THE
NAVIGATOR
CLASS
OF THE
LEGG MASON
TAXABLE
INCOME FUNDS
--------
Putting Your Future First
Taxable Income Funds
Navigator Class of U.S.
Government Intermediate-
Term Portfolio
Navigator Class of Investment
Grade Income Portfolio
Navigator Class of
High Yield Portfolio
Prospectus
May 1, 1997
This wrapper is not part of the prospectus.
Addresses
Distributor:
Legg Mason Wood Walker, Inc.
111 South Calvert Street
P.O. Box 1476, Baltimore, MD 21203-1476
410 o 539 o 0000 800 o 822 o 5544
Authorized Dealer:
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 Massachusetts Avenue, N.W.
Washington, DC 20036-1800
Independent Accountants:
Coopers & Lybrand L.L.P.
217 East Redwood Street
Baltimore, MD 21202
No person has been authorized to give any information or to make any
representations not contained in this Prospectus or the Statement of Additional
Information in connection with the offering made by the Prospectus and, if given
or made, such information or representations must not be relied upon as having
been authorized by 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.
[LEGG MASON FUNDS LOGO]
<PAGE>
NAVIGATOR TAXABLE INCOME FUNDS
PROSPECTUS
DATED: MAY 1, 1997
LEGG MASON U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO
LEGG MASON INVESTMENT GRADE INCOME PORTFOLIO
LEGG MASON HIGH YIELD PORTFOLIO
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
May 1, 1997 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.
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 Corporation's investment adviser, Western
Asset Management Company ("Adviser"), under normal circumstances, invests at
least 75% of the Fund's total assets in obligations issued or guaranteed by the
U.S. Government, its agencies or instrumentalities, or instruments secured by
such securities. The Fund expects to maintain an average dollar-weighted
maturity of between three and ten years.
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 fixed-income 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 ("S&P"), securities comparably rated by another nationally recognized
statistical rating organization ("NRSRO"), or unrated securities judged by the
Adviser to be of comparable quality.
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 OBJECTIVES, THE ADVISER, UNDER NORMAL CIRCUMSTANCES, INVESTS
AT LEAST 65% OF THE FUND'S TOTAL ASSETS IN HIGH YIELD, FIXED-INCOME SECURITIES
(COMMONLY KNOWN AS "JUNK BONDS"); THAT IS, INCOME-PRODUCING DEBT SECURITIES AND
PREFERRED STOCKS OF ALL TYPES, INCLUDING 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 "INVESTMENT
TECHNIQUES AND RISKS" ON PAGE 9. 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 to assume a high
degree of risk.
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 monies and monies for which they act
in a fiduciary capacity, to clients of Legg Mason Trust Company ("Trust
Company") for which Trust
<PAGE>
Company exercises discretionary investment management responsibility (such
institutional investors are referred to collectively as "Institutional Clients"
and accounts of the customers with such Institutional 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,
to clients of Bartlett & Co. ("Bartlett") who, as of December 19, 1996, were
shareholders of Bartlett Short Term Bond Fund or Bartlett Fixed Income Fund and
for whom Bartlett acts as an ERISA fiduciary, 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.
TABLE OF CONTENTS
Expenses 3
Financial Highlights 4
Performance Information 6
Investment Objectives and Policies 7
How to Purchase and Redeem Shares 17
How Shareholder Accounts are Maintained 18
How Net Asset Value Is Determined 19
Dividends and Other Distributions 19
Tax Treatment of Dividends and Other
Distributions 19
Shareholder Services 20
The Corporation's Board of Directors, Manager and
Investment Adviser 21
The Funds' Distributor 22
Description of the Corporation and its Shares 22
Appendix A-1
Legg Mason Wood Walker, Incorporated
111 South Calvert Street
P.O. Box 1476
Baltimore, MD 21203-1476
410 o 539 o 0000
800 o 822 o 5544
2
<PAGE>
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 average net assets and annual Fund operating expenses of the
Navigator Classes of Government Intermediate and Investment Grade for the year
ended December 31, 1996 and are based on estimated expenses for the initial
period of operations of the Navigator Class of High Yield.
ANNUAL FUND OPERATING EXPENSES -- NAVIGATOR SHARES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
GOVERNMENT INVESTMENT HIGH
INTERMEDIATE(A) GRADE(A) YIELD
------------------------------------
Management fees
(after fee
waivers) 0.28% 0.14% 0.65%
12b-1 fees None None None
Other expenses 0.14% 0.27% 0.20%
-------------------------------------
Total operating
expenses (after
fee waivers) 0.42% 0.41% 0.85%
=====================================
(A) The Manager has agreed to continue to waive fees to the extent the expenses
attributable to Navigator Shares (exclusive of taxes, interest, brokerage
and extraordinary expenses) exceed during any month an annual rate of 0.50%
of average daily net assets attributable to Navigator Shares for such
month, until the earlier of December 31, 1997, or, with respect to
Government Intermediate, until its net assets reach $400 million and, with
respect to Investment Grade, until its net assets reach $100 million, and
unless extended will terminate on that date. If Government Intermediate's
assets total $400 million before December 31, 1997, the Manager has agreed
not to increase this "cap" by more than 10 basis points. The Manager does
not anticipate that Government Intermediate's assets will total $400
million before December 31, 1997, although there can be no assurance that
this will be the case. In the absence of such waivers, the expected
management fees, other expenses and total operating expenses would be as
follows: for Government Intermediate, 0.55%, 0.14% and 0.69%; and for
Investment Grade, 0.60%, 0.27% and 0.87%.
For further information concerning Fund expenses, see "The Corporation's
Board of Directors, Manager and Investment Adviser," page 21.
EXAMPLE
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.
The Funds charge no redemption fees of any kind.
GOVERNMENT INVESTMENT HIGH
INTERMEDIATE GRADE YIELD
-----------------------------------
1 Year $ 4 $ 4 $ 9
3 Years $ 13 $ 13 $ 27
5 Years $ 24 $ 23 $ 47
10 Years $ 53 $ 52 $105
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 waives its
fees, and the extent to which Navigator Shares incur variable expenses, such as
transfer agency costs.
3
<PAGE>
FINANCIAL HIGHLIGHTS
Government Intermediate, Investment Grade and High Yield each offers
two classes of shares, Primary Shares and Navigator Shares. The information
shown below for prior periods is for Primary Shares and reflects 12b-1 fees
paid by that class and not by Navigator Shares.
The financial information in the table that follows has been audited by
Coopers & Lybrand L.L.P., independent accountants. Each Fund's financial
statements for the year ended December 31, 1996 and the report of Coopers &
Lybrand L.L.P. thereon are included in the Corporation's Annual Report to
Shareholders and are incorporated by reference into the Statement of
Additional Information. The annual report is available to shareholders
without charge by calling a financial advisor at Fairfield, Legg Mason or
Legg Mason's Funds Marketing Department at 800-822-5544.
<TABLE>
<CAPTION>
Investment Operations Distributions From:
-------------------------------------- ------------------------------------------------
Net Realized
and Unrealized In Excess
Net Asset Net Gain (Loss) on Total In Excess Net of Net
Value, Investment Investments, From Net of Net Realized Realized
Beginning Income Options Investment Investment Investment Gain on Gain on
of Year (Loss) and Futures Operations Income Income Investments Investments
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C>
U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO
-- Primary Class
Years Ended Dec. 31,
1996 $ 10.47 $ .61(A) $ (.16) $ .45 $ (.60) $ (.01) $ -- $ --
1995 9.72 .57(A) .75 1.32 (.57) -- -- --
1994 10.43 .51(A) (.71) (.20) (.51) -- -- --
1993 10.70 .53(A) .17 .70 (.53) -- (.39) (.05)
1992 10.77 .60(A) .05 .65 (.60) -- (.12) --
1991 10.29 .72(A) .70 1.42 (.72) -- (.22) --
1990 10.20 .78(A) .09 .87 (.78) -- -- --
1989 9.79 .80(A) .41 1.21 (.80) -- -- --
1988 9.92 .74(A) (.12) .62 (.74) -- (.01) --
Aug. 7(H)- Dec. 31,
1987 10.00 .30(A) (.08) .22 (.30) -- -- --
-- Navigator Class
Years Ended Dec.
31,
1996 $ 10.47 $ .67(B) $ (.16) $ .51 $ (.66) $ (.01) $ -- $ --
1995 9.72 .62(B) .75 1.37 (.62) -- -- --
Dec. 1(C)- 31, 1994 9.72 .05(B) -- .05 (.05) -- -- --
INVESTMENT GRADE INCOME PORTFOLIO
-- Primary Class
Years Ended Dec. 31,
1996 $ 10.44 $ .64(F) $ (.22) $ .42 $ (.64) $ -- $ -- $ --
1995 9.27 .65(F) 1.17 1.82 (.65) -- -- --
1994 10.40 .60(F) (1.09) (.49) (.60) -- (.04) --
1993 10.71 .62(F) .33 .95 (.62) -- (.63) (.01)
1992 10.71 .66(F) .25 .91 (.66) -- (.25) --
1991 9.97 .76(F) .77 1.53 (.76) -- (.03) --
1990 10.29 .84(F) (.28) .56 (.84) -- (.04) --
1989 9.88 .82(F) .41 1.23 (.82) -- -- --
1988 9.94 .78(F) (.035) .745 (.78) -- (.025) --
Aug. 7(H)- Dec. 31,
1987 10.00 .31(F) (.06) .25 (.31) -- -- --
-- Navigator Class
Years Ended Dec. 31,
1996 $ 10.44 $ .70(G) $ (.22) $ .48 $ (.70) $ -- $ -- $ --
Dec. 1(C)- 31, 1995 10.32 .03(G) .12 .15 (.03) -- -- --
</TABLE>
<TABLE>
<CAPTION>
Ratios/Supplemental Data
---------------------------------------------------------------
Net
Net Asset Investment Net Assets,
Value, Expenses Income (Loss) Portfolio End of
Total End of Total to Average to Average Turnover Year
Distributions Year Return Net Assets Net Assets Rate (in thousands)
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
U.S. GOVERNMENT INTERMEDIATE-TERM PORTFOLIO
-- Primary Class
Years Ended Dec. 31,
1996 $ (.61) $ 10.31 4.47% .98%(A) 5.91%(A) 354% $293,846
1995 (.57) 10.47 13.88% .93%(A) 5.59%(A) 290% 231,886
1994 (.51) 9.72 (1.93)% .90%(A) 5.11%(A) 316% 231,255
1993 (.97) 10.43 6.64% .90%(A) 4.84%(A) 490% 299,529
1992 (.72) 10.70 6.26% .87%(A) 5.54%(A) 513% 307,320
1991 (.94) 10.77 14.40% .80%(A) 6.70%(A) 643% 211,627
1990 (.78) 10.29 9.10% .60%(A) 7.70%(A) 67% 74,423
1989 (.80) 10.20 12.80% .80%(A) 7.90%(A) 57% 43,051
1988 (.75) 9.79 6.40% 1.00%(A) 7.40%(A) 133% 27,087
Aug. 7(H)- Dec. 31, 1987 (.30) 9.92 2.20%(D) 1.00%(A,E) 7.40%(A,E) 66%(E) 16,617
-- Navigator Class
Years Ended Dec. 31,
1996 $ (.67) $ 10.31 5.09% .42%(B) 6.47%(B) 354% $ 8,082
1995 (.62) 10.47 14.45% .44%(B) 6.08%(B) 290% 4,184
Dec. 1(C)- 31, 1994 (.05) 9.72 .50%(D) .40%(B,E) 6.44%(B,E) 316%(E) 4,024
INVESTMENT GRADE INCOME PORTFOLIO
-- Primary Class
Years Ended Dec. 31,
1996 $ (.64) $ 10.22 4.31% .97%(F) 6.42%(F) 383% $ 91,928
1995 (.65) 10.44 20.14% .88%(F) 6.49%(F) 221% 85,633
1994 (.64) 9.27 (4.82)% .85%(F) 6.09%(F) 200% 66,196
1993 (1.26) 10.40 11.22% .85%(F) 5.62%(F) 348% 68,781
1992 (.91) 10.71 6.77% .85%(F) 6.11%(F) 317% 48,033
1991 (.79) 10.71 16.00% .71%(F) 7.30%(F) 213% 36,498
1990 (.88) 9.97 5.80% .50%(F) 8.30%(F) 55% 22,994
1989 (.82) 10.29 13.00% .82%(F) 8.10%(F) 92% 13,891
1988 (.805) 9.88 7.70% 1.00%(F) 7.70%(F) 146% 9,913
Aug. 7(H)- Dec. 31, 1987 (.31) 9.94 2.60%(D) 1.00%(F,E) 7.80%(F,E) 72%(E) 5,661
-- Navigator Class
Years Ended Dec. 31,
1996 $ (.70) $ 10.22 4.88% .41%(G) 6.99%(G) 383% $ 243
Dec. 1(C)- 31, 1995 (.03) 10.44 1.42%(D) .40%(G,E) 6.73%(G,E) 221%(E) 249
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Investment Operations Distributions From:
-------------------------------------- ------------------------------------------------
Net Realized
and Unrealized In Excess
Net Asset Net Gain (Loss) on Total In Excess Net of Net
Value, Investment Investments, From Net of Net Realized Realized
Beginning Income Options Investment Investment Investment Gain on Gain on
of Year (Loss) and Futures Operations Income Income Investments Investments
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C>
HIGH YIELD PORTFOLIO
Years Ended Dec. 31,
1996 $ 14.62 $ 1.33 $ .76 $ 2.09 $(1.34) $ -- $ -- $ --
1995 13.57 1.29 1.05 2.34 (1.29) -- -- --
Feb. 1(H)- Dec. 31,
1994 15.00 1.02 (1.44) (.42) (1.01) -- -- --
</TABLE>
<TABLE>
<CAPTION>
Ratios/Supplemental Data
---------------------------------------------------------------
Net
Net Asset Investment Net Assets,
Value, Expenses Income (Loss) Portfolio End of
Total End of Total to Average to Average Turnover Year
Distributions Year Return Net Assets Net Assets Rate (in thousands)
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
HIGH YIELD PORTFOLIO
Years Ended Dec. 31,
1996 $ (1.34) $ 15.37 14.91% 1.35% 9.05% 77% $234,108
1995 (1.29) 14.62 18.01% 1.47% 9.28% 47% 108,417
Feb. 1(H)- Dec. 31, 1994 (1.01) 13.57 (2.90)%(D) 1.6%(E) 8.4%(E) 67%(E) 53,424
</TABLE>
(A) NET OF FEES WAIVED BY THE MANAGER FOR EXPENSES IN EXCESS OF VOLUNTARY
LIMITATIONS OF: 1.0% UNTIL SEPTEMBER 10, 1989; 0.5% UNTIL MARCH 30,
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; 0.95% UNTIL APRIL 30, 1996; AND 1.00% UNTIL DECEMBER 31,
1997.
(B) NET OF FEES WAIVED BY THE MANAGER FOR EXPENSES IN EXCESS OF VOLUNTARY
LIMITATIONS OF: 0.4% UNTIL APRIL 30, 1995; 0.45% UNTIL APRIL 30, 1996;
AND 0.50% UNTIL DECEMBER 31, 1997.
(C) COMMENCEMENT OF SALE OF NAVIGATOR SHARES.
(D) NOT ANNUALIZED
(E) ANNUALIZED
(F) 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 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; 0.9% UNTIL APRIL 30, 1996; AND 1.0% UNTIL DECEMBER 31,
1997.
(G) NET OF FEES WAIVED BY THE MANAGER FOR EXPENSES IN EXCESS OF VOLUNTARY
EXPENSE LIMITATIONS OF 0.4% UNTIL APRIL 30, 1996 AND 0.5% UNTIL
DECEMBER 31, 1997.
(H) COMMENCEMENT OF OPERATIONS.
5
<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 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.
Total returns as of December 31, 1996 were as follows:
CUMULATIVE TOTAL GOVERNMENT INVESTMENT HIGH
RETURN INTERMEDIATE GRADE YIELD
- ---------------------------------------------------------------
Primary Class:
One Year +4.47% +4.31% +14.91%
Five Years +32.22% +41.65% N/A
Life of Class +102.34%(A) +116.89%(A) +31.69%(B)
Navigator Class:
One Year +5.09% +4.88% N/A
Life of Class +20.88%(C) +6.38%(D) N/A
AVERAGE ANNUAL
TOTAL RETURN
- ------------------------
Primary Class:
One Year +4.47% +4.31% +14.91%
Five Years +5.74% +7.21% N/A
Life of Class +7.78%(A) +8.58%(A) +9.89%(B)
Navigator Class:
One Year +5.09% +4.88% N/A
Life of Class +9.52%(C) +6.13%(D) N/A
- ----------
(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 DECEMBER 31, 1996.
(D) FOR THE PERIOD DECEMBER 1, 1995 (COMMENCEMENT OF SALE OF NAVIGATOR SHARES)
TO DECEMBER 31, 1996.
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 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 1996. 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 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 the
Corporation's annual report to shareholders, which may be obtained without
charge by calling a financial advisor at Fairfield, Legg Mason or Legg Mason's
Funds Marketing Department at 800-822-5544.
6
<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,
all of which will fluctuate as market interest rates change. Investments
in mortgage-related securities issued by governmental or
government-related entities, as described on page 11, 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 NRSRO, 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 fixed-income 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 fixed-income 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.
(4) preferred stocks (including step down preferred securities), rated
no lower than Baa by Moody's or, if unrated by Moody's, judged by the
Adviser to be of comparable quality.
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; and (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).
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 to achieve the Fund's objectives, the Adviser,
under normal circum-
7
<PAGE>
stances, invests at least 65% of the Fund's total assets in high yield,
fixed-income securities, that is, income producing debt securities and
preferred stocks of all types, including 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
objectives of the Fund 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, securities comparably rated by another
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 Moody's and S&P's 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, (Rule 144A permits large institutions to trade certain
securities even though they are not registered 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
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 lever-
8
<PAGE>
age; 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
its 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. The Adviser also
analyzes interest rate trends and specific developments which it believes
may affect individual issuers.
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 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.
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 judgment 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-
9
<PAGE>
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 Investment Grade is
subsequently given a rating below investment grade, the Adviser will
consider that fact in determining whether to retain that security in the
Fund's portfolio.
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, 1996, 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>
Investment
Grade 67.5% 15.3% 14.2% 3.0% -- -- -- --
High Yield 4.1% -- 5.0% 70.8% 4.8% -- 0.4% 14.9%
</TABLE>
<TABLE>
<CAPTION>
AAA/
S&P AA/A BBB BB B CCC CC/C D NR
- -----------------------------------------------------------------------------------
<S> <C>
Investment
Grade 67.5% 18.7% 8.9% 4.9% -- -- -- --
High Yield 4.1% -- 15.2% 54.1% 3.4% -- 0.4% 22.8%
</TABLE>
Investment Grade held no unrated debt securities during the fiscal
year. The dollar-weighted average of debt securities not rated by either
Moody's or S&P amounted to 12.3% for High Yield. This may include
securities rated by other NRSROs, 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 (e.g., certificates of the
Government National Mortgage Association ("GNMA")); (2) the right of the
issuer to borrow from the U.S. Treasury (e.g., Federal Home Loan Banks
securities); (3) the discretionary authority of the U.S. Treasury to lend
to the issuer (e.g., Fannie Mae ("FNMA") securities); and (4) solely by
the creditworthiness of the issuer (e.g., 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.
Inflation-Indexed Securities
The Funds may also invest in U.S. Treasury securities whose principal
value is adjusted daily in accordance with changes to the Consumer Price
Index (also known as "Treasury Inflation-Protection Securities"). Interest
is calculated on the basis of the adjusted principal value on the payment
date. The principal value of inflation-indexed securities declines in
periods of deflation, but holders at maturity receive no less than par. If
inflation is lower than expected during the period a Fund holds the
security, the Fund may earn less on it than on a conventional bond. Any
increase in principal value is taxable in the year the increase occurs,
even though holders do not receive cash representing the increase at that
time. Changes in market interest rates from causes other than inflation
will likely affect the market prices of inflation-indexed securities in
the same manner as conventional bonds.
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.
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
10
<PAGE>
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
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. 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 issued by FNMA ("FNMA certificates") 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
11
<PAGE>
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.
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 a 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 market price can reflect a premium or
discount, in addition to the original issue discount, reflecting the
market's judgment as to the issuer's creditworthiness, the interest rate
or other similar factors. The original issue 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 make periodic interest
payments, 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
12
<PAGE>
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.
Stripped Mortgage-Backed Securities
The Funds 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 Funds 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 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, a
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 each Fund's 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.
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 likely to respond to changes in interest
rates to a greater degree than the prices of securities paying interest
currently. 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 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 most likely 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.
Preferred Stock
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.
Trust Originated Preferred Securities
The Funds may also invest in trust originated preferred securities, a
new type of security issued by financial institutions such as banks and
insurance companies. Trust originated preferred securities represent
interests in a trust formed by a financial institution. The trust sells
preferred shares and invests the proceeds in notes issued by the financial
institution. These notes may be subordinated and unsecured. Distributions
on the trust originated preferred securities match the interest payments
on the notes; if no interest is paid on the notes, the trust will not make
current payments on its preferred securities. Trust originated preferred
securities currently enjoy favorable tax treatment. If the tax
characterization of these securities were to change adversely, they could
be redeemed by the issuers, which could result in a loss to a Fund. In
addition, some trust originated preferred securities are restricted
securities available only to qualified institutional buyers under Rule
144A.
13
<PAGE>
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, although there are other risks as set forth below.
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 contracts ("forward currency contracts").
Forward 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
forward 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 its investment or anticipated
investment in securities denominated in foreign currencies. Forward
currency contracts involve certain risks, including the risk that 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 countries in Latin America,
Eastern Europe, Asia and Africa).
Risks of Foreign Securities
Investment in foreign securities (including those denominated in U.S.
dollars) 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 income and withholding taxes. 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
Repurchase agreements are agreements under which 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 a custodian bank, 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: A Fund will not enter into repurchase agreements of more
than seven days' duration if more than 10% (15% in the case of High
14
<PAGE>
Yield) of its net 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 appropriate
liquid securities in an account with its custodian 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 subject to a when-issued purchase, which
may result in a gain or loss.
Government Intermediate and Investment Grade each does 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 or appropriate liquid securities 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 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
securities or currencies to the Fund 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. The Fund
may also purchase and write options on such futures contracts.
Risks of Futures, Options and Forward Currency Contracts
Many options on debt securities are traded primarily on the
over-the-counter ("OTC") market. OTC 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 OTC 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 a Fund as well as the loss of the expected benefit of the
transaction. OTC options may be considered "illiquid securities" for
purposes of the Funds' investment limitations.
15
<PAGE>
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"). Each day the Fund pays or receives cash ("variation margin")
equal to the daily change in value of the futures contract. 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 contracts involves
certain investment risks and transaction costs to which a 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,
futures contracts or options thereon, or forward currency contracts 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 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, or forward
currency contract at any particular time which may result in unanticipated
losses; (5) the possibility that the use of cover or segregation involving
a large percentage of 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 and forward currency contracts in
order to continue to qualify for the beneficial tax treatment afforded
"regulated investment companies" under the Internal Revenue Code of 1986,
as amended ("Code") (see "Additional Tax Information" in the Statement of
Additional Information); and (7) the 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 investments. 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
Fund to additional risk. The use of futures or forward currency 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, defined
as securities that cannot be sold within 7 days at approximately the price
they are valued, 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. No more than 10% of
Government Intermediate's or Investment Grade's net assets will be
invested in illiquid securities.
Lending
Each 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.
Interest Rate Swaps (HIGH YIELD ONLY)
The Fund may enter into interest rate swaps. An interest rate swap is
an agreement under which two parties exchange interest rate obligations,
one of which typically is an interest rate fixed until the maturity of the
obligation, while the other typically 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
16
<PAGE>
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.
PORTFOLIO TURNOVER
For the year ended December 31, 1996, Government Intermediate's
portfolio turnover rate was 354%, Investment Grade's portfolio turnover
rate was 383% and High Yield's portfolio turnover rate was 77%. Each Fund
anticipates that its annual portfolio turnover rate may exceed 300%. 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. 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 net short-term capital gains, if any, realized by a Fund and may
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 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.
Customers of certain Institutional Clients that maintain omnibus
accounts with the Funds' transfer agent may obtain shares through those
Institutions. Such Institutional Clients may receive payments from the
Funds' distributor for account servicing, and may receive payments from
their Customers for other services performed. Investors otherwise eligible
to purchase Navigator Shares can purchase them from Legg Mason without
receiving or paying for such other services.
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.
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 on the
next day the Exchange is open. See "How Net Asset Value is Determined" on
page 19.
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
17
<PAGE>
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
financial advisors 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.
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 10 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.
To the extent permitted by law, each Fund reserves the right to take
up to seven days 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 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 financial advisor 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. Fund shares may not be held in, or
transferred to, an account with any brokerage firm other than Fairfield,
Legg Mason or their affiliates. The Funds no longer issue share
certificates.
Navigator Shares sold to Institutional Clients acting in a fiduciary,
advisory, custodial, or other similar capacity on behalf of persons
maintaining Customer Accounts at Institutional Clients will normally be
held of record by the Institutional Clients. Therefore, in the context of
Institutional Clients, references in this Prospectus to shareholders
18
<PAGE>
mean the Institutional Clients rather than their Customers.
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 Navigator Shares from the
total assets attributable to such shares and dividing the result by the
number of 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. 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.
DIVIDENDS AND OTHER DISTRIBUTIONS
Each Fund declares dividends to holders of Navigator Shares out of its
investment company taxable income attributable to those shares, which
consists of net investment income and net short-term capital gain.
Dividends from net investment income are declared daily and paid monthly
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 financial advisor. 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, in the case of High Yield, net realized gains from
foreign currency transactions generally are declared and paid after the
end of the taxable year in which the gain is realized. A second
distribution of net capital gain may be necessary in some years to avoid
imposition of the excise tax described under the heading "Additional Tax
Information" in the Statement of Additional Information. Shareholders may
elect to:
1. Receive both dividends and other distributions in Navigator Shares
of the distributing Fund;
2. Receive dividends in cash and other distributions in Navigator
Shares of the distributing Fund;
3. Receive dividends in Navigator Shares of the distributing Fund and
other distributions in cash; or
4. Receive both dividends and other distributions in cash.
In certain cases, shareholders may reinvest dividends and other
distributions in the corresponding class of shares of another Navigator
fund. Please contact a financial advisor 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 are
credited to the Institutional Client's account in Navigator Shares of the
distributing Fund 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 are
credited to the account at that net asset value. If an investor elects to
receive dividends and/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 other 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 and other tax-exempt
investors) as ordinary income to the extent of that Fund's earnings and
profits. Distributions of a Fund's net capital gain (whether paid
19
<PAGE>
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 other
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.
A redemption of Navigator 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 Navigator Shares for shares of another Navigator
fund will generally have similar tax consequences. See "Shareholder
Services -- Exchange Privilege." If Fund shares are purchased within 30
days before or after redeeming at a loss other shares of the same Fund
(regardless of class), all or part of that loss will not be deductible and
instead will increase the basis of the newly purchased shares.
A dividend or other distribution paid shortly after shares have been
purchased, although in effect a return of investment, is subject to
federal income tax. Accordingly, an investor should recognize that a
purchase of Navigator Shares immediately prior to the record date for a
dividend or other distribution could cause the investor to incur tax
liabilities and should not be made solely for the purpose of receiving the
dividend or other distribution.
The foregoing is only a summary of some of the important federal 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
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.
Confirmations for each purchase and redemption transaction (except a
reinvestment of dividends or other distributions) 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 by the
transfer agent. 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.
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.
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 the
corresponding class of shares of any of the Legg Mason Funds, the Legg
Mason Cash Reserve Trust, the Navigator Money Market Fund, Inc. and the
Navigator Tax-Free Money Market Fund, Inc., provided that such shares are
eligible for sale under applicable state securities laws.
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 financial
advisor. To effect an exchange by telephone, please call your financial
advisor with the information described in the section "How to Purchase and
Redeem Shares," page
20
<PAGE>
17. 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.
THE CORPORATION'S 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 a separate management agreement with each Fund
("Management Agreement"), which was approved by the Corporation's Board of
Directors, Legg Mason Fund Adviser, 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 has agreed that until December 31, 1997 or when Government
Intermediate reaches net assets of $400 million, whichever occurs first,
it will continue to waive fees 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 0.50% of
the Fund's average daily net assets attributable to Navigator Shares for
such month. If the Fund's assets total $400 million before December 31,
1997, the Manager has agreed not to increase this "cap" by more than 10
basis points. The Manager does not anticipate that the Fund's assets will
total $400 million before December 31, 1997, although there can be no
assurance that this will be the case. After waiver by the Manager of its
fees, the Fund's total operating expenses for the year ended December 31,
1996 were 0.42% of average daily net assets. The Manager has also agreed
that until December 31, 1997 or when Investment Grade reaches net assets
of $100 million, whichever occurs first, it will continue to waive fees 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 0.50% of the Fund's average daily net assets
attributable to Navigator Shares for such month. After waiver by the
Manager of its fees, the Fund's total operating expenses for the year
ended December 31, 1996 were 0.41% of average daily net assets. These
agreements are voluntary and may or may not be renewed by the Manager.
Waiver by the Manager reduces a Fund's expenses and increases its yield
and total return.
The Manager acts as manager, investment adviser or investment
consultant to eighteen investment company portfolios which had aggregate
assets under management of over $7.0 billion as of March 31, 1997. The
Manager's address is 111 South Calvert Street, Baltimore, Maryland 21202.
INVESTMENT ADVISER
Western Asset Management Company 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 Funds)
pays the Adviser a fee, computed daily and payable monthly, at an annual
rate equal to: 0.20% of Government Intermediate's average daily net
assets, not to exceed the fee paid to the Manager; 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 renders investment advice to sixteen open-end investment
companies and one closed-end investment company, which together had
aggregate assets under management of approximately $4.3 billion as of
March 31, 1997. The Adviser also renders investment advice to private
accounts with fixed income assets under management of approximately $22.6
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.
21
<PAGE>
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
Agreements obligate Legg Mason to pay certain expenses in connection with
the offering of shares of the Funds, including any compensation to its
financial advisors, 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 receives a fee from BFDS for assisting it with its transfer
agent and shareholder servicing functions; for the year ended December 31,
1996, Legg Mason received from BFDS $46,000, $20,000 and $29,000, for
performing such services in connection with Government Intermediate,
Investment Grade and High Yield, respectively.
Legg Mason and Fairfield are wholly owned subsidiaries of Legg Mason,
Inc., which is also the parent of the Manager and the Adviser. Fairfield
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 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 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 financial advisor, 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 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 the earlier of December 31, 1997 or,
with respect to Government Intermediate, net assets reach $400 million
and, with respect to Investment Grade, net assets
22
<PAGE>
reach $100 million, it will continue to waive management fees 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 1.00% of the average daily net assets of Primary Shares for
such month. If Government Intermediate's assets total $400 million before
December 31, 1997, the Manager has agreed not to increase this "cap" by
more than 10 basis points. The Manager does not anticipate that Government
Intermediate's assets will total $400 million before December 31, 1997,
although there can be no assurance that this will be the case. Waiver 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.
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. The address of BFDS is P.O. Box
953, Boston, MA 02103.
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.
23
<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 ("S&P") CORPORATE BOND RATINGS:
AAA -- This is the highest rating assigned by S&P to an obligation.
Capacity to pay interest and repay principal is extremely strong.
AA -- Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the higher rated issues only in small
degree.
A -- Bonds rated A have a strong capacity to pay interest and repay
principal, although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt in
higher categories.
BBB -- Bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for bonds in this category than for bonds in
higher rated categories.
BB, B, CCC, CC -- Bonds rated BB, B, CCC and CC are regarded, on
balance, as predominately speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms
of the obligation. BB indicates the lowest degree of speculation and CC
the highest degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by large
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.
A-1
<PAGE>
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-2
