Lincoln National Global Asset Allocation Fund, Inc.
Description of the fund
The Global Asset Allocation Fund (fund) was incorporated in Maryland in 1987.
It is an open-end diversified management investment company whose investment
objective is long-term total return consistent with preservation of capital.
The concept of total return is to increase the value of a shareholder's
investment through both capital appreciation and current income. The fund
pursues its objective by investing in a diversified portfolio of equity and
fixed income securities of both United States and foreign issuers (including
money market instruments) through the allocation of fund assets among a
number of investment categories described more fully in Investment policies
and techniques. The fund's objective is fundamental and cannot be changed
without the affirmative vote of a majority of the outstanding shares of
the fund. See General information in the Appendix. There is no assurance
that the objective of the fund will be achieved. The fund is designed to
provide a complete investment program for investors seeking a diversified
portfolio that will be professionally managed to achieve long-term results
through a variety of market conditions.
Portfolio managers
Since this is an asset allocation fund, day-to-day investment advice is
provided by nine individual portfolio managers from Putnam Investment
Management, Inc. (Putnam) the sub-advisor to the fund. The managers are:
William J. Landes, Managing Director, is the lead manager for the fund and
is responsible for the asset allocation of the portfolio. Landes has managed
the fund since January 1993, and has been with Putnam since 1985.
John J. Morgan, Jr., Managing Director, is responsible for the Growth Equity
Securities segment of the fund's portfolio. Morgan has managed this segment of
the fund since July 1992, and has been with Putnam since 1987.
Anthony I. Kreisel, Managing Director, is responsible for the Conservative
Equity Securities segment of the fund's portfolio. Kreisel has been with
this segment of the fund since November 1992, and has been with Putnam since
1986.
Christopher A. Ray, vice-president, is responsible for the U.S. Fixed Income
Securities segment of the fund's portfolio. Ray has been with this segment of
the fund since January 1993. Before January 1993, Ray was vice-president and
Portfolio Manager at Scudder, Stevens & Clark, Inc., and from February 1986 to
March 1992, he was a vice-president at Putnam.
Jonathan H. Francis, vice-president, is responsible for the International Fixed
Income Securities segment of the fund's portfolio. Francis has been with this
segment of the fund since April 1994, and has been with Putnam since 1992.
Before that, Francis was an independent consultant.
Richard M. Frucci, Senior vice-president, is responsible for the Aggressive
Equity Securities segment of the fund's portfolio. Frucci has been with this
segment of the fund since March 1994, and has been with Putnam since 1984.
John K. Storkerson, Senior vice-president, is responsible for the
International Equity Securities segment of the fund's portfolio. Storkerson
has been with this segment of the fund since April 1992, and has been with
Putnam since 1989.
Lindsey Callen, vice-president, is responsible for the Money Market Instruments
segment of the fund's portfolio. Callen has been with this segment of the fund
since February 1992, and has been with Putnam since 1984.
Rosemary Thomsen, Senior vice-president, is responsible for selection of U. S.
Domestic fixed-income securities for the lower-rated fixed Income securities
("junk bond") segment of the fund's portfolio. Thomsen has been analyzing
domestic high-yield bond investments since 1986, when she joined Putnam
Investments.
Investment policies and techniques.
The fund's investment strategy is based on two principles: 1. Greater
diversification among different types of securities reduces fluctuations in
the value of a portfolio and therefore reduces the risk of loss in
unfavorable market conditions and/or
2. The relative market opportunities and risks in the major securities
categories typically represented in a fully diversified portfolio equities,
fixed income securities and money market instruments vary at times. By
employing an investment practice known as asset allocation, the proportion
of the fund's assets invested in each category can be shifted in anticipation
of or in response to changing market conditions, in pursuit of the fund's
objective.
In regard to the asset allocation method, the fund's portfolio may include
investments in each of the following categories:
Aggressive Equity Securities
Growth Equity Securities
Conservative Equity Securities
International Equity Securities
Convertible Securities (including Common Stock
Equivalents)
U.S. Fixed-Income Securities
International Fixed-Income Securities
Lower-Rated Fixed-Income Securities (starts 9/1/96)
Money Market Instruments
The specific allocation of fund assets among the categories will be
determined by the sub-advisor at least quarterly based on its assessment of
relative market opportunities and risks. The determination of asset mix is
based on the sub-advisor's analyses and forecasts relating to economic and
market factors.
Aggressive Equity Securities
This category will include investments in common stocks of companies which the
sub-advisor believes have potential for capital appreciation which is
significantly greater than that of the market averages. A significant
portion of the investments will generally consist of smaller and less
seasoned issuers which the sub-advisor believes have a unique proprietary
product or profitable market niche and the potential to grow rapidly. These
securities present greater opportunity for capital appreciation, but may
also involve greater risk, and may change in value more than securities of
larger, more established companies. The fund will also invest in
securities of larger companies where opportunities for above average capital
appreciation appear favorable. Portfolio securities in this category may be
traded for short-term profits. Portfolio securities in this category are not
purchased to generate current income.
Growth Equity Securities
This category will include investments in common stocks of companies believed to
have above-average growth characteristics. In selecting such instruments, growth
potential is given greater consideration than current income.
Conservative Equity Securities
This category will include investments in common stocks of large, mature
companies that offer the potential for capital growth, current income or
both. These stocks often have relatively high levels of dividend payments.
International Equity Securities
This category will include investments in equity securities principally traded
in foreign securities markets. The securities will primarily be in common
stocks or securities convertible into common stock. Investments will be made
in small or large companies (including relatively less well-known companies)
whose earnings are believed to be in a fairly strong growth trend or whose
market value per share is, in the sub-advisor's opinion, undervalued. With
respect to 65% of the assets allocated to this category, the fund will hold
securities in at least three countries outside the United States at all
times.
Convertible Securities
This category will include investments in corporate bonds, notes or
preferred stocks that can be converted into or exchanged for common stock.
U.S. Fixed-Income Securities
This category will include investments in investment grade debt securities,
including both government and corporate obligations, with maturities of 1 to
40 years. Investment grade bonds include high grade bonds which are in the
top three credit rating categories of Moody's Investors Service and Standard
& Poor's Corp. Investments may also be made in bonds rated Baa and BBB,
respectively, by these organizations, which are considered medium grade.
As such, they may bear a greater element of risk than those rated in the top
three categories. That risk can involve increased market price volatility
stemming from the sensitivity of interest rates, concerns over
creditworthiness and availability of quotations on the secondary market.
For a description of these ratings, see Bond Ratings in the SAI.
International Fixed-Income Securities
This category will include investments principally in debt securities
denominated in foreign currencies which are issued by foreign governments and
governmental or supranational agencies. The fund may also invest in other debt
securities, convertible securities, and preferred stocks principally traded in
foreign securities markets. The fund will invest only in securities which, at
the time of purchase, are rated at least A or higher by Moody's Investors
Service or Standard & Poor's Corp. or in unrated securities judged by Putnam
to be of comparable quality. With respect to 65% of the assets allocated to
this category, the fund will hold securities in at
least three countries outside the United States, at all times.
Lower-rated Fixed-Income Securities ("Junk Bonds")
This category will include investments in U. S. and Emerging
Markets fixed-income instruments rated at the time of purchase below
Baa by Moody's, or BBB by S&P, or if unrated, determined by the
subadvisor to be of comparable quality, as long as, after the purchase,
15% or less of the fund's total assets would be invested in Securities
of that quality. (Securities rated Baa or BBB, while still
considered investment-grade, are more vulnerable to adverse economic
conditions than securities in the higher-rated categories and have
speculative elements.)
The values of junk bonds (i.e., those below Baa or BBB) generally fluctuate
more than those of higher-rated fixed-income securities. In addition, the
lower rating reflects a greater possibility that the financial condition of
the issuer, or adverse changes in general economic conditions or both, may
impair the ability of the issuer to make payments of interest and repayments
of principal. The rating services' descriptions of debt securities are
included in the Appendix to the SAI. The fund will not necessarily dispose of
a security when its rating is reduced below its rating at the time of
purchase, although the subadvisor will monitor the investment to determine
whether continued investment in the security will assist in meeting the fund's
investment objective.
The fund may take full advantage of the entire range of U.S. and Emerging
Markets junk bonds (except than no more than 10% of fund assets may be in
Emerging Market issues). The fund may adjust the average maturity of the
fund's portfolio from time to time, depending on its assessment of relative
yields on securities of different maturities and its expectation of future
changes in interest rates.
Through investment analysis and attention to current developments in interest
rates and economic conditions, the subadvisor seeks to minimize the risks of
investing in lower-rated securities. The lower ratings of certain fixed-income
securities held by the fund reflect a greater possibility that declines in the
financial conditions of the issuers, or in general economic conditions of the
issuers, or in geral economic conditions, or both, or an unanticipated rise in
interest rates, may make it harder for their issuers to make payments of
interest and principal. In addition, under these circumstances, the values
of these securities may be more volatile, and the markets for them may be less
liquid than those for higher-rated securities. As a result, the fund may find
it more difficult to determine the fair value of these securities. When the
Fund invests in fixed-income securities in these lower rating categories, the
achievement of the fund's goals is more dependent on the subadvisor's investment
analysis than would be the case if the fund were investing in fixed-income
securities in the higher-rating categories.
In any event,the Fund will not purchase securities rated at the
time of purchase lower than Caa by Moody's or CCC by S&P or, if unrated,
determined by the subadvisor to be of comparable quality, if as a result of
the purchase more than 5% of the Fund's total assets would be invested in
securities of that quality. (Securities rated this low may be in default and
are generally regarded by the rating agencies as
having extremely poor prospects of ever becoming investment-grade.)
For additional information concerning the risks associated with
investments by each fund in securities in the lower-rating categories,
see the SAI.
Money Market Instruments
This category will include investments in money market instruments consisting
of certificates of deposit and bankers' acceptances of major banks, high-grade,
short-term municipal obligations, U.S. Government securities and related
repurchase agreements, high grade commercial paper and other corporate
obligations.
Asset allocation policy
Under normal circumstances, not more than 50% of the fund's assets will be
invested in the Conservative Equity Securities category; and not more than
35% of the fund's assets will be invested in any other category.
Under no circumstances will more than 15% of the Fund's assets be invested in
the Lower-rated Fixed-Income Securities Category. No more than two-thirds of
the Fund's assets invested in this category (that is, no more than 10% of
the Fund's total assets) may be invested in Emerging Markets debt
instruments.
When conditions dictate a defensive position or during periods
of structuring or restructuring, Putnam may invest up to 50% of the fund's
assets in each of the U.S. Fixed Income Securities and Money Market
instruments categories.
Within these limitations, they will adjust the percentage of the fund assets
in each category based upon its market outlook and its analysis of long term
trends. For example, if Putnam believes that conditions will be favorable for
equity securities, a greater proportion may be invested in Aggressive Equity
Securities. Similarly, a greater proportion will be invested in International
Equity Securities if foreign equity markets are viewed favorably. Since the
fund's objective of total return consistent with preservation of capital may
be achieved by receipt of income, as well as by capital gains, Putnam may
increase the proportion of fund assets in Fixed Income Securities or
Convertible Securities when it believes the outlook for the bond market is
favorable.
In pursuing the fund's objective, Putnam expects generally to employ a
relatively conservative strategy for seeking total return. Accordingly,
their asset allocation decisions will seek to have the fund's assets decline
significantly less in value than the Standard and Poor's 500 Index (S&P 500)
in unfavorable securities markets, while correlating more closely with the
performance of the index in favorable securities markets. There is no
assurance that this strategy will be successful.
Changes in investment policies
The investment policies of the fund may be changed without shareholder
approval, although the shareholders will be notified of any material
changes, additions or deletions.
Foreign investments; American Depositary Receipts (ADRs) and European
Depositary Receipts (EDRs)
The International Equity and International Fixed Income Securities investment
categories will each invest 100% of their respective assets in securities
principally traded in foreign markets. The other investment categories may do
so as well, but only up to the following percentages of their total assets:
the Money Market Instruments category 50%; all other categories 10%.
(Eurodollar certificates of deposit are excluded for purposes of these
limitations.) Foreign investments can involve risks not present in domestic
investments. For a discussion of those risks, see Foreign investments in the
Appendix. A detailed discussion of how the fund intends to handle these
risks appears in the SAI.
For the domestic categories, the fund may invest in depositary receipts. These
consist of ADRs and EDRs, and involve investing indirectly in an underlying
foreign security. Generally ADRs, which are in registered form, are U.S. dollar
- -denominated securities designed for use in the U.S. securities markets and
which may be converted into the underlying security. EDRs, which are in
bearer form, are designed for use in the European securities markets.
PORTFOLIO TURNOVER
The fund's portfolio turnover rate is expected to average approximately 200%.
(For example, a rate of portfolio turnover of 100% would occur if all of the
fund's portfolio were replaced in a period of one year.) The actual turnover
rate will vary, depending upon the turnover rate in each investment category,
the amount of assets allocated to each category, and the extent to which assets
are reallocated among categories from time to time. High portfolio turnover may
involve correspondingly greater brokerage commissions and other transaction
costs, which are borne directly by the fund. See Portfolio Transactions and
Brokerage in the SAI. During 1995 the fund's portfolio turnover was 146.49%
and in 1994 it was 134.33%.
Investment restrictions
There are some specific investment restrictions that help the fund limit
investment risks for its shareholder. The restrictions in this section are
fundamental. See General information in the Appendix.
The fund may not:
1. Acquire more than 10% of the voting securities of any one issuer;
2. Invest more than 5% of its total assets in securities of any one issuer
(other than the U.S. Government or its agencies or instrumentalities);
3. Invest more than 5% of its net assets in securities restricted as to
resale; and/or
4. Invest more than 25% of its assets in any one industry.
A complete listing of all of the fund's fundamental and non-fundamental
restrictions can be found in the SAI.
Strategic portfolio transactions
The portfolio manager for the fund has considerable discretion in the
selection of appropriate fund investments. In the exercise of that
discretion, the portfolio manager may, at any given time, invest a portion
of the fund's assets in one or more strategic portfolio transactions which
we define as derivative transactions and cash enhancement transactions.
For your convenience, in the Appendix, we have included a basic discussion of
these special financial arrangement transactions and some of the risks
associated with them. Note also that the SAI booklet for the 11 funds
contains definitions of the more commonly used derivative transactions,
technical explanations of how these transactions will be used and the
limits on their use. You should consult your financial counselor if you
have specific questions.
The Global Asset Allocation Fund is authorized: a) for derivative transactions,
to: buy and sell foreign currency forward contracts; buy and sell foreign
currency futures contracts; and buy exchange-listed and over-the-counter put
and call options on foreign currency futures contracts and on foreign
currencies. For hedging purposes, the fund may sell covered call options on
foreign currencies. All of the foregoing may also be done as cross hedging-
that is, using a currency different from the one in which the portfolio
securities are denominated. (See Foreign currency exchange transactions
in the SAI.) In addition, the fund may sell covered call and put options
on equity and fixed-income (debt) securities of U.S. issuers; sell put and
call options and buy put options on securities of U.S. issuers; buy and
sell futures contracts and options on futures contracts with respect to
securities issued or guaranteed by the U.S. Government or its agencies or
instrumentalities; buy and sell futures contracts and related options with
respect to stock indices, foreign fixed-income securities and
foreign currencies (See Options and futures portfolio strategies in the
SAI); engage in spread and straddle transactions.
b) for cash enhancements transactions, to: lend portfolio securities; engage in
repurchase transactions. Collateral will be continually maintained at no less
than 102% of the value of the loaned securities or of the repurchase price,
as applicable.
Appendix- contains important information for all funds
This Appendix constitutes part of the Prospectuses of Lincoln National
Aggressive Growth Fund, Inc. (Aggressive Growth Fund), Lincoln National Bond
Fund, Inc. (Bond Fund), Lincoln National Capital Appreciation Fund, Inc.
(Capital Appreciation Fund), Lincoln National Equity-Income Fund, Inc.
(Equity-Income Fund), Lincoln National Global Asset Allocation Fund, Inc.
(Global Asset Allocation Fund), Lincoln National Growth and Income Fund, Inc.
(Growth and Income Fund), Lincoln National International Fund, Inc.
(International Fund), Lincoln National Managed Fund, Inc. (Managed Fund),
Lincoln National Money Market Fund, Inc. (Money Market Fund), Lincoln
National Social Awareness Fund, Inc. (Social Awareness Fund), and Lincoln
National Special Opportunities Fund, Inc. (Special Opportunities
Fund). Unless otherwise indicated, the following information applies to
each Fund.
Net asset value
Each Fund's net asset value per share is determined as of close of
business (currently 4:00 p.m., New York Time) on the New York Stock
Exchange (NYSE) on each day it is open for trading. The net asset value per
share for all Funds except the Money Market Fund is determined by adding the
values of all securities and other assets, subtracting liabilities
(including dividends payable) and dividing by the number of shares outstanding.
Debt securities and other assets of the Fund, other than equity securities, for
which market quotations are readily available, are valued at their bid
quotations.
When market quotations are not readily available, debt securities and
other assets are valued at their fair value as determined in good faith.
This valuation is made by or under the authority of the Fund's Board of
Directors and it may include the use of valuations furnished by outside
sources, including pricing services which utilize electronic data processing
techniques for valuing normal institutional-size trading units of debt
securities. The value of equity securities is based on the last sale prices
of those securities on national securities exchanges or, in the absence
of recorded sales, at the average of readily available closing bid and
asked prices on exchanges or over-the-counter. In the absence of readily
available closing bid and asked prices, equity securities will be valued at
fair value.
Short-term investments. For Funds (other than the Money Market Fund) that trade
in short-term investments which mature in less than 60 days, these instruments
are valued at amortized cost; if these securities are acquired with a
remaining maturity of 61 days or more, the cost for purposes of valuation is
deemed to be the value on the sixty-first day prior to maturity.
Options trading. For those Funds engaging in options trading, Fund investments
underlying call options will be valued as described previously. Options are
valued at the last sale price or, if there has been no sale that day, at
the mean of the last bid and asked price on the principal exchange where the
option is traded, as of the close of trading on the NYSE. The Fund's net
asset value will be increased or decreased by the difference between the
premiums received on writing options and the cost of liquidating those
positions measured by the closing price of those options on the exchange
where traded.
Foreign securities. For Funds investing in foreign securities, the value of a
foreign portfolio security held by a Fund is determined based upon its
closing price or upon the mean of the closing bid and asked prices on the
foreign exchange or market on which it is traded and in the currency of
that market, as of the close of the appropriate exchange. As of the close
of business on the NYSE, that Fund's portfolio securities which are quoted
in foreign currencies are converted into their U.S. dollar equivalents at
the prevailing market rates, as computed by the Custodian of the Fund's
assets.
However, trading on foreign exchanges may take place on dates or at
times of day when the NYSE is not open; conversely, overseas trading may
not take place on dates or at times of day when the NYSE is open. Any of these
circumstances could affect the net asset value of Fund shares on days when the
investor has no access to the Fund. There are more detailed explanations of
these circumstances<PAGE>
in the SAI for the various Funds. See the Preface to the
Prospectus booklet for information about how to obtain a copy of the SAI
booklet.
Money Market Fund. The net asset value per share of the Money Market
Fund is determined by the amortized cost method of valuation, pursuant to
Rule 2a-7 (the Rule) of the 1940 Act.Under the Rule, the Fund's net asset
value under the amortized cost method must fairly reflect the value
calculated under a market-based valuation method. The Board of Directors of
the Fund has put in force procedures to assist Fund management and the
Investment Advisor in complying with the requirements of the Rule. In 1991,
an amendment was imposed specific standards for the maturity, quality, and
diversification of portfolio securities. It also revised and expanded the
duties of the Money Market Fund's management and its Board of Directors. The
Fund's procedures have been amended in accordance with those requirements.
Management of the funds
The business and affairs of each Fund are managed under the direction of
its Board of Directors. The Board has the power to amend the Bylaws of each
Fund, to declare and pay dividends, and to exercise all the powers of the
Fund except those granted to the shareholder. Lincoln Life is the sole
shareholder of each Fund.
Investment Advisor. Lincoln Investment Management, Inc.
(Lincoln Investment) is the Investment Advisor to the Funds and is
headquartered at 200 East Berry Street, Fort Wayne, Indiana 46802. Lincoln
Investment (the Advisor) is registered with the Securities and Exchange
Commission (the Commission) [SEC] as an Investment Advisor and has acted as
an Investment Advisor to mutual funds for over 40 years. The Advisor also
acts as Investment Advisor to Lincoln National Convertible Securities Fund,
Inc., and Lincoln National Income Fund, Inc., closed-end investment
companies as well as Lincoln Advisor Funds, Inc., an open-end series.
The Advisor is a wholly-owned subsidiary of Lincoln National
Corporation (LNC), a publicly-held insurance holding company organized
under Indiana law. Through its subsidiaries, LNC provides life insurance
and annuities, property-casualty insurance, reinsurance, and financial
services.
Under Advisory agreements described in the Prospectus for the Variable
Account, the Advisor provides portfolio management and investment advice to
the Funds and administers their other affairs, subject to the supervision of
each Fund's Board of Directors.
As compensation for its services to each Fund, the Advisor is paid an
Investment Advisory Fee at an annual rate based on the average daily net
asset value of each Fund, as shown in the following chart:
<TABLE>
<S> <C> <C> <C>
First Next In excess of
Fund $20 million... $200 million... $400 million...
... of average daily net asset value
Aggressive Growth .75 of 1% .70 of 1% .65 of 1%
Capital Appreciation .80 of 1 .80 of 1 .80 of 1
Equity-Income .95 of 1 .95 of 1 .95 0f 1
Global Asset Allocation .75 of 1 .70 of 1 .68 of 1
International .90 of 1 .75 of 1 .60 of 1
All other Funds .48 of 1 .40 of 1 .30 of 1
</TABLE>
The Advisory fees for the Capital Appreciation, Equity-Income, and
International Funds reflect the more extensive services and increased
expense associated with portfolios of securities issued outside the United
States.
<TABLE>
<S> <C> <C>
Fund expenses (see 1995 ratio of the 1995 ratio of total
accompaning text below) Advisor's compensation expenses to average
to average net assets net assets operational fund
Fund
Aggressive Growth .75% .94%
Bond .47 .49
Capital Appreciation .81 1.07
Equity-Income .95 1.15
Global Asset Allocation .70 .92
Growth and Income .34 .35
International .84 1.27
Managed .41 .43
Money Market .48 .52
Social Awareness .47 .50
Special Opportunities .43 .45
</TABLE>
Expenses specifically assumed by each Fund include: compensation
and expenses of Directors of the Fund who are not interested persons of the
Fund as defined in the 1940 Act; registration, filing, and other fees in
connection with filings with regulatory authorities, including the costs of
printing and mailing registration statements and updated prospectuses
provided to current Contract Owners; fees and expenses of independent
auditors; the expenses of printing and mailing proxy statements and
shareholder reports; custodian and transfer agent charges; brokerage
commissions and securities and options transaction costs incurred by the
Fund; taxes and corporate fees; legal fees incurred in connection with the
affairs of the Fund (other than legal services provided
by personnel of the Advisor or its affiliated companies); the fees of any
trade association of which the Fund is a member; and expenses of
shareholder and Director meetings.
Sub-Advisors. As Advisor, Lincoln Investment is primarily responsible
for investment decisions affecting each of the Funds. However, Lincoln
Investment has entered into Sub-Advisory agreements with several professional
investment management firms. These firms provide some or substantially all
of the investment advisory services required by the Funds, including day-to-
day investment management of those Funds' portfolios. Each Sub-Advisor
makes investment decisions for its respective Fund in accordance with that
Fund's investment objectives and places orders on behalf of that Fund to
effect those decisions. See the following tables for more information about the
Sub-Advisors and their fees:
<TABLE>
<S> <C> <C> <C>
Date of Annual fee rate based on
Fund Sub-advisor agreement average daily net asset value
Aggressive Lynch & .50 of 1% of the first $150 million
Growth Mayer 12/20/93 .35 of 1% of the excess over $150 million
Capital .60 of 1% of the first $100 million
Appreciation Janus 1/1/94 .55 of 1% of the excess over $100 million
Equity-Income Fidelity 12/20/93 .75 of 1%
Global Asset The greater of (a) $40,000; or (b) .47 of
Allocation Putnam 6/8/87 1% of the first $200 million; .42 of 1%
of the next $200 million; and .40 of 1%
of any excess over $400 million
International Clay Finlay 11/19/90 .665 of 1% of the first $50 million;
.475 of 1% of the next $50 million; and .250 of
1% of any excess over $100 million
</TABLE>
...............................................................................
<TABLE>
<S> <C> <C> <C>
Annual fee rate based on market value of
securities held in the portfolio of each
respective client fund at the close of
Date of business on the last trading day of each
Fund Sub-advisor agreement calendar quarter
Growth and
Income Vantage 8/21/85 .20 of 1%
Managed Vantage
(stock portfolio 8/21/85 .20 of 1%
only)
Social
Awareness Vantage 4/30/88 .20 of 1%
Special
Opportunities Vantage 8/21/85 .20 of 1%
</TABLE>
No additional compensation from the assets of the Funds will be assessed
as a result of the Sub-Advisory agreements; the Sub-Advisors are paid by
Lincoln Investment. There is no Sub-Advisor for the Bond and Monsy Market
Funds.
Service marks. The service mark for the Funds and the name Lincoln National
have been adopted by the Funds with the permission of LNC, and their continued
use is subject to the right of LNC to withdraw this permission in the event
the Advisor should not be the Investment Advisor of the Funds.
In the Prospectus and sales literature, the name Fidelity Investments
will be used with the Equity-Income Fund, Janus with the Capital
Appreciation Fund, and Putnam with the Global Asset Allocation Fund. The
continued use of these names is subject to the right of the respective
Sub-Advisor to withdraw its permission in the event it ceases to be the
Sub-Advisor to the particular Fund it advises.
Purchase of securities being offered
Shares of the Funds' common stock ($.01 par value) will be sold to
Lincoln Life for allocation to the Variable Annuity Account (VAA), which
has been established for the purpose of funding Variable Annuity Contracts;
shares in the Funds will also be sold to Lincoln Life for allocation to one
or more of the Variable Life Accounts, which have been established for the
purpose of funding variable life insurance contracts. Shares of each Fund
are sold and redeemed at their net asset value determined daily. See Sale
and redemption of shares. Also see Net asset value.
The Funds' shares are sold to Lincoln Life for the Variable Accounts on a
no-load basis-that is without the imposition of a sales charge.
Sale and redemption of shares
The shares of each Fund are sold and redeemed by the Fund at their net
asset value next determined after receipt of a purchase or redemption order
in acceptable form. The value of shares redeemed may be more or less than
original cost, depending upon the market value of the portfolio securities
at the time of redemption. Payment for shares redeemed will be made within
seven days after the redemption request is received in proper form by the
Funds. However, the right to redeem Fund shares may be suspended or payment
postponed for any period during which (1) trading on the NYSE is restricted
as determined by the Commission, or the NYSE is closed for other than
weekends and holidays; (2) an emergency exists, as determined by the
Commission, as a result of which (a) disposal by each Fund of securities
owned by it is not reasonably practicable, or (b) it is not reasonably
practicable for each Fund to determine fairly the value of its net assets;
or (3) the Commission by order so permits for the protection of shareholders
of the Funds.
Distribution and federal income tax considerations
Each Fund's policy is to distribute, at least once a year, substantially
all of its net investment income. Net realized capital gains may only be
distributed annually. These distributions, when paid to Lincoln Life for the
Variable Accounts, will be reinvested automatically in additional shares of
that Fund, at its net asset value.
Each Fund intends to qualify and has elected to be taxed as a regulated
investment company under the provisions of Subchapter M of the Internal
Revenue Code of 1986, as amended (the Code). If a Fund qualifies as a
regulated investment company and complies with the provisions of the Code
relieving regulated investment companies which distribute substantially all
of their net income (both ordinary income and capital gain) from
Federal income tax and the four percent nondeductible Federal Excise tax,
the Funds will be relieved of those taxes on the amounts distributed. See
the SAI for a more complete discussion.
Since the sole shareholder of the Funds is Lincoln Life, there is no
discussion here about the Federal income tax consequences at the shareholder
level. For information concerning the Federal income tax consequences to
holders of annuity or life insurance contracts, see the Prospectus for the
particular Variable Account at the front of this booklet.
Internal Revenue Service (IRS) limitations
As a condition of maintaining the tax-deferred status of variable
contracts, the Funds intend to comply with the diversification
requirements currently imposed by the IRS on separate accounts of insurance
companies. More specific information is contained in the prospectus for the
Variable Account.
Management discussion of fund performance
In the Annual Report for the Funds, the portfolio manager for each Fund
discusses that Fund's performance for the previous fiscal year and the
factors which affected that performance. We will send you a copy of the Annual
Report free upon request.
Description of shares
The authorized capital stock of each Fund consists of 50 million
shares of common stock (100 million for the Growth and Income Fund), $.01
par value. As of April 1, 1996, each Fund had the following number of shares
issued and outstanding:
<TABLE>
<S> <C> <C> <C>
Aggressive Growth Fund xxx International Fund xxx
Bond Fund xxx Managed Fund xxx
Capital Appreciation Fund xxx Money Market Fund xxx
Equity-Income Fund xxx Social Awareness Fund xxx
Global Asset Allocation Fund xxx Special Opportunities
Fund xxx
Growth and Income Fund xxx
</TABLE>
Fund Shares will be owned by Lincoln Life and will be held by it in the
Variable Accounts. As stated in the Prospectuses for the Variable Accounts,
Lincoln Life provides to Contract Owners of the Variable Accounts the right
to direct the voting of Fund shares at shareholder meetings, to the extent
provided by law. However, if the 1940 Act or any regulation under it should
change, and as a result Lincoln Life determines it is permitted to vote Fund
shares in its own right, it may elect to do so.
All the shares of each Fund are of the same class with equal rights and
privileges. Each full share is entitled to one vote and each fractional
share is entitled to a proportionate fractional vote, on all matters
subjected to a vote of the shareholder. All shares, full and fractional,
participate proportionately in any dividends and capital gains distributions
and, in the event of liquidation, in that Fund's net assets remaining after
satisfaction of outstanding liabilities.
When issued, each share is fully-paid and non-assessable and
shareholders have no preemptive or conversion rights. Fund shares have
non-cumulative voting rights, which means that holders of more than 50% of
the shares voting for the election of directors can elect 100% of the
directors if they choose to do so. In that event the holders of the
remaining shares so voting will not be able to elect any directors. Shares
may be redeemed as set forth under Sale and redemption of shares.
The Bylaws of the Funds allow them, in proper cases, to dispense with
their annual meetings of the shareholder. Generally, this may be done as
long as: (1) a majority of the Directors then in office have at some point been
elected by the shareholder and, if any vacancy is filled by vote of the Board
of Directors, then immediately after filling the vacancy at least two thirds
of the Directors shall have been elected by the shareholder; (2) there is no
change in the independent auditor of the Funds; (3) there is no material
change to the investment advisory and/or sub-advisory agreements; and (4) a
shareholder vote is not required with respect to a distribution agreement. In
adopting this procedure for dispensing with annual meetings that are a mere
formality, the Directors of the Funds have undertaken to comply with the
requirements of Section 16 (c) of the 1940 Act. That Section protects Contract
Owners by providing a procedure by which they may require management to
convene a meeting of the shareholder to vote on removal of one or more
Directors. The Directors also have agreed to facilitate communication among
Contract Owners for the purpose of calling those meetings. Further
information about these procedures is available from Fund management.
Strategic portfolio transactions
Because of their different investment objectives and portfolio
management philosophies many of the Funds engage to varying degrees in
strategic portfolio transactions, in order to preserve or enhance the value
of their assets. These can be generally identified as either derivative
transactions or cash enhancement transactions. Derivative transactions are
recognized by the investment community as an acceptable way to increase a
Fund's overall value (or, depending on the condition of the securities
markets, at least to slow its decrease). Cash enhancement transactions are
designed to make some extra money for the Fund when it has excess cash, or to
help a Fund obtain some cash for temporary purposes when needed. SEE THE
PROSPECTUS FOR EACH FUND FOR A LISTING OF THE KINDS OF TRANSACTIONS IN
WHICH EACH FUND MAY ENGAGE.
1. Derivative Transactions
A. Introduction.
A derivative transaction is a financial agreement the value of which
is dependent upon the values of one or more underlying assets or upon
the values of one or more indices of asset values. The following types
are currently in fairly common use in the investment community, although
not every Fund will use all of them:
1. Equity contracts: stock options and indexed options; equity swaps;
stock index futures and options on futures; swaptions;
2. Interest rate contracts: interest rate futures and options on them;
forward rate agreements (FRAs); interest rate swaps and their related
transactions (e.g., caps, floors, collars and corridors); and/or
3. Currency derivative contracts: currency forward contracts; currency
options; currency futures; currency swaps; cross-currency interest
rate swaps.
Simplified definitions for these transactions are provided in the SAI
Appendix.
Although they may be structured in complex combinations, derivative
transactions in which the Funds engage generally fall into two broad
categories: options contracts or forward contracts. The combined forms are
constantly evolving. In fact, variations on the types listed previously may
come into use after the date of these Prospectuses. Therefore, where the
Prospectus for a particular Fund discloses the intent of that Fund to engage
in any of the types listed, that Fund hereby reserves the right to engage
in related variations on those transactions.
The Funds intend to engage in derivative transactions only defensively.
Examples of this defensive use might be: to hedge against a perceived
decrease in a Fund's asset value; to control transaction costs associated
with market timing; and to lock in returns, spreads, or currency exchange
rates in anticipation of future cash market transactions.
There is no discussion here of asset-backed or mortgage-backed
securities (such as collateralized mortgage obligations, structured notes,
inverse floaters, principal-only or interest-only securities, etc.). See the
Prospectus and SAI for the Capital Appreciation and Equity-Income Funds,
which are authorized to engage in this kind of trading.
B. Risk factors commonly associated with derivative transactions.
There are certain risks associated with derivatives, and some derivatives
involve more of these risks than others. We briefly describe the most common
ones here; however, this is not an exhaustive list. Consult your financial
counselor if you have additional questions.
CREDIT RISK is the possibility that a counterparty to a transaction
will fail to perform according to the terms and conditions of the contract,
causing the holder of the claim to suffer a loss.
CROSS-CURRENCY SETTLEMENT RISK (or Herstatt risk) is related to the
settlement of foreign exchange contracts. It arises when one of the
counterparties to a contract pays out one currency prior to receiving
payment of the other. Herstatt risk arises because the hours of operation
of domestic interbank fund transfer systems often do not overlap, due to
time zone differences. In the interval between the time one counterparty
has received payment in the indicated currency and the time the other
counterparty(ies) receive payment in the others, those awaiting payment
are exposed to credit risk and market risk.
LEGAL RISK is the chance that a derivative transaction, which involves
highly complex financial arrangements, will be unenforceable in particular
jurisdictions or against a financially troubled entity; or will be
subject to regulation from unanticipated sources.
MARKET LIQUIDITY RISK is the risk that a Fund will be unable to control
its losses if a liquid secondary market for a financial instrument does not
exist. It is often considered as the risk that a (negotiable or assignable)
financial instrument cannot be sold quickly and at a price close to its
fundamental value.
MARKET RISK is the risk of a change in the price of a financial
instrument, which may depend on the price of an underlying asset.
OPERATING RISK is the potential of unexpected loss from inadequate
internal controls or procedures; human error; system (including data
processing system) failure; or employee dishonesty.
SETTLEMENT RISK between two counterparties is the possibility that a
counterparty to whom a firm has made a delivery of assets or money defaults
before the amounts due or assets have been received; or the risk
that technical difficulties interrupt delivery or settlement even if the
counterparties are able to perform. In the latter case, payment is likely
to be delayed but recoverable.
SYSTEMIC RISK is the uncertainty that a disruption (at a firm,
in a market segment, to a settlement system, etc.) might cause widespread
difficulties at other firms, in other market segments, or in the financial
system as a whole.
SPECIAL NOTE FOR OPTIONS AND FUTURES TRANSACTIONS: Gains and losses on
options and futures transactions depend on the portfolio manager's ability
to correctly predict the direction of stock prices and interest rates,
and other economic factors. Options and futures trading may fail as hedging
techniques in cases where the price movements of the securities underlying
the options and futures do not follow the price movements of the portfolio
securities subject to the hedge. The loss from investing in futures
transactions is potentially unlimited.
Some of these risks may be present in each type of transaction, while
others may pertain only to certain ones. These risks are discussed here
only briefly. Before you invest in a particular Fund, please consult your
financial counselor if you have questions about the risks associated with
that Fund's use of derivatives.
C. Varying usage of derivative transactions
Subject to the terms of the Prospectus and SAI for each Fund, that
Fund's portfolio manager decides which types of derivative transactions to
employ, at which times and under what circumstances. For a description of
the limits, risk factors and circumstances under which derivative
transactions will be used by each Fund, refer to the SAI booklet.
D. Increased government scrutiny
Derivative transactions are coming under increased scrutiny by Congress
and industry regulators (such as the SEC and the Office of the Comptroller
of the<PAGE>
Currency), and by self-regulatory agencies (such as the NASD). Should
legislation or regulatory initiatives be enacted resulting in additional
restrictive requirements for derivative transactions, we reserve the right
to make all necessary changes in the Contracts and/or the Registration
Statements for the Funds to comply with those requirements.
2. Cash Enhancement Transactions
Cash enhancement transactions also involve certain risks to the Fund.
They are discussed more fully in the SAI.
A. Lending of portfolio securities
Any Fund authorized to do so may make secured loans of its portfolio
securities, in order to realize additional income. The loans are limited
to a maximum of a stipulated amount of the Fund's total assets. As a
matter of policy, securities loans are made to broker/dealers under
agreements requiring that the loans be continuously secured by collateral in
cash or short-term debt obligations at least equal at all times to 102% of
the value of the securities lent.
The borrower pays the Fund an amount equal to any dividends or interest
received on securities lent. The Fund retains all or a portion of the
interest received on securities lent. The Fund also retains all or a portion
of the interest received on investment of the cash collateral, or receives a
fee from the borrower.
With respect to the loaned securities, voting rights or rights to
consent pass to the borrower. However, the Fund retains the right to call
in the loans and have the loaned securities returned at any time with reasonable
notice. This is important when issuers of the securities ask holders of those
securities including the Fund to vote or consent on matters which could
materially affect the holders' investment. The Fund may also call in the
loaned securities in order to sell them. None of the Fund's portfolio
securities will be loaned to Lincoln Investment, to any Sub-Advisor, or to
any of their respective affiliates. The Fund may pay reasonable finder's
fees to persons unaffiliated with it in connection with the arrangement of
the loans.
B. Repurchase (Repo) and reverse repurchase (Reverse Repo) transactions
1.Repos. From time to time, the Funds may enter into Repo transactions.
In a typical Repo transaction, the Fund involved buys U.S. Government or
other money market securities from a financial institution (such as a
bank, broker, or savings and loan association). At the same time, as part of
the arrangement, the Fund obtains an agreement from the seller to
repurchase those same securities from the Fund at a specified price on a fixed
future date.
The repurchase date is normally not more than seven days from the date
of purchase. Keeping the term under seven days is significant, because the
SEC considers Repo Agreements with maturities of more than seven days to be
illiquid assets of the Fund, and the Funds have strict limitations on the
percentage of their respective assets which may be illiquid.
2.Reverse repos. A Fund may also be authorized to enter into Reverse
Repo transactions. This simply means the Fund is on the reverse side of a
Repo transaction. That is, the Fund is the Seller of some of its portfolio
securities, subject to buying them back at a set price and date.
Authorized Funds will engage in Reverse Repos for temporary purposes,
such as for obtaining cash to fund redemptions; or for the purpose of
increasing the income of the Fund by investing the cash proceeds at a
higher rate than the cost of the agreement. Entering into a reverse repo
transaction is considered to be the borrowing of money by the Fund.
Funds authorized to engage in Repos as buyers are not necessarily
authorized to do Reverse Repos.
Foreign investments
There are certain risks involved in investing in foreign securities,
including those resulting from fluctuations in currency exchange rates;
devaluation of currencies; political or economic developments including
the possible imposition of currency exchange blockages or other foreign
governmental laws or restrictions; reduced availability
of public information concerning issuers; and the fact that foreign
companies are not generally subject to uniform accounting, auditing, and
financial reporting standards or to other regulatory practices and requirements
comparable to those applicable to domestic companies.With respect to certain
foreign countries, there is also the possibility of expropriation,
nationalization, confiscatory taxation, and limitations on the use or
removal of cash or other assets of a Fund, including the withholding of
interest payments or dividends. These risks may be particularly great in
so-called developing or undeveloped countries, sometimes referred to as
Emerging Markets.
In addition, while the volume of transactions effected on foreign stock
exchanges has increased in recent years, in most cases it remains
appreciably below that of the NYSE. Accordingly, a Fund's foreign investments
may be less liquid and their prices may be more volatile than comparable
investments in securities of U.S. companies. Moreover, the settlement
periods for foreign securities, which are often longer than those for
securities of U.S. issuers, may affect portfolio liquidity. The Funds will
incur costs in converting foreign currencies into U.S. dollars. Custody
charges are generally higher for foreign securities. In buying and selling
securities on foreign exchanges, a Fund normally pays fixed commissions that
are generally higher than the negotiated commissions charged in the United
States. In addition, there is generally less governmental supervision and
regulation of securities exchanges, brokers and issuers in foreign countries
that in the United States. There may be difficulty in enforcing legal rights
outside the United States. For example, in the event of default on any
foreign debt obligations, it may be more difficult or impossible for the
Fund to obtain or to enforce a judgment against the issuers of those
securities. The Advisor or Sub-Advisor will take all these factors into
consideration in managing a Fund's foreign investments.
Certain state insurance regulations impose additional restrictions on
the extent to which a Fund may invest in foreign securities. See the SAI.
The share price of a Fund that invests in foreign securities will
reflect the movements of both the prices of the portfolio securities and
the currencies in which those securities are denominated. Depending on the
extent of a Fund's investments abroad, changes in a Fund's share price may
have a low correlation with movements in the U.S. markets. Because most of
the foreign securities in which the Fund invests will be denominated in
foreign currencies, or otherwise will have values that depend on the
performance of foreign currencies relative to the U.S. dollar, the
relative strength of the U.S. dollar may be an important factor in the
performance of the Fund.
Foreign currencies
When the Advisor or Sub-Advisor believes that a currency in which a
portfolio security or securities is denominated may suffer a decline against
the U. S. dollar, it may hedge that risk by entering into a forward contract
to sell an amount of foreign currency approximating the value of some or all
of the portfolio securities denominated in that foreign currency.
Because foreign securities generally are denominated and pay dividends
or interest in foreign currencies, and a Fund may hold various foreign
currencies, the value of the net assets of that Fund as measured in U. S.
dollars will be affected favorably or unfavorably by changes in exchange
rates. Generally, currency exchange transactions will be conducted on a spot
(i.e., cash) basis at the spot rate prevailing in the currency exchange
market. The cost of currency exchange transactions will generally be the
difference between the bid and offer spot rate of the currency being
purchased or sold.
Investors should be aware that exchange rate movements can be
significant and can endure for long periods of time. In order to protect
against uncertainty in the level of future foreign currency exchange rates,
a Fund's Advisor or Sub-Advisor may attempt to manage exchange rate risk
through active currency management, including the use of certain foreign
currency hedging transactions.
For example, it may hedge some or all of its investments denominated
in a foreign currency against a decline in the value of that currency
relative to the U.S. dollar by entering into contracts to exchange that
currency for U.S. dollars (not exceeding the value of the Fund's assets
denominated in that currency), or by participating in
options or futures contracts with respect to that currency. If the Advisor
or Sub-Advisor believes that a particular currency may decline relative to
the U.S. dollar, the Fund may also enter into contracts to sell that currency
(up to the value of the Fund's assets denominated in that currency) in
exchange for another currency that the Advisor or Sub-Advisor expects to
remain stable or to appreciate relative to the U.S. dollar. This technique
is known as currency cross-hedging. Refer to the Prospectus for each Fund
to determine which Funds may engage in these transactions.
These strategies minimize the effect of currency appreciation as well
as depreciation, but do not protect against a decline in the underlying value
of the hedged security. In addition, these strategies may reduce or eliminate
the opportunity to profit from increases in the value of the original
currency and may adversely impact the Fund's performance if the Advisor or
Sub-Advisor's projection of future exchange rates is inaccurate. See Strategic
portfolio transactions.
General information
Your inquiries should be directed to Lincoln National Life Insurance
Co., at P.O. Box 2340, Fort Wayne, Indiana 46801; or you may call
1-800-348-1212.
The Funds will issue unaudited semi-annual reports showing current
investments in each Fund and other information and annual financial
statements audited by their independent auditors.
Under the 1940 Act, a fundamental policy of a fund may not be changed
without the affirmative vote of a majority of the fund's outstanding shares.
As used in this Prospectus, the term majority of the Fund's outstanding
shares means the vote of: (1) 67% or more of each Fund's shares present at a
meeting, if the holders of more than 50% of the outstanding shares of
each Fund are present or represented by proxy, or (2) more than 50% of each
Fund's outstanding shares, whichever is less.
These Prospectuses do not contain all the information included in their
Registration Statements filed with the Commission. The Registration
Statements, including the exhibits filed with them, may be examined at the
office of the Commission in Washington, D.C. Statements contained in the
Prospectuses about the contents of any Contract or other document referred
to in them are not necessarily complete. In each instance, reference is made
to the copy of that Contract or other document filed as an exhibit to the
Registration Statement of which the particular Prospectus forms a part,
and each statement is qualified in all respects by that reference.
The use of Funds by both variable annuity and variable life insurance
separate accounts is known as mixed funding. Due to differences in
redemption rates, tax treatment, or other considerations, the interests of
Contract Owners under the Variable Life Accounts may conflict with those of
Contract Owners under the Variable Annuity Account, in those cases where
mixed funding occurs. The Board of Directors of each Fund will monitor for any
material conflicts and determine what action, if any, should be taken.
Should any conflict arise which requires that a substantial amount of
assets be withdrawn from any of the Funds, orderly portfolio management
could be disrupted, to the detriment of those Contract Owners still investing
in that Fund. Also, if that Fund believes that any portfolio has become so
large as to materially impair investment performance, then the Fund will
examine other investment options. Lincoln Life performs the dividend and
transfer functions for the Funds.
Statement of Additional Information table of contents-eleven underlying Funds*
Item
Investment objective
Investment policies and techniques
Investment restrictions
Portfolio transactions and brokerage
Dtermination of net asset value
Derivative transactions
Appendix
Investment advisor and sub-advisor
Directors and officers
Investment policies and techniques (continued): options, futures, securities
lending, repurchase and reverse repurchase agreements
Custodians
Independent auditors
Financial statements
Bond ratings
Commercial paper ratings
U.S. Government obligations
Taxes
State requirements
Derivative transactions-definitions
* Note: There are variations in these listings from Fund to Fund.
SAI
LINCOLN NATIONAL GLOBAL ASSET ALLOCATION FUND, INC.
This Statement of Additional Information should be read in
conjunction with the Prospectus of Lincoln National Global
Asset Allocation Fund, Inc. (fund) dated May 1, 1996. You may
obtain a copy of the fund's Prospectus on request and without
charge. Please write Kim Oakman, Lincoln National Life
Insurance Co., P.O. Box 2340, Fort Wayne, Indiana 46801 or
call 1-800-348-1212, Ext. 4912.
THIS SAI IS NOT A PROSPECTUS.
May 1, 1996.
Form 19462-GAA (SAI) 5/96
<TABLE>
<CAPTION>
Table of contents
<S> <C>
Page
General Information and History
Investment objective and policies of the fund 2
Investment restrictions 7
Portfolio transactions and brokerage 8
Determination of net asset value 9
Appendix
Investment advisor and sub-advisor A-1
Directors and officers A-2
Investment policies and techniques (continued):
options, futures, securities lending, repurchase
and reverse repurchase agreements A-2
Custodian A-6
Independent auditors A-7
Financial statements A-7
Bond ratings A-7
Commercial paper ratings A-8
U.S. Government obligations A-8
Taxes A-8
State requirements A-9
Derivative transactions-definitions A-9
</TABLE>
Investment objective and policies of the fund
The Prospectus describes the fund's investment objective and
its general investment policies. This SAI includes additional
information about engaging in options and futures trading and
the various investment restrictions of the fund.
The investment policies described in the Prospectus and in
this SAI are not fundamental, and the Boarcd of Directors may
change such policies without shareholder approval.
Depositary receipts
As discussed in the Prospectus, the fund may invest in
American Depositary Receipts (ADRs) and European Depositary
Receipts (EDRs). Generally, ADRs in registered form are U.S.
dollar denominated securities designed for use in the U.S.
securities markets, which represent and may be converted into
the underlying foreign security. EDRs are typically issued in
bearer form and are designed for use in the European
securities markets. No more than 5% of the fund's assets will
be invested in unsponsored ADRs or EDRs. Issuers of the stock
of such unsponsored ADRs and EDRs are not obligated to
disclose material information in the United States and, therefore, there
may not be a correlation between such information and the market
value of such ADRs.
Lower-rated Fixed-income Securities
The Fund may invest in lower-rated fixed-income securities (commonly known
as "junk bonds"), to the extent described in the prospectus. The inability
(or perceived inability) of issuers of these securities to make timely
payment of interest and principal would likely make the values of the
securities held by the Fund more volatile. It could also limit the Fund's
ability to sell its securities at prices approximating the values the Fund
had placed on them. In the absence of a liquid trading market for
securities held by it, the Fund may be unable at times to establish the
fair value of those securities. The rating assigned to a security
by Moody's Investors Service, Inc. or Standard & Poor's Corp. (or by any
other nationally recognized statistical rating organization) does not reflect
an assessment of the volatility of the security's market value or the
liquidity of an investment in the security. See the SAI Appendix for a
description of bond ratings.
Like those of other fixed-income securities, the values of lower-rated
securities fluctuate in response to changes in interest rates. Thus, a
decrease in interest rates will generally result in an increase in the
value of the Fund's assets. Conversely, during periods of rising interest
rates the value of the Fund's assets will generally decline. Changes
by recognized rating services in their ratings of any fixed-income
security and in the ability of an issuer to make payments of
interest and principal may also affect the value of these investments.
Changes in the value of portfolio securities generally will not affect cash
income derived from those securities, but will affect the Fund's net asset
value.
At times, a substantial portion of the Fund's assets may be invested in
securities of which the Fund (by itself or together with other funds and
accounts managed by the subadvisor and its affiliates) holds a major portion.
Although the subadvisor generally considers these securities to be liquid
because of the availability of an institutional market for them, it is
possible that under adverse market or economic conditions or in the event of
adverse changes in the financial condition of the issuer, the Fund could
find it more difficult to sell these securities when the subadvisor believes
it advisable to do so. Also, under the same conditions the Fund may be able
to sell them only at prices lower than they could get if these securities
were more widely held. Under these circumstances, it may also be more
difficult to determine the fair value of these securities for the purpose
of computing the Fund's net asset value.
In order to enforce its rights in the event of a default under these
securities, the Fund may be required to take possession of and manage assets
securing the issuer's obligations on them, which may increase the Fund's
operating expenses and adversely affect its net asset value.
In the case of tax-exempt funds, any income derived from the Fund's ownership
or operation of these assets would not be tax-exempt. In addition, the Fund's
intention to qualify as a "regulated investment company" under the Internal
Revenue Code may limit the extent to which the Fund may exercise its rights by
taking possession of these assets.
Certain securities held by the Fund may permit the issuer at its option to
"call" or redeem them. If this were to occur during a time of declining
interest rates, the Fund may not be able to reinvest the proceeds in
securities providing the same investment return as the securities redeemed.
The amount of information about the financial condition of an issuer of tax
exempt securities may not be as extensive as that which is made available by
corporations whose securities are publicly traded. Therefore, to the extent
the Fund invests in tax-exempt securities in the lower rating categories, the
achievement of the Fund's goals is more dependent on the subadvisor's
investment analysis than would be the case if the Fund were investing in
securities in the higher rating categories.
The values of "junk bonds", (I. e., those below Baa or BBB), generally
fluctuate more than those of higher-rated fixed-income securities. In
addition, the lower rating reflects a greater possibility that the
financial condition of the issuer, or adverse changes in general economic
conditions, or both, may impair the ability of the issuer to make payments of
interest and repayments of principal. The rating services' descriptions of
debt securities are included in the Appendix to the SAI.
A fund will not necessarily dispose of a security when its rating is reduced
below its rating at the time of purchase, although the sub-advisor will monitor
the investment to determine whether continued investment in the security will
assist in meeting that Fund's investment objective.
The Fund may take full advantage of the entire range of U. S. And Emerging
Markets junk bonds and may adjust the average maturity of the portfolio from
time to time, depending on its assessment of relative yields on securities of
different maturities and its expectations of future changes in interest rates.
The subadvisor seeks to minimize the risks of investing in lower-rated
securities through investment analysis and attention to current developments
in interest rates and economic conditions. The lower ratings of certain
fixed-income securities held by the Fund reflect a greater possibility that
declines in the financial condition of their issuers, or in general economic
conditions, or both, or an unanticipated rise in interest rates, may make it
harder for their issuers to make payments of interest and principal.
In addition, under these circumstances the values of these securities may be
more volatile, and the markets for them may be less liquid, than those for
higher-rated securities. As a result, the Fund may find it more difficult
to determine the fair value of these securities. When the Fund invests in
fixed-income securities in these lower rating categories, the achievement
of the Fund's goals is more dependent on the subadvisor's
investment analysis than would be the case if the Fund were investing in
fixed-income securities in the higher rating categories.
The Fund may at times invest in so-called "zero-coupon" bonds and "payment-
in-kind" bonds. Zero-coupon bonds are issued at a significant discount from
their principal amount and pay interest only at maturity rather than at
intervals during the life of the security. Payment-in-kind bonds allow the
issuer, at its option, to make current interest payments on the bonds either
in cash or in additional bonds. The values of zero-coupon and payment-in-
kind bonds are subject to greater fluctuation in response to changes in
market interest rates than bonds which pay interest in cash currently.
Both zero-coupon bonds and payment-in-kind bonds allow an issuer to avoid
the need to generate cash to meet current interest payments. Accordingly,
those bonds may involve greater credit risks than bonds paying interest
currently. Even though zero-coupon and payment-in-kind bonds do not pay
current interest in cash, the Fund is nonetheless required to accrue interest
income on those investments and to distribute those amounts at least annually
to shareholders. Thus, the Fund could be required at times to liquidate
other investments in order to satisfy its dividend distribution requirements.
Certain securities held by a Fund may permit the issuer at its option to
"call", or redeem, its securities. If an issuer were to redeem securities
held by a Fund during a time of declining interest rates, that Fund might not
be able to reinvest the proceeds in securities providing the same investment
return as the securities redeemed.
Options and futures portfolio strategies
The fund may seek to increase its current return by writing covered call or
put option with respect to some or all of the debt or equity securities of
issuers in the United States (U.S. securities) held in its portfolio. In
addition, through writing of options and purchase of put option on U.S.
securities and the purchase and sale of futures contracts and related
options with respect to securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities, and with respect to stock
indices, foreign fixed income securities and foreign currencies, the fund
may at times seek to reduce fluctuations in net asset value by hedging
against a decline in the value of U.S. securities or other securities
owned by the fund or an increase in the price of U.S. securities intended
to reduce fluctuations in the fund's net asset value, the fund nonetheless
anticipates that its net asset value will fluctuate to some degree.
Expenses and any losses resulting from such hedging strategies will tend
to reduce the fund's current return.
The fund's ability to engage in options and futures strategies will
depend on the availability of liquid markets in such instruments. It is
impossible to predict the amount of trading interest that may exist in
various types of options or futures contracts. Therefore no
assurance can be given that the fund will be able to utilize these
instruments effectively for the purposes stated previously. Furthermore the
fund's ability to engage in options and futures contracts transactions may
be limited by tax considerations. Although the fund will only engage in
options and futures contracts transactions for limited purposes, they involve
certain risks which are described under Risk factors in options and futures
transactions.
In connection with transactions in futures contracts, including foreign
currency futures contracts and related options, the fund will be required
to deposit as initial margin an amount of cash and short-term U.S.
Government securities of up to 5% of the contract amount.
Thereafter, subsequent payments are made to and from the broker to reflect
changes in the value of the futures contracts. The fund will not purchase
or sell futures contracts or related options if, as a result, the sum of
the initial margin deposits on the fund's existing futures and
related options positions and premiums paid for options on futures
contracts would exceed 5% of the fund's assets. (For options which are in-
the-money at the time of purchase, the amount by which the option is in-
the-money is excluded from this calculation.)
The fund may purchase and sell options and futures on foreign securities
and currencies held in its portfolio when, in the opinion of the advisor,
the investment characteristics of such options and contracts are acceptable.
It is expected that risks related to those transactions will not differ
materially from risks related to options and futures on U.S. securities.
However, position limits and other rules of foreign exchanges may differ from
those in the United States. Also, options and futures markets in some
countries, many of which are relatively new, may be less liquid than
comparable markets in the United States.
In addition to the options strategies described previously, the fund may
engage in spread transactions in which it purchases and writes a put or
call option on the same underlying security or currency, with the options
having different exercise prices and/or expiration dates. The fund may also
engage in so-called straddles, in which it purchases or sells
combinations of put and call options on the same security or currency. When
it engages in spread and straddle transactions, the fund seeks to profit from
differentials in the option premiums paid and received by it and in the
market options by the fund in connection with these transactions may, under
certain circumstances, involve a limited degree of investment
leverage, the fund will not enter into any spreads or straddles or otherwise
purchase puts or calls if, as a result, more than 5% of its net assets will
be invested at any time in such option transactions. Spread and straddle
transactions require the fund to purchase and/or write more
than one option simultaneously. Accordingly, the fund's ability to enter
into such transactions and to liquidate its positions when necessary or
deemed advisable may be more limited than if the fund were to purchase or
sell a single option. Similarly, costs incurred by the fund in connection
with these transactions will in many cases by greater than if the fund
were to purchase or sell a single option.
A call option included in a spread or straddle will be deemed to be
covered if the fund holds, on a security-for-security or currency-for-
currency basis, a call option on the same security or currency with an
exercise price equal to or less than the exercise price of the call
written (or, where the exercise price is greater than that of the option
written by the fund, if the fund segregates cash or high-grade, short-term
debt obligations equal to the difference). Similarly, a put option included
in a spread or straddle will be deemed to be covered if the
fund holds, on a security-for-security or currency-for-currency basis, a
put option on the same security or currency with an exercise price equal
to or greater than the exercise price of the put option written by the fund
(or, where the exercise price is less than that of the option written by
the fund, if the fund segregates cash or high-grade short-term debt
obligations equal to the difference). The fund's ability to engage in
spread or straddle transactions may be limited by state securities laws.
Risk factors in options and futures transactions
The use of options and futures for hedging may involve certain special
risks. Options and futures transactions involve costs and may result in
losses. Options and futures transactions involve certain special risks,
including the risk that the fund may be unable at times to close
out such positions, that hedging transactions may not accomplish their
purpose because of imperfect market correlations, or that the advisor may
not forecast market or interest rate movements correctly.
The effective use of options and futures strategies is dependent on,
among other things,the fund's ability to terminate options and futures
positions at times when the advisor deems it desirable to do so. Although
the fund will enter into an option or futures contract position
only if the advisor believes that a liquid secondary market exists for such
an option or futures contract, there is no assurance the fund will be able
to effect closing transactions at any particular time or at any acceptable
price. The fund generally expects that its option and futures contract
transactions may purchase and sell options in the over-the-counter market.
The fund's ability to terminate option positions in the over-the-counter
market may be more limited than for exchange-traded options and may also
involve the risk that securities dealers participating in such transactions
would fail to meet their obligations to the fund. However, the fund will
engage in these transactions only if, in the opinion of the advisor,
the pricing mechanism and liquidity of the over-the-counter market are
satisfactory and the participants are responsible parties likely to meet
their contractual obligations.
The use of options and futures strategies also involve the risk of
imperfect correlation between movements in options and futures contracts
prices and movements in the prices of securities or currencies which are
the subject of the hedge. The successful use of these
strategies further depends on the ability of the advisor to forecast market
or interest rate movements correctly.
The securities exchanges have established limitations governing the
maximum number of options which may be written by an investor or group of
investors acting in concert. It is possible that the fund and other clients
of the advisor may be considered to be such a group. These position limits
may restrict the fund's ability to sell options on a particular security.
Options on securities
Writing covered options. The fund may write covered call options and
covered put options on optionable securities held in its portfolio, when in
the opinion of the advisor such transactions are consistent with the fund's
investment objectives and policies. Call options written by the fund give
the purchaser the right to buy the underlying securities from the
fund at a stated exercise price; put options give the purchaser the right
to sell the underlying securities to the fund at a stated price.
The fund may write only covered options, which means that, so long as
the fund is obligated as the writer of a call option, it will own the
underlying securities subject to the option (or comparable securities
satisfying the cover requirements of securities exchanges). In the case of
put options, the fund will hold cash and/or high-grade short-term debt
obligations equal to the price to be paid if the option is exercised. In
addition, the fund will be considered to have covered a put or call option
if and to the extent that it holds an option that offsets some or all of
the risk of the option it has written. The fund may write
combinations of covered puts and calls on the same underlying security.
The fund will receive a premium from writing a put or call option, which
increases the fund's return on the underlying security in the event the
option expires unexercised or is closed out at a profit. The amount of the
premium reflects, among other things, the relationship between the exercise
price and the current market value of the underlying security, the
volatility of the underlying security, the amount of time remaining until
expiration, current interest rates and the effect of supply and demand in
the options market and in the market for the underlying security. By writing
a call option, the fund limits its opportunity to profit from any increase in
the market value of the underlying security above the exercise price of the
option but continues to bear the risk of a decline in the value of the
underlying security. By writing a put option, the fund assumes the risk that
it may be required to purchase the underlying security for an exercise price
higher than its then-current market value, resulting in a potential capital
loss unless the security subsequently appreciates in value.
The fund may terminate an option that it has written before its expiration
by entering into a closing purchase transaction, in which it purchases an
offsetting option. The fund realizes a profit or loss from a closing
transaction if the cost of the transaction (option premium plus transaction
costs) is less or more than the premium received from writing the option.
Because increases in the market price of a call option generally reflect
increases in the market price of the security underlying the option, any
loss resulting from a closing purchase transaction may be offset in whole
or in part by unrealized appreciation of the underlying security owned by
the fund.
If the fund writes a call option but does not own the underlying security,
and when it writes a put option, the fund may be required to deposit cash or
securities with its broker as margin, or collateral, for its obligation to buy
or sell the underlying security. As the value of the underlying security
varies, the fund may have to deposit additional margin with the broker.
Margin requirements are complex and are fixed by individual brokers, subject
to minimum requirements currently imposed by the Federal Reserve Board and
by stock exchanges and other self-regulatory organizations.
Purchasing put options. The fund may purchase put options to protect its
portfolio holdings in an underlying security against a decline in market
value. Such protection is provided during the life of the put option since
the fund, as holder of the option, is able to sell the underlying security
at the put exercise price regardless of any decline in the
underlying security's market price. In order for a put option to be
profitable, the market price of the underlying security must decline
sufficiently below the exercise price to cover the premium and transaction
costs. By using put options in this manner, the fund will reduce any
profit it might otherwise have realized from appreciation of the
underlying security by the premium paid, for the put option and by
transaction costs.
Purchasing call options. The fund may purchase call options to hedge
against an increase in the price of securities that the fund wants
ultimately to buy. Such hedge protection is provided during the life of the
call option since the fund, as holder of the call option, is able to buy the
underlying security at the exercise price regardless of any increase
in the underlying security's market price. In order for a call option to be
profitable, the market price of the underlying security must rise
sufficiently above the exercise price to cover the premium and transaction
costs.
Risk factors in options transactions
The successful use of the fund's options strategies depends on the ability
of the advisor to forecast correctly interest rate and market movements. For
example, if the fund were to write a call option based on the advisor
expectation that the price of the underlying security would fall, but the
price were to rise instead, the fund could be required to sell the security
upon exercise at a price below the current market price. Similarly, if the
fund were to write a put option based on the advisor's expectation that the
price of the underlying security would rise, but the price were to fall
instead, the fund could be required to purchase the security upon exercise
at a price higher than the current market price.
When the fund purchases an option, it runs the risk that it will lose
its entire investment in the option in a relatively short period of time,
unless the fund exercises the option or enters into a closing sale
transaction before the option's expiration. If the price of the underlying
security does not rise (in the case of a call) or fall (in the case of a
put) to an extent sufficient to cover the option premium and transaction
costs, the fund will lose part or all of its investment in the option.
This contrasts with an investment by the fund in the underlying security,
since the fund will not lose any of its investment in such security if the
price does not change.
The effective use of options also depends on the fund's ability to
terminate option positions at times when the advisor deems it desirable to
do so. Although the fund will take an option position only if the advisor
believes there is a liquid secondary market for the option, there is no
assurance that the fund will be able to effect closing transactions at any
particular time or at an acceptable price.
If a secondary market in options were to become unavailable, the fund
could no longer engage in closing transactions. Lack of investor interest
might adversely affect the liquidity of the market for particular options
or series of options. A market may discontinue trading of a particular
option or options generally. In addition, a market could become temporarily
unavailable if unusual events -- such as volume in excess of trading or
clearing capability -- were to interrupt its normal operations.
A market may at times find it necessary to impose restrictions on
particular types of options transactions, such as opening transactions.
For example, if an underlying security ceases to meet qualifications imposed
by the market or the Options Clearing Corp. (OCC), new series of options on
that security will no longer be opened to replace expiring series, and
opening transactions in existing series may be prohibited. If an options
market were to become unavailable, the fund as a holder of an option would
be able to realize profits or limit losses only by exercising the option,
and the fund, as option writer, would remain obligated
under the option until expiration or exercise.
Disruptions in the markets for the securities underlying options
purchased or sold by the fund could result in losses on the options. If
trading is interrupted in an underlying security,
the trading of options on that security is normally halted as well.
As a result, the fund as purchaser or writer of an option will be unable to
close out its positions until options trading resumes, and it may be faced
with considerable losses if trading in the security reopens at a
substantially different price. In addition, the OCC or other options markets
may impose exercise restrictions. If a prohibition on exercise is imposed
at the time when trading in the option has also been halted, the fund as
purchaser or writer of an option will be locked into its position until one
of the two restrictions has been lifted. If the OCC were to determine
that the available supply of an underlying security appears insufficient to
permit delivery by the writers of all outstanding calls in the event of
exercise, it may prohibit indefinitely the exercise of put options. The
fund, as holder of such a put option, could lose its entire investment if
the prohibition remained in effect until the put option's expiration and
the fund was unable either to acquire the underlying security or to sell
the put option in the market.
Special risks are presented by internationally-traded options. Because
of time differences between the United States and the various foreign
countries, and because different holidays are observed in different
countries, foreign options markets may be open for trading during
hours or on days when U.S. markets are closed. As a result, option premiums
may not reflect the current prices of the underlying interest in the United
States.
Futures contracts and related options
A financial futures contract sale creates an obligation by the seller to
deliver the type of financial instrument called for in the contract in a
specified delivery month for a stated price. A futures contract purchase
creates an obligation by the purchaser to take delivery of the type of
financial instrument called for in the contract in a specified delivery
month at a stated price. The specific instruments delivered or taken,
respectively, at settlement date are not determined until on or near that
date. The determination is made in accordance with the rules of the exchange
on which the futures contract sale or purchase was made. Futures
contracts are traded in the United States only on commodity exchanges or
boards of trade --known as contract markets -- approved for such trading by
the Commodity Futures Trading Commission (CFTC), and must be executed
through a futures commission merchant or brokerage firm which is a member
of the relevant contract market.
Although futures contracts by their terms call for actual delivery or
acceptance of commodities or securities, in most cases the contracts are
closed out before the settlement date without the making or taking of
delivery. Closing out a futures contract sale is effected
by purchasing a futures contract for the same aggregate amount of the
specific type of financial instrument or commodity with the same delivery
date. If the price of the initial sale of the futures contract exceeds the
price of the offsetting purchase, the seller is paid the difference and
realizes a gain. Conversely, if the price of the offsetting purchase exceeds
the price of the initial sale, the seller realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the purchaser's
entering into a futures contract sale. If the offsetting sale price exceeds
the purchase price, the purchaser realizes a gain, and if the purchase
price exceeds the offsetting sale price, he realizes a loss.
Unlike when the fund purchases or sells a security, no price is paid or
received by the fund upon the purchase or sale of a futures contract. Upon
entering into a contract, the fund is required to deposit with its custodian
in a segregated account in the name of the futures broker an amount of cash
and/or U.S. Government securities. This amount is known as initial margin.
The nature of initial margin in futures transactions is different from that of
margin in security transactions in that futures contract margin does not
involve the borrowing of funds to finance the transactions. Rather, initial
margin is similar to a performance bond or good faith deposit which is
returned to the fund upon termination of the futures contract, assuming
all contractual obligations have been satisfied. Futures contracts
also involve brokerage costs.
Subsequent payments, called variation margin, to and from the broker (or the
custodian) are made on a daily basis as the price of the underlying security or
commodity fluctuates, making the long and short positions in the futures
contract more or less valuable, a process known as marking to the market.
For example, when the fund has purchased a futures contract on a security
and the price of the underlying security has risen, that position will
have increased in value and the fund will receive from the broker a
variation margin payment based on that increase in value. Conversely, when
the fund has purchased a security futures contract and the price of the
underlying security has declined, the position would be less valuable and
the fund would be required to make a variation margin payment to the broker.
The fund may elect to close some or all of its futures positions at any
time before their expiration in order to reduce or eliminate a hedge
position then currently held by the fund. The fund may close its positions
by taking opposite positions which will operate to terminate the fund's
position in the futures contracts. Final determinations of variation margin are
then made, additional cash is required to be paid by or released to the fund,
and the fund realizes a loss or a gain. Such closing transactions involve
additional commission costs.
Options on futures contracts. The fund may purchase and write call and
put options on futures contracts it may buy or sell and enter into closing
transactions with respect to such options to terminate existing positions.
The fund may use options on futures contracts in lieu of writing or buying
options directly on the underlying securities or purchasing and selling
the underlying futures contracts. For example, to hedge against a possible
decrease in the value of its portfolio securities, the fund may purchase
put options or write call options on futures contracts rather than selling
futures contracts. Similarly, the fund may purchase call options or write
put options on futures contracts as a substitute for the purchase of futures
contracts to hedge against a possible increase in the price of securities
which the fund expects to purchase. Such options generally operate in the
same manner as options purchased or written directly on the underlying
investments.
As with options on securities, the holder or writer of an option may
terminate the position by selling or purchasing an offsetting option. There
is no guarantee that such closing transactions can be effected.
The fund will be required to deposit initial margin and maintenance
margin with respect to put and call options on futures contracts written
by it pursuant to brokers' requirements similar to those described above.
With respect to long positions assumed by the fund, the fund will establish
a segregated asset account with its custodian, and will deposit into it an
amount of cash and other assets permitted by CFTC regulations. The fund
does not intend to leverage the futures contracts.
Risks of transactions in futures contracts and related options.
Successful use of futures contracts by the fund is subject to the advisor's
ability to predict movements in the direction of interest rates and other
factors affecting securities markets. For example, if the
fund has hedged against the possibility of decline in the values of its
investments and the values of its investments increase instead, the fund
will lose part or all of the benefit of the increase through payments of
daily maintenance margin. The fund may have to sell investments at a time
when it may not be advantageous to do so in order to meet margin
requirements.
Compared to the purchase or sale of futures contracts, the purchase of
call or put options on futures contracts involves less potential risk to the
fund because the maximum amount at risk is the premium paid for the options
(plus transaction costs). However, there may be circumstances when the
purchase of a call or put option on the futures contract itself would
result in a loss to the fund when the purchase or sale of a futures
contract would not, such as when there is no movement in the prices of the
hedged investments. The writing of an option on a futures contract involves
risks similar to those risks relating to the sale of futures contracts.
There is no assurance that higher than anticipated trading activity or
other unforeseen events might not, at times, render certain market clearing
facilities inadequate, and thereby result in the institution by exchanges of
special procedures which may interfere with the timely execution of
customer orders.
To reduce or eliminate a hedge position held by the fund, the fund may
seek to close out a position. The ability to establish and close out
positions will be subject to the development and maintenance of a liquid
secondary market. It is not certain that this market will develop
or continue to exist for a particular futures contract or option. Reasons
for the absence of a liquid secondary market on an exchange include the
following:
(1) there may be insufficient trading interest in certain contracts
or options;
(2) restrictions may be imposed by an exchange on
opening transactions or closing transactions or both;
(3) trading halts, suspensions or other restrictions may be imposed
with respect to particular classes or series of contracts or
options, or underlying securities;
(4) unusual or unforeseen circumstances may interrupt normal
operations on an exchange;
(5) the facilities of an exchange or a clearing
corporation may not at all times be adequate to handle current
trading volume;
or
(6) one or more exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the
trading of contracts or options (or a particular class or series
of contracts or options), in which event the secondary market on
that exchange for such contracts or options (or in the class or
series of contracts or options) would cease to exist, although
outstanding contracts or options on the exchange that had been
issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their
terms.
U.S. Treasury security futures contracts and options. If the fund invests in
tax-exempt securities issued by a governmental entity, the fund may purchase
and sell futures contracts and related options on U.S. Treasury securities
when, in the opinion of the advisor, price movements in Treasury security
futures and related options will correlate closely with price movements in
the tax-exempt securities which are the subject of the hedge. U.S. Treasury
security futures contracts require the seller to deliver, or the purchaser
to take delivery of, the type of U.S. Treasury security called for in the
contract at a specified date and price. Options on U.S. Treasury security
futures contracts give the purchaser the right in return for the premium
paid to assume a position in a U.S. Treasury security futures contract at
the specified option exercise price at any time during the period of the
option.
Successful use of U.S. Treasury security futures contracts by the fund
is subject to the advisor's ability to predict movements in the direction
of interest rates and other factors affecting markets for debt securities.
For example, if the fund has sold U.S. Treasury security futures contracts
in order to hedge against the possibility of an increase in interest rates
which would adversely affect tax-exempt securities held in its portfolio,
and the prices of the fund's tax-exempt securities increase instead as a
result of a decline in interest rates, the fund will lose part or all of
the benefit of the increased value of its securities which it has hedged
because it will have offsetting losses in its futures positions. In
addition, in such situations, if the fund has insufficient cash, it may have
to sell securities to meet daily maintenance margin requirements at a time
when it may be disadvantageous to do so.
Foreign currency exchange transactions
With respect to investments made for the International Fixed Income
Securities and the International Equity Securities investment categories, the
fund may engage in foreign currency exchange transactions to protect against
uncertainty in the level of future exchange rates. The advisor may engage in
foreign currency exchange transactions in connection with the purchase
and sale of portfolio securities (transaction hedging), and to protect the
value of specific portfolio positions (position hedging.)
The fund may engage in transaction hedging to protect against a change
in the foreign currency exchange rate between the date on which the fund
contracts to purchase or sell the security and the settlement date, or to
lock in the U.S. dollar equivalent of a dividend or interest payment in a
foreign currency. For the purpose, the fund may purchase or sell a foreign
currency on a spot (or cash) basis at the prevailing spot rate in connection
with the settlement of transactions in portfolio securities denominated in
that foreign currency.
If conditions warrant, the fund may also enter into contract to purchase
or sell foreign currencies at a future date (forward contracts) and
purchase and sell foreign currency futures contracts as a hedge against
changes in foreign currency exchange rates between the trade and settlement
dates on particular transactions and not for speculation. A foreign currency
forward contract is a negotiated agreement to exchange currency at a future
time at a rate or rates that may be higher or lower than the spot rate.
Foreign currency futures contracts are standardized exchange-traded contracts
and have margin requirements.
For transaction hedging purposes the fund may also purchase exchange-
listed and over-the counter call and put options on foreign currency futures
contracts and on foreign currencies.
The fund may engage in position hedging to protect against the decline in
the value relative to the U.S. dollar of the currencies in which its
portfolio securities are denominated or quoted (or an increase in the value
of currency for securities which the fund expects to buy, when the fund
holds cash reserves and short-term investments). For position hedging
purposes the fund may purchase or sell foreign currency futures contracts
and foreign currency forward contracts, and may purchase put or call
options on foreign currency futures contracts and on foreign currencies on
exchanges or over-the-counter markets. In connection with position hedging,
the fund may also purchase or sell foreign currency on a spot basis. In
addition, as part of its position hedging strategies, the fund may engage in
the forward contract, futures contract and options transactions described
previously using a currency different from that in which the portfolio
securities are denominated (cross-hedging) if the advisor believes that the
U.S. dollar value of the currency used in cross-hedging will fall or
rise, as the case may be, whenever there is a decrease or increase,
respectively, in the U.S. dollar value of the currency in which the
portfolio securities are denominated.
Hedging transactions involve costs and may result in losses. The fund may
write covered call options on foreign currencies to offset some of the
costs of hedging those currencies, as well as to increase current return.
The fund will engage in over-the-counter transactions only when appropriate
exchange-traded transactions are unavailable and when, in the opinion of
the advisor, the pricing mechanism and liquidity are satisfactory and the
participants are responsible parties likely to meet their contractual
obligations. The fund's ability to engage in hedging and related option
transactions may be limited by tax considerations.
Lending of securities
The fund may make secured loans of its portfolio securities amounting to not
more than 25% of its total assets, thereby realizing additional income. The
risks in lending portfolio securities, as with other extensions of credit,
consist of possible delay in recovery of the securities or possible loss of
rights in the collateral should the borrower fail financially. As a matter of
policy, securities loans are made to broker-dealers pursuant to agreements
requiring that loans be continuously secured by collateral in cash or short-
term debt obligations at least equal at all times to the value of the
securities lent. The borrower pays to the fund an amount equal to any
dividends or interest received on securities lent. The fund
retains all or a portion of the interest received on investment of the cash
collateral or receives a fee from the borrower. Although voting rights, or
rights to consent, with respect to the loaned securities pass to the
borrower, the fund retains the right to call the loans at any time on
reasonable notice, and it will do so in order that the securities may be voted
by the fund if the holders of such securities are asked to vote upon or consent
to matters materially affecting the investment. The fund may also call
such loans in order to sell the securities involved. The fund will not loan
its portfolio securities to the advisor, the sub-advisor or an
affiliate thereof.
Forward commitments
The fund may make contracts to purchase securities for a fixed price at a
future date beyond customary settlement time (forward commitments) if the
fund holds, and maintains until the settlement date in a segregated account,
cash or high-grade debt obligations in an amount sufficient to meet the
purchase price, or if the fund enters into offsetting contracts for the
forward sale of other securities it purchased declines before the
settlement date, the risk of which is in addition to the risk of decline in
value of the fund's other assets. Where such purchases are made through
dealers, the fund relies on the dealer to consummate the sale. The dealer's
failure to do so may result in the loss to the fund of an advantageous yield of
price. Although the fund will generally enter into forward commitments with the
intention of acquiring the securities for its portfolio, the fund may dispose
of a commitment before settlement if the advisor deems it appropriate to do so.
The fund may realize short-term profits or losses upon the sale of forward
commitments.
Repurchase agreements
The fund may enter into repurchase agreements with respect to the amount of
its total assets (taken at current value) specified in the Prospectus. A
repurchase agreement is a contract under which the fund acquires a security
for a relatively short period (usually not more than one week) subject to
the obligation of the seller to repurchase and the fund to re-sell such
security at a fixed time and price (representing the fund's cost plus
interest). It is the fund's present intention to enter into repurchase
agreements only with commercial banks and registered broker-dealers and
only with respect to obligations of the U.S. Government or its agencies or
instrumentalities. The Board of Directors of the fund will evaluate the
creditworthiness of all entities with which the fund proposes to enter into
repurchase agreements. Repurchase agreements may also be viewed as loans
made by the fund which are collateralized by the securities subject to the
repurchase. The advisor will monitor such transactions to ensure that the
value of the underlying securities will be at least equal at all
times to the total amount of the repurchase obligation, including the
interest factor. If the seller defaults, the fund could realize a loss on
the sale of the underlying security to the extent that the proceeds of sale
including accrued interest are less than the resale price provided in the
agreement including interest. In addition, if the seller should be involved in
bankruptcy or insolvency proceedings, the fund may incur delay and costs in
selling the underlying security or may suffer a loss of principal and
interest if the fund is treated as an unsecured creditor and required to
return the underlying collateral to the seller's estate.
Investment restrictions
The following 17 restrictions are fundamental. The fund may not and will
not:
1. Borrow money in excess of 10% of the value (taken at the
lower of cost or current value) of its total assets (not
including the amount borrowed) at the time the
borrowing is made, and then only from banks as a temporary measure
to facilitate the meeting of redemption requests (not for leverage)
which might otherwise require the untimely disposition of portfolio
investments or for extraordinary or emergency purposes. Such
borrowings will be repaid before any additional investments are
purchased.
2. Pledge, hypothecate, mortgage or otherwise encumber its assets in
excess of 15% of its total assets (taken at current value) and then
only to secure borrowings permitted by restriction 1. (The deposit of
underlying securities and other assets in escrow and other
collateral arrangements in connection with the writing of put or
call options and collateral arrangements with respect to margin for
options on financial futures contracts are not deemed to be pledges or
other encumbrances.)
3. Purchase securities on margin, except such short-term credits as may be
necessary for the clearance of purchases and sales of securities, and
except that it may make margin payments in connection with options on
financial futures contracts.
4. Make short sales of securities or maintain a short sale position for
the account of the fund unless at all times when a short position is
open it owns an equal amount of such securities or owns securities
which, without payment of any further consideration, are convertible
into or exchangeable for securities of the same issue as, and equal
in amount to, the securities sold short.
5. Underwrite securities issued by other persons except to the extent
that, in connection with disposition of its portfolio investments, it
may be deemed to be an underwriter under certain federal securities
laws.
6. Purchase or sell real estate, although it may purchase securities
which are secured by or represent interests in real estate.
7. Purchase or sell commodities or commodity contracts, except that the
fund may write and purchase options on financial futures contracts.
8. Make loans, except by purchase of debt obligations in which the fund
may invest consistent with its investment policies, by entering into
repurchase agreements with respect to not more than 25% of its total
assets (taken at current value), or through the lending of its
portfolio securities with respect to not more than 25% of its assets.
9. Invest in securities of any issuer, if, to the knowledge of the fund,
officers and directors of the fund and officers and directors of the
advisor or the sub-advisor who beneficially own more than 0.5% of the
shares of securities of that issuer together own more than 5%.
10. Invest in securities of any issuer if, immediately after such
investment, more than 5% of the total assets of the fund (taken at
current value) would be invested in the securities of such issuer;
provided that this limitation does not apply to securities issued
by the U.S. Government or its agencies or instrumentalities (U.S.
Government obligations).
11. Acquire more than 10% of the voting securities of any issuer.
12. Invest more than 25% of the value of its total assets in any one
industry.
13. Invest in the securities of other investment companies,except as
they may be acquired as part of a merger of consolidation or
acquisition of assets.
14. Invest more than 5% of its net assets in securities restricted as
to resale.
15. Buy or sell oil, gas or other mineral leases, rights or royalty
contracts.
16. Make investments for the purpose of gaining control of a company's
management.
17. Issue any class of securities which is senior to the fund's stock.
(For purposes of this restriction, collateral arrangements with
respect to the writing of options are not deemed to be the
issuance of a senior security).
The following three restrictions are not fundamental, but are contrary to
the fund's present policy:
1. To invest in (a) securities which at the time of such
investment are not readily marketable, (b) restricted
securities and (c) repurchase agreements maturing in more
than seven days, if, as a result, more than 10% of the
fund's total assets (taken at current value) would then
be invested in the aggregate in securities described in
(a), (b) and (c).
2. To invest in warrants (other than warrants acquired by
the fund as part of a unit or attached to securities at
the time of purchase).
3. To invest in securities of any issuer, which together
with any predecessors or controlling persons, has been in
operation for less than three consecutive years and in equity
securities for which market quotations are not readily available
if, as a result, the aggregate of such
investments would exceed 5% of the value of the fund's
net assets; provided, however, that this restriction shall not
apply to U.S. Government obligations. (Debt securities having equity
features are not considered equity securities for purposes of this
restriction.)
Although the provisions of fundamental investment restrictions 1., 2. and 4.
permit the fund to engage in certain practices to a limited extent, the fund
does not have any present intention of engaging in such practices.
All percentage limitations on investments will apply at the time of the
making of an investment and shall not be considered violated unless an
excess or deficiency occurs or exists immediately after and as a result of
such investment.
The Investment Company Act of 1940 (1940 Act) provides that a vote of a
majority of the outstanding voting securities means the affirmative vote of
the lesser of (1) more than 50% of the outstanding shares of the fund, or
(2) 67% or more of the shares present at a meeting in person or by proxy.
Portfolio transactions and brokerage
The advisor is responsible for decisions to buy and sell securities for
the fund, the selection of brokers and dealers to effect the transactions
and the negotiation of brokerage commissions, if any. Purchases and sales of
securities on a security exchange are effected through brokers who charge a
commission for their services. Transactions in foreign securities generally
involve the payment of fixed brokerage commissions, which are generally
higher than those in the United States. There is generally no stated
commission in the case of most securities traded in the over-the-counter
markets; rather, the price paid by the fund usually includes an undisclosed
dealer commission or mark-up. Increasingly, however, these securities have
begun to be traded electronically, thereby avoiding the cost of trading
through dealers. These electronic trades do require the payment of
commissions to the "electronic" broker.
In the U.S. Government securities market, securities are generally traded on
a net basis with dealers acting as principal for their own accounts without
a stated commission, although the price of the securities usually includes a
profit to the dealer. In underwritten offerings, securities are purchased at
a fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On
occasion, certain money market instruments may be purchased directly from
an issuer, in which case no commissions or discounts are paid.
The advisor currently provides investment advice to a number of other
clients. See Investment advisor. It will be the practice of the advisor to
allocate purchase and sale transactions among the fund and others whose
assets are managed in such manner as is deemed equitable. In making such
allocations, major factors to be considered are investment objectives, the
relative size of portfolio holdings of the same or comparable securities, the
availability of cash for investment, the size of investment commitments
generally held and the opinions of the persons responsible for managing the
portfolios of the fund and other client accounts. Portfolio securities are
not purchased from or sold to the advisor or any affiliated person (as
defined in the 1940 Act) of the advisor.
In connection with effecting portfolio transactions, primary
consideration will be given to securing the most favorable price and
efficient execution. Within the framework of this policy, the reasonableness
of commission or other transaction costs is a major factor in the
selection of brokers and is considered together with other relevant factors,
including financial responsibility, research and investment information and
other services provided by such brokers. It is expected that, as a result
of such factors, transaction costs charged by some brokers may be greater
than the amounts other brokers might charge. The advisor may
determine in good faith that the amount of such higher transaction costs
is reasonable in relation to the value of the brokerage and research
services provided. The Board of Directors of the fund will review regularly
the reasonableness of commission and other transaction costs incurred from
time to time, and, in that connection, will receive reports from the
advisor and published data concerning transaction costs incurred by
institutional investors generally. The nature of the research services
provided to the advisor by brokerage firms varies from time to time but
generally includes current and historical financial data
concerning particular companies and their securities; information and
analysis concerning securities markets and economic and industry matters;
and technical and statistical studies and data dealing with various
investment opportunities; and risks and trends, all of which the advisor
regards as a useful supplement of its own internal research capabilities.
The advisor may from time to time direct trades to brokers which have
provided specific brokerage or research services for the benefit of the
advisor's clients; in addition, the advisor may allocate trades among
brokers that generally provide superior brokerage and research services.
Research services furnished by brokers are used for the benefit of all the
advisor's clients and not solely or necessarily for the benefit of the fund.
The advisor believes that the value of research services received is not
determinable and does not significantly reduce its expenses. The fund does
not reduce its fee to the advisor by any amount that might be attributable
to the value of such services. The aggregate amount of brokerage commissions
paid by the fund during 1995 was XXXXX; for 1994 was $309,000; and for 1993
it was $427,400.
Under the sub-advisory agreement between the advisor and the sub-advisor,
the sub-advisor may perform some, or substantially all, of the investment
advisory services required by the fund, even though the advisor remains
primarily responsible for investment decisions affecting the fund. The sub-
advisor will follow the same procedures and policies which are followed by
the advisor as described previously. The sub-advisor currently provides
investment advice to a number of other clients. See Sub-advisor. References to
advisor in this SAI include both Lincoln Investment Management, Inc. and The
Putnam Management Co., Inc.
Determination of net asset value
A description of the days on which the fund's net asset value per share will
be determined is given in the Prospectus. The New York Stock Exchange's most
recent announcement (which is subject to change) states that in 1996 it will
be closed on New Year's Day, January 1; President's Day, February 19; Good
Friday, April 5; Memorial Day, May 27; Independence Day, July 4; Labor Day,
September 2; Thanksgiving Day, November 28; and Christmas Day, December 25.
It may also be closed on other days.
Since a significant portion of the fund's portfolio may at any one time
consist of securities primarily listed on foreign exchanges or otherwise
traded outside the United States, those securities may be traded (and the
net asset value of the fund could therefore be significantly affected) on
days when the investor has no access to the fund.
APPENDIX
(NOTE: THIS IS UNIFORM INFORMATION FOR THE ELEVEN FUNDS. SEE EACH FUND'S
SAI FOR INFORMATION SPECIFIC TO THAT FUND.)
THIS APPENDIX CONSTITUTES PART OF THE STATEMENTS OF ADDITIONAL INFORMATION OF
LINCOLN NATIONAL AGGRESSIVE GROWTH FUND, INC. (AGGRESSIVE GROWTH FUND), LINCOLN
NATIONAL BOND FUND, INC. (BOND FUND), LINCOLN NATIONAL CAPITAL APPRECIATION
FUND, INC. (CAPITAL APPRECIATION FUND), LINCOLN NATIONAL EQUITY-INCOME FUND,
INC. (EQUITY-INCOME FUND), LINCOLN NATIONAL GLOBAL ASSET ALLOCATION FUND,
INC. (GLOBAL ASSET ALLOCATION FUND), LINCOLN NATIONAL GROWTH AND INCOME
FUND, INC. (GROWTH AND INCOME FUND), LINCOLN NATIONAL INTERNATIONAL FUND, INC.
(INTERNATIONAL FUND), LINCOLN NATIONAL MANAGED FUND, INC. (MANAGED FUND),
LINCOLN NATIONAL MONEY MARKET FUND, INC. (MONEY MARKET FUND), LINCOLN
NATIONAL SOCIAL AWARENESS FUND, INC. (SOCIAL AWARENESS FUND), AND LINCOLN
NATIONAL SPECIAL OPPORTUNITIES FUND, INC. (SPECIAL OPPORTUNITIES FUND).
UNLESS OTHERWISE INDICATED, THE FOLLOWING INFORMATION APPLIES TO EACH
FUND.
INVESTMENT ADVISOR AND SUB-ADVISOR
Lincoln Investment Management Company, Inc. (Lincoln Investment ) is the
investment Advisor to the funds and is headquartered at 200 E. Berry Street,
Fort Wayne, Indiana 46802. Lincoln Investment (the Advisor) is a wholly-
owned subsidiary of Lincoln National Corporation (LNC), a publicly-held
insurance holding company organized under Indiana law. Through its
subsidiaries, LNC provides, on a national basis, life insurance and
annuities, property-casualty insurance, reinsurance, and financial services.
Lincoln Investment is registered with the Securities and Exchange Commission
(the Commission) as an investment Advisor and has acted as an investment
Advisor to mutual funds for over 40 years. The Advisor also acts an
investment Advisor to Lincoln National Income Fund, Inc. (a closed-end
investment company whose investment objective is to provide a high level of
current income from interest on fixed-income securities); and Lincoln
National Convertible Securities Fund, Inc. (a closed-end investment company
whose investment objective is a high level of total return on its assets
through a combination of capital appreciation and current income), Lincoln
Advisor Funds, Inc. (a retail mutual fund complex) and to other clients.
Under Advisory Agreements with the Funds, the Advisor provides portfolio
management and investment advice to the Funds and administers its other
affairs, subject to the supervision of the Funds' Board of Directors. The
Advisor, at its expense, will provide office space to the Funds and all
necessary office facilities, equipment and personnel, and will make its
officers and employees available to the Funds as appropriate. In addition,
the Advisor will pay all expenses incurred by it or by the Funds in
connection with the management of each Fund's assets or the administration
of its affairs, other than those assumed by the Funds, as described below.
Lincoln Life has paid the organizational expenses of all the funds. The
rates of compensation to the Advisor and the Sub-Advisor are set
forth in the Appendix to the Prospectus.
During the last three years, the Advisor received the following amounts for
investment Advisory services:
<TABLE>
<S> <C> <C> <C>
1995 1994 1993
Aggressive Growth Fund $ 725,544 $ 232,000 $ N/A
Bond Fund 1,061,701 999,397 978,266
Capital Appreciation Fund 726,011 211,773 N/A
Equity-Income Fund 1,457,623 348,255 N/A
Global Asset Allocation Fund 1,570,876 1,381,059 901,004
Growth and Income Fund 5,077.981 3,896,902 3,293,315
International Fund 2,770,197 2,262,664 759,801
Managed Fund 2,120,656 1,919,150 1,756,544
Money Market Fund 385,019 404,441 449,374
Social Awareness Fund 1,048,366 736,602 542,142
Special Opportunities Fund 1,809,514 1,351,374 1,052,967
</TABLE>
Expenses specifically assumed by the Funds include: compensation and expenses
of directors of the Funds who are not "interested persons" of the Funds as
defined in the Investment Company Act of 1940 (the Act); registration,
filing and other fees in connection with filings with regulatory authorities,
including the costs of printing and mailing registration statements and
updated prospectuses provided to current stockholders; fees and expenses of
independent auditors; the expenses of printing and mailing proxy statement
and stockholder reports; custodian charges; brokerage commissions and
securities transaction costs incurred by the Funds; taxes and corporate
fees; legal fees incurred in connection with the affairs of the Funds (other
than legal services provided by personnel of the Advisor or its affiliated
companies); the fees of any trade association of which the Funds are
members: and expenses of stockholder and director meetings.
If total expenses of the Funds (excluding taxes, interest, portfolio brokerage
commissions and fees, and expenses of an extraordinary and non-recurring
nature, but including the investment Advisory fee) exceed 1 1/2% per annum
of the average daily net assets of each Fund (2% for the International Fund),
the Advisor will pay such excess by offsetting it against the Advisory fee.
If such offset is insufficient to cover the excess, any balance remaining will
be paid directly by the Advisor to each Fund.
The current Advisory Agreements between the Advisor and the Funds will remain in
effect from year to year if approved annually by: (1) the Board of Directors of
each Fund or by the vote of a majority of the outstanding
voting securities of each Fund, and (2) a vote of a majority of the directors
who are not "interested persons" of the Funds or the Advisor, cast in person
at a meeting called for the purpose of voting on such approval. The Advisory
Agreement may be terminated without penalty at any time, on 60 days' written
notice by: (1) the Board of Directors of each Fund, (2) vote of a majority
of the outstanding voting securities of each Fund or (3) the Advisor.
The Advisory Agreement terminates automatically in the event of assignment.
In like manner, the current Sub-Advisory Agreements will remain in effect
from year to year if approved annually by the Board of Directors of the
applicable Funds or by the vote of a majority of the outstanding voting
securities of those Funds. The Sub-Advisory Agreements may be terminated
without penalty at any time, on 60 days' written notice, by: (1) the Board of
Directors of the applicable fund, (2) vote of the majority of the outstanding
voting securities of the applicable Fund, (3) the Sub-Advisor, or (4) the
Advisor. The Sub-Advisory Agreements terminate automatically in the event
of assignment.
DIRECTORS AND OFFICERS
The directors and executive officers of each Fund and their principal
occupations during the past five years are as follows:
<TABLE>
<S> <C> <C>
NAME AND BUSINESS POSITIONS WITH FUND PRINCIPAL OCCUPATION DURING
ADDRESS PAST FIVE YEARS
Kelly D. Clevenger Chairman of the Board, Vice President, Lincoln National Life
1300 S. Clinton Street President and Director Insurance Company
Fort Wayne, Indiana 46802
John B. Borsch, Jr. Director Retired, formerly Associate Vice President-
1776 Sherwood Road Investments, Northwestern University
Des Planes, IL 60016
Nancy L. Frisby, CPA Director Regional Vice President/Chief Financial
700 Broadway Officer (formerly Vice-President-Finance;
Fort Wayne, IN 46802 Regional Controller of Finance), St.
Joseph Medical Center, Fort Wayne,
Indiana
*Barbara S. Kowalczyk Director Executive Vice President, Lincoln National
1300 S. Clinton Street Investment Management Company
Fort Wayne, IN 46802 (formerly, Senior Vice President); Vice
President, The Lincoln National Life
Insurance Company
Stanley R. Nelson Director Executive in Residence Program in Health 420
Delaware St., S.E. Services Administration, University of
Minneapolis, MN 55455 Minnesota, Minneapolis, Minnesota,
(formerly President, Henry Ford Health Care
Corporation, Detroit, Michigan)
* Cynthia A. Rose Assistant Secretary Assistant Secretary, Lincoln National
200 East Berry Street Corporation; Assistant Secretary, The
Fort Wayne, IN 46802 Lincoln National Life Insurance Company
* Janet C. Whitney Vice President and Vice President and Treasurer, Lincoln National
Treasurer 200 East Berry Street Corporation
Fort Wayne, IN 46802
</TABLE>
* "Interested persons" of the Funds, as defined in the Act.
Directors' fees of $250 per meeting are paid by each Fund to each director who
is not an "interested person" of the Fund.
INVESTMENT POLICIES AND TECHNIQUES (CONTINUED)
OPTIONS AND FINANCIAL FUTURES TRADING
This discussion relates to the Bond, Growth, Managed, Social Awareness, and
Special Opportunities Funds. Neither the International Fund nor the Money
Market Fund has sought the authority to engage either in options or
in futures trading. (NOTE: The Aggressive Growth, Capital Appreciation,
Equity-Income and Global Asset Allocation Funds have their own respective
discussions of the Strategic Portfolio Transactions in which they may
engage).
OPTIONS TRADING
The Fund may purchase or write (sell) options on financial instruments as a
means of achieving additional return or hedging the value of the Fund's
portfolio. The Fund may not write put or covered call options in an amount
exceeding 30% of the value of its total assets. The Fund would invest in
options in standard contracts which may be quoted on NASDAQ, or on national
securities exchanges. Currently options are traded on numerous securities
and indices including, without limitation, the S & P 100 Index, the S&P 500
Index, and the NYSE Beta Index.
A) In General. Put and call options are generally short-term contracts
with durations of nine months or less. The Investment Advisor will generally
write covered call options when it anticipates declines in the market value of
the portfolio securities and the premiums received may offset to some extent
the decline in the Fund's net asset value. On the other hand, writing put
options is a useful portfolio investment strategy when the Fund has cash or
other reserves and it intends to purchase securities but expects prices to
decline.
Generally, the risk to the Fund in writing options is that the Investment
Advisor's assumption about the price trend of the underlying security may
prove inaccurate. If, as a result, the Fund wrote a put, expecting the
price of a security to increase, and it decreased, or if the Fund wrote a
call, expecting the price to decrease but it increased, the Fund could
suffer a loss if the premium received in each case did not equal the
difference between the exercise price and the market price.
B) Call Options. The Fund may write only call options which are "covered,"
meaning that the Fund either owns the underlying security or has an absolute
and immediate right to acquire that security, without additional cash
consideration, upon conversion or exchange of other securities currently held
in its portfolio. In addition, the Fund will not, prior to the expiration
of a call option, permit the call to become uncovered. If the Fund writes a
call option, the purchaser of the option has the right to buy (and the Fund
has the obligation to sell) the underlying security at the exercise price
throughout the term of the option. The amount paid to the Fund by the purchaser
of the option is the "premium." The Fund's obligation to deliver the underlying
security against payment of the exercise price would terminate either upon
expiration of the option or earlier if the Fund were to effect a "closing
purchase transaction" through the purchase of an equivalent option on an
exchange. The Fund would not be able to effect a closing purchase
transaction after it had received notice of exercise.
In order to write a call option, the Fund is required to deposit in escrow the
underlying security or other assets in accordance with the rules of The
Options Clearing Corporation and the various exchanges. The Fund may not
purchase call options except in connection with a closing purchase
transaction. It is possible that the cost of effecting a closing purchase
transaction may be greater than the premium received by the Fund for writing
the option.
Generally, the investment Advisor (the Advisor) intends to write listed
covered calls during periods when it anticipates declines in the market
values of portfolio securities and the premiums received (net of transaction
costs) may offset to some extent the decline in the Fund's net asset value
occasioned by such declines in market value. The Advisor will generally not
write listed covered call options when it anticipates that the market value of
the Fund's portfolio securities will increase.
If the Advisor decides that at a price higher than the current value a
portfolio security would be overvalued and should be sold, the Fund may
write an option on the security at that price. Should the security
subsequently reach that price and the option be exercised, the Fund would,
in effect, have increased the selling price of that security, which it
would have sold at that price in any event, by the amount of the premium.
In the event the market price of the security declined and the option were
not exercised, the premium would offset all or some portion of that
decline. It is possible, of course, that the price of the security could
increase beyond the exercise price; in that event, the Fund would forego the
opportunity to sell the security at that higher price.
In addition, call options may be used as part of a different strategy in
connection with sales of portfolio securities. If, in the judgment of the
Advisor, the market price of a security is overvalued and it should be sold,
the Fund may elect to write a call with an exercise price substantially below
the current market price. So long as the value of the underlying security
remains above the exercise price during the term of the option, the option
will be exercised, and the Fund will be required to sell the security at the
exercise price. If the sum of the premium and the exercise price exceeds
the market price of the security at the time the call is written, the Fund
would, in effect, have increased the selling price of the security. The
Fund would not write a call under these circumstances if the sum of the
premium and the exercise price were less than the current market price of
the security.
In summary, a principal reason for writing calls on a securities portfolio is
to attempt to realize, through the receipt of premium income, a greater
return than would be earned on the securities alone. A covered call writer,
such as the Fund, which owns the underlying security has, in return for the
premium, given up the opportunity for profit from a price increase in the
underlying security above the exercise price, but has retained the risk of
loss should the price of the security decline. Unlike one who owns
securities not subject to a call, the Fund as a call writer may be required
to hold such securities until the expiration of the call option or until the
Fund engages in a closing purchase transaction at a price that may be below
the prevailing market.
C) Put Options. The Fund may also write put options. If the Fund writes a put
option, it is obligated to purchase a given security at a specified price at any
time during the term of the option. The rules regarding the writing of put
options are generally comparable to those described above with respect to
call options.
Writing put options is a useful portfolio investment strategy when the Fund has
cash or other reserves available for investment as a result of sales of Fund
shares or because the Advisor believes a more defensive and less fully
invested position is desirable in light of market conditions. If the Fund
wishes to invest its cash or reserves in a particular security at a price
lower than current market value, it may write a put option on that security
at an exercise price which reflects the lower price it is willing to pay.
The buyer of the put option generally will not exercise the option unless
the market price of the underlying security declines to a price near or
below the exercise price. If the Fund writes a put option, the price of the
underlying security declines and the option is exercised, the premium, net of
transaction charges, will reduce the purchase price paid by the Fund for the
security. Of course, the price of the security may continue to decline
after exercise of the put options, in which event the Fund would have
foregone an opportunity to purchase the security at a lower price, or the
option might never be exercised.
If, prior to the exercise of a put, the Advisor determines that it no longer
wishes to invest in the security on which the put has been written, the
Fund may be able to effect a closing purchase transaction on an exchange by
purchasing a put of the same series as the one which it has previously
written. The cost of effecting a closing purchase transaction may be
greater than the premium received on writing the put option, and there is no
guarantee that a closing purchase transaction can be effected. The Fund may
purchase put options only in connection with a closing transaction.
As with the writer of a call, a put writer generally hopes to realize premium
income. The risk position of the Fund as a put writer is similar to that of
a covered call writer which owns the underlying securities. Like the covered
call writer (who must bear the risk of his position in the underlying
security), the Fund as a put writer stands to incur a loss if and to the
extent the price of the underlying security falls below the exercise price
plus premium.
At the time a put option is written, the Fund will be required to establish, and
will maintain until the put is exercised or has expired, a segregated account
with its custodian consisting of cash or short-term U.S. government
securities equal in value to the amount which the Fund will be obligated to
pay upon exercise of the put. Principal factors affecting the market value
of a put or call option include supply and demand, interest rates,
the current market price and price volatility of the underlying security and
the time remaining until the expiration date. In addition, there is no
assurance that the Fund will be able to effect a closing transaction at a
favorable price. If the Fund cannot enter into such a transaction, it may
be required to hold a security that it might otherwise have sold, in which
case it would continue to be a market risk on the security. If a substantial
number of covered options written by the Fund are exercised, the Fund's rate
or portfolio turnover could exceed historic levels. This could result in
higher transaction costs, including brokerage commissions. The Fund will pay
brokerage commissions in connection with the writing and purchasing of
options to close out previously written options. Such brokerage
commissions are normally higher than those applicable to purchases and sales
of portfolio securities.
FUTURES CONTRACTS AND OPTIONS THEREON
A. In General. Generally, the Fund may buy and sell financial futures
contracts ("futures contracts") and related options thereon solely for
hedging purposes. The Fund may sell a futures contract or purchase a put
option on that futures contract to protect the value of the Fund's portfolio
in the event the Investment Advisor anticipates declining security prices.
Similarly, if security prices are expected to rise, the Fund may purchase a
futures contract or a call option thereon. (For certain limited purposes,
as explained below, the Fund is also authorized to buy futures contracts on
an unleveraged basis and not as an anticipatory hedge.)
The Fund will not invest in futures contracts and options thereon if immediately
thereaafter the amount committed to margins plus the amount paid or option
premiums exceeds 5% oof the Fund's total assets. In addition the Fund
will not hedge more than one-third of its net assets.
B. Futures Contracts. The Fund may purchase and sell financial futures
contracts ("futures contracts") as a hedge against fluctuations in the value
of securities which are held in the Fund's portfolio or which the Fund
intends to purchase. The Fund will engage in such transactions consistent
with the Fund's investment objective. Currently, futures contracts are
available on Treasury bills, notes, and bonds.
There are a number of reasons why entering into futures contracts for hedging
purposes can be beneficial to the Fund. First, futures markets may be more
liquid than the corresponding cash markets on the underlying securities.
Such enhanced liquidity results from the standardization of the futures
contracts and the large transaction volumes. Greater liquidity permits a
portfolio manager to effect a desired hedge both more quickly and in greater
volume than would be possible in the cash market. Second, a desired sale and
subsequent purchase can generally be accomplished in the futures market for
a fraction of the transaction costs that might be incurred in the cash
market.
The purpose of selling a futures contract is to protect the Fund's portfolio
from fluctuation in asset value resulting from stock price changes. Selling
a futures contract has an effect similar to selling a portion of the Fund's
portfolio securities. If stock prices were to decline, the value of the
Fund's futures contracts would increase, thereby keeping the net asset value
of the Fund from declining as much as it otherwise might have. In this way,
selling futures contracts acts as a hedge against the effects of declining
stock prices. However, an increase in the value of portfolio securities
tends to be offset by a decrease in the value of corresponding futures
contracts.
Similarly, when stock prices are expected to rise, futures contracts may be
purchased to hedge against anticipated subsequent purchases of portfolio
securities at higher prices. By buying futures, the Fund could effectively
hedge against an increase in the price of the securities it intends to
purchase at a later date in order to permit the purchase to be effected in
an orderly manner. At that time, the futures contracts could be liquidated
at a profit if stock prices had increased as expected, and the Fund's cash
position could be used to purchase securities.
When a purchase or sale of a futures contract occurs, a deposit of high-quality,
liquid securities called "initial margin" is made by both buyer and seller with
a custodian for the benefit of the broker. Unlike other types of
margin, a futures margin account does not involve any loan or borrowing but
is merely a good faith deposit that must be maintained in a minimum amount of
cash or U.S. Treasury bills. All futures positions, both long and short,
are marked-to-market daily, with cash payments called "variation margin"
being made by buyers and sellers to the custodian, and passed through to the
sellers and buyers, to reflect daily changes in the contract values.
Most futures contracts are typically cancelled or closed out before the
scheduled settlement date. The closing is accomplished by purchasing (or
selling) an identical futures contract to offset a short (or long) position.
Such an offsetting transaction cancels the contractual obligations
established by the original futures transaction. Other financial futures
contracts call for cash settlements rather than delivery of securities.
If the price of an offsetting futures transaction varies from the price of the
original futures transaction, the hedger will realize a gain or loss
corresponding to the difference. That gain or loss will tend to offset the
unrealized loss or gain on the hedged securities position, but may not always
or completely do so.
The Fund will not enter into any futures contract if, immediately thereafter,
the aggregate initial margin for all existing futures contracts and options
thereon and for premiums paid for related options would exceed 5% of the
Fund's total assets. The Fund will not purchase or sell futures contracts
or related options if immediately thereafter more than one-third of its net
assets would be hedged.
C. Risks and Limitations Involved in Futures Hedging. There are a number of
risks associated with futures hedging. Changes in the price of a futures
contract generally parallel but do not necessarily equal changes in the
prices of the securities being hedged. The risk of imperfect correlation
increases as the composition of the Fund's securities portfolio diverges
from the securities that are the subject of the futures contract. Because
the change in the price of the futures contract may be more or less than the
change in the prices of the underlying securities, even a correct forecast
of stock price changes may not result in a successful hedging transaction.
Another risk is that the Investment Advisor could be incorrect in its
expectation as to the direction or extent of various market
trends or the time period within which the trends are to take place.
The Fund intends to purchase and sell futures contracts only on exchanges where
there appears to be a market in such futures sufficiently active to
accommodate the volume of its trading activity. There can be no assurance that
a liquid market will always exist for any particular contract at any particular
time. Accordingly, there can be no assurance that it will always be
possible to close a futures position when such closing is desired and, in
the event of adverse price movements, the Fund would continue to be required
to make daily cash payments of variation margin. However, in the event
futures contracts have been sold to hedge portfolio securities, such securities
will not be sold until the offsetting futures contracts can be executed.
Similarly, in the event futures have been bought to hedge anticipated
securities purchases, such purchases will not be executed until the
offsetting futures contracts can be sold.
Successful use of futures contracts by the Fund is also subject to the ability
of the Investment Advisor to predict correctly movements in the direction of
interest rates and other factors affecting markets for securities. For
example, if the Fund has hedged against the possibility of an increase in
interest rates that would adversely affect the price of securities in its
portfolio and prices of such securities increase instead, the Fund will lose
part or all of the increased value of its securities because it will have
offsetting losses in its futures positions. In addition, in such situations,
if the Fund has insufficient cash to meet daily variation margin
requirements, it may have to sell securities to meet such requirements.
Such sale of securities may be, but will not necessarily be, at increased
prices that reflect the rising market. The Fund may have to sell securities
at a time when it is disadvantageous to do so. Where futures are purchased
to hedge against a possible increase in the price of securities before the
Fund is able to invest its cash in an orderly fashion, it is possible that
the market may decline instead; if the Fund then concludes not to invest in
securities at that time because of concern as to possible further market decline
or for other reasons, the Fund will realize a loss on the futures contract that
is not offset by a reduction in the price of
the securities purchased.
The selling of futures contracts by the Fund and use of related transactions in
options on futures contracts (discussed below) are subject to position limits,
which are affected by the activities of the Investment Advisor.
The hours of trading of futures contracts may not conform to the hours during
which the Fund may trade equity securities. To the extent that the futures
markets close before the equity securities markets, significant price and
rate movements can take place in the equity securities markets that cannot
be reflected in the futures markets.
Pursuant to Rule 4.5 under the Commodity Exchange Act, investment companies
registered under the Investment Company Act of 1940, as amended (the
"Investment Company Act"), are exempted from the definition of "commodity
pool operator" in the Commodity Exchange Act, subject to compliance with
certain conditions. The exemption is conditioned upon a requirement that all
of the investment company's commodity futures transactions constitute bona
fide hedging transactions (except on an unleveraged basis, as described in
E. below). With respect to long positions assumed by the Fund, the Fund
will segregate with its custodian, an amount of cash and other
assets permitted by Commodity Futures Trading Commission (CFTC)regulations
equal to the market value of the futures contracts and thereby insure that
the use of futures contracts is unleveraged. The Fund will use futures in
a manner consistent with these requirements.
D. Options on Futures Contracts. The Fund only intends to engage in options
on futures contracts for bona fide hedging purposes in compliance with CFTC
regulations. An option on a futures contract gives the purchaser the
right, but not the obligations, to assume a position in a futures contract
(which position may be a long or short position) at a specified exercise
price at any time during the option exercise period. The writer of the
option is required upon exercise to assume an offsetting futures position
(which position may be a long or short position). Upon exercise of the
option, the assumption of offsetting futures positions by the writer and
holder of the option will be accompanied by delivery of the accumulated
balance in the writer's futures margin account that represents the amount
by which the market price of the futures contract, at exercise, exceeds, in
the case of a call, or is less than, in the case of a put, the exercise
price of the option on the futures contract.
The holder or writer of an option may terminate its position by selling or
purchasing an option of the same series. There is no guarantee that such
closing transactions can be effected.
The Fund will be required to deposit initial and variation margin with
respect to put and call options on futures contracts written by it pursuant
to the Fund's futures commissions merchants' requirements similar to those
applicable to the futures contracts themselves, described above.
E. Risks of Futures Transactions. The Fund's successful use of futures
contracts and options thereon depends upon the ability of its Investment
Advisor to predict movements in the stock market and other factors affecting
markets for securities and upon the degree of correlation between the prices
of the futures contracts and the prices of the securities being hedged.
As a result, even a correct forecast of stock price changes may not result in
a successful hedging transaction. Although futures contracts and options
thereon may limit the Fund's exposure to loss, they may also limit the Fund's
potential for capital gains. For example, if the Fund has hedged against the
possibility of decrease in stock prices which would adversely affect the
price of securities in its portfolio and prices of such securities increase
instead, the Fund will lose part or all of the benefit of the increased value
of its securities because it will have offsetting losses in its futures
positions. Although the Fund will enter into futures contracts only where
there appears to be a liquid market, there can be no assurance that such
liquidity will always exist.
F. The Fund also is authorized, subject to the limitations set out in the
Prospectus, to purchase futures contracts on an unleveraged basis, when not
intended as an anticipatory hedge. When a contract is purchased on this basis
the investment company establishes a segregated account, composed of cash and/
or cash equivalents, equal to the total value of the contract (less margin on
deposit). As with other futures trading, these purchases must not be for
speculative purposes.
The ability to engage in these purchases on an unleveraged basis can
significantly decrease transaction costs to the Funds in certain instances.
For example, if an inordinately large deposit should occur on a single day,
the sheer volume of securities purchases required for that day may place the
Fund at a market disadvantage by requiring it to purchase particular
securities in such volume that its own buying activity could cause prices to
increase. In addition, if this deposit had involved 'market-timing' and as
a result there subsequently were an oversized withdrawal, the Fund could
again suffer market disadvantage, this time because the volume of sales
could, for the same reason, force prices of particular securities to
decrease. The Fund, by buying a futures contract (followed by the
appropriate closing transaction) instead of purchasing securities could
achieve considerable savings in transaction costs without departing from
Fund objectives. Furthermore, as stated in (B.) above, price changes in a
futures contract generally parallel price changes in the securities that the
Fund might otherwise have purchased. Thus, purchase of a futures contract on
an unleveraged basis allows the Fund to comply with its objective while at
the same time achieving these lower transaction costs.
LENDING OF PORTFOLIO SECURITIES
As described in the Prospectus, the Funds may from time to time lend securities
from their portfolios to brokers, dealers and financial institutions and
receive collateral from the borrower, in the form of cash (which may be
invested in short-term securities), U.S. government obligations or
certificates of deposit. Such collateral will be maintained at all times in
an amount equal to at least 100% of the current market value of the loaned
securities, and and will be in the actual or constructive possession of the
particular Fund during the term of the loan. The Fund will maintain the
incidents of ownership of the loaned securities and will continue to be
entitled to the interest or dividends payable on the loaned securities. In
addition, the Fund will receive interest on the amount of the loan. The
loans will be terminable by the Fund at any time and will not be made to any
affiliates of the Fund or the Adviser. The Fund may pay reasonable finder's
fees to persons unaffiliated with it in connection with the
arrangement of the loans.
As with any extensions of credit, there are risks of delay in recovery and, in
some cases, even loss of rights in the collateral or the loaned securities
should the borrower of securities fail financially. However, loans of portfolio
securities will be made only to firms deemed by the Adviser to be
creditworthy.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
The Funds may make short-term investments in repurchase agreements. A
repurchase agreement typically involves the purchase by the Fund of
securities (U.S. government or other money market securities) from a
financial institution such as a bank, broker or savings and loan association,
coupled with an agreement by the seller to repurchase the same securities
from the Fund at the specified price and at a fixed time in the future,
usually not more than seven days from the date of purchase. The difference
between the purchase price to the Fund and the resale price to the seller
represents the interest earned by the Fund which is unrelated to the coupon
rate or maturity of the purchased security. If the seller defaults, the Fund
may incur a loss if the value of the collateral securing the repurchase
agreement declines, or the Fund may incur disposition costs in connection with
liquidating the collateral. If bankruptcy proceedings are commenced with
respect to the seller, realization upon the collateral by the Fund may be
delayed or limited and a loss may be incurred if the collateral securing the
repurchase agreement declines in value during the bankruptcy proceedings.
The Board of Directors of the Fund will evaluate the creditworthiness of all
entities, including banks and broker-dealers, with which they propose to
enter into repurchase agreements. These transactions will be fully
collateralized; and the collateral for each transaction will be in the
actual or constructive possession of the particular Fund during the terms of
the transaction, as provided in the agreement.
In a reverse repurchase agreement, the Fund involved sells a portfolio security
to another party, such as a bank or broker-dealer, in return for cash and
agrees to repurchase the instrument at a particular price and time. While a
reverse repurchase agreement is outstanding, the Fund will maintain cash and
appropriate liquid assets in a segregated custodial account to cover its
obligation under the agreement. The Fund will enter into reverse
repurchase agreements only with parties that the Advisor or Sub-Advisor deems
creditworthy. Reverse repurchase agreements are considered to be borrowing
transactions, and thus are subject to the Fund's limitation on
borrowing. Not every Fund is authorized to enter into reverse repurchase
agreements.
CUSTODIAN
All securities, cash and other similar assets of the Bond, Growth and Income ,
Managed, Money Market, Social Awareness and Special Opportunities Funds are
currently held in custody by Bankers Trust Company, 14 Wall Street, 4th
Floor, New York, New York 10005. Bankers Trust agreed to act as custodian
for each Fund pursuant to a Custodian Agreement dated June 17, 1985 (March
10, 1986 for the Social Awareness Fund).
All securities, cash and other similar assets of the Aggressive Growth, Capital
Appreciation, Equity-Income, Global Asset Allocation
and International Funds are held in custody by State Street Bank and
Trust Company, 225 Franklin Street, Boston, Massachusetts 02110. State
Street agreed to act as custodian for these Funds pursuant to Custodian
Contracts effective July 21, 1987 for the Global Asset Allocation Fund, April
29, 1991 for the International Fund, and December 6, 1993 for the other three
funds.
Under these Agreements, the respective custodians shall (1) receive and disburse
money; (2) receive and hold securities; (3) transfer, exchange, or deliver
securities; (4) present for payment coupons and other income items,
collect interest and cash dividends received, hold stock dividends, etc.;
(5) cause escrow and deposit receipts to be executed; (6) register
securities; and (7) deliver to the Funds proxies, proxy statements, etc.
INDEPENDENT AUDITORS
Each Fund's Board of Directors has engaged Ernst & Young LLP, 2300 Fort Wayne
National Bank Building, Fort Wayne, Indiana 46802, to be the independent
auditors for the Fund. In addition to the audit of the 1995 financial
statements of the Funds, other services provided include review and
consultation connected with filings of annual reports and registration
statements with the Securities and Exchange Commission; consultation on
financial accounting and reporting matters; and meetings with the Audit
Committee.
FINANCIAL STATEMENTS
The financial statements for the Funds are incorporated by reference to the
Funds' 1995 Annual Report (see Pages 36-49 for all Funds; and Pages 10-11,
Aggressive Growth; Pages 11-13, Bond Fund; Pages 13-14, Capital Appreciation
Fund; Pages 14-18, Equity-Income Fund; Pages 18-24, Global Asset Allocation
Fund; Pages 24-25, Growth and Income Fund; Pages 26-27, International Fund;
Pages 27-31, Managed Fund; Pages 31-32, Money Market Fund; Pages 32-33,
Social Awareness Fund; and Pages 33-35, Special Opportunities Fund).
We will provide a copy of the Annual Report on request and without charge.
Please write or call Eric Jones, The Lincoln National Life Insurance
Company, P.O. Box 2340, Fort Wayne, Indiana 46801; telephone: 1-800-1212,
Extension 6536.
BOND RATINGS
MOODY'S INVESTORS SERVICE, INC.
Aaa--Bonds which are rated Aaa are judged to be of the best quality and carry
the smallest degree of investment risk. Interest payments are protected by
a large or by an exceptionally stable margin, and principal is secure.
While the various protective elements are likely to change, such changes as
can be visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because
margins of protection may not be as large as in Aaa securities or fluctuation
of protective elements may be of greater amplitude or there may be other
elements present which make the long-term risks appear somewhat larger
than in Aaa securities.
A--Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment some time in the future.
Baa--Bonds which are rated Baa are considered as medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments are
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any
great length of time. Such bonds lack outstanding investment characteristics
and in fact have speculative characteristics as well.
Ba--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance
of other terms of the contract over any long period of time may be small.
Caa--Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca--Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
STANDARD & POOR'S CORPORATION
AAA--This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA--Bonds rated AA also qualify as high-quality debt obligations. Capacity
to pay principal and interest is very strong, and in the majority of
instances they differ from AAA issues only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas these bonds normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to pay principal and interest
than for bonds in the A category and higher.
BB-B-CCC-CC--Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation.
BB indicates the lowest degree of speculation and C the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
COMMERCIAL PAPER RATINGS
MOODY'S INVESTORS SERVICE, INC.
Moody's Commercial Paper ratings are opinions of the ability of issuers to repay
punctually promissory obligations not having an original maturity in excess
of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Prime 1--Highest Quality; Prime 2--Higher Quality; Prime 3--High Quality. (The
Fund will not invest in commercial paper rated Prime 3).
STANDARD & POOR'S CORPORATION
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more
than 365 days. The Fund will invest in commercial paper rated in the "A"
Categories, as follows:
A Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are further refined
with the designation 1, 2, and 3 to indicate the relative degree of safety.
(The Fund will not invest in commercial paper rated A-3).
A--1 This designation indicates that the degree of safety regarding timely
payment is very strong.
A--2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not overwhelming as for issues
designated A-1.
U.S. GOVERNMENT OBLIGATIONS
Securities issued or guaranteed as to principal and interest by the U.S.
government include a variety of Treasury securities, which differ only in
their interest rates, maturities and times of issuance. Treasury bills have a
maturity of one year or less. Treasury notes have maturities of one to seven
years and Treasury bonds generally have a maturity of greater than five years.
Various agencies of the U.S. government issue obligations. Some of these
securities are supported by the full faith and credit of the U.S. Treasury
(for example those issued by Export-Import Bank of the United States, Farmers
Home Administration, Federal Housing Administration, Government National
Mortgage Association, Maritime Administration, Small Business Administration
and The Tennessee Valley Authority). Obligations of instrumentalities of
the U.S. government are supported by the right of the issuer to borrow from
the Treasury (for example, those issued by Federal Farm Credit Banks, Federal
Home Loan Bank, Federal Home Loan Mortgage Corporation, Federal Intermediate
Credit Banks, Federal Land Bank and the U.S. Postal Service). Obligations
supported by the credit of the instrumentality include securities issued by
government sponsored corporations whose stock is publicly held (for example,
the Federal National Mortgage Association, and the Student Loan
Marketing Association).
TAXES
Each Fund intends to qualify and has elected to be taxed as a "regulated
investment company" under certain provisions of the Internal Revenue Code of
1986, as amended (the "Code"). If a Fund qualifies as a "regulated
investment company" and complies with the provisions of the Code relieving
regulated investment companies which distribute substantially all of their
net income (both net ordinary income and net capital gain) from Federal
income tax, it will be relieved from such tax on the part of its net ordinary
income and net realized capital gain which it distributes to its
shareholders. To qualify for treatment as a "regulated investment company,"
each Fund must, among other things, derive in each taxable year at least 90
percent of its gross income from dividends, interest, payments with respect
to securities loans, and gains from the sale or other disposition of stock or
securities or foreign currencies (subject to the authority of the Secretary
of the Treasury to exclude foreign currency gains which are not directly
related to the Fund's principal business of investing in stock or securities or
options and futures with respect to such stock or securities), or other income
(including but not limited to gains from options, futures, or forward contracts)
derived with respect to its investing in such stock, securities, or
currencies. In addition to qualify as a "regulated investment company" each
Fund must derive less than 30% of its gross income from the sale or other
disposition of securities held for less than three months. In order to meet
these requirements, a Fund may be required to defer disposing of certain
futures contracts and underlying securities beyond the time when it might
otherwise be advantageous to do so. Specifically, these requirements
may limit a Fund's ability to (a) sell securities held for less than three
months; (b) effect closing transactions on futures contracts entered into
less than three months previously; (c) enter into futures contracts for a
period of less than three months; and (d) enter into futures contracts on
securities held for less than the long-term capital gains holding period.
Further, for purposes of the 30% test, increases (and decreases) in the value
of positions that are part of a "designated hedge" (as defined in the Code)
are netted.
The Federal tax laws impose a four percent nondeductible excise tax on each
regulated investment company with respect to an amount, if any, by which
such company does not meet distribution requirements specified in such
tax laws, unless certain exceptions apply. Each Fund intends to comply with
such distribution requirements or qualify under one or more exceptions, and
thus does not expect to incur the four percent nondeductible excise tax.
Since the sole shareholder of each Fund will be LNL, no discussion is stated
herein as to the Federal income tax consequences at the shareholder level.
The discussion of Federal income tax considerations in the Prospectus, in
conjunction with the foregoing, is a general and abbreviated summary of the
applicable provisions of the Code and Treasury Regulations currently in
effect as interpreted by the Courts and the Internal Revenue Service. These
interpretations can be changed at any time. The above discussion covers only
Federal tax considerations with respect to the Fund. State and local taxes
vary.
STATE REQUIREMENTS
The California Department of Insurance has established the following Guidelines
for an underlying portfolio of a Separate Account. The Funds intend to
comply with these Guidelines:
BORROWING
The borrowing limits for any variable contract separate account portfolio are
(1) 10% of net asset value when borrowing for any general purpose and
(2) 25% of net asset value when borrowing as a temporary measure to
facilitate redemptions.
Net asset value of a portfolio is the market value of all investments or assets
owned less outstanding liabilities of the portfolio at the time that any new
or additional borrowing is undertaken.
FOREIGN INVESTMENTS--DIVERSIFICATION
The foreign country diversification guidelines to be followed by the Funds are
as follows: 1. A Portfolio will be invested in a minimum of five different
foreign countries at all times. However, this minimum is reduced to four
when foreign country investments comprise less than 80% of the Portfolio's net
asset value; to three when less than 60% of such value; to two when less than
40%; and to one when less than 20%. 2. Except as set forth in items 3 and 4
below, a Portfolio will have no more than 20% of its net asset value
invested in securities of issuers located in any one country.
3. A Portfolio may have an additional 15% of its value invested in
securities of issuers located in any one of the following countries:
Australia, Canada, France, Japan, the United Kingdom or West Germany.
4. A Portfolio's investments in United States issuers are not subject to the
foreign country diversification guidelines.
DERIVATIVE TRANSACTIONS - DEFINITIONS
The Prospectus for each Fund and the uniform Appendix for the Prospectus booklet
discuss the type of Derivative Transactions in which the Funds may engage and
the risks typically associated with many Derivative transactions.
Here are some definitions for the derivatives listed in the Appendix:
. OPTION: a contract which gives the Fund the right, but not the obligation,
to buy or sell specified securities at a fixed price before or at a
designated future date. If the Contract allows the Fund to buy securities,
it is a call option; if to sell, it is a put option. It is common practice
in options trading to terminate an outstanding option contract by entering
into an offsetting transaction known as a 'closing transaction;, as a result
of which the Fund would either pay out or receive a cash settlement. This
is discuss below.
CURRENCY OPTION: Discussed below.
FIXED INCOME OPTION: one based on a fixed-income security, such as a
corporate or government bond.
INDEXED OPTION: one based on the value of an index which measures the
fluctuating value of a 'basket' of pre-selected securities.
STOCK (EQUITY) OPTION: one based on the shares of stock of a particular
company.
OPTION ON A FUTURES CONTRACT: Discussed below.
SWAP: a financial transaction in which the Fund and another party agree to
exchange streams of payments at periodic intervals under a predetermined
set of occurrences related to the price, level, performance or value of one
or more underlying securities, and pegged to a reference amount known s the
'notional amount'. A swap is normally used to change the market risk
associated with a loan or bond borrowing from one interest rate base
(fixed term or floating rate) or currency of one denomination to another.
EQUITY SWAP: one which allows the Fund to exchange the rate of return (or
some portion of the rate) on its portfolio stocks (an individual share,
a basket or index) for the rate of return on another equity or non-equity
investment.
INTEREST RATE SWAP: one in which th e Fund and another party exchange
different types of interest payment streams, pegged to an underlying
notional principal amount. The three main types of interest rate swaps are
coupon swaps (fixed rate to floating rate in the same currency); basis swaps
(one floating rate index to another floating rate index in the same currency)
; and cross-currency interest rate swaps (fixed rate in one currency to
floating rate in another).
RELATED TRANSACTIONS TO INTEREST RATE SWAPS:
a. CAP: A contract for which the buyer pays a fee, or premium, to
obtain protection against a rise in a particular int erest rate above a certain
level. For example, an interest rate cap may cover a specified principal
amount of a loan over a designated time period, such as a calendar quarter.
If the covered interest rate rises above the rate ceiling, the seller of the
rate cap pays the purchaser an amount of money equal to the average rate
differential times the
b. FLOOR: a contract in which the seller agrees to pay to the
purchaser, in return for the payment of a premium, the difference between
current interest rates and an agreed (strike) rate times the notional amount,
should interest rates fall below the agreed level (the 'floor'). A floor
contract has the effect of a string of interest rate guarantees.
c. COLLAR: an arrangement to simultaneously purchase a cap and sell a
floor, in order to maintain interest rates within a defined range. The premium
income from the sale of the floor reduces or offsets the cost of buying the
cap.
d. CORRIDOR: an agreement to buy a cap at one interest rate and sell
a cap at a higher rate.
SWAPTION: an option to enter into, extend, or cancel a swap.
FUTURES CONTRACT: a contract which commits the Fund to buy or sell a specified
amount of a financial instrument at a fixed price on a fixed date in the future.
Futures contracts are normally traded on an exchange and their terms are
standardized, which makes it easier to buy and sell them.
INTEREST RATE FUTURES (AND OPTIONS ON THEM): futures contracts pegged to
U.S. and foreign fixed-income securities, debt indices and reference rates.
STOCK INDEX FUTURES. futures contracts based on an index of pre-selected
stocks, with prices based on a composite of the changes to the prices of the
individual securities in the index (e.g., S&P 500).
OPTION ON A FUTURES CONTRACT: an option taken on a futures position.
FORWARD CONTRACT: an over-the-counter, individually-tailored futures contract.
FORWARD RATE AGREEMENT (FRA): a con tract in which the Fund and another
party agree on the interest rate to be paid on a notional deposit of
specified maturity at a specific future time. Normally, no exchange of
principal is involved; the difference between the contracted rate and the
prevailing rate is settled in cash.
CURRENCY CONTRACT: a contract entered into for the purpose of reducing or
eliminating an anticipated rise or drop in currency exchange rates over time.
CURRENCY FUTURES: futures contracts on foreign currencies. Used to hedge
the purchase or sale of foreign securities.
CURRENCY OPTION: an option taken on foreign currency.
CURRENCY SWAP: a swap involving the exchange of cash flows and principal
in one currency for those in another, with an agreement to reverse the
principal swap at a future date.
CROSS-CURRENCY INTEREST RATE SW AP: a swap involving the exchange of
streams of interest rate payments (but not necessarily principal payments)
in different currencies and often on different interest bases (e.g., fixed
Deutsche Mark against floating dollar, but also fixed Deutsche Mark against
fixed dollar).
CURRENCY FORWARD CONTRACT: a contract to 'lock in' a currency exchange rate
at a future date, to eliminate risk of currency fluctuation when the time comes
to convert from one currency to another.
