<PAGE>
As filed with the Securities and Exchange Commission on August 21, 1995.
[/R]
1933 Act File No. 33-12092
1940 Act File No. 811-5029
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM N-lA
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No: _______ [ ]
Post-Effective Amendment No: 23 [X]
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No: 22
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)
[___] on ___________________, 1995 pursuant to Rule 485(b)
[ X ] 60 days after filing pursuant to Rule 485(a)(i)
[___] on __________________, 1995 pursuant to Rule 485(a)(i)
[___] 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>
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
Legg Mason Investment Grade Income Portfolio -- Primary Shares
Legg Mason High Yield Portfolio -- Primary Shares
Legg Mason U.S. Government Money Market Portfolio
-------------------------------------------------
Part A - Prospectus
Navigator U.S. Government Intermediate-Term Portfolio
Navigator Investment Grade Income Portfolio
Navigator High Yield Portfolio
------------------------------
Part A - Prospectus
Legg Mason U. S. Government Intermediate-Term Portfolio
Legg Mason Investment Grade Income Portfolio
Legg Mason High Yield Portfolio
(Primary Shares and Navigator Shares)
Legg Mason U.S. Government Money Market 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
Legg Mason Investment Grade Income Portfolio - Primary Shares
Legg Mason High Yield Portfolio - Primary Shares
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; Expenses
3 Financial Highlights; Performance
Information
4 Investment Objectives and Policies;
Description of the Corporation and Its
Shares
5 Expenses; Dividends and Other
Distributions; The Funds' Board of
Directors, Manager and Investment
Adviser; The Funds' 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 Funds; How
Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined; The
Funds' Distributor; Investing Through
Tax-Deferred Retirement Plans
8 How You Can Redeem Your Primary Shares
9 Not Applicable
<PAGE>
Legg Mason Income Trust, Inc.
Navigator U. S. Government Intermediate-Term Portfolio
Navigator Investment Grade Income Portfolio
Navigator High Yield Portfolio
Form N-1A Cross Reference Sheet
-------------------------------
Part A Item No. Prospectus Caption
--------------- ------------------
1 Cover Page
2 Prospectus Highlights; Expenses
3 Financial Highlights; Performance
Information
4 Investment Objectives and Policies;
Description of the Corporation and Its
Shares
5 Expenses; Dividends and Other
Distributions; The Funds' Board of
Directors, Manager and Investment
Adviser;
The Funds' 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 Funds; How
Your Shareholder Account Is Maintained;
How Net Asset Value Is Determined; The
Funds' Distributor; Investing Through
Tax-Deferred Retirement Plans
8 How You Can Redeem Your Primary Shares
9 Not Applicable
<PAGE>
Legg Mason Income Trust, Inc.
Legg Mason U. S. Government Intermediate-Term Portfolio
Legg Mason Investment Grade Income Portfolio
Legg Mason High Yield Portfolio
(Primary Shares and Navigator Shares)
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 Agreement; Investment
Advisory Agreement; The Funds'
Distributor; The Corporation's
Independent Accountants; The Funds'
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 Funds' Distributor; The Funds'
Custodian and Transfer and Dividend-
Disbursing Agent
22 Performance Information
23 Financial Statements
<PAGE>
<PAGE>
TABLE OF CONTENTS
Prospectus Highlights 2
Expenses 4
Financial Highlights 5
Performance Information 9
Investment Objectives and Policies 10
How You Can Invest in the Funds 22
How Your Shareholder Account is Maintained 23
How You Can Redeem Your Primary Shares 24
How Net Asset Value is Determined 26
Dividends and Other Distributions 27
Tax Treatment of Dividends and Other Distributions 27
Shareholder Services 28
Investing Through Tax-Deferred Retirement Plans 30
The Funds' Board of Directors, Manager and
Investment Adviser 30
The Funds' Distributor 31
Description of the Corporation and its Shares 32
Appendix 34
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 LLP
1800 M Street, N.W., Washington, DC 20036
INDEPENDENT ACCOUNTANTS /AUDITORS:
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 ANY FUND OR ITS DISTRIBUTOR. THE PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING BY ANY 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
LEGG MASON
INCOME
TRUST, INC.
GOVERNMENT INTERMEDIATE
INVESTMENT GRADE
HIGH YIELD
GOVERNMENT MONEY MARKET
PRIMARY SHARES
PUTTING YOUR FUTURE FIRST
PROSPECTUS
OCTOBER , 1995
(Legg Mason logo appears here)
<PAGE>
LEGG MASON INCOME TRUST , INC. -- PRIMARY SHARES
LEGG MASON U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO
LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
LEGG MASON HIGH YIELD PORTFOLIO
LEGG MASON U.S. GOVERNMENT MONEY MARKET PORTFOLIO
This Prospectus sets forth concisely the information about the
funds that a prospective investor ought to know before investing. It
should be read and retained for future reference. A Statement of
Additional Information about the funds dated October [ ], 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 the funds' distributor, Legg Mason
Wood Walker, Incorporated ("Legg Mason") (address and telephone
numbers listed below).
LEGG MASON U.S. GOVERNMENT MONEY MARKET PORTFOLIO IS A MONEY
MARKET FUND; LEGG MASON U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO,
LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO AND LEGG MASON HIGH YIELD
PORTFOLIO ARE BOND FUNDS. A MAJORITY OF LEGG MASON HIGH YIELD
PORTFOLIO'S TOTAL ASSETS WILL BE INVESTED IN LOWER-RATED, FIXED-INCOME
SECURITIES (INCLUDING THOSE COMMONLY KNOWN AS "JUNK BONDS"). 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.
LEGG MASON U.S. GOVERNMENT MONEY MARKET PORTFOLIO ATTEMPTS TO
STABILIZE THE VALUE OF ITS SHARES AT $1.00. AN INVESTMENT IN THIS FUND
IS NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT. THERE CAN BE
NO ASSURANCE THAT THIS FUND WILL ALWAYS BE ABLE TO MAINTAIN A STABLE
NET ASSET VALUE OF $1.00 PER SHARE.
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.
PROSPECTUS
October [ ], 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 following summary is qualified in its entirety by the more
detailed information appearing in the body of this Prospectus and in the
Statement of Additional Information.
The Legg Mason Income Trust, Inc. ("Corporation") is a diversified
open-end management investment company which currently has four
portfolios: The Legg Mason U.S. Government Intermediate-Term Portfolio
("Government Intermediate"), The Legg Mason Investment Grade Income
Portfolio ("Investment Grade"), The Legg Mason High Yield Portfolio ("High
Yield") and The Legg Mason U.S. Government Money Market Portfolio
("Government Money Market") (each separately referred to as a "Fund" and
collectively referred to as the "Funds").
GOVERNMENT INTERMEDIATE is a professionally managed portfolio seeking
to provide investors with high current income consistent with prudent
investment risk and liquidity needs. In seeking to achieve the Fund's
objective, the Funds' 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 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.
INVESTMENT GRADE 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. In seeking to achieve the
Fund's objective, the 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. ("Moody's") or Standard & Poor's Ratings
Group ("S&P"), 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.
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 specualtive 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.
HIGH YIELD 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. 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
2
<PAGE>
issuer in the event of a default. The Fund's participation in hedging and
option income strategies also involves certain risks.
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.
GOVERNMENT MONEY MARKET is a professionally managed portfolio seeking
high current income consistent with liquidity and conservation of
principal. In seeking to achieve the Fund's objective, the 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 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.
Of course, there can be no assurance that any Fund will achieve its
objective. See "Investment Objectives and Policies," page 10.
Government Intermediate, Investment Grade and High Yield each offers
two classes of shares -- Primary Class ("Primary Shares") and Navigator
Class ("Navigator Shares"). Government Money Market offers only one class
of shares.
Primary Shares offered in this Prospectus are available to all
investors except certain institutions (see page 5). No initial sales
charge is payable on purchases, and no redemption charge is payable on
sales of the Funds' shares. Each Fund pays management fees to its Manager,
Legg Mason Fund Adviser, Inc. ("Manager"), and each Fund except Government
Money Market pays distribution fees with respect to Primary Shares to its
Distributor, Legg Mason, as described on pages 31-33 of this Prospectus.
DISTRIBUTOR :
Legg Mason Wood Walker, Incorporated
MANAGER AND ADVISER :
Legg Mason Fund Adviser, Inc. serves as each Fund's manager, and
Western Asset Management Company serves as investment adviser to each
Fund.
INITIAL PURCHASE :
$1,000 minimum, generally.
SUBSEQUENT PURCHASES :
$100 minimum, generally, except for Government Money Market which has
a $500 minimum, generally.
PURCHASE METHODS :
Send bank/personal check or wire federal funds. See "How You Can
Invest in the Funds," page 22.
PUBLIC OFFERING PRICE PER SHARE :
Net asset value. Government Money Market seeks to maintain its net
asset value at $1.00 per share.
CHECKWRITING :
Available to qualified shareholders of Government Money Market upon
request. Unlimited number of checks. Minimum amount per check: $500.
EXCHANGE PRIVILEGE :
All funds in the Legg Mason Family of Funds. See "Exchange Privilege,"
page 29.
DIVIDENDS :
Declared daily and paid monthly for Government Intermediate,
Investment Grade and Government Money Market. Declared and paid monthly
for High Yield.
REINVESTMENT :
All dividends and/or other distributions are automatically reinvested
unless cash payments are requested.
3
<PAGE>
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 a 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 (or period
ended, with respect to High Yield) December 31, 1994, adjusted for current
expense and fee waiver levels.
SHAREHOLDER TRANSACTION EXPENSES FOR EACH FUND
Maximum sales charge on purchases or
reinvested dividends None
Redemption or exchange fees None
ANNUAL FUND OPERATING EXPENSES -- PRIMARY SHARES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
<TABLE>
<CAPTION>
GOVERNMENT
GOVERNMENT INVESTMENT HIGH MONEY
INTERMEDIATE GRADE YIELD MARKET
<S> <C> <C> <C> <C>
Management fees 0.31%A 0.10%B 0.65 % 0.50%
12b-1 fees 0.50% 0.50% 0.50 % None
Other expenses 0.14% 0.30% 0.44 % 0.19%
Total operating
expenses 0.95%A 0.90%B 1.59 % 0.69%
</TABLE>
A The expense ratio for Primary Shares of Government Intermediate 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 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.
B The expense ratio for Primary Shares of Investment Grade would have been
1.40% had the Fund's Manager not agreed to reimburse fees. The
reimbursement agreement, wherein the Manager has agreed to continue to
reimburse management 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 0.90% of 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 each Fund (except Government Money Market) 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 Dealer, Inc. ("NASD"). For further information concerning the
Funds' expenses, see "The Funds' Board of Directors, Manager and
Investment Adviser," page 30.
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 prior table, the Funds charge no redemption fees
of any kind.
<TABLE>
<CAPTION>
GOVERNMENT
GOVERNMENT INVESTMENT HIGH MONEY
INTERMEDIATE GRADE YIELD MARKET
<S> <C> <C> <C> <C>
1 Year $ 10 $ 9 $ 16 $ 7
3 Years $ 30 $ 29 $ 50 $ 22
5 Years $ 53 $ 50 $ 87 $ 38
10 Years $117 $111 $ 189 $ 86
</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 OF THE FUNDS. THE
ABOVE TABLES AND EXAMPLES SHOULD NOT BE CONSIDERED REPRESENTATIONS 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, the extent to which the Manager and/or
Legg Mason waive their fees and reimburse all or a portion of a Fund's
expenses and the extent to which Primary Shares incur variable expenses,
such as transfer agency costs.
4
<PAGE>
FINANCIAL HIGHLIGHTS
Effective December 1, 1994, Government Intermediate commenced the sale
of Navigator Shares. Effective October [ ], 1995, Investment Grade and
High Yield will commence the sale of 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 year-end financial information that follows has been derived from
each Fund's financial statements which have been audited by Coopers &
Lybrand L.L.P., independent accountants. Each Fund's financial statements
for the year ended December 31, 1994 and the report of Coopers & Lybrand
L.L.P. thereon are included in that 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. Information shown for the period
ended June 30, 1995 has not been audited.
GOVERNMENT INTERMEDIATE
<TABLE>
<CAPTION>
NAVIGATOR
CLASS PRIMARY CLASS
Years Ended December 31, 1995B 1994C 1995B 1994 1993 1992
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning
of period $9.72 $9.72 $9.72 $10.43 $10.70 $10.77
Net investment income 0.16D 0.05D 0.28E 0.51E 0.53E 0.60E
Net realized and unrealized
gain (loss) on
investments, options and
futures 0.57 -- 0.57 (0.71) 0.17 0.05
Total from investment
operations 0.73 0.05 0.85 (0.20) 0.70 0.65
Distributions to
shareholders:
Net investment income (0.16) (0.05) (0.28) (0.51) (0.53) (0.60)
Net realized gain -- -- -- -- (0.39) (0.12)
In excess of net realized
gain on investments -- -- -- -- (0.05) --
Net asset value, end of
period $10.29 $9.72 $10.29 $9.72 $10.43 $10.70
Total returnF 9.11% 0.50% 8.82% (1.93)% 6.6% 6.3%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net
assets:
Expenses 0.4%D,G 0.4%D,G 0.9%E,G,H 0.9%E,H 0.9%E,H 0.9%E,H
Net investment income 6.1%D,G 6.4%D,G 5.6%E,G 5.1%E 4.8%E 5.5%E
Portfolio turnover rate 269.3%G 315.7% 269.3%G 315.7% 490.2% 512.6%
Net assets, end of period
(in thousands) $3,245 $4,024 $234,420 $231,255 $299,529 $307,320
</TABLE>
<TABLE>
<CAPTION>
PRIMARY CLASS
1991 1990 1989 1988 1987A
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning
of period $10.29 $10.20 $9.79 $9.92 $10.00
Net investment income 0.72E 0.78E 0.80E 0.74E 0.30E
Net realized and unrealized
gain (loss) on
investments, options and
futures 0.70 0.09 0.41 (0.12) (0.08)
Total from investment
operations 1.42 0.87 1.21 0.62 0.22
Distributions to
shareholders:
Net investment income (0.72) (0.78) (0.80) (0.74) (0.30)
Net realized gain (0.22) -- -- (0.01) --
In excess of net realized
gain on investments -- -- -- -- --
Net asset value, end of
period $10.77 $10.29 $10.20 $9.79 $9.92
Total returnF 14.4% 9.1% 12.8% 6.4% 2.2%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net
assets:
Expenses 0.8%E,H 0.6%E,H 0.8%E,H 1.0%E,H 1.0%E,G,H
Net investment income 6.7%E 7.7%E 7.9%E 7.4%E 7.4%E,G
Portfolio turnover rate 642.8% 67.0% 57.3% 132.5% 66.3%G
Net assets, end of period
(in thousands) $211,627 $74,423 $43,051 $27,087 $16,617
</TABLE>
A FOR THE PERIOD AUGUST 7, 1987 (COMMENCEMENT OF OPERATIONS) TO DECEMBER
31, 1987.
B FOR THE SIX MONTHS ENDED JUNE 30, 1995.
C FOR THE PERIOD DECEMBER 1, 1994 (COMMENCEMENT OF SALE OF NAVIGATOR
SHARES) TO DECEMBER 31, 1994.
D NET OF FEES WAIVED AND REIMBURSEMENTS MADE BY THE MANAGER FOR EXPENSES IN
EXCESS OF VOLUNTARY LIMITATIONS AS FOLLOWS: 0.4% UNTIL APRIL 30, 1995 AND
0.45% UNTIL OCTOBER 31, 1995.
E NET OF FEES WAIVED AND REIMBURSEMENTS MADE BY THE MANAGER FOR EXPENSES IN
EXCESS OF VOLUNTARY 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; 0.9% UNTIL APRIL 30, 1995; AND 0.95% UNTIL OCTOBER 31, 1995.
F NOT ANNUALIZED FOR PERIODS OF LESS THAN A FULL YEAR.
G ANNUALIZED.
H INCLUDES DISTRIBUTION FEE OF 0.5%.
5
<PAGE>
INVESTMENT GRADE
<TABLE>
<CAPTION>
PRIMARY CLASS
Years Ended December 31, 1995B 1994 1993 1992 1991 1990
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $9.27 $10.40 $10.71 $10.71 $9.97 $10.29
Net investment incomeC 0.32 0.60 0.62 0.66 0.76 0.84
Net realized and unrealized gain (loss)
on investments, options and futures 0.84 (1.09) 0.33 0.25 0.77 (0.28)
Total from investment
operations 1.16 (0.49) 0.95 0.91 1.53 0.56
Distributions to shareholders:
Net investment income (0.32) (0.60) (0.62) (0.66) (0.76) (0.84)
Net realized gain on investments,
options and futures -- (0.04) (0.63) (0.25) (0.03) (0.04)
In excess of net realized gain on
investments, options and futures -- -- (0.01) -- -- --
Net asset value, end of period $10.11 $9.27 $10.40 $10.71 $10.71 $9.97
Total returnD 12.7% (4.8)% 11.2% 6.8% 16.0% 5.8%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
ExpensesC 0.87%E,F 0.85%F 0.85%F 0.85%F 0.71%F 0.50%F
Net investment incomeC 6.7%E 6.1% 5.6% 6.1% 7.3% 8.3%
Portfolio turnover rate 174.2%E 200.1% 348.2% 316.7% 212.5% 54.9%
Net assets, end of period (in
thousands) $76,885 $66,196 $68,781 $48,033 $36,498 $22,994
</TABLE>
<TABLE>
<CAPTION>
PRIMARY CLASS
Years Ended December 31, 1989 1988 1987A
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $9.88 $9.94 $10.00
Net investment incomeC 0.82 0.78 0.31
Net realized and unrealized gain (loss)
on investments, options and futures 0.41 (0.035) (0.06)
Total from investment
operations 1.23 0.745 0.25
Distributions to shareholders:
Net investment income (0.82) (0.78) (0.31)
Net realized gain on investments,
options and futures -- (0.025) --
In excess of net realized gain on
investments, options and futures -- -- --
Net asset value, end of period $10.29 $9.88 $9.94
Total returnD 13.0% 7.7% 2.6%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
ExpensesC 0.82%F 1.00%F 1.00%E,F
Net investment incomeC 8.1% 7.7% 7.8%E
Portfolio turnover rate 92.4% 146.3% 72.4%E
Net assets, end of period (in
thousands) $13,891 $9,913 $5,661
</TABLE>
A FOR THE PERIOD AUGUST 7, 1987 (COMMENCEMENT OF OPERATIONS) TO DECEMBER
31, 1987.
B FOR THE SIX MONTHS ENDED JUNE 30, 1995.
C 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; 0.85% UNTIL APRIL
30, 1995; AND 0.9% UNTIL OCTOBER 31, 1995.
D NOT ANNUALIZED FOR PERIODS OF LESS THAN A FULL YEAR.
E ANNUALIZED.
F INCLUDES DISTRIBUTION FEE OF 0.5%.
6
<PAGE>
HIGH YIELD
<TABLE>
<CAPTION>
PRIMARY CLASS
Years Ended December 31, 1995B 1994A
(UNAUDITED)
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $13.57 $15.00
Net investment income .63 1.02
Net realized and unrealized gain (loss) on investments .59 (1.44)
Total from investment operations 1.22 (.42)
Distributions to shareholders from net investment income (.57) (1.01)
Net asset value, end of period $14.22 $13.57
Total returnC 9.28% (2.90)%
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses 1.5%D 1.6%D
Net investment income 9.3%D 8.4%D
Portfolio turnover rate 29.9%D 67.4%D
Net assets, end of period (in thousands) $71,038 $53,424
</TABLE>
A FOR THE PERIOD FEBRUARY 1, 1994 (COMMENCEMENT OF OPERATIONS) TO DECEMBER
31, 1994.
B FOR THE SIX MONTHS ENDED JUNE 30, 1995.
C NOT ANNUALIZED FOR PERIODS OF LESS THAN A FULL YEAR.
D ANNUALIZED.
7
<PAGE>
GOVERNMENT MONEY MARKET
<TABLE>
<CAPTION>
PRIMARY CLASS
Years Ended December 31, 1995B 1994 1993 1992 1991 1990 1989A
(UNAUDITED)
<S> <C> <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 $1.00
Net investment income .03 .04 .03 .03 .05 .07 .08C
Net realized gain (loss) on
investments NIL (NIL) -- -- NIL -- --
Total from investment
operations .03 .04 .03 .03 .05 .07 .08
Dividends paid from:
Net investment income (.03) (.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 $1.00
Total return 5.29%D 3.66% 2.80% 3.49% 5.87% 7.56% 8.68%D
RATIOS/SUPPLEMENTAL DATA:
Ratios to average net assets:
Expenses .68%D .69% .71% .73% .73% .81% .80%CD
Net investment income 5.32%D 3.66% 2.76% 3.45% 5.36% 7.29% 8.35%D
Net assets, end of period (in
thousands) $266,517 $214,576 $172,533 $170,910 $180,733 $132,408 $87,958
</TABLE>
A FOR THE PERIOD JANUARY 31, 1989 (COMMENCEMENT OF OPERATIONS) TO DECEMBER
31, 1989.
B FOR THE SIX MONTHS ENDED JUNE 30, 1995.
C 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.
D ANNUALIZED.
8
<PAGE>
PERFORMANCE INFORMATION
From time to time each 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 gains 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 performances only 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 as of June 30, 1995 were as follows:
CUMULATIVE TOTAL RETURN :
<TABLE>
<CAPTION>
GOVERNMENT INVESTMENT
INTERMEDIATE GRADE HIGH YIELD
<S> <C> <C> <C>
Primary Class:
One Year +9.02% +12.90% +8.95%
Five Years +46.72% +53.10% N/A
Life of Class +85.07%A +95.10%A +6.11%B
Navigator Class:
Life of Class +9.66%C N/A N/A
</TABLE>
AVERAGE ANNUAL TOTAL RETURN :
<TABLE>
<CAPTION>
GOVERNMENT INVESTMENT
INTERMEDIATE GRADE HIGH YIELD
<S> <C> <C> <C>
Primary Class:
One Year +9.02% +12.90% +8.95%
Five Years +7.97% +8.89% N/A
Life of Class +8.11%A +8.83%A +4.29%B
</TABLE>
A Inception of Government Intermediate and Investment Grade -- August 7,
1987.
B Inception of High Yield -- February 1, 1994.
C For the period December 1, 1994 (commencement of sale of Navigator
Shares) to June 30, 1995.
No adjustment has been made for any income taxes payable by
shareholders. The investment return of each Fund will fluctuate. The
principal value of an investment in each Fund (except Government Money
Market) will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost. Returns of Government
Intermediate and Investment Grade would have been lower if the Manager had
not waived/reimbursed certain fees and expenses during the fiscal years
1987 through 1994.
Further information about each Fund's performance is contained in the
respective 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.
GOVERNMENT INTERMEDIATE, INVESTMENT GRADE AND HIGH YIELD :
Each 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.
GOVERNMENT MONEY MARKET :
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 June 30, 1995 was
5.29%. The effective yield for the same period was 5.43%.
9
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
Each Fund's investment objective may not be changed without
shareholder approval; however, except as otherwise noted, the investment
policies of each Fund described below may be changed by the Corporation's
Board of Directors without a shareholder vote. There can be no assurance
that any Fund will achieve its investment objective.
GOVERNMENT INTERMEDIATE'S investment objective is to provide investors
with high current income consistent with prudent investment risk and
liquidity needs. 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. 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 page 15, 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 S&P (AAA, AA, A or
BBB) or 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 this Prospectus.
INVESTMENT GRADE'S investment objective 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.
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 or S&P, or, if unrated by Moody's
or S&P, judged by the Adviser to be of comparable quality.
(2) securities of, or guaranteed by, the U.S. government, its agencies
or instrumentalities.
(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, or if unrated by Moody's or S&P, judged by the Adviser to have
investment quality comparable 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, or if unrated by Moody's or S&P,
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
10
<PAGE>
average dollar-weighted maturity of between five and twenty years.
HIGH YIELD'S investment objective is to provide investors with a high
level of current income. As a secondary objective, the Fund seeks capital
appreciation. 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 S&P or Baa by 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 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 or 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. 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.
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. 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.
GOVERNMENT MONEY MARKET'S investment objective is to obtain high
current income consistent with liquidity and conservation of principal.
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
11
<PAGE>
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 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.
GENERAL:
The market value of the interest-bearing debt securities held by a
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.
Certain of the mortgage-backed and other securities in which a Fund
can invest pay interest at variable or floating rates. Variable rate
instruments reset at specified intervals, while floating rate instruments
reset whenever there is a change in a specified index rate. The more
closely these changes reflect current market rates, the more likely the
instrument will trade at a price close to its par value. Some instruments
do not directly track the underlying index, but reset based on formulas
that can produce an effect similar to leverage; others may provide for
interest payments that vary inversely with market rates; these instruments
are regarded as "derivatives," and may vary significantly in market price
when interest rates change.
Each 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.
INVESTMENT TECHNIQUES AND RISKS
The following investment techniques and risks apply to Government
Intermediate, Investment Grade and High Yield unless otherwise stated.
CORPORATE DEBT SECURITIES
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.
In selecting corporate debt securities for a 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.
12
<PAGE>
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 a Fund is called for redemption,
that 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 adverse
effect on a Fund's ability to achieve its investment objectives.
RISKS OF LOWER RATED DEBT SECURITIES
Debt securities rated Baa and preferred stock rated Ba are deemed by
Moody's to have speculative characteristics. Debt securities rated B by
Moody's "generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other
terms of the contract over any long period of time may be small." 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."
High yield bonds offer a higher yield to maturity than bonds with
higher ratings, as compensation for holding an obligation that is subject
to greater risk. 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 financings and (viii) the
possibility of adverse publicity and investor perceptions, 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 decline 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. Yields on lower rated debt
securities may rise dramatically in such periods, 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. Because the market for
high yield securities is less liquid, the valuation of these securities
may require greater judgement than is necessary with respect to securities
having more active markets.
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
restructurings. 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.
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 portfolio of
Investment Grade.
13
<PAGE>
The table below provides a summary of ratings assigned to debt
holdings in the portfolios of Investment Grade and High Yield. 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>
AAA/
MOODY'S AA/A BAA BA B CAA CA C NR
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment
Grade 60.2% 19.5% 13.2% 1.6% -- -- -- 5.5%
High Yield 1.7% 0.8% 9.3% 65.3% 3.3% 4.6% 0.4% 14.6%
</TABLE>
<TABLE>
<CAPTION>
AAA/
S&P AA/A BBB BB B CCC CC/C D NR
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Investment
Grade 62.9% 22.0% 13.8% 1.3% -- -- -- --
High Yield 1.7% -- 16.0% 48.4% 14.3% -- 2.0% 17.6%
</TABLE>
There were no debt securities not rated by either Moody's or S&P for
Investment Grade. The dollar-weighted average of debt securities not rated
by either Moody's or S&P amounted to 12.0% for High Yield. This may
include securities rated by other nationally recognized rating
organizations, as well as unrated securities. Unrated securities are not
necessarily lower-quality securities, but may not be attractive to as many
investors.
U.S. GOVERNMENT SECURITIES (including Government
Money Market also)
U.S. government securities include direct obligations of the U.S.
Treasury 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 (i.e., certificates of the
Government National Mortgage Association ("GNMA")); (2) the right of the
issuer to borrow from the U.S. Treasury (i.e., Federal Home Loan Banks
securities); (3) the discretionary authority of the U.S. Treasury to lend
to the issuer (i.e., Federal National Mortgage Association ("FNMA")
securities); and (4) solely by the creditworthiness of the issuer (i.e.,
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
Mortgage-related securities represent interests in pools of mortgages.
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. Some mortgage-related 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.
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 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. When interest rates are
declining, such prepayments usually increase. On the other hand, a
decrease in the rate of prepayments, resulting from an increase in market
interest rates, among other causes, may extend the effective maturities of
mortgage-related securities, increasing their sensitivity to changes in
market interest rates. The volume of prepayments of principal on
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a pool of mortgages underlying a particular mortgage-related security will
influence the yield of that security. Increased prepayment of principal
may limit a 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 a Fund to incur a loss on
a mortgage-related security that was purchased at a premium. In
determining a 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.
A Fund may enter into mortgage "dollar roll" transactions
with selected banks and broker-dealers pursuant to which that 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.
RESTRICTIONS: Government Intermediate and Investment Grade normally
may invest up to 50% of their total assets in mortgage-related securities,
including those issued by the governmental or government-related entities
referred to above. No more than 25% of Government Intermediate's or
Investment Grade's total assets normally are invested in mortgage-related
securities issued by non-governmental entities. Mortgage dollar roll
transactions may be considered borrowings and, if so, will be subject to
each Fund's investment limitation that except for temporary purposes, a
Fund will not borrow money in excess of 5% of its total assets at the time
of borrowing.
GOVERNMENT MORTGAGE-RELATED SECURITIES
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 a Fund's GNMA securities can be expected to
fluctuate in response to changes in interest rate levels.
FHLMC, a corporate instrumentality of the U.S. Government, 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 that purchases residential mortgages from a list of approved
seller/servicers, including 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.
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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.
The market for conventional pools is smaller and less liquid than the
market for the government and government-related mortgage pools.
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. The value of such securities depends in part
on loan repayments by individuals, which may be adversely affected during
general downturns in the economy.
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.
Government Intermediate and Investment Grade do not intend to exercise
conversion rights for any convertible security they own and do not intend
to hold any security which has been subject to conversion.
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
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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 a
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, a 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 a 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 that Fund and when
that Fund would not otherwise choose to dispose of the assets.
PAY-IN-KIND BONDS (High Yield only)
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 these 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. 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 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, 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.
STRIPPED MORTGAGE-BACKED SECURITIES (High Yield only)
High Yield 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. 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"). 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.
PREFERRED STOCK (High Yield only)
Preferred stock may be purchased 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
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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.
FOREIGN SECURITIES
GOVERNMENT INTERMEDIATE AND INVESTMENT GRADE :
The Funds may invest in U.S. dollar-denominated debt securities issued
by foreign companies and governments. The foreign government securities in
which a Fund invests generally consist of obligations supported by
national, state or provincial governments or similar political
subdivisions. The Funds 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. Because the foreign securities in which the
Funds invest are U.S. dollar-denominated, there is no risk of currency
fluctuation.
HIGH YIELD :
High Yield 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.
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 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).
RISKS OF FOREIGN SECURITIES
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. Additional risks
associated with investing in foreign securities include 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. 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 instrument.
Some foreign governments have defaulted on principal and/or interest
payments; in such cases, a Fund would have limited recourse to enforce its
rights under the instruments it holds. 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 (including Government
Money Market also)
Repurchase agreements are agreements under which either U.S.
government obligations or (with
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respect to Government Intermediate, Investment Grade and High Yield) other
high-quality, liquid debt securities are acquired from a securities dealer
or bank subject to resale at an agreed-upon price and date. The securities
are held for the Funds by State Street Bank and Trust Company ("State
Street"), the Funds' 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. A
Fund bears a risk of loss in the event that the other party to a
repurchase agreement defaults on its obligations and that Fund is delayed
or prevented from exercising its right to dispose of the collateral
securities, which may decline in value in the interim. A 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.
RESTRICTIONS: Neither Government Intermediate, Investment Grade nor
Government Money Market will 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. High Yield
will not enter into repurchase agreements of more than seven days'
duration if more than 15% of its total assets would be invested in such
agreements and other illiquid investments.
WHEN-ISSUED SECURITIES (including Government Money
Market also)
Each Fund may enter into commitments to purchase U.S. government
securities or other securities on a when-issued basis. A 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 a 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, a Fund does not have to pay for the obligations until they are
delivered to it, 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, that Fund will set aside cash or liquid,
high-quality debt securities equal to the payment that will be due.
Depending on market conditions, a Fund's when-issued purchases could cause
its net asset value to be more volatile, because they will increase the
amount by which that Fund's total assets, including the value of the
when-issued securities held by it, exceed its net assets. A Fund may sell
the securities underlying a when-issued purchase which may result in a
capital gain or loss.
Government Intermediate, Investment Grade and Government Money Market
each do not expect that commitments to purchase when-issued securities
will at any time exceed, in the aggregate, 20% of its total assets.
FUTURES AND OPTIONS TRANSACTIONS
GOVERNMENT INTERMEDIATE AND INVESTMENT GRADE :
In an effort to protect against the effect of adverse changes in
interest rates, a 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 a Fund to buy or sell securities at a specified date and
price. The purchase of a put option on a futures contract allows a Fund,
at its option, to enter into a particular futures contract to sell
securities at any time up to the option's expiration date.
A Fund may seek to enhance its income or hedge the portfolio by
writing (selling) covered call options (i.e., a Fund will own the
underlying instrument while the call is outstanding) and covered put
options (i.e., a 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).
RESTRICTIONS: A Fund will not enter into any futures contracts and
related options and premiums paid for related options the Fund has
purchased would exceed 5% of that Fund's total assets. A Fund will not
purchase futures contracts or related options if, as a result, more than
33-1/3% of that Fund's total assets would be so invested.
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HIGH YIELD :
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.
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.
RISKS OF FUTURES, OPTIONS AND FORWARD 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 a
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.
When a 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 a 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
a 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 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 options thereon
or to use 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, futures contract or option thereon 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 a 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, futures contracts and options thereon 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 fact that, although use of these
instruments for hedging purposes can reduce the risk of loss, they can
also reduce the opportunity for gain, or even result in losses, by
offsetting favorable price movements in hedged instruments. The use of
options for speculative purposes, i.e., to enhance income or to increase a
Fund's exposure to a particular security or foreign currency, subjects the
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Fund to additional risk. The use of futures or forward contracts to hedge
an anticipated purchase (other than a when-issued or delayed delivery
purchase), also subjects a Fund to additional risk until the purchase is
completed or the position is closed out.
The Statement of Additional Information contains a more detailed
description of futures, options and forward strategies.
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. Repurchase agreements maturing in
more than seven days are considered illiquid. Illiquid securities may be
difficult to value, and a Fund may have difficulty disposing of such
securities promptly.
RESTRICTIONS: No more than 15% of High Yield'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. No more than 10% of Government Intermediate's or Investment
Grade's net assets will be invested in illiquid securities.
INTEREST RATE SWAPS (High Yield only)
The Fund may enter into interest rate swaps. An interest rate swap is
an agreement between two parties which transfers interest rate
obligations, one of which is an interest rate fixed until the maturity of
the obligation, while the other is 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.
LOAN PARTICIPATIONS AND ASSIGNMENTS (High Yield only)
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. 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.
RESTRICTIONS: Many of the interests in loans purchased by the Fund
will be illiquid and therefore subject to the Fund's 15% limit on illiquid
investments.
LENDING (High Yield only)
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.
PORTFOLIO TURNOVER
For the year ended December 31, 1994, Government Intermediate's
portfolio turnover rate was 315.7% and Investment Grade's portfolio
turnover rate was 200.1%. Each Fund anticipates that in the future its
portfolio turnover rate may exceed 300%. For the period February 1, 1994
(commencement of operations) to December 31, 1994, High Yield's annualized
portfolio turnover rate was 67.39%. The Funds 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 Funds. 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 a Fund. It may also increase the amount of short-term capital
gains, if any, realized
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by a 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. Each Fund will take these possibilities into
account as part of its investment strategy.
HOW YOU CAN INVEST IN THE FUNDS
You may purchase Primary Shares of the Funds 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 Funds 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 Funds 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 Fund
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 for Government Intermediate, Investment Grade
and High Yield and $500 for Government Money Market, 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 Funds
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").
Cash held in Legg Mason brokerage accounts of Fund shareholders may be
invested in Government Money Market during regularly scheduled "sweeps" of
such accounts made twice each month. (Brokerage accounts participating in
the Premier Asset Management Account described on page 29 are swept daily
for free credit balances of $100 or more and weekly for free credit
balances of less than $100.) For purchases of shares through payroll
deduction plans, a 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. Each Fund may change
these minimum amount requirements at its discretion. You should always
furnish your shareholder account number when making additional purchases
of shares.
There are three ways you can invest in Primary Shares:
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 Funds 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.
If you want to purchase shares by mail, send a check for $100 or more
($500 or more for Government Money Market), payable to:
[insert complete Fund name]
c/o Legg Mason Funds Processing,
P.O. Box 1476,
Baltimore, Maryland 21203-1476
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 Funds' 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
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or credit unions, for regular automatic monthly 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 Funds through any Legg Mason or affiliated investment
executive.
In addition to the above, you may also use the following method
to invest in Government Money Market:
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.
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 of Government
Intermediate, Investment Grade or High Yield 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 three
business days to Legg Mason. Orders for one of those Funds, received by
your Legg Mason or affiliated investment executive before the close of
business of the New York Stock Exchange ("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 for one of those Funds, 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.
Shares of Government Money Market 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 for shares of Government Money Market 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 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 26.
Each Fund reserves the right to reject any order for its shares 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 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 their shares only by mail. Certificates will be issued in full
shares only. No certificates will be issued for shares of any Fund prior
to 15 business days after purchase of such shares by
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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
THE FOLLOWING REDEMPTION INFORMATION APPLIES TO GOVERNMENT INTERMEDIATE,
INVESTMENT GRADE AND HIGH YIELD :
There are two ways you can redeem your Primary Shares of Government
Intermediate, Investment Grade or High Yield. 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 name of the Fund, the number of shares to be redeemed and your
shareholder account number. Second, you may send a written request for
redemption to: [insert complete Fund name], 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 Funds, 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, your 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, each Fund reserves
the right to take longer (up to seven days in some cases) to make payment
upon redemption if, in the judgment of the Adviser, the respective 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 Primary Shares to be
redeemed, the complete Fund name 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.
THE FOLLOWING REDEMPTION INFORMATION APPLIES TO GOVERNMENT MONEY MARKET :
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 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
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<PAGE>
allow time for the check to clear. Any of the following methods may be
used to redeem shares of Government Money Market:
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
three business days of redemption but may take longer (up to seven days in
some cases) if the Adviser believes that immediate payment could adversely
affect the Fund. (The Statement of Additional Information describes
several other circumstances in which the date of payment may be postponed
or the right of redemption suspended.) 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.
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 Mason or its affiliates may request further documentation from
corporations, executors, partnerships, administrators, trustees or
custodians. Checks normally will be mailed within three business days of
receipt of a proper redemption request to your address of record or, in
accordance with your written request, to some other person.
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<PAGE>
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.
FOR EACH FUND:
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 Funds will not be responsible for the authenticity of redemption
instructions received by telephone, provided they follow reasonable
procedures to identify the caller. The Funds may request identifying
information from callers or employ identification numbers. The Funds may
be liable for losses due to unauthorized or fraudulent instructions if
they do 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 Legg Mason 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,
each 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 Funds will not redeem accounts that fall
below $500 solely as a result of a reduction in net asset value per share.
If a 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
FOR GOVERNMENT INTERMEDIATE, INVESTMENT GRADE AND HIGH YIELD :
Net asset value per Primary 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 Funds 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. With
respect to High Yield, 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 Fund will value its foreign securities in U.S. dollars on the basis of
the then-prevailing exchange rates.
FOR GOVERNMENT MONEY MARKET :
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, 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.
26
<PAGE>
DIVIDENDS AND OTHER DISTRIBUTIONS
Each 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. With
respect to Government Intermediate, Investment Grade and Government Money
Market, dividends from net investment income are declared daily and paid
monthly. For High Yield, dividends from net investment income are declared
and paid monthly. Shareholders of Government Intermediate, Investment
Grade and High Yield begin to earn dividends on their Fund shares as of
settlement date, which is normally the third business day after their
orders are placed with their Legg Mason or affiliated investment
executive. With respect to Government Intermediate, Investment Grade and
High Yield, 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. Since Government
Money Market'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.
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 of the distributing Fund;
2. Receive dividends in cash and capital gain distributions in Primary
Shares of the distributing Fund;
3. Receive dividends in Primary Shares of the distributing 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 the corresponding class of 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: [insert
complete Fund name], 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
Each 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 each 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 each 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-
27
<PAGE>
term capital gain, regardless of how long they have held their Fund
shares.
Each Fund sends its shareholders 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.
Each 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. Each 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.
FOR GOVERNMENT INTERMEDIATE, INVESTMENT GRADE AND HIGH YIELD :
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 similar tax consequences. If Fund shares are purchased
within 30 days before or after redeeming other shares of the same Fund
(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 each 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 Funds, depending on the laws of your home
state and locality, though the portion of the dividends paid by each Fund
attributable to direct U.S. government obligations is not subject to state
and local income taxes in most jurisdictions. Each 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 Legg Mason a confirmation after each transaction
involving Primary Shares (except a reinvestment of dividends, capital gain
distributions 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 each Fund's
shareholders at least semiannually showing its portfolio and other
information; the annual report will contain financial statements audited
by the Corporation's independent accountants.
Shareholder inquiries should be addressed to: [insert complete Fund
name], 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 a Fund while they are participating in the Systematic
Withdrawal Plan with respect to that Fund. Please contact your Legg Mason
or affiliated investment executive for further information.
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LEGG MASON PREMIER ASSET MANAGEMENT ACCOUNT
(FOR GOVERNMENT MONEY MARKET)
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 Primary
Shares of a Fund for the corresponding class of shares of any of the Legg
Mason 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
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 seeking primarily 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
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal
29
<PAGE>
and Maryland state and local income taxes, consistent with prudent
investment risk and preservation of capital.
Legg Mason Pennsylvania Tax-Free Income Trust A
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,B
A tax-exempt municipal bond fund seeking a high level of current
income exempt from federal income tax, consistent with prudent investment
risk.
A Shares of these funds are sold with an initial sales charge.
B Effective August 1, 1995 through January 31, 1996, the sales charge will
be waived for all new accounts and subsequent investments into existing
accounts. After January 31, 1996, any exchanges of these shares will be
subject to the full sales charge, if any, since no sales charge will be
paid on shares purchased during this period.
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 each Fund reserves the right to terminate or
limit the exchange privilege of any shareholder who makes more than four
exchanges from that 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 24. Please read the prospectus for the other fund(s)
carefully before you invest by exchange. Each 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
Investors who are considering establishing an IRA, Keogh Plan, SEP or
other qualified retirement 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 FUNDS' BOARD OF DIRECTORS, MANAGER AND INVESTMENT ADVISER
BOARD OF DIRECTORS
The business and affairs of each Fund are managed under the direction
of the Corporation's Board of Directors.
MANAGER
Pursuant to separate management agreements with each Fund (each a
"Management Agreement"), which were approved by the Corporation's Board of
Directors, Legg Mason Fund Adviser, Inc., a wholly owned subsidiary of
Legg Mason, Inc., serves as each Fund's manager. The Manager manages the
noninvestment affairs of each Fund, directs all matters related to the
operation of the Funds and provides office space and administrative staff
for the Funds. Each Fund pays the Manager, pursuant to the Management
Agreement, a management fee equal to annual rates of its average daily net
assets attributable to Primary Shares: Government Intermediate, 0.55%;
Investment
30
<PAGE>
Grade, 0.60%; High Yield, 0.65%; and Government Money Market, 0.50%. The
Manager has agreed that until October 31, 1995 or when Government
Intermediate 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 attributable to Primary Shares (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 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. The Manager has also agreed that until
October 31, 1995 or when Investment Grade 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 attributable to
Primary Shares (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. These
reimbursement agreements are voluntary and may not be renewed by the
Manager. Reimbursement by the Manager reduces a Fund's expenses and
increases its yield and total return.
The Manager acts as investment adviser, manager or consultant to
sixteen investment company portfolios which had aggregate assets under
management of over $4.8 billion as of July 31, 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 each 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 each Fund and directs the investments of
the Funds in accordance with its investment objective, policies and
limitations. For these services, the Manager (not the Funds) 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 Government
Intermediate's average daily net assets; 40% of the fee received by the
Manager, or 0.24% of Investment Grade's average daily net assets; 77% of
the fee received by the Manager, or 0.50% of High Yield's average daily
net assets; and 30% of the fee received by the Manager, or 0.15% of
Government Money Market's average daily net assets.
An investment committee has been responsible for the day-to-day
management of each Fund since its inception.
The Adviser also renders investment advice to sixteen open-end
investment companies and one closed-end investment company, which together
had aggregate assets under management of approximately $3.8 billion as of
July 31, 1995. The Adviser also renders investment advice to private
accounts with fixed income assets under management of approximately $13.0
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 FUNDS' DISTRIBUTOR
Legg Mason is the distributor of the Funds' 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 each Fund, including any compensation to its
investment executives, the printing and distribution of prospectuses,
statements of additional
31
<PAGE>
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 31, 1994, Legg Mason received $57,597, $19,980, $9,327 and
$62,115 for performing such services in connection with Government
Intermediate, Investment Grade, High Yield and Government Money Market,
respectively.
The Board of Directors of the Corporation has adopted Distribution and
Shareholder Services Plans (each a "Plan") pursuant to Rule 12b-1 under
the Investment Company Act of 1940 ("1940 Act") for each Fund. The Plans
provide 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, Government Intermediate,
Investment Grade and High Yield each pay 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 its average daily net
assets. 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.
Government Money Market 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 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.
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. Each 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. 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 $0.001 per share. Government Intermediate, Investment Grade and High
Yield currently offer two Classes of Shares -- Class A (known as "Primary
Shares") and Class Y (known as "Navigator Shares"). The two Classes
represent interests in the same pool of assets. A separate vote is taken
by a Class of Shares of a Fund if a matter affects just that Class of
Shares. Each Class of Shares may bear certain 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.
32
<PAGE>
Each 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 Funds, because
of the lower expenses attributable to Navigator Shares. The per share net
asset value of the classes of shares of High Yield will tend to converge,
however, immediately after the payment of ordinary income dividends.
Navigator Shares of a 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 Corporation 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 Boards will
consider whether any such conflict exists and, if so, take appropriate
action.
Shareholders of the Funds are entitled to one vote per share and
fractional votes for fractional shares held. Voting rights are not
cumulative. All shares of the Funds are fully paid and nonassessable 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 their respective Fund at 111 South Calvert
Street, Baltimore, Maryland 21202, stating the purpose of the proposed
meeting and the matters to be acted upon.
Each Fund acknowledges that it is solely responsible for the
information or any lack of information about it in this joint Prospectus
and in the joint Statement of Additional Information, and no other Fund is
responsible therefor. There is a possibility that one Fund might be deemed
liable for misstatements or omission regarding another Fund in this
Prospectus or in the joint Statement of Additional Information; however,
the Funds deem this possibility slight.
33
<PAGE>
APPENDIX
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 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 CC
the highest degree of speculation. While such bonds will likely have some
quality and protective
34
<PAGE>
characteristics, these are outweighed by large 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 dividend payments and maintenance
of other terms of the issue over any long period of time may be small.
CAA -- An issue which is rated "caa" is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate
the future status of payments.
CA -- An issue which is rated "ca" is speculative in a high degree and
is likely to be in arrears on dividends with little likelihood of eventual
payments.
C -- This is the lowest rated class of preferred stock or preference
stock. Issues so rated can be regarded as having extremely poor prospects
of ever attaining any real investment standing.
35
<PAGE>
Navigator Income Trust
Prospectus
Dated: October , 1995
Shares of Navigator U.S. Government Intermediate-Term Portfolio,
Navigator Investment Grade Income Portfolio and Navigator High Yield
Portfolio (collectively referred to as "Navigator Shares") represent
separate classes ("Navigator Classes") of interest in the Legg Mason U.S.
Government Intermediate-Term Portfolio ("Government Intermediate"), Legg
Mason Investment Grade Income Portfolio ("Investment Grade") and Legg
Mason High Yield Portfolio ("High Yield"), respectively. Government
Intermediate, Investment Grade and High Yield (each separately referred to
as a "Fund" and collectively referred to as the "Funds") are separate,
professionally managed portfolios of Legg Mason Income Trust, Inc.
("Corporation"), a diversified open-end management investment company.
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
Funds that a prospective investor ought to know before investing. It
should be retained for future reference. A Statement of Additional
Information about the Funds dated October , 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 the
Funds' distributor, Legg Mason Wood Walker, Incorporated ("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.
High Yield seeks to provide investors with a high level of
current income. As a secondary objective, the Fund seeks capital
appreciation. In seeking to achieve the Fund's objective, the 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 "[ ]" on page [ ]. 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
<PAGE>
the Fund to be illiquid. An investment in the Fund does not constitute a
complete investment program and is not appropriate for persons unwilling
to assume a high degree of risk.
Government Intermediate seeks to provide investors with high
current income consistent with prudent investment risk and liquidity
needs. In seeking to achieve the Fund's objective, the Funds' 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.
Investment Grade seeks to provide investors with a high level of
current income through investment in a diversified portfolio of debt
securities. In seeking to achieve the Fund's objective, the 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. ("Moody's) or
Standard & Poor's Ratings Group ("S&P"), securities comparably rated by
another nationally recognized statistical rating organization, or unrated
securities judged by the Adviser to be of comparable quality.
The Navigator Classes of Shares, described in this Prospectus,
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 (such institutional
investors are referred to collectively as "Institutional Clients" and
accounts of the customers with such Clients ("Customers") 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 Funds, 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." Each Fund pays management fees to Legg Mason Fund Adviser, Inc.,
but Navigator Classes pay no distribution fees.
2
<PAGE>
Legg Mason Wood Walker, Incorporated
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410-539-0000
800-822-5544
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 of a Fund will bear directly or indirectly. The expenses and fees
set forth in the table are based on estimated expenses for the initial
period of operations of the Navigator Classes.
Shareholder Transaction Expenses For Each Fund
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)
Government Investment High
Intermediate Grade Yield
Management fees 0.33% A 0.10% B 0.65%
12b-1 fees None None None
Other expenses 0.12% 0.30% 0.44%
Total operating 0.45% A 0.40% B 1.09%
expenses
A The expense ratio for the Navigator Class of Government Intermediate
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 of Government Intermediate'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.
B The expense ratio for the Navigator Class of Investment Grade would
have been 0.90% 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
3
<PAGE>
Navigator Class of Investment Grade's expenses (exclusive of taxes,
interest, brokerage and extraordinary expenses) exceed during any month an
annual rate of 0.40% 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.
For further information concerning Fund expenses, see "The Funds'
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 in Navigator 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 Funds charge no redemption
fees of any kind.
1 Year 3 Years 5 Years 10 Years
Government Intermediate $5 $14 $25 $57
Investment Grade $4 $13 $22 $51
High Yield $11 $35 $60 $133
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 Navigator Shares of the Funds. The
above tables and example 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, whether the Manager reimburses all or a
portion of the Funds' expenses, and the extent to which Navigator Shares
incur variable expenses, such as transfer agency costs.
Financial Highlights
Effective December 1, 1994, the Fund commenced the sale of Navigator
Shares of Government Intermediate. Effective October , 1995, Investment
Grade and High Yield will commence the sale of Navigator Shares. The
information shown below for prior periods is for Primary Shares (the other
class of shares currently offered) and reflects 12b-1 fees paid by that
class and not by Navigator Shares.
4
<PAGE>
The year-end financial information that follows has been derived from
each Fund's financial statements which have been audited by Coopers &
Lybrand L.L.P., independent accountants. Each Fund's financial statements
for the year ended December 31, 1994 and the report of Coopers & Lybrand
L.L.P. thereon are included in that Fund's annual report and are
incorporated by reference into the Statement of Additional Information.
The annual report for each Fund 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. Information
shown for the period ended June 30, 1995 has not been audited.
For Government Intermediate:
<TABLE>
<CAPTION>
NAVIGATOR PRIMARY CLASS
CLASS
Years Ended December 31, 1995 B 1994 C 1995 B 1994 1993 1992
<S> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance: (unaudited) (unaudited)
Net asset value, beginning of
period $9.72 $9.72 $9.72 $10.43 $10.70 $10.77
Net investment income 0.16 D 0.05 D 0.28 E 0.51 E 0.53 E 0.60 E
Net realized and unrealized gain
(loss) on investments 0.57 -- 0.57 (0.71) 0.17 0.05
Total from investment
operations 0.73 0.05 0.85 (0.20) 0.70 0.65
Distributions to shareholders:
Net investment income (0.16) (0.05) (0.28) (0.51) (0.53) (0.60)
Net realized gain on
investments -- -- -- -- (0.39) (0.12)
In excess of net realized gain
on investments -- -- -- -- (0.05) --
Net asset value, end of period $10.29 $9.72 $10.29 $9.72 $10.43 $10.70
Total return F 9.11% 0.50% 8.82% -1.93% 6.6% 6.3%
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses .4% DG 0.4% DG 0.9% EGH .9% EH .9% EH .9% EH
Net investment income 6.1% DG 6.4% DG 5.6% E 5.1% E 4.8% E 5.5% E
Portfolio turnover rate 269.3% G 315.7% 269.3% G 315.7% 490.2% 512.6%
Net assets, end of period (in
thousands) $3,245 $4,024 $234,420 $231,255 $299,529 $307,320
5
<PAGE>
PRIMARY CLASS
Years Ended December 31, 1991 1990 1989 1988 1987A
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of
period $10.29 $10.20 $9.79 $9.92 $10.00
Net investment income 0.72 E 0.78 E 0.80 E 0.74 E 0.30 E
Net realized and unrealized gain
(loss) on investments 0.70 0.09 0.41 (0.12) (0.08)
Total from investment
operations 1.42 0.87 1.21 0.62 0.22
Distributions to shareholders:
Net investment income (0.72) (0.78) (0.80) (0.74) (0.30)
Net realized gain on
investments (0.22) -- -- (0.01) --
In excess of net realized gain
on investments -- -- -- -- --
Net asset value, end of period $10.77 $10.29 $10.20 $9.79 $9.92
Total return F 14.4% 9.1% 12.8% 6.4% 2.2%
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses .8% EH .6%EH .8% EH 1.0% EH 1.0% EGH
7.4% EG
Net investment income 6.7% E 7.7% E 7.9% E 7.4% E
Portfolio turnover rate 642.8% 67.0% 57.3% 132.5% 66.3% G
Net assets, end of period (in
thousands) $211,627 $74,423 $43,051 $27,087 $16,617
</TABLE>
____________________________
A For the period August 7, 1987 (commencement of operations) to December
31, 1987.
B For the six months ended June 30, 1995.
C For the period December 1, 1994 (commencement of sale of Navigator
Shares) to December 31, 1994.
D 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.
E Net of fees waived and reimbursements made by the manger 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.
F Not annualized for periods of less than a full year.
G Annualized.
6
<PAGE>
H Includes distribution fee of 0.5%.
Investment Grade:
<TABLE>
<CAPTION>
PRIMARY CLASS
Years Ended December 31, 1995 B 1994 1993 1992 1991
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance: (Unaudited)
Net asset value, beginning of
period $9.27 $10.40 $10.71 $10.71 $9.97
Net investment income C 0.32 .60 .62 .66 .76
Net realized and unrealized gain
(loss) on investments, options
and futures 0.84 (1.09) .33 .25 .77
Total from investment
operations 1.16 (.49) .95 .91 1.53
Distributions to shareholders
from:
Net investment income (0.32) (.60) (.62) (.66) (.76)
Net realized gain on
investments, options and
futures -- (.04) (.63) (.25) (.03)
In excess of net realized gain
on investments -- -- (.01) -- --
Net asset value, end of period $10.11 $9.27 $10.40 $10.71 $10.71
Total return D 12.7% (4.8)% 11.2% 6.8% 16.0%
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses CF 0.87% E 0.85% 0.85% 0.85% 0.71%
Net investment income C 6.7% E 6.1% 5.6% 6.1% 7.3%
Portfolio turnover rate 174.2% E 200.1% 348.2% 316.7% 212.5%
Net assets, end of period
(in thousands) $76,885 $66,196 $68,781 $48,033 $36,498
7
<PAGE>
PRIMARY CLASS
Years Ended December 31, 1990 1989 1988 1987 A
<S> <C> <C> <C> <C>
Per Share Operating Performance:
Net asset value, beginning of
period $10.29 $9.88 $9.94 $10.00
Net investment income C .84 .82 .78 .31
Net realized and unrealized gain
(loss) on investments, options
and futures (.28) .41 (.035) (.06)
Total from investment operations .56 1.23 .745 .25
Distributions to shareholders
from:
Net investment income (.84) (.82) (.78) (.31)
Net realized gain on
investments, options and
futures (.04) -- (.025) --
In excess of net realized gain
on investments -- -- -- --
Net asset value, end of period $9.97 $10.29 $9.88 $9.94
Total return D 5.8% 13.0% 7.7% 2.6%
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses CF 0.50% 0.82% 1.00% 1.00% E
Net investment income C 8.3% 8.1% 7.7% 7.8% E
Portfolio turnover rate 54.9% 92.4% 146.3% 72.4% E
Net assets, end of period
(in thousands) $22,994 $13,891 $9,913 $5,661
</TABLE>
A For the period August 7, 1987 (commencement of operations) to December
31, 1987.
B For the six months ended June 30, 1995.
C Net of fees waived and reimbursements made by the Adviser 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 0.9% until
October 31, 1995.
D Not annualized for periods of less than a full year.
E Annualized.
F Includes distribution fee of 0.5%.
8
<PAGE>
High Yield:
PRIMARY CLASS
Years Ended December 31, 1995 B 1994 A
Per Share Operating Performance: (Unaudited)
Net asset value, beginning of $13.57 $15.00
period
Net investment income .63 1.02
Net realized and unrealized
gain (loss) on investments .59 (1.44)
Total from investment 1.22 (.42)
operations
Distributions to shareholders
from net investment income (.57) (1.01)
Net asset value, end of period $14.22 $13.57
Total return C 9.28% (2.90)%
Ratios/Supplemental Data:
Ratios to average net assets:
Expenses 1.5% D 1.6% D
Net investment income 9.3% D 8.4% D
Portfolio turnover rate 29.9% D 67.4% D
Net assets, end of period
(in thousands) $71,038 $53,424
A For the period February 1, 1994 (commencement of operations) to
December 31, 1994.
B For the six months ended June 30, 1995.
C Not annualized for periods of less than a full year.
D Annualized.
Performance Information
From time to time each 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 only 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.
9
<PAGE>
Total returns as of June 30, 1995 were as follows:
Cumulative Total Return
Government Investment
Intermediate Grade High Yield
Primary Class:
One Year +9.02% +12.90% +8.95%
Five Years +46.72% +53.10% N/A
Life of Class +85.07% A +95.10% A +6.11% B
Navigator Class:
Life of Class +9.66% C N/A N/A
Average Annual Total Return
Government Investment
Intermediate Grade High Yield
Primary Class:
One Year +9.02% +12.90% +8.95%
Five Years +7.97% +8.89% N/A
Life of Class +8.11% A +8.83% A +4.29% B
A Inception of Government Intermediate and Investment Grade - August 7,
1987.
B Inception of High Yield - February 1, 1994.
C For the period December 1, 1994 (commencement of sale of Navigator
Shares) to June 30, 1995.
No adjustment has been made for any income taxes payable by
shareholders. The investment return and principal value of an investment
in the Funds 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. Because Navigator
Shares have lower total expenses, they will generally have a higher return
than Primary Shares.
Each 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
10
<PAGE>
computations differ from other accounting methods and therefore may differ
from dividends actually paid or reported net income.
Further information about each Fund's performance is contained in that
Fund's 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.
Investment Objectives and Policies
Each Fund's investment objective may not be changed without
shareholder approval; however, except as otherwise noted, the investment
policies of each Fund described below may be changed by the Corporation's
Board of Directors without a shareholder vote. There can be no assurance
that any Fund will achieve its investment objective.
Government Intermediate's investment objective is to provide investors
with high current income consistent with prudent investment risk and
liquidity needs. 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. 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 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 S&P (AAA, AA, A or
BBB) or 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 this Prospectus.
Investment Grade's investment objective 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
11
<PAGE>
investment grade, of which some may be privately placed and some may have
equity features.
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 or S&P, or, if unrated by Moody's
or S&P, judged by the Adviser to be of comparable quality.
(2) securities of, or guaranteed by, the U.S. government, its agencies
or instrumentalities.
(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, or if unrated by Moody's or S&P, judged by the Adviser to have
investment quality comparable 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, or if unrated by Moody's or S&P,
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.
High Yield's investment objective is to provide investors with a high
level of current income. As a secondary objective, the Fund seeks capital
appreciation. 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 S&P or Baa by Moody's, comparably rated by
another nationally recognized statistical rating organization ("NRSRO"),
or unrated securities deemed by the Adviser to be of equivalent quality.
12
<PAGE>
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 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 or 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. 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 the
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.
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. 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.
General:
The market value of the interest-bearing debt securities held by a
Fund, and therefore the net asset value of Fund shares, is affected by
changes in market interest rates. There is normally an inverse
13
<PAGE>
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.
Certain of the mortgage-backed and other securities in which a Fund
can invest pay interest at variable or floating rates. Variable rate
instruments reset at specified intervals, while floating rate instruments
reset whenever there is a change in a specified index rate. The more
closely these changes reflect current market rates, the more likely the
instrument will trade at a price close to its par value. Some instruments
do not directly track the underlying index, but reset based on formulas
that can produce an effect similar to leverage; others may provide for
interest payments that vary inversely with market rates; these instruments
are regarded as "derivatives," and may vary significantly in market price
when interest rates change.
Each 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.
Investment Techniques and Risks
The following investment techniques and risks apply to each of the
Funds unless otherwise stated.
Corporate Debt Securities
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.
In selecting corporate debt securities for a 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.
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 a Fund is called for redemption,
that 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 adverse
effect on a Fund's ability to achieve its investment objectives.
14
<PAGE>
Risks of Lower Rated Debt Securities
Debt securities rated Baa and preferred stock rated Ba are deemed by
Moody's to have speculative characteristics. Debt securities rated B by
Moody's "generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other
terms of the contract over any long period of time may be small." 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."
High yield bonds offer a higher yield to maturity than bonds with
higher ratings, as compensation for holding an obligation that is subject
to greater risk. 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 financings and (viii) the
possibility of adverse publicity and investor perceptions, 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 decline 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. Yields on lower rated debt
securities may rise dramatically in such periods, 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. Because the market for
high yield securities is less liquid, the valuation of these securities
may require greater judgement than is necessary with respect to securities
having more active markets.
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
15
<PAGE>
weathered economic downturns, there has been in recent years a substantial
increase in the use of such securities to fund corporate acquisitions and
restructurings. 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.
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 portfolio of
Investment Grade.
The table below provides a summary of ratings assigned to debt
holdings in the portfolios of High Yield and Investment Grade. 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.
Aaa/Aa
Moody's /A Baa Ba B Caa Ca C NR
Investment
Grade 60.2% 19.5% 13.2% 1.6% -- -- -- 5.5%
High Yield 1.7% 0.8% 9.3% 65.3% 3.3% 4.6% 0.4% 14.6%
S&P AAA/AA BBB BB B CCC CC/C D NR
/A
Investment 62.9% 22.0% 13.8% 1.3% -- -- -- --
Grade
High Yield 1.7% -- 16.0% 48.4% 14.3% -- 2.0% 17.6%
There were no debt securities not rated by either Moody's or S&P
for Investment Grade. The dollar-weighted average of debt securities not
rated by either Moody's or S&P amounted to 12.0% for High Yield. This may
include securities rated by other nationally recognized rating
organizations, as well as unrated securities. Unrated securities are not
necessarily lower-quality securities, but may not be attractive to as many
investors.
U.S. Government Securities
U.S. government securities include direct obligations of the U.S.
Treasury 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 (i.e., certificates of the
Government National Mortgage Association ("GNMA")); (2) the right of the
issuer to borrow from the U.S. Treasury (i.e., Federal Home Loan Banks
securities); (3) the discretionary authority of the U.S. Treasury to lend
16
<PAGE>
to the issuer (i.e., Federal National Mortgage Association ("FNMA")
securities); and (4) solely by the creditworthiness of the issuer (i.e.,
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
Mortgage-related securities represent interests in pools of
mortgages. 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. Some mortgage-related 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.
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 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. When interest
rates are declining, such prepayments usually increase. On the other
hand, a decrease in the rate of prepayments, resulting from an increase in
market interest rates, among other causes, may extend the effective
maturities of mortgage-related securities, increasing their sensitivity to
changes in market interest rates. The volume of prepayments of principal
on a pool of mortgages underlying a particular mortgage-related security
will influence the yield of that security. Increased prepayment of
principal may limit a 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 a Fund to incur a
loss on a mortgage-related security that was purchased at a premium. In
determining a 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.
A Fund may enter into mortgage "dollar roll" transactions with
selected banks and broker-dealers pursuant to which that Fund sells
mortgage-backed securities for delivery in the future (generally within 30
17
<PAGE>
days) and simultaneously contracts to repurchase substantially similar
securities on a specified future date.
Restrictions: Government Intermediate and Investment Grade normally may
invest up to 50% of their total assets in mortgage-related securities,
including those issued by the governmental or government-related entities
referred to above. No more than 25% of Government Intermediate's or
Investment Grade's total assets normally are invested in mortgage-related
securities issued by non-governmental entities. Mortgage dollar roll
transactions may be considered borrowings and, if so, will be subject to
each Fund's investment limitation that except for temporary purposes, a
Fund will not borrow money in excess of 5% of its total assets at the time
of borrowing.
Government Mortgage-Related Securities
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 a Fund's GNMA securities can be expected to
fluctuate in response to changes in interest rate levels.
FHLMC, a corporate instrumentality of the U.S. Government, 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 that purchases residential mortgages from a list of
approved seller/servicers, including 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
18
<PAGE>
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.
The market for conventional pools is smaller and less liquid than the
market for the government and government-related mortgage pools.
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. The value of such securities depends in part
on loan repayments by individuals, which may be adversely affected during
general downturns in the economy.
Stripped Mortgage-Backed Securities (High Yield only)
High Yield 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. 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"). 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
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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.
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 a 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, a 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 a 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 that Fund
and when that Fund would not otherwise choose to dispose of the assets.
Pay-In-Kind Bonds (High Yield only)
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 these 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. 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 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, 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
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circumstances in order to generate cash to satisfy these distribution
requirements.
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.
Government Intermediate and Investment Grade do not intend to
exercise conversion rights for any convertible security they own and do
not intend to hold any security which has been subject to conversion.
Preferred Stock (High Yield only)
Preferred stock may be purchased 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.
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Foreign Securities
Government Intermediate and Investment Grade:
The Funds may invest in U.S. dollar-denominated debt securities
issued by foreign companies and governments. The foreign government
securities in which a Fund invests generally consist of obligations
supported by national, state or provincial governments or similar
political subdivisions. The Funds 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. Because the foreign securities in
which the Funds invest are U.S. dollar-denominated, there is no risk of
currency fluctuation.
High Yield:
High Yield 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.
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 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).
Risks of Foreign Securities
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. Additional risks associated with investing in foreign
securities include the possibility of nationalization, expropriation or
confiscatory taxation; adverse changes in investment or exchange control
22
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regulations (which may include suspension of the ability to transfer
currency out of a country); and political instability. 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 instrument. Some foreign governments have defaulted on
principal and/or interest payments; in such cases, a Fund would have
limited recourse to enforce its rights under the instruments it holds.
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
Repurchase agreements are agreements under which either U.S.
government obligations or other high-quality, liquid debt securities are
acquired from a securities dealer or bank subject to resale at an
agreed-upon price and date. The securities are held for the Funds by State
Street Bank and Trust Company ("State Street"), the Funds' 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. A Fund bears a risk of loss in the event that
the other party to a repurchase agreement defaults on its obligations and
that Fund is delayed or prevented from exercising its right to dispose of
the collateral securities, which may decline in value in the interim. A
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.
Restrictions: Neither Government Intermediate nor Investment Grade will
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. High Yield will not enter into repurchase
agreements of more than seven days' duration if more than 15% of its total
assets would be invested in such agreements and other illiquid
investments.
When-Issued Securities
Each Fund may enter into commitments to purchase U.S. government
securities or other securities on a when-issued basis. A 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 a 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, a Fund does not have to pay for the obligations until they are
delivered to it, 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, that Fund will set aside cash or liquid,
high-quality debt securities equal to the payment that will be due.
Depending on market conditions, a Fund's when-issued purchases could cause
its net asset value to be more volatile, because they will increase the
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amount by which that Fund's total assets, including the value of the
when-issued securities held by it, exceed its net assets. A Fund may sell
the securities underlying a when-issued purchase which may result in a
capital gain or loss.
Government Intermediate and Investment Grade each do not expect
that their commitments to purchase when-issued securities will at any time
exceed, in the aggregate, 20% of their total assets.
Futures and Options Transactions
Government Intermediate and Investment Grade:
In an effort to protect against the effect of adverse changes in
interest rates, a 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 a Fund to buy or sell securities at a specified date and
price. The purchase of a put option on a futures contract allows a Fund,
at its option, to enter into a particular futures contract to sell
securities at any time up to the option's expiration date.
A Fund may seek to enhance its income or hedge the portfolio by
writing (selling) covered call options (i.e., a Fund will own the
underlying instrument while the call is outstanding) and covered put
options (i.e., a 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).
Restrictions: A 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 that Fund's total assets. A Fund will not
purchase futures contracts or related options if, as a result, more than
33-1/3% of that Fund's total assets would be so invested.
High Yield:
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.
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.
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Risks of Futures, Options, and Forward 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.
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 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 options thereon
or to use 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, futures contract or option thereon 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, futures contracts and options thereon 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 fact that, although use of these
instruments for hedging purposes can reduce the risk of loss, they also
can reduce the opportunity for gain, or even result in losses, by
offsetting favorable price movements in hedged investments. 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
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hedge an anticipated purchase (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.
The Statement of Additional Information contains a more detailed
description of futures, options and forward strategies.
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. Repurchase agreements maturing in
more than seven days are considered illiquid. Illiquid securities may be
difficult to value, and a Fund may have difficulty disposing of such
securities promptly.
Restrictions: No more than 15% of High Yield'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. No more than 10% of Government Intermediate's or Investment
Grade's net assets will be invested in illiquid securities.
Interest Rate Swaps (High Yield only)
The Fund may enter into interest rate swaps. An interest rate
swap is an agreement between two parties which transfers interest rate
obligations, one of which is an interest rate fixed until the maturity of
the obligation, while the other is 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.
Loan Participations and Assignments (High Yield only)
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. 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.
Restrictions: Many of the interests in loans purchased by the Fund will
be illiquid and therefore subject to the Fund's 15% limit on illiquid
investments.
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Lending (High Yield only)
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.
Portfolio Turnover
For the year ended December 31, 1994, Government Intermediate's
portfolio turnover rate was 315.7% and Investment Grade's portfolio
turnover rate was 200.1%. Each Fund anticipates that in the future its
portfolio turnover rate may exceed 300%. For the period February 1, 1994
(commencement of operations) to December 31, 1994, High Yield's annualized
portfolio turnover rate was 67.39%. The Funds 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 Funds. 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 a Fund. It may also increase the amount of
short-term capital gains, if any, realized by a 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. Each Fund
will take these possibilities into account as part of its investment
strategy.
How to Purchase and Redeem Shares
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. (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 of each Fund and $100 for each subsequent investment.
Each Fund may 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 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 ("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
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on the next day the Exchange is open. See "How Net Asset Value is
Determined" on page [ ].
Each Fund reserves the right to reject any order for its shares,
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 any of the Funds 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 a 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
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 Funds, 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 Legg Mason or Fairfield 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 respective Fund. Such
payments will normally be transmitted on the next business day following
receipt of a valid request for redemption. However, each Fund reserves
the right to take longer (up to seven days in some cases) to make payment
upon redemption if, in the judgment of the Adviser, the respective Fund
could be adversely affected by immediate payment. (The Statement of
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Additional Information describes several other circumstances in which the
date of payment may be postponed or the right of redemption suspended.)
The proceeds of redemption or repurchase may be more or less than the
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 that Fund can be reasonably assured that the check has been
collected.
The Funds will not be responsible for the authenticity of
redemption instructions received by telephone, provided they follow
reasonable procedures to identify the caller. The Funds may request
identifying information from callers or employ identification numbers. A
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, each 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 the investor. However, the Funds will not redeem accounts
that fall below $500 solely as a result of a reduction in net asset value
per share. If a 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
shareholder. Any shares the shareholder 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 of any Fund prior to 15 business days after purchase of
such shares by check unless that 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 a 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
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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 each Fund on a timely
basis.
How Net Asset Value Is Determined
Net asset value per Navigator Share of each Fund is determined
daily as of the close of the Exchange, on every day that the Exchange is
open, by subtracting the liabilities attributable to those Navigator
Shares from the total assets attributable to such shares and dividing the
result by the number of those Navigator Shares outstanding. Securities
owned by each 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.
High Yield:
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
Fund will value its foreign securities in U.S. dollars on the basis of the
then-prevailing exchange rates.
Dividends and Other Distributions
Dividends from net investment income are declared daily and paid
monthly for Government Intermediate and Investment Grade and are declared
and paid monthly for High Yield. Shareholders begin to earn dividends on
their Fund shares as of settlement date, which is normally the third
business day after their 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) (and any net gain from foreign
currency transactions with respect to High Yield) 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 distributing Fund;
2. Receive dividends in cash and capital gain distributions in
Navigator Shares of the distributing Fund;
3. Receive dividends in Navigator Shares of the distributing
Fund and capital gain distributions in cash; or
4. Receive both dividends and capital gain distributions in
cash.
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In certain cases, shareholders may reinvest dividends and capital
gain distributions in the corresponding class of shares of another
Navigator fund. Please contact an investment executive for additional
information about 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 applicable Fund in writing at:
[insert complete Fund name], c/o Fairfield Group, Inc., 200 Gibraltar
Road, Horsham, Pennsylvania 19044. Those purchasing through Legg Mason
should write to:[insert complete Fund name], 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
Each 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 a 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 that Fund's earnings and profits. Distributions of
a 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 Funds send 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. Each 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 Funds with a certified
taxpayer identification number. Each 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
31
<PAGE>
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 each 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 Funds, depending on the laws of
your home state and locality, though the portion of the dividends paid by
each Fund attributable to direct U.S. government obligations is not
subject to state and local income taxes in most jurisdictions. Each
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
Shareholders will receive from the distributor a confirmation
after each transaction involving Navigator Shares (except a reinvestment
of dividends or capital gains 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 each Fund's shareholders at least semiannually
showing its portfolio and other information; the annual report for each
Fund 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: "[insert complete
Fund name], 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:
32
<PAGE>
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
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.
Navigator American Leading Companies Trust
A mutual fund seeking long-term capital appreciation and current
income consistent with prudent investment risk.
Navigator 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.
Navigator 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.
Navigator 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.
Navigator 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.
33
<PAGE>
Navigator 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.
Navigator 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.
Navigator 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.
Navigator 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.
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 [ ]. The other factors relating to telephone
redemptions described in that section apply also to telephone exchanges.
Please read the prospectus for the other fund(s) carefully before you
invest by exchange. Each 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 Funds' Board of Directors, Manager and Investment Adviser
Board of Directors
The business and affairs of each Fund are managed under the
direction of the Corporation's Board of Directors.
34
<PAGE>
Manager
Pursuant to a separate management agreement with each 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 each Fund's manager. The Manager manages the
non-investment affairs of each Fund, directs all matters related to the
operation of the Funds and provides office space and administrative staff
for the Funds. Each Fund pays the Manager, pursuant to its Management
Agreement, a fee equal to the following annual percentage of its average
daily net assets: Government Intermediate, 0.55%; Investment Grade, 0.60%;
and High Yield, 0.65%.
The Manager acts as manager, investment adviser or investment
consultant to sixteen investment company portfolios which had aggregate
assets under management of over $4.8 billion as of July 31, 1995. The
Manager's address is 111 South Calvert Street, Baltimore, Maryland 21202.
The Manager has agreed that until October 31, 1995 or when Government
Intermediate 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 relating to Navigator Shares (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. The Manager has also agreed that until October 31, 1995 or
when Investment Grade 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 relating to Navigator Shares (exclusive of
taxes, interest, brokerage and extraordinary expenses) exceed during any
month an annual rate of 0.40%of the Fund's average daily net assets for
such month. These reimbursement agreements are voluntary and may not be
renewed by the Manager. Reimbursement by the Manager reduces a Fund's
expenses and increases its yield and total return.
Investment Adviser
Western Asset Management Company, another wholly owned subsidiary
of Legg Mason, Inc., serves as investment adviser to each 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 each Fund and directs the investments of
each 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: for Government Intermediate, 40% of the fee received by the Manager,
or 0.22% of average daily net assets; for Investment Grade, 40% of the fee
received by the Manager, or 0.24% of average daily net assets; and for
High Yield, 77% of the fee received by the Manager, or 0.50% of average
daily net assets.
An investment committee has been responsible for the day-to-day
management of each 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 July 31, 1995. The Adviser also renders investment advice to private
35
<PAGE>
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 Funds' Distributor
Legg Mason is the distributor of each Fund's shares pursuant to a
separate Underwriting Agreement with each Fund. The Underwriting Agreement
obligates Legg Mason to pay certain expenses in connection with the
offering of shares of the Funds, 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 each 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 31, 1994, Legg Mason received from BFDS $57,597, $19,980 and
$9,327, for performing such services in connection with Government
Intermediate, Investment Grade and High Yield, respectively.
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 Funds' 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 may issue separate
classes of shares. There are currently four portfolios of the Corporation.
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. Government Intermediate, Investment
36
<PAGE>
Grade and High Yield currently offer two classes of shares -- Class Y
(known as "Navigator Shares") and Class A (known as "Primary Shares").
The two classes represent interests in the same pool of assets. A
separate vote is taken by a class of shares of a Fund if a matter affects
just that class of shares. Each class of shares may bear certain
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
of the classes of shares will tend to converge, however, immediately after
the payment of ordinary income dividends. Primary Shares of a 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 Manager has agreed that until October 31, 1995 or when
Government Intermediate 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. The Manager has also agreed that until October 31,
1995 or when Investment Grade reaches net assets of $100 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 0.90% 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 Corporation 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 Funds are entitled to one vote per share and
fractional votes for fractional shares held. Voting rights are not
cumulative. All shares of the Funds are fully paid and nonassessable and
have no preemptive or conversion rights.
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<PAGE>
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 their respective Fund at 111 South Calvert
Street, Baltimore, Maryland 21202, stating the purpose of the proposed
meeting and the matters to be acted upon.
Each Fund acknowledges that it is solely responsible for the
information or any lack of information about it in this joint Prospectus
and in the joint Statement of Additional Information, and no other Fund is
responsible therefor. There is a possibility that one Fund might be
deemed liable for misstatements or omissions regarding another Fund in
this Prospectus or in the joint Statement of Additional Information;
however, the Funds deem this possibility slight.
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<PAGE>
APPENDIX A
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>
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 market
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 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 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.
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
A-2
<PAGE>
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 dividend payments and maintenance
of other terms of the issue over any long period of time may be small.
caa-An issue which is rated "caa" is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate
the future status of payments.
ca-An issue which is rated "ca" is speculative in a high degree
and is likely to be in arrears on dividends with little likelihood of
eventual payments.
c-This is the lowest rated class of preferred stock or preference
stock. Issues so rated can be regarded as having extremely poor prospects
of ever attaining any real investment standing.
A-3
<PAGE>
Table of Contents
Expenses 3
Financial Highlights 5
Performance Information 9
Investment Objectives and Policies 11
How to Purchase and Redeem Shares 25
How Shareholder Accounts are Maintained 27
How Net Asset Value Is Determined 27
Dividends and Other Distributions 28
Tax Treatment of Dividends and Other Distributions 29
Shareholder Services 30
The Funds' Board of Directors, Manager and Investment Adviser 32
The Funds' Distributor 33
Description of the Corporation and its Shares 34
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
Fairfield Group, Inc.
200 Gibraltar Road
Horsham, PA 19044
Transfer and Shareholder Servicing Agent:
Boston Financial Data Services
P.O. Box 953, Boston, MA 02103
Counsel:
Kirkpatrick & Lockhart LLP
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.
<PAGE>
THE LEGG MASON INCOME TRUST, INC.:
U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO
INVESTMENT GRADE PORTFOLIO
HIGH YIELD PORTFOLIO
(Primary Shares and Navigator Shares)
AND
U.S. GOVERNMENT MONEY MARKET PORTFOLIO
STATEMENT OF ADDITIONAL INFORMATION
Dated: October [ ], 1995
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 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 October [ ], 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).
Legg Mason U.S. Government Intermediate-Term Portfolio
("Government Intermediate"), Legg Mason Investment Grade Income Portfolio
("Investment Grade"), Legg Mason High Yield Portfolio ("High Yield") and
Legg Mason U.S. Government Money Market Portfolio ("Government Money
Market") (each separately referred to as a "Fund" and collectively
referred to as the "Funds") are separate series of Legg Mason Income
Trust, Inc. ("Corporation"), an open-end, diversified management
investment company.
Government Intermediate seeks to provide investors with high
current income consistent with prudent investment risk and liquidity
needs. In attempting to achieve this objective, the Funds' investment
adviser, Western Asset Management Company ("Adviser"), under normal
circumstances, invests at least 75% of Government Intermediate's assets in
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities. Government Intermediate 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.
Investment Grade seeks to provide investors with a high level of
current income through investment in a diversified portfolio of debt
<PAGE>
securities. In attempting to achieve Investment Grade's objective, the
Adviser invests primarily in debt securities which it considers to be
investment grade. Investment Grade expects to maintain an average dollar-
weighted maturity of between five and twenty years. The Fund's current
yield is expected to be higher than the current yields of mutual funds
that own debt securities with shorter average maturities.
High Yield 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.
Government Money Market 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.
Shares of Navigator Government Intermediate, Navigator Investment
Grade and Navigator High Yield ("Navigator Shares"), described in this
Statement of Additional Information, represent interests in Government
Intermediate, Investment Grade and High Yield, respectively, 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 Trust Company exercises discretionary
investment management responsibility (such institutional investors are
referred to collectively as "Institutional Clients" and accounts of the
customers with such Clients ("Customers") 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 Government Intermediate,
Investment Grade, High Yield and Government Money Market ("Primary
<PAGE>
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 Funds, although Institutional
Clients may charge their Customer Accounts for services provided in
connection with the purchase or redemption of shares. Each Fund will pay
management fees to Legg Mason Fund Adviser, Inc. Primary Shares (other
than Government Money Market) pay a 12b-1 distribution fee, but Navigator
Shares pay no distribution fees. See "The Funds' Distributor."
LEGG MASON WOOD WALKER,
INCORPORATED
111 South Calvert Street
Baltimore, Maryland 21202
(410) 539-0000 (800) 822-5544
<PAGE>
ADDITIONAL INFORMATION ABOUT INVESTMENT LIMITATIONS AND
POLICIES
The following information supplements the information concerning
each Fund's investment objectives, policies and limitations found in the
Prospectuses. Each Fund has adopted certain fundamental investment
limitations that cannot be changed except by vote of a majority of each
Fund's outstanding voting securities.
Government Intermediate and Investment Grade each 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;
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 each Fund 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 Fund maintains a long position in the same
security in an amount at least equal thereto; provided, however, that the
Fund 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-
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end investment companies where no underwriter or dealer commission or
profit, other than a customary brokerage commission, is involved and only
if immediately thereafter not more than 10% of a Fund's total assets
(taken at market value) would be invested in such securities;
8. Purchase or sell commodities and commodity contracts, except
that each Fund 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, each Fund 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 each Fund 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.
High Yield 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;
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;
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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.
High Yield interprets fundamental investment limitation (4) to
prohibit investment in real estate limited partnerships.
Government Money Market 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;
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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;
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
Fund, along with its investment objective, may not be changed without the
vote of a majority of the Fund'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 Fund means 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 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 Fund 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.
The following are some of the non-fundamental limitations which
High Yield currently observes. High Yield may not:
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<PAGE>
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. Acquire securities of other open-end investment companies,
except in connection with a merger, consolidation, reorganization or
acquisition.
7. Hold more than 10% of the outstanding voting securities of any
one issuer.
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 the Prospectuses. A 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
7
<PAGE>
standards of quality. Consequently, obligations with the same maturity,
interest rate and rating may have different market prices. Subsequent to
its purchase by a Fund, an issue of obligations may cease to be rated or
its rating may be reduced below the minimum rating required for purchase
by a Fund. The Adviser will consider such an event in determining whether
a 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 a
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.
The following information about futures and options applies to Government
Intermediate and Investment Grade:
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.
A 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
8
<PAGE>
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.
A 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. Each 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, each Fund 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 each Fund will not exactly match the securities that 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
that 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 a Fund wishes to
hedge and the standardized futures contracts available to it, a 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 a 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. A 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 a Fund
will be able to offset a futures position at the time it wishes to, or at
a price that is advantageous. If a Fund were unable to enter into an
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<PAGE>
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 a 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 a 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 each 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.
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 a 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 a 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 a 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. Each Fund will not sell
futures contracts with a value exceeding the value of securities it owns,
except that a 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, a Fund in effect becomes exposed to price
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<PAGE>
fluctuations resulting from changes in interest rates, and by selling a
futures contract a Fund generally expects to neutralize those
fluctuations. If interest rates fall, a 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, a 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, a Fund's positions in futures contracts could have a negative
effect on that Fund's net asset value. If interest rates rise when a Fund
has purchased futures contracts, that Fund could suffer a loss in its
futures positions. Similarly, if interest rates fall, losses in a futures
contract that 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 a 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 a Fund wishes to hedge or intends to
purchase. This may result from differences between the instrument
underlying the futures contracts and the securities a Fund wishes to hedge
or intends to purchase, as would be the case, for example, if a 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.
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<PAGE>
Put Options on Interest Rate Futures Contracts A 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. A 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 that Fund
intends to purchase. A Fund may not use these instruments for speculation
or leverage. Purchasing a put option on an interest rate futures contract
gives a 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.
Each Fund may purchase put options on interest rate futures
contracts to hedge against a decline in the market value of securities
that 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, a 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.
A 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
lost by that 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. A Fund is not
required to make futures margin payments when it purchases an option on an
interest rate futures contract.
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Risks of Transactions in Options on Interest Rate Futures
Contracts 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 a 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.
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 a
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, a 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 Each Fund may from time to
time write (sell) covered call options and covered put options on certain
of its portfolio securities. A Fund may write call options on securities
in its portfolio in an attempt to realize, through the premium that Fund
receives, a greater current return than would be realized on the
securities alone. A 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. A 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. When it writes a
covered call option, a 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 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
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<PAGE>
under the call. When a 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.
Each Fund may also write covered put options. When a 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).
Each 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,
each 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 a 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 a 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. Each 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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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 each 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, a 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 that 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%. Each Fund will not purchase futures contracts or
related options if as a result more than 33 1/3% of that Fund's total
assets would be so invested. Where a 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 a Fund's investments in
futures contracts are not fundamental and may be changed by the Board of
Directors as regulatory agencies permit. A 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.
The following information about futures and options applies to High Yield:
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
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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
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.
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<PAGE>
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.
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
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<PAGE>
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
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.
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<PAGE>
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,
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
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<PAGE>
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
to invest in a security denominated in a foreign currency, the Fund may
20
<PAGE>
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.
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<PAGE>
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
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
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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.
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
23
<PAGE>
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
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
24
<PAGE>
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
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
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<PAGE>
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
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.
26
<PAGE>
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
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.
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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.
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
28
<PAGE>
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
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
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<PAGE>
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
--------------------------------------------------------------------------
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
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<PAGE>
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."
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
31
<PAGE>
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.
Other Investment Policies
-------------------------
The following investment policies apply only to Government Intermediate,
Investment Grade and High Yield unless otherwise stated:
ILLIQUID SECURITIES SEC regulations permit the sale of
certain restricted securities to qualified institutional buyers. The
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 each Fund's liquidity.
PRIVATE PLACEMENTS Each 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
each 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 a 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.
RESTRICTIONS: Restricted securities will not be purchased by
either Government Intermediate or Investment Grade if, as a result, more
than 5% of that Fund's assets would consist of restricted securities.
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<PAGE>
SECURITIES LENDING (Applies to all of the Funds) Each Fund
may lend portfolio securities to brokers or dealers in corporate or U.S.
government securities (U.S. government securities only, with respect to
Government Intermediate and Government Money Market), 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 Funds' custodian.
During the time portfolio securities are on loan, the borrower will pay
that 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. Each 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, a 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. Each
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. Each 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.
Each Fund presently does not intend to loan more than 5% of its portfolio
securities at any given time.
REPURCHASE AGREEMENTS (Applies to all of the
Funds) Repurchase agreements are usually for periods of one week or
less, but may be for longer periods. The securities are held for each
Fund by State Street Bank and Trust Company ("State Street"), the Funds'
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. Each Fund bears a risk of loss in
the event that the other party to a repurchase agreement defaults on its
obligations and a Fund is delayed or prevented from exercising its rights
to dispose of the collateral securities. Each 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. Each Fund
currently intends to invest in repurchase agreements when cash is
temporarily available or for temporary defensive purposes.
REVERSE REPURCHASE AGREEMENTS (Applies to all of the Funds) A
reverse repurchase agreement is a portfolio management technique in which
a Fund temporarily transfers possession of a portfolio instrument to
another person, such as a financial institution or broker-dealer, in
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<PAGE>
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. Each Fund (other than Government Money
Market) may also enter into dollar rolls, in which a 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,
that 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 forward price for the future purchase, as well as by any
interest earned on the proceeds of the initial sale.
Each Fund may engage in reverse repurchase agreements and (with
the exception of Government Money Market) 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.
When a 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 that
Fund's assets. If a Fund reinvests the proceeds of the agreement at a
rate lower than the cost of the agreement, engaging in the agreement will
lower that Fund's yield. While engaging in reverse repurchase agreements
and dollar rolls, each Fund will maintain cash, U.S. Government securities
(or other high-grade, liquid debt securities, with respect to Investment
Grade and High Yield) in a segregated account at its custodian bank with a
value at least equal to that Fund's obligation under the agreements.
Restrictions: The ability of a Fund to engage in reverse repurchase
agreements and/or dollar rolls is subject to each 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 a Fund's
total assets.
WARRANTS Although not a fundamental policy subject to
shareholder vote, as long as each Fund's Shares continue to be registered
in certain states, each 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. With respect to High Yield,
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.
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<PAGE>
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
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
35
<PAGE>
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.
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.
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<PAGE>
RATINGS OF DEBT OBLIGATIONS Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's ("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 this Statement of Additional Information.
Each Fund may consider these ratings in determining whether to purchase,
sell or hold a security.
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.
The following investment policies apply only to High Yield:
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.
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
37
<PAGE>
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.
RESTRICTIONS: 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.
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
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<PAGE>
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 TAX INFORMATION
The following is a general summary of certain federal tax
considerations affecting each 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, each 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"), each 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 a 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 foreign currencies with
respect to High Yield), or other income (including gains from options or
futures contracts (or forward contracts with respect to High Yield))
derived with respect to its business of investing in securities (or those
currencies with respect to High Yield)("Income Requirement"); (2) a 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
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<PAGE>
less than three months -- options or futures contracts (with respect to
Government Intermediate and Investment Grade); with respect to High Yield:
options, futures or forward contracts (other than those on foreign
currencies), foreign currencies (or options, futures or forward contracts
thereon) that are not directly related to High Yield'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 a 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
a 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.
Each 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 a 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 that 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 the shareholders for the year in which that December 31 falls.
The following additional tax information applies only to Government
Intermediate, Investment Grade and High Yield:
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.
HEDGING INSTRUMENTS The use of hedging instruments, such as
options and futures contracts and entering into forward contracts (with
respect to High Yield), involves complex rules that will determine for
income tax purposes the character and timing of recognition of the gains
and losses each Fund will realize in connection therewith.
Regulated futures contracts and options that are subject to
Section 1256 of the Code (collectively, "Section 1256 contracts") and are
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<PAGE>
held by a 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 that
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. A 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 that Fund's shareholders).
Generally, the hedging transactions undertaken by a 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 (with
respect to Government Intermediate and Investment Grade) or from
transactions in options, futures, forward contracts and foreign currencies
(except certain gains therefrom that may be excluded by future
regulations) (with repsect to High Yield)derived by a 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 (other than those on foreign currencies with
repsect to High Yield) will be subject to the Short-Short Limitation if
they are held for less than three months. With respect to High Yield:
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 a 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 that Fund satisfies the Short-Short Limitation. Thus, only the
net gain (if any) from the designated hedge will be included in gross
41
<PAGE>
income for purposes of this limitation. Each Fund 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 each Fund will elect to have this treatment apply
to, all hedging transactions undertaken by that Fund. To the extent this
treatment is not available, a Fund may be forced to defer the closing out
of certain options and futures contracts (and forward contracts with
respect to High Yield) 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 Each Fund may acquire zero coupon
securities or other debt securities issued with original issue discount.
As a holder of those securities, a Fund 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. Similarly, High Yield must include in its gross income
securities it receives as "interest" on pay-in-kind securities. Because
each 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 each
Fund's cash assets or from the proceeds of sales of portfolio securities,
if necessary. A 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 a
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.
The following additional tax information applies only to High Yield:
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 disposition 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
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<PAGE>
company taxable income and, accordingly, will not be taxable to it to the
extent that income is distributed to its shareholders.
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.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Government Intermediate, Investment Grade and High Yield each
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
43
<PAGE>
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. Government Money Market offers only one class of shares which
corresponds to the Primary Class of other Legg Mason funds.
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
authorizing Boston Financial Data Services ("BFDS"), the Funds' 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 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 a 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 own Primary Shares with a net asset value of $5,000 or
more, you may also elect to make systematic withdrawals from your Fund
account of a minimum of $50 on a monthly basis. 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
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<PAGE>
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 ("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. Each
Fund, its transfer agent, 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 other 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
in which you have an account if you maintain a Systematic Withdrawal Plan
because you may incur tax liabilities in connection with such purchases
and withdrawals. Each 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.
The following information applies to Government Money Market:
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
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<PAGE>
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 Fund who have cash or negotiable securities
(including Government Money Market 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 account and his or her
Brokerage Account. Premier provides shareholders with a convenient method
to invest in the Fund 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 Fund 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 Fund. If Fund 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 Fund transactions, securities activity, check writing activity
and VISA Gold purchases and cash advances.
BancOne Columbus ("BancOne"), 757 Carolyn Avenue, Columbus, Ohio
43271, is the Fund'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 Fund account balance and
subtracting (1) all shares purchased by other than federal funds wired
within 15 days; (2) all shares for which certificates have been issued;
and (3) any previously authorized VISA transaction.
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<PAGE>
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 Fund 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 Fund 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 Fund shares on the next business day following
the day the transaction is credited to the Brokerage Account.
Fund 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 Fund.
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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 at their discretion.
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.
Other Information Regarding Redemption
--------------------------------------
Government Money Market 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 Government Money Market'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 Government Money Market
maintained with State Street. When honoring a check presented for
payment, the Fund 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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<PAGE>
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 account because when the check is written
you will not know the exact 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 all of the Funds:
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
a Fund normally utilizes is restricted, or an emergency, as defined by
rules and regulations of the SEC, exists, making disposal of that 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 a 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.
Each Fund reserves the right, under certain conditions, to honor
any request or combination of requests for redemption 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 that 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.
Each 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.
PERFORMANCE INFORMATION
For Government Intermediate, Investment Grade and High Yield:
TOTAL RETURN CALCULATIONS Average annual total return quotes
used in a Fund's advertising and other promotional materials ("performance
advertisements") are calculated separately for each Class according to the
following formula:
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<PAGE>
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
redeeming value, all dividends and other distributions by a Fund are
assumed to have been reinvested at net asset value on the reinvestment
dates during the period.
YIELD Yields used in a Fund's performance advertisements for
each Class of Shares are calculated by dividing a 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), a 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
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<PAGE>
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.
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) a
Fund accounts for gain or loss attributable to actual paydowns as an
increase or decrease to interest income during the period and (2) a 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 of Government Intermediate, Investment Grade and High Yield for the
30-day period ended December 31, 1994 was 5.43%, 8.50% and 9.42%
respectively. The 30-day yield for Navigator Shares of Government
Intermediate for the same period was 5.97%. As of the date of this
Statement of Additional Information, Navigator Shares of Investment Grade
and High Yield have no performance record. Yields of Government
Intermediate and Investment Grade would have been lower if the Manager had
not waived a portion of those Funds' expenses.
For Government Money Market:
YIELD The current annualized yield for the Fund is based upon a
seven-day period and is computed by determining the net change in the
value of a hypothetical account in the Fund. 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 Fund 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 Fund'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 Fund'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 Fund 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 portfolio, the method used to compute the yield and
whether there are any special charges that may reduce the yield.
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Other Information
-----------------
In performance advertisements each 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.
Each 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 a
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.
Each 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
distributions. They do not take account of the costs or the tax
consequences of investing.
Each 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 an investment in a Fund
are reinvested 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.
Each 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
52
<PAGE>
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 a 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, each 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.
Each Fund may use other recognized sources as they become available.
Each 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.
Each 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.
Each Fund may also include in advertising biographical
information on key investment and managerial personnel.
Each 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
53
<PAGE>
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.
Each 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 March 31, 1995.
In advertising, each 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 each Fund at
commencement of operations of each class of Fund shares. The tables
assume that all dividends and other distributions are reinvested in each
respective 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 Funds, 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.
<TABLE>
<CAPTION>
Government Intermediate:
Primary Shares
--------------
Value of Original Shares
Plus Shares Obtained Value of Shares Acquired
Fiscal Year Through Reinvestment of Through Reinvestment of Total
Capital Gain Distributions Income Dividends Value
<S> <C> <C> <C>
1987* $9,920 $302 $10,222
1988 9,990 1,080 10,880
1989 10,210 2,062 12,272
54
<PAGE>
Primary Shares
--------------
Value of Original Shares
Plus Shares Obtained Value of Shares Acquired
Fiscal Year Through Reinvestment of Through Reinvestment of Total
Capital Gain Distributions Income Dividends Value
<S> <C> <C> <C>
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 10,829 6,179 17,008
</TABLE>
*August 7, 1987 (commencement of operations) to December 31 1987.
Navigator Shares
----------------
Value of Original Shares
Plus Shares Obtained Value of Shares
Fiscal Through Reinvestment of Acquired Through Total
Year Capital Gain Reinvestment of Value
Distributions Income Dividends
1994* $9,720 $49 $9,769
*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,
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.
55
<PAGE>
Investment Grade:
Value of Original
Shares Plus Shares Value of Shares
Obtained Through Acquired Through Total
Fiscal Reinvestment of Reinvestment of Value
Year Capital Gain Income Dividends
Distributions
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
1992 10,893 5,456 16,349
1993 11,940 6,244 18,184
1994 10,717 6,590 17,307
*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.
High Yield:
Fiscal Year Value of Original Value of Shares Total
Shares Plus Shares Acquired Through Value
Obtained Through Reinvestment of
Reinvestment of Income Dividends
Capital Gain
Distributions
1994* $13,560 $1,006 $14,566
*February 1, 1994 (commencement of operations) to December 31 1994.
56
<PAGE>
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.
The tables for Investment Grade and High Yield are based only on
Primary Shares. As of the date of this Statement of Additional
Information, Navigator Shares of Investment Grade and High Yield have no
performance history of their own.
VALUATION OF FUND SHARES
For Government Intermediate, Investment Grade and High Yield:
Net asset value of a Fund share is determined daily for each
Class as of the close of the Exchange, 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.
For Government Money Market:
Government Money Market 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.
57
<PAGE>
USE OF THE AMORTIZED COST METHOD The directors have determined
that the interests of shareholders are best served by using the amortized
cost method for determining the value of portfolio instruments. 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
the appropriateness of this method of valuation.
The Fund'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 Fund's investment objective.
MONITORING PROCEDURES The Fund'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 Fund 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 Fund 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 Fund may 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 Fund 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 can be purchased by the Fund;
except that the Fund may hold securities with remaining maturities greater
than 397 days as collateral for repurchase agreements and other
collateralized transactions of short duration.
58
<PAGE>
Should the disposition of a portfolio security result in a
dollar-weighted average portfolio maturity of more than 90 days, the Fund
will invest its available cash to reduce the average maturity to 90 days
or less as soon as possible.
It is the Fund'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 Fund'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 Fund, computed by dividing the annualized daily income on
the Fund'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 Fund 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
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 an IRA, Keogh Plan, SEP or other qualirfied
retirement 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 employer. Additional information with respect to these plans is
available upon request from any Legg Mason or affiliated investment
executive.
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
59
<PAGE>
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
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.
60
<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 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.*, [56] 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.*, [59] 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*, [52] President of each Fund; 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, [68] Director; 948 Kennett Way, West Chester,
Pennsylvania. 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 other 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.
61
<PAGE>
CHARLES F. HAUGH, [70] 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 other Legg Mason funds; and Trustee of two
Legg Mason funds.
ARNOLD L. LEHMAN, [52] Director; The Baltimore Museum of Art,
Art Museum Drive, Baltimore, Maryland. Director of the Baltimore Museum
of Art; Director of six other Legg Mason funds; Trustee of two Legg Mason
funds.
JILL E. McGOVERN, [51] Director; 1500 Wilson Boulevard,
Arlington, Virginia. Chief Executive Officer of the Marrow Foundation.
Director of six other Legg Mason funds; Trustee of two Legg Mason funds.
Formerly: Executive Director of the Baltimore International Festival
January 1991 - March 1993; and Senior Assistant to the President of The
Johns Hopkins University (1986-1991).
T. A. RODGERS, [61] Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T.A. Rodgers & Associates (management consulting);
Director of six other 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, Primerica Corporation (1989-1991).
Officers and directors of the Corporation who are "interested
persons" of the Corporation, as defined in the 1940 Act, 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.
62
<PAGE>
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 July 31, 1995 the directors and officers of the Corporation
beneficially owned, in the aggregate, less than 1% of each Fund's
outstanding Shares.
The following table provides certain information relating to the
compensation of the Corporation's directors for the fiscal year ended
December 31, 1994.
<TABLE>
<CAPTION>
COMPENSATION TABLE
------------------
Name of Person and Position Aggregate Pension or Estimated Total Compensation
Compensation Retirement Benefits Annual From Corporation and
From Accrued as Part of Benefits Upon Fund Complex Paid to
Corporation* Corporation's Retirement Directors**
Expenses
<S> <C> <C> <C> <C>
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 -
Director $6,000 N/A N/A $21,600
</TABLE>
63
<PAGE>
* Represents fees paid to each director during the fiscal year
ended December 31, 1994.
** Represents aggregate compensation paid to each director during
the calendar year ended December 31, 1994.
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 each Fund under separate management
agreements dated June 19, 1987 for Government Intermediate and Investment
Grade, November 1, 1988 for Government Money Market and January 24, 1994
for High Yield (each a "Management Agreement"). Each Management
Agreement provides that, subject to overall direction by the Board of
Directors, the Manager will manage the investment and other affairs of
each Fund. Under the Management Agreement, the Manager is responsible for
managing each Fund's securities and for making purchases and sales of
securities consistent with the investment objectives and policies
described in each Fund's Prospectus and this Statement of Additional
Information. The Manager is obligated to furnish each Fund with office
space and certain administrative services as well as executive and other
personnel necessary for the operation of the Funds. 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 Fund to the Adviser, Western Asset Management Company.
As explained in the Funds' Prospectuses, the Manager receives for
its services a management fee, calculated daily and payable monthly, at
annual rates of each Fund's average daily net assets according to the
following:
Management Fee:
--------------
Government Intermediate 0.55%
Investment Grade 0.60%
High Yield 0.65%
Government Money Market 0.50%
The management fee paid by each Fund may be reduced under
regulations in various states where shares of each Fund are qualified for
sale that impose limitations on the annual expense ratio of each Fund.
The most restrictive annual expense limitation currently requires that the
Manager reimburse each 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
64
<PAGE>
fiscal year in which a 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 Government Intermediate
and Investment Grade if and to the extent the expenses of each (exclusive
of taxes, interest, brokerage and extraordinary expenses) exceed during
any month annual rates of each Fund's average daily net assets for such
month, until the specified expiration date or until certain asset levels
are achieved, whichever occurs first, in accordance with the following
schedule:
Government Intermediate:
Primary Shares
Rate Expiration Date Asset Level
--- --------------- -----------
0.95% October 31, 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
received management fees of $1,496,733, $1,700,594 and $1,479,686,
respectively (prior to fees waived of $788,260, $860,095, and $1,003,037,
respectively), for Government Intermediate.
Investment Grade:
Primary Shares
Rate Expiration Date Asset Level
---- --------------- ------------
0.90% October 31, 1995 $100 million
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
65
<PAGE>
For the years ended December 31, 1994 and 1993, the Manager
received management fees of $406,981 and $362,659, respectively (prior to
fees waived $370,500 and $361,254, respectively), and for the year ended
December 31, 1992, the Manager waived all management fees for Investment
Grade.
For the period February 1, 1994 (commencement of operations) to
December 31, 1994, High Yield paid management fees of $253,100 to the
Manager.
During the fiscal years ended December 31, 1994, 1993 and 1992,
Government Money Market paid management fees of $1,006,789, $898,826, and
$886,904, respectively, to the Manager.
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
Fund in connection with the performance of the respective 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.
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 that 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 respective Fund.
Each 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 Funds' distributor, compensation of the
independent directors, legal, accounting and audit expenses, insurance
expenses, expenses of registering and qualifying shares of each Fund for
sale under federal and state law, governmental fees and expenses incurred
in connection with membership in investment company organizations. Each
Fund also is liable for such nonrecurring expenses as may arise, including
litigation to which a Fund may be a party. Each Fund may also have an
obligation to indemnify the directors and officers of the Corporation with
respect to any such litigation.
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<PAGE>
Under each Management Agreement, each 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 each Fund under separate Investment Advisory
Agreements, dated June 19, 1987 for Government Intermediate and Investment
Grade; November 1, 1988 for Government Money Market and January 24, 1994
for High Yield, between the Adviser and the Manager (each an "Advisory
Agreement").
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 each 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 each Fund, the
Manager (not the Funds) pays the Adviser a fee, computed daily and payable
monthly, at an annual rate (of the fee received by the Manager) equal to
the following:
Fund Advisory Fee:
---- ------------
Government Intermediate 40%*
Investment Grade 40%
Government Money Market 30%
High Yield 77%
* Effective October 1, 1994, the Adviser has agreed to waive payments by
the Manager with respect to Government Intermediate in excess of 0.20%
annually of Government Intermediate's average daily net assets. This does
not affect the fee paid by the Fund.
For the fiscal years ended December 31, the Manager paid the following
fees to the Adviser on behalf of the Funds:
Fund: 1994 1993 1992
---- ---- ---- ----
Government Intermediate $342,829 $336,400 $477,347
Investment Grade $14,593 $560 $0
High Yield $194,887 N/A N/A
Government Money Market $302,037 $269,648 $266,071
67
<PAGE>
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 a 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.
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 each Fund's outstanding
voting securities, by the Manager or by the Adviser, on not less than 60
days' notice to the respective 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 each Fund.
To mitigate the possibility that a 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, each Fund's (other
than Government Money Market) portfolio turnover rates were as follows:
Fund: 1994 1993
---- ---- ----
Government Intermediate 315.7% 490.2%
Investment Grade 200.1% 348.2%
High Yield 67.39% (annualized) N/A
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
68
<PAGE>
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. A Fund may not always pay the lowest
commission or spread available. Rather, in placing orders on behalf of a
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 Funds. The Adviser's fee is not
reduced by reason of its receiving such brokerage and research services.
For the years ended December 31, the following Funds paid commissions to
broker-dealers who acted as agents in executing options and futures
trades.
Fund: 1994 1993 1992
---- ---- ---- ----
Government Intermediate $381,650 $526,090 $400,030
Investment Grade $112,930 $152,260 $47,750
No Fund may 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 a 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 each 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 each account. In some cases, this procedure may adversely
affect the price or quantity of the security available to a particular
69
<PAGE>
account. In other cases, however, an account's ability to participate in
large-volume transactions may produce better executions and prices.
THE FUNDS' DISTRIBUTOR
Legg Mason acts as distributor of each Fund's shares pursuant to
Underwriting Agreements with the Corporation. The Underwriting Agreements
obligate Legg Mason to pay certain expenses in connection with the
offering of a 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 each Fund's expense,
and for supplementary sales literature and advertising costs.
For the year ended December 31, 1994, Legg Mason incurred the
following expenses with respect to Primary Shares of each Fund:
Government Investment
Intermediate Grade High Yield*
Compensation to sales $962,000 $241,000 $122,000
personnel
Printing and mailing of 42,000 32,000 39,000
prospectuses to
prospective
shareholders
Advertising 60,000 61,000 86,000
Other 438,000 225,000 678,000
Total expenses $1,502,000 $559,000 $925,000
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 Distribution and Shareholder Services
Plans ("Plans") which, among other things, permit 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.
70
<PAGE>
Payments are made only from assets attributable to Primary Shares. The
Plans were adopted, as required by Rule 12b-1 under the 1940 Act, by a
vote of the Board of Directors on May 8, 1987 (for Government Intermediate
and Investment Grade), October 27, 1988 (for Government Money Market) and
October 22, 1993 (for High Yield), 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 Plans or the Underwriting Agreements
("12b-1 directors"). Continuation of the Plans 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 Plans, 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 each Plan will
continue to benefit its respective Fund and its present and future Primary
Class shareholders.
Each 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. Each Plan may be terminated 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 appropriate Fund. Any
change in a Plan that would materially increase the distribution cost to a
Fund requires Primary Class shareholder approval. Otherwise, the Plans
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 a 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 a 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 each 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 fiscal years ended December 31,
1994, 1993 and 1992, each Fund paid distribution and service fees to Legg
Mason, pursuant to the Underwriting Agreement from assets attributable to
Primary Shares as follows:
71
<PAGE>
Government Intermediate paid $1,344,353, $1,533,030 and $1,333,705,
respectively, to Legg Mason; Investment Grade paid $339,151, $302,213 and
$198,544, respectively to Legg Mason; and High Yield paid $194,692 to Legg
Mason for the period February 1, 1994 (commencement of operations) to
December 31, 1994.
Pursuant to the Plan, Government Money Market 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 its average
daily net assets. Legg Mason has no present intention of requesting such
a fee, but may do so in the future.
THE FUNDS' CUSTODIAN AND TRANSFER AND
DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company, P.O. Box 1713, Boston,
Massachusetts 02105, serves as custodian of each 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. 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. Shareholders who request an historical transcript
of their account will be charged a fee based upon the number of years
researched. Each 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 LLP, 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 (for Government
Intermediate and Investment Grade); the Statement of Net Assets as of
December 31, 1994 (for Government Money Market and High Yield); the
Statement of Assets and Liabilities as of December 31, 1994 (for
Government Intermediate and Investment Grade); 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 (for Government
Intermediate, Investment Grade and Government Money Market); 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 periods
72
<PAGE>
presented; the Notes to Financial Statements and the Report of the
Independent Accountants, which are included in each respective Fund's
Annual Report to Shareholders for the year or (with respect to High Yield)
for the period ended December 31, 1994, are hereby incorporated by
reference in this Statement of Additional Information.
The unaudited financial statements for the six months ended June 30,
1995 for each Fund are hereby incorporated by reference in this Statement
of Additional Information.
73
<PAGE>
APPENDIX A
The following are descriptions of hedging instruments which may be
used by Government Intermediate, Investment Grade or High Yield:
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
1
<PAGE>
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.
A-2
<PAGE>
Table of Contents
Page
Additional Information About Investment
Limitations and Policies 2
Additional Tax Information 12
Additional Purchase and Redemption
Information 14
Performance Information 16
Valuation of Fund Shares 20
Tax-Deferred Retirement Plans 20
The Corporation's Directors and Officers 21
Management Agreement 26
Investment Advisory Agreement 27
Portfolio Transactions and Brokerage 28
The Funds' Distributor 29
The Funds, Custodian and Transfer
and Dividend-Disbursing Agent 30
The Corporation's Legal Counsel 31
The Corporation's Independent Accountants 31
Financial Statements 31
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 a Fund or its
distributor. The Prospectuses and this Statement of Additional
Information do not constitute offerings by the Funds or by the distributor
in any jurisdiction in which such offering may not lawfully be made.
A-3
<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 by
reference to each respective Portfolio's Report to
Shareholders for the same period.
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 six months ended June 30, 1995 are
incorporated into the Statement of Additional Information of
the respective Portfolios by reference to each Portfolio's
Semi-Annual Report to Shareholders for the same period.
The financial 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 accounts are incorporated
into the Statement of Additional information by reference to
the Portfolio's Report to Shareholders for the same period.
The finanical statements for the Navigator U.S. Government
Intermediate-Term Portfolio for the six months ended June 30,
1995 are incorporated into the Statement of Additional
Information by reference to the Portfolio's Semi-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 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
six months ended June 30, 1995 are incorporated into the
Statement of Additional Information by reference to the
<PAGE>
Portfolio's Semi-Annual Report to Shareholders for the same
period.
(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/
(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: filed herewith
(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/
<PAGE>
(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)
(27) Financial Data Schedules (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.
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.
<PAGE>
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 July 31, 1995)
-------------- ------------------------
Shares of Capital Stock,
($.001 par value)
U.S. Government Intermediate-Term Portfolio:
Primary Shares 12,248
Navigator Shares 2
Investment Grade Income Portfolio
Primary Shares 5,088
Navigator Shares 0
U.S. Government Money Market Portfolio 13,561
High Yield Portfolio
Primary Shares 5,523
Navigator Shares 0
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 fifteen 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, 1995 with the Securities and Exchange Commission (registration
number 801-16958) and is incorporated herein by reference.
<PAGE>
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 sixteen 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 May 17, 1995 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").
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 Vice Chairman of
Vice President and the Board
Director
Robert G. Sabelhaus Executive Vice None
President and
Director
Richard J. Himelfarb Executive Vice None
President and
Director
<PAGE>
Edward A. Taber III Executive Vice President
President and
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
Robert G. Donovan Senior Vice None
President and
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 H. McIntyre 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
William F. Haneman, Jr. Senior Vice None
One Battery Park Plaza President
New York, New York 10005
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
Douglas C. Petty, Jr. Senior Vice None
1747 Pennsylvania President
Avenue, N.W.
Washington, D.C. 20006
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
Joseph Sullivan Senior Vice None
<PAGE>
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
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
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
<PAGE>
Eugene B. Shephard Vice President None
1111 Bagby St.
Houston, TX 77002-2510
Lawrence D. Shubnell Vice President None
Alexsander 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
Charles R. Spencer, Jr. Vice President None
600 Thimble Shoals Blvd.
Newport News, VA 23606
_________________________________
* 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
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 Investment Company Act of 1940,
the Registrant has duly caused this Registration Statement to be signed on
its behalf by the undersigned, thereto duly authorized, in the City of
Baltimore and State of Maryland, on the 21st day of August, 1995.
LEGG MASON INCOME TRUST, INC.
by: /s/ 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
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 August 21, 1995
-------------------------
John F. Curley, Jr. and Director
/s/ Edmund J. Cashman, Jr.
-------------------------- Vice Chairman of the August 21, 1995
Edmund J. Cashman, Jr. Board and Director
/s/Edward A. Taber, III
------------------------- President and Director August 21, 1995
Edward A. Taber, III
/s/Richard G. Gilmore Director August 21, 1995
-------------------------
Richard G. Gilmore*
/s/Charles F. Haugh Director August 21, 1995
-------------------------
Charles F. Haugh*
/s/Arnold L. Lehman Director August 21, 1995
-------------------------
Arnold L. Lehman*
/s/Jill E. McGovern Director August 21, 1995
-------------------------
Jill E. McGovern*
/s/T.A. Rodgers Director August 21, 1995
-------------------------
T.A. Rodgers*
<PAGE>
/s/Marie K. Karpinski Vice President August 21, 1995
------------------------- and Treasurer
Marie K. Karpinsk
*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>
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. 23 to the Registration Statement of Legg Mason Income Trust,
Inc. (the "Corporation") on Form N-1A (File Number 33-12092) of our
reports dated February 3, 1995, on our audits 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 reports are included in the Annual Reports To
Shareholders for the period ended December 31, 1994, which are
incorporated by reference in the Registration Statement. We also consent
to the reference to our firm under the caption "Corporation's Independent
Accountants" in the Statement of Additional Information.
COOPERS & LYBRAND L.L.P.
Baltimore, Maryland
August 17, 1995
<PAGE>
<TABLE>
<CAPTION>
LEGG MASON US GOVERNMENT INTERMEDIATE PORTFOLIO - PRIMARY SHARES
- -----------------------------------------------------------------
<S> <C>
June 30, 1994 - June 30, 1995 (one year)
- ------------------------------
Cumulative Total Return:
-----------------------
ERV= (10.29 x 1.798584) - (9.95 x 1.706095) x 1000 + 1000 = 1090.23
---------------------------------------
(9.95 x 1.706095)
P = 1000
C = 1090.23 - 1 = 0.090234 = 9.02%
------- -----
1000
Average Annual Return: Same
---------------------
June 30, 1990 - June 30, 1995 (five years)
- ------------------------------
Cumulative Total Return:
-----------------------
ERV= (10.29 x 1.798584) - (10.08 x 1.251366) x 1000 + 1000 = 1467.24
----------------------------------------
(10.08 x 1.251366)
P = 1000
C = 1467.24 - 1 = 0.46724 = 46.72%
------- ------
1000
Average Annual Return:
- ---------------------
1
-
5
(0.4672 + 1) - 1 = 0.0797 = 7.97%
-----
<PAGE>
August 7, 1987 - June 30, 1995 (life of class)
- -------------------------------
Cumulative Total Return:
-----------------------
ERV = (10.29 X 1.798584) - (10.00 x 1.0) x 1000 + 1000 = 1850.74
--------------------------------------
(10.00 x 1.0)
P = 1000
C = 1850.74 - 1 = 0.85074 = 85.07%
------- ------
1000
Average Annual Return:
----------------------
1
-------
7.89863
(0.8507 + 1) - 1 = 0.0811 = 8.11%
-----
<PAGE>
LEGG MASON US GOVERNMENT INTERMEDIATE PORTFOLIO - NAVIGATOR SHARES
------------------------------------------------------------------
December 1, 1994 - June 30, 1995 (life of class)
--------------------------------------------------
Cumulative Total Return:
------------------------
ERV = (10.29 X 1.035876) - (9.72 x 1.0) x 1000 + 1000 = 1096.62
- ---------------------------------------------
(9.72 x 1.0)
P = 1000
C = 1096.62 - 1 = 0.09662 = 9.66%
------- ----
1000
<PAGE>
LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
---------------------------------------------
June 30, 1994 - June 30, 1995 (one year)
------------------------------
Cumulative Total Return
----------------------
(10.11 x 1.929725) - (9.60 x 1.799988) x 1000 + 1000 = 1129.03
- ---------------------------------------
(9.60 x 1.799988)
P = 1000
C = 1129.03 - 1 = 0.12903 = 12.90%
------- ------
1000
Average Annual Return: Same
-------------------
June 30, 1990 - June 30, 1995 (5 years)
------------------------------
Cumulative Total Return:
-----------------------
ERV = (10.11 X 1.929725) - (10.04 x 1.269208) x 1000 + 1000 = 1531.02
- --------------------------------------------------
(10.04 x 1.269208)
P = 1000
C = 1531.02 - 1 = 0.53102 = 53.10%
------- ------
1000
Average Annual Return:
---------------------
1
-
5
(0.53102 + 1) - 1 = 0.0889 = 8.89%
------
August 7, 1987 - June 30, 1995 (life of class)
------------------------------
Cumulative Total Return
-----------------------
ERV = (10.11 X 1.929725) - (10.00 x 1.0) x 1000 + 1000 = 1950.95
------------------------------------
(10.00 x 1.0)
P = 1000
C = 1950.95 - 1 = 0.95095 = 95.10%
---------- ------
1000
<PAGE>
Average Annual Return:
- --------------------
1
---------
7.89863
(0.95095 + 1) - 1 = 0.0883 = 8.83%
------
<PAGE>
U.S. GOVERNMENT MONEY MARKET YIELD CALCULATIONS:
1. 7 day yield at 6/30/95 annualized:
[7 days dividends ended 6/30/95 (DIVIDED BY) 7 x 365] =
-----------------------------------------------------
$1.00 (NAV)
(.001015413 (DIVIDED BY) 7 x 365) = 5.29%
--------------------------------
1.00
2. Effective yield:
365
-----
7
[base period return + 1] - 1 =
365
---
7
(.001015413 + 1) - 1 = 5.43%
<PAGE>
LEGG MASON HIGH YIELD PORTFOLIO
-------------------------------
June 30, 1994 - June 30, 1995 (one year)
- -----------------------------
Cumulative Total Return
-----------------------
(14.22 x 1.1193350) - (14.25 x 1.0252074) x 1000 + 1000 = 1089.51
- --------------------------------------------
(14.25 x 1.0252074)
P = 1000
C = 1089.51 - 1 = 0.08951 = 8.95%
------- ----
1000
Average Annual Return: Same
----------------------
February 1, 1994 - June 30, 1995 (life of fund)
- ---------------------------------
Cumulative Total Return
-----------------------
ERV = (14.22 X 1.1193350) - (15.00 x 1.0) x 1000 + 1000 = 1061.13
---------------------------------------
(15.00 x 1.0)
P = 1000
C = 1061.13 + 1 = 0.06113 = 6.11%
------- -----
1000
Average Annual Return:
---------------------
1
----
1.41095
(0.06113 + 1) - 1 = 0.0429 = 4.29%
----
</TABLE>
<PAGE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> LEGG MASON INCOME TRUST, INC.
<MULTIPLIER> 1
<CAPTION>
<FISCAL-YEAR-END> 31-Dec-94 31-Dec-95
<PERIOD-END> 31-Dec-94 30-Jun-95
<S> <C> <C>
<INVESTMENTS-AT-COST> 240,695,488 234,673,462
<INVESTMENTS-AT-VALUE> 234,086,253 239,675,368
<RECEIVABLES> 21,960,422 2,993,268
<ASSETS-OTHER> 16,941 17,876
<OTHER-ITEMS-ASSETS> 0 0
<TOTAL-ASSETS> 256,063,616 242,686,512
<PAYABLE-FOR-SECURITIES> 19,589,063 3,029,531
<SENIOR-LONG-TERM-DEBT> 0 0
<OTHER-ITEMS-LIABILITIES> 1,195,239 1,991,485
<TOTAL-LIABILITIES> 20,784,302 5,021,016
<SENIOR-EQUITY> 0 0
<PAID-IN-CAPITAL-COMMON> 256,001,906 245,266,588
<SHARES-COMMON-STOCK> 23,789,484 22,782,571
<SHARES-COMMON-PRIOR> 28,716,974 27,098,441
<ACCUMULATED-NII-CURRENT> 0 103,106
<OVERDISTRIBUTION-NII> 0 0
<ACCUMULATED-NET-GAINS> (14,179,382) (12,318,679)
<OVERDISTRIBUTION-GAINS> 0 0
<ACCUM-APPREC-OR-DEPREC> (6,543,210) 4,614,481
<NET-ASSETS> 235,279,314 237,665,496
<DIVIDEND-INCOME> 0 0
<INTEREST-INCOME> 16,385,338 7,562,804
<OTHER-INCOME> 0 0
<EXPENSES-NET> 2,447,456 1,058,769
<NET-INVESTMENT-INCOME> 13,937,882 6,504,035
<REALIZED-GAINS-CURRENT> (13,085,213) 2,125,809
<APPREC-INCREASE-CURRENT> (6,567,644) 11,157,691
<NET-CHANGE-FROM-OPS> (5,714,975) 19,787,535
<EQUALIZATION> 0 0
<DISTRIBUTIONS-OF-INCOME> (13,917,718) (6,404,297)
<DISTRIBUTIONS-OF-GAINS> 0 0
<DISTRIBUTIONS-OTHER> 0 0
<NUMBER-OF-SHARES-SOLD> 8,766,895 2,589,735
<NUMBER-OF-SHARES-REDEEMED> (14,901,773) (4,120,640)
<SHARES-REINVESTED> 1,207,389 523,692
<NET-CHANGE-IN-ASSETS> (64,250,172) 2,386,182
<ACCUMULATED-NII-PRIOR> 0 0
<ACCUMULATED-GAINS-PRIOR> 0 (14,179,382)
<OVERDISTRIB-NII-PRIOR> 0 0
<OVERDIST-NET-GAINS-PRIOR> (1,350,275) 0
<GROSS-ADVISORY-FEES> 1,496,733 640,270
<INTEREST-EXPENSE> 0 0
<GROSS-EXPENSE> 3,235,716 1,417,066
<AVERAGE-NET-ASSETS> 271,804,324 231,470,508
<PER-SHARE-NAV-BEGIN> 10.43 9.72
<PER-SHARE-NII> 0.51 0.28
<PER-SHARE-GAIN-APPREC> (0.71) 0.57
<PER-SHARE-DIVIDEND> (0.51) (0.28)
<PER-SHARE-DISTRIBUTIONS> 0.00 0.00
<RETURNS-OF-CAPITAL> 0.00 0.00
<PER-SHARE-NAV-END> 9.72 10.29
<EXPENSE-RATIO> 0.90 0.90
<PAGE>
<AVG-DEBT-OUTSTANDING> 0 0
<AVG-DEBT-PER-SHARE> 0 0
<PAGE>
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 6
<SERIES>
<NUMBER> 1
<NAME> LEGG MASON INCOME TRUST, INC.
<MULTIPLIER> 1
<CAPTION>
<FISCAL-YEAR-END> 31-Dec-94 31-Dec-95
<PERIOD-END> 31-Dec-94 30-Jun-95
<S> <C> <C> <C> <C>
<INVESTMENTS-AT-COST> 72,951,478 75,976,083
<INVESTMENTS-AT-VALUE> 68,370,103 77,134,822
<RECEIVABLES> 6,539,973 1,488,612
<ASSETS-OTHER> 2,283 38,543
<OTHER-ITEMS-ASSETS> 0 0
<TOTAL-ASSETS> 74,912,359 78,661,977
<PAYABLE-FOR-SECURITIES> 8,359,925 1,171,262
<SENIOR-LONG-TERM-DEBT> 0 0
<OTHER-ITEMS-LIABILITIES> 356,429 605,282
<TOTAL-LIABILITIES> 8,716,354 1,776,544
<SENIOR-EQUITY> 0 0
<PAID-IN-CAPITAL-COMMON> 74,225,601 78,787,413
<SHARES-COMMON-STOCK> 7,141,366 7,602,898
<SHARES-COMMON-PRIOR> 6,611,253 6,895,462
<ACCUMULATED-NII-CURRENT> 82,373 30,108
<OVERDISTRIBUTION-NII> 0 0
<ACCUMULATED-NET-GAINS> 0 (2,993,136)
<OVERDISTRIBUTION-GAINS> (3,540,379) 0
<ACCUM-APPREC-OR-DEPREC> (4,571,590) 1,061,048
<NET-ASSETS> 66,196,005 76,885,433
<DIVIDEND-INCOME> 0 0
<INTEREST-INCOME> 4,704,662 2,668,531
<OTHER-INCOME> 0 0
<EXPENSES-NET> 576,554 305,604
<NET-INVESTMENT-INCOME> 4,128,108 2,362,927
<REALIZED-GAINS-CURRENT> (3,131,107) 498,287
<APPREC-INCREASE-CURRENT> (4,482,508) 5,632,638
<NET-CHANGE-FROM-OPS> (3,485,507) 8,493,852
<EQUALIZATION> 0 0
<DISTRIBUTIONS-OF-INCOME> (4,128,108) (2,361,760)
<DISTRIBUTIONS-OF-GAINS> (286,685) (476)
<DISTRIBUTIONS-OTHER> 0 0
<NUMBER-OF-SHARES-SOLD> 3,164,208 1,333,814
<NUMBER-OF-SHARES-REDEEMED> (3,024,476) (1,062,841)
<SHARES-REINVESTED> 390,380 190,559
<NET-CHANGE-IN-ASSETS> (2,584,906) 10,689,428
<ACCUMULATED-NII-PRIOR> 0 82,373
<ACCUMULATED-GAINS-PRIOR> 0 0
<OVERDISTRIB-NII-PRIOR> 0 0
<OVERDIST-NET-GAINS-PRIOR> (40,214) (3,540,379)
<GROSS-ADVISORY-FEES> 406,981 211,271
<INTEREST-EXPENSE> 0 0
<GROSS-EXPENSE> 947,054 497,981
<AVERAGE-NET-ASSETS> 67,830,291 71,007,378
<PER-SHARE-NAV-BEGIN> 10.40 9.27
<PER-SHARE-NII> 0.60 0.32
<PER-SHARE-GAIN-APPREC> (1.09) 0.84
<PER-SHARE-DIVIDEND> (0.60) (0.32)
<PER-SHARE-DISTRIBUTIONS> (0.04) 0.00
<RETURNS-OF-CAPITAL> 0.00 0.00
<PAGE>
<PER-SHARE-NAV-END> 9.27 10.11
<EXPENSE-RATIO> 0.85 0.87
<AVG-DEBT-OUTSTANDING> 0 0
<AVG-DEBT-PER-SHARE> 0 0
<PAGE>
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
^WPC%^^^ ^^^rinter^<PAGE>
<SERIES>
<NUMBER> 1
<NAME> LEGG MASON INCOME TRUST, INC.
<MULTIPLIER> 1
<CAPTION>
^^T^^^^20,993 ^^^^^^^ABILITIES>^^^287,606 ^^^NET-GAINS>^^^119,093 ^^^^^
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
^WPC%^^^ ^^^rinter^<PAGE>
<SERIES>
<NUMBER> 1
<NAME> LEGG MASON INCOME TRUST, INC.
<MULTIPLIER> 1
<CAPTION>
^^T^^CAL-YEAR-END>^^^^40,665,154 ^^S>^<PAID-IN-CAPITAL-COMMON>^^^^^^^^-APPREC-OR-DEPREC>^^
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
^WPC%^^^ ^^^rinter^<PAGE>
<SERIES>
<NUMBER> 1
<NAME> LEGG MASON INCOME TRUST, INC.
<MULTIPLIER> 1
<CAPTION>
^^T^^^^,673,462 ^^^^^^H0 ^^R>^ED-NET-GAINS>^0 ^^^^^8^2,804 ^^^
</TABLE>
