shares at
$1.00. AN INVESTMENT IN THE FUND IS NEITHER INSURED NOR GUARANTEED BY THE
U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE THAT THE FUND WILL ALWAYS BE
ABLE TO MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
The Adviser believes that shares of the Fund may be appropriate both
for direct investment and for investment through Individual Retirement
Accounts and qualified retirement plans.
This Prospectus sets forth concisely the information about the Fund
that a prospective investor ought to know before investing. It should be
retained for future reference. A Statement of Additional Information about
the Fund dated May 1, 1995 has been filed with the Securities and Exchange
Commission ("SEC") and, as amended or supplemented from time to time, is
incorporated herein by reference. The Statement of Additional Information
is available without charge upon request from Legg Mason Wood Walker,
Incorporated ("Legg Mason") (address and telephone numbers listed at
right).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Dated: May 1, 1995
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
800 (Bullet) 822 (Bullet) 5544
<PAGE>
PROSPECTUS HIGHLIGHTS
THE LEGG MASON U.S. GOVERNMENT MONEY MARKET PORTFOLIO
The following summary is qualified in its entirety by the more
detailed information appearing in the body of this Prospectus.
FUND TYPE:
The Fund, a separate portfolio of Legg Mason Income Trust, Inc., is a
no-load, open-end, diversified management investment company. You may
purchase or redeem shares of the Fund through a brokerage account with
Legg Mason or certain of its affiliates. See "How You Can Invest in the
Fund," page 7, and "How You Can Redeem Your Fund Shares," page 8.
FUND STARTED:
January 31, 1989
NET ASSETS:
Over $232.9 million as of February 28, 1995
INVESTMENT OBJECTIVE AND POLICIES:
The Fund's investment objective is high current income consistent with
liquidity and conservation of principal. The Fund attempts to meet this
investment objective by investing its assets in debt obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities, and
in repurchase agreements secured by such instruments. Of course, there can
be no assurance that the Fund will achieve its objective. See "The Fund's
Investment Objective and Policies," page 6.
DISTRIBUTOR:
Legg Mason Wood Walker, Incorporated
MANAGER AND ADVISER:
Legg Mason Fund Adviser, Inc. serves as the Fund's manager, and
Western Asset Management Company serves as investment adviser to the Fund.
TRANSFER AND SHAREHOLDER SERVICING AGENT :
Boston Financial Data Services
CUSTODIAN:
State Street Bank and Trust Company
EXCHANGE PRIVILEGE:
All funds in the Legg Mason Family of Funds. See "Exchange Privilege,"
page 11.
YIELD:
Varies with current money market rates; quoted in the financial
section of most newspapers.
DIVIDENDS:
Declared daily and paid monthly.
REINVESTMENT :
All dividends are automatically reinvested in Fund shares unless cash
payments are requested.
INITIAL PURCHASE:
$1,000 minimum, generally.
SUBSEQUENT PURCHASES:
$100 minimum, generally. See "How You Can Invest in the Fund," page 7.
PURCHASE METHODS:
Send bank/personal check or wire federal funds.
PUBLIC OFFERING PRICE PER SHARE:
Net asset value, which the Fund seeks to maintain at $1.00 per share.
CHECKWRITING:
Available to qualified shareholders upon request. Unlimited number of
checks. Minimum amount per check: $500.
2
<PAGE>
FUND EXPENSES
The purpose of the following table is to assist an investor in understanding
the various costs and expenses that an investor in the Fund will bear directly
or indirectly. The expenses and fees set forth in the table are based on average
net assets and annual Fund operating expenses for the year ended December 31,
1994.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum sales charge on purchases or
reinvested dividends None
Redemption or exchange fees None
</TABLE>
ANNUAL FUND OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
<TABLE>
<S> <C>
Management fees 0.50%
12b-1 fees None
Other expenses 0.19%
Total operating expenses 0.69%
</TABLE>
EXAMPLE OF EFFECT OF FUND EXPENSES
The following example illustrates the expenses that you would pay on a
$1,000 investment over various time periods assuming (1) a 5% annual rate of
return and (2) full redemption at the end of each time period. As noted in the
table above, the Fund charges no redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
<S> <C> <C> <C>
$7 $22 $38 $ 86
</TABLE>
This example assumes that all dividends are reinvested and that the
percentage amounts listed under "Annual Fund Operating Expenses" remain the same
over the time periods shown. The above tables and the assumption in the example
of a 5% annual return are required by regulations of the SEC applicable to all
mutual funds. THE ASSUMED 5% ANNUAL RETURN IS NOT A PREDICTION OF, AND DOES NOT
REPRESENT, THE FUND'S PROJECTED OR ACTUAL PERFORMANCE. THE ABOVE TABLES SHOULD
NOT BE CONSIDERED REPRESENTATIONS OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES
MAY BE GREATER OR LESS THAN THOSE SHOWN. The Fund's actual expenses will depend
upon, among other things, the level of average net assets, the levels of sales
and redemptions of shares, and the extent to which the Fund incurs variable
expenses, such as transfer agency costs.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights for the period January 31, 1989 (commencement
of operations) to December 31, 1989 and for each of the five years ended
December 31, 1990 through December 31, 1994 have been derived from
financial statements which have been audited by Coopers & Lybrand L.L.P.,
independent accountants. The Fund's financial statements for the year ended
December 31, 1994 and the report of Coopers & Lybrand L.L.P thereon are
included in the Fund's annual report and are incorporated by reference in
the Statement of Additional Information. The annual report is available to
shareholders without charge by calling your Legg Mason or affiliated
investment executive or Legg Mason's Funds Marketing Department at
800-822-5544.
<TABLE>
<CAPTION>
JANUARY 31, 1989*
FOR THE YEARS ENDED DECEMBER 31, TO
1994 1993 1992 1991 1990 DECEMBER 31, 1989
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
Net investment income .04 .03 .03 .05 .07 .08(1)
Net realized gain (loss) on
investments (Nil) -- -- Nil -- --
Total from investment
operations .04 .03 .03 .05 .07 .08
Dividends paid from:
Net investment income (.04) (.03) (.03) (.05) (.07) (.08)
Realized gain on investments -- -- -- (Nil) -- --
Net asset value, end of period $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
Total return 3.66% 2.80% 3.49% 5.87% 7.56% 8.68%(2)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses .69% .71% .73% .73% .81% .80%(1)(2)
Net investment income 3.66% 2.76% 3.45% 5.36% 7.29% 8.35%(2)
Net assets, end of period
(in thousands) $214,576 $172,533 $170,910 $180,733 $132,408 $87,958
</TABLE>
* Commencement of operations.
(1) Net of fees waived by the manager for expenses in excess of the
following annual rates: 0.50% through March 28, 1989; 0.75% through
June 30, 1989; and 0.85% through December 31, 1989.
(2) Annualized.
4
<PAGE>
PERFORMANCE INFORMATION
From time to time, the Fund may quote its yield, including a compound
effective yield, in advertisements or in reports or other communications to
shareholders. The Fund's "yield" refers to the income generated by an investment
in the Fund over a stated seven-day period. This income is then "annualized."
That is, the average daily net income generated by the investment during that
week is assumed to be generated each day over a 365-day period and is shown as a
percentage of the investment. The "effective yield" is calculated similarly but
assumes that the income earned by an investment is reinvested. The Fund's
effective yield will be slightly higher than the Fund's yield because of the
compounding effect of this assumed reinvestment.
Yield information may be useful in reviewing the Fund's performance and for
providing a basis for comparison with other investment alternatives. However,
since the calculation is based on past performance and the Fund's yield changes
in response to fluctuations in interest rates and Fund expenses, any given yield
quotation should not be considered representative of the Fund's yield for any
future period.
The Fund's yield for the seven-day period ended December 31, 1994 was 4.88%.
The effective yield for the same period was 5.00%.
5
<PAGE>
THE FUND'S INVESTMENT OBJECTIVE AND POLICIES
The objective of the Fund is to obtain high current income consistent
with liquidity and conservation of principal. There can be no assurance
that the Fund's investment objective will be achieved. The investment
objective of the Fund may not be changed without a vote of Fund
shareholders; however, except as otherwise noted, the investment policies
of the Fund described below may be changed by the Corporation's Board of
Directors without a shareholder vote.
The Fund will invest only in U.S. government obligations and
repurchase agreements secured by such instruments. U.S. government
obligations include (1) U.S. Treasury obligations, which differ only in
their interest rates, maturities and times of issuance, and (2)
obligations issued or guaranteed by U.S. government agencies and
instrumentalities which are supported by any of the following: (a) the
full faith and credit of the U.S. Government (such as certificates of the
Government National Mortgage Association), (b) the right of the issuer to
borrow an amount limited to a specific line of credit from the U.S.
Government (such as obligations of the Federal Home Loan Bank), or (c)
only the credit of the instrumentality (such as the Federal National
Mortgage Association). In the case of obligations not backed by the full
faith and credit of the United States, the Fund must look to the agency or
instrumentality issuing or guaranteeing the obligation for ultimate
repayment and may not be able to assert a claim against the United States
itself in the event the agency or instrumentality does not meet its
commitments. The U.S. Government does not insure or guarantee the market
value of the Fund's shares.
The market value of the interest-bearing debt securities held by the
Fund is affected by changes in market interest rates. There is normally an
inverse relationship between the market value of securities sensitive to
prevailing interest rates and actual changes in interest rates; i.e., a
decline in interest rates produces an increase in market value, while an
increase in interest rates produces a decrease in market value. Moreover,
the longer the remaining maturity of a security, the greater the effect of
interest rate changes on the market value of such a security. In addition,
changes in the ability of an issuer to make repayments of interest and
principal and in the market's perception of an issuer's creditworthiness
also affect the market value of the debt securities of that issuer.
The Fund attempts to stabilize the net asset value of a Fund share at
$1.00. To maintain that net asset value, the Fund pursues several
practices intended to minimize the effect of interest rate fluctuations.
It invests in a portfolio of money market instruments with remaining
maturities of 397 days or less; it maintains the dollar-weighted average
maturity of the portfolio at 90 days or less; and it buys only high
quality securities which present minimal credit risk. The Fund, of course,
cannot guarantee a net asset value of $1.00 per share. The Fund may invest
in variable rate U.S. government obligations that have stated maturities
in excess of 397 days. Also, securities held by the Fund as collateral for
repurchase agreements and other collateralized transactions may have
remaining maturities in excess of 397 days.
The Fund has adopted certain fundamental investment limitations which,
like its investment objective, may not be changed without the approval of
the Fund's shareholders. A full description of those investment
limitations is included in the Statement of Additional Information.
Repurchase Agreements
Repurchase agreements are agreements under which U.S. government
obligations are acquired from a securities dealer or bank subject to
resale at an agreed-upon price and date. The securities are held for the
Fund by State Street Bank and Trust Company ("State Street"), the Fund's
custodian, as collateral until resold and will be supplemented by
additional collateral if necessary to maintain a total value equal to or
in excess of the value of the repurchase agreement. The Fund bears a risk
of loss in the event that the other party to a repurchase agreement
defaults on its obligations and the Fund is delayed or prevented from
exercising its rights to dispose of the collateral securities, which may
decline in value in the interim. The Fund will enter into repurchase
agreements only with financial institutions determined by the Adviser to
present minimal risk of default during the term of the agreement based on
guidelines established by the Corporation's Board of Directors. Although
not a
6
<PAGE>
fundamental investment limitation, the Fund will not enter into repurchase
agreements of more than seven days' duration if more than 10% of its total
assets would be invested in such agreements and other illiquid
investments.
When-Issued Securities
The Fund may enter into commitments to purchase short-term U.S.
government securities on a when-issued basis. When-issued securities are
often the most efficiently priced and have the best liquidity in the bond
market. As with the purchase of any security, when the Fund purchases
securities on a when-issued basis, it assumes the risks of ownership at
the time of purchase, not at the time of receipt. However, the Fund does
not have to pay for the obligations until they are delivered to the Fund.
This is normally seven to 15 days later, but could be considerably longer
in the case of some mortgage-backed securities. To meet that payment
obligation, the Fund will set aside cash or liquid debt securities equal
to the payment that will be due. Failure by the issuer to deliver a
security purchased on a when-issued basis may result in a loss or missed
opportunity to make an alternative investment. The Fund does not expect
that its commitment to purchase when-issued securities will at any time
exceed, in the aggregate, 20% of its total assets.
HOW YOU CAN INVEST IN THE FUND
You may purchase shares of the Fund through a brokerage account with
Legg Mason or with an affiliate that has a dealer agreement with Legg
Mason (Legg Mason is a wholly owned subsidiary of Legg Mason, Inc., a
financial services holding company). Your Legg Mason or affiliated
investment executive will be pleased to explain the shareholder services
available from the Fund and answer any questions you may have. Documents
available from your Legg Mason or affiliated investment executive should
be completed if you invest in shares of the Fund through an Individual
Retirement Account ("IRA"), Self-Employed Individual Retirement Plan
("Keogh Plan"), Simplified Employee Pension Plan ("SEP") or other
qualified retirement plan.
The minimum initial investment in the Fund for each account, including
investments made by exchange from other Legg Mason funds, is $1,000, and
the minimum investment for each purchase of additional shares is $100,
except as noted below. Those investing through the Fund's Future First
Systematic Investment Plan, payroll deduction plans and plans involving
automatic payment of funds from financial institutions or automatic
investment of dividends from certain unit investment trusts are subject to
lower minimum initial and subsequent investments.
Cash held in Legg Mason brokerage accounts of Fund shareholders may be
invested in the Fund during regularly scheduled "sweeps" of such accounts
made twice each month. (Brokerage accounts participating in the Premier
Asset Management Account described on page 11 are swept daily for free
credit balances of $100 or more and weekly for free credit balances of
less than $100.) The Fund reserves the right to change these minimum
amount requirements at its discretion. You should always furnish your
shareholder account number when making additional purchases of shares of
the Fund.
Initial investments in an IRA account established on behalf of a
nonworking spouse of a shareholder who has an IRA invested in the Fund
require a minimum amount of only $250. Subsequent investments in an IRA or
similar plan require a minimum amount of $100. However, once an account is
established, the minimum amount for subsequent investments will be waived
if an investment in an IRA or similar plan will bring the annual
investment therein to the maximum amount permitted under the Internal
Revenue Code of 1986, as amended ("Code").
There are four ways you can invest:
1. BY MAIL
Once you have opened an account with the Fund, you may purchase shares
by mail by sending a check for $100 or more (payable to "Legg Mason U.S.
Government Money Market Portfolio") to:
Legg Mason U.S. Government
Money Market Portfolio
P.O. Box 1476
Baltimore, Maryland 21203-1476
[Insert your name and account number.]
7
<PAGE>
2. BY TELEPHONE OR WIRE TRANSFER OF FUNDS
Once you have opened an account with the Fund you can also purchase
shares by telephone from available cash balances in your Legg Mason or
affiliated brokerage account or by wire transfer of funds from your bank
directly to Legg Mason. Please contact any Legg Mason or affiliated
investment executive for further information. Wire transfers may be
subject to a service charge by your bank. Purchases made by telephone from
available cash balances in your Legg Mason or affiliated brokerage account
or wire payments representing federal funds will normally be completed on
the same or the next business day.
Any order for which your investment executive has submitted a purchase
by 12:00 noon, Eastern time, and for which wired funds have been received,
will earn dividends on shares purchased that day.
3. THROUGH THE FUTURE FIRST SYSTEMATIC INVESTMENT PLAN
You may also buy shares in the Fund through the Future First
Systematic Investment Plan. Under this plan, you may arrange for automatic
monthly investments in the Fund of $50 or more by authorizing Boston
Financial Data Services ("BFDS"), the Fund's transfer agent, to prepare a
check each month drawn on your checking account. There is no minimum
initial investment. Please contact any Legg Mason or affiliated investment
executive for further information.
4. THROUGH AUTOMATIC INVESTMENTS
Arrangements may be made with some employers and financial
institutions, such as banks or credit unions, for regular automatic
monthly investments of $50 or more in shares of the Fund. In addition, it
may be possible for dividends from certain unit investment trusts to be
invested automatically in Fund shares. Persons interested in establishing
such automatic investment programs should contact the Fund through any
Legg Mason or affiliated investment executive.
Shares of the Fund are issued at the net asset value next determined
after receipt of a purchase order and payment in proper form. Many
instruments in which the Fund invests must be paid for in immediately
available money called "federal funds." Therefore, payments received from
you for the purchase of shares in other than federal funds form will
require conversion into federal funds before your purchase order may be
executed. For checks, this normally will take two days but may take up to
nine days. All checks are accepted subject to collection at full face
value in federal funds and must be drawn in U.S. dollars on a domestic
bank. If an order and payment in federal funds is received by your Legg
Mason or affiliated investment executive prior to 12:00 noon, Eastern
time, on any day that the New York Stock Exchange, Inc. ("Exchange") is
open, the shares will be purchased and earn dividends on that day; if such
an order is received at 12:00 noon or later, the shares will be purchased
at the next determined net asset value and will earn dividends on the next
day the Exchange is open. See "How Net Asset Value is Determined," page
10.
The Fund reserves the right to reject any order for shares of the Fund
or to suspend the offering of shares for a period of time.
HOW YOUR SHAREHOLDER ACCOUNT IS MAINTAINED
When you initially purchase shares of the Fund, a shareholder account
is automatically established for you. Any shares that you purchase or
receive as a dividend will be credited directly to your account at the
time of purchase or receipt. No certificates are issued unless you
specifically request them in writing. Shareholders who elect to receive
certificates can redeem shares only by mail. Certificates will be issued
in full shares only. No certificates will be issued for shares prior to 15
business days after purchase of such shares by check unless the Fund can
be reasonably assured during that period that payment for the purchase of
such shares has been collected. Fund shares may not be held in, or
transferred to, an account with any brokerage firm other than Legg Mason
or its affiliates.
HOW YOU CAN REDEEM YOUR FUND SHARES
All redemptions will be made in cash at the net asset value per share
next determined after the receipt by the Fund of a redemption request in
proper form either in writing or by telephone as described below. Requests
for redemption received after 12:00 noon, Eastern time, will be executed
on the next day the Exchange is open, at the net asset value next
determined. However, payment of
8
<PAGE>
redemption proceeds for shares purchased by check and shares acquired
through reinvestment of dividends on such shares may be delayed for up to
10 days after receipt of the check in order to allow time for the check to
clear. Any of the following methods may be used to redeem shares:
1. REDEMPTION BY TELEPHONE
Telephone redemptions may be made by calling your Legg Mason or
affiliated investment executive. However, you may not redeem shares by
telephone for which certificates have been issued. The minimum amount for
telephone redemptions is $100 unless you require a lesser amount to
complete a transaction in your Legg Mason or affiliated brokerage account.
Proceeds of redemptions requested by telephone will be transmitted only to
you. They may be transferred by mail or wire, at your direction (see
below). Proceeds of redemptions authorized by telephone will be credited
directly to your Legg Mason or affiliated brokerage account the same day.
Checks representing redemption proceeds normally will be mailed within
seven calendar days of redemption. Wire transfers of proceeds to you from
your Legg Mason or affiliated brokerage account will normally be
transmitted within two business days.
To make a telephone redemption, you should call your Legg Mason or
affiliated investment executive and provide your name, the Fund's name,
your Fund account number and the number of shares or dollar amount you
wish to redeem. In the event that you are unable to reach your Legg Mason
or affiliated investment executive by telephone, you may make a redemption
request by mail. There is no fee for telephone redemptions with the
exception of wire redemptions by telephone, as described below.
You may request by telephone that your shares be redeemed and the
proceeds wired to your account at a commercial bank in the United States.
In order to initiate a wire redemption by telephone, you must inform your
Legg Mason or affiliated investment executive of the name and address of
your bank and your bank account number. If your designated bank is not a
member of the Federal Reserve System, the proceeds will be wired to a
member bank that has a correspondent relationship with your bank. The
failure of the member bank immediately to notify your bank of the wire
transfer could delay the crediting of redemption proceeds to your bank. An
$18 fee for using the wire redemption service will be deducted by Legg
Mason or its affiliate from the redemption proceeds that are wired to your
bank.
The Fund will not be responsible for the authenticity of redemption
instructions received by telephone, provided it follows reasonable
procedures to identify the caller. The Fund may request identifying
information from callers or employ identification numbers. The Fund may be
liable for losses due to unauthorized or fraudulent instructions if it
does not follow reasonable procedures. Telephone redemption privileges are
available automatically to all shareholders unless certificates have been
issued. Shareholders who do not wish to have telephone redemption
privileges should call their Legg Mason or affiliated investment executive
for further instructions.
2. REDEMPTION BY CHECK
The Fund offers a free checkwriting service that permits you to write
checks to anyone in amounts of $500 or more. The checks will be paid at
the time they are received by BFDS for payment by redeeming the
appropriate number of shares in your account; the shares will earn
dividends until the check clears BFDS for payment. Please contact your
Legg Mason or affiliated investment executive for further information
regarding this service.
3. REDEMPTION BY MAIL
You may request the redemption of your shares by sending a letter
signed by all of the registered owners of the account to: "Legg Mason U.S.
Government Money Market Portfolio, c/o Legg Mason Funds Processing, P.O.
Box 1476, Baltimore, Maryland 21203-1476." Any stock certificates issued
for the shares must be surrendered at the same time. For your protection,
certificates, if any, should be sent by registered mail. On all requests
for the redemption of shares valued at $10,000 or more, or when the
proceeds of the redemption are to be paid to someone other than you, your
signature must have been guaranteed without qualification by a national
bank, a state bank, a member firm of a principal stock exchange, or other
entity described in Rule 17Ad-15 under the Securities Exchange Act of
1934. Legg
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<PAGE>
Mason or its affiliates may request further documentation from
corporations, executors, partnerships, administrators, trustees or
custodians. Checks normally will be mailed within seven calendar days of
receipt of a proper redemption request to your address of record or, in
accordance with your written request, to some other person.
4. REDEMPTION TO PAY FOR SECURITIES PURCHASES AT LEGG MASON
Legg Mason has established special redemption procedures for Fund
shareholders who wish to purchase stocks, bonds or other securities at
Legg Mason. You may place an order to buy securities through your Legg
Mason or affiliated investment executive and, in the absence of any
indication that you wish to make payment in another manner, Fund shares
will be redeemed on the settlement date for the amount due. Fund shares
may also be redeemed by Legg Mason to cover debit balances in your
brokerage account. Contact your Legg Mason or affiliated investment
executive for details.
Because of the relatively high cost of maintaining small accounts, the
Fund may elect to close any account with a current value due to
redemptions of less than $500, by redeeming all of the shares in the
account and mailing the proceeds to you. If the Fund elects to redeem the
shares in your account, you will be notified that your account is below
$500 and will be allowed 60 days in which to make an additional investment
in order to avoid having your account closed.
To redeem your Fund retirement account, a Distribution Request Form
must be completed and returned to Legg Mason Client Services for
processing. This form can be obtained through your Legg Mason or
affiliated investment executive or Legg Mason Client Services in
Baltimore, Maryland.
HOW NET ASSET VALUE IS DETERMINED
Net asset value per Fund share is determined twice daily, as of 12:00
noon, Eastern time, and the close of business of the Exchange (normally
4:00 p.m., Eastern time), on every day that the Exchange is open, by
subtracting the Fund's liabilities from its total assets and dividing the
result by the number of shares outstanding. The Fund attempts to maintain
a per share net asset value of $1.00 by using the amortized cost method of
valuation. The Fund cannot guarantee that net asset value will always
remain at $1.00 per share.
DIVIDENDS
Dividends are declared daily and paid monthly. Dividends are
automatically reinvested on payment dates in shares of the Fund unless
cash payments are requested by writing to a Legg Mason or affiliated
investment executive. Requests for payments of dividends in cash must be
received at least 10 days prior to a payment date in order to be honored
on that date.
In certain cases, you may reinvest your dividends in shares of another
Legg Mason fund. Please contact your Legg Mason or affiliated investment
executive for additional information about this option.
Since the Fund's policy is, under normal circumstances, to hold
portfolio securities to maturity and to value portfolio securities at
amortized cost, it does not expect to realize any capital gain or loss. If
the Fund does realize any net short-term capital gains, it will distribute
them at least once every 12 months.
TAX TREATMENT OF DIVIDENDS
The Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will be relieved of federal
income tax on that part of its investment company taxable income
(generally consisting of net investment income and any net short-term
capital gain) that is distributed to its shareholders. Such distributions
(whether paid in cash or reinvested in Fund shares) are taxable to the
Fund's shareholders (other than IRAs, Keogh Plans, SEPs, other qualified
retirement plans and other tax-exempt investors) as ordinary income to the
extent of the Fund's earnings and profits.
The Fund sends each shareholder a notice following the end of each
calendar year specifying, among other things, the amount of all dividends
paid (or deemed paid) during that year. The Fund is required to withhold
31% of all dividends payable to any individuals and certain other
noncorporate shareholders who do not provide the Fund with a certified
taxpayer identification number or who otherwise are subject to backup
withholding.
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<PAGE>
The foregoing is only a summary of some of the important federal
income tax considerations generally affecting the Fund and its
shareholders; for further information, see the Statement of Additional
Information. In addition to federal income tax, you may also be subject to
state and local income taxes on distributions from the Fund, depending on
the laws of your home state and locality, though the portion of the
dividends paid by the Fund attributable to direct U.S. government
obligations is not subject to state and local income taxes in most
jurisdictions. The Fund's annual notice to shareholders regarding the
amount of dividends identifies this portion. Prospective shareholders are
urged to consult their tax advisers with respect to the effects of this
investment on their own tax situations.
SHAREHOLDER SERVICES
CONFIRMATIONS AND REPORTS
As transfer agent for the Fund, BFDS maintains a share account for
each shareholder. Share certificates are not issued unless requested by
writing to your Legg Mason or affiliated investment executive.
You will receive from the distributor a confirmation after each
transaction (except a reinvestment of dividends, capital gains and shares
purchased through the Future First Systematic Investment Plan or through
automatic investments). An account statement will be sent to you monthly
unless there has been no activity in the account or you are purchasing
shares through the Future First Systematic Investment Plan or through
automatic investments, in which case an account statement will be sent
quarterly. Reports will be sent to shareholders at least semiannually
showing the Fund's portfolio and other information; the annual report will
contain financial statements audited by the Fund's independent
accountants.
Shareholder inquires should be addressed to "Legg Mason U.S.
Government Money Market Portfolio, c/o Legg Mason Funds Processing, P.O.
Box 1476, Baltimore, Maryland 21203-1476."
SYSTEMATIC WITHDRAWAL PLAN
You may elect to make systematic withdrawals from your Fund account of
a minimum of $50 on a monthly basis if you are purchasing or already own
shares with a net asset value of $5,000 or more. Please contact your Legg
Mason or affiliated investment executive for further information.
LEGG MASON PREMIER ASSET MANAGEMENT ACCOUNT
Shareholders may participate in Legg Mason's Premier Asset Management
Account, which combines the Fund account, a preferred customer VISA Gold
debit card, a Legg Mason brokerage account with margin borrowing
availability and unlimited checks with no minimum check amount. Other
services include automatic transfer of free credit balances in a
participant's brokerage account to the Fund account and automatic
redemption of Fund shares to offset debit balances in the participant's
brokerage account. Legg Mason charges an annual fee for the Premier Asset
Management Account, which is currently $85 for individuals and $100 for
corporations and businesses. For further information, contact your Legg
Mason or affiliated investment executive.
EXCHANGE PRIVILEGE
As a Fund shareholder, you are entitled to exchange your shares of the
Fund for shares of the following funds in the Legg Mason Family of Funds,
provided that such shares are eligible for sale in your state of
residence:
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current income
consistent with stability of principal.
Legg Mason Tax Exempt Trust, Inc.
A money market fund seeking high current income exempt from federal
income tax, preservation of capital, and liquidity.
Legg Mason Value Trust, Inc.
A mutual fund seeking long-term growth of capital.
Legg Mason Special Investment Trust, Inc.
A mutual fund seeking capital appreciation by investing principally in
issuers with market capitalizations of less than $2.5 billion.
Legg Mason Total Return Trust, Inc.
A mutual fund seeking capital appreciation and current income in order
to achieve an attractive total investment return consistent with
reasonable risk.
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Legg Mason American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Legg Mason Global Equity Trust
A mutual fund seeking maximum long-term total return, by investing in
common stocks of companies located in at least three different countries.
Legg Mason Global Government Trust
A mutual fund seeking capital appreciation and current income by
investing principally in debt securities issued or guaranteed by foreign
governments, the U.S. Government, their agencies, instrumentalities and
political subdivisions.
Legg Mason U.S. Government Intermediate-Term Portfolio
A mutual fund seeking high current income consistent with prudent
investment risk and liquidity needs, primarily by investing in debt
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, while maintaining an average dollar-weighted maturity
of between three and ten years.
Legg Mason Investment Grade Income Portfolio
A mutual fund seeking a high level of current income, primarily
through investment in a diversified portfolio of investment grade debt
securities.
Legg Mason High Yield Portfolio
A mutual fund primarily seeking a high level of current income and
secondarily, capital appreciation by investing principally in lower-rated,
fixed-income securities.
Legg Mason Maryland Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal and Maryland state and local income taxes,
consistent with prudent investment risk and preservation of capital.
Legg Mason Pennsylvania Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax and Pennsylvania personal income
tax, consistent with prudent investment risk and preservation of capital.
Legg Mason Tax-Free Intermediate-Term Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
*Shares of these funds are sold with an initial sales charge.
Investments by exchange into the Legg Mason funds sold without an
initial sales charge are made at the per share net asset value determined
on the same business day as redemption of the Fund shares you wish to
exchange. Investments by exchange into the Legg Mason funds sold with an
initial sales charge are made at the per share net asset value, plus the
applicable sales charge, determined on the same business day as redemption
of the Fund shares you wish to redeem; except that no sales charge will be
imposed upon proceeds from the redemption of Fund shares to be exchanged
that were originally purchased by exchange from a fund on which the same
or higher initial sales charge previously was paid. There is no charge for
the exchange privilege, but the Fund reserves the right to terminate or
limit the exchange privilege of any shareholder who makes more than four
exchanges from the Fund in one calendar year. To obtain further
information concerning the exchange privilege and prospectuses of other
Legg Mason funds, or to make an exchange, please contact your Legg Mason
or affiliated investment executive. To effect an exchange by telephone,
please call your Legg Mason or affiliated investment executive with the
information described in the section "How You Can Redeem Your Fund
Shares -- Redemption By Telephone" on page 9. The other factors relating
to telephone redemptions described in that section apply also to telephone
exchanges. Please read the prospectus for the other funds carefully before
you invest by exchange. The Fund reserves the right to modify or terminate
the exchange privilege upon 60 days' notice to shareholders.
There is no assurance the money market funds will be able to maintain
a $1.00 share price. None of the funds is insured or guaranteed by the
U.S. Government.
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<PAGE>
INVESTING THROUGH TAX-DEFERRED RETIREMENT PLANS
An investment in shares of the Fund may be appropriate for IRAs, Keogh
Plans, SEPs and other qualified retirement plans. Investors who are
considering establishing such a plan may wish to consult their attorneys
or other tax advisers with respect to individual tax questions. Your Legg
Mason or affiliated investment executive can make available to you forms
of plans. The option of investing in these plans through regular payroll
deductions may be arranged with Legg Mason and your employer. Additional
information with respect to these plans is available upon request from any
Legg Mason or affiliated investment executive.
THE FUND'S BOARD OF DIRECTORS, MANAGER AND INVESTMENT ADVISER
BOARD OF DIRECTORS
The business and affairs of the Fund are managed under the direction
of the Corporation's Board of Directors.
MANAGER
Pursuant to a management agreement with the Fund ("Management
Agreement"), which was approved by the Corporation's Board of Directors,
Legg Mason Fund Adviser, Inc. ("Manager"), a wholly owned subsidiary of
Legg Mason, Inc., serves as the Fund's manager. The Manager manages the
non-investment affairs of the Fund, directs all matters related to the
operation of the Fund and provides office space and administrative staff
for the Fund. The Fund pays the Manager, pursuant to the Management
Agreement, a management fee equal to an annual rate of 0.50% of the Fund's
average daily net assets.
The Manager acts as investment adviser, manager or consultant to
fifteen investment company portfolios (excluding the Fund) which had
aggregate assets under management of over $3.8 billion as of February 28,
1995. The Manager's address is 111 South Calvert Street, Baltimore,
Maryland 21202.
INVESTMENT ADVISER
Western Asset Management Company, another wholly owned subsidiary of
Legg Mason, Inc., serves as investment adviser to the Fund pursuant to the
terms of an Investment Advisory Agreement with the Manager, which was
approved by the Corporation's Board of Directors. The Adviser manages the
investment and other affairs of the Fund and directs the investments of
the Fund in accordance with its investment objective, policies and
limitations. For these services, the Manager (not the Fund) pays the
Adviser a fee, computed daily and payable monthly, at an annual rate equal
to 30% of the fee received by the Manager, or 0.15% of the Fund's average
daily net assets.
The Adviser also renders investment advice to eleven open-end
investment companies and one closed-end investment company which together
had aggregate assets under management of approximately $2.3 billion as of
February 28, 1995. The Adviser also renders investment advice to private
accounts with fixed income assets under management of approximately $10.8
billion as of that date. The address of the Adviser is 117 East Colorado
Boulevard, Pasadena, California 91105.
THE FUND'S DISTRIBUTOR
Legg Mason acts as distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay all expenses in connection with the offering
of shares of the Fund, including any compensation to its investment
executives, the printing and distribution of prospectuses, statements of
additional information and periodic reports used in connection with the
offering to prospective investors, after the prospectuses, statements of
additional information and periodic reports have been prepared, set in
type and mailed to existing shareholders at the Fund's expense, and for
any supplementary sales literature and advertising costs. Legg Mason
receives no compensation from the Fund for these expenses.
Pursuant to a distribution plan ("Plan") adopted in accordance with
Rule 12b-1 under the Investment Company Act of 1940 ("1940 Act"), the Fund
may pay Legg Mason a fee for its distribution services in an amount not to
exceed an annual rate of 0.20% of the Fund's average daily net assets.
Legg Mason has no current intention of requesting any such payments from
the Fund, but may do so in the future. Payments may not be made pursuant
to the Plan, however, until the Board of Directors has approved its
implementation. Activities for which such payments could be
13
<PAGE>
made if the Plan is implemented include, but are not limited to,
compensation to persons, including Legg Mason investment executives, who
engage in or support distribution of shares or who provide shareholder
services, printing of prospectuses and reports for persons other than
existing shareholders, advertising, preparation and distribution of sales
literature, overhead, travel and telephone expenses. In any given year,
such expenses might exceed or be less than the fee payable to Legg Mason
under the Plan. Legg Mason may also receive payments for shareholder
services from the Manager out of fees paid to the Manager, its past
profits or other source of funds available to it.
Legg Mason also receives a fee from BFDS for assisting it with its
transfer agent and shareholder servicing functions. For the year ended
December 31, 1994, Legg Mason received $62,115 for performing such
services in connection with this Fund.
The Chairman, President and Treasurer of the Corporation are employed
by Legg Mason.
THE FUND'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1713, Boston, MA 02105,
is custodian for the securities and cash of the Fund. Boston Financial
Data Services, P.O. Box 953, Boston, MA 02103 is transfer agent for Fund
shares, and dividend-disbursing agent for the Fund.
DESCRIPTION OF THE CORPORATION AND ITS SHARES
The Corporation is a diversified open-end investment company which was
incorporated in Maryland on April 28, 1987. The Articles of Incorporation
of the Corporation permit the Board of Directors to create additional
series (or portfolios), each of which issues a separate class of shares.
There are currently four portfolios of the Corporation, including the
Fund. While additional series may be created in the future, there is no
intention at this time to form any particular additional series.
The Corporation has authorized capital of one billion shares of common
stock, par value $.001 per share. The Board has designated 800,000,000 of
those shares as shares of the Fund. Shareholders of each portfolio of the
Corporation are entitled to one vote per share and fractional votes for
fractional shares held. However, shareholders of the Fund vote separately
on certain matters affecting it. For example, a change in investment
policy for the Fund would be voted upon only by its shareholders. Voting
rights are not cumulative. All shares of the Corporation are fully paid
and nonassessable and have no preemptive or conversion rights.
Although the Fund is not required to hold annual shareholder meetings,
it will hold a special meeting of shareholders when the 1940 Act requires
a shareholder vote on certain matters (including the election of
directors, approval of an advisory contract, and approval of a plan of
distribution pursuant to Rule 12b-1). The Corporation will call a special
meeting of the shareholders at the request of 10% of more of the shares
entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the Fund at 111 South Calvert Street,
Baltimore, Maryland 21202, stating the purpose of the proposed meeting and
the matters to be acted upon.
14
<PAGE>
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424B1
File Number 000-00000
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Prospectus Highlights 2
Fund Expenses 3
Financial Highlights 4
Performance Information 5
Investment Objectives and Policies 6
How You Can Invest in the Fund 15
How Your Shareholder Account is Maintained 16
How You Can Redeem Your Fund Shares 16
How Net Asset Value is Determined 17
Dividends and Other Distributions 18
Taxes 18
Shareholder Services 19
The Fund's Board of Directors,
Manager and Investment Adviser 21
The Fund's Distributor 21
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent 22
Description of the Corporation and its
Shares 22
Appendix A 23
Appendix B 24
</TABLE>
ADDRESSES
DISTRIBUTOR:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000 800 (Bullet) 822 (Bullet) 5544
TRANSFER AND SHAREHOLDER SERVICING AGENT:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
COUNSEL:
Kirkpatrick & Lockhart
1800 M Street, N.W., Washington, DC 20036
INDEPENDENT ACCOUNTANTS:
Coopers & Lybrand L.L.P.
217 E. Redwood Street, Baltimore, MD 21202
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS OR THE STATEMENT OF
ADDITIONAL INFORMATION IN CONNECTION WITH THE OFFERING MADE BY THE
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THE PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR
BY THE PRINCIPAL UNDERWRITER IN ANY JURISDICTION IN WHICH SUCH OFFERING
MAY NOT LAWFULLY BE MADE.
(Recycle Logo appears here) PRINTED ON RECYCLED PAPER
LMF-053
PROSPECTUS
MAY 1, 1995
LEGG MASON
HIGH
YIELD
PORTFOLIO
PUTTING YOUR FUTURE FIRST
(Legg Mason Funds Logo appears here)
<PAGE>
THE LEGG MASON HIGH YIELD PORTFOLIO
PROSPECTUS
The Legg Mason High Yield Portfolio ("Fund") is a professionally
managed portfolio seeking to provide investors with a high level of
current income. As a secondary objective, the Fund seeks capital
appreciation. The Fund is a separate portfolio of Legg Mason Income Trust,
Inc. ("Corporation"), a diversified open-end investment company which
currently has four portfolios.
IN SEEKING TO ACHIEVE THE FUND'S OBJECTIVE, THE FUND'S INVESTMENT
ADVISER, WESTERN ASSET MANAGEMENT COMPANY ("ADVISER"), UNDER NORMAL
CIRCUMSTANCES, WILL INVEST A MAJORITY OF THE FUND'S TOTAL ASSETS IN
LOWER-RATED, FIXED-INCOME SECURITIES (COMMONLY KNOWN AS "JUNK BONDS");
THAT IS, INCOME-PRODUCING DEBT SECURITIES AND PREFERRED STOCKS OF ALL
TYPES, INCLUDING (BUT NOT LIMITED TO) CORPORATE DEBT SECURITIES AND
PREFERRED STOCK. IN ADDITION TO OTHER RISKS, THESE BONDS ARE SUBJECT TO
GREATER FLUCTUATIONS IN VALUE AND RISK OF LOSS OF INCOME AND PRINCIPAL DUE
TO DEFAULT BY THE ISSUER THAN ARE HIGHER-RATED BONDS; THEREFORE, INVESTORS
SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED WITH AN INVESTMENT IN THIS
FUND. SEE "RISK FACTORS" ON PAGE 8.
The Fund may invest up to 25% of its total assets in securities
restricted as to their disposition, which may include securities for which
the Fund believes there is a liquid market. No more than 15% of the Fund's
net assets will be invested in securities deemed by the Fund to be
illiquid.
An investment in the Fund does not constitute a complete investment
program and is not appropriate for persons unwilling or unable to assume a
high degree of risk.
No initial sales charge is payable on purchases, and no redemption
charge is payable on sales of Fund shares. The Fund pays management fees
to Legg Mason Fund Adviser, Inc. ("Manager") and distribution fees to Legg
Mason Wood Walker, Incorporated ("Legg Mason") as described on pages 21
and 22 of this Prospectus.
This Prospectus sets forth concisely the information about the Fund
that a prospective investor ought to know before investing. It should be
retained for future reference. A Statement of Additional Information about
the Fund dated May 1, 1995 has been filed with the Securities and Exchange
Commission ("SEC") and, as amended or supplemented from time to time, is
incorporated herein by reference. The Statement of Additional Information
is available without charge upon request from Legg Mason (address and
telephone numbers listed below).
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Dated: May 1, 1995
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410 (Bullet) 539 (Bullet) 0000
800 (Bullet) 822 (Bullet) 5544
<PAGE>
PROSPECTUS HIGHLIGHTS
THE LEGG MASON HIGH YIELD PORTFOLIO
The following summary is qualified in its entirety by the more
detailed information appearing in the body of this Prospectus.
FUND TYPE:
The Fund is a separate portfolio of Legg Mason Income Trust, Inc., an
open-end, diversified management investment company. You may purchase or
redeem shares of the Fund through a brokerage account with Legg Mason or
certain of its affiliates. See "How You Can Invest in the Fund," page 15,
and "How You Can Redeem Your Fund Shares," page 16.
FUND STARTED:
February 1, 1994
NET ASSETS:
Over $57.5 million as of February 28, 1995
INVESTMENT OBJECTIVES, POLICIES AND RISKS:
The Fund's primary investment objective is to provide investors with a
high level of current income. As a secondary objective, the Fund seeks
capital appreciation. Under normal circumstances, the Fund will invest at
least 65% of its total assets in high yield, fixed-income securities
(including those commonly known as "junk bonds "). Such securities are
considered speculative and involve increased risk of exposure to adverse
business and economic conditions. The value of debt instruments held by
the Fund, and thus the net asset value of Fund shares, also generally
fluctuates inversely with movements in market interest rates.
The Fund may invest up to 25% of its total assets in foreign
securities. Investment in foreign securities entails certain additional
risks, including risks arising from currency fluctuation, accounting
systems and disclosure regulations that differ from those in the U.S., and
political and economic changes in foreign countries. The Fund may have
limited recourse against a foreign governmental issuer in the event of a
default. The Fund's participation in hedging and option income strategies
also involves certain risks. See "Investment Objectives and Policies,"
page 6, and "Risk Factors," page 8.
DISTRIBUTOR :
Legg Mason Wood Walker, Incorporated
MANAGER AND ADVISER :
Legg Mason Fund Adviser, Inc. serves as the Fund's manager, and
Western Asset Management Company serves as investment adviser to the Fund.
TRANSFER AND SHAREHOLDER SERVICING AGENT :
Boston Financial Data Services
CUSTODIAN:
State Street Bank and Trust Company
EXCHANGE PRIVILEGE:
All funds in the Legg Mason Family of Funds registered in your state.
See "Exchange Privilege," page 19.
DIVIDENDS:
Declared and paid monthly. See "Dividends and Other Distributions,"
page 18.
REINVESTMENT :
All dividends and other distributions are automatically reinvested in
Fund shares unless cash payments are requested.
INITIAL PURCHASE:
$1,000 minimum, generally.
SUBSEQUENT PURCHASES:
$100 minimum, generally. See "How You Can Invest in the Fund," page
15.
PURCHASE METHODS:
Send bank/personal check or wire federal funds.
PUBLIC OFFERING PRICE PER SHARE:
Net asset value
2
<PAGE>
FUND EXPENSES
The purpose of the following table is to assist an investor in understanding
the various costs and expenses that an investor in the Fund will bear directly
or indirectly. The expenses and fees set forth in the table are based on average
net assets and annual Fund operating expenses for the period February 1, 1994
(commencement of operations) to December 31, 1994.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Maximum sales charge on purchases or
reinvested dividends None
Redemption or exchange fees None
ANNUAL FUND OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
Management fees 0.65%
12b-1 fees 0.50%
Other expenses 0.44%
Total operating expenses 1.59%
</TABLE>
Because the Fund pays a 12b-1 fee, long-term shareholders may pay more in
distribution expenses than the economic equivalent of the maximum front-end
sales charge permitted by the National Association of Securities Dealers, Inc.
("NASD").
For further information concerning Fund expenses, see "The Fund's Board of
Directors, Manager and Investment Adviser," page 21.
EXAMPLE OF EFFECT OF FUND EXPENSES
The following example illustrates the expenses that you would pay on a
$1,000 investment over various time periods assuming (1) a 5% annual rate of
return and (2) full redemption at the end of each time period. As noted in the
table above, the Fund charges no redemption fees of any kind.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
<S> <C> <C> <C>
$ 16 $50 $87 $189
</TABLE>
This example assumes that all dividends and other distributions are
reinvested and that the percentage amounts listed under "Annual Fund Operating
Expenses" remain the same over the time periods shown. The above tables and the
assumption in the example of a 5% annual return are required by regulations of
the SEC applicable to all mutual funds. THE ASSUMED 5% ANNUAL RETURN IS NOT A
PREDICTION OF, AND DOES NOT REPRESENT, THE FUND'S PROJECTED OR ACTUAL
PERFORMANCE. THE ABOVE TABLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST
OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. The
Fund's actual expenses will depend upon, among other things, the level of
average net assets, the levels of sales and redemptions of shares and the extent
to which the Fund incurs variable expenses, such as transfer agency costs.
3
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights for the period February 1, 1994 (commencement
of operations) to December 31, 1994 have been derived from financial
statements which have been audited by Coopers & Lybrand L.L.P., independent
accountants. The Fund's financial statements for the period February 1,
1994 (commencement of operations) to December 31, 1994 and the report of
Coopers & Lybrand L.L.P. thereon are included in the Fund's annual report
and are incorporated by reference in the Statement of Additional
Information. The annual report is available to shareholders without charge
by calling your Legg Mason or affiliated investment executive or Legg
Mason's Funds Marketing Department at 800-822-5544.
<TABLE>
<CAPTION>
FEBRUARY 1, 1994*
TO
DECEMBER 31, 1994
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $15.00
Net investment income 1.02
Net realized and unrealized loss on investments (1.44)
Total from investment operations (0.42)
Distributions to shareholders from net investment income (1.01)
Net asset value, end of period $13.57
Total return (2.90)%(1)
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses 1.59%(2)
Net investment income 8.41%(2)
Portfolio turnover rate 67.39%(2)
Net assets, end of period (in thousands) $53,424
</TABLE>
* COMMENCEMENT OF OPERATIONS.
(1) NOT ANNUALIZED.
(2) ANNUALIZED.
4
<PAGE>
PERFORMANCE INFORMATION
From time to time the Fund may quote its total return in advertisements or
in reports or other communications to shareholders. A mutual fund's TOTAL RETURN
is a measurement of the overall change in value, including changes in share
price and assuming reinvestment of dividends and capital gain distributions of
an investment in the fund. CUMULATIVE TOTAL RETURN shows the fund's performance
over a specific period of time. AVERAGE ANNUAL TOTAL RETURN is the average
annual compounded return that would have produced the same cumulative total
return if the fund's performance had been constant over the entire period.
Performance figures, including total return and yield figures, reflect past
performance and are not intended to indicate future performance. Average annual
returns tend to smooth out variations in a fund's return, so they differ from
actual year-by-year results.
The Fund's total return as of December 31, 1994 was as follows:
<TABLE>
<CAPTION>
CUMULATIVE
TOTAL RETURN
<S> <C>
Life of Fund(|) -2.90%
</TABLE>
(|) Fund's inception -- February 1, 1994.
No adjustment has been made for any income taxes payable by shareholders.
The investment return and principal value of an investment in the Fund will
fluctuate so that an investor's shares, when redeemed, may be worth more or less
than their original cost.
The Fund may also advertise its yield or effective yield. Yield reflects net
investment income per share (as defined by applicable SEC regulations) over a
30-day (or one-month) period, expressed as an annualized percentage of net asset
value at the end of the period. The effective yield, although calculated
similarly, will be slightly higher than the yield because it assumes that income
earned from the investment is reinvested (i.e., the compounding effect of
reinvestment). Yield computations differ from other accounting methods and
therefore may differ from dividends actually paid or reported net income.
Further information about the Fund's performance is contained in the annual
report to shareholders, which may be obtained without charge by calling your
Legg Mason or affiliated investment executive or Legg Mason's Funds Marketing
Department at 800-822-5544.
5
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to provide investors with a
high level of current income. As a secondary objective, the Fund seeks
capital appreciation. The investment objectives of the Fund may not be
changed without a vote of Fund shareholders; however, except as otherwise
noted, the investment policies of the Fund described below may be changed
by the Corporation's Board of Directors without a shareholder vote. There
can be no assurance that the Fund's investment objectives will be
achieved.
In seeking its objectives, the Fund, under normal conditions, invests
at least 65% of its total assets in high yield, fixed-income securities,
that is, income producing debt securities and preferred stocks of all
types, including (but not limited to) corporate debt securities and
preferred stock, convertible securities, zero coupon securities, deferred
interest securities, mortgage-backed securities and asset-backed
securities. The Fund's remaining assets may be held in cash or money
market instruments, or invested in common stocks and other equity
securities when these types of investments are consistent with the primary
objective of high current income or are acquired as part of a unit
consisting of a combination of fixed-income securities and equity
investments. Such remaining assets may also be invested in fixed-income
securities rated above BBB by Standard & Poor's Ratings Group ("S&P") or
Baa by Moody's Investors Services, Inc. ("Moody's"), comparably rated by
another nationally recognized statistical rating organization ("NRSRO"),
or unrated securities deemed by the Adviser to be of equivalent quality.
Moreover, the Fund may hold cash or money market instruments without limit
for temporary defensive purposes or pending investment. Current yield is
the primary consideration used by the Fund's Adviser in the selection of
portfolio securities, although consideration may also be given to the
potential for capital appreciation.
Higher yields are generally available from securities rated BBB or
lower by S&P, Baa or lower by Moody's, securities comparably rated by
another NRSRO, or unrated securities of equivalent quality, and the Fund
may invest all or a substantial portion of its assets in such securities.
Debt securities rated below investment grade (i.e., below BBB/Baa) are
deemed by these agencies to be predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal and may involve
major risk of exposure to adverse conditions. The Fund may invest in
securities rated as low as "C" by Moody's or "D" by S&P, which ratings
indicate that the obligations are highly speculative and may be in default
or in danger of default as to principal and interest. See "Risk Factors,"
page 8. Ratings are only the opinions of the agencies issuing them and are
not absolute guarantees as to quality. The Adviser does not rely solely on
the ratings of rated securities in making investment decisions but also
evaluates other economic and business factors affecting the issuer. The
Appendix to this Prospectus describes the rating categories of securities
in which the Fund may invest.
Fixed-income securities in which the Fund may invest include preferred
stocks and all types of debt obligations of both domestic and foreign
issuers, commercial paper, and obligations issued or guaranteed by the
U.S. Government, foreign governments or of any of their respective
political subdivisions, agencies, or instrumentalities, including
repurchase agreements secured by such instruments.
Corporate debt securities may pay fixed or variable rates of interest,
or interest at a rate contingent upon some other factor, such as the price
of some commodity. These securities may be convertible into preferred or
common equity, or may be bought as part of a unit containing common stock.
The Fund may purchase common stock directly if such an investment meets
the primary investment objective of a high level of current income or the
secondary objective of capital appreciation potential. The Fund may also
purchase warrants or rights to purchase corporate or other securities. The
Fund may purchase corporate or other securities which are in default, in
cases where the Adviser feels that the returns potentially available in
those securities offset the lack of current income. The Fund may hold
common stock received under an exchange offer or plan of reorganization
made by an issuing corporation. No more than 25% of the Fund's total
assets will be invested in common stocks, warrants or rights.
6
<PAGE>
The Fund may invest up to 25% of its total assets in private
placements, securities traded pursuant to Rule 144A under the Securities
Act of 1933, or securities which, though not registered at the time of
their initial sale, are issued with registration rights. Some of these
securities may be deemed by the Adviser to be liquid, under guidelines
adopted by the Corporation's Board of Directors pursuant to SEC
regulations. No more than 15% of the Fund's net assets will be invested in
securities which are deemed illiquid, defined as securities that cannot be
sold within 7 days at approximately the price they are valued. The Fund
may also invest in "loan participations or assignments." In purchasing a
loan participation or assignment, the Fund acquires some or all of the
interest of a bank or other lending institution in a loan to a corporate
borrower. Many such loans are secured and most impose restrictive
covenants which must be met by the borrower and which are generally more
stringent than the covenants available in publicly traded debt securities.
These participations may also be purchased by the Fund when the borrowing
company is in default.
The Fund may purchase debt obligations on a "when-issued" or
"delayed-delivery" basis. Such securities are subject to market
fluctuation prior to delivery to the Fund and therefore may cause the Fund
to experience a gain or loss on the securities prior to their delivery.
However, the Fund does not have to pay for the obligations until they are
delivered. This is normally seven to 15 days later, but could be
considerably longer. Use of this practice would have a leveraging effect
on the Fund. Such securities generally do not earn interest until their
scheduled delivery date.
Foreign Securities
The Fund may invest up to 25% of its total assets in securities of
domestic and foreign issuers that are denominated in currencies other than
the U.S. dollar. To facilitate investment in foreign securities, the Fund
may hold positions in foreign currencies. In addition, for hedging
purposes, the Fund may purchase and write either listed or
over-the-counter put and call options on foreign currencies or may enter
into forward foreign currency exchange contracts.
Options Contracts
The Fund may write (sell) or purchase put and call options on domestic
and foreign securities, securities indices and on foreign currencies. Call
options written by the Fund give the holder the right to buy the
underlying securities or currencies from the Fund at a fixed exercise
price up to a stated expiration date, or in the case of certain options,
on such date. Put options give the holder the right to sell the underlying
security or currencies to the Fund during the term of the option at a
fixed exercise price up to a stated expiration date, or in the case of
certain options, on such date.
The Fund may also enter into options on the yield "spread" or yield
differential between two fixed-income securities, a transaction referred
to as a "yield curve" option, for hedging and non-hedging purposes.
Futures Contracts
The Fund may purchase and sell futures contracts on foreign
currencies, securities or indices of securities, including indices of
fixed-income securities which may become available for trading ("Futures
Contracts"). The Fund may also purchase and write options on such Futures
Contracts.
Interest Rate Swaps
The Fund may enter into interest rate swaps. An interest rate swap is
an agreement between two parties to pay each other interest or a certain
amount of principal; one of which pays an interest rate fixed until the
maturity of the obligation, while the other pays a rate which changes with
the changes in some other rate, such as the prime rate or the London
Interbank Offered Rate (LIBOR). Such swaps will be used when the Fund
wishes to effectively convert a floating rate asset into a fixed-rate
asset, or vice versa.
Mortgage Pass-Through Securities
The Fund may invest in mortgage pass-through securities. Mortgage
pass-through securities are securities representing interests in "pools"
of mortgage loans. Monthly payments of interest and principal by the
individual borrowers on mortgages are passed through to the holders of the
securities (net of fees paid to the issuer, guarantor or servicer of the
securities) as the mortgages in the underlying pools are paid off.
7
<PAGE>
The Fund may enter into mortgage "dollar roll" transactions with
selected banks and broker-dealers pursuant to which the Fund sells
mortgage-backed securities for delivery in the future (generally within 30
days) and simultaneously contracts to repurchase substantially similar
securities on a specified future date.
Collateralized Mortgage Obligations, Multiclass Pass-Through Securities
The Fund may invest a portion of its assets in collateralized mortgage
obligations ("CMO's"), which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities. The Fund may also
invest a portion of its assets in multiclass pass-through securities which
are equity interests in a trust composed of mortgage assets.
Stripped Mortgage-Backed Securities
The Fund may also invest in stripped mortgage-backed securities, which
are derivative securities usually structured with two classes that receive
different proportions of the interest and principal distributions from an
underlying pool of mortgage assets. They may be issued by
instrumentalities of the U.S. Government or by private mortgage lenders.
The Fund may purchase securities representing only the interest payment
portion of the underlying mortgage pools (commonly referred to as "IOs")
or only the principal portion of the underlying mortgage pools (commonly
referred to as "POs").
Asset-Backed Securities
The Fund may invest in asset-backed securities. These securities,
issued by trusts and special purpose corporations, are backed by a pool of
assets, such as credit card, automobile loan, or other financial
receivables, representing the obligations of a number of different
parties. Asset-backed securities in which the Fund invests may include
asset-backed commercial paper.
New types of mortgage-backed and asset-backed securities, derivative
securities and hedging instruments are developed and marketed from time to
time and that, consistent with its investment limitations, the Fund may
invest in those new types of securities or instruments that the Adviser
believes may assist the Fund in achieving its investment objectives.
OTHER INVESTMENT POLICIES
The Fund may loan its portfolio securities to qualified borrowers who
deposit and maintain with the Fund cash collateral equal to at least 100%
of the market value of the securities loaned. The Fund may enter into
repurchase transactions, in which the Fund purchases a security subject to
resale to a bank or broker-dealer at an agreed-upon price and date. In
such a transaction, the obligation is collateralized by securities with a
market value at least equal to the value of the repurchase transaction.
The Fund will not invest more than 5% of its total assets in any one
issuer, except for issues of the U.S. Government, its agencies and
instrumentalities or repurchase agreements collateralized by such
securities; however, up to 25% of the Fund's total assets may be invested
in securities issued by Canadian provinces or by Crown Corporations whose
obligations are guaranteed by either the Canadian federal government or a
provincial government. No more than 25% of the Fund's total assets may be
invested in issuers having their principal business activity in the same
industry.
The Fund has adopted certain other fundamental investment limitations
that, like its investment objective, can be changed only by a vote of Fund
shareholders. These investment limitations are set forth in the Statement
of Additional Information under "Additional Information About Investment
Limitations and Policies." Except as expressly stated otherwise, the
investment policies and limitations contained in this prospectus are not
fundamental and can be changed without a shareholder vote.
RISK FACTORS
The investment income of the Fund is based on the income earned on the
securities it holds, less expenses incurred; thus, the Fund's investment
income may be expected to fluctuate in response to changes in such
expenses or income. For example, the investment income of the Fund may be
affected if it experiences a net inflow of new money that is then invested
in securities whose yield is higher or lower than that earned on then-
current investments.
High yield bonds offer a higher yield to maturity than bonds with
higher ratings, as compensation for holding an obligation that is subject
8
<PAGE>
to greater risk. During periods of rising interest rates, the values of
outstanding fixed-income securities generally fall, and vice versa. The
magnitude of these fluctuations will generally be greater for securities
with long maturities. Those changes will affect the values of the Fund's
portfolio securities, and therefore, its net asset value per share.
Because of their high coupon rates, high yield securities are generally
less price sensitive to changes in interest rates than U.S. Treasury
securities.
The principal risks of high yield securities include: (i) limited
liquidity and secondary market support, (ii) substantial market price
volatility resulting from changes in prevailing interest rates, (iii) the
fact that such obligations are often unsecured and are subordinated to the
claims of banks and other senior lenders in bankruptcy proceedings, (iv)
the operation of mandatory sinking fund or call/redemption provisions
during periods of declining interest rates, whereby the holder might
receive redemption proceeds at times when only lower-yielding portfolio
securities are available for investment, (v) the possibility that earnings
of the issuer may be insufficient to meet its debt service, (vi) the
issuer's low creditworthiness and potential for insolvency during periods
of rising interest rates and economic downturn, (vii) the fact that the
issuers are often highly leveraged and may not have access to more
traditional methods of financing and (viii) the possibility of adverse
publicity and investor perception, whether or not due to fundamental
analysis, which may result in widespread sales and declining market
prices. If the Fund is required to seek recovery upon a default in the
payment of principal or interest, it may incur additional expenses and may
have limited legal recourse in the event of a default.
As a result of the limited liquidity of high yield securities, their
prices have at times experienced significant and rapid declines when a
significant number of holders of high yield securities simultaneously
decided to sell them. A decline is also likely in the high yield bond
market during an economic downturn. An economic downturn or an increase in
interest rates could severely disrupt the market for high yield securities
and adversely affect the value of outstanding securities and the ability
of the issuers to repay principal and interest. Because the market for
high yield securities is less liquid, the valuation of these securities
may require greater judgment than is necessary with respect to securities
for which more market information is available.
Although the prices of lower-rated bonds are generally less sensitive
to interest rate changes than are higher-rated bonds, the prices of lower-
rated bonds may be more sensitive to adverse economic changes and
developments regarding the individual issuer. Although the market for
lower-rated debt securities is not new, and the market has previously
weathered economic downturns, there has been in recent years a substantial
increase in the use of such securities to fund corporate acquisitions and
restructuring. Accordingly, the past performance of the market for such
securities may not be an accurate indication of its performance during
future economic downturns or periods of rising interest rates.
The table below provides a summary of ratings assigned to debt
holdings in the Fund's portfolio. These figures are dollar-weighted
averages of month-end portfolio holdings during the period February 1,
1994 (commencement of operations) to December 31, 1994, presented as a
percentage of total investments. These percentages are historical and are
not necessarily indicative of the quality of current or future portfolio
holdings, which may vary.
<TABLE>
<CAPTION>
MOODY'S S&P
RATINGS AVERAGE RATINGS AVERAGE
<S> <C> <C> <C>
Aaa/Aa/A 1.7% AAA/AA/A 1.7%
Baa 0.8% BBB --%
Ba 9.3% BB 16.0%
B 65.3% B 48.4%
Caa 3.3% CCC 14.3%
Ca 4.6% CC --%
C 0.4% C --%
NR 14.6% D 2.0%
NR 17.6%
</TABLE>
The dollar-weighted average of debt securities not rated by either
Moody's or S&P amounted to 12.0%. This may include securities rated by
other nationally recognized rating organizations, as well as unrated
securities. Unrated securities are not necessarily lower-quality
securities.
9
<PAGE>
Zero Coupon and Pay-In-Kind Bonds
Investments in zero coupon and pay-in-kind bonds involve additional
special considerations. Zero coupon bonds are debt obligations that do not
entitle the holder to any periodic payments of interest prior to maturity
or a specified cash payment date when the securities begin paying current
interest ("cash payment date") and therefore are issued and traded at a
discount from their face amount or par value. Pay-in-kind bonds pay
"interest" through the issuance of additional bonds, thereby adding debt
to the issuer's balance sheet. The market prices of both types of
securities are generally more volatile than the market prices of
securities that pay interest periodically and are likely to respond to
changes in interest rates to a greater degree than the prices of
securities paying interest currently and having similar maturities and
credit quality. Zero coupon and pay-in-kind bonds carry additional risk in
that, unlike bonds that pay interest throughout the period to maturity,
the Fund will realize no cash until the cash payment date unless a portion
of such securities is sold and the Fund may obtain no return at all on its
investment if the issuer defaults.
The holder of a zero coupon security or pay-in-kind bond must accrue
income with respect to these securities prior to the receipt of cash
payments thereon. To avoid liability for federal income and excise taxes
(see "Taxes" on page 18 and "Additional Tax Information" in the Statement
of Additional Information), the Fund will be required to distribute income
accrued with respect to these securities, even though the Fund has not
received that income in cash, and may be required to dispose of portfolio
securities under disadvantageous circumstances in order to generate cash
to satisfy these distribution requirements.
Mortgage-Related Securities
Mortgage-related securities represent interests in pools of mortgages
created by lenders such as commercial banks, savings and loan
institutions, mortgage bankers and others. Mortgage-related securities may
be issued by governments or government-related entities or by
non-governmental entities such as banks, savings and loan institutions,
private mortgage insurance companies, mortgage bankers and other secondary
market issuers.
Mortgage-related securities provide monthly payments which consist of
interest and, in most cases, principal. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on
their residential mortgage loans, net of any fees paid to the issuer or
guarantor of such securities. Additional payments to holders of
mortgage-related securities are caused by repayments resulting from the
sale of the underlying residential property, refinancing or foreclosure,
net of fees or costs which may be incurred. Some mortgage-related
securities are described as "modified pass-through." These securities
entitle the holders to receive all interest and principal payments owed on
the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Mortgage-backed securities issued by the Government National Mortgage
Association ("GNMA") are backed by the full faith and credit of the United
States Government. Those issued by the Federal National Mortgage
Association ("FNMA") and the Federal Home Loan Mortgage Corporation
("FHLMC") are supported only by the creditworthiness of the issuing
entity. Regardless of such support, government mortgage securities are
subject to the risks of market interest rate fluctuations and prepayments
described below.
Mortgage-related securities offered by private issuers include
pass-through securities comprised of pools of residential mortgage loans;
mortgage-backed bonds which are considered to be debt obligations of the
institution issuing the bonds and are collateralized by mortgage loans;
and bonds and CMOs which are collateralized by mortgage-related securities
issued by FHLMC, FNMA or GNMA or by pools of conventional mortgages.
CMOs are typically structured with two or more classes or series which
have different maturities and are generally retired in sequence. Although
full payoff of each class of obligations is contractually required by a
certain date, any or all classes of obligations may be paid off sooner
than expected because of an increase in the payoff speed of the pool.
Mortgage-related securities created by nongovernmental issuers
generally offer a higher rate of interest than government and
government-related securities because there are no direct or indirect
government guarantees of payment in the former
10
<PAGE>
securities, resulting in higher risks. However, many issuers or servicers
of mortgage-related securities guarantee timely payment of interest and
principal on such securities. Timely payment of principal may also be
supported by various forms of insurance, including individual loan, title,
pool and hazard policies. There can be no assurance that the private
issuers or insurers will be able to meet their obligations under the
relevant guarantees and insurance policies, and such guarantees and
policies often do not cover the full amount of the pool. Where privately
issued securities are collateralized by securities issued by FHLMC, FNMA
or GNMA, the timely payment of interest and principal is supported by the
government-related securities collateralizing such obligations. Some
mortgage-backed securities will be considered illiquid and will be subject
to the limitation that no more than 15% of the Fund's net assets may be
invested in illiquid securities.
Asset-Backed Securities
Payments or distributions of principal and interest on asset-backed
securities may be supported by credit enhancements, such as various forms
of cash collateral accounts or letters of credit. Like mortgage-related
securities, asset-backed securities are subject to the risk of prepayment.
The risk that recovery on repossessed collateral might be unavailable or
inadequate to support payments on asset-backed securities, however, is
greater than in the case of mortgage-backed securities. The value of such
securities depends in part on loan repayments by individuals, which may be
adversely affected during general downturns in the economy.
Prepayment Risk
The principal of most mortgage-backed and other asset-backed
securities may be prepaid at any time. As a result, if such securities are
purchased at a premium, a prepayment rate that is faster than expected
will reduce yield to maturity, while a prepayment rate that is slower than
expected will have the opposite effect. Conversely, if the securities are
purchased at a discount, prepayments faster than expected will increase
yield to maturity and prepayments slower than expected will decrease it.
Accelerated prepayments on securities purchased at a premium also impose a
risk of loss of principal because the premium may not have been fully
amortized at the time the principal is repaid in full. Accelerated
prepayments also reduce the yield because the Fund must reinvest the
assets at the then-current rates. When interest rates are declining, such
prepayments usually increase, and reinvestments of such principal
prepayments will be at a lower rate than that on the original
mortgage-related security. Increased prepayment of principal may limit the
Fund's ability to realize the appreciation in the value of such securities
that would otherwise accompany declining interest rates.
Stripped mortgage-backed securities are more sensitive to changes in
prepayment and interest rates and the market for such securities is less
liquid than is the case for traditional debt securities and
mortgage-backed securities. The yield on such IOs is extremely sensitive
to the rate of principal payments (including prepayments) on the
underlying mortgage assets, and a rapid rate of repayment may have a
material adverse effect on such securities' yield to maturity. If the
underlying mortgage assets experience greater than anticipated prepayments
of principal, the Fund will fail to recoup fully its initial investment in
these securities, even if they are rated high quality. Most IOs and POs
are regarded as illiquid and will be included in the Fund's 15% limit on
illiquid securities. U.S. government-issued IOs and POs backed by
fixed-rate mortgages may be deemed liquid by the Adviser, following
guidelines and standards established by the Corporation's Board of
Directors.
A "residual" represents an interest in any amount that may be
remaining in a mortgage-backed pool after all of the fixed commitments
have been paid. The value of residuals is extremely sensitive to market
interest rates and prepayment rates over the life of the pool, and the
owner of a residual may, in some circumstances, lose the entire
investment.
Callable Debt Securities
A debt security may be callable, I.E., subject to redemption at the
option of the issuer at a price established in the security's governing
instrument. If a debt security held by the Fund is called for redemption,
the Fund will be required to permit the issuer to redeem the security or
sell it to a third party. Either of these actions could have an
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adverse effect on the Fund's ability to achieve its investment objectives.
Preferred Stock
The Fund may purchase preferred stock as a substitute for debt
securities of the same issuer when, in the opinion of the Adviser, the
preferred stock is more attractively priced in light of the risks
involved. Preferred stock pays dividends at a specified rate and generally
has preference over common stock in the payment of dividends and the
liquidation of the issuer's assets but is junior to the debt securities of
the issuer in those same respects. Unlike interest payments on debt
securities, dividends on preferred stock are generally payable at the
discretion of the issuer's board of directors, and shareholders may suffer
a loss of value if dividends are not paid. Preferred shareholders
generally have no legal recourse against the issuer if dividends are not
paid. The market prices of preferred stocks are subject to changes in
interest rates and are more sensitive to changes in the issuer's
creditworthiness than are the prices of debt securities. Under ordinary
circumstances, preferred stock does not carry voting rights.
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 a different issuer within a
particular period of time at a specified price or formula. A convertible
security entitles the holder to receive interest paid or accrued on debt
or the dividend paid on preferred stock until the convertible security
matures or is redeemed, converted or exchanged. Before conversion,
convertible securities ordinarily provide a stable stream of income with
generally higher yields than those of common stocks of the same or similar
issuers, but lower than the yield on non-convertible debt. Convertible
securities are usually subordinated to comparable-tier non-convertible
securities but rank senior to common stock in a corporation's capital
structure.
The value of a convertible security is a function of (1) its yield in
comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at
market value, if converted into the underlying common stock. Convertible
securities are typically issued by smaller capitalized companies, whose
stock prices may be volatile. The price of a convertible security often
reflects such variations in the price of the underlying common stock in a
way that non-convertible debt does not. A convertible security may be
subject to redemption at the option of the issuer at a price established
in the convertible security's governing instrument, which could have an
adverse effect on the Fund's ability to achieve its investment objectives.
Foreign Securities
Investing in the securities of issuers in any foreign country involves
special risks and considerations not typically associated with investing
in U.S. companies. These include risks resulting from differences in
accounting, auditing and financial reporting standards; lower liquidity
than U.S. fixed-income or debt securities; the possibility of
nationalization, expropriation or confiscatory taxation; adverse changes
in investment or exchange control regulations (which may include
suspension of the ability to transfer currency out of a country); and
political instability. In many cases, there is less publicly available
information concerning foreign issuers than is available concerning U.S.
issuers. Additionally, purchases and sales of foreign securities and
dividends and interest payable on those securities may be subject to
foreign income and withholding taxes. Foreign securities generally exhibit
greater price volatility. Changes in foreign exchange rates will affect
the value of securities denominated or quoted in currencies other than the
U.S. dollar irrespective of the performance of the underlying investment.
Some foreign governments have defaulted on principal and/or interest
payments; in such cases, the Fund would have limited recourse to enforce
its rights under the instruments it holds.
Forward foreign currency contracts involve obligations to purchase or
sell a specific amount of a specific currency at a future date, which may
be any fixed number of days from the date of the contract agreed upon by
the parties, at a price set at the time of the contract. By entering into
a foreign currency contract, the Fund "locks in" the exchange rate between
the currency it will deliver and the currency it will receive for the
duration of
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the contract. The Fund may enter into these contracts for the purpose of
hedging against risk arising from the Fund's investment or anticipated
investment in securities denominated in foreign currencies. Forward
currency contracts involve certain risks, including the risk that
anticipated currency movements will not be accurately predicted causing
the Fund to sustain losses on these contracts.
The Fund may invest in fixed-income and other debt securities of
issuers based in emerging markets (including, but not limited to,
countries in Latin America, Eastern Europe, Asia and Africa). The risks of
foreign investment, described above, are greater for investments in
emerging markets. Debt securities of issuers in such countries will
typically be rated below investment grade or be of comparable quality.
Repurchase Agreements
A repurchase agreement is an agreement under which the Fund acquires
either U.S. government obligations or other high-quality liquid debt
securities from a securities dealer or bank subject to resale at an
agreed-upon price and date. The securities are held for the Fund by State
Street Bank and Trust Company ("State Street"), the Fund's custodian, as
collateral until resold and will be supplemented by additional collateral
if necessary to maintain a total value equal to or in excess of the value
of the repurchase agreement. The Fund bears a risk of loss in the event
that the other party to a repurchase agreement defaults on its obligations
and the Fund is delayed or prevented from exercising its rights to dispose
of the collateral securities, which may decline in value in the interim.
The Fund will enter into repurchase agreements only with financial
institutions which are deemed by the Adviser to present minimal risk of
default during the term of the agreement based on guidelines established
by the Corporation's Board of Directors.
Restricted and Illiquid Securities
Restricted securities are securities subject to legal or contractual
restrictions on their resale, such as private placements. Such
restrictions might prevent the sale of restricted securities at a time
when sale would otherwise be desirable. The Fund will not acquire
securities for which there is not a readily available market ("illiquid
assets") if such acquisition would cause the aggregate value of illiquid
assets to exceed 15% of the Fund's net assets. Repurchase agreements
maturing in more than seven days are considered illiquid. Illiquid
securities may be difficult to value; and the Fund may have difficulty
disposing of such securities promptly.
Loan Participations and Assignments
Many of the loans in which the Fund may purchase an interest are
secured and most impose restrictive covenants which must be met by the
borrower and which are generally more stringent than the covenants
available in publicly traded debt securities. However, interests in some
loans may not be secured, and the Fund will be exposed to a risk of loss
if the borrower defaults. Loan participations may also be purchased by the
Fund when the borrowing company is already in default.
In purchasing a loan participation, the Fund may have less protection
under the federal securities laws than it has in purchasing traditional
types of securities. The Fund's ability to assert its rights against the
borrower will also depend on the particular terms of the loan agreement
among the parties. Interests in many loans are illiquid and would
therefore be subject to the Fund's 15% limit on illiquid investments.
Options and Futures; Foreign Currency Exchange Contracts
Many options on debt securities are traded primarily on the
over-the-counter market. Over-the-counter options differ from
exchange-traded options in that the former are two-party contracts with
price and other terms negotiated between buyer and seller and generally do
not have as much market liquidity as exchange-traded options. Thus, when
the Fund purchases an over-the-counter option, it relies on the dealer
from which it has purchased the option to make or take delivery of the
securities underlying the option. Failure by the dealer to do so would
result in the loss of the premium paid by the Fund as well as the loss of
the expected benefit of the transaction. Over-the-counter options may be
considered illiquid securities for purposes of the Fund's investment
limitations. Currency options traded on U.S. or other exchanges may be
subject to position limits
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which may limit the ability of the Fund to reduce foreign currency risk
using such options.
Most futures exchanges and boards of trade limit the amount of
fluctuation permitted in futures contract prices during a single day; once
the daily limit has been reached on a particular contract, no trades may
be made that day at a price beyond that limit. In addition, certain of
these instruments are relatively new and without a significant trading
history. As a result, there is no assurance that an active secondary
market will develop or continue to exist. Lack of a liquid market for any
reason may prevent the Fund from liquidating an unfavorable position, and
the Fund would remain obligated to meet margin requirements until the
position is closed. Purchase of such instruments for which there is no
liquid secondary market will be subject to the Fund's investment
limitation on illiquid securities.
The Fund will establish segregated accounts or maintain covering
positions when engaging in the above strategies, to the extent required by
the SEC and staff positions. The Fund may write a call or put option only
if the option is "covered." A call option is covered if, so long as the
Fund is obligated under the option, it owns an offsetting position in the
underlying security, currency or futures contract, or a right to obtain
the security, currency or futures contract. A put option is covered if the
Fund maintains in a segregated account with the Fund's custodian, cash, or
liquid high-quality debt securities, with a value sufficient to cover its
potential obligations, as marked-to-market daily.
When the Fund purchases or sells a futures contract, the Fund is
required to deposit with its custodian (or a broker, if legally permitted)
a specified amount of cash or U.S. government securities ("initial
margin"). The use by the Fund of futures contracts or commodities option
positions for other than bona fide hedging purposes is restricted by
government regulations. (See the Statement of Additional Information.) If
the Fund writes an option or sells a futures contract and is not able to
close out that position prior to settlement date, the Fund may be required
to deliver cash or securities substantially in excess of these amounts.
The Fund might not employ any of the strategies described above, and
there can be no assurance that any strategy used will succeed. The Fund's
ability to engage in these practices may be limited by market conditions,
the rules and regulations of the Commodity Futures Trading Commission, tax
considerations and certain other legal considerations. Moreover, in the
event that an anticipated change in the price of the securities or
currencies that are the subject of the strategy does not occur, it may be
that the Fund would have been in a better position had it not used that
strategy at all.
The use of options, futures and forward currency exchange contracts
involves certain investment risks and transaction costs to which the Fund
might not be subject if it did not use such instruments. These risks
include (1) dependence on the adviser's ability to predict movements in
the prices of individual securities, fluctuations in the general
securities markets or in market sectors and movements in interest rates
and currency markets; (2) imperfect correlation between movements in the
price of options, currencies, futures contracts, forward currency exchange
contracts or options thereon and movements in the price of the securities
or currencies hedged or used for cover; (3) the fact that skills and
techniques needed to trade options, futures contracts and forward currency
exchange contracts are different from those needed to select the
securities in which the Fund invests; (4) lack of assurance that a liquid
secondary market will exist for any particular option or futures contract
at any particular time, which may result in unanticipated losses; (5) the
possibility that the use of cover or segregation involving a large
percentage of the Fund's assets could impede portfolio management or the
Fund's ability to meet redemption requests or other short-term
obligations; (6) the possible need to defer closing out certain options or
futures contracts in order to continue to qualify for the beneficial tax
treatment afforded regulated investment companies under the Internal
Revenue Code of 1986, as amended ("Code") (see "Additional Tax
Information" in the Statement of Additional Information); and (7) the
costs and commissions associated with such trades, which will reduce the
Fund's yield. The use of options for speculative purposes, I.E., to
enhance income or to increase the Fund's exposure to a particular security
or foreign currency, subjects the Fund to additional risk. The use of
futures or forward contracts to hedge an anticipated purchase
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(other than a when-issued or delayed-delivery purchase), also subjects the
Fund to additional risk until the purchase is completed or the position is
closed out. Although the Fund generally will not enter into such
anticipatory hedges without the expectation of completing the transaction,
it is required to complete only 75% of them. If the transaction is not
completed, the risk of the anticipatory hedge is the same as if the Fund
had entered into the transaction for speculative purposes.
The Statement of Additional Information contains a more detailed
description of futures, options and forward strategies.
New futures contracts, options thereon and other financial products
and risk management techniques continue to be developed. The Fund may use
these investments or techniques to the extent consistent with its
investment objectives and regulatory and federal tax considerations.
Portfolio Turnover
For the period February 1, 1994 (commencement of operations) to
December 31, 1994, the Fund's annualized portfolio turnover rate was
67.39%. The Fund may sell fixed-income securities and buy similar
securities to obtain yield and take advantage of market anomalies, a
practice which will increase the reported turnover rate of the Fund. High
turnover rates (100% or more) result in correspondingly greater
transaction costs, which will be borne directly by the Fund. It may also
increase the amount of short-term capital gains, if any, realized by the
Fund and would affect the tax treatment of distributions paid to
shareholders because distributions of net short-term capital gains are
taxable as ordinary income. The Fund will take these possibilities into
account as part of its investment strategy.
HOW YOU CAN INVEST IN THE FUND
You may purchase shares of the Fund through a brokerage account with
Legg Mason or with an affiliate that has a dealer agreement with Legg
Mason (Legg Mason is a wholly owned subsidiary of Legg Mason, Inc., a
financial services holding company). Your Legg Mason or affiliated
investment executive will be pleased to explain the shareholder services
available from the Fund and answer any questions you may have. Documents
available from your Legg Mason or affiliated investment executive should
be completed if you invest in shares of the Fund through an Individual
Retirement Account ("IRA"), Self-Employed Individual Retirement Plan
("Keogh Plan"), Simplified Employee Pension Plan ("SEP") or other
qualified retirement plan.
The minimum initial investment in the Fund for each account, including
investments made by exchange from other Legg Mason funds, is $1,000, and
the minimum investment for each purchase of additional shares is $100,
except as noted below. Initial investments in an IRA account established
on behalf of a nonworking spouse of a shareholder who has an IRA invested
in the Fund require a minimum amount of only $250. Subsequent investments
in an IRA or similar plan also require a minimum amount of $100. However,
once an account is established, the minimum amount for subsequent
investments will be waived if an investment in an IRA or similar plan will
bring the investment for the year to the maximum amount permitted under
the Code. For those investing through the Fund's Future First Systematic
Investment Plan, payroll deduction plans and plans involving automatic
payment of funds from financial institutions or automatic investment of
dividends from certain unit investment trusts, minimum initial and
subsequent investments are lower. The Fund may change these minimum amount
requirements at its discretion.
Fund shares purchased on behalf of an IRA, Keogh Plan, SEP or other
qualified retirement plan will be processed at the net asset value next
determined after Legg Mason's Funds Processing receives a check for the
amount of the purchase. Other share purchases will be processed at the net
asset value next determined after your Legg Mason or affiliated investment
executive has received your order; payment must be made within five
business days to Legg Mason. Beginning in June, 1995, payment must be made
within three business days to Legg Mason. Orders received by your Legg
Mason or affiliated investment executive before the close of business of
the New York Stock Exchange, Inc. ("Exchange") (normally 4:00 p.m. Eastern
time) ("close of the Exchange") on any day the Exchange is open will be
executed at the net asset value determined as of the close of the Exchange
on that day. Orders
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received by your Legg Mason or affiliated investment executive after the
close of the Exchange or on days the Exchange is closed will be executed
at the net asset value determined as of the close of the Exchange on the
next day the Exchange is open. See "How Net Asset Value is Determined" on
page 17. The Fund reserves the right to reject any order for shares of the
Fund or to suspend the offering of shares for a period of time.
You should always furnish your share-
holder account number when making additional purchases of shares.
There are three ways you can invest in the Fund:
1. THROUGH YOUR LEGG MASON OR AFFILIATED INVESTMENT EXECUTIVE
Fund shares may be purchased through any Legg Mason or affiliated
investment executive. An investment executive will be pleased to open an
account for you, explain to you the shareholder services available from
the Fund, and answer any questions you may have. After you have
established a Legg Mason or affiliated account, you can order shares of
the Fund from your investment executive in person, by telephone or by
mail.
2. THROUGH THE FUTURE FIRST SYSTEMATIC INVESTMENT PLAN
You may also buy shares in the Fund through the Future First
Systematic Investment Plan. Under this plan, you may arrange for automatic
monthly investments in the Fund of $50 or more by authorizing Boston
Financial Data Services ("BFDS"), the Fund's transfer agent, to prepare a
check each month drawn on your checking account. There is no minimum
initial investment. Please contact any Legg Mason or affiliated investment
executive for further information.
3. THROUGH AUTOMATIC INVESTMENTS
Arrangements may be made with some employers and financial
institutions, such as banks or credit unions, for regular automatic
monthly investments of $50 or more in shares of the Fund. In addition, it
may be possible for dividends from certain unit investment trusts to be
invested automatically in Fund shares. Persons interested in establishing
such automatic investment programs should contact the Fund through any
Legg Mason or affiliated investment executive.
HOW YOUR SHAREHOLDER ACCOUNT IS MAINTAINED
When you initially purchase Fund shares, a shareholder account is
established automatically for you. Any shares that you purchase or receive
as a dividend or other distribution will be credited directly to your
account at the time of purchase or receipt. No certificates are issued
unless you specifically request them in writing. Shareholders who elect to
receive certificates can redeem their shares only by mail. Certificates
will be issued in full shares only. No certificates will be issued for
shares prior to 15 business days after purchase of such shares by check
unless the Fund can be reasonably assured during that period that payment
for the purchase of such shares has been collected. Fund shares may not be
held in, or transferred to, an account with any brokerage firm other than
Legg Mason or its affiliates.
HOW YOU CAN REDEEM YOUR FUND SHARES
There are two ways you can redeem your Fund shares. First, you may
give your Legg Mason or affiliated investment executive an order for
repurchase of your shares. Please have the following information ready
when you call: the number of shares to be redeemed and your shareholder
account number. Second, you may send a written request for redemption to
"Legg Mason High Yield Portfolio, c/o Legg Mason Funds Processing, P.O.
Box 1476, Baltimore, Maryland 21203-1476."
Requests for redemption in "good order," as described below, received
by your Legg Mason or affiliated investment executive before the close of
the Exchange on any day when the Exchange is open, will be transmitted to
BFDS, transfer agent for the Fund, for redemption at the net asset value
per share determined as of the close of the Exchange on that day. Requests
for redemption received by your Legg Mason or affiliated investment
executive after the close of the Exchange will be executed at the net
asset value determined as of the close of the Exchange on its next trading
day. A redemption request received by your Legg Mason or affiliated
investment executive may be treated as a request for repurchase and, if it
is accepted by Legg Mason, the shares will be purchased at the net asset
value per share determined as of the next close of the Exchange.
Proceeds from your redemption will settle in your Legg Mason brokerage
account two business
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days after trade date. However, the Fund reserves the right to take up to
seven days to make payment upon redemption if, in the judgment of the
Adviser, the Fund could be adversely affected by immediate payment. (The
Statement of Additional Information describes several other circumstances
in which the date of payment may be postponed or the right of redemption
suspended.) The proceeds of your redemption or repurchase may be more or
less than your original cost. If the shares to be redeemed or repurchased
were paid for by check (including certified or cashier's checks) within 15
business days of the redemption or repurchase request, the proceeds will
not be disbursed unless the Fund can be reasonably assured that the check
has been collected.
A redemption request will be considered to be received in "good order"
only if:
1. You have indicated in writing the number of shares to be redeemed
and your shareholder account number;
2. The written request is signed by you and by any co-owner of the
account with exactly the same name or names used in establishing the
account;
3. The written request is accompanied by any certificates representing
the shares that have been issued to you, and you have endorsed the
certificates for transfer or an accompanying stock power exactly as the
name or names appear on the certificates; and
4. The signatures on the written redemption request and on any
certificates for your shares (or an accompanying stock power) have been
guaranteed without qualification by a national bank, a state bank, a
member firm of a principal stock exchange, or other entity described in
Rule 17Ad-15 under the Securities Exchange Act of 1934.
Other supporting legal documents may be required from corporations or
other organizations, fiduciaries or persons other than the shareholder of
record making the request for redemption or repurchase. If you have a
question concerning the redemption of Fund shares, contact your Legg Mason
or affiliated investment executive.
The Fund will not be responsible for the authenticity of redemption
instructions received by telephone, provided it follows reasonable
procedures to identify the caller. The Fund may request identifying
information from callers or employ identification numbers. The Fund may be
liable for losses due to unauthorized or fraudulent instructions if it
does not follow reasonable procedures. Telephone redemption privileges are
available automatically to all shareholders unless certificates have been
issued. Shareholders who do not wish to have telephone redemption
privileges should call their Legg Mason or affiliated investment executive
for further instructions.
To redeem your Fund retirement account, a Distribution Request Form
must be completed and returned to Legg Mason Client Services for
processing. This form can be obtained through your Legg Mason or
affiliated investment executive or Legg Mason Client Services in
Baltimore, Maryland.
Because of the relatively high cost of maintaining small accounts, the
Fund may elect to close any account with a current value of less than $500
by redeeming all of the shares in the account and mailing the proceeds to
you. However, the Fund will not redeem accounts that fall below $500
solely as a result of a reduction in net asset value per share. If the
Fund elects to redeem the shares in your account, you will be notified
that your account is below $500 and will be allowed 60 days in which to
make an additional investment in order to avoid having your account
closed.
HOW NET ASSET VALUE IS DETERMINED
Net asset value per Fund share is determined daily, as of the close of
the Exchange, on every day that the Exchange is open, by subtracting the
Fund's liabilities from its total assets and dividing the result by the
number of shares outstanding. Securities owned by the Fund for which
market quotations are readily available are valued at current market
value. In the absence of readily available market quotations, securities
are valued at fair value as determined by the Corporation's Board of
Directors. Where a security is traded on more than one market, which may
include foreign markets, the securities are generally valued on the market
considered by the Adviser to be the primary market. Securities with
remaining maturities of 60 days or less are valued at amortized cost. The
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Fund will value its foreign securities in U.S. dollars on the basis of the
then-prevailing exchange rates.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Fund declares dividends to its shareholders out of its investment
company taxable income, which consists of net investment income, any net
short-term capital gain and any net gains from certain foreign currency
transactions. Dividends from net investment income are declared and paid
monthly. Shareholders begin to earn dividends on their Fund shares as of
settlement date, which is normally the fifth business day after their
orders are placed with their Legg Mason or affiliated investment
executive. Beginning in June, 1995, settlement date will normally be the
third business day after orders are placed with a Legg Mason or affiliated
investment executive. Dividends from net short-term capital gain and
distributions of substantially all net capital gain (the excess of net
long-term capital gain over net short-term capital loss) and any net gain
from foreign currency transactions generally are declared and paid after
the end of the taxable year in which the gain is realized. A second
distribution of net capital gain may be necessary in some years to avoid
imposition of the excise tax described under the heading "Additional Tax
Information" in the Statement of Additional Information. Dividends and
other distributions, if any, on shares held in an IRA, Keogh Plan, SEP or
other qualified retirement plan and by shareholders maintaining a
Systematic Withdrawal Plan generally are reinvested in Fund shares on the
payment dates. Other shareholders may elect to:
1. Receive both dividends and other distributions in Fund shares;
2. Receive dividends in cash and other distributions in Fund shares;
3. Receive dividends in Fund shares and other distributions in cash;
or
4. Receive both dividends and other distributions in cash.
In certain cases, you may reinvest your dividends and other
distributions in shares of another Legg Mason fund. Please contact your
Legg Mason or affiliated investment executive for additional information
about this option.
If no election is made, both dividends and other distributions will be
credited to your account in Fund shares at the net asset value of the
shares determined as of the close of the Exchange on the reinvestment
date. Shares received pursuant to any of the first three (reinvestment)
elections above also will be credited to your account at that net asset
value. If you elect to receive dividends and/or other distributions in
cash, you will be sent a check or will have your Legg Mason account
credited after the payment date. You may elect at any time to change your
option by notifying the Fund in writing at: Legg Mason High Yield
Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476, Baltimore,
Maryland 21203-1476. Your election must be received at least 10 days
before the record date in order to be effective for dividends and other
distributions paid to shareholders as of that date.
TAXES
The Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will be relieved of federal
income tax on that part of its investment company taxable income and net
capital gain that is distributed to its shareholders.
Dividends from the Fund's investment company taxable income (whether
paid in cash or reinvested in Fund shares) are taxable to its shareholders
(other than IRAs, Keogh Plans, SEPs, other qualified retirement plans and
other tax-exempt investors) as ordinary income to the extent of the Fund's
earnings and profits. Distributions of the Fund's net capital gain
(whether paid in cash or reinvested in Fund shares), when designated as
such, are taxable to those shareholders as long-term capital gain,
regardless of how long they have held their Fund shares.
The Fund sends each shareholder a notice following the end of each
calendar year specifying, among other things, the amounts of all dividends
and other distributions paid (or deemed paid) during that year. The Fund
is required to withhold 31% of all dividends, capital gain distributions
and redemption proceeds payable to any individuals and certain other
noncorporate shareholders who do not provide the Fund with a certified
taxpayer identification number. The Fund also is required to withhold 31%
of all dividends and capital gain
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distributions payable to such shareholders who otherwise are subject to
backup withholding.
A redemption of Fund shares may result in taxable gain or loss to the
redeeming shareholder, depending on whether the redemption proceeds are
more or less than the shareholder's adjusted basis for the redeemed
shares. An exchange of Fund shares for shares of any other Legg Mason fund
generally will have similar tax consequences. See "Shareholder
Services -- Exchange Privilege," below. If Fund shares are purchased
within 30 days before or after redeeming other Fund shares at a loss, all
or part of that loss will not be deductible and instead will increase the
basis of the newly purchased shares.
A dividend or other distribution paid shortly after shares have been
purchased, although in effect a return of investment, is subject to
federal income tax. Accordingly, an investor should recognize that a
purchase of Fund shares immediately prior to the record date for a
dividend or other distribution could cause the investor to incur tax
liabilities and should not be made solely for the purpose of receiving the
dividend or other distribution.
The foregoing is only a summary of some of the important federal
income tax considerations generally affecting the Fund and its
shareholders; see the Statement of Additional Information for a further
discussion. In addition to federal income tax, you may also be subject to
state, local or foreign taxes on distributions from the Fund, depending on
the laws of your home state and locality. A portion of the dividends paid
by the Fund attributable to direct U.S. government obligations is not
subject to state and local income taxes in most jurisdictions. The Fund's
annual notice to shareholders regarding the amount of dividends identifies
this portion. Prospective shareholders are urged to consult their tax
advisers with respect to the effects of this investment on their own tax
situations.
SHAREHOLDER SERVICES
CONFIRMATIONS AND REPORTS
You will receive from the distributor a confirmation after each
transaction (except a reinvestment of dividends, capital gains and shares
purchased through the Future First Systematic Investment Plan or through
automatic investments). An account statement will be sent to you monthly
unless there has been no activity in the account or you are purchasing
shares through the Future First Systematic Investment Plan or through
automatic investments, in which case an account statement will be sent
quarterly. Reports will be sent to shareholders at least semiannually
showing the Fund's portfolio and other information; the annual report will
contain financial statements audited by the Corporation's independent
accountants.
Shareholder inquiries should be addressed to "Legg Mason High Yield
Portfolio, c/o Legg Mason Funds Processing, P.O. Box 1476, Baltimore,
Maryland 21203-1476."
SYSTEMATIC WITHDRAWAL PLAN
You may elect to make systematic withdrawals from your Fund account of
a minimum of $50 on a monthly basis if you are purchasing or already own
shares with a net asset value of $5,000 or more. Shareholders should not
purchase shares of the Fund while they are participating in the Systematic
Withdrawal Plan. Please contact your Legg Mason or affiliated investment
executive for further information.
EXCHANGE PRIVILEGE
As a Fund shareholder, you are entitled to exchange your shares of the
Fund for shares of the following funds in the Legg Mason Family of Funds,
provided that such shares are eligible for sale in your state of
residence:
Legg Mason Cash Reserve Trust
A money market fund seeking stability of principal and current income
consistent with stability of principal.
Legg Mason Tax Exempt Trust, Inc.
A money market fund seeking high current income exempt from federal
income tax, preservation of capital, and liquidity.
Legg Mason U.S. Government Money Market Portfolio
A money market fund seeking high current income consistent with
liquidity and conservation of principal.
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Legg Mason Value Trust, Inc.
A mutual fund seeking long-term growth of capital.
Legg Mason Special Investment Trust, Inc.
A mutual fund seeking capital appreciation by investing principally in
issuers with market capitalizations of less than $2.5 billion.
Legg Mason Total Return Trust, Inc.
A mutual fund seeking capital appreciation and current income in order
to achieve an attractive total investment return consistent with
reasonable risk.
Legg Mason American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Legg Mason Global Equity Trust
A mutual fund seeking maximum long-term total return, by investing in
common stocks of companies located in at least three different countries.
Legg Mason U.S. Government Intermediate-Term Portfolio
A mutual fund seeking high current income consistent with prudent
investment risk and liquidity needs, primarily by investing in debt
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities, while maintaining an average dollar-weighted maturity
of between three and ten years.
Legg Mason Investment Grade Income Portfolio
A mutual fund seeking a high level of current income, primarily
through investment in a diversified portfolio of investment grade debt
securities.
Legg Mason Global Government Trust
A mutual fund seeking capital appreciation and current income by
investing principally in debt securities issued or guaranteed by foreign
governments, the U.S. Government, their agencies, instrumentalities and
political subdivisions.
Legg Mason Maryland Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal and Maryland state and local income taxes,
consistent with prudent investment risk and preservation of capital.
Legg Mason Pennsylvania Tax-Free Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax and Pennsylvania personal income
tax, consistent with prudent investment risk and preservation of capital.
Legg Mason Tax-Free Intermediate-Term Income Trust*
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
*Shares of these funds are sold with an initial sales charge.
Investments by exchange into the Legg Mason funds sold without an
initial sales charge are made at the per share net asset value determined
on the same business day as redemption of the Fund shares you wish to
exchange. Investments by exchange into the Legg Mason funds sold with an
initial sales charge are made at the per share net asset value, plus the
applicable sales charge, determined on the same business day as redemption
of the Fund shares you wish to redeem; except that no sales charge will be
imposed upon proceeds from the redemption of Fund shares to be exchanged
that were originally purchased by exchange from a fund on which the same
or higher initial sales charge previously was paid. There is no charge for
the exchange privilege, but the Fund reserves the right to terminate or
limit the exchange privilege of any shareholder who makes more than four
exchanges from the Fund in one calendar year. To obtain further
information concerning the exchange privilege and prospectuses of other
Legg Mason funds, or to make an exchange, please contact your Legg Mason
or affiliated investment executive. To effect an exchange by telephone,
please call your Legg Mason or affiliated investment executive with the
information described in "How You Can Redeem Your Fund Shares" on page 16.
Please read the prospectus for the other funds carefully before you invest
by exchange. The Fund reserves the right to modify or terminate the
exchange privilege upon 60 days' notice to shareholders.
There is no assurance the money market funds will be able to maintain
a $1.00 share price. None
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of the funds is insured or guaranteed by the U.S. Government.
THE FUND'S BOARD OF DIRECTORS, MANAGER AND INVESTMENT ADVISER
BOARD OF DIRECTORS
The business and affairs of the Fund are managed under the direction
of the Corporation's Board of Directors.
MANAGER
Pursuant to a management agreement with the Fund ("Management
Agreement "), which was approved by the Corporation's Board of Directors,
Legg Mason Fund Adviser, Inc., a wholly owned subsidiary of Legg Mason,
Inc., serves as the Fund's manager. The Manager manages the non-investment
affairs of the Fund, directs all matters related to the operation of the
Fund and provides office space and administrative staff for the Fund. The
Fund pays the Manager, pursuant to the Management Agreement, a management
fee equal to an annual rate of 0.65% of the Fund's average daily net
assets.
The Manager acts as investment adviser, manager or consultant to
fifteen investment company portfolios (excluding the Fund) which had
aggregate assets under management of over $4.0 billion as of February 28,
1995. The Manager's address is 111 South Calvert Street, Baltimore,
Maryland 21202.
INVESTMENT ADVISER
Western Asset Management Company, another wholly owned subsidiary of
Legg Mason, Inc., serves as investment adviser to the Fund pursuant to the
terms of an Investment Advisory Agreement with the Manager, which was
approved by the Corporation's Board of Directors. The Adviser manages the
investment and other affairs of the Fund and directs the investments of
the Fund in accordance with its investment objectives, policies and
limitations. For these services, the Manager (not the Fund) pays the
Adviser a fee, computed daily and payable monthly, at an annual rate equal
to 77% of the fee received by the Manager, or 0.50% of the Fund's average
daily net assets.
An investment committee has been responsible for the day-to-day
management of the Fund since its inception.
The Adviser also renders investment advice to eleven open-end
investment companies and one closed-end investment company, which together
had aggregate assets under management of approximately $2.5 billion as of
February 28, 1995. The Adviser also renders investment advice to private
accounts with fixed-income assets under management of approximately $10.8
billion as of that date. The address of the Adviser is 117 East Colorado
Boulevard, Pasadena, California 91105.
The Adviser has managed fixed-income portfolios continuously since its
founding in 1971, and has focused exclusively on such accounts since 1984.
In managing fixed-income portfolios, the Adviser first studies the
range of factors that influence interest rates and develops a long-term
interest rate forecast. It then allocates available funds to those sectors
of the market (for example, government, corporate, or mortgage-backed
securities), which it considers most attractive. Then it selects the
specific issues which it believes represent the best values. All three
decisions are integral parts of the Adviser's portfolio management process
and contribute to its performance record.
THE FUND'S DISTRIBUTOR
Legg Mason is the distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of shares of the Fund, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional information and periodic reports used in
connection with the offering to prospective investors, after the
prospectuses, statements of additional information and reports have been
prepared, set in type and mailed to existing shareholders at the Fund's
expense, and for any supplementary sales literature and advertising costs.
Legg Mason also receives a fee from BFDS for assisting it with its
transfer agent and shareholder servicing functions. For the period
February 1, 1994 (commencement of operations) to December
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31, 1994, Legg Mason received $9,327 for performing such services in
connection with the Fund.
The Board of Directors of the Corporation has adopted a Distribution
and Shareholder Services Plan ("Plan") pursuant to Rule 12b-1 under the
Investment Company Act of 1940 ("1940 Act"). The Plan provides that as
compensation for Legg Mason's ongoing services to shareholders and its
activities and expenses related to the sale and distribution of Fund
shares, Legg Mason receives from the Fund an annual distribution fee and
an annual service fee, each of which is equal to 0.25% of the Fund's
average daily net assets. The distribution and service fees are calculated
daily and paid monthly. The fees received by Legg Mason during any year
may be more or less than its cost of providing distribution and
shareholder services to the Fund.
NASD rules limit the amount of annual distribution fees that may be
charged by mutual funds and impose a ceiling on the cumulative
distribution fees received. The Fund's Plan complies with those rules.
The Chairman, President and Treasurer of the Corporation are employed
by Legg Mason.
THE FUND'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company ("State Street"), P.O. Box 1790,
Boston, Massachusetts 02105, serves as custodian of the Fund's assets.
Boston Financial Data Services, P.O. Box 953, Boston, Massachusetts 02103,
serves as transfer and dividend-disbursing agent, and administrator of
various shareholder services. Shareholders who request an historical
transcript of their account will be charged a fee based on the number of
years researched. The Fund reserves the right, upon 60 days' written
notice, to make other charges to investors to cover administrative costs.
Pursuant to rules adopted under Section 17(f) of the 1940 Act, the
Fund may maintain foreign securities and cash in the custody of certain
eligible foreign banks and securities depositories. Selection of these
foreign custodial institutions is made by the Board of Directors in
accordance with SEC rules. The Board of Directors will consider a number
of factors, including, but not limited to, the relationship of the
institution to State Street, the reliability and financial stability of
the institution, the ability of the institution to capably perform
custodial services for the Fund, the reputation of the institution in its
national market, the political and economic stability of the countries in
which the sub-custodians will be located and risks of potential
nationalization or expropriation of Fund assets. No assurance can be given
that the Board of Directors' appraisal of the risks in connection with
foreign custodial arrangements will always be correct or that
expropriation, nationalization, freezes, or confiscation of Fund assets
will not occur.
DESCRIPTION OF THE CORPORATION AND ITS SHARES
The Corporation is a diversified open-end investment company which was
incorporated in Maryland on April 28, 1987. The Articles of Incorporation
of the Corporation permit the Board of Directors to create additional
series (or portfolios), each of which issues a separate class of shares.
There are currently four portfolios of the Corporation, including the
Fund. While additional series may be created in the future, there is no
intention at this time to form any particular additional series.
The Corporation has authorized one billion shares of common stock, par
value $.001 per share. Shareholders of each portfolio of the Corporation
are entitled to one vote per share and fractional votes for fractional
shares held. However, shareholders of the Fund vote separately on certain
matters affecting it. For example, a change in investment policy for the
Fund would be voted upon only by its shareholders. Voting rights are not
cumulative. All shares of the Corporation are fully paid and
non-assessable and have no preemptive or conversion rights.
Shareholders' meetings will not be held except where the 1940 Act
requires a shareholder vote on certain matters (including the election of
directors, approval of an advisory contract and approval of a plan of
distribution pursuant to Rule 12b-1). The Corporation will call a special
meeting of the shareholders at the request of 10% or more of the shares
entitled to vote; shareholders wishing to call such a meeting should
submit a written request to the Fund at 111 South Calvert Street,
Baltimore, Maryland 21202, stating the purpose of the proposed meeting and
the matters to be acted upon.
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APPENDIX A
The Fund may use the following hedging instruments:
OPTIONS ON SECURITIES AND FOREIGN CURRENCIES -- A call option is a
short-term contract pursuant to which the purchaser of the option, in
return for a premium, has the right to buy the security or currency
underlying the option at a specified price at any time during the term of
the option. The writer of the call option, who receives the premium, has
the obligation, upon exercise of the option during the option term, to
deliver the underlying security or currency against payment of the
exercise price. A put option is a similar contract that gives its
purchaser, in return for a premium, the right to sell the underlying
security or currency at a specified price during the option term. The
writer of the put option, who receives the premium, has the obligation,
upon exercise of the option during the option term, to buy the underlying
security or currency at the exercise price.
OPTION ON A SECURITIES INDEX -- An option on a securities index is
similar to an option on a security or foreign currency, except that
settlement of an index option is effected with a cash payment based on the
value of the index and does not involve the delivery of the securities
included in the index. Thus, upon settlement of an index option, the
purchaser will realize, and the writer will pay, an amount based on the
difference between the exercise price of the option and the closing price
of the index.
INTEREST RATE AND FOREIGN CURRENCY FUTURES CONTRACTS -- Interest rate
and foreign currency futures contracts are bilateral agreements pursuant
to which one party agrees to make, and the other party agrees to accept,
delivery of a specified type of debt security or currency at a specified
future time and at a specified price. Although such futures contracts by
their terms call for actual delivery or acceptance of debt securities or
currency, in most cases the contracts are closed out before the settlement
date without the making or taking of delivery. An index futures contract
is similar to any other futures contract except that settlement of an
index futures contract is effected with a cash payment based on the value
of the index and does not involve the delivery of the securities included
in the index.
OPTIONS ON FUTURES CONTRACTS -- Options on futures contracts are
similar to options on securities or currency, except that an option on a
futures contract gives the purchaser the right, in return for the premium,
to assume a position in a futures contract (a long position if the option
is a call and a short position if the option is a put), rather than to
purchase or sell a security or currency, at a specified price at any time
during the option term. Upon exercise of the option, the delivery of the
futures position to the holder of the option will be accompanied by
delivery of the accumulated balance that represents the amount by which
the market price of the futures contract exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on
the future. The writer of an option, upon exercise, will assume a short
position in the case of a call and a long position in the case of a put.
An option on a bond index futures contract is similar to any other option
on a futures contract except that the purchaser has the right, in return
for the premium, to assume a position in a bond index futures contract at
a specified price at any time during the option term.
FORWARD CURRENCY CONTRACTS -- A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future
date, which may be any fixed number of days from the contract date agreed
upon by the parties, at a price set at the time the contract is entered
into.
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APPENDIX B
RATINGS OF SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") CORPORATE BOND
RATINGS:
Aaa -- Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally
referred to as "gilt edge". Interest payments are protected by a large or
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa -- Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risks appear
somewhat larger than the Aaa securities.
A -- Bonds which are rated A possess many favorable investment
attributes and are to be considered 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
some time in the future.
Baa -- Bonds which are rated Baa are considered medium-grade
obligations, (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have speculative
characteristics as well.
Ba -- Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered well-assured. Often the
protection of interest and principal payments may be very moderate, and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B -- Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time
may be small.
Caa -- Bonds which are rated Caa are of poor standing and 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 and are often in default or have other marked
shortcomings.
C -- Bonds which are rated C are the lowest rated class of bonds and
can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP ("S&P") CORPORATE BOND RATINGS:
Aaa -- This is the highest rating assigned by Standard & Poor's to an
obligation. Capacity to pay interest and repay principal is extremely
strong.
AA -- Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small
degree.
A -- Bonds rated A have a strong capacity to pay interest and repay
principal, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher categories.
BBB -- Bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for bonds in this category than for bonds in
higher rated categories.
BB, B, CCC, CC -- Bonds rated BB, B, CCC and CC are regarded, on
balance, as predominately speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms
of the obligation. BB indicates the lowest degree of speculation and CC
the highest degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by large
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<PAGE>
uncertainties or major risk exposures to adverse conditions.
C -- Bonds on which no interest is being paid are rated C.
D -- Bonds rated D are in payment default and payment of interest
and/or repayment of principal is in arrears.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS:
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 that 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 divided 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 pre-
ferred or preference stock. Issues so rated can be regarded as having
extremely poor prospects of
ever attaining any real investment standing.
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<PAGE>
THE LEGG MASON INCOME TRUST, INC.:
U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO
PRIMARY SHARES
NAVIGATOR SHARES
STATEMENT OF ADDITIONAL INFORMATION
U.S. Government Intermediate-Term Portfolio ("Government
Intermediate Portfolio" or "Fund"), is a separate series of Legg Mason
Income Trust, Inc. ("Corporation"), an open-end, diversified management
investment company. The Fund seeks to provide investors with high current
income consistent with prudent investment risk and liquidity needs. In
attempting to achieve this objective, the Fund's investment adviser,
Western Asset Management Company ("Adviser"), under normal circumstances,
invests at least 75% of the Government Intermediate Portfolio's assets in
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. The Government Intermediate Portfolio expects to
maintain an average dollar-weighted maturity of between three and ten
years. The Fund seeks to provide income higher than that of money market
funds and greater price stability than funds with longer average
maturities.
Shares of Navigator U.S. Government Intermediate-Term Portfolio
("Navigator Shares"), described in this Statement of Additional
Information, represent interests in the Fund that are currently offered
for sale only to institutional clients of the Fairfield Group, Inc.
("Fairfield") for investment of their own funds and funds for which they
act in a fiduciary capacity, to clients of Legg Mason Trust Company
("Trust Company") for which the Trust Company exercises discretionary
investment management responsibility (such institutional investors are
referred to collectively as "Institutional Clients" and accounts of such
Clients are referred to collectively as "Customer Accounts"), to qualified
retirement plans managed on a discretionary basis and having net assets of
at least $200 million, and to The Legg Mason Profit Sharing Plan and
Trust. The Navigator Class of Shares may not be purchased by individuals
directly, but Institutional Clients may purchase shares for Customer
Accounts maintained for individuals.
The Primary Class of shares of U.S. Government Intermediate-Term
Portfolio ("Primary Shares") are offered for sale to all other investors
and may be purchased directly by individuals.
Navigator and Primary Shares are sold and redeemed without any
purchase or redemption charge imposed by the Fund, although Institutional
Clients may charge their Customer Accounts for services provided in
connection with the purchase or redemption of shares. The Fund will pay
management fees to Legg Mason Fund Adviser, Inc. Primary Shares pay a
12b-1 distribution fee, but Navigator Shares pay no distribution fees.
See "The Fund's Distributor."
Mutual fund shares are not deposits or obligations of, or
guaranteed or endorsed by, any bank or other depository institution.
Shares are not insured by the FDIC, the Federal Reserve Board or any other
<PAGE>
agency, and are subject to investment risk, including the possible loss of
the principal amount invested.
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectuses for Primary Shares and
for Navigator Shares, both dated May 1, 1995, which have been filed with
the Securities and Exchange Commission ("SEC"). Copies of the
Prospectuses are available without charge from the Corporation's
distributor, Legg Mason Wood Walker, Incorporated ("Legg Mason") (address
and telephone numbers listed below).
Dated: May 1, 1995
LEGG MASON WOOD WALKER,
INCORPORATED
111 South Calvert Street
Baltimore, Maryland 21202
(410) 539-0000 (800) 822-5544
<PAGE>
Table of Contents
Page
Additional Information About Investment
Limitations and Policies 2
Additional Tax Information 15
Additional Purchase and Redemption Information 18
Performance Information 18
Valuation of Fund Shares 25
Tax-Deferred Retirement Plans 25
The Corporation's Directors and Officers 27
Management Agreement 30
Investment Advisory Agreement 32
Portfolio Transactions and Brokerage 32
The Fund's Distributor 34
The Fund's Custodian and Transfer
and Dividend-Disbursing Agent 35
The Corporation's Legal Counsel 36
The Corporation's Independent Accountants 36
Financial Statements 36
Appendix A: Ratings of Securities A-1
No person has been authorized to give any information or
to make any representations not contained in the Prospectuses
or this Statement of Additional Information in connection with
the offerings made by the Prospectuses and, if given or made,
such information or representations must not be relied upon as
having been authorized by the Fund or its distributor. The
Prospectuses and this Statement of Additional Information do
not constitute an offering by the Fund or by the distributor in
any jurisdiction in which such offering may not lawfully be
made.
<PAGE>
ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND
POLICIES
The following information supplements the information concerning
the Fund's investment objective, policies and limitations found in the
Prospectuses.
The Fund has adopted certain fundamental investment limitations
that cannot be changed except by vote of a majority of the Fund's
outstanding voting securities. The Fund may not:
1. Borrow money, except for temporary purposes in an aggregate
amount not to exceed 5% of the value of its total assets at the time of
borrowing. (Although not a fundamental policy subject to shareholder
approval, the Government Intermediate Portfolio intends to repay any money
borrowed before any additional portfolio securities are purchased.);
2. Invest more than 5% of its total assets (taken at market
value) in securities of any one issuer, other than the U.S. Government,
its agencies and instrumentalities, or buy more than 10% of the voting
securities or more than 10% of all the securities of any issuer;
3. Mortgage, pledge or hypothecate any of its assets, except to
collateralize permitted borrowings up to 5% of the value of its total
assets at the time of borrowing; provided, that the deposit in escrow of
underlying securities in connection with the writing of call options is
not deemed to be a pledge; and provided further, that deposit of initial
margin or the payment of variation margin in connection with the purchase
or sale of futures contracts or of options on futures contracts shall not
be deemed to constitute pledging assets;
4. Purchase securities on "margin," except that the Government
Intermediate Portfolio may make margin deposits in connection with its use
of options, interest rate futures contracts and options on interest rate
futures contracts;
5. Make short sales of securities unless at all times while a
short position is open the Government Intermediate Portfolio maintains a
long position in the same security in an amount at least equal thereto;
provided, however, that the Government Intermediate Portfolio may purchase
or sell futures contracts, and may make initial and variation margin
payments in connection with purchases or sales of futures contracts or of
options on futures contracts;
6. Invest more than 25% of its total assets (taken at market
value) in any one industry;
7. Invest in securities issued by other investment companies,
except in connection with a merger, consolidation, acquisition or
reorganization or by purchase in the open market of securities of closed-
end investment companies where no underwriter or dealer commission or
2
<PAGE>
profit, other than a customary brokerage commission, is involved and only
if immediately thereafter not more than 10% of the Government Intermediate
Portfolio's total assets (taken at market value) would be invested in such
securities;
8. Purchase or sell commodities and commodity contracts, except
that the Government Intermediate Portfolio may purchase or sell options,
interest rate futures contracts and options on interest rate futures
contracts;
9. Underwrite the securities of other issuers, except to the
extent that in connection with the disposition of restricted securities or
the purchase of securities either directly from the issuer or from an
underwriter for an issuer, the Government Intermediate Portfolio may be
deemed to be an underwriter;
10. Make loans, except loans of portfolio securities and except
to the extent the purchase of a portion of an issue of publicly
distributed notes, bonds or other evidences of indebtedness or deposits
with banks and other financial institutions may be considered loans;
11. Purchase or sell real estate, except that the Government
Intermediate Portfolio may invest in securities collateralized by real
estate or interests therein or in securities issued by companies that
invest in real estate or interests therein; or
12. Purchase or sell interests in oil and gas or other mineral
exploration or development programs.
Yield Factors and Ratings Standard & Poor's Ratings Group
("S&P") and Moody's Investors Service, Inc. ("Moody's") are private
services that provide ratings of the credit quality of obligations.
Investment grade bonds are generally considered to be those bonds rated at
the time of purchase within one of the four highest grades assigned by S&P
or Moody's. A description of the range of ratings assigned to obligations
by Moody's and S&P is included in Appendix A to this Statement of
Additional Information. The Fund may use these ratings in determining
whether to purchase, sell or hold a security. These ratings represent
Moody's and S&P's opinions as to the quality of the obligations which they
undertake to rate. It should be emphasized, however, that ratings are
general and are not absolute standards of quality. Consequently,
obligations with the same maturity, interest rate and rating may have
different market prices. Subsequent to its purchase by the Fund, an issue
of obligations may cease to be rated or its rating may be reduced below
the minimum rating required for purchase by the Fund. The Adviser will
consider such an event in determining whether the Fund should continue to
hold the obligation, but is not required to dispose of it.
In addition to ratings assigned to individual bond issues, the
Adviser will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and
asset quality. The yields on bonds and other debt securities in which the
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<PAGE>
Fund invests are dependent on a variety of factors, including general
money market conditions, general conditions in the bond market, the
financial conditions of the issuer, the size of the offering, the maturity
of the obligation and its rating. There is a wide variation in the
quality of bonds, both within a particular classification and between
classifications. An issuer's obligations under its bonds are subject to
the provisions of bankruptcy, insolvency and other laws affecting the
rights and remedies of bond holders or other creditors of an issuer;
litigation or other conditions may also adversely affect the power or
ability of issuers to meet their obligations for the payment of interest
and principal on their bonds.
Interest Rate Futures Contracts Interest rate futures contracts,
which are traded on commodity futures exchanges, provide for the sale by
one party and the purchase by another party of a specified type and amount
of financial instruments (or an index of financial instruments) at a
specified future date. Interest rate futures contracts currently exist
covering such financial instruments as U.S. Treasury bonds, notes and
bills, Government National Mortgage Association certificates, bank
certificates of deposit and 90-day commercial paper. An interest rate
futures contract may be held until the underlying instrument is delivered
and paid for on the delivery date, but most contracts are closed out
before then by taking an offsetting position on a futures exchange.
The Fund may purchase an interest rate futures contract (that is,
enter into a futures contract to purchase an underlying financial
instrument) when it intends to purchase fixed-income securities but has
not yet done so. This strategy is sometimes called an anticipatory hedge.
This strategy is intended to minimize the effects of an increase in the
price of the securities the Fund intends to purchase (but may also reduce
the effects of a decrease in price), because the value of the futures
contract would be expected to rise and fall in the same direction as the
price of the securities the Fund intends to purchase. The Fund could
purchase the intended securities either by holding the contract until
delivery and receiving the financial instrument underlying the futures
contract, or by purchasing the securities directly and closing out the
futures contract position. If the Fund no longer wished to purchase the
securities, the Fund would close out the futures contract before delivery.
The Fund may sell a futures contract (that is, enter into a
futures contract to sell an underlying financial instrument) to offset
price changes of securities it already owns. This strategy is intended to
minimize any price changes in the securities the Fund owns (whether
increases or decreases) caused by interest rate changes, because the value
of the futures contract would be expected to move in the opposite
direction from the value of the securities owned by the Fund. The Fund
does not expect ordinarily to hold futures contracts it has sold until
delivery or to use securities it owns to satisfy delivery requirements.
Instead, the Fund expects to close out such contracts before the delivery
date.
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The prices of interest rate futures contracts depend primarily on
the value of the instruments on which they are based, the price changes of
which, in turn, primarily reflect changes in current interest rates.
Because there are a limited number of types of interest rate futures
contracts, it is likely that the standardized futures contracts available
to the Fund will not exactly match the securities the Fund wishes to hedge
or intends to purchase, and consequently will not provide a perfect hedge
against all price fluctuation. Because fixed-income instruments all
respond similarly to changes in interest rates, however, a futures
contract the underlying instrument of which differs from the securities
the Fund wishes to hedge or intends to purchase may still provide
protection against changes in interest rate levels. To compensate for
differences in historical volatility between positions the Fund wishes to
hedge and the standardized futures contracts available to it, the Fund may
purchase or sell futures contracts with a greater or lesser value than the
securities it wishes to hedge or intends to purchase.
Futures Trading If the Fund does not wish to hold a futures
contract position until the underlying instrument is delivered and paid
for on the delivery date, it may attempt to close out the contract by
entering into an offsetting position on a futures exchange that provides a
secondary market for the contract. A futures contract is closed out by
entering into an opposite position in an identical futures contract (for
example, by purchasing a contract on the same instrument and with the same
delivery date as a contract the Fund had sold) at the current price as
determined on the futures exchange. The Fund's gain or loss on closing
out a futures contract depends on the difference between the price at
which the Fund entered into the contract and the price at which the
contract is closed out. Transaction costs in opening and closing futures
contracts must also be taken into account. There can be no assurance that
the Fund will be able to offset a futures position at the time it wishes
to, or at a price that is advantageous. If the Fund were unable to enter
into an offsetting position in a futures contract, it might have to
continue to hold the contract until the delivery date, in which case it
would continue to bear the risk of price fluctuation in the contract until
the underlying instrument was delivered and paid for.
At the time the Fund enters into an interest rate futures
contract, it is required to deposit with its custodian, in the name of the
futures broker (known as a futures commission merchant, or "FCM"), a
percentage of the contract's value. This amount, which is known as
initial margin, generally equals 5% or less of the value of the futures
contract. Initial margin is in the nature of a good faith deposit or
performance bond, and is returned to the Fund when the futures position is
terminated, after all contractual obligations have been satisfied.
Futures margin does not represent a borrowing by the Fund, unlike margin
extended by a securities broker, and depositing initial margin in
connection with futures positions does not constitute purchasing
securities on margin for the purposes of the Fund's investment
limitations. Initial margin may be maintained either in cash or in
liquid, high-quality debt securities such as U.S. government securities.
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As the contract's value fluctuates, payments known as variation
margin or maintenance margin are made to or received from the FCM. If the
contract's value moves against the Fund (i.e., the Fund's futures position
declines in value), the Fund may be required to make payments to the FCM,
and, conversely, the Fund may be entitled to receive payments from the FCM
if the value of its futures position increases. This process is known as
"marking to market" and takes place on a daily basis.
In addition to initial margin deposits, the Fund will instruct
its custodian to segregate additional cash and liquid debt securities to
cover its obligations under futures contracts it has purchased and to
ensure that the contracts are unleveraged. The value of the assets held
in the segregated account will be equal to the daily market value of all
outstanding futures contracts purchased by the Fund, less the amount
deposited as initial margin. Where the Fund enters into positions that
substantially offset one another, it may segregate assets equal to only
one side of the transaction, consistent with SEC staff interpretive
positions. When the Fund has sold futures contracts to hedge securities
it owns, it will not sell those securities (or lend them to another party)
while the contracts are outstanding, unless it substitutes other similar
securities for the securities sold or lent. The Fund will not sell
futures contracts with a value exceeding the value of securities it owns,
except that the Fund may do so to the extent necessary to adjust for
differences in historical volatility between the securities owned and the
contracts used as a hedge.
Risks of Interest Rate Futures Contracts By purchasing an
interest rate futures contract, the Fund in effect becomes exposed to
price fluctuations resulting from changes in interest rates, and by
selling a futures contract the Fund neutralizes those fluctuations. If
interest rates fall, the Fund would expect to profit from an increase in
the value of the instrument underlying a futures contract it had
purchased, and if interest rates rise, the Fund would expect to offset the
resulting decline in the value of the securities it owns by profits in a
futures contract it has sold. If interest rates move in the direction
opposite that which was contemplated at the time of purchase, however, the
Fund's positions in futures contracts could have a negative effect on the
Fund's net asset value. If interest rates rise when the Fund has
purchased futures contracts, the Fund could suffer a loss in its futures
positions. Similarly, if interest rates fall, losses in a futures
contract the Fund has sold could negate gains on securities the Fund owns,
or could result in a net loss to the Fund. In this sense, successful use
of interest rate futures contracts by the Fund will depend on the
Adviser's ability to hedge the Fund in an advantageous way at the
appropriate time.
Other than the risk that interest rates will not move as
expected, the primary risk in employing interest rate futures contracts is
that the market value of the futures contracts may not move in concert
with the value of the securities the Fund wishes to hedge or intends to
purchase. This may result from differences between the instrument
underlying the futures contracts and the securities the Fund wishes to
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hedge or intends to purchase, as would be the case, for example, if the
Fund hedged U.S. Treasury bonds by selling futures contracts on U.S.
Treasury notes.
Even if the securities which are the objects of a hedge are
identical to those underlying the futures contract, there may not be
perfect price correlation between the two. Although the value of interest
rate futures contracts is primarily determined by the price of the
underlying financial instruments, the value of interest rate futures
contracts is also affected by other factors, such as current and
anticipated short-term and long-term interest rates, the time remaining
until expiration of the futures contract, and conditions in the futures
markets, which may not affect the current market price of the underlying
financial instruments in the same way. In addition, futures exchanges
establish daily price limits for interest rate futures contracts, and may
halt trading in the contracts if their prices move up or down more than a
specified daily limit on a given day. This could distort the relationship
between the price of the underlying instrument and the futures contract,
and could prevent prompt liquidation of unfavorable futures positions.
The value of a futures contract may also move differently from the price
of the underlying financial instrument because of inherent differences
between the futures and securities markets, including variations in
speculative demand for futures contracts and for debt securities, the
differing margin requirements for futures contracts and debt securities,
and possible differences in liquidity between the two markets.
Put Options on Interest Rate Futures Contracts Purchasing a put
option on an interest rate futures contract gives the Fund the right to
assume a seller's position in the contract at a specified exercise price
at any time up to the option's expiration date. In return for this right,
the Fund pays the current market price for the option (known as the option
premium), as determined on the commodity futures exchange where the option
is traded.
The Fund may purchase put options on interest rate futures
contracts to hedge against a decline in the market value of securities the
Fund owns. Because a put option is based on a contract to sell a
financial instrument at a certain price, its value will tend to move in
the opposite direction from the price of the financial instrument
underlying the futures contract; that is, the put option's value will tend
to rise when prices fall, and fall when prices rise. By purchasing a put
option on an interest rate futures contract, the Fund would attempt to
offset potential depreciation of securities it owns by appreciation of the
put option. This strategy is similar to selling the underlying futures
contract directly.
The Fund's position in a put option on an interest rate futures
contract may be terminated either by exercising the option (and assuming a
seller's position in the underlying futures contract at the option's
exercise price) or by closing out the option at the current price as
determined on the futures exchange. If the put option is not exercised or
closed out before its expiration date, the entire premium paid will be
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lost by the Fund. The Fund could profit from exercising a put option if
the current market value of the underlying futures contract were less than
the sum of the exercise price of the put option and the premium paid for
the option (because the Fund would, in effect, be selling the futures
contract at a price higher than the current market price). The Fund could
also profit from closing out a put option if the current market price of
the option is greater than the premium the Fund paid for the option.
Transaction costs must also be taken into account in these calculations.
The Fund may close out an option it has purchased by selling an identical
option (that is, an option on the same futures contract, with the same
exercise price and expiration date) in a closing transaction on a futures
exchange that provides a secondary market for the option. The Fund is not
required to make futures margin payments when it purchases an option on an
interest rate futures contract.
Compared to the purchase or sale of an interest rate futures
contract, the purchase of a put option on an interest rate futures
contract involves a smaller potential risk to the Fund, because the
maximum amount at risk is the premium paid for the option (plus related
transaction costs). If prices of debt securities remain stable, however,
purchasing a put option may involve a greater probability of loss than
selling a futures contract, even though the amount of the potential loss
is limited. The Adviser will consider the different risk and reward
characteristics of options and futures contracts when selecting hedging
instruments.
Risks of Transactions in Options on Interest Rate Futures
Contracts Options on interest rate futures contracts are subject to
risks similar to those described above with respect to interest rate
futures contracts. These risks include the risk that the Adviser may not
hedge the Fund in an advantageous way at the appropriate time, the risk of
imperfect price correlation between the option and the securities being
hedged, and the risk that there may not be an active secondary market for
the option. There is also a risk of imperfect price correlation between
the option and the underlying futures contract.
Although the Adviser will purchase and write only those options
for which there appears to be a liquid secondary market, there can be no
assurance that such a market will exist for any particular option at any
particular time. If there were no liquid secondary market for a
particular option, the Fund might have to exercise an option it had
purchased in order to realize any profit, and might continue to be
obligated under an option it had written until the option expired or was
exercised.
Options Writing on Debt Securities The Fund may from time to
time write (sell) covered call options and covered put options on certain
of its portfolio securities. When it writes a covered call option, the
Fund obligates itself to sell the underlying security to the purchaser of
the option at a fixed price if the purchaser exercises the option during
the option period. A call is "covered" if the Fund owns the optioned
securities or, in the case of options on certain U.S. government
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<PAGE>
securities, the Fund maintains with its custodian in a segregated account
cash, U.S. government securities or other high-grade, liquid debt
securities with a value sufficient to meet its obligations under the call.
When the Fund writes a call option, it receives a premium from the
purchaser. During the option period, the Fund forgoes the opportunity to
profit from any increase in the market price of the security above the
exercise price of the option, but retains the risk that the price of the
security may decline.
The Fund may also write covered put options. When the Fund
writes a put option, it receives a premium and gives the purchaser of the
put the right to sell the underlying security to the Fund at the exercise
price at any time during the option period. A put is "covered" if the
Fund maintains cash, U.S. government securities or other high-grade,
liquid debt securities with a value equal to the exercise price in a
segregated account. The risk in writing puts is that the market price of
the underlying security may decline below the exercise price (less the
premiums received).
The Fund may seek to terminate its obligations as a writer of a
put or call option prior to its expiration by entering into a "closing
purchase transaction." A closing purchase transaction is the purchase of
an option covering the same underlying security and having the same
exercise price and expiration date as an option previously written by the
Fund on which it wishes to terminate its obligation.
Although not a fundamental policy subject to shareholder vote,
the Fund presently does not intend to write options on portfolio
securities exceeding 25% of its total assets. Normally, options will be
written on those portfolio securities which the Adviser does not expect to
have significant short-term capital appreciation.
Risks of Writing Options on Debt Securities When the Fund
writes an option, it assumes the risk of fluctuations in the value of the
underlying security in return for a fixed premium and must be prepared to
satisfy exercise of the option at any time until the expiration date. The
writing of options could also result in an increase in the Fund's turnover
rate, particularly in periods of appreciation in the market price of the
underlying securities. In addition, writing options on portfolio
securities involves a number of other risks, including the risk that the
Adviser may not correctly predict interest rate movement and the risk
that there may not be a liquid secondary market for the option, as a
result of which the Fund might be unable to effect a closing transaction.
If the Fund is unable to close out an option it has written, it
must continue to bear the risks associated with the option, and must
continue to hold cash or securities to cover the option until the option
is exercised or expires. The Fund may engage in options on securities
which are not traded on national exchanges ("unlisted options"). Because
unlisted options may be closed out only with the other party to the option
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<PAGE>
transaction, it may be more difficult to close out unlisted options than
listed options.
Regulatory Notification of Futures and Options Strategies The
Corporation has filed on behalf of the Fund a notice of eligibility for
exclusion from the definition of the term "commodity pool operator" with
the Commodity Futures Trading Commission ("CFTC") and the National Futures
Association, which regulate trading in the futures markets. Under Section
4.5 of the regulations under the Commodity Exchange Act, the notice of
eligibility must include representations that the Fund will use futures
contracts and related options solely for bona fide hedging purposes within
the meaning of the CFTC regulations, provided that the Fund may hold
futures contracts and related options that do not fall within the
definition of bona fide hedging transactions if, with respect to such non-
hedging transactions, the sum of initial margin deposits on futures
contracts and related options and premiums paid for related options, after
taking into account unrealized profits and losses on such contracts, do
not exceed 5% of the Fund's net assets; and provided further that the Fund
may exclude the amount by which an option is "in the money" in computing
such 5%. The Fund will not purchase futures contracts or related options
if as a result more than 33 1/3% of the Fund's total assets would be so
invested. Where the Fund enters into two positions that substantially
offset each other, it determines compliance with the foregoing limitation
by considering its net exposure to changes in the underlying instrument or
market. These limits on the Fund's investments in futures contracts are
not fundamental and may be changed by the Board of Directors as regulatory
agencies permit. The Fund will not modify these limits to increase its
permissible futures and related options activities without supplying
additional information in a supplement to a current Prospectus or
Statement of Additional Information that has been distributed or made
available to the Fund's shareholders.
Private Placements The Fund may acquire restricted
securities in private placement transactions, directly from the issuer or
from security holders, frequently at higher yields than comparable
publicly traded securities. Restricted securities will not be purchased
if as a result more than 5% of the Fund's assets would consist of
restricted securities. Privately placed securities can be sold by the
Fund only (1) pursuant to SEC Rule 144A or other exemption; (2) in
privately negotiated transactions to a limited number of purchasers; or
(3) in public offerings made pursuant to an effective registration
statement under the Securities Act of 1933. Private or public sales of
such securities by the Fund may involve significant delays and expense.
Private sales require negotiations with one or more purchasers and
generally produce less favorable prices than the sale of comparable
unrestricted securities. Public sales generally involve the time and
expense of preparing and processing a registration statement under the
Securities Act of 1933 and may involve the payment of underwriting
commissions; accordingly, the proceeds may be less than the proceeds from
the sale of securities of the same class which are freely marketable.
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Securities Lending The Fund may lend portfolio securities to
brokers or dealers in corporate or U.S. government securities, banks or
other recognized institutional borrowers of securities, provided that the
borrower maintains cash or equivalent collateral, equal to at least 100%
of the market value of the securities loaned with the Fund's custodian.
During the time portfolio securities are on loan, the borrower will pay
the Fund an amount equivalent to any dividends or interest paid on such
securities, and the Fund may invest the cash collateral and earn income,
or it may receive an agreed upon amount of interest income from the
borrower who has delivered equivalent collateral. These loans are subject
to termination at the option of the Fund or the borrower. The Fund may
pay reasonable administrative and custodial fees in connection with a loan
and may pay a negotiated portion of the interest earned on the cash or
equivalent collateral to the borrower or placing broker. In the event of
the bankruptcy of the other party to a securities loan, the Fund could
experience delays in recovering the securities lent. To the extent that,
in the meantime, the value of the securities purchased had decreased or
the securities lent increased, the Fund could experience a loss. The Fund
will enter into securities loan transactions only with financial
institutions which the Adviser believes to present minimal risk of default
during the term of the loan. The Fund does not have the right to vote
securities on loan, but would terminate the loan and regain the right to
vote if that were considered important with respect to the investment.
The Fund presently does not intend to loan more than 5% of its portfolio
securities at any given time.
Repurchase Agreements Repurchase agreements are usually for
periods of one week or less, but may be for longer periods. The
securities are held for the Fund by State Street Bank and Trust Company
("State Street"), the Fund's custodian, as collateral until resold and are
supplemented by additional collateral if necessary to maintain a total
value equal to or in excess of the value of the repurchase agreement. The
Fund bears a risk of loss in the event that the other party to a
repurchase agreement defaults on its obligations and the Fund is delayed
or prevented from exercising its rights to dispose of the collateral
securities. The Fund enters into repurchase agreements only with
financial institutions which the Adviser believes to present minimal risk
of default during the term of the agreement based on guidelines
established by the Corporation's Board of Directors. The Fund currently
intends to invest in repurchase agreements when cash is temporarily
available or for temporary defensive purposes.
Reverse Repurchase Agreements A reverse repurchase agreement is
a portfolio management technique in which the Fund temporarily transfers
possession of a portfolio instrument to another person, such as a
financial institution or broker-dealer, in return for cash. At the same
time, the Fund agrees to repurchase the instrument at an agreed upon time
(normally within seven days) and price, including interest payment. The
Fund may engage in reverse repurchase agreements as a means of raising
cash to satisfy redemption requests or for other temporary or emergency
purposes without the necessity of selling portfolio instruments.
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When the Fund reinvests the proceeds of a reverse repurchase
agreement in other securities, any fluctuations in the market value of
either the securities transferred to another party or the securities in
which the proceeds are invested would affect the market value of the
Fund's assets. As a result, such transactions could increase fluctuation
in the Fund's net asset value. If the Fund reinvests the proceeds of the
agreement at a rate lower than the cost of the agreement, engaging in the
agreement will lower the Fund's yield. While engaging in reverse
repurchase agreements, the Fund will maintain cash, U.S. government
securities or other high-grade, liquid debt securities in a segregated
account at its custodian bank with a value at least equal to the Fund's
obligation under the agreements.
The ability of the Fund to engage in reverse repurchase
agreements is subject to the Fund's fundamental investment limitation
concerning borrowing, i.e., that borrowing may be for temporary purposes
only and in an amount not to exceed 5% of the Fund's total assets.
Warrants Although not a fundamental policy subject to
shareholder vote, as long as the Fund's Shares continue to be registered
in certain states, the Fund may not invest more than 5% of the value of
its net assets, taken at the lower of cost or market value, in warrants or
invest more than 2% of the value of such net assets in warrants not listed
on the New York or American Stock Exchanges.
Mortgage-Related Securities Mortgage-related securities
represent an ownership interest in a pool of residential mortgage loans.
These securities are designed to provide monthly payments of interest, and
in most instances, principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to investors
such as the Fund. Most issuers or poolers provide guarantees of payments,
regardless of whether or not the mortgagor actually makes the payment.
The guarantees made by issuers or poolers are backed by various forms of
credit, insurance and collateral.
Pools consist of whole mortgage loans or participations in loans.
The majority of these loans are made to purchasers of one- to four-family
homes. The terms and characteristics of the mortgage instruments are
generally uniform within a pool but may vary among pools. For example, in
addition to fixed-rate, fixed-term mortgages, the Fund may purchase pools
of variable-rate mortgages, growing-equity mortgages, graduated-payment
mortgages and other types.
All poolers apply standards for qualification to lending
institutions which originate mortgages for the pools. Poolers also
establish credit standards and underwriting criteria for individual
mortgages included in the pools. In addition, many mortgages included in
pools are insured through private mortgage insurance companies.
The majority of mortgage-related securities currently available
are issued by governmental or government-related organizations formed to
increase the availability of mortgage credit. The largest government-
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sponsored issuer of mortgage-related securities is the Government National
Mortgage Association ("GNMA"). GNMA certificates are interests in pools
of loans insured by the Federal Housing Administration or by the Farmer's
Home Administration ("FHA"), or guaranteed by the Veterans Administration
("VA"). The Federal National Mortgage Association ("FNMA") and the
Federal Home Loan Mortgage Corporation ("FHLMC") each issue pass-through
securities which are guaranteed as to principal and interest by FNMA and
FHLMC, respectively.
The average life of mortgage-related securities varies with the
maturities and the nature of the underlying mortgage instruments. For
example, GNMAs tend to have a longer average life than FHLMC participation
certificates ("PCs") because there is a tendency for the conventional and
privately-insured mortgages underlying FHLMC PCs to repay at faster rates
than the FHA and VA loans underlying GNMAs. In addition, the term of a
security may be shortened by unscheduled or early payments of principal
and interest on the underlying mortgages. The occurrence of mortgage pre-
payments is affected by various factors, including the level of interest
rates, general economic conditions, the location and age of the mortgaged
property and other social and demographic conditions.
In determining the dollar-weighted average maturity of the Fund's
portfolio, the Adviser will follow industry practice in assigning an
average life to the mortgage-related securities of the Fund unless the
interest rate on the mortgages underlying such securities is such that a
different prepayment rate is likely. For example, where a GNMA has a high
interest rate relative to the market, that GNMA is likely to have a
shorter overall maturity than a GNMA with a market rate coupon. Moreover,
the Adviser may deem it appropriate to change the projected average life
for the Fund's mortgage-related security as a result of fluctuations in
market interest rates and other factors.
Quoted yields on mortgage-related securities are typically based
on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to
differ from the average life yield. Reinvestment of the prepayments may
occur at higher or lower interest rates than the original investment, thus
affecting the yield of the Fund. The compounding effect from the
reinvestments of monthly payments received by the Fund will increase the
yield to shareholders compared to bonds that pay interest semi-annually.
Like other debt securities, the value of mortgage-related
securities will tend to rise when interest rates fall, and fall when rates
rise. The value of mortgage-related securities may also change because of
changes in the market's perception of the creditworthiness of the
organization that issued or guaranteed them. In addition, the mortgage
securities market in general may be adversely affected by changes in
governmental regulation or tax policies.
ADDITIONAL TAX INFORMATION
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The following is a general summary of certain federal tax
considerations affecting the Fund and its shareholders. Investors are
urged to consult their own tax advisers for more detailed information
regarding any federal, state or local taxes that may be applicable to
them.
General For federal tax purposes, the Fund is treated as a
separate corporation. In order to continue to qualify for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended ("Code"), the Fund must distribute annually to its
shareholders at least 90% of its investment company taxable income
(generally, net investment income plus any net short-term capital gain)
("Distribution Requirement") and must meet several additional
requirements. These requirements include the following: (1) at least 90%
of the Fund's gross income each taxable year must be derived from
dividends, interest, payments with respect to securities loans and gains
from the sale or other disposition of securities, or other income
(including gains from options or futures contracts) derived with respect
to its business of investing in securities ("Income Requirement"); (2) the
Fund must derive less than 30% of its gross income each taxable year from
the sale or other disposition of securities, options or futures contracts
held for less than three months ("Short-Short Limitation"); (3) at the
close of each quarter of the Fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, U.S.
government securities, securities of other RICs and other securities, with
those other securities 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 (4)
at the close of each quarter of the Fund'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.
If Fund shares are sold at a loss after being held for six months
or less, the loss will be treated as a long-term, instead of a short-term,
loss to the extent of any capital gain distributions received on those
shares. Investors also should be aware that if shares are purchased
shortly before the record date for any dividend or other distribution, the
investor will pay full price for the shares and receive some portion of
the price back as a taxable distribution.
The Fund 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 gain net income for the one-year period ending on October 31 of
that year, plus certain other amounts. For this and other purposes,
dividends and other distributions declared by the Fund in December of any
year and payable to shareholders of record on a date in that month will be
deemed to have been paid by the Fund and received by the shareholders on
December 31 if the distributions are paid by the Fund during the following
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January. Accordingly, those dividends and other distributions will be
taxed to the shareholders for the year in which that December 31 falls.
Hedging Instruments The use of hedging instruments, such as
options and futures contracts, involves complex rules that will determine
for income tax purposes the character and timing of recognition of the
gains and losses the Fund realizes in connection therewith.
Regulated futures contracts and options that are subject to
Section 1256 of the Code (collectively, "Section 1256 contracts") and are
held by the Fund at the end of its taxable year will be required to be
"marked-to market" for federal income tax purposes (that is, treated as
having been sold at that time at market value). Any unrealized gain or
loss recognized under this mark-to-market rule will be added to any
realized gains and losses on Section 1256 contracts actually sold by the
Fund during the year, and the resulting gain or loss will be treated
(without regard to the holding period) as 60% long-term capital gain or
loss and 40% short-term capital gain or loss. These rules may operate to
increase the amount of dividends, which will be taxable to shareholders,
that must be distributed to meet the Distribution Requirement and avoid
imposition of the Excise Tax, without providing the cash with which to
make the distributions. The Fund may elect to exclude certain
transactions from Section 1256, although doing so may have the effect of
increasing the relative proportion of short-term capital gain (taxable as
ordinary income when distributed to the Fund's shareholders).
Generally, the hedging transactions undertaken by the Fund may
result in "straddles" for federal income tax purposes. Because
application of the straddle rules may affect the character of gains or
losses, defer the recognition of losses and/or accelerate the recognition
of gains from the affected straddle positions, and may require the
capitalization of interest expense associated therewith, the amount that
must be distributed to shareholders (and the character of the distribution
as ordinary income or long-term capital gain) may be increased or
decreased substantially as compared to a fund that did not engage in such
hedging transactions.
Income from transactions in options and futures contracts derived
by the Fund with respect to its business of investing in securities will
qualify as permissible income under the Income Requirement. However,
income from the disposition of options and futures contracts will be
subject to the Short-Short Limitation if they are held for less than three
months. Furthermore, if the Fund satisfies certain requirements, any
increase in value of a position that is part of a "designated hedge" will
be offset by any decrease in value (whether realized or not) of the
offsetting hedging position during the period of the hedge for purposes of
determining whether the Fund satisfies the Short-Short Limitation. Thus,
only the net gain (if any) from the designated hedge will be included in
gross income for purposes of this limitation. The Fund intends that, when
it engages in hedging transactions, it will qualify for this treatment,
15
<PAGE>
but at the present time it is not clear whether this treatment will be
available for, or that the Fund will elect to have this treatment apply
to, all hedging transactions undertaken by the Fund. To the extent this
treatment is not available, the Fund may be forced to defer the closing
out of certain options and futures contracts beyond the time when it
otherwise would be advantageous to do so, in order for the Fund to
continue to qualify as a RIC.
Original Issue Discount The Fund may acquire zero coupon
securities or other debt securities issued with original issue discount.
As a holder of those securities, the Fund must include in its income the
original issue discount that accrues on the securities during the taxable
year, even if the Fund receives no corresponding payment on the securities
during the year. Because the Fund annually must distribute substantially
all of its investment company taxable income, including any earned
original issue discount, to satisfy the Distribution Requirement and avoid
imposition of the Excise Tax, it 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 the
Fund's cash assets or from the proceeds of sales of portfolio securities,
if necessary. The Fund may realize capital gains or losses from those
sales, which would increase or decrease its investment company taxable
income and/or net capital gain (the excess of net long-term capital gain
over net short-term capital loss). In addition, any such gains may be
realized on the disposition of securities held for less than three months.
Because of the Short-Short Limitation, any such gains would reduce the
Fund's ability to sell other securities, or options or futures contracts,
held for less than three months that it might wish to sell in the ordinary
course of its portfolio management.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Fund offers two classes of shares, known as Primary Shares
and Navigator Shares. Primary Shares are available from Legg Mason and
certain of its affiliates. Navigator Shares are currently offered for
sale only to Institutional Clients, to clients of Trust Company for which
the Trust Company exercises discretionary investment management
responsibility, to qualified retirement plans managed on a discretionary
basis and having net assets of at least $200 million, and to The Legg
Mason Profit Sharing Plan and Trust. Navigator Shares may not be
purchased by individuals directly, but Institutional Clients may purchase
shares for Customer Accounts maintained for individuals. Primary Shares
are available to all other investors.
Future First Systematic Investment Plan and Transfer of Funds from
Financial Institutions
If you invest in Primary Shares, the Prospectus for those shares
explains that you may buy additional Primary Shares through the Future
First Systematic Investment Plan. Under this plan you may arrange for
automatic monthly investments in Primary Shares of $50 or more by
16
<PAGE>
authorizing Boston Financial Data Services ("BFDS"), the Fund's transfer
agent, to prepare a check each month drawn on your checking account. Each
month the transfer agent will send a check to your bank for collection,
and the proceeds of the check will be used to buy Primary Shares at the
per share net asset value determined on the day the check is sent to your
bank. You will receive a quarterly cumulative account statement. You
may terminate the Future First Systematic Investment Plan at any time
without charge or penalty. Forms to enroll in the Future First Systematic
Investment Plan are available from any Legg Mason or affiliated office.
Investors in Primary Shares may also buy additional Primary
Shares through a plan permitting transfers of funds from a financial
institution. Certain financial institutions may allow the investor, on a
pre-authorized basis, to have $50 or more automatically transferred
monthly for investment in shares of the Fund to:
Legg Mason Wood Walker, Incorporated
Funds Processing
P.O. Box 1476
Baltimore, Maryland 21203-1476
If the investor's check is not honored by the institution it is
drawn on, the investor may be subject to extra charges in order to cover
collection costs. These charges may be deducted from the investor's
shareholder account.
Systematic Withdrawal Plan
If you invest in Primary Shares, you may also elect to make
systematic withdrawals from your Fund account of a minimum of $50 on a
monthly basis if you own Primary Shares with a net asset value of $5,000
or more. The amounts paid to you each month are obtained by redeeming
sufficient Primary Shares from your account to provide the withdrawal
amount that you have specified. The Systematic Withdrawal Plan is not
currently available for shares held in an Individual Retirement Account
("IRA"), Self-Employed Individual Retirement Plan ("Keogh Plan"),
Simplified Employee Pension Plan ("SEP") or other qualified retirement
plan. You may change the monthly amount to be paid to you without charge
not more than once a year by notifying Legg Mason or the affiliate with
which you have an account. Redemptions will be made at the Primary
Shares' net asset value per share determined as of the close of regular
trading on the New York Stock Exchange, Inc. ("Exchange") on the first day
of each month. If the Exchange is not open for business on that day, the
shares will be redeemed at the per share net asset value determined as of
the close of regular trading on the Exchange on the preceding business
day. The check for the withdrawal payment will usually be mailed to you
on the next business day following redemption. If you elect to
participate in the Systematic Withdrawal Plan, dividends and other
distributions on all Primary Shares in your account must be automatically
reinvested in Primary Shares. You may terminate the Systematic Withdrawal
Plan at any time without charge or penalty. The Fund, its transfer agent,
17
<PAGE>
and Legg Mason also reserve the right to modify or terminate the
Systematic Withdrawal Plan at any time.
Withdrawal payments are treated as a sale of shares rather than
as a dividend or a capital gain distribution. These payments are taxable
to the extent that the total amount of the payments exceeds the tax basis
of the shares sold. If the periodic withdrawals exceed reinvested
dividends and other distributions, the amount of your original investment
may be correspondingly reduced.
Ordinarily, you should not purchase additional shares of the Fund
if you maintain a Systematic Withdrawal Plan because you may incur tax
liabilities in connection with such purchases and withdrawals. The Fund
will not knowingly accept purchase orders from you for additional shares
if you maintain a Systematic Withdrawal Plan unless your purchase is equal
to at least one year's scheduled withdrawals. In addition, if you
maintain a Systematic Withdrawal Plan you may not make periodic
investments under the Future First Systematic Investment Plan.
Other Information Regarding Redemption
The date of payment for a redemption may not be postponed for
more than seven days, and the right of redemption may not be suspended,
except (i) for any period during which the Exchange is closed (other than
for customary weekend and holiday closings), (ii) when trading in markets
the Fund normally utilizes is restricted, or an emergency, as defined by
rules and regulations of the SEC, exists, making disposal of the Fund's
investments or determination of its net asset value not reasonably
practicable, or (iii) for such other periods as the SEC by regulation or
order may permit for protection of the Fund's shareholders. In the case
of any such suspension, you may either withdraw your request for
redemption or receive payment based upon the net asset value next
determined after the suspension is lifted.
The Fund reserves the right, under certain conditions, to honor
any request for redemption or combination of requests from the same
shareholder in any 90-day period, totalling $250,000 or 1% of the net
assets of the Fund, whichever is less, by making payment in whole or in
part by securities valued in the same way as they would be valued for
purposes of computing the Fund's net asset value per share. If payment is
made in securities, a shareholder should expect to incur brokerage
expenses in converting those securities into cash and will be subject to
fluctuation in the market price of those securities until they are sold.
The Fund does not redeem "in kind" under normal circumstances, but would
do so where the Adviser determines that it would be in the best interests
of the shareholders as a whole.
18
<PAGE>
PERFORMANCE INFORMATION
Total Return Calculations Average annual total return quotes
used in the Fund's advertising and other promotional materials
("performance advertisements") are calculated separately for each Class
according to the following formula:
n
P(1+T) = ERV
where P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a
hypothetical $1,000 payment made at the
beginning of that period.
Under the foregoing formula, the time periods used in performance
advertisements will be based on rolling calendar quarters, updated to the
last day of the most recent quarter prior to submission of the performance
advertisements for publication. Total return, or "T" in the formula
above, is computed by finding the average annual change in the value of an
initial $1,000 investment over the period. In calculating the redeeming
value all dividends and other distributions by the Fund are assumed to
have been reinvested at net asset value on the reinvestment dates during
the period.
Yield Yields used in the Fund's performance advertisements for
each Class of Shares are calculated by dividing the Fund's net investment
income for a 30-day period ("Period") attributable to that Class, by the
average number of Shares in that Class entitled to receive dividends
during the Period, and expressing the result as an annualized percentage
(assuming semi-annual compounding) of the maximum offering price per share
at the end of the Period. Yield quotations are calculated according to
the following formula:
6
Yield = 2 [(a-b +1) - 1]
-------
cd
where: a = 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.
Except as noted below, in determining net investment income
earned during the Period (variable "a" in the above formula), the Fund
calculates interest earned on each debt obligation held by it during the
Period by (1) computing the obligation's yield to maturity based on the
market value of the obligation (including actual accrued interest) on the
last business day of the Period or, if the obligation was purchased during
19
<PAGE>
the Period, the purchase price plus accrued interest and (2) dividing the
yield to maturity by 360, and multiplying the resulting quotient by the
market value of the obligation (including actual accrued interest). Once
interest earned is calculated in this fashion for each debt obligation
held by the Fund, interest earned during the Period is then determined by
totalling the interest earned on all debt obligations. For the purposes
of these calculations, the maturity of an obligation with one or more call
provisions is assumed to be the next on which the obligation reasonably
can be expected to be called or, if none, the maturity date.
With respect to the treatment of discount and premium on
mortgage-backed and other asset-backed obligations that are expected to be
subject to monthly payments of principal and interest ("paydowns"): (1)
the Fund accounts for gain or loss attributable to actual paydowns as an
increase or decrease to interest income during the period and (2) the Fund
accrues the discount and amortizes the premium on the remaining
obligation, based on the cost of the obligation, to the weighted average
maturity date or, if weighted average maturity information is not
available, to the remaining term of the obligation. The yield for
Primary Shares for the 30-day period ended December 31, 1994 was 5.43%.
The 30-day yield for Navigator Shares for the same period was 5.97%.
Yields would have been lower if the Manager had not waived a portion of
the Fund's expenses.
Other Information In performance advertisements the Fund may
compare the total return of a class of shares with data published by
Lipper Analytical Services, Inc. ("Lipper"), CDA Investment Technologies,
Inc. ("CDA"), Wiesenberger Investment Companies Service ("Wiesenberger"),
or Morningstar Mutual Funds ("Morningstar"), or with the performance of
U.S. Treasury securities of various maturities, recognized stock, bond and
other indexes, including (but not limited to) the Salomon Brothers Bond
Index, Shearson Lehman Bond Index, Shearson Lehman Government/Corporate
Bond Index, the Standard & Poor's 500 Composite Stock Price Index ("S & P
500"), the Dow Jones Industrial Average ("Dow Jones"), and changes in the
Consumer Price Index as published by the U.S. Department of Commerce. The
Fund also may refer in such materials to mutual fund performance rankings
and other data, such as comparative asset, expense and fee levels,
published by Lipper, CDA, Wiesenberger or Morningstar. Performance
Advertisements also may refer to discussions of a Class of the Fund and
comparative mutual fund data and ratings reported in independent
periodicals, including THE WALL STREET JOURNAL, MONEY Magazine, FORBES,
BUSINESS WEEK, FINANCIAL WORLD, BARRON'S, FORTUNE and THE NEW YORK TIMES.
The Fund invests primarily in the fixed-income securities
described in its Prospectus, and does not invest in the equity securities
that make up the S&P 500 or the Dow Jones indices. Comparison with such
indices is intended to show how an investment in a class of shares behaved
as compared to indices that are often taken as a measure of performance of
the equity market as a whole. The indices, like the total return of a
class of shares, assume reinvestment of all dividends and other
20
<PAGE>
distributions. They do not take account of the costs or the tax
consequences of investing.
The Fund may include discussions or illustrations of the effects
of compounding in performance advertisements. "Compounding" refers to the
fact that, if dividends or other distributions on the Fund investment are
reinvested by being paid in additional shares, any future income or
capital appreciation of the Fund would increase the value, not only of the
original Fund investment, but also of the additional shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been
paid in cash.
The Fund may also compare the performance of a Class of Shares
with the performance of bank certificates of deposit (CDs) as measured by
the CDA Investment Technologies, Inc. Certificate of Deposit Index and the
Bank Rate Monitor National Index. In comparing the performance of a Class
to CD performance, investors should keep in mind that bank CDs are insured
in whole or in part by an agency of the U.S. Government and offer fixed
principal and fixed or variable rates of interest, and that bank CD yields
may vary. Fund Shares are not insured or guaranteed by the U.S.
Government and returns and net asset value will fluctuate. The securities
held by the Fund generally have longer maturities than most CDs and may
reflect interest rate fluctuations for longer-term securities.
Fund advertisements may reference the history of the distributor
and its affiliates, and the education and experience of the portfolio
manager. Advertisements may also describe techniques the Adviser employs
in selecting among the sectors of the fixed-income market and may focus on
the technique of "value investing." With value investing, the Adviser
invests in those securities it believes to be undervalued in relation to
the long-term earning power or asset value of their issuers. Securities
may be undervalued because of many factors, including market decline, poor
economic conditions, tax-loss selling or actual or anticipated unfavorable
developments affecting the issuer of the security.
In advertising, the Fund may illustrate hypothetical investment
plans designed to help investors meet long-term financial goals, such as
saving for a child's college education or for retirement. Sources such as
the Internal Revenue Service, the Social Security Administration, the
Consumer Price Index and Chase Global Data and Research may supply data
concerning interest rates, college tuitions, the rate of inflation, Social
Security benefits, mortality statistics and other relevant information.
The Fund may use other recognized, reliable sources as they become
available.
The Fund may use data prepared by Ibbotson Associates of Chicago,
Illinois ("Ibbotson") to compare the returns of various capital markets
and to show the value of a hypothetical investment in a capital market.
Ibbotson relies on different indices to calculate the performance of
common stocks, corporate and government bonds and Treasury bills.
21
<PAGE>
The Fund may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is
represented by the performance of an appropriate market index, such as the
S&P 500 and the performance of bonds is represented by a nationally
recognized bond index, such as the Lehman Brothers Long-Term Government
Bond Index.
The Fund may also include in advertising biographical information
on key investment and managerial personnel.
The Fund may advertise examples of the potential benefits of
periodic investment plans, such as dollar cost averaging, a long-term
investment technique designed to lower average cost per share. Under such
a plan, an investor invests in a mutual fund at regular intervals a fixed
dollar amount thereby purchasing more shares when prices are low and fewer
shares when prices are high. Although such a plan does not guarantee
profit or guard against loss in declining markets, the average cost per
share could be lower than if a fixed number of shares were purchased at
the same intervals. Investors should consider their ability to purchase
shares through low price levels.
The Fund may discuss Legg Mason's tradition of service. Since
1899, Legg Mason and its affiliated companies have helped investors meet
their specific investment goals and have provided a full spectrum of
financial services. Legg Mason affiliates serve as investment advisors
for private accounts and mutual funds with assets of more than $17 billion
as of December 31, 1994.
In advertising, the Fund may discuss the advantages of saving
through tax-deferred retirement plans or accounts, including the
advantages and disadvantages of "rolling over" a distribution from a
retirement plan into an IRA, factors to consider in determining whether
you qualify for such a rollover, and the other options available. These
discussions may include graphs or other illustrations that compare the
growth of a hypothetical tax-deferred investment to the after-tax growth
of a taxable investment.
The following tables show the value, as of the end of each fiscal
year, of a hypothetical investment of $10,000 made in the Fund at
commencement of operations of each class of Fund shares. The tables
assume that all dividends and other distributions are reinvested in the
Fund. They include the effect of all charges and fees applicable to the
respective class of shares the Fund has paid. (There are no fees for
investing or reinvesting in the Fund, and there are no redemption fees.)
They do not include the effect of any income taxes that an investor would
have to pay on distributions.
22
<PAGE>
<TABLE>
<CAPTION>
Primary Shares
<S> <C> <C> <C>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Fiscal Through Reinvestment of Reinvestment of Total
Year Capital Gain Distributions Income Dividends Value
1987* $9,920 $302 $10,222
1988 9,990 1,080 10,880
1989 10,210 2,062 12,272
1990 10,301 3,081 13,382
1991 11,087 4,217 15,304
1992 11,180 5,081 16,261
1993 11,607 5,735 17,342
1994 17,008
</TABLE>
*August 7, 1987 (commencement of operations) to December 31 1987.
<TABLE>
<CAPTION>
Navigator Shares
<S> <C> <C> <C>
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Fiscal Through Reinvestment of Reinvestment of Total
Year Capital Gain Distributions Income Dividends Value
1994* $9,720 $49 $9,769
</TABLE>
*December 1, 1994 (commencement of operations) to December 31 1994.
With respect to Primary Shares, if the investor had not
reinvested dividends and other distributions, the total value of the
hypothetical investment as of December 31, 1994 would have been $9,720,
23
<PAGE>
and the investor would have received a total of $5,774 in distributions.
With respect to Navigator Shares, if the investor had not reinvested
dividends and other distributions, the total value of the hypothetical
investment as of December 31, 1994 would have been $9,720, and the
investor would have received a total of $49 in distributions. Returns
would have been lower if the Manager had not waived/reimbursed certain
Fund expenses during the fiscal years 1987 through 1994.
VALUATION OF FUND SHARES
Net asset value of a Fund share is determined daily for each
Class as of the close of the Exchange (normally 4:00 p.m., eastern time),
on every day that the Exchange is open, by subtracting liabilities
attributable to that Class, from total assets attributable to that Class,
and dividing the result by the number of shares of that Class,
outstanding. Pricing will not be done on days when the Exchange is closed.
The Exchange currently observes the following holidays: New Year's Day,
President's Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving and Christmas. When market quotations for institutional size
positions are readily available portfolio securities are valued based upon
market quotations. Where such market quotations are not readily
available, securities are valued based upon appraisals received from a
pricing service using a computerized matrix system or based upon
appraisals derived from information concerning the security or similar
securities received from recognized dealers in those securities. The
methods used by the pricing service and the quality of the valuations so
established are reviewed by the Adviser under the general supervision of
the Corporation's Board of Directors. The amortized cost method of
valuation is used with respect to obligations with 60 days or less
remaining to maturity unless the Adviser determines that this does not
represent fair value. All other assets are valued at fair value as
determined in good faith, by or under the direction of the Corporation's
Board of Directors. Premiums received on the sale of put and call options
are included in net asset value of each class, and the current market
value of options sold by the Fund will be subtracted from net assets of
each class.
TAX-DEFERRED RETIREMENT PLANS
As noted in the Prospectus for Primary Shares, an investment in
those shares may be appropriate for IRAs, Keogh Plans, SEPs and other
qualified retirement plans. In general, income earned through the
investment of assets of qualified retirement plans is not taxed to the
beneficiaries of such plans until the income is distributed to them.
Primary Share investors who are considering establishing such a plan
should consult their attorneys or other tax advisers with respect to
individual tax questions. The option of investing in these plans with
respect to Primary Shares through regular payroll deductions may be
arranged with a Legg Mason or affiliated investment executive and your
24
<PAGE>
employer. Additional information with respect to these plans is available
upon request from any Legg Mason or affiliated investment executive.
25
<PAGE>
Individual Retirement Account -- IRA
Certain Primary Share investors may obtain tax advantages by
establishing IRAs. Specifically, if neither you nor your spouse is an
active participant in a qualified employer or government retirement plan,
or if either you or your spouse is an active participant and your adjusted
gross income does not exceed a certain level, you may deduct cash
contributions made to an IRA in an amount for each taxable year not
exceeding the lesser of 100% of your earned income or $2,000. In
addition, if your spouse is not employed and you file a joint return, you
may establish a separate IRA for your spouse and contribute up to a total
of $2,250 to the two IRAs, provided that the contribution to either does
not exceed $2,000. If you and your spouse are both employed and neither
of you is an active participant in a qualified employer or government
retirement plan and you establish separate IRAs, you each may contribute
all of your earned income, up to $2,000 each, and thus may together
receive tax deductions of up to $4,000 for contributions to your IRAs. If
your employer's plan qualifies as a SEP, permits voluntary contributions
and meets certain requirements, you may make voluntary contributions to
that plan that are treated as deductible IRA contributions.
Even if you are not in one of the categories described in the
preceding paragraph, you may find it advantageous to invest in Primary
Shares through IRA contributions, up to certain limits, because all
dividends and capital gain distributions on your Primary Shares are then
not immediately taxable to you or the IRA; they become taxable only when
distributed to you. To avoid penalties, your interest in an IRA must be
distributed, or start to be distributed, to you not later than the end of
the taxable year in which you attain age 70 1/2. Distributions made
before age 59 1/2, in addition to being taxable, generally are subject to
a penalty equal to 10% of the distribution, except in the case of death or
disability or where the distribution is rolled over into another qualified
plan or certain other situations.
Self-Employed Individual Retirement Plan -- Keogh Plan
Legg Mason makes available to self-employed individuals a Plan
and Trustee Agreement for a Keogh Plan through which Primary Shares may be
purchased. Primary Share investors have the right to use a bank of their
own choice to provide these services at their own cost. There are
penalties for distributions from a Keogh Plan prior to age 59 1/2, except
in the case of death or disability.
Simplified Employee Pension Plan -- SEP
Legg Mason makes available to corporate and other employers a SEP
for investment in Primary Shares.
Withholding at the rate of 20% is required for federal income tax
purposes on certain distributions (excluding, for example, certain
periodic payments) from the foregoing retirement plans (except IRAs and
26
<PAGE>
SEPs), unless the recipient transfers the distribution directly to an
"eligible retirement plan" (including IRAs and other qualified plans) that
accepts those distributions. Other distributions generally are subject to
regular wage withholding at the rate of 10% (depending on the type and
amount of the distribution), unless the recipient elects not to have any
withholding apply. Primary Share investors should consult their plan
administrator or tax adviser for further information.
THE CORPORATION'S DIRECTORS AND OFFICERS
The Corporation's officers are responsible for the operation of
the Corporation under the direction of the Board of Directors. The
officers and directors of the Corporation and their principal occupations
during the past five years are set forth below. An asterisk (*) indicates
those officers and/or directors who are interested persons of the
Corporation as defined by the Investment Company Act of 1940, as amended
("1940 Act"). The business address of each officer and director is 111
South Calvert Street, Baltimore, Maryland 21202, unless otherwise
indicated.
JOHN F. CURLEY, JR.*, [55] Chairman of the Board and
Director; Vice Chairman and Director of Legg Mason Wood Walker, Inc. and
Legg Mason, Inc.; Director of Legg Mason Fund Adviser, Inc. and Western
Asset Management Company; Officer and/or Director of various other
affiliates of Legg Mason, Inc.; Chairman of the Board and Director of
three Legg Mason funds; President and Director of three Legg Mason funds;
Chairman of the Board, President and Trustee of one Legg Mason fund and
Chairman of the Board and Trustee of one Legg Mason fund.
EDMUND J. CASHMAN, JR.*, [58] Vice Chairman and Director; Senior
Executive Vice President and Director of Legg Mason, Inc.; Officer and/or
Director of various other affiliates of Legg Mason, Inc.; President and
Director of one Legg Mason fund; President and Trustee of one Legg Mason
fund; Director of Worldwide Value Fund, Inc.
EDWARD A. TABER, III*, [51] President and Director; Executive
Vice President of Legg Mason, Inc. and Legg Mason Wood Walker, Inc.; Vice
Chairman and Director of Legg Mason Fund Adviser, Inc.; Director of three
Legg Mason funds; President and Director of two Legg Mason funds; Trustee
of one Legg Mason fund; Vice President of Worldwide Value Fund, Inc.
Formerly: Executive Vice President of T. Rowe Price-Fleming
International, Inc. (1986-1992) and Director of the Taxable Fixed Income
Division at T. Rowe Price Associates, Inc. (1973-1992).
RICHARD G. GILMORE, [67] Director; 5534 Chanteclaire, Sarasota,
Florida. Independent Consultant. Director of CSS Industries, Inc.
27
<PAGE>
(diversified holding company whose subsidiaries are engaged in manufacture
and sale of decorative paper products, business forms, and specialty metal
packaging); Director of PECO Energy Company (formerly Philadelphia
Electric Company); Director of six Legg Mason funds; and Trustee of one
Legg Mason fund. Formerly: Senior Vice President and Chief Financial
Officer of Philadelphia Electric Company (now PECO Energy Company);
Executive Vice President and Treasurer, Girard Bank, and Vice President of
its parent holding company, the Girard Company and Director of Finance,
City of Philadelphia.
CHARLES F. HAUGH, [69] Director; 14201 Laurel Park Drive, Suite
104, Laurel, Maryland. Real Estate Developer and Investor; President and
Director of Resource Enterprises, Inc. (real estate brokerage); Chairman
of Resource Realty LLC (management of retail and office space); Partner in
Greater Laurel Health Park Ltd. Partnership (real estate investment and
development); Director of six Legg Mason funds; and Trustee of two Legg
Mason funds.
ARNOLD L. LEHMAN, [51] Director; The Baltimore Museum of Art,
Art Museum Drive, Baltimore, Maryland. Director of the Baltimore Museum
of Art; Director of six Legg Mason funds; Trustee of two Legg Mason
funds.
JILL E. McGOVERN, [50] Director; 1500 Wilson Boulevard,
Arlington, Virginia. Chief Executive Officer of the Marrow Foundation.
Director of six Legg Mason funds; Trustee of two Legg Mason funds.
Formerly: Executive Director of the Baltimore International Festival
January 1991 - March 1993; formerly: Senior Assistant to the President of
The Johns Hopkins University (1986-1991).
T. A. RODGERS, [60] Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T.A. Rodgers & Associates (management consulting);
Director of six Legg Mason funds; Trustee of one Legg Mason fund.
Formerly: Director and Vice President of Corporate Development, Polk
Audio, Inc. (manufacturer of audio components) .
The executive officers of the Corporation, other than those who
also serve as directors, are:
MARIE K. KARPINSKI*, [46] Vice President and Treasurer; Treasurer
of Legg Mason Fund Adviser, Inc.; Vice President and Treasurer of eight
Legg Mason funds; and Secretary/Treasurer of Worldwide Value Fund, Inc.;
Vice President of Legg Mason.
STEFANIE L. WONG*, [27] Secretary; Secretary of one Legg Mason
fund; employee of Legg Mason.
28
<PAGE>
BLANCHE P. ROCHE*, [46] Assistant Secretary and Assistant Vice
President; Assistant Secretary and Assistant Vice President of seven Legg
Mason funds; employee of Legg Mason since 1991. Formerly: Manager of
Consumer financial services (1989-1991).
Officers and directors of the Corporation who are interested
persons of the Corporation receive no salary or fees from the Corporation.
Independent directors of the Corporation receive a fee of $400 annually
for serving as a director, and a fee of $400 for each meeting of the Board
of Directors attended by him or her. For the fiscal year ended December
31, 1994, the present independent directors as a group received a total of
$7,500 from each Portfolio of the Corporation.
The Nominating Committee of the Board of Directors is responsible
for the selection and nomination of disinterested directors. The
Committee is composed of Messrs. Haugh, Gilmore, Lehman and Dr. McGovern,
each of whom is a disinterested director as that term is defined in the
1940 Act.
At February 28, 1995 the directors and officers of the
Corporation beneficially owned, in the aggregate, less than 1% of the
Fund's outstanding Shares.
29
<PAGE>
<TABLE>
<CAPTION>
COMPENSATION TABLE
<S> <C> <C> <C> <C>
Aggregate Pension or Retirement Estimated Annual Total Compensation From
Name of Person and Compensation Benefits Accrued as Part Benefits Upon Corporation and Fund
Position From Corporation of Fund Expenses Retirement Complex Paid to Directors
John F. Curley, Jr. -
Chairman of the Board
and Director None N/A N/A None
Edward A. Taber, III -
President and Director None N/A N/A None
Edmund J. Cashman, Jr.
Vice Chairman and
Director None N/A N/A None
Marie K. Karpinski -
Vice President and
Treasurer None N/A N/A None
Richard G. Gilmore -
Director $6,000 N/A N/A $21,600
Charles F. Haugh -
Director $6,000 N/A N/A $23,600
Arnold L. Lehman -
Director $6,000 N/A N/A $23,600
Jill E. McGovern -
Director $6,000 N/A N/A $23,600
T. A. Rodgers - $21,600
Director $6,000 N/A N/A
</TABLE>
The information provided above is for the year ended December 31, 1994.
30
<PAGE>
MANAGEMENT AGREEMENT
Legg Mason Fund Adviser, Inc. ("Manager"), 111 South Calvert
Street, Baltimore, Md. 21202, is a wholly owned subsidiary of Legg Mason,
Inc., which is also the parent of Legg Mason Wood Walker, Incorporated.
The Manager serves as the manager for the Fund under a Management
Agreement dated June 19, 1987 ("Management Agreement"), which was
approved by the Corporation's Board of Directors, including a majority of
the directors who are not "interested persons" (as defined in the 1940
Act) of the Corporation, the Manager or the Adviser, on May 8, 1987, and
was approved by the shareholders of the Fund on April 22, 1988.
Continuation of the Management Agreement was most recently approved by the
Board of Directors on October 21, 1994. The Management Agreement provides
that, subject to overall direction by the Board of Directors, the Manager
will manage the investment and other affairs of the Fund. Under the
Management Agreement, the Manager is responsible for managing the Fund's
securities and for making purchases and sales of securities consistent
with the investment objectives and policies described in the Fund's
Prospectus and this Statement of Additional Information. The Manager
is obligated to furnish the Fund with office space and certain
administrative services as well as executive and other personnel necessary
for the operation of the Fund. The Manager and its affiliates also are
responsible for the compensation of directors and officers of the
Corporation who are employees of the Manager and/or its affiliates. The
Manager has delegated the portfolio management functions for the Fund to
the Adviser, Western Asset Management Company.
As explained in the Fund's Prospectus, the Manager receives for
its services a management fee, calculated daily and payable monthly, at an
annual rate equal to 0.55% of the Fund's average daily net assets. The
management fee paid by the Fund may be reduced under regulations in
various states where shares of the Fund are qualified for sale that impose
limitations on the annual expense ratio of the Fund. The most restrictive
annual expense limitation currently requires that the Manager reimburse
the Fund for certain expenses, including the management fees received by
it (but excluding interest, taxes, brokerage fees and commissions,
distribution fees and certain extraordinary charges), in any fiscal year
in which the Fund's expenses exceed 2.5% of the first $30 million, 2.0% of
the next $70 million, and 0.5% of the balance over $100 million in net
assets. No reimbursements have been made nor have any been required to be
made pursuant to this undertaking. In addition, the Manager has agreed to
waive its fees and reimburse the Fund if and to the extent the expenses
(exclusive of taxes, interest, brokerage and extraordinary expenses)
exceed during any month annual rates of the Fund's average daily net
assets for such month, or certain asset levels are achieved, whichever
occurs first, in accordance with the following schedule:
Primary Shares:
Rate Expiration Date Asset Level
---- --------------- -----------
31
<PAGE>
0.90% April 30, 1995 $400 million
0.90% October 31, 1994 $400 million
0.90% August 31, 1993 $400 million
0.85% October 31, 1992 $300 million
Navigator Shares:
Rate Expiration Date Asset Level
---- --------------- -----------
0.45% October 31, 1995 $400 million
0.40% April 30, 1995 $400 million
For the years ended December 31, 1994, 1993 and 1992, the Manager
waived management fees of $788,260, $860,000, and $1,003,000,
respectively, for the Fund.
Under the Management Agreement, the Manager will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund
in connection with the performance of the Management Agreement, except a
loss resulting from a breach of fiduciary duty with respect to the receipt
of compensation for services or losses resulting from willful misfeasance,
bad faith or gross negligence in the performance of its duties or from
reckless disregard of its obligations or duties thereunder.
The Management Agreement terminates automatically upon assignment and
is terminable at any time without penalty by vote of the Corporation's
Board of Directors, by vote of a majority of the outstanding voting
securities of the Fund or by the Manager, on not less than 60 days'
written notice to the other party, and may be terminated immediately upon
the mutual written consent of the Manager and the Fund.
The Fund pays all of its expenses which are not expressly assumed by
the Manager. These expenses include, among others, interest expense,
taxes, brokerage fees and commissions, expenses of preparing and printing
prospectuses, statements of additional information, proxy statements and
reports and of distributing them to existing shareholders, custodian
charges, transfer agency fees, organizational expenses, distribution fees
to the Fund's distributor, compensation of the independent directors,
legal, accounting and audit expenses, insurance expenses, expenses of
registering and qualifying shares of the Fund for sale under federal and
state law, governmental fees and expenses incurred in connection with
membership in investment company organizations. The Fund also is liable
for such nonrecurring expenses as may arise, including litigation to which
the Fund may be a party. The Fund may also have an obligation to
indemnify the directors and officers of the Corporation with respect to
any such litigation.
Under the Management Agreement, the Fund has the non-exclusive right
to use the name "Legg Mason" until that Agreement is terminated, or until
the right is withdrawn in writing by the Manager.
32
<PAGE>
INVESTMENT ADVISORY AGREEMENT
The Adviser, Western Asset Management Company, 117 East Colorado
Boulevard, Pasadena, CA 91105, an affiliate of Legg Mason, serves as
investment adviser to the Fund under an Investment Advisory Agreement,
dated June 19, 1987, between the Adviser and the Manager ("Advisory
Agreements"). The Advisory Agreement was approved by the Board of
Directors, including a majority of the directors who are not "interested
persons" of the Corporation, the Adviser or the Manager, on May 8, 1987,
and was approved by the shareholders of the Fund on April 22, 1988.
Continuation of the Agreement was most recently approved by the Board of
Directors on October 21, 1994.
Under the Advisory Agreement, the Adviser is responsible, subject to
the general supervision of the Manager and the Corporation's Board of
Directors, for the actual management of the Fund's assets, including
the responsibility for making decisions and placing orders to buy, sell
or hold a particular security. For the Adviser's services to the Fund,
the Manager (not the Fund) pays the Adviser a fee, computed daily and
payable monthly, at an annual rate equal to 40% of the fee received by the
Manager. During the years ended December 31, 1994, 1993 and 1992, the
Manager paid $598,693, $336,400 and $477,347,, respectively, to the
Adviser on behalf of the Fund.
Under the Advisory Agreement, the Adviser will not be liable for any
error of judgment or mistake of law or for any loss suffered by the
Manager or by the Fund in connection with the performance of the Advisory
Agreement, except a loss resulting from a breach of fiduciary duty with
respect to the receipt of compensation for services or a loss resulting
from willful misfeasance, bad faith or gross negligence on its part in the
performance of its duties or from reckless disregard by it of its
obligations or duties thereunder.
The Advisory Agreement terminates automatically upon assignment and is
terminable at any time without penalty by vote of the Corporation's Board
of Directors, by vote of a majority of the Fund's outstanding voting
securities, by the Manager or by the Adviser, on not less than 60 days'
notice to the Fund and/or the other party(ies). The Advisory Agreement
terminates immediately upon any termination of the Management Agreement or
upon the mutual written consent of the Adviser, the Manager and the Fund.
To mitigate the possibility that the Fund will be affected by personal
trading of employees, the Corporation, the Manager and the Adviser have
adopted policies that restrict securities trading in the personal accounts
of portfolio managers and others who normally come into advance possession
of information on portfolio transactions. These policies comply, in all
material respects, with the recommendations of the Investment Company
Institute.
PORTFOLIO TRANSACTIONS AND BROKERAGE
33
<PAGE>
The portfolio turnover rate is computed by dividing the lesser of
purchases or sales of securities for the period by the average value of
portfolio securities for that period. Short-term securities are excluded
from the calculation. For the years ended December 31, 1994 and 1993, the
Fund's portfolio turnover rates were 315.7% and 490.2%, respectively.
Under the Advisory Agreement, the Adviser is responsible for the
execution of portfolio transactions. Corporate and government debt
securities are generally traded on the over-the-counter market on a "net"
basis without a stated commission, through dealers acting for their own
account and not as brokers. Prices paid to a dealer in debt securities
will generally include a "spread", which is the difference between the
price at which the dealer is willing to purchase and sell the specific
security at the time, and includes the dealer's normal profit. Some
portfolio transactions may be executed through brokers acting as agent.
In selecting brokers or dealers, the Adviser must seek the most favorable
price (including the applicable dealer spread) and execution for such
transactions, subject to the possible payment as described below of higher
brokerage commissions for agency transactions or spreads to broker-dealers
who provide research and analysis. The Fund may not always pay the lowest
commission or spread available. Rather, in placing orders on behalf of
the Fund, the Adviser also takes into account such factors as size of the
order, difficulty of execution, efficiency of the executing broker's
facilities (including the services described below) and any risk assumed
by the executing broker.
Consistent with the policy of most favorable price and
execution, the Adviser may give consideration to research, statistical
and other services furnished by brokers or dealers to the Adviser for its
use, may place orders with broker-dealers who provide supplemental
investment and market research and securities and economic analysis, and
may, for agency transactions, pay to these broker-dealers a higher
brokerage commission than may be charged by other broker-dealers. Such
research and analysis may be useful to the Adviser in connection with
services to clients other than the Fund. The Adviser's fee is not reduced
by reason of its receiving such brokerage and research services. For the
years ended December 31, 1994, 1993 and 1992, the Fund paid commissions of
$381,650, $526,090 and $400,030, respectively, to broker-dealers who acted
as agents in executing options and futures trades.
The Fund may not buy securities from, or sell securities to, Legg
Mason or its affiliated persons as principal. However, the Corporation's
Board of Directors has adopted procedures in conformity with Rule 10f-3
under the 1940 Act whereby the Fund may purchase securities that are
offered in underwritings in which Legg Mason or any of its affiliated
persons is a participant.
Investment decisions for the Fund are made independently from those of
other funds and accounts advised by the Adviser. However, the same
security may be held in the portfolios of more than one fund or account.
When two or more accounts simultaneously engage in the purchase or sale of
the same security, the prices and amounts will be equitably allocated to
34
<PAGE>
each account. In some cases, this procedure may adversely affect the
price or quantity of the security available to a particular account. In
other cases, however, an account's ability to participate in large-volume
transactions may produce better executions and prices.
THE FUND'S DISTRIBUTOR
Legg Mason acts as distributor of the Fund's shares pursuant to an
Underwriting Agreement with the Corporation. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of the Fund's shares, including compensation to its investment
executives. Legg Mason also pays for the printing and distribution of
prospectuses and periodic reports used in connection with the
offering to prospective investors, after the prospectuses and reports have
been prepared, set in type and mailed to shareholders at the Fund's
expense, and for supplementary sales literature and advertising costs.
35
<PAGE>
For the year ended December 31, 1994, Legg Mason incurred the
following expenses with respect to Primary Shares:
Compensation to sales personnel $962,000
Printing and mailing of prospectuses
to prospective shareholders 42,000
Advertising 60,000
Other 438,000
------------
Total expenses $1,502,000
============
The foregoing are estimated and do not include all expenses fairly
allocable to Legg Mason's or its affiliates' efforts to distribute Shares.
Fairfield Group, Inc., a wholly owned subsidiary of Legg Mason, Inc.,
with principal offices at 200 Gibraltar Road, Horsham, Pennsylvania, acts
as a dealer for Navigator Shares pursuant to a Dealer Agreement with Legg
Mason. Neither Legg Mason nor Fairfield receives any compensation from
the Fund for its activities in selling Navigator Shares.
The Corporation has adopted a Distribution and Shareholder Services
Plan ("Plan") which, among other things, permits it to pay Legg Mason fees
for its services related to sales and distribution of Primary Shares and
for the provision of ongoing services to Primary Class shareholders.
Payments are made only from assets attributable to Primary Shares. The
Plan was adopted, as required by Rule 12b-1 under the 1940 Act, by a vote
of the Board of Directors on May 8, 1987, including a majority of the
directors who are not "interested persons" of the Corporation as that term
is defined in the 1940 Act and who have no direct or indirect financial
interest in the operation of the Plan or the Underwriting Agreement
("12b-1 directors"). Continuation of the Plan was most recently approved
by the Board of Directors on October 21, 1994, including a majority of the
12b-1 directors. In approving the continuance of the Plan, in accordance
with the requirements of Rule 12b-1, the directors considered various
factors, including the amount of the distribution fee. The directors
determined that there is a reasonable likelihood that the Plan will
continue to benefit the Fund and its present and future Primary Class
shareholders. The Plan was also approved by the vote of a majority of the
Fund's outstanding Primary Shares on April 22, 1988.
The Plan continues in effect only so long as it is approved at least
annually by the vote of a majority of the Board of Directors, including a
majority of the 12b-1 directors, cast in person at a meeting called for
the purpose of voting on the Plan. The Plan may be terminated with respect
to the Fund by vote of a majority of the 12b-1 directors, or by vote of a
majority of the outstanding voting Primary Class securities of the Fund.
Any change in the Plan that would materially increase the distribution
cost to the Fund requires Primary Class shareholder approval. Otherwise,
the Plan may be amended by the directors, including a majority of the 12b-
1 directors, as previously described.
36
<PAGE>
Rule 12b-1 requires that any person authorized to direct the
disposition of monies paid or payable by the Fund, pursuant to the Plan or
any related agreement, shall provide to the Corporation's Board of
Directors, and the directors shall review, at least quarterly, a written
report of the amounts so expended and the purposes for which the
expenditures were made. Rule 12b-1 also provides that the Fund may rely
on that Rule only if, while the Plan is in effect, the nomination and
selection of the Corporation's independent directors is committed to the
discretion of such independent directors.
As compensation for its services and expenses, Legg Mason receives
from the Corporation annual distribution and service fees equivalent to
0.25% of the Fund's average daily net assets attributable to Primary
Shares in accordance with the Plan. The distribution and service fees are
computed daily and paid monthly. For the years ended December 31, 1994,
1993 and 1992, the Fund paid distribution and service fees of $1,344,353,
$1,533,030 and $1,333,705, respectively, to Legg Mason, pursuant to the
Underwriting Agreement from assets attributable to Primary Shares.
THE FUND'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1713, Boston, Massachusetts
02105, serves as custodian of the Fund's assets. Boston Financial Data
Services P.O. Box 8000, Boston, Massachusetts, serves as transfer and
dividend-disbursing agent, and administrator of various shareholder
services. BFDS has contracted with Legg Mason for the latter to assist it
with certain of its duties as transfer agent, for which BFDS compensates
Legg Mason. For the year ended December 31, 1994, Legg Mason received
$57,597 for such services. Shareholders who request an historical
transcript of their account will be charged a fee based upon the number of
years researched. The Fund reserves the right, upon 60 days' written
notice, to make other charges to investors to cover administrative costs.
THE CORPORATION'S LEGAL COUNSEL
Kirkpatrick & Lockhart, 1800 M Street, N.W., Washington, D.C. 20036,
serves as counsel to the Corporation.
THE CORPORATION'S INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 217 East Redwood Street, Baltimore, MD
21202, have been selected by the Directors to serve as the Corporation's
independent accountants.
FINANCIAL STATEMENTS
The Portfolio of Investments as of December 31, 1994; the Statement of
Assets and Liabilities as of December 31, 1994; the Statement of
Operations for the year ended December 31, 1994; the Statement of Changes
in Net Assets for the years ended December 31, 1994 and 1993; the
Financial Highlights for the periods presented; the Notes to Financial
Statements and the Report of the Independent Accountants, all of which are
37
<PAGE>
included in the Fund's Annual Report to Shareholders for the year ended
December 31, 1994, are hereby incorporated by reference in this Statement
of Additional Information.
38
<PAGE>
APPENDIX A
For the Government Intermediate Portfolio:
-----------------------------------------
RATINGS OF SECURITIES
Description of Moody's Investors Service, Inc. ("Moody's") corporate bond
ratings:
Aaa-Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a large or
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa-Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risks appear
somewhat larger than the Aaa securities.
A-Bonds which are rated A possess many favorable investment attributes
and are to be considered 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 some time in
the future.
Baa-Bonds which are rated Baa are considered medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba-Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B-Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time
may be small.
Description of Standard & Poor's Ratings Group corporate bond ratings:
A-1
<PAGE>
AAA-This is the highest rating assigned by Standard & Poor's to an
obligation. Capacity to pay interest and repay principal is extremely
strong.
AA-Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small
degree.
A-Bonds rated A have a strong capacity to pay interest and repay
principal, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher categories.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal
for bonds in this category than for bonds in higher rated categories.
BB, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded, on balance,
as predominately speculative with respect to the issuer's 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 bonds will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions. Description
of Moody's preferred stock ratings:
Description of Moody's preferred stock ratings:
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 that
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
A-2
<PAGE>
adverse periods. Uncertainty of position characterizes preferred stocks
in this class.
A-3
<PAGE>
THE
LEGG MASON INCOME TRUST, INC.
Legg Mason Investment Grade Income Portfolio
Legg Mason U. S. Government Money Market Portfolio
STATEMENT OF ADDITIONAL INFORMATION
Legg Mason Income Trust, Inc. ("Corporation") is an open-end,
diversified management investment company which currently has four
separate investment portfolios. This Statement of Additional Information
relates to two of those portfolios ("Portfolios").
Legg Mason Investment Grade Income Portfolio ("Investment Grade
Portfolio") seeks to provide investors with a high level of current income
through investment in a diversified portfolio of debt securities. In
attempting to achieve the Investment Grade Portfolio's objective, its
investment adviser, Western Asset Management Company ("Adviser"), invests
primarily in debt securities which it considers to be investment grade.
The Investment Grade Portfolio expects to maintain an average dollar-
weighted maturity of between five and twenty years. The Portfolio's
current yield is expected to be higher than the current yields of mutual
funds that own debt securities with shorter average maturities.
Legg Mason U. S. Government Money Market Portfolio ("Government Money
Market Portfolio") seeks to obtain high current income consistent with
liquidity and conservation of principal. In attempting to achieve this
objective, the Adviser will invest only in debt obligations guaranteed as
to principal and interest by the U.S. Government, its agencies or
instrumentalities, and in repurchase agreements collateralized by such
instruments. The Adviser attempts to maintain a stable net asset value
per share of $1.00, although there can be no assurance that it will always
be able to do so.
Separate Statements of Additional Information each dated May 1, 1995
are available for the Legg Mason High Yield Portfolio, and the Legg Mason
U.S. Government Intermediate-Term Portfolio, the other portfolios of the
Corporation.
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectus for the Investment Grade
Portfolio or the Government Money Market Portfolio, each dated May 1,
1995, and each of which has been filed with the Securities and Exchange
Commission ("SEC"). A copy of each Portfolio's prospectus is available
without charge from the Corporation's distributor, Legg Mason Wood Walker,
Incorporated ("Legg Mason") (address and telephone numbers listed below).
Dated: May 1, 1995
<PAGE>
LEGG MASON WOOD WALKER, INCORPORATED
111 South Calvert Street
Baltimore, Maryland 21202
(410) 539-0000 (800) 822-5544
This Statement of Additional Information is not an offer of sale of
the securities of either Portfolio. An offer can be made only by means of
a Prospectus.
<PAGE>
Table of Contents
Page
Additional Information About Investment
Limitations and Policies 2
Additional Tax Information 14
Additional Purchase and Redemption
Information 17
Performance Information 21
Valuation of Shares 27
Tax-Deferred Retirement Plans 29
The Corporation's Directors and Officers 30
Management Agreements 33
Investment Advisory Agreements 35
Portfolio Transactions and Brokerage 36
The Portfolios' Distributor 37
The Portfolios' Custodian and Transfer
and Dividend-Disbursing Agent 39
The Corporation's Legal Counsel 39
The Corporation's Independent Accountants 39
Financial Statements 39
Appendix A: Ratings of Securities A-1
No person has been authorized to give any information or to make any
representations not contained in the Prospectuses or this Statement of
Additional Information in connection with the offerings made by the
Prospectuses and, if given or made, such information or representations
must not be relied upon as having been authorized by either Portfolio or
its distributor. The Prospectuses and the Statement of Additional
Information do not constitute offerings by either Portfolio or by the
distributor in any jurisdiction in which such offerings may not lawfully
be made.
<PAGE>
ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND POLICIES
The following information supplements the information concerning
each Portfolio's investment objectives, policies and limitations found in
the relevant Prospectus.
Investment Grade Portfolio The Investment Grade Portfolio has
adopted certain fundamental investment limitations that cannot be changed
except by vote of a majority of its outstanding voting securities. The
Investment Grade Portfolio may not:
1. Borrow money, except for temporary purposes in an aggregate amount
not to exceed 5% of the value of its total assets at the time of
borrowing. (Although not a fundamental policy subject to shareholder
approval, the Investment Grade Portfolio intends to repay any money
borrowed before any additional portfolio securities are purchased.);
2. Invest more than 5% of its total assets (taken at market value) in
securities of any one issuer, other than the U.S. Government, its agencies
and instrumentalities, or buy more than 10% of the voting securities or
more than 10% of all the securities of any issuer;
3. Mortgage, pledge or hypothecate any of its assets, except to
collateralize permitted borrowings up to 5% of the value of its total
assets at the time of borrowing; provided, that the deposit in escrow of
underlying securities in connection with the writing of call options is
not deemed to be a pledge; and provided further, that deposit of initial
margin or the payment of variation margin in connection with the purchase
or sale of futures contracts or of options on futures contracts shall not
be deemed to constitute pledging assets;
4. Purchase securities on "margin," except that the Investment Grade
Portfolio may make margin deposits in connection with its use of options,
interest rate futures contracts and options on interest rate futures
contracts;
5. Make short sales of securities unless at all times while a short
position is open the Investment Grade Portfolio maintains a long position
in the same security in an amount at least equal thereto; provided,
however, that the Investment Grade Portfolio may purchase or sell futures
contracts, and may make initial and variation margin payments in
connection with purchases or sales of futures contracts or of options on
futures contracts;
6. Invest more than 25% of its total assets (taken at market value) in
any one industry;
7. Invest in securities issued by other investment companies, except
in connection with a merger, consolidation, acquisition or reorganization
or by purchase in the open market of securities of closed-end investment
companies where no underwriter or dealer commission or profit, other than
A-2
<PAGE>
a customary brokerage commission, is involved and only if immediately
thereafter not more than 10% of the Investment Grade Portfolio's total
assets (taken at market value) would be invested in such securities;
8. Purchase or sell commodities and commodity contracts, except that
the Investment Grade Portfolio may purchase or sell options, interest rate
futures contracts and options on interest rate futures contracts;
9. Underwrite the securities of other issuers, except to the extent
that in connection with the disposition of restricted securities or the
purchase of securities either directly from the issuer or from an
underwriter for an issuer, the Investment Grade Portfolio may be deemed to
be an underwriter;
10. Make loans, except loans of portfolio securities and except to the
extent the purchase of a portion of an issue of publicly distributed
notes, bonds or other evidences of indebtedness or deposits with banks and
other financial institutions may be considered loans;
11. Purchase or sell real estate, except that the Investment Grade
Portfolio may invest in securities collateralized by real estate or
interests therein or in securities issued by companies that invest in real
estate or interests therein; or
12. Purchase or sell interests in oil and gas or other mineral
exploration or development programs.
GOVERNMENT MONEY MARKET PORTFOLIO The Government Money Market
Portfolio has adopted certain fundamental investment limitations that
cannot be changed except by vote of a majority of its outstanding voting
securities. The Government Money Market Portfolio may not:
1. Borrow money, except for temporary purposes in an aggregate amount
not to exceed 5% of the value of its total assets at the time of
borrowing. (Although not a fundamental policy subject to shareholder
approval, the Fund intends to repay any money borrowed before any
additional portfolio securities are purchased);
2. Mortgage, pledge or hypothecate any of its assets, except to
collateralize permitted borrowings up to 5% of the value of its total
assets at the time of borrowing;
3. Purchase securities on "margin" except that the Fund may obtain
such credits as may be necessary for clearing the purchases and sales of
securities;
4. Make short sales of securities unless at all times while a short
position is open the Fund maintains a long position in the same security
in an amount at least equal thereto;
5. Purchase or sell commodities and commodity contracts;
A-3
<PAGE>
6. Underwrite the securities of other issuers, except to the extent
that in connection with the disposition of restricted securities or the
purchase of securities either directly from the issuer or from an
underwriter for an issuer, the Fund may be deemed to be an underwriter;
7. Make loans, except loans of portfolio securities and except to the
extent the purchase of a portion of an issue of publicly distributed
notes, bonds or other evidences of indebtedness, entry into repurchase
agreements or deposits with banks and other financial institutions may be
considered loans;
8. Purchase or hold real estate, except that the Fund may invest in
securities collateralized by real estate or interests therein; and
9. Purchase or sell interests in oil and gas or other mineral
exploration or development programs.
As noted above, the fundamental investment limitations of each
Portfolio, along with its investment objective, may not be changed without
the vote of a majority of the Portfolio's outstanding voting securities.
Under the Investment Company Act of 1940, as amended ("1940 Act"), a "vote
of a majority of the outstanding voting securities" of a Portfolio means
the affirmative vote of the lesser of (1) more than 50% of the outstanding
shares of the Portfolio or (2) 67% or more of the shares present at a
shareholders' meeting if more than 50% of the outstanding shares are
represented at the meeting in person or by proxy. If a percentage
restriction described above is complied with at the time an investment is
made, a later increase in percentage resulting from changing values of
portfolio securities or in the amount of assets of the Portfolio will not
be considered a violation of any of those restrictions. Except as
otherwise noted, the investment policies and limitations described in this
Statement of Additional Information are non-fundamental and may be changed
without a shareholder vote.
YIELD FACTORS AND RATINGS Standard & Poor's Ratings Group
("S&P") and Moody's Investors Service, Inc. ("Moody's") are private
services that provide ratings of the credit quality of obligations.
Investment grade bonds are generally considered to be those bonds rated at
the time of purchase within one of the four highest grades assigned by S&P
or Moody's. A description of the range of ratings assigned to obligations
by Moody's and S&P is included in Appendix A to this Statement of
Additional Information. A Portfolio may use these ratings in determining
whether to purchase, sell or hold a security. These ratings represent
Moody's and S&P's opinions as to the quality of the obligations which they
undertake to rate. It should be emphasized, however, that ratings are
general and are not absolute standards of quality. Consequently,
obligations with the same maturity, interest rate and rating may have
different market prices. Subsequent to its purchase by either Portfolio,
an issue of obligations may cease to be rated or its rating may be reduced
below the minimum rating required for purchase by that Portfolio. The
Adviser will consider such an event in determining whether the Portfolio
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should continue to hold the obligation, but is not required to dispose of
it.
In addition to ratings assigned to individual bond issues, the
Adviser will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and
asset quality. The yields on bonds and other debt securities in which the
Portfolios invest are dependent on a variety of factors, including general
money market conditions, general conditions in the bond market, the
financial conditions of the issuer, the size of the offering, the maturity
of the obligation and its rating. There is a wide variation in the
quality of bonds, both within a particular classification and between
classifications. An issuer's obligations under its bonds are subject to
the provisions of bankruptcy, insolvency and other laws affecting the
rights and remedies of bond holders or other creditors of an issuer;
litigation or other conditions may also adversely affect the power or
ability of issuers to meet their obligations for the payment of interest
and principal on their bonds.
FUTURES AND OPTIONS
-------------------
The following information about futures and options applies to
the Investment Grade Portfolio:
INTEREST RATE FUTURES CONTRACTS Interest rate futures contracts,
which are traded on commodity futures exchanges, provide for the sale by
one party and the purchase by another party of a specified type and amount
of financial instruments (or an index of financial instruments) at a
specified future date. Interest rate futures contracts currently exist
covering such financial instruments as U.S. Treasury bonds, notes and
bills, Government National Mortgage Association certificates, bank
certificates of deposit and 90-day commercial paper. An interest rate
futures contract may be held until the underlying instrument is delivered
and paid for on the delivery date, but most contracts are closed out
before then by taking an offsetting position on a futures exchange.
The Portfolio may purchase an interest rate futures contract
(that is, enter into a futures contract to purchase an underlying
financial instrument) when it intends to purchase fixed-income securities
but has not yet done so. This strategy is sometimes called an
anticipatory hedge. This strategy is intended to minimize the effects of
an increase in the price of the securities the Portfolio intends to
purchase (but may also reduce the effects of a decrease in price), because
the value of the futures contract would be expected to rise and fall in
the same direction as the price of the securities the Portfolio intends to
purchase. The Portfolio could purchase the intended securities either by
holding the contract until delivery and receiving the financial instrument
underlying the futures contract, or by purchasing the securities directly
and closing out the futures contract position. If the Portfolio no longer
wished to purchase the securities, it would close out the futures contract
before delivery.
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The Portfolio may sell a futures contract (that is, enter into a
futures contract to sell an underlying financial instrument) to offset
price changes of securities it already owns. This strategy is intended to
minimize any price changes in the securities the Portfolio owns (whether
increases or decreases) caused by interest rate changes, because the value
of the futures contract would be expected to move in the opposite
direction from the value of the securities owned by the Portfolio. The
Portfolio does not expect ordinarily to hold futures contracts it has sold
until delivery or to use securities it owns to satisfy delivery
requirements. Instead, the Portfolio expects to close out such contracts
before the delivery date.
The prices of interest rate futures contracts depend primarily on
the value of the instruments on which they are based, the price changes of
which, in turn, primarily reflect changes in current interest rates.
Because there are a limited number of types of interest rate futures
contracts, it is likely that the standardized futures contracts available
to the Portfolio will not exactly match the securities the Portfolio
wishes to hedge or intends to purchase, and consequently will not provide
a perfect hedge against all price fluctuation. Because fixed-income
instruments all respond similarly to changes in interest rates, however, a
futures contract the underlying instrument of which differs from the
securities the Portfolio wishes to hedge or intends to purchase may still
provide protection against changes in interest rate levels. To compensate
for differences in historical volatility between positions the Portfolio
wishes to hedge and the standardized futures contracts available to it,
the Portfolio may purchase or sell futures contracts with a greater or
lesser value than the securities it wishes to hedge or intends to
purchase.
FUTURES TRADING If the Portfolio does not wish to hold a futures
contract position until the underlying instrument is delivered and paid
for on the delivery date, it may attempt to close out the contract by
entering into an offsetting position on a futures exchange that provides a
secondary market for the contract. A futures contract is closed out by
entering into an opposite position in an identical futures contract (for
example, by purchasing a contract on the same instrument and with the same
delivery date as a contract the Portfolio had sold) at the current price
as determined on the futures exchange. The Portfolio's gain or loss on
closing out a futures contract depends on the difference between the price
at which the Portfolio entered into the contract and the price at which
the contract is closed out. Transaction costs in opening and closing
futures contracts must also be taken into account. There can be no
assurance that the Portfolio will be able to offset a futures position at
the time it wishes to, or at a price that is advantageous. If the
Portfolio were unable to enter into an offsetting position in a futures
contract, it might have to continue to hold the contract until the
delivery date, in which case it would continue to bear the risk of price
fluctuation in the contract until the underlying instrument was delivered
and paid for.
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At the time the Portfolio enters into an interest rate futures
contract, it is required to deposit with its custodian, in the name of the
futures broker (known as a futures commission merchant, or "FCM"), a
percentage of the contract's value. This amount, which is known as
initial margin, generally equals 5% or less of the value of the futures
contract. Initial margin is in the nature of a good faith deposit or
performance bond, and is returned to the Portfolio when the futures
position is terminated, after all contractual obligations have been
satisfied. Futures margin does not represent a borrowing by the
Portfolio, unlike margin extended by a securities broker, and depositing
initial margin in connection with futures positions does not constitute
purchasing securities on margin for the purposes of the Portfolio's
investment limitations. Initial margin may be maintained either in cash
or in liquid, high-quality debt securities such as U.S. government
securities.
As the contract's value fluctuates, payments known as variation
margin or maintenance margin are made to or received from the FCM. If the
contract's value moves against the Portfolio (i.e., the Portfolio's
futures position declines in value), the Portfolio may be required to make
payments to the FCM, and, conversely, the Portfolio may be entitled to
receive payments from the FCM if the value of its futures position
increases. This process is known as marking-to-market and takes place on
a daily basis.
In addition to initial margin deposits, the Portfolio will
instruct its custodian to segregate additional cash and liquid debt
securities to cover its obligations under futures contracts it has
purchased and to ensure that the contracts are unleveraged. The value of
the assets held in the segregated account will be equal to the daily
market value of all outstanding futures contracts purchased by the
Portfolio, less the amount deposited as initial margin. Where the
Portfolio enters into positions that substantially offset one another, it
may segregate assets equal to only one side of the transaction, consistent
with SEC staff interpretive positions. When the Portfolio has sold
futures contracts to hedge securities it owns, it will not sell those
securities (or lend them to another party) while the contracts are
outstanding, unless it substitutes other similar securities for the
securities sold or lent. The Portfolio will not sell futures contracts
with a value exceeding the value of securities it owns, except that the
Portfolio may do so to the extent necessary to adjust for differences in
historical volatility between the securities owned and the contracts used
as a hedge.
RISKS OF INTEREST RATE FUTURES CONTRACTS By purchasing an
interest rate futures contract, the Portfolio in effect becomes exposed to
price fluctuations resulting from changes in interest rates, and by
selling a futures contract the Portfolio neutralizes those fluctuations.
If interest rates fall, the Portfolio would expect to profit from an
increase in the value of the instrument underlying a futures contract it
had purchased, and if interest rates rise, the Portfolio would expect to
offset the resulting decline in the value of the securities it owns by
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profits in a futures contract it has sold. If interest rates move in the
direction opposite that which was contemplated at the time of purchase,
however, the Portfolio's positions in futures contracts could have a
negative effect on the Portfolio's net asset value. If interest rates
rise when the Portfolio has purchased futures contracts, the Portfolio
could suffer a loss in its futures positions. Similarly, if interest
rates fall, losses in a futures contract the Portfolio has sold could
negate gains on securities the Portfolio owns, or could result in a net
loss to the Portfolio. In this sense, successful use of interest rate
futures contracts by the Portfolio will depend on the Adviser's ability to
hedge the Portfolio in an advantageous way at the appropriate time.
Other than the risk that interest rates will not move as
expected, the primary risk in employing interest rate futures contracts is
that the market value of the futures contracts may not move in concert
with the value of the securities the Portfolio wishes to hedge or intends
to purchase. This may result from differences between the instrument
underlying the futures contracts and the securities the Portfolio wishes
to hedge or intends to purchase, as would be the case, for example, if the
Portfolio hedged U.S. Treasury bonds by selling futures contracts on U.S.
Treasury notes.
Even if the securities which are the objects of a hedge are
identical to those underlying the futures contract, there may not be
perfect price correlation between the two. Although the value of interest
rate futures contracts is primarily determined by the price of the
underlying financial instruments, the value of interest rate futures
contracts is also affected by other factors, such as current and
anticipated short-term and long-term interest rates, the time remaining
until expiration of the futures contract, and conditions in the futures
markets, which may not affect the current market price of the underlying
financial instruments in the same way. In addition, futures exchanges
establish daily price limits for interest rate futures contracts, and may
halt trading in the contracts if their prices move up or down more than a
specified daily limit on a given day. This could distort the relationship
between the price of the underlying instrument and the futures contract,
and could prevent prompt liquidation of unfavorable futures positions.
The value of a futures contract may also move differently from the price
of the underlying financial instrument because of inherent differences
between the futures and securities markets, including variations in
speculative demand for futures contracts and for debt securities, the
differing margin requirements for futures contracts and debt securities,
and possible differences in liquidity between the two markets.
PUT OPTIONS ON INTEREST RATE FUTURES CONTRACTS Purchasing a put
option on an interest rate futures contract gives a Portfolio the right to
assume a seller's position in the contract at a specified exercise price
at any time up to the option's expiration date. In return for this right,
the Portfolio pays the current market price for the option (known as the
option premium), as determined on the commodity futures exchange where the
option is traded.
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The Portfolio may purchase put options on interest rate futures
contracts to hedge against a decline in the market value of securities the
Portfolio owns. Because a put option is based on a contract to sell a
financial instrument at a certain price, its value will tend to move in
the opposite direction from the price of the financial instrument
underlying the futures contract; that is, the put option's value will tend
to rise when prices fall, and fall when prices rise. By purchasing a put
option on an interest rate futures contract, the Portfolio would attempt
to offset potential depreciation of securities it owns by appreciation of
the put option. This strategy is similar to selling the underlying
futures contract directly.
The Portfolio's position in a put option on an interest rate
futures contract may be terminated either by exercising the option (and
assuming a seller's position in the underlying futures contract at the
option's exercise price) or by closing out the option at the current price
as determined on the futures exchange. If the put option is not exercised
or closed out before its expiration date, the entire premium paid would be
lost by the Portfolio. The Portfolio could profit from exercising a put
option if the current market value of the underlying futures contract were
less than the sum of the exercise price of the put option and the premium
paid for the option (because the Portfolio would, in effect, be selling
the futures contract at a price higher than the current market price).
The Portfolio could also profit from closing out a put option if the
current market price of the option is greater than the premium the
Portfolio paid for the option. Transaction costs must also be taken into
account in these calculations. The Portfolio may close out an option it
had purchased by selling an identical option (that is, an option on the
same futures contract, with the same exercise price and expiration date)
in a closing transaction on a futures exchange that provides a secondary
market for the option. The Portfolio is not required to make futures
margin payments when it purchases an option on an interest rate futures
contract.
Compared to the purchase or sale of an interest rate futures
contract, the purchase of a put option on an interest rate futures
contract involves a smaller potential risk to the Portfolio, because the
maximum amount at risk is the premium paid for the option (plus related
transaction costs). If prices of debt securities remain stable, however,
purchasing a put option may involve a greater probability of loss than
selling a futures contract, even though the amount of the potential loss
is limited. The Adviser will consider the different risk and reward
characteristics of options and futures contracts when selecting hedging
instruments.
RISKS OF TRANSACTIONS IN OPTIONS ON INTEREST RATE FUTURES
CONTRACTS Options on interest rate futures contracts are subject to
risks similar to those described above with respect to interest rate
futures contracts. These risks include the risk that the Adviser may not
hedge the Portfolio in an advantageous way at the appropriate time, the
risk of imperfect price correlation between the option and the securities
being hedged, and the risk that there may not be an active secondary
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market for the option. There is also a risk of imperfect price
correlation between the option and the underlying futures contract.
Although the Adviser will purchase and write only those options
for which there appears to be a liquid secondary market, there can be no
assurance that such a market will exist for any particular option at any
particular time. If there were no liquid secondary market for a
particular option, the Portfolio might have to exercise an option it had
purchased in order to realize any profit, and might continue to be
obligated under an option it had written until the option expired or was
exercised.
OPTIONS WRITING ON DEBT SECURITIES The Portfolio may from time
to time write (sell) covered call options and covered put options on
certain of its portfolio securities. When it writes a covered call
option, the Portfolio obligates itself to sell the underlying security to
the purchaser of the option at a fixed price if the purchaser exercises
the option during the option period. A call is "covered" if the Portfolio
owns the optioned securities or, in the case of options on certain U.S.
Government securities, the Portfolio maintains with its custodian in a
segregated account cash, U.S. Government securities or high-grade liquid
debt securities with a value sufficient to meet its obligations under the
call. When the Portfolio writes a call option, it receives a premium from
the purchaser. During the option period, the Portfolio forgoes the
opportunity to profit from any increase in the market price of the
security above the exercise price of the option, but retains the risk that
the price of the security may decline.
The Portfolio may also write covered put options. When the
Portfolio writes a put option, it receives a premium and gives the
purchaser of the put the right to sell the underlying security to the
Portfolio at the exercise price at any time during the option period. A
put is "covered" if the Portfolio maintains cash, U.S. Government
securities or high-grade liquid debt securities with a value equal to the
exercise price in a segregated account. The risk in writing puts is that
the market price of the underlying security may decline below the exercise
price (less the premiums received).
The Portfolio may seek to terminate its obligations as a writer
of a put or call option prior to its expiration by entering into a
"closing purchase transaction." A closing purchase transaction is the
purchase of an option covering the same underlying security and having the
same exercise price and expiration date as an option previously written by
the Portfolio on which it wishes to terminate its obligation.
Although not a fundamental policy subject to shareholder vote,
the Portfolio does not presently intend to write options on portfolio
securities exceeding 25% of its total assets. Normally, options will be
written on those portfolio securities which the Adviser does not expect to
have significant short-term capital appreciation.
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RISKS OF WRITING OPTIONS ON DEBT SECURITIES When the Portfolio
writes an option, it assumes the risk of fluctuations in the value of the
underlying security in return for a fixed premium and must be prepared to
satisfy exercise of the option at any time until the expiration date. The
writing of options could also result in an increase in the Portfolio's
turnover rate, particularly in periods of appreciation in the market price
of the underlying securities. In addition, writing options on portfolio
securities involves a number of other risks, including the risk that the
Adviser may not correctly predict interest rate movement and the risk that
there may not be a liquid secondary market for the option, as a result of
which the Portfolio might be unable to effect a closing transaction.
If the Portfolio is unable to close out an option it has written,
it must continue to bear the risks associated with the option, and must
continue to hold cash or securities to cover the option until the option
is exercised or expires. The Portfolio may engage in options on
securities which are not traded on national exchanges ("unlisted
options"). Because unlisted options may be closed out only with the other
party to the option transaction, it may be more difficult to close out
unlisted options than listed options.
REGULATORY NOTIFICATION OF FUTURES AND OPTIONS STRATEGIES The
Corporation has filed on behalf of the Portfolio a notice of eligibility
for exclusion from the definition of the term "commodity pool operator"
with the Commodity Futures Trading Commission ("CFTC") and the National
Futures Association, which regulate trading in the futures markets. Under
Section 4.5 of the regulations under the Commodity Exchange Act, the
notice of eligibility must include representations that the Portfolio will
use futures contracts and related options solely for bona fide hedging
purposes within the meaning of the CFTC regulations, provided that the
Portfolio may hold futures contracts and related options that do not fall
within the definition of bona fide hedging transactions if, with respect
to such non-hedging transactions, the sum of initial margin deposits on
futures contracts and related options and premiums paid for related
options after taking into account unrealized profits and losses on such
contracts, do not exceed 5% of the Portfolio's net assets; and provided
further that the Portfolio may exclude the amount by which an option is
"in the money" in computing such 5%. The Portfolio will not purchase
futures contracts or related options if as a result more than 33 1/3% of
the Portfolio's total assets would be so invested. Where the Portfolio
enters into two positions that substantially offset each other, it
determines compliance with the foregoing limitation by considering its net
exposure to changes in the underlying instrument or market. These limits
on the Portfolio's investments in futures contracts are not fundamental
and may be changed by the Board of Directors as regulatory agencies
permit. The Portfolio will not modify these limits to increase its
permissible futures and related options activities without supplying
additional information in a supplement to a current Prospectus or
Statement of Additional Information that has been distributed or made
available to the Portfolio's shareholders.
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OTHER INVESTMENT POLICIES
-------------------------
PRIVATE PLACEMENTS The Investment Grade Portfolio may
acquire restricted securities in private placement transactions, directly
from the issuer or from security holders, frequently at higher yields than
comparable publicly-traded securities. Restricted securities will not be
purchased if as a result more than 5% of the Portfolio's assets would
consist of restricted securities. Privately-placed securities can be sold
by the Portfolio only (1) pursuant to SEC Rule 144A or other exemption;
(2) in privately-negotiated transactions to a limited number of
purchasers; or (3) in public offerings made pursuant to an effective
registration statement under the Securities Act of 1933. Private or
public sales of such securities by the Portfolio may involve significant
delays and expense. Private sales require negotiations with one or more
purchasers and generally produce less favorable prices than the sale of
comparable unrestricted securities. Public sales generally involve the
time and expense of preparing and processing a registration statement
under the Securities Act of 1933 and may involve the payment of
underwriting commissions; accordingly, the proceeds may be less than the
proceeds from the sale of securities of the same class which are freely
marketable.
SECURITIES LENDING A Portfolio may lend portfolio securities to
brokers or dealers in corporate (with respect to the Investment Grade
Portfolio only) or government securities, banks or other recognized
institutional borrowers of securities, provided that the borrower
maintains cash or equivalent collateral, equal to at least 100% of the
market value of the securities loaned with the Portfolios' custodian.
During the time portfolio securities are on loan, the borrower will pay
the Portfolio an amount equivalent to any dividends or interest paid on
such securities, and the Portfolio may invest the cash collateral and earn
income, or it may receive an agreed upon amount of interest income from
the borrower who has delivered equivalent collateral. These loans are
subject to termination at the option of the Portfolio or the borrower. A
Portfolio may pay reasonable administrative and custodial fees in
connection with a loan and may pay a negotiated portion of the interest
earned on the cash or equivalent collateral to the borrower or placing
broker. In the event of the bankruptcy of the other party to a securities
loan, the Portfolio could experience delays in recovering the securities
lent. To the extent that, in the meantime, the value of the securities
purchased had decreased or the securities lent increased, the Portfolio
could experience a loss. The Portfolio will enter into securities loan
transactions only with financial institutions which the Adviser believes
to present minimal risk of default during the term of the loan. A
Portfolio does not have the right to vote securities on loan, but would
terminate the loan and regain the right to vote if that were considered
important with respect to the investment. The Portfolios presently do not
intend to loan more than 5% of their respective portfolio securities at
any given time.
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REPURCHASE AGREEMENTS Repurchase agreements are usually for
periods of one week or less, but may be for longer periods. The
securities are held for the Portfolios by State Street Bank and Trust
Company ("State Street"), the Portfolios' custodian, as collateral until
resold and are supplemented by additional collateral if necessary to
maintain a total value equal to or in excess of the value of the
repurchase agreement. A Portfolio bears a risk of loss in the event that
the other party to a repurchase agreement defaults on its obligations and
the Portfolio is delayed or prevented from exercising its rights to
dispose of the collateral securities. The Portfolios enter into
repurchase agreements only with financial institutions which the Adviser
believes to present minimal risk of default during the term of the
agreement based on guidelines established by the Board of Directors. Each
of the Portfolios currently intends to invest in repurchase agreements
when cash is temporarily available or for temporary defensive purposes.
REVERSE REPURCHASE AGREEMENTS A reverse repurchase agreement is
a portfolio management technique in which a Portfolio temporarily
transfers possession of a portfolio instrument to another person, such as
a financial institution or broker-dealer, in return for cash. At the same
time, the Portfolio agrees to repurchase the instrument at an agreed upon
time (normally within seven days) and price, including interest payment.
A Portfolio may engage in reverse repurchase agreements as a means of
raising cash to satisfy redemption requests or for other temporary or
emergency purposes without the necessity of selling portfolio instruments.
When a Portfolio reinvests the proceeds of a reverse repurchase
agreement in other securities, any fluctuations in the market value of
either the securities transferred to another party or the securities in
which the proceeds are invested would affect the market value of the
Portfolio's assets. As a result, such transactions could increase
fluctuation in the Portfolio's net asset value. If a Portfolio reinvests
the proceeds of the agreement at a rate lower than the cost of the
agreement, engaging in the agreement will lower the Portfolio's yield.
While engaging in reverse repurchase agreements, each Portfolio will
maintain cash, U.S. government securities or other high-grade, liquid debt
securities in a segregated account at its custodian bank with a value at
least equal to the Portfolio's obligation under the agreements.
The ability of each Portfolio to engage in reverse repurchase
agreements is subject to each Portfolio's fundamental investment
limitation concerning borrowing, i.e., that borrowing may be for temporary
purposes only and in an amount not to exceed 5% of the Portfolio's total
assets.
For the Investment Grade Portfolio:
-----------------------------------
WARRANTS Although not a fundamental policy subject to
shareholder vote, so long as the Portfolio's shares continue to be
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registered in certain states, the Portfolio may not invest more than 5% of
the value of its net assets, taken at the lower of cost or market value,
in warrants or invest more than 2% of the value of such net assets in
warrants not listed on the New York or American Stock Exchanges.
MORTGAGE-RELATED SECURITIES Mortgage-related securities
represent an ownership interest in a pool of residential mortgage loans.
These securities are designed to provide monthly payments of interest, and
in most instances, principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to investors
such as the Portfolio. Most issuers or poolers provide guarantees of
payments, regardless of whether or not the mortgagor actually makes the
payment. The guarantees made by issuers or poolers are backed by various
forms of credit, insurance and collateral.
Pools consist of whole mortgage loans or participations in loans.
The majority of these loans are made to purchasers of one- to four-family
homes. The terms and characteristics of the mortgage instruments are
generally uniform within a pool but may vary among pools. For example, in
addition to fixed-rate, fixed-term mortgages, the Portfolio may purchase
pools of variable-rate mortgages, growing-equity mortgages, graduated-
payment mortgages and other types.
All poolers apply standards for qualification to lending
institutions which originate mortgages for the pools. Poolers also
establish credit standards and underwriting criteria for individual
mortgages included in the pools. In addition, many mortgages included in
pools are insured through private mortgage insurance companies.
The majority of mortgage-related securities currently available
are issued by governmental or government-related organizations formed to
increase the availability of mortgage credit. The largest government-
sponsored issuer of mortgage-related securities is the Government National
Mortgage Association ("GNMA"). GNMA certificates are interests in pools
of loans insured by the Federal Housing Administration or by the Farmer's
Home Administration ("FHA"), or guaranteed by the Veterans Administration
("VA"). The Federal National Mortgage Association ("FNMA") and the
Federal Home Loan Mortgage Corporation ("FHLMC") each issue pass-through
securities which are guaranteed as to principal and interest by FNMA and
FHLMC, respectively.
The average life of mortgage-related securities varies with the
maturities and the nature of the underlying mortgage instruments. For
example, GNMAs tend to have a longer average life than FHLMC participation
certificates ("PCs") because there is a tendency for the conventional and
privately-insured mortgages underlying FHLMC PCs to repay at faster rates
than the FHA and VA loans underlying GNMAs. In addition, the term of a
security may be shortened by unscheduled or early payments of principal
and interest on the underlying mortgages. The occurrence of mortgage pre-
payments is affected by various factors, including the level of interest
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rates, general economic conditions, the location and age of the mortgaged
property and other social and demographic conditions.
In determining the dollar-weighted average maturity of the
Portfolio's portfolio, the Adviser will follow industry practice in
assigning an average life to the mortgage-related securities of the
Portfolio unless the interest rate on the mortgages underlying such
securities is such that a different prepayment rate is likely. For
example, where a GNMA has a high interest rate relative to the market,
that GNMA is likely to have a shorter overall maturity than a GNMA with a
market rate coupon. Moreover, the Adviser may deem it appropriate to
change the projected average life for the Portfolio's mortgage-related
security as a result of fluctuations in market interest rates and other
factors.
Quoted yields on mortgage-related securities are typically based
on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to
differ from the average life yield. Reinvestment of the prepayments may
occur at higher or lower interest rates than the original investment, thus
affecting the yield of the Portfolio. The compounding effect from the
reinvestments of monthly payments received by the Portfolio will increase
the yield to shareholders compared to bonds that pay interest semi-
annually.
Like other debt securities, the value of mortgage-related
securities will tend to rise when interest rates fall, and fall when rates
rise. The value of mortgage-related securities may also change because of
changes in the market's perception of the creditworthiness of the
organization that issued or guaranteed them. In addition, the mortgage
securities market in general may be adversely affected by changes in
governmental regulation or tax policies.
ADDITIONAL TAX INFORMATION
The following is a general summary of certain federal tax
considerations affecting each Portfolio and their shareholders. Investors
are urged to consult their own tax advisers for more detailed information
regarding any federal, state or local taxes that may be applicable to
them.
GENERAL For federal tax purposes, each Portfolio is treated as a
separate corporation. In order to continue to qualify for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code of
1986, as amended ("Code"), a Portfolio must distribute annually to its
shareholders at least 90% of its investment company taxable income
(generally, net investment income plus any net short-term capital gain)
("Distribution Requirement") and must meet several additional
requirements. For each Portfolio, these requirements include the
following: (1) the Portfolios must derive at least 90% of its gross income
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each taxable year must be derived from dividends, interest, payments with
respect to securities loans and gains from the sale or other disposition
of securities, or other income (including gains from options or futures
contracts) derived with respect to its business of investing in securities
("Income Requirement"); (2) the Portfolio must derive less than 30% of its
gross income each taxable year from the sale or other disposition of
securities, options or futures contracts held for less than three months
("Short-Short Limitation"); (3) at the close of each quarter of the
Portfolio's taxable year, at least 50% of the value of its total assets
must be represented by cash and cash items, U.S. government securities,
securities of other RICs and other securities, with those other securities
limited, in respect of any one issuer, to an amount that does not exceed
5% of the value of the Portfolio's total assets; and (4) 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.
A 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 gain net income for the one-year period ending on October 31 of
that year, plus certain other amounts. For this and other purposes,
dividends and other distributions declared by a Portfolio in December of
any year and payable to shareholders of record on a date in that month
will be deemed to have been paid by the Portfolio and received by the
shareholders on December 31 if the distributions are paid by the Portfolio
during the following January. Accordingly, such distributions will be
taxed to the shareholders for the year in which that December 31 falls.
For the Investment Grade Portfolio:
----------------------------------
If shares of the Investment Grade Portfolio are sold at a loss
after being held for six months or less, the loss will be treated as a
long-term, instead of a short-term, loss to the extent of any capital gain
distributions received on those shares. Investors also should be aware
that if shares of the Portfolio are purchased shortly before the record
date for any dividend or other distribution, the investor will pay full
price for the shares and receive some portion of the price back as a
taxable distribution.
HEDGING INSTRUMENTS The use of hedging instruments, such as
options and futures contracts, involves complex rules that will determine
for income tax purposes the character and timing of recognition of the
gains and losses the Portfolio realizes in connection therewith.
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Regulated futures contracts and options that are subject to
Section 1256 of the Code (collectively, "Section 1256 contracts") and are
held by the Portfolio at the end of each taxable year will be required to
be "marked-to-market" for federal income tax purposes (that is, treated as
having been sold at that time at market value). Any unrealized gain or
loss recognized under this mark-to-market rule will be added to any
realized gains and losses on Section 1256 contracts actually sold by the
Portfolio during the year, and the resulting gain or loss will be treated
(without regard to the holding period) as 60% long-term capital gain or
loss and 40% short-term capital gain or loss. These rules may operate to
increase the amount of dividends, which will be taxable to shareholders,
that must be distributed to meet the Distribution Requirement and avoid
imposition of the Excise Tax, without providing the cash with which to
make the distributions. The Portfolio may elect to exclude certain
transactions from Section 1256, although doing so may have the effect of
increasing the relative proportion of short-term capital gain (taxable as
ordinary income when distributed to the Portfolio's shareholders).
Generally, the hedging transactions undertaken by the Portfolio
may result in "straddles" for federal income tax purposes. Because
application of the straddle rules may affect the character of gains or
losses, defer the recognition of losses and/or accelerate the recognition
of gains from the affected straddle positions, and may require the
capitalization of interest expense associated therewith, the amount that
must be distributed to shareholders (and the character of the distribution
as ordinary income or long-term capital gain) may be increased or
decreased substantially as compared to a fund that did not engage in such
hedging transactions.
Income from transactions in options and futures contracts derived
by the Portfolio with respect to its business of investing in securities
will qualify as permissible income under the Income Requirement. However,
income from the disposition of options and futures contracts will be
subject to the Short-Short Limitation if they are held for less than three
months. Furthermore, if the Portfolio satisfies certain requirements, any
increase in value of a position that is part of a "designated hedge" will
be offset by any decrease in value (whether realized or not) of the
offsetting hedging position during the period of the hedge for purposes of
determining whether the Portfolio satisfies the Short-Short Limitation.
Thus, only the net gain (if any) from the designated hedge will be
included in gross income for purposes of this limitation. The Portfolio
intends that, when it engages in hedging transactions, it will qualify for
this treatment, but at the present time it is not clear whether this
treatment will be available for, or that the Portfolio will elect to have
this treatment apply to, all hedging transactions it undertakes. To the
extent this treatment is not available, the Portfolio may be forced to
defer the closing out of certain options and futures contracts beyond the
time when it otherwise would be advantageous to do so, in order for the
Portfolio to continue to qualify as a RIC.
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ORIGINAL ISSUE DISCOUNT The Portfolio may acquire zero coupon
bonds or other debt securities issued with original issue discount. As a
holder of those securities, the Portfolio must include in its income the
original issue discount that accrues on the securities during the taxable
year, even if it receives no corresponding payment on the securities
during the year. Because the Portfolio annually must distribute
substantially all of its investment company taxable income, including any
earned original issue discount, to satisfy the Distribution Requirement
and avoid imposition of the Excise Tax, it 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 the Portfolio's cash assets or from the proceeds of sales of
portfolio securities, if necessary. The Portfolio may realize capital
gains or losses from those sales, which would increase or decrease its
investment company taxable income and/or net capital gain (the excess of
net long-term capital gain over net short-term capital loss). In
addition, any such gains may be realized on the disposition of securities
held for less than three months. Because of the Short-Short Limitation,
any such gains would reduce the Portfolio's ability to sell other
securities, or options or futures contracts, held for less than three
months that it might wish to sell in the ordinary course of its portfolio
management.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
FUTURE FIRST SYSTEMATIC INVESTMENT PLAN AND TRANSFER OF FUNDS
FROM FINANCIAL INSTITUTIONS The Prospectus for each Portfolio
explains that you may buy additional shares of the Portfolio through the
Portfolio's Future First Systematic Investment Plan. Under this plan you
may arrange for automatic monthly investments in a Portfolio of $50 or
more by authorizing Boston Financial Data Services ("BFDS"), the
Portfolios' transfer agent, to prepare a check each month drawn on your
checking account. Each month the transfer agent will send a check to your
bank for collection, and the proceeds of the check will be used to buy
shares of the Portfolio at the per share net asset value determined on the
day the check is sent to your bank. You will receive a cumulative
quarterly confirmation for the purchase of additional shares through your
checking account. You may terminate the Future First Systematic
Investment Plan at any time without charge or penalty. Forms to enroll in
the Future First Systematic Investment Plan are available from any Legg
Mason or affilitated office.
You may also buy additional shares of the Portfolios through a
plan permitting transfers of funds from a financial institution. Certain
financial institutions may allow you, on a pre-authorized basis, to have
$50 or more automatically transferred monthly for investment in shares of
the Portfolios to:
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Legg Mason Wood Walker, Incorporated
Funds Processing
P.O. Box 1476
Baltimore, MD 21203-1476
If your check is not honored by the institution it is drawn on,
you may be subject to extra charges in order to cover collection costs.
These charges may be deducted from your shareholder account.
SYSTEMATIC WITHDRAWAL PLAN You may also elect to make
systematic withdrawals from your Portfolio account of a minimum of $50 on
a monthly basis if you own shares with a net asset value of $5,000 or
more. The amounts paid to you each month are obtained by redeeming
sufficient shares from your account to provide the withdrawal amount that
you have specified. The Systematic Withdrawal Plan is not currently
available for shares held in an Individual Retirement Account ("IRA"),
Self-Employed Individual Retirement Plan ("Keogh Plan"), Simplified
Employee Pension Plan ("SEP") or other qualified retirement plan. You may
change the monthly amount to be paid to you without charge not more than
once a year by notifying Legg Mason or the affiliate with which you have
an account. Redemptions will be made at the net asset value determined as
of the close of business on the New York Stock Exchange, Inc. ("Exchange")
on the first day of each month. If the Exchange is not open for business
on that day, the shares will be redeemed at the net asset value as
determined as of the close of regular trading of the Exchange on the
preceding business day. The check for the withdrawal payment will usually
be mailed to you on the next business day following redemption. If you
elect to participate in the Systematic Withdrawal Plan, dividends and
distributions on all shares in your Portfolio account must be
automatically reinvested in shares of that Portfolio. You may terminate
the Systematic Withdrawal Plan at any time without charge or penalty.
Each Portfolio, its transfer agent, Legg Mason and its affiliates also
reserve the right to modify or terminate the Systematic Withdrawal Plan at
any time.
Withdrawal payments are treated as a sale of shares rather than
as a dividend or capital gain distribution. These payments are taxable to
the extent that the total amount of the payment exceeds the tax basis of
the shares sold. If the periodic withdrawals exceed reinvested dividends
and distributions, the amount of your original investment will be
correspondingly reduced.
Ordinarily, you should not purchase additional shares of a
Portfolio if you maintain a Systematic Withdrawal Plan because you may
incur tax liabilities in connection with such purchases and withdrawals.
The Portfolios will not knowingly accept purchase orders from you for
additional shares if you maintain a Systematic Withdrawal Plan unless your
purchase is equal to at least one year's scheduled withdrawals. In
addition, if you maintain a Systematic Withdrawal Plan you may not make
periodic investments under the Future First Systematic Investment Plan.
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For Government Money Market Portfolio:
-------------------------------------
CONVERSION TO FEDERAL FUNDS A cash deposit made after the
daily cashiering deadline of the Legg Mason office in which the deposit is
made will be credited to your Legg Mason brokerage account ("Brokerage
Account") on the next business day following the day of deposit, and the
resulting free credit balance will be invested on the second business day
following the day of receipt.
LEGG MASON PREMIER ASSET MANAGEMENT ACCOUNT/VISA ACCOUNT
Shareholders of the Government Money Market Portfolio who have cash or
negotiable securities (including Government Money Market Portfolio shares)
valued at $20,000 or more in accounts with Legg Mason may subscribe to
Legg Mason's Premier Asset Management Account ("Premier"). This program
provides a direct link between a shareholder's Government Money Market
Portfolio account and his or her Brokerage Account. Premier provides
shareholders with a convenient method to invest in the Government Money
Market Portfolio through their Brokerage Account, which includes automatic
daily investment of free credit balances of $100 or more and automatic
weekly investment of free credit balances of less than $100.
Premier is a comprehensive financial service which combines a
shareholder's Government Money Market Portfolio account, a preferred
customer VISA Gold debit card, a Legg Mason Brokerage Account and
unlimited checks with no minimum check amount. Premier is offered as an
exclusive preferred customer service for shareholders of certain Legg
Mason funds.
The VISA Gold debit card may be used to purchase merchandise or
services from merchants honoring VISA or to obtain cash advances (which a
bank may limit to $5,000 or less, per account per day) from any bank
honoring VISA.
Checks, VISA charges and cash advances are posted to the
shareholder's margin account and create automatic same day redemptions if
shares are available in the Government Money Market Portfolio. If
Portfolio shares have been exhausted, the debits will remain in the margin
account, reducing the cash available. The shareholder will receive one
consolidated monthly statement which details all Portfolio transactions,
securities activity, check writing activity and VISA Gold purchases and
cash advances.
BancOne Columbus ("BancOne"), 757 Carolyn Avenue, Columbus, Ohio
43271, is the Government Money Market Portfolio's agent for processing
payment of VISA Gold debit card charges and clearance of checks written on
the Premier Account. Shareholders are subject to BancOne's rules and
regulations governing VISA accounts, including the right of BancOne not to
honor VISA drafts in amounts exceeding the authorization limit of the
shareholder's account at the time the VISA draft is presented for payment.
The authorization limit is determined daily by taking the shareholder's
Government Money Market Portfolio account balance and subtracting (1) all
shares purchased by other than federal funds wired within 15 days; (2) all
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shares for which certificates have been issued; and (3) any previously
authorized VISA transaction.
PREFERRED CUSTOMER CARD SERVICES Unlike some other investment
programs which offer the VISA card privilege, Premier also includes
travel/accident insurance at no added cost when shareholders purchase
travel tickets with their Premier VISA Gold debit card. Coverage is
provided through VISA and extends up to $250,000.
If a VISA Gold debit card is lost or stolen, the shareholder
should report the loss immediately by contacting Legg Mason directly
between the hours of 8:30 a.m. and 5:00 p.m., or BancOne collect after
hours at 1-614-248-4242. Those shareholders who subscribe to the Premier
VISA account privilege may be liable for the unauthorized use of their
VISA Gold debit card in amounts up to $50.
Legg Mason is responsible for all Premier VISA Gold debit card
inquiries as well as billing and account resolutions. Simply call Legg
Mason Premier Client Services directly between 8:30 a.m. and 5:00 p.m.,
Eastern time, at 1-800-253-0454 or 1-410-528-2066 with your account
inquiries.
AUTOMATIC PURCHASES OF FUND SHARES For shareholders
participating in the Premier program who sell shares held in their
Brokerage Account, any free credit balances of $100 or more resulting from
any such sale will automatically be invested in shares of the Government
Money Market Portfolio on the same business day the proceeds of sale are
credited to the Brokerage Account. Free credit balances of less than $100
will be invested in Portfolio shares weekly.
Free credit balances arising from sales of Brokerage Account
shares for cash (i.e., same day settlement), redemption of debt
securities, dividend and interest payments and cash deposits will be
invested automatically in Portfolio shares on the next business day
following the day the transaction is credited to the Brokerage Account.
Portfolio shares will receive the next dividend declared
following purchase (normally 12:00 noon, Eastern time, on the following
business day). A purchase order will not become effective until cash in
the form of federal funds is received by the Portfolio.
HOW TO OPEN A PREMIER ACCOUNT To subscribe to Premier services,
clients must contact Legg Mason to execute both a Premier Agreement with
Legg Mason and a VISA Account Application and Agreement with BancOne.
Legg Mason charges a fee for the Premier service, which is currently $85
per year for individuals and $100 per year for businesses and
corporations. Legg Mason reserves the right to alter or waive the
conditions upon which a Premier Account may be opened. Both Legg Mason
and BancOne reserve the right to terminate or modify any shareholder's
Premier services for any reason.
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You may request Premier Account status by filling out the Premier
Asset Management Account Agreement and Check Application which can be
obtained from your investment executive. You will receive your VISA Gold
debit card (if applicable) from BancOne. The Premier VISA Gold debit card
may be used at over 8 million locations, including 23,000 ATMs, in 24
countries around the world. Premier checks will be sent to you directly.
There is no limit to the number of checks you may write against your
Premier account.
Shareholders should be aware that the various features of the
Premier program are intended to provide easy access to assets in their
accounts and that the Premier Account is not a bank account. Additional
information about the Premier program is available by calling your Legg
Mason or affiliated investment executive or Legg Mason's Premier Client
Services.
REDEMPTION TO PAY FOR SECURITIES PURCHASED AT LEGG MASON Legg
Mason has established a special redemption procedure for Government Money
Market Portfolio shareholders who wish to purchase stocks, bonds or other
securities at Legg Mason. When shareholders place orders to buy
securities through their Legg Mason or affiliated investment executive,
the purchases will be paid for by the redemption of Government Money
Market Portfolio shares on the settlement date. Shareholders may indicate
that they wish to make payment in another manner. However, in the absence
of such an indication or if such payment is not received, Portfolio shares
will be redeemed on settlement date for the amount due. Automatic
redemption of Portfolio shares may also be made to offset other debit
balances in the shareholder's Brokerage Account. Shareholders should
contact their Legg Mason or affiliated investment executive for details.
OTHER INFORMATION REGARDING REDEMPTION The Government Money
Market Portfolio reserves the right to modify or terminate the check,
wire, telephone or VISA Gold card redemption services described in the
Prospectus and this Statement of Additional Information at any time.
You may request the Government Money Market Portfolio's
checkwriting service by sending a written request to Legg Mason. State
Street will supply you with checks which can be drawn on an account of the
Government Money Market Portfolio maintained with State Street. When
honoring a check presented for payment, the Government Money Market
Portfolio will cause State Street to redeem exactly enough full and
fractional shares from your account to cover the amount of the check.
Cancelled checks will be returned to you.
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Check redemption is subject to State Street's rules and
regulations governing checking accounts. Checks should not be used to
close a Government Money Market Portfolio account because when the check
is written you will not know the exact total value of the account,
including accrued dividends, on the day the check clears. Persons
obtaining certificates for their shares may not use the checkwriting
service.
For Both Portfolios:
-------------------
Each Portfolio reserves the right to modify or terminate the wire
or telephone redemption services described in their Prospectus at any
time.
The date of payment for a redemption may not be postponed for
more than seven days, and the right of redemption may be suspended except
(1) for any period during which the Exchange is closed (other than for
customary weekend or holiday closings), (2) when trading in markets a
Portfolio normally utilizes is restricted, or an emergency, as defined by
rules and regulations of the SEC, exists, making disposal of a Portfolio's
investments or determination of its net asset value not reasonably
practicable, or (3) for such other periods as the SEC by regulation or
order may permit for protection of a Portfolio's shareholders. In the
case of any such suspension, you may either withdraw your request for
redemption or receive payment based upon the net asset value next
determined after the suspension is lifted.
Each Portfolio reserves the right, under certain conditions, to
honor any request for redemption or combination of requests from the same
shareholder in any 90-day period, totalling $250,000 or 1% of the net
assets of the Portfolio, whichever is less, by making payment in whole or
in part by securities valued in the same way as they would be valued for
purposes of computing each Portfolio's net asset value per share. If
payment is made in securities, a shareholder should expect to incur
brokerage expenses in converting those securities into cash and will be
subject to fluctuation in the market price of those securities until they
are sold. The Portfolios do not redeem "in kind" under normal
circumstances, but would do so where the Adviser determines that it would
be in the best interests of the shareholders as a whole.
Although a Portfolio may elect to redeem any shareholder account
with a current value of less than $500, a Portfolio will not redeem
accounts that fall below $500 solely as a result of a reduction in net
asset value per share.
PERFORMANCE INFORMATION
-----------------------
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For the Investment Grade Portfolio:
-----------------------------------
TOTAL RETURN CALCULATIONS Average annual total return
quotes used in the Portfolio's advertising and other promotional materials
("Performance Advertisements") are calculated according to the following
formula:
n
P(1+T) = ERV
where P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a
hypothetical $1,000 payment made at the
beginning of that period.
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the
last day of the most recent quarter prior to submission of the Performance
Advertisements for publication. Total return, or "T" in the formula
above, is computed by finding the average annual change in the value of an
initial $1,000 investment over the period. In calculating the redeeming
value all dividends and other distributions by the Portfolio are assumed
to have been reinvested at net asset value on the reinvestment dates
during the period.
YIELD Yields used in the Portfolio's Performance Advertisements
are calculated by dividing the Portfolio's net investment income for a 30-
day period ("Period"), by the average number of shares entitled to receive
dividends during the Period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the maximum offering
price per share at the end of the Period. Yield quotations are calculated
according to the following formula:
6
Yield = 2 [ (a-b +1) - 1 ]
------
cd
where: a = 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.
Except as noted below, in determining net investment income
earned during the Period (variable "a" in the above formula), the
Portfolio calculates interest earned on each debt obligation held by it
during the Period by (1) computing the obligation's yield to maturity
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based on the market value of the obligation (including actual accrued
interest) on the last business day of the Period or, if the obligation was
purchased during the Period, the purchase price plus accrued interest and
(2) dividing the yield to maturity by 360, and multiplying the resulting
quotient by the market value of the obligation (including actual accrued
interest). Once interest earned is calculated in this fashion for each
debt obligation held by the Portfolio, interest earned during the Period
is then determined by totalling the interest earned on all debt
obligations. For the purposes of these calculations, the maturity of an
obligation with one or more call provisions is assumed to be the next on
which the obligation reasonably can be expected to be called or, if none,
the maturity date.
With respect to the treatment of discount and premium on
mortgage-backed and other asset-backed obligations that are expected to be
subject to monthly payments of principal and interest ("paydowns"): (1)
the Portfolio accounts for gain or loss attributable to actual paydowns as
an increase or decrease to interest income during the period and (2) the
Portfolio accrues the discount and amortizes the premium on the remaining
obligation, based on the cost of the obligation, to the weighted average
maturity date or, if average weighted average maturity information is not
available, to the remaining term of the obligation. The yield of the
Investment Grade Portfolio for the 30-day period ended December 31, 1994
was 8.50%. The yield would have been lower if the Manager had not
reimbursed the Portfolio for a portion of its expenses.
For the Government Money Market Portfolio:
-----------------------------------------
YIELD The current annualized yield for the Government Money
Market Portfolio is based upon a seven-day period and is computed by
determining the net change in the value of a hypothetical account in the
Portfolio. The net change in the value of the account includes the value
of dividends and of additional shares purchased with dividends, but does
not include gains and losses or unrealized appreciation and depreciation.
In addition, the Portfolio may use a compound effective annualized yield
quotation which is calculated as prescribed by SEC regulations, by adding
one to the base period return (calculated as described above), raising the
sum to a power equal to 365 divided by 7, and subtracting one.
The Government Money Market Portfolio's yield may fluctuate daily
depending upon such factors as the average maturity of its securities,
changes in investments, changes in interest rates and variations in
operating expenses. Therefore, current yield does not provide a basis for
determining future yields. The fact that the Portfolio's current yield
will fluctuate and that shareholders' principal is not guaranteed or
insured should be considered in comparing the Portfolio's yield with
yields on fixed-income investments, such as insured savings certificates.
In comparing the yield of the Portfolio to other investment vehicles,
consideration should be given to the investment policies of each,
including the types of investments owned, lengths of maturities of the
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portfolio, the method used to compute the yield and whether there are any
special charges that may reduce the yield.
OTHER INFORMATION In Performance Advertisements each Portfolio
may compare its total return (or taxable yield with respect to the
Government Money Market Portfolio) with data published by Lipper
Analytical Services, Inc. ("Lipper") for U. S. government funds, corporate
bond (BBB) funds (Investment Grade Portfolio) and for money funds
(Government Money Market Portfolio), CDA Investment Technologies, Inc.
("CDA"), Wiesenberger Investment Companies Service ("Wiesenberger"), or
Morningstar Mutual Funds ("Morningstar"), or with the performance of U.S.
Treasury securities of various maturities, recognized stock, bond and
other indexes, including (but not limited to) the Salomon Brothers Bond
Index, Shearson Lehman Bond Index, Shearson Lehman Government/Corporate
Bond Index, the Standard & Poor's 500 Composite Stock Price Index ("S & P
500"), the Dow Jones Industrial Average, and changes in the Consumer Price
Index as published by the U.S. Department of Commerce. Each Portfolio
also may refer in such materials to mutual fund performance rankings and
other data, such as comparative asset, expense and fee levels, published
by Lipper, CDA, Wiesenberger or Morningstar. Performance Advertisements
also may refer to discussions of a Portfolio and comparative mutual fund
data and ratings reported in independent periodicals, including (but not
limited to) THE WALL STREET JOURNAL, MONEY Magazine, FORBES, BUSINESS
WEEK, FINANCIAL WORLD, BARRONS, FORTUNE and THE NEW YORK TIMES.
The Portfolios invest primarily in the fixed-income securities
described in their Prospectuses, and do not invest in the equity
securities that make up the S&P 500 or the Dow Jones indices. Comparison
with such indices is intended to show how an investment in a Portfolio
behaved as compared to indices that are often taken as a measure of
performance of the equity market as a whole. The indices, like the
Portfolios' total returns, assume reinvestment of all dividends and other
distributions. They do not take account of the costs or the tax
consequences of investing.
Each Portfolio may include discussions or illustrations of the
effects of compounding in performance advertisements. "Compounding" refers
to the fact that, if dividends or other distributions on a Portfolio
investment are reinvested by being paid in additional Portfolio shares,
any future income or capital appreciation of the Portfolio would increase
the value, not only of the original Portfolio investment, but also of the
additional Portfolio shares received through reinvestment. As a result,
the value of the Portfolio investment would increase more quickly than if
dividends or other distributions had been paid in cash.
Each Portfolio may also compare its performance with the
performance of bank certificates of deposit (CDs) as measured by the CDA
Investment Technologies, Inc. Certificate of Deposit Index and the Bank
Rate Monitor National Index. In comparing the Portfolio's performance to
CD performance, investors should keep in mind that bank CDs are insured in
whole or in part by an agency of the U.S. Government and offer fixed
principal and fixed or variable rates of interest, and that bank CD yields
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may vary. Portfolio shares are not insured or guaranteed by the U.S.
Government and returns and net asset value will fluctuate. The securities
held by a Portfolio generally have longer maturities than most CDs and may
reflect interest rate fluctuations for longer-term securities.
Portfolio advertisements may reference the history of the
distributor and its affiliates, and the education and experience of the
portfolio manager. Advertisements may also describe techniques the
Adviser employs in selecting among the sectors of the fixed-income market
and may focus on the technique of "value investing." With value
investing, the Adviser invests in those securities it believes to be
undervalued in relation to the long-term earning power or asset value of
their issuers. Securities may be undervalued because of many factors,
including market decline, poor economic conditions, tax-loss selling, or
actual or anticipated unfavorable developments affecting the issuer of the
security.
In advertising, the Portfolios may illustrate hypothetical
investment plans designed to help investors meet long-term financial
goals, such as saving for a child's college education or for retirement.
Sources such as the Internal Revenue Service, the Social Security
Administration, the Consumer Price Index and Chase Global Data and
Research may supply data concerning interest rates, college tuitions, the
rate of inflation, Social Security benefits, mortality statistics and
other relevant information. The Portfolios may use other recognized,
reliable sources as they become available.
The Portfolios may use data prepared by Ibbotson Associates of
Chicago, Illinois ("Ibbotson") to compare the returns of various capital
markets and to show the value of a hypothetical investment in a capital
market. Ibbotson relies on different indices to calculate the performance
of common stocks, corporate and government bonds and Treasury bills.
The Portfolios may illustrate and compare the historical
volatility of different portfolio compositions where the performance of
stocks is represented by the performance of an appropriate market index,
such as the S&P 500 and the performance of bonds is represented by a
nationally recognized bond index, such as the Lehman Brothers Long-Term
Government Bond Index.
The Portfolios may also include in advertising biographical
information on key investment and managerial personnel.
The Portfolios may advertise examples of the potential benefits
of periodic investment plans, such as dollar cost averaging, a long-term
investment technique designed to lower average cost per share. Under such
a plan, an investor invests in a mutual fund at regular intervals a fixed
dollar amount thereby purchasing more shares when prices are low and fewer
shares when prices are high. Although such a plan does not guarantee
profit or guard against loss in declining markets, the average cost per
share could be lower than if a fixed number of shares were purchased at
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<PAGE>
the same intervals. Investors should consider their ability to purchase
shares through low price levels.
The Portfolios may discuss Legg Mason's tradition of service.
Since 1899, Legg Mason and its affiliated companies have helped investors
meet their specific investment goals and have provided a full spectrum of
financial services. Legg Mason affiliates serve as investment advisors
for private accounts and mutual funds with assets of more than $17 billion
as of December 31, 1994.
In advertising, the Portfolios may discuss the advantages of
saving through tax-deferred retirement plans or accounts, including the
advantages and disadvantages of "rolling over" a distribution from a
retirement plan into an IRA, factors to consider in determining whether
you qualify for such a rollover, and the other options available. These
discussions may include graphs or other illustrations that compare the
growth of a hypothetical tax-deferred investment to the after-tax growth
of a taxable investment.
The following table shows the value, as of the end of each fiscal
year, of hypothetical investments of $10,000 made in the Investment Grade
Portfolio at the commencement of operations on August 7, 1987. The table
assumes that all dividends and other distributions are reinvested in the
Portfolio. It includes the effect of all charges and fees the Portfolio
has paid. (There are no fees for investing or reinvesting in the
Portfolio, and there are no redemption fees.) It does not include the
effect of any income taxes that an investor would have to pay on
distributions.
<TABLE>
<CAPTION>
Investment Grade Portfolio
--------------------------
<S> <C> <C> <C>
Value of Original Shares
Plus Shares Obtained Value of Shares
Through Reinvestment of Acquired Through
Fiscal Capital Gain Reinvestment of Total
Year Distributions Income Dividends Value
1987* $9,940 $320 $10,260
1988 9,908 1,137 11,045
1989 10,319 2,158 12,477
1990 10,046 3,154 13,200
1991 10,835 4,476 15,311
A-28
<PAGE>
1992 10,893 5,456 16,349
1993 11,940 6,244 18,184
1994 10,717 6,590 17,307
</TABLE>
*August 7, 1987 (commencement of operations) to December 31, 1987.
If the investor had not reinvested dividends and other
distributions, the total value of the hypothetical investment as of
December 31, 1994 would have been $9,270, and the investor would have
received a total of $6,415 in distributions. Returns would have been
lower if the Adviser had not waived/reimbursed certain Fund expenses
during the fiscal years 1987 through 1994.
VALUATION OF SHARES
For the Investment Grade Portfolio:
----------------------------------
Net asset value of the shares of the Portfolio is determined
daily as of the close of the Exchange (normally 4:00 p.m., eastern time),
on every day that the Exchange is open, by subtracting the Portfolio's
liabilities from its total assets and dividing the result by the
Portfolio's number of shares outstanding. Pricing will not be done on
days when the Exchange is closed. The Exchange currently observes the
following holidays: New Year's Day, President's Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas.
When market quotations for institutional size positions are readily
available, portfolio securities are valued based upon market quotations.
Where such market quotations are not readily available, securities are
valued based upon appraisals received from a pricing service using a
computerized matrix system or based upon appraisals derived from
information concerning the security or similar securities received from
recognized dealers in those securities. The methods used by the pricing
service and the quality of the valuations so established are reviewed by
the Adviser under the general supervision of the Corporation's Board of
Directors. The amortized cost method of valuation is used with respect to
obligations with 60 days or less remaining to maturity unless the Adviser
determines that this does not represent fair value. All other assets are
valued at fair value as determined in good faith, by or under the
direction of the Corporation's Board of Directors. Premiums received on
the sale of put and call options are included in the Portfolio's net asset
value, and the current market value of options sold by the Portfolio will
be subtracted from its net assets.
For the Government Money Market Portfolio:
-----------------------------------------
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<PAGE>
The Government Money Market Portfolio attempts to stabilize the
value of a share at $1.00. Net asset value will not be calculated on days
when the Exchange is closed.
USE OF THE AMORTIZED COST METHOD The directors have decided that
the best method for determining the value of portfolio instruments is
amortized cost. Under this method, portfolio instruments are valued at
the acquisition cost as adjusted for amortization of premium or
accumulation of discount rather than at current market value. The Board
of Directors continually assesses this method of valuation.
The Portfolio's use of the amortized cost method of valuing portfolio
instruments depends on its compliance with Rule 2a-7 under the 1940 Act.
Under that Rule, the directors must establish procedures reasonably
designed to stabilize the net asset value per share, as computed for
purposes of distribution and redemption, at $1.00 per share, taking into
account current market conditions and the Portfolio's investment
objective.
MONITORING PROCEDURES The Portfolio's procedures include
monitoring the relationship between the amortized cost value per share and
the net asset value per share based upon available indications of market
value. If there is a difference of more than 0.5% between the two, the
directors will take any steps they consider appropriate (such as
shortening the dollar-weighted average portfolio maturity) to minimize any
material dilution or other unfair results arising from differences between
the two methods of determining net asset value.
INVESTMENT RESTRICTIONS Rule 2a-7 requires the Portfolio, if it
wishes to value its assets at amortized cost, to limit its investments to
instruments that, (i)in the opinion of the Adviser, present minimal credit
risk and (ii) (a) are rated in the two highest rating categories by at
least two nationally recognized statistical rating organizations
("NRSROs") (or one, if only one rating services has rated the security)
or, (b) if unrated, determined to be of comparable quality by the Adviser,
all pursuant to procedures determined by the Board of Directors ("Eligible
Securities"). The Portfolio may invest no more than 5% of its total
assets in securities that are Eligible Securities but have not been rated
in the highest short-term ratings category by at least two NRSROs (or by
one NRSRO, if only one NRSRO has assigned the obligation a short-term
rating) or, if the obligations are unrated, determined by the Adviser to
be of comparable quality ("Second Tier Securities"). In addition, the
Portfolio will not invest more than 1% of its total assets or $1 million
(whichever is greater) in the Second Tier Securities of a single issuer.
The Rule requires the Portfolio to maintain a dollar-weighted average
portfolio maturity appropriate to the objective of maintaining a stable
net asset value of $1.00 per share and in any event not more than 90 days.
In addition, under the Rule, no instrument with a remaining maturity (as
defined in the Rule) of more than 397 days, as defined, can be purchased
by the Portfolio; except that the Portfolio may hold securities with
remaining maturities greater than 397 days as collateral for repurchase
agreements and other collateralized transactions of short duration.
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<PAGE>
Should the disposition of a portfolio security result in a
dollar-weighted average portfolio maturity of more than 90 days, the
Portfolio will invest its available cash to reduce the average maturity to
90 days or less as soon as possible.
It is the Portfolio's usual practice to hold portfolio securities
to maturity and realize par, unless the Adviser determines that sale or
other disposition is appropriate in light of the Portfolio's investment
objective. Under the amortized cost method of valuation, neither the
amount of daily income nor the net asset value is affected by any
unrealized appreciation or depreciation of the portfolio.
In periods of declining interest rates, the indicated daily yield
on shares of the Portfolio, computed by dividing the annualized daily
income on the Portfolio's investment portfolio by the net asset value
computed as above, may tend to be higher than a similar computation made
by using a method of valuation based upon market prices and estimates.
In periods of rising interest rates, the indicated daily yield on
shares of the Portfolio computed the same way may tend to be lower than a
similar computation made by using a method of calculation based upon
market prices and estimates.
TAX-DEFERRED RETIREMENT PLANS
As noted in the Prospectus for each Portfolio, an investment in
Portfolio shares may be appropriate for IRAs, Keogh Plans, SEPs and other
qualified retirement plans. In general, income earned through the
investment of assets of those accounts and plans is not taxed to their
beneficiaries until the income is distributed to them. Investors who are
considering establishing such an account or plan should consult their
attorneys or tax advisers with respect to individual tax questions. The
option of investing in these accounts or plans through regular payroll
deductions may be arranged with a Legg Mason or affiliated investment
executive and your employer. Additional information with respect to these
accounts and plans is available upon request from any Legg Mason or
affiliated investment executive.
Individual Retirement Account - IRA
-----------------------------------
Certain investors may obtain tax advantages by establishing IRAs.
Specifically, if neither you nor your spouse is an active participant in a
qualified employer or government retirement plan, or if either you or your
spouse is an active participant and your adjusted gross income does not
exceed a certain level, then you may deduct cash contributions made to an
IRA in an amount for each taxable year not exceeding the lesser of 100% of
your earned income or $2,000. In addition, if your spouse is not employed
and you file a joint return, you may establish a separate IRA for your
spouse and contribute up to a total of $2,250 to the two IRAs, provided
that the contribution to either does not exceed $2,000. If you and your
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<PAGE>
spouse are both employed and neither of you is an active participant in a
qualified employer or government retirement plan and you establish
separate IRAs, you each may contribute all of your earned income, up to
$2,000 each, and thus may together receive tax deductions of up to $4,000
for contributions to your IRAs. If your employer's plan qualifies as a
SEP, permits voluntary contributions and meets certain other requirements,
you may make voluntary contributions to that plan that are treated as
deductible IRA contributions.
Even if you are not in one of the categories described in the
preceding paragraph, you may find it advantageous to invest in shares of a
Portfolio through nondeductible IRA contributions, up to certain limits,
because all dividends and capital gain distributions on your Portfolio
shares are then not immediately taxable to you or the IRA; they become
taxable only when distributed to you. To avoid penalties, your interest
in an IRA must be distributed, or start to be distributed, to you not
later than the end of the taxable year in which you attain age 70 1/2.
Distributions made before age 59 1/2, in addition to being taxable,
generally are subject to a penalty equal to 10% of the distribution,
except in the case of death or disability, where the distribution is
rolled over into another qualified plan or certain other situations.
Self-Employed Individual Retirement Plan - Keogh Plan
-----------------------------------------------------
Legg Mason makes available to self-employed individuals a Plan
and Trustee Agreement for a Keogh Plan through which shares of the
Portfolios may be purchased. You have the right to use a bank of your own
choice to provide these services at your own cost. There are penalties
for distributions from a Keogh Plan prior to age 59 1/2, except in the
case of death or disability.
Simplified Employee Pension Plan - SEP
--------------------------------------
Legg Mason also makes available to corporate and other employers
a S EP Plan for investment in shares of the Portfolios.
Withholding at the rate of 20% is required for federal income tax
purposes on certain distributions (excluding, for example, certain
periodic payments) from the foregoing retirement plans (except IRAs and
SEPs), unless the recipient transfers the distribution directly to an
"eligible retirement plan" (including IRAs and other qualified plans) that
accepts those distributions. Other distributions generally are subject to
regular wage withholding or withholding at the rate of 10% (depending on
the type and amount of the distribution), unless the recipient elects not
to have any withholding apply. Please consult your plan administrator or
tax adviser for further information.
A-32
<PAGE>
THE CORPORATION'S DIRECTORS AND OFFICERS
The Corporation's officers are responsible for the operation of
the Corporation under the direction of the Board of Directors. The
officers and directors of the Corporation and their principal occupations
during the past five years are set forth below. An asterisk (*) indicates
those officers and/or directors who are interested persons of the
Corporation as defined by the 1940 Act. The business address of each
officer and director is 111 South Calvert Street, Baltimore, Maryland
21202, unless otherwise indicated.
JOHN F. CURLEY, JR.*, [55] Chairman of the Board and Director;
Vice Chairman and Director of Legg Mason Wood Walker, Inc. and Legg Mason,
Inc.; Director of Legg Mason Fund Adviser, Inc. and Western Asset
Management Company; Officer and/or Director of various other affiliates of
Legg Mason, Inc.; Chairman of the Board and Director of three Legg Mason
funds; President and Director of three Legg Mason funds; Chairman of the
Board, President and Trustee of one Legg Mason fund and Chairman of the
Board and Trustee of one Legg Mason fund.
EDMUND J. CASHMAN, JR.*, [58] Vice Chairman and Director; Senior
Executive Vice President and Director of Legg Mason, Inc.; Officer and/or
Director of various other affiliates of Legg Mason, Inc.; President and
Director of one Legg Mason fund; President and Trustee of one Legg Mason
fund; Director of Worldwide Value Fund, Inc.
EDWARD A. TABER, III*, [51] President and Director; Executive
Vice President of Legg Mason, Inc. and Legg Mason Wood Walker, Inc.; Vice
Chairman and Director of Legg Mason Fund Adviser, Inc.; Director of three
Legg Mason funds; President and Director of two Legg Mason funds; Trustee
of one Legg Mason fund; Vice President of Worldwide Value Fund, Inc.
Formerly: Executive Vice President of T. Rowe Price-Fleming
International, Inc. (1986-1992) and Director of the Taxable Fixed Income
Division at T. Rowe Price Associates, Inc. (1973-1992).
RICHARD G. GILMORE, [67] Director; 5534 Chanteclaire, Sarasota,
Florida. Independent Consultant. Director of CSS Industries, Inc.
(diversified holding company whose subsidiaries are engaged in manufacture
and sale of decorative paper products, business forms, and specialty metal
packaging); Director of PECO Energy Company (formerly Philadelphia
Electric Company); Director of six Legg Mason funds; and Trustee of one
Legg Mason fund. Formerly: Senior Vice President and Chief Financial
Officer of Philadelphia Electric Company (now PECO Energy Company);
Executive Vice President and Treasurer, Girard Bank, and Vice President of
its parent holding company, the Girard Company and Director of Finance,
City of Philadelphia.
A-33
<PAGE>
CHARLES F. HAUGH, [69] Director; 14201 Laurel Park Drive, Suite
104, Laurel, Maryland. Real Estate Developer and Investor; President and
Director of Resource Enterprises, Inc. (real estate brokerage); Chairman
of Resource Realty LLC (management of retail and office space); Partner in
Greater Laurel Health Park Ltd. Partnership (real estate investment and
development); Director of six Legg Mason funds; and Trustee of two Legg
Mason funds.
ARNOLD L. LEHMAN, [51] Director; The Baltimore Museum of Art,
Art Museum Drive, Baltimore, Maryland. Director of the Baltimore Museum
of Art; Director of six Legg Mason funds; Trustee of two Legg Mason
funds.
JILL E. McGOVERN, [50] Director; 1500 Wilson Boulevard,
Arlington, Virginia. Chief Executive Officer of the Marrow Foundation.
Director of six Legg Mason funds; Trustee of two Legg Mason funds.
Formerly: Executive Director of the Baltimore International Festival
January 1991 - March 1993; formerly: Senior Assistant to the President of
The Johns Hopkins University (1986-1991).
T. A. RODGERS, [60] Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T.A. Rodgers & Associates (management consulting);
Director of six Legg Mason funds; Trustee of one Legg Mason fund.
Formerly: Director and Vice President of Corporate Development, Polk
Audio, Inc. (manufacturer of audio components) .
The executive officers of the Corporation, other than those who
also serve as directors, are:
MARIE K. KARPINSKI*, [46] Vice President and Treasurer; Treasurer
of Legg Mason Fund Adviser, Inc.; Vice President and Treasurer of eight
Legg Mason funds; and Secretary/Treasurer of Worldwide Value Fund, Inc.;
Vice President of Legg Mason.
STEFANIE L. WONG*, [27] Secretary; Secretary of one Legg Mason
fund; Employee of Legg Mason.
BLANCHE P. ROCHE*, [46] Assistant Secretary and Assistant Vice
President; Assistant Secretary and Assistant Vice President of seven Legg
Mason funds; employee of Legg Mason since 1991. Formerly: Manager of
Consumer financial services (1989-1991).
Officers and directors of the Corporation who are interested
persons of the Corporation receive no salary or fees from the Corporation.
Independent directors of the Corporation receive a fee of $400 annually
for serving as a director, and a fee of $400 for each meeting of the Board
A-34
<PAGE>
of Directors attended by him or her. For the fiscal year ended December
31, 1994, the present independent directors as a group received a total of
$7,500 from each Portfolio of the Corporation.
The Nominating Committee of the Board of Directors is responsible
for the selection and nomination of disinterested directors. The
Committee is composed of Messrs. Haugh, Gilmore, Lehman and Dr. McGovern,
each of whom is a disinterested director as that term is defined in the
1940 Act.
At February 28, 1995, the directors and officers of the
Corporation beneficially owned, in the aggregate, less than 1% of the
Corporation's outstanding shares.
A-35
<PAGE>
<TABLE>
<CAPTION>
COMPENSATION TABLE
<S> <C> <C> <C> <C>
Total Compensation From
Aggregate Pension or Retirement Estimated Annual Corporation and Fund
Compensation From Benefits Accrued as Benefits Upon Complex Paid to
Name of Person and Position Corporation Part of Fund Expenses Retirement Directors
John F. Curley, Jr. -
Chairman of the Board and
Director None N/A N/A None
Edward A. Taber, III -
President and Director None N/A N/A None
Edmund J. Cashman, Jr.
Vice Chairman and Director
None N/A N/A None
Marie K. Karpinski -
Vice President and
Treasurer None N/A N/A None
Richard G. Gilmore -
Director $7,500 N/A N/A $21,600
Charles F. Haugh -
Director $7,500 N/A N/A $23,600
Arnold L. Lehman -
Director $7,500 N/A N/A $23,600
Jill E. McGovern -
Director $7,500 N/A N/A $23,600
T. A. Rodgers -
Director $7,500 N/A N/A $21,600
</TABLE>
The information provided above is for the year ended December 31, 1994.
A-36
<PAGE>
A-37
<PAGE>
MANAGEMENT AGREEMENTS
Legg Mason Fund Adviser, Inc. ("Manager"), 111 South Calvert
Street, Baltimore, MD 21202, is a wholly owned subsidiary of Legg Mason,
Inc., which is also the parent of Legg Mason Wood Walker, Incorporated.
The Manager serves as the manager for each Portfolio under separate
Management Agreements dated June 19, 1987 for the Investment Grade
Portfolio and November 1, 1988 for the Government Money Market Portfolio
("Management Agreements"), which were approved by the Corporation's Board
of Directors, including a majority of the directors who are not
"interested persons" (as defined in the 1940 Act) of the Corporation, the
Manager or the Adviser, on May 8, 1987, and was approved by the
shareholders of the Investment Grade Portfolio on April 22, 1988.
Continuation of the Management Agreements was most recently approved by
the Board of Directors on October 21, 1994. Each Management Agreement
provides that, subject to overall direction by the Board of Directors, the
Manager will manage the investment and other affairs of the Portfolio.
Under each Management Agreement, the Manager is responsible for managing
the Portfolio's securities and for making purchases and sales of
securities consistent with the investment objectives and policies
described in the Portfolio's Prospectus and this Statement of Additional
Information. The Manager is obligated to furnish each Portfolio with
office space and certain administrative services as well as executive and
other personnel necessary for the operation of the Portfolio. The Manager
and its affiliates also are responsible for the compensation of directors
and officers of the Corporation who are employees of the Manager and/or
its affiliates. The Manager has delegated the portfolio management
functions for each Portfolio to the Adviser, Western Asset Management
Company.
As explained in each Portfolio's Prospectus, the Manager receives
for its services to the Investment Grade Portfolio, a management fee,
calculated daily and payable monthly, at an annual rate equal to 0.60% of
the Investment Grade Portfolio's average daily net assets and for its
services to the Government Money Market Portfolio, a management fee,
calculated daily and payable monthly, at an annual rate equal to 0.50% of
the Government Money Market Portfolio's average daily net assets. The
management fee paid by a Portfolio may be reduced under regulations in
various states where shares of the Portfolio are qualified for sale that
impose limitations on the annual expense ratio of the Portfolio. The most
restrictive annual expense limitation currently requires that the Manager
reimburse a Portfolio for certain expenses, including the management fees
received by it (but, in the Manager's opinion, excluding interest, taxes,
brokerage fees and commissions, distribution fees and certain
extraordinary charges), in any fiscal year in which the Portfolio's
expenses exceed 2.5% of the first $30 million, 2.0% of the next $70
million, and 0.5% of the balance over $100 million in net assets. No
reimbursements have been made nor have any been required to be made
pursuant to this undertaking. In addition, the Manager has agreed to
waive its fees and reimburse each Portfolio if and to the extent its
expenses (exclusive of taxes, interest, brokerage and extraordinary
expenses) exceed during any month annual rates of each Portfolio's average
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<PAGE>
daily net assets for such month, or certain asset levels, whichever occurs
first, in accordance with the following schedule:
For the Investment Grade Portfolio:
Rate Expiration Date Asset Level
0.85% April 30, 1995 $100 million
0.85% October 31, 1994 $100 million
0.85% August 31, 1993 $ 75 million
0.85% October 31, 1992 $ 75 million
For the years ended December 31, 1994 and 1993, the Manager waived
management fees of $370,000 and $361,000, respectively, and for the year
ended December 31, 1992, the Manager waived all management fees for the
Investment Grade Portfolio. During the fiscal years ended December 31,
1994, 1993 and 1992, the Government Money Market Portfolio paid fees of
$1,006,789, $898,826, and $886,904, respectively, to the Manager, net of
waivers and reimbursements.
Under each Management Agreement, the Manager will not be liable for
any error of judgment or mistake of law or for any loss suffered by a
Portfolio in connection with the performance of the Management Agreements,
except a loss resulting from a breach of fiduciary duty with respect to
the receipt of compensation for services or losses resulting from willful
misfeasance, bad faith or gross negligence in the performance of its
duties or from reckless disregard of its obligations or duties thereunder.
Each Management Agreement terminates automatically upon assignment and
is terminable at any time without penalty by vote of the Corporation's
Board of Directors, by vote of a majority of the outstanding voting
securities of the applicable Portfolio or by the Manager, on not less than
60 days' written notice to the other party, and may be terminated
immediately upon the mutual written consent of the Manager and the
Portfolio.
Each Portfolio pays all of its expenses which are not expressly
assumed by the Manager. These expenses include, among others, interest
expense, taxes, brokerage fees and commissions, expenses of preparing and
printing prospectuses, statements of additional information, proxy
statements and reports and of distributing them to existing shareholders,
custodian charges, transfer agency fees, organizational expenses,
distribution fees to the Portfolio's distributor, compensation of the
independent directors, legal, accounting and audit expenses, insurance
expenses, expenses of registering and qualifying shares of the Portfolios
for sale under federal and state law, governmental fees and expenses
incurred in connection with membership in investment company
organizations. Each Portfolio also is liable for such nonrecurring
expenses as may arise, including litigation to which the Portfolio may be
a party. Each Portfolio may also have an obligation to indemnify the
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<PAGE>
directors and officers of the Corporation with respect to any such
litigation.
Under each Management Agreement, the Portfolio has the non-exclusive
right to use the name "Legg Mason" until that Agreement is terminated, or
until the right is withdrawn in writing by the Manager.
INVESTMENT ADVISORY AGREEMENTS
The Adviser, Western Asset Management Company, 117 East Colorado
Boulevard, Pasadena, CA 91105, an affiliate of Legg Mason, serves as
investment adviser to each Portfolio under a separate Investment Advisory
Agreement with respect to the Investment Grade Portfolio, dated June 19,
1987, and November 1, 1988 with respect to the Government Money Market
Portfolio, between the Adviser and the Manager ("Advisory Agreements").
Each Advisory Agreement was approved by the Board of Directors, including
a majority of the directors who are not "interested persons" of the
Corporation, the Adviser or the Manager, on May 8, 1987, and was approved
by the shareholders of the Investment Grade Portfolio on April 22, 1988.
Continuation of the Agreements was most recently approved by the Board of
Directors on October 21, 1994.
Under each Advisory Agreement, the Adviser is responsible, subject to
the general supervision of the Manager and the Corporation's Board of
Directors, for the actual management of the Portfolio's assets, including
the responsibility for making decisions and placing orders to buy, sell or
hold a particular security. For the Adviser's services to the Investment
Grade Portfolio, the Manager (not the Portfolio) pays the Adviser a fee,
computed daily and payable monthly, at an annual rate equal to 40% of the
fee received by the Manager. During the years ended December 31, 1994,
1993, and 1992, the Manager paid $14,593, $560, and $0, respectively, to
the Adviser on behalf of the Investment Grade Portfolio. For the
Adviser's services to the Government Money Market Portfolio, the Manager
(not the Portfolio) pays the Adviser a fee, computed daily and payable
monthly, at an annual rate equal to 30% of the fee received by the
Manager. During the years ended December 31, 1994, 1993 and 1992, the
Manager paid the Adviser fees of $302,037, $269,648, and $266,071,
respectively, on behalf of the Government Money Market Portfolio.
Under each Advisory Agreement, the Adviser will not be liable for any
error of judgment or mistake of law or for any loss suffered by the
Manager or by the Portfolio in connection with the performance of the
Advisory Agreement, except a loss resulting from a breach of fiduciary
duty with respect to the receipt of compensation for services or a loss
resulting from willful misfeasance, bad faith or gross negligence on its
part in the performance of its duties or from reckless disregard by it of
its obligations or duties thereunder.
Each Advisory Agreement terminates automatically upon assignment and
is terminable at any time without penalty by vote of the Corporation's
Board of Directors, by vote of a majority of the applicable Portfolio's
outstanding voting securities, by the Manager or by the Adviser, on not
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<PAGE>
less than 60 days' notice to the Portfolio and/or the other party(ies).
Each Advisory Agreement terminates immediately upon any termination of the
Management Agreement or upon the mutual written consent of the Adviser,
the Manager and the applicable Portfolio.
To mitigate the possibility that the Fund will be affected by personal
trading of employees, the Corporation, the Manager and the Adviser have
adopted policies that restrict securities trading in the personal accounts
of portfolio managers and others who normally come into advance possession
of information on portfolio transactions. These policies comply, in all
material respects, with the recommendations of the Investment Company
Institute.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The portfolio turnover rate is computed by dividing the lesser of
purchases or sales of securities for the period by the average value of
portfolio securities for that period. Short-term securities are excluded
from the calculation. For the years ended December 31, 1994 and 1993, the
Investment Grade Portfolio's portfolio turnover rates were 200.1% and
348.2%, respectively.
Under each Advisory Agreement, the Adviser is responsible for the
execution of portfolio transactions. Corporate and government debt
securities are generally traded on the over-the-counter market on a "net"
basis without a stated commission, through dealers acting for their own
account and not as brokers. Prices paid to a dealer in debt securities
will generally include a "spread", which is the difference between the
price at which the dealer is willing to purchase and sell the specific
security at the time, and includes the dealer's normal profit. Some
portfolio transactions may be executed through brokers acting as agent.
In selecting brokers or dealers, the Adviser must seek the most favorable
price (including the applicable dealer spread) and execution for such
transactions, subject to the possible payment as described below of higher
brokerage commissions for agency transactions or spreads to broker-dealers
who provide research and analysis. The Portfolios may not always pay the
lowest commission or spread available. Rather, in placing orders on
behalf of a Portfolio, the Adviser also takes into account such factors as
size of the order, difficulty of execution, efficiency of the executing
broker's facilities (including the services described below) and any risk
assumed by the executing broker.
Consistent with the policy of most favorable price and execution, the
Adviser may give consideration to research, statistical and other services
furnished by brokers or dealers to the Adviser for its use, may place
orders with broker-dealers who provide supplemental investment and market
research and securities and economic analysis, and may, for agency
transactions, pay to these broker-dealers a higher brokerage commission
than may be charged by other broker-dealers. Such research and analysis
may be useful to the Adviser in connection with services to clients other
than the Portfolios. The Adviser's fee is not reduced by reason of its
receiving such brokerage and research services. For the years ended
A-41
<PAGE>
December 31, 1994, 1993, and 1992, the Investment Grade Portfolio paid
commissions of $112,930, $152,260 and $47,750, respectively, to broker-
dealers who acted as agents in executing options and futures trades. The
Government Money Market Portfolio paid no brokerage commissions, nor did
it allocate any transactions to dealers for research, analysis, advice or
similar services during any of its last three fiscal years.
From time to time, the Investment Grade Portfolio may use Legg Mason
as its broker for agency transactions in listed securities at commission
rates and under circumstances consistent with the policy of best
execution. Commissions paid to Legg Mason will not exceed "usual and
customary" brokerage commissions. Rule 17e-1 under the 1940 Act defines
"usual and customary" commissions to include amounts which are "reasonable
and fair compared to the commission, fee or other remuneration received or
to be received by other brokers in connection with comparable transactions
involving similar securities being purchased or sold on a securities
exchange during a comparable period of time." In the over-the-counter
market, the Investment Grade Portfolio generally will deal with
responsible primary market makers unless a more favorable execution can
otherwise be obtained.
The Portfolios may not buy securities from, or sell securities to,
Legg Mason or its affiliated persons as principal. However, the
Corporation's Board of Directors has adopted procedures in conformity with
Rule 10f-3 under the 1940 Act whereby each Portfolio may purchase
securities that are offered in underwritings in which Legg Mason or any of
its affiliated persons is a participant.
Investment decisions for each Portfolio are made independently from
those of other funds and accounts advised by the Adviser. However, the
same security may be held in the portfolios of more than one fund or
account. When two or more accounts simultaneously engage in the purchase
or sale of the same security, the prices and amounts will be equitably
allocated to each account. In some cases, this procedure may adversely
affect the price or quantity of the security available to a particular
account. In other cases, however, an account's ability to participate in
large-volume transactions may produce better executions and prices.
THE PORTFOLIOS' DISTRIBUTOR
Legg Mason acts as distributor of the Portfolios' shares pursuant to
an Underwriting Agreement with the Corporation. The Underwriting
Agreement obligates Legg Mason to pay certain expenses in connection with
the offering of the Portfolios' shares, including compensation to its
investment executives. Legg Mason also pays for the printing and
distribution of prospectuses and periodic reports used in connection with
the offering to prospective investors, after the prospectuses and reports
have been prepared, set in type and mailed to shareholders at the
Portfolios' expense, and for supplementary sales literature and
advertising costs.
A-42
<PAGE>
For the year ended December 31, 1994, Legg Mason incurred the
following expenses:
A-43
<PAGE>
Investment Grade
Portfolio
---------
Compensation to sales personnel $241,000
Printing and mailing of prospectuses
to prospective shareholders 32,000
Advertising 61,000
Other 225,000
-------
Total expenses $559,000
========
The Corporation has adopted a Distribution and Shareholder Services
Plan ("Plan") which, among other things, permits it to pay Legg Mason a
distribution fee out of the net assets of each Portfolio. The Plan was
adopted, as required by Rule 12b-1 under the 1940 Act, by a vote of the
Board of Directors on May 8, 1987 (for the Investment Grade Portfolio),
and October 27, 1988 (for the Government Money Market Portfolio),
including a majority of the directors who are not "interested persons" of
the Corporation as that term is defined in the 1940 Act and who have no
direct or indirect financial interest in the operation of the Plan or the
Underwriting Agreement ("12b-1 directors"). Continuation of the Plan was
most recently approved by the Board of Directors on October 21, 1994,
including a majority of the 12b-1 directors. In approving the continuance
of the Plan, in accordance with the requirements of Rule 12b-1, the
directors considered various factors, including the amount of the
distribution fee. The directors determined that there is a reasonable
likelihood that the Plan will continue to benefit the Portfolios and their
present and future shareholders. The Plan was also approved by the vote
of a majority of the Investment Grade Portfolio's outstanding shares on
April 22, 1988.
The Plan continues in effect only so long as it is approved at least
annually by the vote of a majority of the Board of Directors, including a
majority of the 12b-1 directors, cast in person at a meeting called for
the purpose of voting on the Plan. The Plan may be terminated with
respect to either Portfolio by vote of a majority of the 12b-1 directors,
or by vote of a majority of the outstanding voting securities of such
Portfolio. Any change in the Plan that would materially increase the
distribution cost to the Portfolios requires shareholder approval.
Otherwise, the Plan may be amended by the directors, including a majority
of the 12b-1 directors, as previously described.
Rule 12b-1 requires that any person authorized to direct the
disposition of monies paid or payable by the Portfolios, pursuant to the
Plan or any related agreement, shall provide to the Corporation's Board of
Directors, and the directors shall review, at least quarterly, a written
report of the amounts so expended and the purposes for which the
expenditures were made. Rule 12b-1 also provides that the Portfolios may
rely on that Rule only if, while the Plan is in effect, the nomination and
A-44
<PAGE>
selection of the Corporation's independent directors is committed to the
discretion of such independent directors.
As compensation for its services and expenses, Legg Mason receives
from the Corporation with respect to the Investment Grade Portfolio,
annual distribution and service fees each equivalent to 0.25% of that
Portfolio's average daily net assets in accordance with the Plan. The
distribution and service fees are computed daily and paid monthly. For
the years ended December 31, 1994, 1993 and 1992, the Investment Grade
Portfolio paid distribution and service fees of $339,151, $302,213, and
$198,544, respectively, to Legg Mason, pursuant to the Underwriting
Agreement. Pursuant to the Plan, the Government Money Market Portfolio is
authorized to pay Legg Mason distribution and service fees for its
distribution and shareholder services not to exceed an annual rate of
0.20% of the Portfolio's average daily net assets. Legg Mason has no
present intention of requesting such a fee, but may do so in the future.
THE PORTFOLIOS' CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1713, Boston,
Massachusetts 02105 serves as custodian of the Portfolios' assets. Boston
Financial Data Services, Inc., P.O. Box 8000, Boston, Massachusetts 02266-
8000, serves as transfer and dividend-disbursing agent, and administrator
of various shareholder services. BFDS has contracted with Legg Mason for
the latter to assist it with certain of its duties as transfer agent, for
which BFDS compensates Legg Mason. For the year ended December 31, 1994,
Legg Mason received $19,980 and $62,115 with respect to the Investment
Grade Portfolio and the Government Money Market Portfolio, respectively,
for such services. Shareholders who request an historical transcript of
their account will be charged a fee based upon the number of years
researched. The Portfolios reserve the right, upon 60 days' written
notice, to make other charges to investors to cover administrative costs.
THE CORPORATION'S LEGAL COUNSEL
Kirkpatrick & Lockhart, 1800 M Street, N.W., Washington, D.C. 20036,
serves as counsel to the Corporation.
THE CORPORATION'S INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 217 East Redwood Street, Baltimore, MD
21202, has been selected by the Directors to serve as the Corporation's
independent accountants.
FINANCIAL STATEMENTS
The Statement of Net Assets as of December 31, 1994 (for the
Government Money Market Portfolio); the Portfolio of Investments as of
December 31, 1994 (for the Investment Grade Portfolio); for each
Portfolio, the Statement of Operations for the year ended December 31,
A-45
<PAGE>
1994; the Statement of Changes in Net Assets for the years ended December
31, 1994 and 1993; the Financial Highlights for the periods presented; the
Notes to Financial Statements and the Report of the Independent
Accountants, all of which are included in each respective Portfolio's
Annual Report to Shareholders for the year ended December 31, 1994, are
hereby incorporated by reference in this Statement of Additional
Information for the Investment Grade Portfolio and the Government Money
Market Portfolio.
A-46
<PAGE>
APPENDIX A
For the Investment Grade Portfolio:
----------------------------------
RATINGS OF SECURITIES
DESCRIPTION OF MOODY'S INVESTORS SERVICE, INC. ("MOODY'S") CORPORATE BOND
RATINGS:
Aaa-Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally
referred to as "gilt edge". Interest payments are protected by a large or
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position
of such issues.
Aa-Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high-grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities or
fluctuation of protective elements may be of greater amplitude or there
may be other elements present which make the long-term risks appear
somewhat larger than the Aaa securities.
A-Bonds which are rated A possess many favorable investment attributes
and are to be considered 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 some time in
the future.
Baa-Bonds which are rated Baa are considered medium-grade obligations,
(i.e., they are neither highly protected nor poorly secured). Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba-Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B- Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or
maintenance of other terms of the contract over any long period of time
may be small.
A-1
<PAGE>
DESCRIPTION OF STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATINGS:
AAA-This is the highest rating assigned by Standard & Poor's to an
obligation. Capacity to pay interest and repay principal is extremely
strong.
AA-Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small
degree.
A-Bonds rated A have a strong capacity to pay interest and repay
principal , although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions then debt in
higher categories.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal
for bonds in this category than for bonds in higher rated categories.
BB, B, CCC, CC-Bonds rated BB, B, CCC and CC are regarded, on balance,
as predominately speculative with respect to the issuer's 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 bonds will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS:
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 that
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.
A-2
<PAGE>
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.
A-3
<PAGE>
LEGG MASON INCOME TRUST, INC.
LEGG MASON HIGH YIELD PORTFOLIO
STATEMENT OF ADDITIONAL INFORMATION
Legg Mason High Yield Portfolio ("Fund"), a diversified,
professionally managed portfolio, is a separate series of Legg Mason
Income Trust, Inc. ("Corporation"), an open-end investment company. The
Fund seeks to provide investors with a high level of current income. As a
secondary objective, the Fund seeks capital appreciation. The Fund
normally will seek to achieve its investment objectives by investing not
less than 65% of its total assets in high-yield, fixed-income securities
(including those commonly known as "junk bonds"); that is, income-
producing debt securities and preferred stocks of all types, including
(but not limited to) corporate debt securities and preferred stock,
convertible securities, zero coupon securities, deferred interest
securities, mortgage-backed securities and asset-backed securities. In
addition to other risks, these bonds are subject to greater fluctuations
in value and risk of loss of income and principal due to default by the
issuer than are lower-yielding, higher-rated bonds; therefore, these
investments may not be suitable for all investors.
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectus for the Fund, dated May
1, 1995, which has been filed with the Securities and Exchange Commission
("SEC"). Copies of the Fund's Prospectus are available without charge
from the Corporation's distributor, Legg Mason Wood Walker, Incorporated
("Legg Mason") (address and telephone numbers listed below).
Dated: May 1, 1995
Legg Mason Wood Walker, Incorporated
----------------------------------------------------------------
111 South Calvert Street
Baltimore, Maryland 21202
(410) 539-0000
Outside Maryland (800) 822-5544
<PAGE>
Table of Contents
PAGE
----
Additional Information About Investment Limitations and Policies
Additional Purchase and Redemption Information
Additional Tax Information
Tax-Deferred Retirement Plans
Performance Information
Valuation of Fund Shares
The Corporation's Directors and Officers
The Fund's Manager
Investment Advisory Agreement
The Fund's Distributor
Portfolio Transactions and Brokerage
The Fund's Custodian and Transfer and
Dividend-Disbursing Agent
The Corporation's Legal Counsel
The Corporation's Independent Accountants
Financial Statements
No person has been authorized to give any information or to make
any representations not contained in the Prospectus or this Statement of
Additional Information in connection with the offerings made by the
Prospectus and, if given or made, such information or representations must
not be relied upon as having been authorized by the Fund or its
distributor. The Prospectus and this Statement of Additional Information
do not constitute an offering by the Fund or by the distributor in any
jurisdiction in which such offering may not lawfully be made.
<PAGE>
ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND POLICIES
In addition to the investment objectives described in the
Prospectus, the Fund has adopted the following fundamental investment
limitations that cannot be changed except by vote of the holders of a
majority of the outstanding voting securities of the Fund. The Fund may
not:
1. Borrow money, except from banks or through reverse
repurchase agreements or dollar rolls for temporary purposes in an
aggregate amount not to exceed 5% of the value of its total assets at the
time of borrowing. (Although not a fundamental policy subject to
shareholder approval, the Fund will repay any money borrowed before any
portfolio securities are purchased);
2. Issue senior securities, except as permitted under the
Investment Company Act of 1940, as amended ("1940 Act");
3. Engage in the business of underwriting the securities of
other issuers except insofar as the Fund may be deemed an underwriter
under the Securities Act of 1933, as amended ("1933 Act"), in disposing of
a portfolio security;
4. Buy or hold any real estate; provided, however, that
instruments secured by real estate or interests therein are not subject to
this limitation;
5. With respect to 75% of its total assets, invest more than
5% of its total assets (taken at market value) in securities of any one
issuer, other than the U.S. Government, its agencies and
instrumentalities, or purchase more than 10% of the voting securities of
any one issuer;
6. Purchase or sell any commodities or commodities
contracts, except that the Fund may purchase or sell currencies, interest
rate and currency futures contracts, options on currencies, securities,
and securities indexes and options on interest rate and currency futures
contracts, and may enter into swap agreements;
7. Make loans, except loans of portfolio securities and
except to the extent the purchase of notes, bonds or other evidences of
indebtedness, the entry into repurchase agreements, or deposits with banks
and other financial institutions may be considered loans;
8. Purchase any security if, as a result thereof, 25% or
more of its total assets would be invested in the securities of issuers
having their principal business activities in the same industry. This
limitation does not apply to securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities and repurchase agreements
with respect thereto.
1
<PAGE>
The foregoing investment limitations cannot be changed without
the affirmative vote of the lesser of (1) more than 50% of the outstanding
shares of the Fund or (2) 67% or more of the shares of the Fund present at
a shareholders' meeting if more than 50% of the outstanding shares of the
Fund are represented at the meeting in person or by proxy.
Except as otherwise specified, the investment limitations and
policies which follow, and those set forth throughout this Statement of
Additional Information, may be changed by the Corporation's Board of
Directors without shareholder approval. The following are some of the
non-fundamental limitations which the Fund currently observes. The Fund
may not:
1. Purchase or sell any oil, gas or mineral exploration or
development programs, including leases;
2. Buy securities on "margin," except for short-term credits
necessary for clearance of portfolio transactions and except that the Fund
may make margin deposits in connection with the use of permitted currency
futures contracts and options on currency futures contracts;
3. Make short sales of securities or maintain a short
position, except that the Fund may (a) make short sales and maintain short
positions in connection with its use of options, futures contracts and
options on futures contracts and (b) sell short "against the box" (the
Fund does not intend to make short sales against the box in excess of 5%
of its net assets during the coming year);
4. Purchase or retain the securities of an issuer if, to the
knowledge of the Fund's management, those officers and directors of the
Fund, of Legg Mason Fund Adviser, Inc. and of Western Asset Management
Company who individually own beneficially more than 0.5% of the
outstanding securities of that issuer own in the aggregate more than 5% of
the securities of that issuer;
5. Purchase any security if, as a result, more than 5% of
the Fund's total assets would be invested in securities of companies that
together with any predecessors have been in continuous operation for less
than three years;
6. Make investments in warrants if such investments, valued
at the lower of cost or market, exceed 5% of the value of its net assets,
which amount may include warrants that are not listed on the New York or
American Stock Exchanges, provided that such unlisted warrants, valued at
the lower of cost or market, do not exceed 2% of the Fund's net assets,
and further provided that this restriction does not apply to warrants
attached to, or sold as a unit with, other securities. For purposes of
this restriction, the term "warrants" does not include options on
securities, stock or bond indices, foreign currencies or futures
contracts.
2
<PAGE>
7. Acquire securities of other open-end investment companies,
except in connection with a merger, consolidation, reorganization or
acquisition.
8. Hold more than 10% of the outstanding voting securities of
any one issuer.
The Fund interprets fundamental investment limitation (4) to
prohibit investment in real estate limited partnerships.
If a percentage limitation is complied with at the time an
investment is made, a later increase or decrease in percentage resulting
from a change in value of portfolio securities, in the net asset value of
the Fund, or in the number of securities an issuer has outstanding will
not be considered a violation of any limitation.
Repurchase Agreements
---------------------
When the Fund enters into a repurchase agreement, it will obtain
from the other party securities equal in value to 102% of the amount of
the repurchase agreement (or 100%, if the securities obtained are U.S.
Treasury bills, notes and bonds). Such securities will be held by the
Fund's custodian or an approved securities depository or book-entry
system.
Illiquid Securities
-------------------
SEC regulations permit the sale of certain restricted securities
to qualified institutional buyers. Western Asset Management Company
("Adviser"), the Fund's investment adviser, acting pursuant to guidelines
established by the Board of Directors, may determine that certain
restricted securities qualified for trading on this newly developing
market are liquid. If the market does not develop as anticipated, it may
adversely affect the Fund's liquidity.
Private Placements
------------------
The Fund may acquire restricted securities in private placement
transactions, directly from the issuer or from security holders,
frequently at higher yields than comparable publicly-traded securities.
Privately-placed securities can be sold by the Fund only (1) pursuant to
SEC Rule 144A or other exemption; (2) in privately-negotiated transactions
to a limited number of purchasers; or (3) in public offerings made
pursuant to an effective registration statement under the 1933 Act.
Private or public sales of such securities by the Fund may involve
significant delays and expense. Private sales require negotiations with
one or more purchasers and generally produce less favorable prices than
the sale of comparable unrestricted securities. Public sales generally
involve the time and expense of preparing and processing a registration
3
<PAGE>
statement under the Securities Act of 1933 and may involve the payment of
underwriting commissions; accordingly, the proceeds may be less than the
proceeds from the sale of securities of the same class which are freely
marketable.
Foreign Securities
------------------
Since the Fund may invest in securities denominated in currencies
other than the U.S. dollar, the Fund may be affected favorably or
unfavorably by exchange control regulations or changes in the exchange
rates between such currencies and the U.S. dollar. Changes in the
currency exchange rates may influence the value of the Fund's shares, and
also may affect the value of dividends and interest earned by the Fund and
gains and losses realized by the Fund. Exchange rates are determined by
the forces of supply and demand in the foreign exchange markets. These
forces are affected by the international balance of payments and other
economic and financial conditions, government intervention, speculation
and other factors.
Foreign securities transactions could be subject to settlement
procedures different from those followed in the United States, where
delivery is made versus payment. The settlement procedures in some
foreign markets expose investors to the creditworthiness of an
intermediary, such as a bank or brokerage firm, for a period of time
during settlement.
Securities Lending
------------------
The Fund may lend portfolio securities to brokers or dealers in
corporate or government securities, banks or other recognized
institutional borrowers of securities provided that cash or equivalent
collateral equal to at least 100% of the market value of the securities
loaned, is continuously maintained by the borrower with the Fund. During
the time portfolio securities are on loan, the borrower pays the Fund an
amount equivalent to any dividends or interest paid on such securities,
and the Fund may invest the cash collateral and earn income, or it may
receive an agreed upon amount of interest income from the borrower who has
delivered equivalent collateral. These loans are subject to termination
at the option of the Fund or the borrower. The Fund may pay reasonable
administrative and custodial fees in connection with a loan and may pay a
negotiated portion of the interest earned on the cash or equivalent
collateral to the borrower or placing broker. The Fund does not have the
right to vote securities on loan, but would terminate the loan and retain
the right to vote if that were considered important with respect to the
investment. The risks of securities lending are similar to those of
repurchase agreements, described in the Prospectus. The Fund presently
does not intend to loan more than 5% of its portfolio securities at any
given time during the foreseeable future.
4
<PAGE>
Options and Futures
-------------------
The Fund may purchase call options on securities that the Adviser
intends to include in the Fund's investment portfolio in order to fix the
cost of a future purchase. Purchased options also may be used as a means
of participating in an anticipated price increase of a security on a more
limited risk basis than would be possible if the security itself were
purchased. In the event of a decline in the price of the underlying
security, use of this strategy would serve to limit the Fund's potential
loss to the option premium paid; conversely, if the market price of the
underlying security increases above the exercise price and the Fund either
sells or exercises the option, any profit realized will be reduced by the
premium.
The Fund may purchase put options in order to hedge against a
decline in the market value of securities held in its portfolio or to
enhance income. The put option enables the Fund to sell the underlying
security at the predetermined exercise price; thus the potential for loss
to the Fund below the exercise price is limited to the option premium
paid. If the market price of the underlying security is higher than the
exercise price of the put option, any profit the Fund realizes on the sale
of the security would be reduced by the premium paid for the put option
less any amount for which the put option may be sold.
The Fund may write covered call options on securities in which it
is authorized to invest. Because it can be expected that a call option
will be exercised if the market value of the underlying security increases
to a level greater than the exercise price, the Fund might write covered
call options on securities generally when its Adviser believes that the
premium received by the Fund will exceed the extent to which the market
price of the underlying security will exceed the exercise price. The
strategy may be used to provide limited protection against a decrease in
the market price of the security, in an amount equal to the premium
received for writing the call option less any transaction costs. Thus, in
the event that the market price of the underlying security held by the
Fund declines, the amount of such decline will be offset wholly or in part
by the amount of the premium received by the Fund. If, however, there is
an increase in the market price of the underlying security and the option
is exercised, the Fund would be obligated to sell the security at less
than its market value. The Fund would give up the ability to sell the
portfolio securities used to cover the call option while the call option
was outstanding. Such securities would also be considered illiquid in the
case of over-the-counter ("OTC") options written by the Fund, and
therefore subject to the Fund's limitation on investing no more than 15%
of its total assets in illiquid securities. In addition, the Fund could
lose the ability to participate in an increase in the value of such
securities above the exercise price of the call option because such an
increase would likely be offset by an increase in the cost of closing out
the call option (or could be negated if the buyer chose to exercise the
5
<PAGE>
call option at an exercise price below the securities' current market
value).
The sale of a put option on a security by the Fund also serves to
partially offset the cost of a security that the Fund anticipates
purchasing. If the price of the security rises, the increased cost to the
Fund of purchasing the security will be offset, in whole or in part, by
the premium received. In the event, however, that the price of the
security falls below the exercise price of the option and the option is
exercised, the Fund will be required to purchase the security from the
holder of the option at a price in excess of the current market price of
the security. The Fund's loss on this transaction will be offset, in
whole or in part, to the extent of the premium received by the Fund for
writing the option.
The Fund may purchase put and call options and write put and
covered call options on bond indices in much the same manner as securities
options, except that bond index options may serve as a hedge against
overall fluctuations in the debt securities markets (or a market sector)
rather than anticipated increases or decreases in the value of a
particular security. A bond index assigns a value to the securities
included in the index and fluctuates with changes in such values.
Settlements of bond index options are effected with cash payments and do
not involve the delivery of securities. Thus, upon settlement of a bond
index option, the purchaser will realize, and the writer will pay, an
amount based on the difference between the exercise price and the closing
price of the bond index. The effectiveness of hedging techniques using
bond index options will depend on the extent to which price movements in
the bond index selected correlate with price movements of the securities
in which the Fund invests.
The Fund may purchase and write covered straddles on securities,
currencies or bond indices. A long straddle is a combination of a call
and a put option purchased on the same security, index or currency where
the exercise price of the put is less than or equal to the exercise price
of the call. The Fund would enter into a long straddle when the Adviser
believes that it is likely that interest rates or currency exchange rates
will be more volatile during the term of the options than the option
pricing implies. A short straddle is a combination of a call and a put
written on the same security, index or currency where the exercise price
of the put is less than or equal to the exercise price of the call. In a
covered short straddle, the same issue of security or currency is
considered cover for both the put and the call that the Fund has written.
The Fund would enter into a short straddle when the Adviser believes that
it is unlikely that interest rates or currency exchange rates will be as
volatile during the term of the options as the option pricing implies. In
such case, the Fund will set aside cash and/or liquid, high grade debt
securities in a segregated account with its custodian equivalent in value
to the amount, if any, by which the put is in-the-money, that is, the
amount by which the exercise price of the put exceeds the current market
value of the underlying security.
6
<PAGE>
Foreign Currency Options and Related Risks
------------------------------------------
The Fund may purchase and write (sell) options on foreign
currencies in order to hedge against the risk of foreign exchange rate
fluctuation on foreign securities the Fund holds or which it intends to
purchase. For example, if the Fund enters into a contract to purchase
securities denominated in a foreign currency, it could effectively fix the
maximum U.S. dollar cost of the securities by purchasing call options on
that foreign currency. Similarly, if the Fund held securities denominated
in a foreign currency and anticipated a decline in the value of that
currency against the U.S. dollar, it could hedge against such a decline by
purchasing a put option on the currency involved. The purchase of an
option on foreign currency may be used to hedge against fluctuations in
exchange rates although, in the event of exchange rate movements adverse
to the Fund's options position, it may forfeit the entire amount of the
premium plus related transaction costs. In addition, the Fund may
purchase call options on foreign currency to enhance income when its
Adviser anticipates that the currency will appreciate in value, but the
securities denominated in that currency do not present attractive
investment opportunities.
If the Fund writes an option on foreign currency, it will
constitute only a partial hedge, up to the amount of the premium received,
and the Fund could be required to purchase or sell foreign currencies at
disadvantageous exchange rates, thereby incurring losses. The Fund may
use options on currency to cross-hedge, which involves writing or
purchasing options on one currency to hedge against changes in exchange
rates of a different, but related, currency.
The Fund's ability to establish and close out positions on such
options is subject to the maintenance of a liquid secondary market.
Although many options on foreign currencies are exchange traded, the
majority are traded on the OTC market. The Fund will not purchase or
write such options unless, in the opinion of the Adviser, the market for
them has developed sufficiently. There can be no assurance that a liquid
secondary market will exist for a particular option at any specific time.
In addition, options on foreign currencies are affected by all of those
factors that influence foreign exchange rates and investments generally.
These OTC options also involve credit risks that may not be present in the
case of exchange-traded currency options.
Futures Contracts and Options on Futures Contracts
--------------------------------------------------
The Fund will limit its use of futures contracts and options on
futures contracts to hedging transactions or other circumstances permitted
by regulatory authorities. For example, the Fund might use futures
contracts to attempt to hedge against anticipated changes in interest
rates that might adversely affect either the value of the Fund's
securities or the price of the securities that the Fund intends to
purchase. The Fund's hedging may include sales of futures contracts as an
7
<PAGE>
offset against the effect of expected increases in interest rates, and
purchases of futures contracts as an offset against the effect of expected
declines in interest rates. Although other techniques could be used to
reduce exposure to interest rate fluctuations, the Fund may be able to
hedge its exposure more effectively and perhaps at a lower cost by using
futures contracts and options on futures contracts.
The Fund may also purchase call or put options on foreign
currency futures contracts to obtain a fixed foreign exchange rate at
limited risk. The Fund may purchase a call option on a foreign currency
futures contract to hedge against a rise in the foreign exchange rate
while intending to invest in a foreign security of the same currency. The
Fund may purchase put options on foreign currency futures contracts as a
hedge against a decline in the foreign exchange rates or the value of its
foreign portfolio securities. The Fund may write a call option on a
foreign currency futures contract as a partial hedge against the effects
of declining foreign exchange rates on the value of foreign securities.
The Fund may sell a put option on a foreign currency to partially offset
the cost of a security denominated in that currency that the Fund
anticipates purchasing; however, the cost will only be offset to the
extent of the premium received by the Fund for writing the option.
The Fund also may use futures contracts on fixed income
instruments and options thereon to hedge its investment portfolio against
changes in the general level of interest rates. A futures contract on a
fixed income instrument is a bilateral agreement pursuant to which one
party agrees to make, and the other party agrees to accept, delivery of
the specified type of fixed income security called for in the contract at
a specified future time and at a specified price. The Fund may purchase a
futures contract on a fixed income security when it intends to purchase
fixed income securities but has not yet done so. This strategy may
minimize the effect of all or part of an increase in the market price of
the fixed income security that the Fund intends to purchase in the future.
A rise in the price of the fixed income security prior to its purchase may
be either offset by an increase in the value of the futures contract
purchased by the Fund or avoided by taking delivery of the fixed income
securities under the futures contract. Conversely, a fall in the market
price of the underlying fixed income security may result in a
corresponding decrease in the value of the futures position. The Fund may
sell a futures contract on a fixed income security in order to continue to
receive the income from a fixed income security, while endeavoring to
avoid part or all of the decline in the market value of that security that
would accompany an increase in interest rates.
The Fund may purchase a call option on a futures contract to
hedge against a market advance in debt securities that the Fund plans to
acquire at a future date. The purchase of a call option on a futures
contract is analogous to the purchase of a call option on an individual
fixed income security that can be used as a temporary substitute for a
position in the security itself. The Fund also may write covered call
options on futures contracts as a partial hedge against a decline in the
price of fixed income securities held in the Fund's investment portfolio,
8
<PAGE>
or purchase put options on futures contracts in order to hedge against a
decline in the value of fixed income securities held in the Fund's
investment portfolio. The Fund may write a put option on a security that
the Fund anticipates purchasing to partially offset the cost of purchasing
that security; however, the cost will only be offset to the extent of the
premium the Fund receives for writing the option.
The Fund may sell securities index futures contracts in
anticipation of a general market or market sector decline that could
adversely affect the market value of its investments. To the extent that
a portion of the Fund's investments correlate with a given index, the sale
of futures contracts on that index could reduce the risks associated with
a market decline and thus provide an alternative to the liquidation of
securities positions. For example, if the Fund correctly anticipates a
general market decline and sells securities index futures to hedge against
this risk, the gain in the futures position should offset some or all of
the decline in the value of the portfolio. The Fund may purchase
securities index futures contracts if a significant market or market
sector advance is anticipated. Such a purchase of a futures contract
would serve as a temporary substitute for the purchase of individual
securities, which securities may then be purchased in an orderly fashion.
This strategy may minimize the effect of all or part of an increase in the
market price of securities that the Fund intends to purchase. A rise in
the price of the securities should be partly or wholly offset by gains in
the futures position.
As in the case of a purchase of a securities index futures
contract, the Fund may purchase a call option on a securities index
futures contract to hedge against a market advance in securities that the
Fund plans to acquire at a future date. The Fund may write put options
on securities index futures as a partial anticipatory hedge and may write
covered call options on securities index futures as a partial hedge
against a decline in the prices of bonds held in its portfolio. This is
analogous to writing covered call options on securities. The Fund also
may purchase put options on securities index futures contracts. The
purchase of put options on securities index futures contracts is analogous
to the purchase of protective put options on individual securities where a
level of protection is sought below which no additional economic loss
would be incurred by the Fund.
The Fund may also purchase and sell futures contracts on a
foreign currency. The Fund may sell a foreign currency futures contract
to hedge against possible variations in the exchange rate of the foreign
currency in relation to the U.S. dollar. In addition, the Fund may sell a
foreign currency futures contract when the Adviser anticipates a general
weakening of the foreign currency exchange rate that could adversely
affect the market values of the Fund's foreign securities holdings. In
this case, the sale of futures contracts on the underlying currency may
reduce the risk to the Fund caused by foreign currency variations and, by
so doing, provide an alternative to the liquidation of securities
positions in the Fund and resulting transaction costs. When the Adviser
anticipates a significant foreign exchange rate increase while intending
9
<PAGE>
to invest in a security denominated in a foreign currency, the Fund may
purchase a foreign currency futures contract to hedge against a rise in
foreign exchange rates pending completion of the anticipated transaction.
Such a purchase would serve as a temporary measure to protect the Fund
against any rise in the foreign exchange rate that may add additional
costs to acquiring the foreign security position.
The Fund may also purchase call or put options on foreign
currency futures contracts to obtain a fixed foreign exchange rate at
limited risk. The Fund may purchase a call option or write a put option
on a foreign currency futures contract to hedge against a rise in the
foreign exchange rate while intending to invest in a foreign security of
the same currency. The Fund may purchase put options on foreign currency
futures contracts as a partial hedge against a decline in the foreign
exchange rates or the value of its foreign portfolio securities. It may
also write a call option on a foreign currency futures contract as a
partial hedge against the effects of declining foreign exchange rates on
the value of foreign securities.
The Fund may also write put options on interest rate, securities
index or foreign currency futures contracts while, at the same time,
purchasing call options on the same interest rate, securities index or
foreign currency futures contract in order synthetically to create a long
interest rate, securities index or foreign currency futures contract
position. The options will have the same strike prices and expiration
dates. The Fund will engage in this strategy only when its Adviser
believes it is more advantageous to the Fund to do so as compared to
purchasing the futures contract.
The Fund may also purchase and write covered straddles on
interest rate, foreign currency or securities index futures contracts. A
long straddle is a combination of a call and a put purchased on the same
futures contract where the exercise price of the put option is less than
the exercise price of the call option. The Fund would enter into a long
straddle when it believes that it is likely that interest rates or foreign
currency exchange rates will be more volatile during the term of the
options than the option pricing implies. A short straddle is a
combination of a call and put written on the same futures contract where
the exercise price of the put option is less than the exercise price of
the call option. In a covered short straddle, the same futures contract
is considered "cover" for both the put and the call that the Fund has
written. The Fund would enter into a short straddle when it believes that
it is unlikely that interest rates or foreign currency exchange rates will
be as volatile during the term of the options as the option pricing
implies. In such case, the Fund will set aside cash and/or liquid, high
grade debt securities in a segregated account with its custodian equal in
value to the amount, if any, by which the put is "in-the-money", that is,
the amount by which the exercise price of the put exceeds the current
market value of the underlying futures contract.
When a purchase or sale of a futures contract is made by the
Fund, the Fund is required to deposit with its custodian (or a broker, if
10
<PAGE>
legally permitted) a specified amount of cash or U.S. Government
securities ("initial margin"). The margin required for a futures contract
is set by the exchange on which the contract is traded and may be modified
during the term of the contract. The initial margin is in the nature of a
performance bond or good faith deposit on the futures contract, which is
returned to the Fund upon termination of the contract assuming all
contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, the Fund may be required by an
exchange to increase the level of its initial margin payment.
Additionally, initial margin requirements may be increased generally in
the future by regulatory action. The Fund expects to earn interest income
on its initial margin deposits. A futures contract held by the Fund is
valued daily at the official settlement price of the exchange on which it
is traded. Each day the Fund pays or receives cash, called "variation
margin," equal to the daily change in value of the futures contract. This
process is known as "marking-to-market." Variation margin does not
represent a borrowing or loan by the Fund but is instead settlement
between the Fund and the broker of the amount one would owe the other if
the futures contract had expired on that date. In computing daily net
asset value, the Fund will mark-to-market its open futures positions.
The Fund is also required to deposit and maintain margin with
respect to put and call options on futures contracts and on certain
foreign currencies written by it. Such margin deposits will vary
depending on the nature of the underlying futures contract or currency
(and the related initial margin requirements), the current market value of
the option and other options and futures positions held by the Fund.
Although some futures contracts call for making or taking
delivery of the underlying securities, generally futures contracts are
closed out prior to delivery by offsetting purchases or sales of matching
futures contracts (involving the same currency, index or underlying
security and delivery month). If an offsetting purchase price is less
than the original sale price, the Fund realizes a gain, or if it is more,
the Fund realizes a loss. If an offsetting sale price is more than the
original purchase price, the Fund realizes a gain, or if it is less, the
Fund realizes a loss. The Fund will also bear transaction costs for each
contract, which must be considered in these calculations.
The Fund will not enter into futures contracts or commodities
option positions if, immediately thereafter, the initial margin deposits
plus premiums paid by it, less the amount by which any such options
positions are "in-the-money" at the time of purchase, would exceed 5% of
the fair market value of the Fund's total assets. A call option is "in-
the-money" if the value of the futures contract that is the subject of the
option exceeds the exercise price. A put option is "in-the-money" if the
exercise price exceeds the value of the futures contract that is the
subject of the option. Foreign currency options traded on a commodities
exchange are considered commodity options for this purpose.
11
<PAGE>
Risks Associated with Futures and Options
-----------------------------------------
In considering the Fund's use of futures contracts and options,
particular note should be taken of the following:
(1) Positions in futures contracts may be closed out only on
an exchange or board of trade that provides a secondary market for such
futures contracts. Futures exchanges may limit the amount of fluctuation
permitted in certain futures contract prices during a single trading day.
The daily limit establishes the maximum amount that the price of a futures
contract may vary either up or down from the previous day's settlement
price at the end of the current trading session. Once the daily limit has
been reached in a futures contract subject to the limit, no more trades
may be made on that day at a price beyond that limit. The daily limit
governs only price movements during a particular trading day and therefore
does not limit potential losses because the limit may work to prevent the
liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days
with little or no trading, thereby preventing prompt liquidation of
positions and subjecting some holders of futures contracts to substantial
losses.
(2) The ability to establish and close out positions in
either futures contracts or exchange-listed options is also subject to the
maintenance of a liquid secondary market. Consequently, it may not be
possible for the Fund to close a position and, in the event of adverse
price movements, the Fund would have to make daily cash payments of
variation margin (except in the case of purchased options). However, in
the event futures contracts or options have been used to hedge portfolio
securities, such securities will not be sold until the contracts can be
terminated. In such circumstances, an increase in the price of the
securities, if any, may partially or completely offset losses on the
futures contract. However, there is no guarantee that the price of the
securities will, in fact, correlate with the price movements in the
contracts and thus provide an offset to losses on the contracts.
(3) Successful use by the Fund of futures contracts and
options will depend upon the Adviser's ability to predict movements in the
direction of the overall securities, currency and interest rate markets,
which may require different skills and techniques than predicting changes
in the prices of individual securities. Moreover, futures contracts
relate not to the current level of the underlying instrument but to the
anticipated levels at some point in the future. There is, in addition,
the risk that the movements in the price of the futures contract will not
correlate with the movements in prices of the securities or currencies
being hedged. For example if the price of the futures contract moves less
than the price of the securities or currencies that are subject to the
hedge, the hedge will not be fully effective; however, if the price of
securities or currencies being hedged has moved in an unfavorable
direction, the Fund would be in a better position than if it had not
hedged at all. If the price of the securities or currencies being hedged
12
<PAGE>
has moved in a favorable direction, this advantage may be partially offset
by losses in the futures position. In addition, if the Fund has
insufficient cash, it may have to sell assets from its investment
portfolio to meet daily variation margin requirements. Any such sale of
assets may or may not be made at prices that reflect the rising market;
consequently, the Fund may need to sell assets at a time when such sales
are disadvantageous to the Fund. If the price of the futures contract
moves more than the price of the underlying securities or currencies, the
Fund will experience either a loss or a gain on the futures contract that
may or may not be completely offset by movements in the price of the
securities or currencies that are the subject of the hedge.
(4) The value of an option position will reflect, among other
things, the current market price of the underlying security, futures
contract or currency, the time remaining until expiration, the
relationship of the exercise price to the market price, the historical
price volatility of the underlying security, index, futures contract or
currency and general market conditions. For this reason, the successful
use of options as a hedging strategy depends upon the Adviser's ability to
forecast the direction of price fluctuations in the underlying market or
market sector.
(5) In addition to the possibility that there may be an
imperfect correlation, or no correlation at all, between price movements
in the futures position and the securities or currencies being hedged,
movements in the prices of futures contracts may not correlate perfectly
with movements in the prices of the hedged securities or currencies due to
price distortions in the futures market. There may be several reasons
unrelated to the value of the underlying securities or currencies that
cause this situation to occur. First, as noted above, all participants in
the futures market are subject to initial and variation margin
requirements. If, to avoid meeting additional margin deposit requirements
or for other reasons, investors choose to close a significant number of
futures contracts through offsetting transactions, distortions in the
normal price relationship between the securities or currencies and the
futures markets may occur. Second, because the margin deposit
requirements in the futures market are less onerous than margin
requirements in the securities market, there may be increased
participation by speculators in the futures market; such speculative
activity in the futures market also may cause temporary price distortions.
Third, participants could make or take delivery of the underlying
securities or currencies instead of closing out their contracts. As a
result, a correct forecast of general market trends may not result in
successful hedging through the use of futures contracts over the short
term. In addition, activities of large traders in both the futures and
securities markets involving arbitrage and other investment strategies may
result in temporary price distortions.
(6) Options normally have expiration dates of up to three
years. The exercise price of the options may be below, equal to or above
the current market value of the underlying security, index, futures
contract or currency. Purchased options that expire unexercised have no
13
<PAGE>
value, and the Fund will realize a loss in the amount paid plus any
transaction costs.
(7) Like options on securities and currencies, options on
futures contracts have a limited life. The ability to establish and close
out options on futures will be subject to the development and maintenance
of liquid secondary markets on the relevant exchanges or boards of trade.
There can be no certainty that liquid secondary markets for all options on
futures contracts will develop.
(8) Purchasers of options on futures contracts pay a premium
in cash at the time of purchase. This amount and the transaction costs
are all that is at risk. Sellers of options on futures contracts,
however, must post an initial margin and are subject to additional margin
calls that could be substantial in the event of adverse price movements.
In addition, although the maximum amount at risk when the Fund purchases
an option is the premium paid for the option and the transaction costs,
there may be circumstances when the purchase of an option on a futures
contract would result in a loss to the Fund when the use of a futures
contract would not, such as when there is no movement in the value of the
securities or currencies being hedged.
(9) The Fund's activities in the futures and options markets
may result in a higher portfolio turnover rate and additional transaction
costs in the form of added brokerage commissions; however, the Fund also
may save on commissions by using such contracts as a hedge rather than
buying or selling individual securities or currencies in anticipation or
as a result of market movements.
(10) The Fund may purchase and write both exchange-traded
options and OTC options. The ability to establish and close out positions
on the exchanges is subject to the maintenance of a liquid secondary
market. Although the Fund intends to purchase or write only those
exchange-traded options for which there appears to be an active secondary
market, there is no assurance that a liquid secondary market will exist
for any particular option at any specific time. Closing transactions may
be effected with respect to options traded in the OTC markets (currently
the primary markets for options on debt securities and foreign currencies)
only by negotiating directly with the other party to the option contract,
or in a secondary market for the option if such market exists. Although
the Fund will enter into OTC options only with dealers that agree to enter
into, and that are expected to be capable of entering into, closing
transactions with the Fund, there can be no assurance that the Fund will
be able to liquidate an OTC option at a favorable price at any time prior
to expiration. In the event of insolvency of the contra-party, the Fund
may be unable to liquidate an OTC option. Accordingly, it may not be
possible to effect closing transactions with respect to certain options,
with the result that the Fund would have to exercise those options that it
has purchased in order to realize any profit. With respect to options
written by the Fund, the inability to enter into a closing transaction may
result in material losses to the Fund. For example, because the Fund must
maintain a covered position with respect to any call option it writes on a
14
<PAGE>
security, futures contract or currency, the Fund may not sell the
underlying security, futures contract or currency or invest any cash, U.S.
Government securities or liquid high quality debt securities used as cover
during the period it is obligated under such option. This requirement may
impair the Fund's ability to sell a portfolio security or make an
investment at a time when such a sale or investment might be advantageous.
(11) Securities index options are settled exclusively in cash.
If the Fund purchases a put or call option on an index, the Fund will not
know in advance the difference, if any, between the closing value of the
index on the exercise date and the exercise price of the option itself.
Thus, if the Fund exercises a securities index option before the closing
index value for that day is available, the Fund runs the risk that the
level of the underlying index may subsequently change.
Special Risks Related to Foreign Currency Futures Contracts and Options on
Such Contracts and Options on Foreign Currencies
--------------------------------------------------------------------------
Buyers and sellers of foreign currency futures contracts are
subject to the same risks that apply to the use of futures generally. In
addition, there are risks associated with foreign currency futures
contracts and their use as a hedging device similar to those associated
with options on foreign currencies described below. Further, settlement
of a foreign currency futures contract must occur within the country
issuing the underlying currency. Thus, the Fund must accept or make
delivery of the underlying foreign currency in accordance with any U.S. or
foreign restrictions or regulations regarding the maintenance of foreign
banking arrangements by U.S. residents and may be required to pay any
fees, taxes or charges associated with such delivery that are assessed in
the issuing country.
Options on foreign currency futures contracts may involve certain
additional risks. The ability to establish and close out positions on such
options is subject to the maintenance of a liquid secondary market. To
reduce this risk, the Fund will not purchase or write options on foreign
currency futures contracts unless and until, in the opinion of the
Adviser, the market for such options has developed sufficiently that the
risks in connection with such options are not greater than the risks in
connection with transactions in the underlying foreign currency futures
contracts. Compared to the purchase or sale of foreign currency futures
contracts, the purchase of call or put options on futures contracts
involves less potential risk to the Fund because the maximum amount at
risk is the premium paid for the option (plus transaction costs).
However, there may be circumstances when the purchase of a call or put
option on a foreign currency futures contract would result in a loss, such
as when there is no movement in the price of the underlying currency or
futures contract, when the purchase of the underlying futures contract
would not result in a loss.
The value of a foreign currency option depends upon the value of
the underlying currency relative to the U.S. dollar. As a result, the
15
<PAGE>
price of the option position may vary with changes in the value of either
or both currencies and may have no relationship to the investment merits
of a foreign security. Because foreign currency transactions occurring in
the interbank market involve substantially larger amounts than those that
may be involved in the use of foreign currency options, investors may be
disadvantaged by having to deal in an odd lot 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 available is generally representative of
very large transactions in the interbank market and thus may not reflect
relatively smaller transactions (i.e., less than $1 million) where rates
may be less favorable. The interbank market in foreign currencies is a
global, around-the-clock market. To the extent that the U.S. options
markets are closed while the markets for the underlying currencies remain
open, significant price and rate movements may take place in the
underlying markets that cannot be reflected in the options markets until
they reopen.
Additional Risks of Options on Securities, Futures Contracts, Options on
Futures and Forward Currency Exchange Contracts and Options Thereon Traded
on Foreign Exchanges
--------------------------------------------------------------------------
Options on securities, futures contracts, options on futures
contracts, currencies and options on currencies may be traded on foreign
exchanges. Such transactions may not be regulated as effectively as
similar transactions in the United States, may not involve a clearing
mechanism and related guarantees and are subject to the risk of
governmental actions affecting trading in, or the price of, foreign
securities. The value of such positions also could be adversely affected
by (1) other complex foreign political, legal and economic factors, (2)
lesser availability than in the United States of data on which to make
trading decisions, (3) delays in the Fund's ability to act upon economic
events occurring in foreign markets during non-business hours in the
United States, (4) the imposition of different exercise and settlement
terms and procedures and margin requirements than in the United States and
(5) lesser trading volume.
Forward Contracts
-----------------
The Fund may use forward currency exchange contracts ("forward
contracts") to hedge against uncertainty in the level of future exchange
rates.
16
<PAGE>
The Fund may enter into forward contracts with respect to
specific transactions. For example, when the Fund anticipates purchasing
or selling a security denominated in a foreign currency, or when it
anticipates the receipt in a foreign currency of dividend or interest
payments on a security that it holds, the Fund may desire to "lock in" the
U.S. dollar price of the security or the U.S. dollar equivalent of such
payment, as the case may be, by entering into a forward contract for the
purchase or sale, for a fixed amount of U.S. dollars or foreign currency,
of the amount of foreign currency involved in the underlying transaction.
The Fund will thereby attempt to protect itself against a possible loss
resulting from an adverse change in the relationship between the currency
exchange rates during the period between the date on which the security is
purchased or sold, or on which the payment is declared, and the date on
which such payments are made or received.
The Fund also may use forward contracts to "lock in" the U.S.
dollar value of its portfolio positions, to increase the Fund's exposure
to foreign currencies that the Adviser believes may rise in value relative
to the U.S. dollar or to shift the Fund's exposure to foreign currency
fluctuations from one country to another. For example, when the Adviser
believes that the currency of a particular foreign country may suffer a
substantial decline relative to the U.S. dollar or another currency, it
may enter into a forward contract to sell the amount of the former foreign
currency approximating the value of some or all of the Fund's securities
denominated in such foreign currency. These investment practices
generally are referred to as "cross-currency hedging" when two foreign
currencies are involved.
At or before the maturity date of a forward contract requiring
the Fund to sell a currency, the Fund may either sell a portfolio security
and use the sale proceeds to make delivery of the currency or retain the
security and offset its contractual obligation to deliver the currency by
purchasing a second contract pursuant to which the Fund will obtain, on
the same maturity date, the same amount of the currency that it is
obligated to deliver. Similarly, the Fund may close out a forward
contract requiring it to purchase a specified currency by entering into a
second contract entitling it to sell the same amount of the same currency
on the maturity date of the first contract. The Fund would realize a gain
or loss as a result of entering into such an offsetting forward contract
under either circumstance to the extent the exchange rate or rates between
the currencies involved moved between the execution dates of the first
contract and the offsetting contract.
The precise matching of the forward contract amount and the value
of the securities involved will not generally be possible because the
future value of such securities in foreign currencies will change as a
consequence of market movements in the value of those securities between
the date the forward contract is entered into and the date it matures.
Accordingly, it may be necessary for the Fund to purchase additional
foreign currency on the spot (i.e., cash) market (and bear the expense of
17
<PAGE>
such purchase) if the market value of the security is less than the amount
of foreign currency the Fund is obligated to deliver and if a decision is
made to sell the security and make delivery of the foreign currency.
Conversely, it may be necessary to sell on the spot market some of the
foreign currency received upon the sale of the portfolio security if its
market value exceeds the amount of foreign currency the Fund is obligated
to deliver.
The projection of short-term currency market movements is
extremely difficult, and the successful execution of a short-term hedging
strategy is highly uncertain. Forward contracts involve the risk that
anticipated currency movements will not be accurately predicted, causing
the Fund to sustain losses on these contracts and transaction costs. The
Fund may enter into forward contracts or maintain a net exposure to such
contracts only if (1) the consummation of the contracts would not obligate
the Fund to deliver an amount of foreign currency in excess of the value
of the Fund's portfolio securities or other assets denominated in that
currency or (2) the Fund maintains cash, U.S. Government securities or
other liquid, high-grade debt securities in a segregated account with the
Fund's custodian, marked-to-market daily, in an amount not less than the
value of the Fund's total assets committed to the consummation of the
contract. Under normal circumstances, 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 Adviser believes that it is important to have the flexibility
to enter into such forward contracts when it determines that the best
interests of the Fund will be served.
The cost to the Fund of engaging in forward contracts varies with
factors such as the currencies involved, the length of the contract period
and the market conditions then prevailing. Because forward contracts are
usually entered into on a principal basis, no fees or commissions are
involved. The use of forward contracts does not eliminate fluctuations in
the prices of the underlying securities the Fund owns or intends to
acquire, but it does fix a rate of exchange in advance. In addition,
although forward contracts limit the risk of loss due to a decline in the
value of the hedged currencies, at the same time they limit any potential
gain that might result should the value of the currencies increase.
Although the Fund values its assets daily in terms of U.S.
dollars, it does not intend to convert its holdings of foreign currencies
into U.S. dollars on a daily basis. The Fund may convert foreign currency
from time to time, and investors should be aware of the costs of currency
conversion. Although foreign exchange dealers do not charge a fee for
conversion, they do realize a profit based on the difference between the
prices at which they are buying and selling various currencies. Thus, a
dealer may offer to sell a foreign currency to the Fund at one rate, while
offering a lesser rate of exchange should the Fund desire to resell that
currency to the dealer.
Foreign Currency Exchange-Related Securities and Foreign Currency Warrants
--------------------------------------------------------------------------
18
<PAGE>
Foreign currency warrants entitle the holder to receive from
their issuer an amount of cash (generally, for warrants issued in the
United States, in U.S. dollars) that is calculated pursuant to a
predetermined formula and based on the exchange rate between a specified
foreign currency and the U.S. dollar as of the exercise date of the
warrant. Foreign currency warrants generally are exercisable upon their
issuance and expire as of a specified date and time. Foreign currency
warrants have been issued in connection with U.S. dollar-denominated debt
offerings by major corporate issuers in an attempt to reduce the foreign
currency exchange risk that is inherent in the international fixed
income/debt marketplace. The formula used to determine the amount payable
upon exercise of a foreign currency warrant may make the warrant worthless
unless the applicable foreign currency exchange rate moves in a particular
direction.
Foreign currency warrants are severable from the debt obligations
with which they may be offered and may be listed on exchanges. Foreign
currency warrants may be exercisable only in certain minimum amounts, and
an investor wishing to exercise warrants who possesses less than the
minimum number required for exercise may be required either to sell the
warrants or to purchase additional warrants, thereby incurring additional
transaction costs. In the case of any exercise of warrants, there may be
a time delay between the time a holder of warrants gives instructions to
exercise and the time the exchange rate relating to exercise is
determined, during which time the exchange rate could change
significantly, thereby affecting both the market and cash settlement
values of the warrants being exercised.
The expiration date of the warrants may be accelerated if the
warrants are delisted from an exchange or if their trading is suspended
permanently, which would result in the loss of any remaining "time value"
of the warrants (i.e., the difference between the current market value and
the exercise value of the warrants) and, in the case where the warrants
were "out-of-the-money," in a total loss of the purchase price of the
warrants. Warrants are generally unsecured obligations of their issuers
and are not standardized foreign currency options issued by the Options
Clearing Corporation ("OCC"). Unlike foreign currency options issued by
OCC, the terms of foreign currency warrants generally will not be amended
in the event of governmental or regulatory actions affecting exchange
rates or in the event of the imposition of other regulatory controls
affecting the international currency markets. The initial public offering
price of foreign currency warrants is generally considerably in excess of
the price that a commercial user of foreign currencies might pay in the
interbank market for a comparable option involving significantly larger
amounts of foreign currencies. Foreign currency warrants are subject to
significant foreign exchange risk, including risks arising from complex
political and economic factors.
The requirements for qualification as a regulated investment
company also may limit the extent to which the Fund may engage in
transactions in options, futures, options on futures or forward contracts.
See "Additional Tax Information."
19
<PAGE>
Cover for Strategies Involving Options, Futures and Forward Contracts
---------------------------------------------------------------------
The Fund will not use leverage in its options, futures and
forward contract strategies. The Fund will not enter into an options,
futures or forward currency strategy that exposes it to an obligation to
another party unless it owns either (1) an offsetting ("covering")
position in securities, currencies or other options, futures or forward
contracts or (2) cash, receivables and liquid high quality debt securities
with a value sufficient to cover its potential obligations. The Fund will
comply with guidelines established by the SEC with respect to coverage of
these strategies by mutual funds, and, if the guidelines so require, will
set aside cash and/or liquid, high-grade debt securities in a segregated
account with its custodian in the amount prescribed, as marked to market
daily. Securities, currencies or other options or futures positions used
for cover and securities held in a segregated account cannot be sold or
closed out while the strategy is outstanding, unless they are replaced
with similar assets. As a result, there is a possibility that the use of
cover or segregation involving a large percentage of the Fund's assets
could impede portfolio management or the Fund's ability to meet redemption
requests or other current obligations.
When-Issued Securities
----------------------
The Fund may enter into commitments to purchase securities on a
when-issued basis. To meet its payment obligation under a when-issued
commitment, the Fund will establish a segregated account with its
custodian and maintain cash or liquid high-quality debt obligations, in an
amount at least equal in value to the Fund's commitments to purchase when-
issued securities. The Fund may sell the securities underlying a when-
issued purchase, which may result in a capital gain or loss.
Reverse Repurchase Agreements and Other Borrowing
-------------------------------------------------
A reverse repurchase agreement is a portfolio management
technique in which the Fund temporarily transfers possession of a
portfolio instrument to another person, such as a financial institution or
broker-dealer, in return for cash. At the same time, the Fund agrees to
repurchase the instrument at an agreed upon time (normally within seven
days) and price, including interest payment. The Fund may also enter into
dollar rolls, in which the Fund sells a fixed income security for delivery
in the current month and simultaneously contracts to repurchase a
substantially similar security (same type, coupon and maturity) on a
specified future date. During the roll period, the Fund would forgo
principal and interest paid on such securities. The Fund would be
compensated by the difference between the current sales price and the
20
<PAGE>
forward price for the future purchase, as well as by any interest earned
on the proceeds of the initial sale.
The Fund may engage in reverse repurchase agreements and dollar
rolls as a means of raising cash to satisfy redemption requests or for
other temporary or emergency purposes without the necessity of selling
portfolio instruments. While engaging in reverse repurchase agreements
and dollar rolls, the Fund will maintain cash, U.S. Government securities
or other high-grade, liquid debt securities in a segregated account at its
custodian bank with a value at least equal to the Fund's obligation under
the agreements.
The ability of the Fund to engage in reverse repurchase
agreements and dollar rolls is subject to the Fund's fundamental
investment limitation concerning borrowing, i.e., that borrowing may be
for temporary purposes only and in an amount not to exceed 5% of the
Fund's total assets.
Mortgage-Related Securities
---------------------------
Mortgage-related securities represent an ownership interest in a
pool of residential mortgage loans. These securities are designed to
provide monthly payments of interest, and in most instances, principal to
the investor. The mortgagor's monthly payments to his/her lending
institution are "passed-through" to investors such as the Fund. Most
issuers or poolers provide guarantees of payments, regardless of whether
or not the mortgagor actually makes the payment. The guarantees made by
issuers or poolers are backed by various forms of credit, insurance and
collateral. They may not extend to the full amount of the pool.
Pools consist of whole mortgage loans or participations in loans.
The majority of these loans are made to purchasers of one- to four-family
homes. The terms and characteristics of the mortgage instruments are
generally uniform within a pool but may vary among pools. For example, in
addition to fixed-rate, fixed-term mortgages, the Fund may purchase pools
of variable-rate mortgages, growing-equity mortgages, graduated-payment
mortgages and other types.
All poolers apply standards for qualification to lending
institutions which originate mortgages for the pools. Poolers also
establish credit standards and underwriting criteria for individual
mortgages included in the pools. In addition, many mortgages included in
pools are insured through private mortgage insurance companies.
The majority of mortgage-related securities currently available
are issued by governmental or government-related organizations formed to
increase the availability of mortgage credit. The largest government-
sponsored issuer of mortgage-related securities is the Government National
Mortgage Association ("GNMA"). GNMA certificates ("GNMAs") are interests
in pools of loans insured by the Federal Housing Administration or by the
Farmer's Home Administration ("FHA"), or guaranteed by the Veterans
21
<PAGE>
Administration ("VA"). The Federal National Mortgage Association ("FNMA")
and the Federal Home Loan Mortgage Corporation ("FHLMC") each issue pass-
through securities which are guaranteed as to principal and interest by
FNMA and FHLMC, respectively.
The average life of mortgage-related securities varies with the
maturities and the nature of the underlying mortgage instruments. For
example, GNMAs tend to have a longer average life than FHLMC participation
certificates ("PCs") because there is a tendency for the conventional and
privately-insured mortgages underlying FHLMC PCs to repay at faster rates
than the FHA and VA loans underlying GNMAs. In addition, the term of a
security may be shortened by unscheduled or early payments of principal
and interest on the underlying mortgages. The occurrence of mortgage pre-
payments is affected by various factors, including the level of interest
rates, general economic conditions, the location and age of the mortgaged
property and other social and demographic conditions.
In determining the dollar-weighted average maturity of the Fund's
portfolio, the Adviser will follow industry practice in assigning an
average life to the mortgage-related securities of the Fund unless the
interest rate on the mortgages underlying such securities is such that a
different prepayment rate is likely. For example, where a GNMA has a high
interest rate relative to the market, that GNMA is likely to have a
shorter overall maturity than a GNMA with a market rate coupon. Moreover,
the Adviser may deem it appropriate to change the projected average life
for the Fund's mortgage-related security as a result of fluctuations in
market interest rates and other factors.
Quoted yields on mortgage-related securities are typically based
on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to
differ from the average life yield. Reinvestment of the prepayments may
occur at higher or lower interest rates than the original investment, thus
affecting the yield of the Fund. The compounding effect from the
reinvestment of monthly payments received by the Fund will increase the
yield to shareholders compared to bonds that pay interest semi-annually.
Like other debt securities, the value of mortgage-related
securities will tend to rise when interest rates fall, and fall when rates
rise. The value of mortgage-related securities may also change because of
changes in the market's perception of the creditworthiness of the
organization that issued or guaranteed them. In addition, the mortgage
securities market in general may be adversely affected by changes in
governmental regulation or tax policies.
Private Mortgage-Related Securities
-----------------------------------
The private mortgage-related securities in which the Fund may
invest include foreign mortgage pass-through securities ("Foreign Pass-
Throughs"), which are structurally similar to the pass-through instruments
22
<PAGE>
described above. Such securities are issued by originators of and
investors in mortgage loans, including savings and loan associations,
mortgage bankers, commercial banks, investment bankers, specialized
financial institutions and special purpose subsidiaries of the foregoing.
Foreign Pass-Throughs usually are backed by a pool of fixed rate or
adjustable-rate mortgage loans. The Foreign Pass-Throughs in which the
Fund may invest are not guaranteed by an entity having the credit status
of the GNMA, but generally utilize various types of credit enhancement.
Certain mortgage pools are organized in such a way that the SEC staff
considers them to be closed-end investment companies. The Fund's
investment in such pools is constrained by a federal statute that
restricts investments in the shares of other investment companies.
Asset-Backed Securities
-----------------------
Asset-backed securities are structurally similar to mortgage-
backed securities, but are secured by interest in a different type of
receivable. Asset-backed securities therefore present certain risks that
are not presented by mortgage-related debt securities or other securities
in which the Fund may invest. Primarily, these securities do not have the
benefit of the same security interest in the related collateral. Credit
card receivables are generally unsecured and the debtors are entitled to
the protection of a number of state and federal consumer credit laws, many
of which give such debtors the right to set off certain amounts owed on
the credit cards, thereby reducing the balance due. Most issuers of
automobile receivables permit the servicers to retain possession of the
underlying obligations. If the servicer were to sell these obligations to
another party, there is a risk that the purchaser would acquire an
interest superior to that of the holders of the automobile receivables.
In addition, because of the large number of vehicles involved in a typical
issuance and technical requirements under state laws, the trustee for the
holders of the automobile receivables may not have proper security
interest in all of the obligations backing such receivables. Therefore,
there is the possibility that recoveries on repossessed collateral may
not, in some cases, be available to support payments on these securities.
Because asset-backed securities are relatively new, the market experience
in these securities is limited and the market's ability to sustain
liquidity through all phases of the market cycle has not been tested.
Ratings of Debt Obligations
---------------------------
Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's
Ratings Group ("S&P") and other nationally recognized statistical rating
organizations ("NRSROs") are private organizations that provide ratings of
the credit quality of debt obligations. A description of the ratings
assigned to corporate debt obligations by Moody's and S&P is included in
Appendix A to the Prospectus. The Fund may consider these ratings in
determining whether to purchase, sell or hold a security.
23
<PAGE>
Ratings are not absolute assurances of quality. Consequently,
securities with the same maturity, interest rate and rating may have
different market prices. Credit rating agencies attempt to evaluate the
safety of principal and interest payments and do not evaluate the risks of
fluctuations in market value. Also, rating agencies may fail to make
timely changes in credit ratings in response to subsequent events, so that
an issuer's current financial condition may be better or worse than the
rating indicates.
Swaps, Caps, Floors and Collars
-------------------------------
The Fund may enter into interest rate swaps, and may purchase and
sell caps, floors, and collars for hedging purposes or in an effort to
increase overall return. An interest rate swap is an exchange of interest
payment streams of differing character between counterparties with respect
to a "notional amount" of principal. Index swaps link one of the payments
to the total return of a market portfolio. A cap enables an investor, in
return for a fee, to receive payments if a predetermined interest rate,
currency rate or index value exceeds a particular level. A floor entitles
the investor to receive payments if the interest rate, currency rate or
index value falls below a predetermined level. A collar is a combination
of a cap and a floor and protects a return within a range of values.
The Fund does not intend to purchase swaps, caps, collars, or
floors if, as a result, more than 5% of the Fund's net assets would
thereby be placed at risk. Swaps, caps, collars and floors can be highly
volatile instruments. The value of these agreements is dependent on the
ability of the counterparty to perform and is therefore linked to the
counterparty's creditworthiness. The Fund may also suffer a loss if it is
unable to terminate an outstanding swap agreement.
The Fund will enter into swaps, caps, collars and floors only
with parties deemed by the Adviser to present a minimal risk of default
during the period of agreement. When the Fund enters into a swap, cap,
collar or floor, it will maintain a segregated account containing cash and
high-quality liquid debt securities equal to the payment, if any, due to
the other party; where contracts are on a net basis, only the net payment
will be segregated. The Fund regards caps, collars and floors as
illiquid, and therefore subject to the Fund's 15% limit on illiquid
securities. There can be no assurance that the Fund will be able to
terminate a swap at the appropriate time. The Fund will sell caps,
collars and floors only to close out its positions in such instruments.
As with options and futures transactions, successful use of swap
agreements depends on the Adviser's ability to predict movements in the
direction of overall interest rate markets. There might be imperfect
correlations between the value of a swap, cap, collar or floor agreement
and movements in the underlying interest rate markets. While swap
agreements can offset the potential for loss on a position, they can also
limit the opportunity for gain by offsetting favorable price movements.
24
<PAGE>
The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. Caps,
collars and floors are more recent innovations for which documentation is
less standardized, and accordingly, they are less liquid than swaps. The
market for all of these instruments is largely unregulated. Swaps, caps,
collars and floors are generally considered "derivatives."
Loan Participations and Assignments
-----------------------------------
The Fund may purchase an interest in loans originated by banks
and other financial institutions. Policies of the Fund limit the
percentage of the Fund's assets that can be invested in the securities of
any one issuer, or in issuers primarily involved in one industry. Legal
interpretations by the SEC staff may require the Fund, in some instances,
to treat both the lending bank and the borrower as "issuers" of a loan
participation by the Fund. In combination, the Fund's policies and the
SEC staff's interpretations may limit the amount the Fund can invest in
loan participations.
Although some of the loans in which the Fund invests may be
secured, there is no assurance that the collateral can be liquidated in
particular cases, or that its liquidation value will be equal to the value
of the debt. Borrowers that are in bankruptcy may pay only a small
portion of the amount owed, if they are able to pay at all. Where the
Fund purchases a loan through an assignment, there is a possibility that
the Fund will, in the event the borrower is unable to pay the loan, become
the owner of the collateral. This involves certain risks to the Fund as a
property owner.
Loans are often administered by a lead bank, which acts as agent
for the lenders in dealing with the borrower. In asserting rights against
the borrower, the Fund may be dependent on the willingness of the lead
bank to assert these rights, or upon a vote of all the lenders to
authorize the action. Assets held by the lead bank for the benefit of the
Fund may be subject to claims of the lead bank's creditors.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Prospectus explains that the basic minimum initial investment
is $1,000 and subsequent investments must be at least $100. Purchases made
through the Future First Systematic Investment Plan, payroll deduction
plans and plans involving automatic payment of funds from financial
institutions or automatic investment of dividends from certain unit
investment trusts are subject to an initial minimum and a minimum monthly
investment of only $50.
Future First Systematic Investment Plan
---------------------------------------
25
<PAGE>
When you purchase shares through the Future First Systematic
Investment Plan, Boston Financial Data Services ("BFDS"), the Fund's
transfer agent, will send a check each month to your bank for collection,
and the proceeds of the check will be used to buy shares of the Fund. The
check will also be reflected on your regular checking account statement.
You will receive a cumulative statement of your purchases quarterly. You
may terminate the Future First Systematic Investment Plan at any time
without charge or penalty. Forms to enroll in the Future First Systematic
Investment Plan are available from any Legg Mason Wood Walker, Inc. ("Legg
Mason") or affiliated office.
Purchases by Check
------------------
In making purchases of Fund shares by check, you should be aware
that checks drawn on a member bank of the Federal Reserve System will
normally be converted to federal funds and used to purchase shares of the
Fund within two business days of receipt by Legg Mason. Legg Mason is
closed on the same days as the New York Stock Exchange, Inc. ("Exchange")
is closed, which are listed under "Valuation of Fund Shares" on page 36.
Checks drawn on banks that are not members of the Federal Reserve System
may take up to nine business days to be converted.
Systematic Withdrawal Plan
--------------------------
You may also elect to make systematic withdrawals from your Fund
account of a minimum of $50 on a monthly basis if you own shares with a
net asset value of $5,000 or more. The amounts paid to you each month are
obtained by redeeming sufficient shares from your account to provide the
withdrawal amount that you have specified. The Systematic Withdrawal Plan
is not currently available for shares held in an Individual Retirement
Account ("IRA"), Self-Employed Individual Retirement Plan ("Keogh Plan"),
Simplified Employee Pension Plan ("SEP") or other qualified retirement
plan. You may change the monthly amount to be paid to you without charge
not more than once a year by notifying Legg Mason or the affiliate with
which you have an account. Redemptions will be made at the net asset
value determined as of the close of regular trading of the Exchange on the
first day of each month. If the Exchange is not open for business on that
day, the shares will be redeemed at the net asset value determined as of
the close of regular trading of the Exchange on the preceding business
day. The check for the withdrawal payment will usually be mailed to you
on the next business day following redemption. If you elect to
participate in the Systematic Withdrawal Plan, dividends and distributions
on all shares in your account must be automatically reinvested. You may
terminate the Systematic Withdrawal Plan at any time without charge or
penalty. The Fund, its transfer agent, and Legg Mason also reserve the
right to modify or terminate the Systematic Withdrawal Plan at any time.
26
<PAGE>
Withdrawal payments are treated as a sale of shares rather than
as a dividend or a capital gain distribution. These payments are taxable
to the extent that the total amount of the payments exceeds the tax basis
of the shares sold. If the periodic withdrawals exceed reinvested
dividends and other distributions, the amount of your original investment
may be correspondingly reduced.
Ordinarily, you should not purchase additional shares of the Fund
if you maintain a Systematic Withdrawal Plan because you may incur tax
liabilities in connection with such purchases and withdrawals. The Fund
will not knowingly accept purchase orders from you for additional shares
if you maintain a Systematic Withdrawal Plan unless your purchase is equal
to at least one year's scheduled withdrawals. In addition, if you
maintain a Systematic Withdrawal Plan you may not make periodic
investments under the Future First Systematic Investment Plan.
Redemption Services
-------------------
The Fund reserves the right to modify or terminate the telephone
redemption services described in the Prospectus at any time.
The date of payment may not be postponed for more than seven
days, and the right of redemption may not be suspended except (a) for any
periods during which the Exchange is closed (other than for customary
weekend and holiday closings), (b) when trading in markets the Fund
normally utilizes is restricted or an emergency, as defined by rules and
regulations of the SEC, exists, making disposal of the Fund's investments
or determination of its net asset value not reasonably practicable, or (c)
for such other periods as the SEC, by order, may permit for protection of
the Fund's shareholders. In the case of any such suspension, you may
either withdraw your request for redemption or receive payment based upon
the net asset value next determined after the suspension is lifted.
The Fund reserves the right, under certain conditions, to honor
any request for redemption, or combination of requests from the same
shareholder in any 90-day period, totalling $250,000 or 1% of the net
assets of the Fund, whichever is less, by making payment in whole or in
part by securities valued in the same way as they would be valued for
purposes of computing the Fund's net asset value per share. If payment is
made in securities, a shareholder should expect to incur brokerage
expenses in converting those securities into cash and will be subject to
fluctuation in the market price of those securities until they are sold.
The Fund does not redeem in kind under normal circumstances, but would do
so where the Adviser determines that it would be in the best interests of
the shareholders as a whole.
ADDITIONAL TAX INFORMATION
27
<PAGE>
The following is a general summary of certain federal tax
considerations affecting the Fund and its shareholders. Investors are
urged to consult their own tax advisers for more detailed information
regarding any federal, state, local or foreign taxes that may be
applicable to them.
General
-------
For federal tax purposes, the Fund is treated as a separate
corporation. In order to continue to qualify for treatment as a regulated
investment company ("RIC") under the Internal Revenue Code of 1986, as
amended ("Code"), the Fund must distribute annually to its shareholders at
least 90% of its investment company taxable income (generally, net
investment income, any net short-term capital gain and any net gains from
certain foreign currency transactions) ("Distribution Requirement") and
must meet several additional requirements. These requirements include the
following: (1) the Fund 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
or forward contracts) derived with respect to its business of investing in
securities or those currencies ("Income Requirement"); (2) the Fund must
derive less than 30% of its gross income each taxable year from the sale
or other disposition of securities, or any of the following, held for less
than three months -- options, futures or forward contracts (other than
those on foreign currencies), or foreign currencies (or options, futures
or forward contracts thereon) that are not directly related to the Fund's
principal business of investing in securities (or options and futures with
respect thereto) ("Short-Short Limitation"); (3) at the close of each
quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government
securities, securities of other RICs and other securities, with those
other securities 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;
and (4) at the close of each quarter of the Fund's taxable year, not more
than 25% of the value of its total assets may be invested in the
securities (other than U.S. government securities or the securities of
other RICs) of any one issuer.
If Fund shares are sold at a loss after being held for six months
or less, the loss will be treated as a long-term, instead of a short-term,
loss to the extent of any capital gain distributions received on those
shares. Investors also should be aware that if shares are purchased
shortly before the record date for any dividend or other distribution, the
investor will pay full price for the shares and receive some portion of
the price back as a taxable distribution.
28
<PAGE>
The Fund will be subject to a nondeductible 4% excise tax
("Excise Tax") to the extent that it fails to distribute by the end of any
calendar year substantially all of its ordinary income for that year and
capital gain net income for the one-year period ending on October 31 of
that year, plus certain other amounts. For this and other purposes,
dividends and other distributions declared by the Fund in December of any
year and payable to shareholders of record on a date in that month will be
deemed to have been paid by the Fund and received by the shareholders on
December 31 if the distributions are paid by the Fund during the following
January. Accordingly, those dividends and other distributions will be
taxed to shareholders for the year in which that December 31 falls.
Interest received by the Fund may be subject to income,
withholding or other taxes imposed by foreign countries and U.S.
possessions that would reduce the yield on the Fund's securities. Tax
conventions between certain countries and the United States may reduce or
eliminate these foreign taxes, however, and many foreign countries do not
impose taxes on capital gains in respect of investments by foreign
investors.
Options, Futures, Forward Contracts and Foreign Currencies
----------------------------------------------------------
The use of hedging instruments, such as writing (selling) and
purchasing options and futures contracts and entering into forward
contracts, involves complex rules that will determine for income tax
purposes the character and timing of recognition of the gains and losses
the Fund realizes in connection therewith.
Regulated futures contracts and options that are subject to
Section 1256 of the Code (collectively, "Section 1256 contracts") and are
held by the Fund at the end of each taxable year will be required to be
"marked-to-market" for federal income tax purposes (that is, treated as
having been sold at that time at market value). Any unrealized gain or
loss recognized under this mark-to-market rule will be added to any
realized gains and losses on Section 1256 contracts actually sold by the
Fund during the year, and the resulting gain or loss will be treated
(without regard to the holding period) as 60% long-term capital gain or
loss and 40% short-term capital gain or loss. These rules may operate to
increase the amount of dividends, which will be taxable to shareholders,
that must be distributed to meet the Distribution Requirement and avoid
imposition of the Excise Tax, without providing the cash with which to
make the distributions. The Fund may elect to exclude certain
transactions from Section 1256, although doing so may have the effect of
increasing the relative proportion of short-term capital gain (taxable as
ordinary income when distributed to the Fund's shareholders).
29
<PAGE>
Generally, the hedging transactions undertaken by the Fund may
result in "straddles" for federal income tax purposes. Because
application of the straddle rules may affect the character of gains or
losses, defer the recognition of losses and/or accelerate the recognition
of gains from the affected straddle positions, and may require the
capitalization of interest expense associated therewith, the amount that
must be distributed to shareholders (and the character of the distribution
as ordinary income or long-term capital gain) may be increased or
decreased substantially as compared to a fund that did not engage in such
hedging transactions.
Income from foreign currencies (except certain gains therefrom
that may be excluded by future regulations), and income from transactions
in options, futures and forward contracts derived by the Fund with respect
to its business of investing in securities or foreign currencies, will
qualify as permissible income under the Income Requirement. However,
income from the disposition of options and futures contracts (other than
those on foreign currencies) will be subject to the Short-Short Limitation
if they are held for less than three months. Income from the disposition
of foreign currencies, and options, futures and forward contracts thereon,
that are not directly related to the Fund's principal business of
investing in securities (or options and futures with respect thereto),
also will be subject to the Short-Short Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value
of a position that is part of a "designated hedge" will be offset by any
decrease in value (whether realized or not) of the offsetting hedging
position during the period of the hedge for purposes of determining
whether the Fund satisfies the Short-Short Limitation. Thus, only the net
gain (if any) from the designated hedge will be included in gross income
for purposes of this limitation. The Fund anticipates engaging in hedging
transactions, if any, that are intended to qualify for this treatment, but
at the present time it is not clear whether this treatment will be
available for, or that the Fund will elect to have this treatment apply
to, all hedging transactions it undertakes. To the extent this treatment
is not available, the Fund may be forced to defer the closing out of
certain options, futures and forward contracts beyond the time when it
otherwise would be advantageous to do so, in order for the Fund to
continue to qualify as a RIC.
Zero Coupon and Pay-in-Kind Securities
--------------------------------------
The Fund may acquire zero coupon securities or other securities
issued with original issue discount. As a holder of those securities, the
Fund must include in its income the original issue discount that accrues
on the securities during the taxable year, even if it receives no
30
<PAGE>
corresponding payment on the securities during the year. Similarly, the
Fund must include in its gross income securities it receives as "interest"
on pay-in-kind securities. Because the Fund annually must distribute
substantially all of its investment company taxable income, including any
earned original issue discount and other non-cash income, to satisfy the
Distribution Requirement and avoid imposition of the Excise Tax, it 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 the Fund's cash assets or from the
proceeds of sales of portfolio securities, if necessary. The Fund may
realize capital gains or losses from those sales, which would increase or
decrease its investment company taxable income and/or net capital gain
(the excess of net long-term capital gain over net short-term capital
loss). In addition, any such gains may be realized on the disposition of
securities held for less than three months. Because of the Short-Short
Limitation, any such gains would reduce the Fund's ability to sell other
securities (or certain options, futures, forward contracts or foreign
currencies), held for less than three months that it might wish to sell in
the ordinary course of its portfolio management.
Passive Foreign Investment Companies
------------------------------------
The Fund may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is a foreign corporation that, in general,
meets either of the following tests: (1) at least 75% of its gross income
is passive or (2) an average of at least 50% of its assets produce, or are
held for the production of, passive income. Under certain circumstances,
the Fund 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 disposi-
tion of that stock (collectively "PFIC income"), plus interest thereon,
even if the Fund distributes the PFIC income as a taxable dividend to its
shareholders. The balance of the PFIC income will be included in the
Fund's investment company taxable income and, accordingly, will not be
taxable to it to the extent that income is distributed to its
shareholders.
If the Fund invests in a PFIC and elects to treat the PFIC as a
"qualified electing fund," then in lieu of the foregoing tax and interest
obligation, the Fund will be required to include in income each year its
pro rata share of the qualified electing fund's annual ordinary earnings
and net capital gain, which most likely would have to be distributed to
satisfy the Distribution Requirement and avoid imposition of the Excise
Tax, even if those earnings and gain are not received by the Fund. In
most instances it will be very difficult, if not impossible, to make this
election because of certain requirements thereof.
The "Tax Simplification and Technical Corrections Bill of 1993,"
passed in May 1994 by the House of Representatives, would substantially
modify the taxation of U.S. shareholders of foreign corporations,
including eliminating the provisions described above dealing with PFICS
31
<PAGE>
and replacing them (and other provisions) with a regulatory scheme
involving entities called "passive foreign corporations." Three similar
bills were passed by Congress in 1991 and 1992 and were vetoed. It is
unclear at this time whether, and in what form, the proposed modifications
may be enacted into law.
Pursuant to proposed regulations, open-end RICs, such as the
Fund, would be entitled to elect to "mark-to-market" their stock in
certain PFICs. "Marking-to-market," in this context, means recognizing as
gain for each taxable year the excess, as of the end of that year, of the
fair market value of each such PFIC's stock over the adjusted basis in
that stock (including mark-to-market gain for each prior year for which an
election was in effect).
Foreign Currencies
------------------
Gains or losses attributable to fluctuations in exchange rates
that occur between the time the Fund accrues dividends, interest or other
receivables or accrues expenses or other liabilities denominated in a
foreign currency and the time the Fund actually collects the receivables
or pays the liabilities generally are treated as ordinary income or
ordinary loss. Similarly, on disposition of a debt security denominated
in a foreign currency or of a forward contract on a foreign currency,
gains or losses attributable to fluctuations in the value of the foreign
currency between the date of acquisition of the security or contract and
the date of disposition also are treated as ordinary gain or loss. These
gains or losses, referred to under the Code as "Section 988" gains or
losses, may increase or decrease the amount of the Fund's investment
company taxable income to be distributed to its shareholders.
Miscellaneous
-------------
If the Fund invests in shares of common stock or preferred stock
or otherwise holds dividend-paying securities as a result of exercising a
conversion privilege, a portion of the dividends from its investment
company taxable income (whether paid in cash or reinvested in additional
Fund shares) may be eligible for the dividends-received deduction allowed
to corporations. The eligible portion may not exceed the aggregate
dividends received by the Fund from U.S. corporations. However, dividends
received by a corporate shareholder and deducted by it pursuant to the
dividends-received deduction are subject indirectly to the alternative
minimum tax.
32
<PAGE>
TAX-DEFERRED RETIREMENT PLANS
As noted in the Fund's Prospectus, an investment in Fund shares
may be appropriate for IRAs, Keogh Plans, SEPs and other qualified
retirement plans. In general, income earned through the investment of
assets of those accounts and plans is not taxed to their beneficiaries
until the income is distributed to them. Investors who are considering
establishing such an account or plan should consult their tax advisers
with respect to individual tax questions. The option of investing in
these accounts or plans through regular payroll deductions may be arranged
with a Legg Mason or affiliated investment executive and your employer.
Additional information with respect to these accounts and plans is
available upon request from any Legg Mason or affiliated investment
executive.
Individual Retirement Account - IRA
-----------------------------------
Certain investors may obtain tax advantages by establishing IRAs.
Specifically, if neither you nor your spouse is an active participant in a
qualified employer or government retirement plan, or if either you or your
spouse is an active participant and your adjusted gross income does not
exceed a certain level, you may deduct cash contributions made to an IRA
in an amount for each taxable year not exceeding the lesser of 100% of
your earned income or $2,000. In addition, if your spouse is not employed
and you file a joint return, you may establish a separate IRA for your
spouse and contribute up to a total of $2,250 to the two IRAs, provided
that the contribution to either does not exceed $2,000. If you and your
spouse are both employed and neither of you is an active participant in a
qualified employer or government retirement plan and you establish
separate IRAs, you each may contribute all of your earned income, up to
$2,000 each, and thus may together receive tax deductions of up to $4,000
for contributions to your IRAs. If your employer's plan qualifies as a
SEP, permits voluntary contributions and meets certain requirements, you
may make voluntary contributions to that plan that are treated as
deductible IRA contributions.
Even if you are not in one of the categories described in the
preceding paragraph, you may find it advantageous to invest in shares of
the Fund through nondeductible IRA contributions, up to certain limits,
because all dividends and other distributions on your Fund shares are then
not immediately taxable to you or the IRA; they become taxable only when
distributed to you. To avoid penalties, your interest in an IRA must be
distributed, or start to be distributed, to you not later than the end of
the taxable year in which you attain age 70-1/2. Distributions made
before age 59-1/2, in addition to being taxable, generally are subject to
a penalty equal to 10% of the distribution, except in the case of death or
disability or where the distribution is rolled over into another qualified
plan or certain other situations.
Self-Employed Individual Retirement Plan-Keogh Plan
33
<PAGE>
---------------------------------------------------
Legg Mason makes available to self-employed individuals a Plan
and Trustee Agreement for a Keogh Plan through which Fund shares may be
purchased. You have the right to use a bank of your own choice to provide
these services at your own cost. There are penalties for distributions
from a Keogh Plan prior to age 59-1/2, except in the case of death or
disability.
Simplified Employee Pension Plan-SEP
------------------------------------
Legg Mason makes available to corporate and other employers a SEP
for investment in Fund shares.
Withholding at the rate of 20% is required for federal income tax
purposes on distributions eligible for rollover from the foregoing
retirement plans (except IRAs and SEPs), unless the recipient transfers
the distribution directly to an "eligible retirement plan" (including IRAs
and other qualified plans) that accepts those distributions. Other
distributions generally are subject to regular wage withholding or
withholding at the rate of 10% (depending on the type and amount of the
distribution), unless the recipient elects not to have any withholding
apply. Please consult your plan administrator or tax adviser for further
information.
PERFORMANCE INFORMATION
Total Return Calculations Average annual total return quotes used
in the Fund's advertising and other promotional materials ("Performance
Advertisements") are calculated according to the following formula:
n
P(1+T) = ERV
where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of that period.
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated at
least to the last day of the most recent quarter prior to submission of
the Performance Advertisements for publication. Total return, or "T" in
the formula above, is computed by finding the average annual change in the
value of an initial $1,000 investment over the period. In calculating the
ending redeemable value all dividends and other distributions by the Fund
are assumed to have been reinvested at net asset value on the reinvestment
dates during the period.
34
<PAGE>
Yield Yields used in the Fund's Performance Advertisements are
calculated by dividing the Fund's net investment income for a 30-day
period ("Period"), by the average number of shares entitled to receive
dividends during the Period, and expressing the result as an annualized
percentage (assuming semi-annual compounding) of the maximum offering
price per share at the end of the Period. Yield quotations are calculated
according to the following formula:
6
Yield = 2 [(a-b +1) - 1]
---
cd
where: a = 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.
Except as noted below, in determining net investment income
earned during the Period (variable "a" in the above formula), the Fund
calculates interest earned on each debt obligation held by it during the
Period by (1) computing the obligation's yield to maturity based on the
market value of the obligation (including actual accrued interest) on the
last business day of the Period or, if the obligation was purchased during
the Period, the purchase price plus accrued interest and (2) dividing the
yield to maturity by 360, and multiplying the resulting quotient by the
market value of the obligation (including actual accrued interest). Once
interest earned is calculated in this fashion for each debt obligation
held by the Fund, interest earned during the Period is then determined by
totalling the interest earned on all debt obligations. For the purposes
of these calculations, the maturity of an obligation with one or more call
provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date.
The Fund's yield for the thirty-day period ended December 31, 1994 was
9.42%.
With respect to the treatment of discount and premium on
mortgage-backed and other asset-backed obligations that are expected to be
subject to monthly payments of principal and interest ("paydowns"): (1)
the Fund accounts for gain or loss attributable to actual paydowns as an
increase or decrease to interest income during the period and (2) the Fund
accrues the discount and amortizes the premium on the remaining
obligation, based on the cost of the obligation, to the weighted average
maturity date or, if weighted average maturity information is not
available, to the remaining term of the obligation.
Other Information In Performance Advertisements the Fund may compare its
total return with data published by Lipper Analytical Services, Inc.
("Lipper") for U.S. government funds, corporate bond (BBB) funds, CDA
Investment Technologies, Inc. ("CDA"), Wiesenberger Investment Companies
35
<PAGE>
Service ("Wiesenberger"), or Morningstar Mutual Funds ("Morningstar"), or
with the performance of U.S. Treasury securities of various maturities,
recognized stock, bond and other indexes, including (but not limited to)
the Salomon Brothers Bond Index, Shearson Lehman Bond Index, Shearson
Lehman Government/Corporate Bond Index, the Standard & Poor's 500
Composite Stock Price Index ("S&P 500"), the Dow Jones Industrial Average
("Dow Jones"), and changes in the Consumer Price Index as published by the
U.S. Department of Commerce. The Fund also may refer in such materials to
mutual fund performance rankings and other data, such as comparative
asset, expense and fee levels, published by Lipper, CDA, Wiesenberger or
Morningstar. Performance Advertisements also may refer to discussions of
the Fund and comparative mutual fund data and ratings reported in
independent periodicals, including (but not limited to) THE WALL STREET
JOURNAL, MONEY Magazine, FORBES, BUSINESS WEEK, FINANCIAL WORLD, BARRONS,
FORTUNE and THE NEW YORK TIMES.
The Fund invests primarily in the fixed-income securities
described in its Prospectus, and does not invest in the equity securities
that make up the S&P 500 or the Dow Jones indices. Comparison with such
indices is intended to show how an investment in the Fund behaved as
compared to indices that are often taken as a measure of performance of
the equity market as a whole. The indices, like the Fund's total return,
assume reinvestment of all dividends and other distributions. They do not
take into account the costs or the tax consequences of investing.
The Fund may include discussions or illustrations of the effects
of compounding in performance advertisements. "Compounding" refers to the
fact that, if dividends or other distributions on the Fund investment are
reinvested by being paid in additional Fund shares, any future income or
capital appreciation of the Fund would increase the value, not only of the
original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been
paid in cash.
The Fund may also compare its performance with the performance of
bank certificates of deposit (CDs) as measured by the CDA Investment
Technologies, Inc. Certificate of Deposit Index and the Bank Rate Monitor
National Index. In comparing the Fund's performance to CD performance,
investors should keep in mind that bank CDs are insured in whole or in
part by an agency of the U.S. government and offer fixed principal and
fixed or variable rates of interest, and that bank CD yields may vary.
Fund shares are not insured or guaranteed by the U.S. Government and
returns and net asset value will fluctuate. The securities held by the
Fund generally have longer maturities than most CDs and may reflect
interest rate fluctuations for longer-term securities.
Fund advertisements may reference the history of the distributor
and its affiliates, and the education and experience of the portfolio
manager. Advertisements may also describe techniques the Adviser employs
in selecting among the sectors of the fixed-income market and adjusting
36
<PAGE>
average portfolio maturity. In particular, the advertisements may focus on
the techniques of "value investing". With value investing, the Adviser
invests in those securities it believes to be undervalued in relation to
the long-term earning power or asset value of their issuers. Securities
may be undervalued because of many factors, including market decline, poor
economic conditions, tax-loss selling, or actual or anticipated
unfavorable developments affecting the issuer of the security.
In advertising, the Fund may illustrate hypothetical investment
plans designed to help investors meet long-term financial goals, such as
saving for a child's college education or for retirement. Sources such as
the Internal Revenue Service, the Social Security Administration, the
Consumer Price Index and Chase Global Data and Research may supply data
concerning interest rates, college tuitions, the rate of inflation, Social
Security benefits, mortality statistics and other relevant information.
The Fund may use other recognized, reliable sources as they become
available.
The Fund may use data prepared by Ibbotson Associates of Chicago,
Illinois ("Ibbotson") to compare the returns of various capital markets
and to show the value of a hypothetical investment in a capital market.
Ibbotson relies on different indices to calculate the performance of
common stocks, corporate and government bonds and Treasury bills.
The Fund may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is
represented by the performance of an appropriate market index, such as the
S&P 500 and the performance of bonds is represented by a nationally
recognized bond index, such as the Lehman Brothers Long-Term Government
Bond Index.
The Fund may also include in advertising biographical information
on key investment and managerial personnel.
The Fund may advertise examples of the potential benefits of
periodic investment plans, such as dollar cost averaging, a long-term
investment technique designed to lower average cost per share. Under such
a plan, an investor invests in a mutual fund at regular intervals a fixed
dollar amount thereby purchasing more shares when prices are low and fewer
shares when prices are high. Although such a plan does not guarantee
profit or guard against loss in declining markets, the average cost per
share could be lower than if a fixed number of shares were purchased at
the same intervals. Investors should consider their ability to purchase
shares through low price levels.
The Fund may discuss Legg Mason's tradition of service. Since
1899, Legg Mason and its affiliated companies have helped investors meet
37
<PAGE>
their specific investment goals and have provided a full spectrum of
financial services. Legg Mason affiliates serve as investment advisors
for private accounts and mutual funds with assets of more than $17 billion
as of December 31, 1994.
In advertising, the Fund may discuss the advantages of saving
through tax-deferred retirement plans or accounts, including the
advantages and disadvantages of "rolling over" a distribution from a
retirement plan into an IRA, factors to consider in determining whether
you qualify for such a rollover, and the other options available. These
discussions may include graphs or other illustrations that compare the
growth of a hypothetical tax-deferred investment to the after-tax growth
of a taxable investment.
The following table shows the value, as of the end of each fiscal
year, of a hypothetical investment of $15,000 made in the Fund at the
Fund's commencement of opertions on February 1, 1994. The table assumes
that all dividends and other distributions are reinvested in the Fund. It
includes the effect of all charges and fees applicable to shares the Fund
has paid. (There are no fees for investing or reinvesting in the Fund,
and there are no redemption fees.) It does not include the effect of any
income taxes that an investor would have to pay on distributions.
Value of Original Shares Value of Shares
Plus Shares Obtained Acquired Through
Fiscal Through Reinvestment of Reinvestment of Income Total
Year Capital Gain Distributions Dividends Value
1994* $13,560 $1,006 $14,566
*February 1, 1994 (commencement of operations) to December 31 1994.
If the investor had not reinvested dividends and other
distributions, the total value of the hypothetical investment as of
December 31, 1994 would have been $13,560, and the investor would have
received a total of $1,012 in distributions.
VALUATION OF FUND SHARES
Net asset value of a Fund share is determined daily as of the
close of the Exchange, on every day that the Exchange is open, by dividing
the value of the total assets of the Fund, less liabilities, by the number
of shares outstanding. Pricing will not be done on days when the Exchange
38
<PAGE>
is closed. The Exchange currently observes the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving and Christmas. When market quotations for
institutional size positions are readily available, portfolio securities
are valued based upon market quotations. Where such market quotations are
not readily available, securities are valued based upon appraisals
received from a pricing service using a computerized matrix system or
based upon appraisals derived from information concerning the security or
similar securities received from recognized dealers in those securities.
The methods used by the pricing service and the quality of the valuations
so established are reviewed by the Adviser under the general supervision
of the Corporation's Board of Directors. The amortized cost method of
valuation is used with respect to obligations with 60 days or less
remaining to maturity unless the Adviser determines that this does not
represent fair value. Foreign securities denominated in foreign currency
generally are valued at the U.S. dollar equivalents at the spot currency
value as reported by a major New York bank. All other securities are
valued at fair value as determined by or under the direction of the Fund's
Board of Directors. Premiums received on the sale of call options are
included in the Fund's net asset value, and the current market value of
options sold by the Fund will be subtracted from net assets.
THE CORPORATION'S DIRECTORS AND OFFICERS
The Corporation's officers are responsible for the operation of
the Fund under the supervision of the Board of Directors. The officers
and directors of the Corporation and their principal occupations during
the past five years are set forth below. An asterisk (*) indicates those
officers and/or directors who are interested persons of the Corporation as
defined by the 1940 Act. The business address of each officer and
director is 111 South Calvert Street, Baltimore, Maryland 21202, unless
otherwise indicated.
JOHN F. CURLEY, JR.*, [55] Chairman of the Board and Director;
Vice Chairman and Director of Legg Mason Wood Walker, Inc. and Legg Mason,
Inc.; Director of Legg Mason Fund Adviser, Inc. and Western Asset
Management Company; Officer and/or Director of various other affiliates of
Legg Mason, Inc.; President and Director of three Legg Mason funds;
Chairman of the Board, President and Trustee of one Legg Mason fund;
Chairman of the Board and Director of three Legg Mason funds; and Chairman
of the Board and Trustee of one Legg Mason fund.
EDWARD A. TABER, III,* [51] President and Director; Executive Vice-
President of Legg Mason, Inc. and Legg Mason Wood Walker, Inc.; Vice-
Chairman and Director of Legg Mason Fund Adviser, Inc.; Director of three
Legg Mason funds; President and Director of two other Legg Mason funds;
Trustee of one Legg Mason fund; and Vice President of Worldwide Value
Fund, Inc. Formerly: Executive Vice President of T. Rowe Price-Fleming
39
<PAGE>
International, Inc. (1986-1992) and Director of the Taxable Fixed Income
Division at T. Rowe Price Associates, Inc. (1973-1992).
EDMUND J. CASHMAN, JR.*, [58] Vice Chairman and Director; Senior
Executive Vice President and Director of Legg Mason, Inc.; Officer and/or
Director of various other affiliates of Legg Mason, Inc.; President and
Director of one Legg Mason fund; President and Trustee of one Legg Mason
fund; and Director of Worldwide Value Fund, Inc.
RICHARD G. GILMORE, [67] Director; 5534 Chanteclaire, Sarasota,
Florida. Independent Consultant; Director of CSS Industries, Inc.
(diversified holding company engaged in manufacture and sale of decorative
paper products, business forms, and specialty metal packaging); Director
of PECO Energy Company (formerly Philadelphia Electric Company); Director
of six Legg Mason funds; Trustee of one Legg Mason fund. Formerly: Senior
Vice President and Chief Financial Officer of Philadelphia Electric
Company (electric and gas utility) (now PECO Energy Company); Executive
Vice President and Treasurer, Girard Bank, and Vice President of its
parent holding company, the Girard Company (bank holding company) and
Director of Finance, City of Philadelphia.
CHARLES F. HAUGH, [69] Director; 14201 Laurel Park Drive, Laurel,
Maryland. Real Estate Developer and Investor; President and Director of
Resource Enterprises, Inc. (real estate brokerage; Chairman of Resource
Realty LLC (management of retail and office space); Partner in Greater
Laurel Health Park Ltd. Partnership (real estate investment and
development); Director of six Legg Mason funds; Trustee of two Legg Mason
funds.
ARNOLD L. LEHMAN, [51] Director; The Baltimore Museum of Art, Art
Museum Drive, Baltimore, Maryland. Director of the Baltimore Museum of
Art; Director of six Legg Mason funds; Trustee of two Legg Mason funds.
JILL E. McGOVERN, [50] Director; 1500 Wilson Boulevard,
Arlington, Virginia. Chief Executive Officer of the Marrow Foundation.
Director of six Legg Mason funds; Trustee of two Legg Mason funds.
Formerly: Executive Director of the Baltimore International Festival,
January 1991-March 31, 1993; Senior Assistant to the President of the
Johns Hopkins University (1986-1991).
T. A. RODGERS, [60] Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T. A. Rodgers & Associates (management consulting);
Director of six Legg Mason funds; Trustee of one Legg Mason fund.
Formerly: Partner, Bufka & Rodgers (investment counsellors), June 1987-
April 1990; Director and Vice President of Corporate Development, Polk
Audio, Inc. (manufacturer of audio components).
40
<PAGE>
The executive officers of the Fund, other than those who also
serve as directors, are:
MARIE K. KARPINSKI*, [46] Vice President and Treasurer; Vice
President and Treasurer of the Adviser; Vice President and Treasurer of
eight Legg Mason funds; Vice President, Secretary and Treasurer of
Worldwide Value Fund, Inc.; Vice President of Legg Mason Wood Walker,
Inc.
STEFANIE L. WONG*, [27] Secretary; Secretary of Legg Mason
Investors Trust, Inc.; employee of Legg Mason since 1990. Prior to 1990,
full-time student.
BLANCHE P. ROCHE*, [46] Assistant Secretary and Assistant Vice
President; Assistant Secretary and Assistant Vice President of seven Legg
Mason funds; employee of Legg Mason since 1991. Formerly: Manager of
Consumer financial services (1989-1991).
41
<PAGE>
COMPENSATION TABLE
------------------
Pension Total
or Compensa-
Retire- tion From
ment Estimated Corpora-
Aggregate Benefits Annual tion and
Compensa- Accrued Benefits Fund
tion From as Part Upon Complex
Name of Person and Corpora- of Fund Retire- Paid to
Position tion Expenses ment Directors
John F. Curley, Jr. -
Chairman of the Board
and Director None N/A N/A None
Edward A. Taber, III -
President and Director None N/A N/A None
Marie K. Karpinski -
Vice President and
Treasurer None N/A N/A None
Edmund J. Cashman -
Vice Chairman and
Director None N/A N/A None
Richard G. Gilmore -
Director $6,000 N/A N/A $21,600
Charles F. Haugh -
Director $6,000 N/A N/A $23,600
Arnold L. Lehman -
Director $6,000 N/A N/A $23,600
Jill E. McGovern -
Director $6,000 N/A N/A $23,600
T. A. Rodgers -
Director $6,000 N/A N/A $21,600
The information provided above is for the year ended December 31, 1994.
42
<PAGE>
Officers and directors of the Corporation who are interested
persons of the Corporation receive no salary or fees from the Fund.
Independent Directors of the Corporation receive a fee of $1,500 annually
for serving as a director. For the fiscal year ended December 31, 1994,
the present independent directors as a group received a total of $7,500
from the Fund.
On February 28, 1995, the directors and officers of the Fund
beneficially owned in the aggregate less than 1% of the Fund's outstanding
shares.
The Nominating Committee of the Board of Directors is responsible
for the selection and nomination of disinterested directors. The
Committee is composed of Messrs. Haugh, Gilmore, Lehman, Rodgers and Dr.
McGovern.
THE FUND'S MANAGER
The Manager, Legg Mason Fund Adviser, Inc., 111 South Calvert
Street, Baltimore, Maryland 21202, is a wholly owned subsidiary of Legg
Mason, Inc., which also is the parent of Legg Mason Wood Walker,
Incorporated. The Manager serves as the Fund's manager under an
Investment Management Agreement ("Management Agreement") dated January 24,
1994, which was approved by the Corporation's Board of Directors,
including a majority of the directors who are not "interested persons" (as
defined in the 1940 Act) of the Corporation, the Manager or the Adviser on
October 22, 1993. The Management Agreement provides that, subject to
overall direction by the Board of Directors, the Manager manages the
investment and other affairs of the Fund. The Manager is responsible for
managing the Fund's securities and for making purchases and sales of
securities consistent with the Fund's investment objectives and policies
described in its Prospectus and this Statement of Additional Information.
The Manager is obligated to furnish the Fund with office space and
executive and other personnel necessary for the operations of the Fund.
The Manager and its affiliates are also responsible for the compensation
of directors and officers of the Corporation who are employees of the
Manager and/or its affiliates. In accordance with the Management
Agreement, the Manager has delegated the portfolio management functions
for the Fund to the Adviser, Western Asset Management Company.
As explained in the Fund's Prospectus, the Manager receives for
its services to the Fund, a management fee, calculated daily and payable
monthly, at an annual rate equal to 0.65% of the Fund's average daily net
assets. The management fee paid by the Fund may be reduced under state
regulations that impose limitations on the annual expense ratio of the
Fund. The most restrictive state limitation currently requires that the
Manager reimburse the Fund for certain expenses, including the management
fees received by it (but, in the Manager's opinion, excluding interest,
43
<PAGE>
taxes, brokerage fees and commissions, distribution fees and certain
extraordinary charges), in any fiscal year in which the Fund's expenses
exceed 2.5% of the first $30 million of the Fund's average net assets,
2.0% of the next $70 million of average net assets, and 1.5% of average
net assets in excess of $100 million. No reimbursements have been made
nor have any been required to be made pursuant to this undertaking. For
the period February 1, 1994 (commencement of operations) to December 31,
1994, the Fund paid fees of $253,100 to the Manager.
Under the Management Agreement, the Manager will not be liable
for any error of judgment or mistake of law or for any loss suffered by
the Fund in connection with the performance of the Management Agreement,
except a loss resulting from a breach of fiduciary duty with respect to
the receipt of compensation for services or a loss resulting from willful
misfeasance, bad faith or gross negligence on its part in the performance
of its duties or from reckless disregard by it of its obligations or
duties thereunder.
The Management Agreement terminates automatically upon assignment
and is terminable at any time without penalty by vote of the Corporation's
Board of Directors, by vote of a majority of the Fund's outstanding voting
securities, or by the Manager, on not less than 60 days' written notice to
the Fund, and may be terminated immediately upon the mutual written
consent of the Manager and the Fund.
The Fund pays all of its expenses which are not expressly assumed
by the Manager. These expenses include, among others, interest expense,
taxes, brokerage fees and commissions, expenses of preparing and printing
prospectuses, statements of additional information, proxy statements and
reports and of distributing them to existing shareholders, custodian
charges, transfer agency fees, organizational expenses, distribution fees
to the Fund's distributor, compensation of the independent directors,
legal, accounting and audit expenses, insurance expenses, expenses of
registering and qualifying shares of the Fund for sale under federal and
state law, governmental fees and expenses incurred in connection with
membership in investment company organizations. The Fund also is liable
for such nonrecurring expenses as may arise, including litigation to which
the Fund may be a party. The Fund may also have an obligation to
indemnify the directors and officers of the Corporation with respect to
any such litigation.
Under the Management Agreement, the Fund has the non-exclusive
right to use the name "Legg Mason" until that Agreement is terminated or
until the right is withdrawn in writing by the Manager.
INVESTMENT ADVISORY AGREEMENT
The Adviser, Western Asset Management Company, 117 East Colorado
Boulevard, Pasadena, CA 91105, an affiliate of Legg Mason, serves as
investment adviser to the Fund under an Investment Advisory Agreement
44
<PAGE>
dated January 24, 1994, between the Adviser and the Manager ("Advisory
Agreement"). The Advisory Agreement was approved by the Board of
Directors, including a majority of the directors who are not "interested
persons" (as that term is defined in the 1940 Act) of the Corporation,
the Adviser or the Manager, on October 22, 1993.
Under the Advisory Agreement, the Adviser is responsible, subject
to the general supervision of the Manager and the Corporation's Board of
Directors, for the actual management of the Fund's assets, including the
responsibility for making decisions and placing orders to buy, sell or
hold a particular security. For the Adviser's services to the Fund, the
Manager (not the Fund) pays the Adviser a fee, computed daily and payable
monthly, at an annual rate equal to 77% of the fee received by the Manager
from the Fund. For the period February 1, 1994 (commencement of
operations) to December 31, 1994, the Manager paid the Adviser fees of
$194,887.
Under the Advisory Agreement, the Adviser will not be liable for
any error of judgment or mistake of law or for any loss suffered by the
Manager or by the Fund in connection with the performance of the Advisory
Agreement, except a loss resulting from a breach of fiduciary duty with
respect to the receipt of compensation for services or a loss resulting
from willful misfeasance, bad faith or gross negligence on its part in the
performance of its duties or from reckless disregard by it of its
obligations or duties thereunder.
The Advisory Agreement terminates automatically upon assignment
and is terminable at any time without penalty by vote of the Corporation's
Board of Directors, by vote of a majority of the Fund's outstanding voting
securities, by the Manager or by the Adviser, on not less than 60 days'
written notice to the Fund and/or the other party(ies). The Advisory
Agreement terminates immediately upon any termination of the Management
Agreement or upon the mutual written consent of the Adviser, the Manager
and the Fund.
To mitigate the possibility that the Fund will be affected by
personal trading of employees, the Corporation, the Manager and the
Adviser have adopted policies that restrict securities trading in the
personal accounts of portfolio managers and others who normally come into
advance possession of information on portfolio transactions. These
policies comply, in all material respects, with the recommendations of the
Investment Company Institute.
THE FUND'S DISTRIBUTOR
Legg Mason acts as distributor of the Fund's shares pursuant to
an Underwriting Agreement with the Corporation. The Underwriting
Agreement obligates Legg Mason to pay certain expenses in connection with
the offering of the Fund's shares, including compensation to its
investment executives. Legg Mason also pays for the printing and
45
<PAGE>
distribution of prospectuses and periodic reports used in connection with
the offering to prospective investors (after the prospectuses and reports
have been prepared, set in type and mailed to existing shareholders at the
Fund's expense) and for supplementary sales literature and advertising
costs.
For the period February 1, 1994 (commencement of operations) to
December 31, 1994, Legg Mason incurred the following expenses:
Compensation to sales personnel $122,000
Printing and mailing of prospectuses
to prospective shareholders 39,000
Advertising 86,000
Other 678,000
-------
Total expenses $925,000
========
The Corporation has adopted a Distribution and Shareholder Services
Plan ("Plan") which, among other things, permits the Fund to pay Legg
Mason fees for its services related to sales and distribution of Fund
shares and the provision of ongoing services to shareholders. The Plan
was adopted, as required by Rule 12b-1 under the 1940 Act, by a vote of
the Board of Directors on October 22, 1993, including a majority of the
directors who are not "interested persons" of the Corporation as that term
is defined in the 1940 Act and who have no direct or indirect financial
interest in the operation of the Plan or the Underwriting Agreement ("12b-
1 directors"). The Plan was approved by Legg Mason Fund Adviser, Inc., as
sole shareholder of the Fund, on December 29, 1993. Continuation of the
Plan was most recently approved by the Board of Directors on October 21,
1994, including a majority of the 12b-1 directors. In approving the
continuance of the Plan, in accordance with the requirements of Rule 12b-
1, the directors considered various factors, including the amount of the
distribution fee. The directors determined that there is a reasonable
likelihood that the Plan will continue to benefit the Fund and its present
and future shareholders.
The Plan continues in effect only so long as it is approved at least
annually by the vote of a majority of the Board of Directors, including a
majority of the 12b-1 directors, cast in person at a meeting called for
the purpose of voting on the Plan. The Plan may be terminated with
respect to the Fund by a vote of a majority of the 12b-1 directors or by
vote of a majority of the outstanding voting securities of the Fund. Any
change in the Plan that would materially increase the distribution costs
to the Fund requires shareholder approval; otherwise, the Plan may be
amended by the directors, including a majority of the 12b-1 directors.
46
<PAGE>
Rule 12b-1 requires that any person authorized to direct the
disposition of monies paid or payable by the Fund, pursuant to the Plan or
any related agreement, shall provide to the Corporation's Board of
Directors, and the directors shall review, at least quarterly, a written
report of any amounts expended pursuant to the Plan and the purposes for
which such expenditures were made. In addition, as long as the Plan is in
effect, the selection and nomination of the directors who are not
interested persons of the Corporation will be committed to the discretion
of such non-interested directors.
As compensation for its services and expenses, Legg Mason receives
from the Fund, annual distribution and service fees each equivalent to
0.25% of the Fund's average daily net assets in accordance with the Plan.
The distribution and service fees are computed daily and paid monthly.
For the period February 1, 1994 (commencement of operations) to December
31, 1994, the Fund paid distribution and service fees of $194,692 to Legg
Mason pursuant to the Underwriting Agreement.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The portfolio turnover rate is computed by dividing the lesser of
purchases or sales of securities for the period by the average value of
portfolio securities for that period. Short-term securities are excluded
from the calculation. For the period February 1, 1994 (commencement of
operations) to December 31, 1994, the Fund's annualized portfolio turnover
rate was 67.39%.
Under the Advisory Agreement, the Adviser is responsible for the
execution of the Fund's portfolio transactions and must seek the most
favorable price and execution for such transactions, subject to the
possible payment (as described below) of higher brokerage commissions or
spreads to brokers who provide research and analysis. The Fund may not
always pay the lowest commission or spread available. Rather, the
Adviser also will take into account such factors as size of the order,
difficulty of execution, efficiency of the executing broker's facilities
(including the services described below), and any risk assumed by the
executing broker.
Consistent with the policy of most favorable price and execution, the
Adviser may give consideration to research, statistical and other services
furnished by brokers or dealers to the Adviser for its use, may place
orders with broker-dealers who provide supplemental investment and market
research and securities and economic analysis, and may, for agency
transactions, pay to those broker-dealers a higher brokerage commission
than may be charged by other brokers. Such services include, without
limitation, advice as to the value of securities; the advisability of
investing in, purchasing, or selling securities; advice as to the
availability of securities or of purchasers or sellers of securities; and
furnishing analyses and reports concerning issuers, industries,
securities, economic factors and trends, portfolio strategy and the
47
<PAGE>
performance of accounts. Such research and analysis may be useful to the
Adviser in connection with services to clients other than the Fund. The
Adviser's fee is not reduced by reason of its receiving such brokerage and
research services. For the period February 1, 1994 (commencement of
operations) to December 31, 1994, the Fund paid no brokerage commissions.
From time to time, the Fund may use Legg Mason as broker for agency
transactions in listed and over-the-counter securities at commission rates
and under circumstances consistent with the policy of best execution.
Commissions paid to Legg Mason will not exceed "usual and customary
brokerage commissions." Rule 17e-1 under the 1940 Act defines "usual and
customary" commissions to include amounts which are "reasonable and fair
compared to the commission, fee or other remuneration received or to be
received by other brokers in connection with comparable transactions
involving similar securities being purchased or sold on a securities
exchange during a comparable period of time." The Adviser also selects
other brokers to execute portfolio transactions. In the over-the-counter
market, the Fund generally deals with responsible primary market-makers
unless the Adviser believes a more favorable execution can otherwise be
obtained.
The Fund may not buy securities from, or sell securities to, Legg
Mason or its affiliated persons as principal. However, the Corporation's
Board of Directors has adopted procedures in conformity with Rule 10f-3
under the 1940 Act whereby the Fund may purchase securities that are
offered in certain underwritings in which Legg Mason or any of its
affiliated persons is a participant. These procedures, among other
things, limit the Fund's investment in the amount of securities of any
class of securities offered in an underwriting in which Legg Mason or any
of its affiliated persons is a participant so that: (i) the Fund together
with all other registered investment companies advised by the Adviser, may
not purchase more than 4% of the principal amount of the offering of such
class or $500,000 in principal amount, whichever is greater, but in no
event greater than 10% of the principal amount of the offering; and (ii)
the consideration to be paid by the Fund in purchasing the securities
being offered may not exceed 3% of the total assets of the Fund. In
addition, the Fund may not purchase securities during the existence of an
underwriting if Legg Mason is the sole underwriter of those securities.
Investment decisions for the Fund are made independently from those of
other accounts advised by the Adviser. However, the same security may be
held in the portfolios of more than one fund or account. When two or more
accounts simultaneously engage in the purchase or sale of the same
security, the prices and amounts will be equitably allocated to each
account. In some cases, this procedure may adversely affect the price or
quantity of the security available to a particular account. In other
cases, however, an account's ability to participate in large-volume
transactions may produce better executions and prices.
THE FUND'S CUSTODIAN AND
TRANSFER AND DIVIDEND-DISBURSING AGENT
48
<PAGE>
State Street Bank and Trust Company ("State Street"), P.O. Box 1790,
Boston, Massachusetts 02105, serves as custodian of the Fund's assets.
Boston Financial Data Services serves as transfer and dividend-disbursing
agent, and administrator of various shareholder services. Legg Mason also
assists BFDS with certain of its duties as transfer agent for which BFDS
pays Legg Mason a fee. For the period February 1, 1994 (commencement of
operations) to December 31, 1994, Legg Mason received $9,327 for such
services in connection with this Fund. Shareholders who request an
historical transcript of their account will be charged a fee based on the
number of years researched. The Fund reserves the right, upon 60 days'
written notice, to make other charges to investors to cover administrative
costs.
THE CORPORATION'S LEGAL COUNSEL
Kirkpatrick & Lockhart, 1800 M Street, N.W., Washington, D.C. 20036,
serves as counsel to the Fund.
THE CORPORATION'S INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 217 E. Redwood Street, Baltimore, MD. 21202,
have been selected by the Fund to serve as the Fund's independent
accountants.
FINANCIAL STATEMENTS
The Statement of Net Assets as of December 31, 1994; the Statement of
Operations for the period ended December 31, 1994; the Statement of
Changes in Net Assets for the period February 1, 1994 (commencement of
operations) to December 31, 1994; the Financial Highlights for the period
February 1, 1994 (commencement of operations) to December 31, 1994; the
Notes to Financial Statements and the Report of the Independent
Accountants, all of which are included in the Fund's annual report for the
period ended December 31, 1994, are hereby incorporated by reference in
this Statement of Additional Information.
49
<PAGE>
Legg Mason Income Trust, Inc.
Part C. Other Information
-----------------
Item 24. Financial Statements and Exhibits
---------------------------------
(a) Financial Statements: The financial statements of each of the
U.S. Government Intermediate-Term Portfolio - Primary Shares,
Investment Grade Income Portfolio and U.S. Government Money
Market Portfolio for the year ended December 31, 1994 and the
reports thereon of the independent accountants are incorporated
into the Statement of Additional Information of the respective
Portfolios by reference Portfolio's Annual Report to
Shareholders for the same period.
The finanical statements for the Navigator U.S. Government
Intermediate-Term Portfolio for the period December 1, 1994
(commencement of operations) to December 31, 1994 and the
report thereon of the independent accountants are
incorporated into the Statement of Additional Information
by reference to the Portfolio's Annual Report to
Shareholders for the same period.
The financial statements for the High Yield Portfolio for
the period February 1, 1994 (commencement of operations) to
December 31, 1994 and the report thereon of the independent
accountants is incorporated into the Statement of
Additional Information by reference to the Portfolio's
Annual Report to Shareholders for the same period.
The Financial Data Schedules of the above series appear as
Exhibits 27.1 through 27.5.
(b) Exhibits
(1) (a) Articles of Incorporation1/
(b) Articles Supplementary2/
(c) Articles Supplementary9/
(d) Articles Supplementary11/
(e) Articles Supplementary12/
(2) (a) Amended By-Laws2/
(b) Amendment to By-Laws (effective May 10, 1991)8/
(3) Voting Trust Agreement - none
(4) Specimen Security
(a) U.S. Government Intermediate-Term Portfolio3/
(b) Investment Grade Income Portfolio3/
<PAGE>
(c) U.S. Government Money Market Portfolio4/
(d) High Yield Portfolio11/
(5) (a) Management Agreement
(i) U.S. Government Intermediate-Term Portfolio5/
(ii) Investment Grade Income Portfolio5/
(iii) U.S. Government Money Market Portfolio4/
(iv) High Yield Portfolio12/
(b) Investment Advisory Agreement
(i) U.S. Government Intermediate-Term Portfolio6/
(ii) Investment Grade Income Portfolio6/
(iii) U.S. Government Money Market Portfolio4/
(iv) High Yield Portfolio12/
(6) Underwriting Agreement
(a) U.S. Government Intermediate-Term and Investment Grade
Income Portfolios5/
(b) U.S. Government Money Market Portfolio4/
(c) Dealer Contract with respect to Navigator Shares (to be
filed)
(d) High Yield Portfolio12/
(7) Bonus, profit sharing or pension plans - none
(8) Custodian Agreement5/
(9) Transfer Agent Agreement5/
(10) Opinion of Counsel
(a) Investment Grade Income and U.S. Government
Intermediate-Term Portfolios3/
(b) U.S. Government Money Market Portfolio4/
(c) High Yield Portfolio11/
(11) Consent of Independent Accountants with regard to the:
(a) U.S. Government Intermediate-Term Portfolio (filed
herewith)
(b) Investment Grade Income Portfolio (filed herewith)
(c) U. S. Government Money Market Portfolio (filed
herewith)
(d) High Yield Portfolio (filed herewith)
<PAGE>
(12) Financial statements omitted from Item 23 - none
(13) Agreements for providing initial capital3/
(14) (a) Prototype IRA Plan7/
(b) Prototype Keogh Plan7/
(15) Plan pursuant to Rule 12b-1
(a) Investment Grade Income and U.S. Government
Intermediate-Term Portfolios5/
(b) U.S. Government Money Market Portfolio4/
(c) High Yield Portfolio12/
(16) Schedule for Computation of Performance Quotations for:
(a) U.S. Government Intermediate-Term Portfolio (filed
herewith)
(b) Investment Grade Income Portfolio (filed herewith)
(c) U.S. Government Money Market Portfolio (filed herewith)
(d) High Yield Portfolio (filed herewith)
-------------------------
1/ Incorporated herein by reference to corresponding Exhibit of Pre-
Effective Amendment No. 1 to the Registration Statement, SEC File No. 33-
12092, filed April 28, 1987.
2/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 3 to the Registration Statement, SEC File No. 33-
12092, filed September 2, 1988.
3/ Incorporated herein by reference to corresponding Exhibit of Pre-
Effective Amendment No. 2 to the Registration Statement, SEC File No. 33-
12092, filed June 15, 1987.
4/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 4 to the Registration Statement, SEC File No. 33-
12092, filed November 1, 1988.
5/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 1 to the Registration Statement, SEC File No. 33-
12092, filed March 3, 1988.
6/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 2 to the Registration Statement, SEC File No. 33-
12092, filed April 28, 1988.
7/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 8 to the Registration Statement, SEC File No. 33-
12092, filed April 28, 1991.
<PAGE>
8/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 10 to the Registration Statement, SEC File No. 33-
12092, filed April 30, 1992.
9/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 11 to the Registration Statement, SEC File No. 33-
12092, filed April 16, 1993.
10/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 12 to the Registration Statement, SEC File No. 33-
12092, filed April 30, 1993.
11/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 15 to the Registration Statement, SEC File No. 33-
12092, filed December 30, 1993.
12/ Incorporated herein by reference to corresponding Exhibit of Post-
Effective Amendment No. 20 to the Registration Statement, SEC File No. 33-
12092, filed September 20, 1994.
Item 25. Persons Controlled By or Under Common Control with Registrant
-------------------------------------------------------------
None
Item 26. Number of Holders of Securities
-------------------------------
Number of Record Holders
Title of Class (as of February 28, 1995)
-------------- -------------------------
Shares of Capital Stock,
($.001 par value)
U.S. Government Intermediate-Term Portfolio:
Primary Shares 12,290
Navigator Shares 1
Investment Grade Income Portfolio 4,881
U.S. Government Money Market Portfolio 12,144
<PAGE>
High Yield Portfolio 4,412
Item 27. Indemnification
---------------
This item is incorporated by reference to Item 27 of Part C of Pre-
Effective Amendment No. 2 to the Registration Statement, SEC File No. 33-
12092 filed June 15, 1987.
Item 28. Business and Connections of Manager and Investment Adviser
----------------------------------------------------------
I. Legg Mason Fund Adviser, Inc. ("Fund Adviser"), the
Registrant's manager, is a registered investment adviser incorporated on
January 20, 1982. Fund Adviser is engaged primarily in the investment
advisory business. Fund Adviser also serves as manager or investment
adviser for eleven open-end investment companies and as investment
consultant for one closed-end investment company. Information as to the
officers and directors of Fund Adviser is included in its Form ADV-S filed
on June 30, 1994 with the Securities and Exchange Commission (registration
number 801-16958) and is incorporated herein by reference.
II. Western Asset Management Company ("Western"), the Registrant's
investment adviser, is a registered investment adviser incorporated on
October 5, 1971. Western is primarily engaged in the investment advisory
business. Western also serves as investment adviser for eight open-end
investment companies and one closed-end investment company. Information
as to the officers and directors of Western is included in its Form ADV
filed on June 8, 1994 with the Securities and Exchange Commission
(registration number 801-08162) and is incorporated herein by reference.
Item 29. Principal Underwriters
----------------------
(a) Legg Mason Cash Reserve Trust
Legg Mason Special Investment Trust, Inc.
Legg Mason Value Trust, Inc.
Legg Mason Tax-Exempt Trust, Inc.
Legg Mason Income Trust, Inc.
Legg Mason Total Return Trust, Inc.
Legg Mason Tax-Free Income Fund
Legg Mason Global Trust, Inc.
Legg Mason Investors Trust, Inc.
Western Asset Trust, Inc.
(b) The following table sets forth information concerning each
director and officer of the Registrant's principal
underwriter, Legg Mason Wood Walker, Incorporated ("LMWW").
<PAGE>
Position and Positions and
Name and Principal Offices with Offices with
Business Address* Underwriter - LMWW Registrant
------------------ ------------------ -------------
Raymond A. Mason Chairman of the None
Board
John F. Curley, Jr. Vice Chairman Chairman of the Board
and Director
James W. Brinkley President and None
Director
Edmund J. Cashman, Jr. Senior Executive None
Vice President and
Director
Robert G. Sabelhaus Executive Vice None
President and
Director
Richard J. Himelfarb Executive Vice None
President and
Director
Edward A. Taber III Executive Vice President and
President and Director
Director
Charles A. Bacigalupo Senior Vice None
President,
Secretary and
Director
Thomas M. Daly, Jr. Senior Vice None
President and
Director
Jerome M. Dattel Senior Vice None
President and
Director
<PAGE>
Robert G. Donovan Senior Vice None
President and
Director
William F. Haneman, Jr. Senior Vice None
One Battery Park Plaza President and
New York, New York 10005 Director
Thomas E. Hill Senior Vice None
One Mill Place President and
Easton, MD 21601 Director
Arnold S. Hoffman Senior Vice None
1735 Market Street President and
Philadelphia, PA 19103 Director
Carl Hohnbaum Senior Vice None
24th Floor President and
Two Oliver Plaza Director
Pittsburgh, PA 15222
William B. Jones, Jr. Senior Vice None
1747 Pennsylvania President and
Avenue, N.W. Director
Washington, D.C. 20006
Laura L. Lange Senior Vice None
President and
Director
Marvin McIntyre Senior Vice None
1747 Pennsylvania President and
Avenue, N.W. Director
Washington, D.C. 20006
Douglas C. Petty, Jr. Senior Vice None
1747 Pennsylvania President and
Avenue, N.W. Director
Washington, D.C. 20006
Mark I. Preston Senior Vice None
President and
Director
<PAGE>
F. Barry Bilson Senior Vice None
President and
Director
M. Walter D'Alessio, Jr. Director None
1735 Market Street
Philadelphia, PA 19103
Harry M. Ford, Jr. Senior Vice None
President
Edward R. Hipp, III Senior Vice None
600 Thimble Shoals Blvd. President
Newport News, VA 23607
Theodore S. Kaplan Senior Vice None
President and
General Counsel
Horace M. Lowman, Jr. Senior Vice None
President and
Asst. Secretary
Robert L. Meltzer Senior Vice None
One Battery Park Plaza President
New York, NY 10004
William H. Miller, III Senior Vice None
President
John A. Pliakas Senior Vice None
99 Summer Street President
Boston, MA 02101
E. Robert Quasman Senior Vice None
President
Gail Reichard Senior Vice None
7 E. Redwood St. President
Baltimore, MD 21202
Timothy C. Scheve Senior Vice None
President and
Treasurer
Elisabeth N. Spector Senior Vice None
President
<PAGE>
Joseph Sullivan Senior Vice None
President
Peter J. Biche Vice President None
1735 Market Street
Philadelphia, PA 19103
John C. Boblitz Vice President None
7 E. Redwood St.
Baltimore, MD 21202
Andrew J. Bowden Vice President None
D. Stuart Bowers Vice President None
7 E. Redwood St.
Baltimore, MD 21202
Edwin J. Bradley, Jr. Vice President None
Scott R. Cousino Vice President None
Robert Dickey, IV Vice President None
One World Trade Center
New York, NY 10048
John R. Gilner Vice President None
Richard A. Jacobs Vice President None
C. Gregory Kallmyer Vice President None
John J. Koorey Vice President None
One Battery Park Plaza
New York, NY 10004
Seth J. Lehr Vice President None
1735 Market St.
Philadelphia, PA 19103
Edward W. Lister, Jr. Vice President None
Eileen M. O'Rourke Vice President None
and Controller
<PAGE>
Marie K. Karpinski Vice President Vice President
and Treasurer
Jonathan M. Pearl Vice President None
1777 Reisterstown Rd.
Pikesville, MD 21208
Douglas F. Pollard Vice President None
Chris Scitti Vice President None
7 E. Redwood St.
Baltimore, MD 21202
Eugene B. Shephard Vice President None
1111 Bagby St.
Houston, TX 77002-2510
Lawrence D. Shubnell Vice President None
Charles R. Spencer, Jr. Vice President None
600 Thimble Shoals Blvd.
Newport News, VA 23606
Alexander M. Stewart Vice President None
One World Trade Center
New York, NY 10048
Lewis T. Yeager Vice President None
7 E. Redwood St.
Baltimore, MD 21202
Joseph F. Zunic Vice President None
----------------------
* All addresses are 111 South Calvert Street, Baltimore, Maryland 21202,
unless otherwise indicated.
(c) The Registrant has no principal underwriter which is not an
affiliated person of the Registrant or an affiliated person
of such an affiliated person.
Item 30. Location of Accounts and Records
--------------------------------
State Street Bank and Trust Company
P. O. Box 1713
Boston, Massachusetts 02105
<PAGE>
Item 31. Management Services
-------------------
None
Item 32. Undertakings
------------
Registrant hereby undertakes to provide each person to whom a
prospectus is delivered with a copy of its latest annual
report to shareholders upon request and without charge.
<PAGE>
SIGNATURE PAGE
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant, Legg Mason Income Trust,
Inc., certifies that it meets all the requirements for effectiveness in
this Post-Effective Amendment No. 22 to its Registration Statement
pursuant to Rule 485(b) under the Securities Act of 1933 and has duly
caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Baltimore and State
of Maryland, on the 19th day of April, 1995.
LEGG MASON INCOME TRUST, INC.
By: John F. Curley, Jr.
-----------------------------------
John F. Curley, Jr.
Chairman of the Board and Director
Pursuant to the requirements of the Securities Act of 1933, this Post-
Effective Amendment No. 22 to the Registrant's Registration Statement has
been signed below by the following persons in the capacities and on the
dates indicated.
Signature Title Date
--------- ----- ----
/s/John F. Curley, Jr. Chairman of the Board and April 19, 1995
------------------------ Director
John F. Curley, Jr.
/s/Edmund J. Cashman, Jr. Vice Chairman of the Board April 19, 1995
-------------------------- and Director
Edmund J. Cashman, Jr.
/s/Edward A. Taber, III President and Director
-------------------------
Edward A. Taber, III
/s/Richard G. Gilmore Director April 19, 1995
-------------------------
Richard G. Gilmore*
/s/Charles F. Haugh Director April 19, 1995
-------------------------
Charles F. Haugh*
/s/Jill E. McGovern Director April 19, 1995
--------------------------
Jill E. McGovern*
/s/T.A. Rodgers Director April 19, 1995
--------------------------
T.A. Rodgers*
/s/Marie K. Karpinski Vice President and
-------------------------- Treasurer
Marie K. Karpinski
*Signatures affixed by Marie K. Karpinski pursuant to powers of attorney,
dated January 3, 1991, incorporated herein by reference to Post-Effective
Amendment No. 9 filed March 2, 1992.
<PAGE>
Exhibit 11
CONSENT OF INDEPENDENT ACCOUNTANTS
_______
To the Board of Directors of
Legg Mason Income Trust, Inc.:
We consent to the incorporation by reference in Post-Effective
Amendment No. 22 to the Registration Statement of Legg Mason Income Trust,
Inc. (the "Corporation") on Form N-1A (File No. 33-12092) of our report
dated February 3, 1995 on our audit of the financial statements and
financial highlights of the U.S. Government Intermediate-Term Portfolio,
U.S. Government Money Market Portfolio, Investment Grade Income Portfolio,
and the High Yield Portfolio, the four portfolios in the Corporation,
which report is included in the Annual Report to Shareholders for the year
ended December 31, 1994, which is incorporated by reference in the
Registration Statement. We also consent to the reference to our Firm
under the caption "The Corporation's Independent Accountants."
COOPERS & LYBRAND, L.L.P.
Baltimore, Maryland
April 24, 1995
<PAGE>
LEGG MASON US GOVERNMENT INTERMEDIATE PORTFOLIO
-----------------------------------------------
January 1, 1994 - December 31, 1994 (one year)
--------------------------------------
Cumulative Total Return:
-----------------------
ERV= (9.72 x 1.74976) - (10.43 x 1.66268) x 1000 - 1000 = (1019.26)
-------------------------------------
(10.43 x 1.66268)
P = 1000
C = (1019.26) + 1 = (0.0193) = (1.93)%
--------- ------
1000
Average Annual Return: Same
---------------------
January 1, 1990 - December 31, 1994 (five years)
-------------------------------------
Cumulative Total Return:
-----------------------
ERV= (9.72 x 1.74976) - (10.20 x 1.20309) x 1000 + 1000 = 1385.94
-------------------------------------
(10.20 x 1.20309)
P = 1000
C = 1385.94 - 1 = 0.3859 = 38.59%
------- -----
1000
Average Annual Return:
---------------------
1
--
5
(0.3859 + 1) - 1 = 0.0675 = 6.75%
-----
<PAGE>
LEGG MASON US GOVERNMENT INTERMEDIATE PORTFOLIO
-----------------------------------------------
August 7, 1987 - December 31, 1994 (life of fund)
------------------------------------
Cumulative Total Return:
-----------------------
ERV = (9.72 X 1.74976) - (10.00 x 1.0) x 1000 + 1000 = 1700.77
------------------------------------
(10.00 x 1.0)
P = 1000
C = 1700.77 - 1 = 0.7008 = 70.08%
------- -----
1000
Average Annual Return:
---------------------
1
------
7.4055
(0.7008 + 1) - 1 = 0.0743 = 7.43%
<PAGE>
LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
--------------------------------------------
January 1, 1994 - December 31, 1994 (one year)
-------------------------------------
Cumulative Total Return
-----------------------
(9.27 x 1.86700) - (10.40 x 1.74842) x 1000 - 1000 = (951.80)
-------------------------------------
(10.40 x 1.74842)
P = 1000
C = (951.80) + 1 = (0.0482) = (4.82)%
-------- ------
1000
Average Annual Return: Same
---------------------
January 1, 1990 - December 31, 1994 (5 years)
-------------------------------------
Cumulative Total Return:
-----------------------
ERV = (9.27 X 1.86700) - (10.29 x 1.21251) x 1000 + 1000 = 1387.15
------------------------------------
(10.29 x 1.21251)
P = 1000
C = 1387.15 - 1 = 0.3871 = 38.71%
------- -----
1000
Average Annual Return:
---------------------
1
--
5
(0.3871 + 1) - 1 = 0.0676 = 6.76%
----
<PAGE>
LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
--------------------------------------------
August 7, 1987 - December 31, 1994 (life of fund)
------------------------------------
Cumulative Total Return
-----------------------
ERV = (9.27 X 1.86700) - (10.00 x 1.0) x 1000 + 1000 = 1730.71
------------------------------------
(10.00 x 1.0)
P = 1000
C = 1730.71 - 1 = 0.07307 = 73.07%
------- -----
1000
Average Annual Return:
---------------------
1
-------
7.4055
(0.7307 + 1) - 1 = 0.0769 = 7.69%
<PAGE>
U.S. GOVERNMENT MONEY MARKET YIELD CALCULATIONS:
-----------------------------------------------
1. 7 day yield at 12/31/94 annualized:
[7 days dividends ended 12/31/94 divided by 7 x 365] =
----------------------------------------------------
$1.00 (NAV)
(.000935272 divided by 7 x 365) = 4.88%
------------------------------- -----
1.00
2. Effective yield:
365
----
7
[base period return + 1] - 1 =
365
----
7
(.000935272 + 1) - 1 = 5.00%
<PAGE>
LEGG MASON HIGH YIELD PORTFOLIO
-------------------------------
February 1, 1994 - December 31, 1994 (life of fund)
--------------------------------------
Cumulative Total Return
-----------------------
ERV = (13.56 X 1.07416702) - (15.00 x 1.0) x 1000 - 1000 = (1028.95)
------------------------------------
(15.00 x 1.0)
P = 1000
C = (1028.95) + 1 = 0.02895 = (2.90)%
--------- -------
1000
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
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<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
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<NAME> Investment Grade Income Portfolio
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<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES> Legg Mason Income Trust, Inc.
<NAME> High Yield Portfolio
<NUMBER> 4
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<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES> Legg Mason Income Trust, Inc.
<NAME> U.S. Government Money Market Portfolio
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<PAGE>
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<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES> Legg Mason Income Trust, Inc.
<NAME> U.S. Government Intermediate-Term Portfolio Navigator Shares
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<PAGE>
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</TABLE>
