<PAGE>
PACIFIC SELECT FUND PROSPECTUS , 2000
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED FEBRUARY 16, 2000
This prospectus tells you about the
You should be aware Pacific Select Fund's
that the Securities I-Net Tollkeeper PortfolioSM
and Exchange managed by Goldman Sachs Asset
Commission has not Management.
reviewed this
portfolio for its It's designed to give you information
investment merit, about an investment option that will be
and does not available under your variable annuity
guarantee that the contract or variable life insurance
information in this policy issued or administered by Pacific
prospectus is Life Insurance Company or its
accurate or subsidiaries.
complete. It is a
criminal offense You'll find details about how your
to say otherwise. annuity contract or life insurance
policy works in your product prospectus
or offering memorandum.
A registration statement relating to shares of the I-Net Tollkeeper Portfolio
has been filed with the Securities and Exchange Commission, but has not yet
become effective. The information in this prospectus is not complete and may be
changed. Shares of the I-Net Tollkeeper Portfolio may not be sold until the
registration statement is effective. This prospectus is not an offer to sell
shares of this Portfolio and is not soliciting an offer to buy these securities
in any state where the offer or sale is not permitted.
<PAGE>
ABOUT THE PORTFOLIO I-NET TOLLKEEPER PORTFOLIO
------------------------------------------------------
The portfolio's This portfolio seeks long-term growth of capital.
investment goal
This portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
------------------------------------------------------
What the portfolio This portfolio's principal investment strategy is to
invests in invest at least 65% of its assets in equity securities
of "I-Net Tollkeeper" companies, which are media,
The management team telecommunications, technology and Internet companies
believes that one that provide access, infrastructure, content and
way to invest in services to Internet companies and Internet users, and
the Internet is to which have developed, or are seeking to develop,
invest in those predictable, sustainable or recurring revenue streams
businesses by increasing "traffic," or customers and sales, and
participating in raising "tolls," or prices in connection with the
the growth of the growth of the Internet.
Internet that may
have long-lasting Examples of I-Net Tollkeeper companies may include:
strategic
advantages . Access providers that enable individuals and
including: dominant businesses to connect to the Internet through, for
market share; example, cable systems or the telephone network;
strong brand names;
recurring revenue . Infrastructure companies that provide items such as
streams; cost servers, routers, software and storage necessary for
advantages; companies to participate in the Internet;
economies of scale;
financial strength; . Media content providers that own copyrights,
technological distribution networks and/or programming who may
advantages; and benefit from increased advertising by Internet
strong experienced companies and/or from having new distribution
management teams. channels;
. Service providers that may facilitate transactions,
communications, security, computer programming and
back-office functions for Internet businesses.
Normally, the portfolio invests at least 90% of its
assets in equity securities, primarily in publicly-
traded U.S. companies. The portfolio may invest up to
35% of its assets in non-I-Net Tollkeeper companies
which may use the Internet to enhance their cost
structure, revenue opportunities or competitive
advantage. The portfolio may also invest in Internet-
based companies (that are not I-Net Tollkeeper
companies) that the portfolio managers believe exhibit
a sustainable business model. To help it achieve its
investment goal, the portfolio may lend some of its
assets, as long as the loans it makes are secured.
The management team may temporarily change these
strategies if it believes economic conditions make it
necessary to try to protect the portfolio from
potential loss. In this case, the portfolio may invest
in U.S. Government securities, commercial paper, bank
instruments, and non-convertible corporate bonds with a
remaining maturity of less than one year.
------------------------------------------------------
Risks you should be The I-Net Tollkeeper Portfolio principally invests in
aware of equity securities, which may go up or down in value,
sometimes rapidly and unpredictably. While equities may
Because the offer the potential for greater long-term growth than
portfolio most fixed income securities, they generally have
concentrates its higher volatility. The portfolio may be affected by the
investments in following risks, among others:
I-Net Tollkeeper
companies, the . industry concentration risk - the portfolio is
portfolio's subject to greater risk of loss as a result of
performance may be adverse economic, business or other developments than
substantially if its investments were diversified across different
different from the industry sectors.
returns of the
broader stock . Internet risk - the risk that the stock prices of
market and of Internet and Internet-related companies will
"pure" Internet experience significant price movements as a result of
funds. intense worldwide competition, consumer preferences,
product compatibility, product obsolescence,
government regulation, excessive investor optimism or
pessimism, or other factors.
. price volatility - the value of the portfolio changes
as the prices of its investments go up and down. This
portfolio invests in companies participating in the
growth of the Internet, which may give the portfolio
higher volatility than a portfolio that invests in
equities of other industries, or a broader spectrum
of industries. The prices of these companies may be
affected by intense competition, changing
technologies, consumer preferences, problems with
product compatibility, government regulation,
interest rates, and investor optimism or pessimism
with little or no basis in traditional economic
analysis.
2
<PAGE>
------------------------------------------------------
Risks you should be . risks of foreign investing - foreign investments may
aware of be riskier than U.S. investments for many reasons,
(continued) including changes in currency exchange rates,
unstable political and economic conditions, a lack of
The portfolio may adequate company information, differences in the way
not invest more securities markets operate, less secure foreign banks
than 25% of its or securities depositories than those in the U.S.,
assets in foreign and foreign controls on investment.
securities,
including emerging . emerging countries risk - compared to developed
market countries. foreign markets, emerging market countries (such as
many in Asia, Latin America, Eastern Europe and
Africa):
. are generally subject to greater price volatility
. may have a higher degree of political and economic
instability
. often have smaller market capitalizations
. have less governmental regulation
. are not subject to as extensive and frequent
accounting, financial and other reporting
requirements.
Investment in securities of Eastern European countries,
including in particular, Russia, and other emerging
market countries, also involve risk of loss resulting
from problems in share registration and custody.
------------------------------------------------------
Who manages the George D. Adler is a vice president and senior
portfolio portfolio manager of Goldman Sachs. He joined the
company as a portfolio manager in 1997. From 1990 to
1997, Mr. Adler was a portfolio manager at Liberty
[LOGO OF GOLDMAN Investment Management, Inc. (Liberty).
SACHS APPEARS HERE]
Steve Barry is a vice president and senior portfolio
The I-Net manager of Goldman Sachs. He joined the company as a
Tollkeeper portfolio manager in 1999. From 1988 to 1999, Mr. Barry
Portfolio is was a portfolio manager at Alliance Capital Management
managed by a team L.P.
of portfolio
managers at Goldman Robert G. Collins is a vice president and senior
Sachs Asset portfolio manager of Goldman Sachs. He joined the
Management. You'll company as a portfolio manager and co-chair of the
find more about growth equity committee in 1997. From 1991 to 1997, Mr.
Goldman Sachs on Collins was a portfolio manager at Liberty.
page 5.
Herbert E. Ehlers is a managing director, senior
portfolio manager and chief investment officer of the
growth equity investment team of Goldman Sachs. He
joined the company in 1997. From 1994 to 1997, Mr.
Ehlers was the chief investment officer and chairman at
Liberty, and from 1984 to 1994 was a portfolio manager
and president at Liberty's predecessor firm, Eagle
Asset Management (Eagle).
Gregory H. Ekizian is a vice president and senior
portfolio manager of Goldman Sachs. He joined the
company as a portfolio manager and co-chair of the
growth equity investment committee in 1997. From 1990
to 1997, Mr. Ekizian was a portfolio manager at Liberty
and its predecessor firm, Eagle.
Scott Kolar is an associate and a portfolio manager of
Goldman Sachs. He joined the company as an equity
analyst in 1997 and became a portfolio manager in 1999.
From 1994 to 1997, Mr. Kolar was an equity analyst and
information systems specialist at Liberty.
Ernest C. Segunda, Jr. is a vice president and senior
portfolio manager of Goldman Sachs. He joined the
company as a portfolio manager in 1997. From 1992 to
1997, Mr. Segunda was a portfolio manager at Liberty.
David G. Shell is a vice president and senior portfolio
manager of Goldman Sachs. He joined the company as a
portfolio manager in 1997. From 1987 to 1997, Mr. Shell
was a portfolio manager at Liberty and its predecessor
firm, Eagle.
3
<PAGE>
MANAGING PACIFIC SELECT FUND
--------------------------------------------------------
Overview The performance of the I-Net Tollkeeper Portfolio is
affected by changes in the economy and financial
markets. The portfolio is also affected by other kinds
of risks, depending on the types of securities it
invests in. Risk is the chance that you'll lose money
on an investment, or that it will not earn as much as
you expect. Every portfolio has some degree of risk
depending on what it invests in and what strategies it
uses. One of the most important investment decisions
you'll need to make is how much risk you're willing to
accept in exchange for potential return on an
investment. There's also the possibility that
investment decisions the portfolio manager makes will
not accomplish what they were designed to achieve, or
that the portfolio will not achieve its investment
goal.
Equity securities historically have offered the
potential for greater long-term growth than most fixed
income securities, but they also tend to have larger
and more frequent changes in price, which means there's
a greater risk you could lose money over the short
term. Fixed income securities are affected primarily by
the financial condition of the companies that have
issued them, and by changes in interest rates.
You'll find a more detailed discussion of the
portfolio's investments, strategies and risks in the
Statement of Additional Information (SAI). Please turn
to the back cover for information about how to get
copies of this document.
Many of the investment techniques and strategies
discussed in this prospectus and in the SAI are
discretionary, which means that the portfolio managers
can decide if they want to use them or not. The
portfolio manager may also use investment techniques or
make investments in securities that are not part of the
portfolio's principal investment strategy. The
portfolio's stated investment goal cannot be changed
without the approval of shareholders. Investment
policies may be changed from time to time by the fund's
board of trustees.
--------------------------------------------------------
Founded in 1868, Pacific Life provides life and health
[LOGO OF PACIFIC insurance products, individual annuities and group
LIFE APPEARS HERE] employee benefits, and offers to individuals,
businesses and pension plans a variety of investment
Pacific Life products and services. Over the past five years, the
Insurance Company company has grown from the 26th to the 18th largest
700 Newport Center life insurance company in the nation. The Pacific Life
Drive family of companies manages more than $300 billion in
Newport Beach, assets, making it one of the largest financial
California 92660 institutions in America, and currently counts 65 of the
100 largest U.S. companies as clients. Additional
information about Pacific Life can be obtained at its
Web site, www.PacificLife.com.
In its role as the fund's investment adviser, Pacific
Life supervises the management of the I-Net Tollkeeper
Portfolio. Pacific Life also oversees and monitors the
performance of the portfolio manager.
Pacific Life, subject to the review of the fund's
board, has ultimate responsibility to oversee the
portfolio manager. Under an exemptive order from the
Securities and Exchange Commission, Pacific Life and
Pacific Select Fund can hire, terminate and replace the
portfolio manager without shareholder approval. Within
90 days of the hiring of any new portfolio manager,
shareholders of the portfolio would be sent information
about the change.
4
<PAGE>
--------------------------------------------------------
[LOGO OF GOLDMAN Created in 1988, Goldman Sachs Asset Management
SACHS APPEARS HERE] (Goldman Sachs) is a unit of the Investment Management
Division (IMD) of Goldman, Sachs & Co. Goldman Sachs
Goldman Sachs Asset provides a wide range of discretionary investment
Management advisory services, quantitatively driven and actively
32 Old Slip managed to U.S. and international equity portfolios,
New York, New York U.S. and global fixed-income portfolios, commodity and
10005 currency products and money market accounts. As of
December 31, 1999, Goldman Sachs, along with other
units of IMD, had assets under management of
$258.5 billion.
Portfolio management at Goldman Sachs is conducted by
teams that are supported by 600 investment research
professionals, 20 market strategists and 30 economists
around the world. The company has more than 14,500
professionals in 41 offices worldwide.
--------------------------------------------------------
Fees and expenses The fund pays Pacific Life an advisory fee for the
paid by the fund services it provides as investment adviser. It also
pays for all of the costs of its operations, as well as
for other services Pacific Life provides through a
support services agreement.
The table below shows the advisory fee as an annual
percentage of the portfolio's average daily net assets.
Pacific Life uses part of this fee to pay for the
services of the portfolio manager.
The projected expenses of the I-Net Tollkeeper
Portfolio as an annual percentage of the portfolio's
average daily net assets are:
<TABLE>
<CAPTION>
--------------------------------------
Other Total
Advisory fee expenses/1/ expenses/2/
--------------------------------------
<S> <C> <C>
1.50 0.15 1.65
--------------------------------------
</TABLE>
/1/ Expenses are estimated. There were no actual
advisory fees or expenses for this portfolio in
1999 because the portfolio will start on May 1,
2000.
/2/ Effective January 1, 2000, the fund implemented a
brokerage enhancement 12b-1 plan, under which
brokerage transactions may be placed with broker-
dealers in return for credits that may be used to
help promote distribution of fund shares. There are
no fees or charges to any portfolio under this
plan, although the fund's distributor may defray
expenses of up to approximately $300,000 for the
year 2000, which it might otherwise incur for
distribution. If such defrayed amount were
considered a fund expense, it would represent
approximately .0017% or less of any portfolio's
average daily net assets.
To help limit expenses, Pacific Life has agreed to
waive all or part of its investment advisory fees or
otherwise reimburse the portfolio for expenses (not
including advisory fees, additional costs associated
with foreign investing and extraordinary expenses) that
exceed 0.25% of its average daily net assets. It does
this voluntarily, but does not guarantee that it will
continue to do so after December 31, 2001.
--------------------------------------------------------
How the fund is The Pacific Select Fund is organized as a Massachusetts
organized business trust. Its business and affairs are managed by
its board of trustees.
Under Massachusetts law, shareholders could, under
certain circumstances, be held personally liable if the
fund is not able to meet its financial obligations. It
is very unlikely that this will ever happen, and the
fund's declaration of trust protects shareholders from
liability.
The portfolio intends to qualify each year as a
regulated investment company under Subchapter M of the
Internal Revenue Code. A portfolio that qualifies does
not have to pay income tax as long as it distributes
sufficient taxable income and net capital gains.
The Pacific Select Fund may discontinue offering shares
of the portfolio at any time. If the portfolio is
discontinued, any allocation to the portfolio will be
allocated to another portfolio the trustees believe is
suitable, as long as any required regulatory approvals
are met.
5
<PAGE>
INFORMATION FOR INVESTORS
The Pacific Select Fund is available only to people who
own a variable annuity contract or variable life
insurance policy issued or administered by Pacific Life
Insurance Company or its subsidiaries. You do not buy,
sell or exchange shares of the fund's portfolios - you
choose investment options through your annuity contract
or life insurance policy. Pacific Life then invests in
the portfolios of the Pacific Select Fund according to
the investment options you've chosen. You'll find
information about how this works in your product
prospectus or offering memorandum.
--------------------------------------------------------
How share prices The price of the portfolio's shares is called its net
are calculated asset value per share. Net asset value per share forms
the basis for all transactions involving buying,
selling, exchanging or reinvesting shares.
An example of how The portfolio's net asset value per share is calculated
we calculate net once a day, every day the New York Stock Exchange
asset value per (NYSE) is open, usually at or about 4:00 p.m. Eastern
share time. Generally, for any transaction, we'll use the
next asset value calculated after we receive a request
to buy, sell or exchange shares.
<TABLE>
<S> <C>
$80 million portfolio's assets
- - $3 million portfolio's liabilities
- ----------------
$77 million
/ 7 million outstanding shares
- ----------------
= $11 net asset value
- ----------------
per share
</TABLE>
The net asset value per share is calculated by taking
the total value of the portfolio's assets, subtracting
the liabilities, and then dividing by the number of
shares that have already been issued. The value of the
portfolio's assets is based on the total market value
of all of the securities it holds. In general, the
value of each security is based on its actual or
estimated market value, with special provision for
assets without readily available market quotes, for
short-term debt securities, and for situations where
market quotations are deemed unreliable or stale. This
special provision means a fair value for a security is
determined under procedures adopted and monitored by
the fund's board of trustees. If the NYSE closes early,
the portfolio will normally consider the closing price
of a security to be its price at 4:00 p.m. Eastern
time.
A delay may happen in any of the following situations:
. the New York Stock Exchange closes on a day other
than a regular holiday or weekend
. trading on the New York Stock Exchange is restricted
. an emergency exists as determined by the SEC, as a
result of which the sale of securities is not
practicable, or it is not practicable to determine
the value of a variable account's assets, or
. the SEC permits a delay for the protection of
shareholders.
Because foreign securities can be traded on weekends,
U.S. holidays and other times when the NYSE is closed,
changes in the market value of these securities are not
always reflected in the portfolio's net asset value.
It's not possible to buy, sell, exchange or reinvest
shares on days the NYSE is closed, even if there has
been a change in the market value of these securities.
Variable annuity contracts and variable life insurance
policies may have other restrictions on buying and
selling shares.
--------------------------------------------------------
Brokerage The fund has adopted a brokerage enhancement plan,
enhancement plan under which the fund, through its distributor, Pacific
Mutual Distributors, Inc., can ask Pacific Life and
The brokerage Goldman Sachs to allocate brokerage transactions to
enhancement plan particular brokers or dealers, subject to best price
was adopted by the and execution, to help promote the distribution of the
Fund pursuant to fund's shares. In return for brokerage transactions,
Rule 12b-1 under certain brokers and dealers may give the fund brokerage
the Investment credits or other benefits or services. The fund,
Company Act of through the distributor, could use these credits with
1940, and may be broker-dealers to help obtain certain distribution-
considered a related activities or services. These credits generally
distribution plan will not take the form of a cash payment or a rebate to
because it uses a the fund, but rather as a "credit" towards another
fund asset - service or benefit provided by a broker or dealer such
brokerage - to help as, (but not limited to), the ability to promote the
promote fund at a conference or meeting sponsored by the
distribution of the broker-dealer.
fund's shares.
The plan is not expected to increase brokerage costs to
the portfolio. The granting of brokerage credits may be
a factor considered by the portfolio manager or the
adviser in allocating brokerage. In addition, the
portfolio manager or the adviser is always free to
consider the sale of fund shares or variable contracts
in allocating brokerage.
6
<PAGE>
PACIFIC SELECT FUND WHERE TO GO FOR MORE INFORMATION
The Pacific Select You'll find more information about the Pacific Select
Fund is available Fund in the following documents:
only to people who
own a variable Annual and semi-annual reports
annuity contract or The fund's annual and semi-annual reports list the
variable life holdings of the fund's portfolios, describe portfolio
insurance policy performance, and tell you how investment strategies and
issued or portfolio performance have responded to recent market
administered by conditions and economic trends.
Pacific Life
Insurance Company Statement of Additional Information (SAI)
or its The SAI contains detailed information about each
subsidiaries. portfolio's investments, strategies and risks, and is
You'll find out how considered to be part of this prospectus because it is
your annuity incorporated by reference.
contract or life
insurance policy
works in your
product prospectus
or offering
memorandum.
Please contact You can get a copy of these documents at no charge by
Pacific Life if you calling or writing to Pacific Life. You can also get a
have any questions copy of these documents by contacting the Securities
about any of the and Exchange Commission. The SEC may charge you a fee
Pacific Select Fund for this information.
portfolios.
--------------------------------------------------------
How to contact Pacific Life Insurance Company
Pacific Life 700 Newport Center Drive
Post Office Box 9000
Newport Beach, California 92660
Annuities: 1-800-722-2333
Life Insurance: 1-800-800-7681
--------------------------------------------------------
How to contact the Public Reference Section of the SEC
SEC Washington, D.C. 20549-6009
1-800-SEC-0330
Internet: www.sec.gov
Form No. 15-22137-00
Form No. 1704-0A SEC file number 811-5141
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
SUBJECT TO COMPLETION
PRELIMINARY STATEMENT OF ADDITIONAL INFORMATION DATED FEBRUARY 16, 2000
[LOGO OF PACIFIC SELECT FUND]
PACIFIC SELECT FUND
STATEMENT OF ADDITIONAL INFORMATION
Date: , 2000
----------------
The Pacific Select Fund is an open-end investment management company
currently offering twenty separate investment portfolios. Effective ,
2000, the Fund will offer an additional Portfolio: I-Net Tollkeeper Portfolio.
The following twenty of those portfolios are classified as diversified: the
Aggressive Equity Portfolio; the Emerging Markets Portfolio; the Diversified
Research Portfolio; the Small-Cap Equity Portfolio; the International Large-
Cap Portfolio; the Bond and Income Portfolio; the Equity Portfolio; the I-Net
TollKeeper Portfolio; the Multi-Strategy Portfolio; the Equity Income
Portfolio; the Growth LT Portfolio; the Mid-Cap Value Portfolio; the Equity
Index Portfolio; the Small-Cap Index Portfolio; the International Value
Portfolio; the Government Securities Portfolio; the Managed Bond Portfolio;
the Money Market Portfolio; the High Yield Bond Portfolio; and the Large-Cap
Value Portfolio. The REIT Portfolio is classified as non-diversified. The
Fund's Adviser is Pacific Life Insurance Company.
This Statement of Additional Information ("SAI") is intended to supplement
the information provided to investors in the Prospectus dated , 2000, of
the Fund and has been filed with the Securities and Exchange Commission as
part of the Fund's Registration Statement. Investors should note, however,
that this SAI is not itself a prospectus and should be read carefully in
conjunction with the Fund's Prospectus and retained for future reference. The
contents of this SAI are incorporated by reference in the Prospectus in their
entirety. A copy of the Prospectus may be obtained free of charge from the
Fund at the address and telephone numbers listed below.
----------------
Distributor:
Pacific Mutual Distributors, Inc.
700 Newport Center Drive
P.O. Box 9000
Newport Beach, CA 92660
(800) 800-7681
Adviser:
Pacific Life Insurance Company
700 Newport Center Drive
P.O. Box 9000
Newport Beach, CA 92660
Annuities (800) 722-2333
Life Insurance (800) 800-7681
A registration statement relating to shares of the I-Net Tollkeeper
Portfolio has been filed with the Securities and Exchange Commission, but has
not yet become effective. The information in this statement of additional
information is not complete and may be changed. Shares of the I-Net Tollkeeper
Portfolio may not be sold until the registration statement is effective. This
statement of additional information is not an offer to sell shares of this
Portfolio and is not soliciting an offer to buy these securities in any state
where the offer or sale is not permitted.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
INTRODUCTION................................................................ 1
ADDITIONAL INVESTMENT POLICIES OF THE PORTFOLIOS............................ 1
Aggressive Equity Portfolio............................................... 1
Emerging Markets Portfolio................................................ 2
Diversified Research Portfolio............................................ 3
Small-Cap Equity Portfolio................................................ 3
International Large-Cap Portfolio......................................... 3
Bond and Income Portfolio................................................. 3
Equity Portfolio.......................................................... 5
I-Net Tollkeeper Portfolio................................................ 5
Multi-Strategy Portfolio.................................................. 6
Equity Income Portfolio................................................... 7
Growth LT Portfolio....................................................... 8
Mid-Cap Value Portfolio................................................... 9
Equity Index Portfolio.................................................... 9
Small-Cap Index Portfolio................................................. 10
REIT Portfolio............................................................ 11
International Value Portfolio............................................. 12
Government Securities Portfolio........................................... 13
Managed Bond Portfolio.................................................... 13
Money Market Portfolio.................................................... 14
High Yield Bond Portfolio................................................. 15
Large-Cap Value Portfolio................................................. 16
Diversification Versus Non-Diversification................................ 17
SECURITIES AND INVESTMENT TECHNIQUES........................................ 17
U.S. Government Securities................................................ 17
Real Estate Investment Trusts............................................. 18
Mortgage-Related Securities............................................... 18
Mortgage Pass-Through Securities........................................ 18
GNMA Certificates....................................................... 19
FNMA and FHLMC Mortgage-Backed Obligations.............................. 20
Collateralized Mortgage Obligations (CMOs).............................. 20
FHLMC Collateralized Mortgage Obligations............................... 20
Other Mortgage-Related Securities....................................... 21
CMO Residuals........................................................... 21
Stripped Mortgage-Backed Securities..................................... 22
Mortgage Dollar Rolls................................................... 23
Other Asset-Backed Securities............................................. 23
High Yield Bonds.......................................................... 23
Bank Obligations.......................................................... 24
Municipal Securities...................................................... 26
Small Capitalization Stocks............................................... 26
Corporate Debt Securities................................................. 27
Variable and Floating Rate Securities..................................... 27
Commercial Paper.......................................................... 28
Convertible Securities.................................................... 29
Repurchase Agreements..................................................... 30
Borrowing................................................................. 31
</TABLE>
i
<PAGE>
<TABLE>
<S> <C>
Reverse Repurchase Agreements and Other Borrowings........................ 31
Firm Commitment Agreements and When-Issued Securities..................... 31
Loans of Portfolio Securities............................................. 32
Short Sales............................................................... 32
Short Sales Against the Box............................................... 33
Illiquid and Restricted Securities (Private Placements)................... 33
Precious Metals-Related Securities........................................ 33
Foreign Securities........................................................ 34
Foreign Currency Transactions and Forward Foreign Currency Contracts...... 36
Options................................................................... 38
Purchasing and Writing Options on Securities............................ 39
Purchasing and Writing Options on Stock Indexes......................... 40
Risks of Options Transactions........................................... 41
Spread Transactions..................................................... 41
Options on Foreign Currencies............................................. 42
Investments in Other Investment Company Securities........................ 43
SPDRs................................................................... 43
WEBS and OPALS.......................................................... 44
Futures Contracts and Options on Futures Contracts........................ 44
Interest Rate Futures................................................... 45
Stock Index Futures..................................................... 45
Futures Options......................................................... 46
Limitations............................................................. 47
Risks Associated with Futures and Futures Options....................... 47
Foreign Currency Futures and Options Thereon.............................. 49
Swap Agreements and Options on Swap Agreements............................ 49
Risks of Swap Agreements................................................ 49
Structured Notes.......................................................... 50
Warrants and Rights....................................................... 50
Duration.................................................................. 50
INVESTMENT RESTRICTIONS..................................................... 52
Fundamental Investment Restrictions....................................... 52
Nonfundamental Investment Restrictions.................................... 53
ORGANIZATION AND MANAGEMENT OF THE FUND..................................... 54
Trustees and Officers..................................................... 54
Investment Adviser........................................................ 55
Other Expenses of the Fund................................................ 58
Portfolio Management Agreements........................................... 58
Distribution of Fund Shares............................................... 67
Purchases and Redemptions................................................. 67
Exchanges Among the Portfolios............................................ 68
PORTFOLIO TRANSACTIONS AND BROKERAGE........................................ 68
Investment Decisions...................................................... 68
Brokerage and Research Services........................................... 68
Portfolio Turnover........................................................ 70
NET ASSET VALUE............................................................. 70
PERFORMANCE INFORMATION..................................................... 72
</TABLE>
ii
<PAGE>
<TABLE>
<S> <C>
TAXATION.................................................................... 75
Distributions............................................................. 76
Hedging Transactions...................................................... 76
OTHER INFORMATION........................................................... 76
Concentration Policy...................................................... 76
Brokerage Enhancement Plan................................................ 77
Capitalization............................................................ 77
Voting Rights............................................................. 78
Custodian and Transfer Agency and Dividend Disbursing Services............ 78
Financial Statements...................................................... 78
Independent Auditors...................................................... 79
Counsel................................................................... 79
Registration Statement.................................................... 79
APPENDIX.................................................................... 80
Description of Bond Ratings............................................... 80
</TABLE>
iii
<PAGE>
INTRODUCTION
This SAI is designed to elaborate upon information contained in the
Prospectus, including the discussion of certain securities and investment
techniques. The more detailed information contained herein is intended solely
for investors who have read the Prospectus and are interested in a more
detailed explanation of certain aspects of the Fund's securities and
investment techniques.
ADDITIONAL INVESTMENT POLICIES OF THE PORTFOLIOS
The investment objective and investment policies of each Portfolio are
described in the Prospectus. The following descriptions present more detailed
information on investment policies that apply to each Portfolio, and are
intended to supplement the information provided in the Prospectus.
Unless otherwise noted, a Portfolio may invest up to 5% of its net assets
(taken at market value at the time of such investment) in any type of security
that the Investment Adviser or Portfolio Manager reasonably believes is
compatible with the investment objectives and policies of the Portfolio.
Aggressive Equity Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts.
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may also invest a portion of its assets in high-
quality money market instruments; mortgage-related and asset-backed
securities; repurchase agreements and reverse repurchase agreements; American
Depositary Receipts ("ADRs"); rights; U.S. Government securities, its agencies
or instrumentalities; bank obligations; variable and floating rate securities;
firm commitment agreements and when-issued securities; enter into short sales
against the box; and securities of foreign issuers, provided that the
Portfolio may not acquire a security of a foreign issuer principally traded
outside the United States if, at the time of such investment, more than 20% of
the Portfolio's total assets would be invested in such foreign securities. The
Portfolio may also invest in restricted securities and up to 15% of its net
assets in illiquid securities.
For hedging purposes, the Portfolio may purchase put and call options on
securities and securities indexes and may write covered call and secured put
options. The Portfolio may also purchase and sell stock index futures
contracts and options thereon. To hedge against the risk of currency
fluctuation associated with investment in foreign securities, the Portfolio
may buy or sell foreign currencies on a spot (cash) basis and enter into
forward foreign currency contracts or options on foreign currencies or foreign
currency futures contracts and options thereon. The Portfolio will not engage
in "short sales against the box," in which the Portfolio sells short a
security it owns, if, at the time of investment, the total market value of all
securities sold short would exceed 25% of the Portfolio's net assets. The
Portfolio may also lend its portfolio securities, in an amount not to exceed
33 1/3% of the value of its total assets, to brokers, dealers, and other
financial institutions to earn income, and may borrow for temporary
administrative or emergency purposes.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. In addition, the Portfolio invests in companies that the
portfolio management team thinks have the potential for rapid growth, which
may give the Portfolio a higher risk of price volatility than a Portfolio that
invests principally in equities that are "undervalued." Small emerging growth
companies may be more susceptible to larger price swings than larger companies
because they have fewer financial resources, limited product and market
diversification and many are dependent on a few key managers. Emerging growth
companies in cyclical industries may be particularly susceptible to rapid
price swings during periods of economic uncertainty.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable
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political and economic conditions, a lack of adequate company information,
differences in the way securities markets operate, less secure foreign banks
or securities depositories than those in the United States, and foreign
controls on investment. Second, the Portfolio may use index options and other
investment techniques to help it achieve its investment goal. These techniques
can potentially reduce returns or increase the Portfolio's volatility. Third,
the Portfolio may engage in short-term trading, which could result in higher-
trading costs.
Emerging Markets Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts.
The Portfolio's policy of being as fully invested in common stock as
practicable at all times precludes the Portfolio from investing in debt
securities as a defensive investment posture (although the Portfolio may
invest in such securities to provide for payment of expenses and to meet
redemption requests.) The Portfolio is subject to guidelines for
diversification of foreign security investments that prescribe the minimum
number of countries in which the Portfolio's assets may be invested. These
guidelines are discussed under "Foreign Securities."
The types of foreign currency transactions in which the Portfolio may enter
include forward foreign currency contracts, currency exchange transactions on
a spot (i.e., cash) basis, put and call options on foreign currencies, and
foreign exchange futures contracts.
The Portfolio may invest up to 10% of its assets in U.S. government
securities, high quality debt securities, money market obligations, and in
cash. Such money market obligations may include short-term corporate or U.S.
government obligations and bank certificates of deposit. The debt securities
and money market obligations in which the Portfolio invests may be issued by
U.S. and foreign issuers and may be denominated in U.S. dollars or foreign
currencies.
The Portfolio also may engage in transactions in options, futures, and
options on futures contracts on securities and securities indexes. The
Portfolio also may invest in convertible securities; equity index swap
agreements; ADRs; Global Depositary Receipts ("GDRs"); European Depositary
Receipts ("EDRs"); rights; variable and floating rate securities; warrants on
securities that it is eligible to purchase; preferred stock; repurchase
agreements and reverse repurchase agreements; firm commitment transactions and
when-issued securities. The Portfolio may also lend its portfolio securities,
in an amount not to exceed 33 1/3% of the value of its total assets, to
brokers, dealers, and other financial institutions to earn income, and may
borrow money for administrative or emergency purposes. The Portfolio may also
invest in restricted securities and up to 15% of its net assets in illiquid
securities.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests in emerging markets, which may be
particularly volatile. It also invests in smaller companies, which tend to
have higher price swings than larger companies because they have fewer
financial resources, limited product and market diversification and many are
dependent on a few key managers.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment. Investments in emerging market countries are generally riskier
than other kinds of foreign investments, partly because emerging market
countries may be less politically and economically stable than other
countries. It may also be more difficult to buy and sell securities in
emerging market countries. Second, the Portfolio may invest in foreign
currency transactions, forward foreign currency contracts or options, index
options, futures and other investment techniques to help it achieve its
investment goal. These techniques can potentially reduce returns or increase
the Portfolio's volatility.
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Diversified Research Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
In addition to the risk factors described in the Prospectus, the Portfolio
may be affected by the following risk factors: The Portfolio's growth oriented
approach to stock selection may result in its securities being more sensitive
to changes in current or expected earnings than the prices of other stocks.
The price of growth stocks also is subject to the risk that the stock price of
one or more companies will fall or will fail to appreciate as anticipated by
the Portfolio Manager, regardless of performance of the securities markets.
Small-Cap Equity Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts.
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may invest in various foreign securities if listed
on a U.S. exchange; commercial paper; repurchase agreements; corporate debt
securities; U.S. Government securities, its agencies or instrumentalities;
ADRs; bank obligations; variable and floating rate securities; firm commitment
agreements and when-issued securities; and may hold a portion of its assets in
cash. The Portfolio may also invest in restricted securities, up to 15% of its
net assets in illiquid securities, and up to 5% of its assets in convertible
bonds and other fixed income securities (other than money market instruments).
The Portfolio may lend its portfolio securities in an amount not to exceed
33 1/3% of the value of its total assets, to brokers, dealers, and other
financial institutions to earn income, and may borrow money for temporary
administrative or emergency purposes.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. While equities may offer the potential for greater long-term
growth than most fixed income securities, they generally have higher
volatility. In addition, the Portfolio invests in companies with smaller
market capitalizations, which may give the Portfolio a higher risk of price
volatility than a portfolio that invests in companies with larger
capitalizations.
International Large-Cap Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
In addition to its investments in securities of non-U.S. issuers, the
Portfolio may invest in high quality debt securities rated, at the time of
purchase, within the top three quality categories by Moody's Investors
Service, Inc. ("Moody's") or Standard and Poor's Rating Services ("S&P") (or
unrated securities of equivalent quality), repurchase agreements, and short-
term debt obligations denominated in U.S. dollars or foreign currencies.
In addition to the risk factors described in the Prospectus, the Portfolio's
investments in currency derivatives can significantly increase its exposure to
market risk or credit risk of the counterparty. Derivatives also involve the
risk of mispricing or improper valuation and the risk that changes in value of
the derivatives may not correlate perfectly with the relevant assets, rates
and indices.
Bond and Income Portfolio
The Portfolio normally invests at least 80% of its assets in securities
rated, at the time of acquisition, investment grade by at least one nationally
recognized statistical rating organization ("NRSRO") (i.e., Baa or better by
Moody's or BBB or better by S&P), or, if not rated by a NRSRO, of comparable
quality as determined
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by the Portfolio Manager. The Portfolio may invest up to 20% of its assets in
securities that are not rated investment grade by at least one NRSRO, 15% of
which may consist of debt securities of issuers located in emerging market
countries.
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may invest up to 10% of its assets in non-U.S.
dollar denominated securities. The Portfolio may also invest in ADRs; warrants
and rights; firm commitment agreements and when-issued securities; reverse
repurchase agreements; municipal securities issued by or on behalf of states,
territories and possessions of the U.S. (including the District of Columbia)
and their political subdivisions, agencies, or instrumentalities, which
securities may include private activity bonds or industrial development bonds,
which are issued by or on behalf of public authorities to obtain funds for
privately operated facilities; high-quality short-term instruments, including,
among others, commercial paper, bank instruments, and repurchase agreements;
asset-backed securities; U.S. dollar-denominated obligations of foreign
governmental agencies and international agencies; and preferred stock. The
Portfolio may invest up to 10% of its assets in the following types of
mortgage-related securities: inverse floaters, super floating rate
collateralized mortgage obligations ("CMO's"), interest only ("IO's") and
principal-only ("PO's") tranches of stripped mortgage-backed securities
(including planned amortization class certificates) and inverse IO's. In
addition, the Portfolio may invest in restricted securities and up to 15% of
its net assets in illiquid securities. The Portfolio may also lend its
portfolio securities, in an amount not to exceed 33 1/3% of the value of its
total assets, to brokers, dealers, and other financial institutions to earn
income, and may borrow money for temporary administrative or emergency
purposes.
For hedging risk or adjusting interest rate exposure, the Portfolio may (but
is not obligated to) use several investment techniques. The Portfolio may
purchase put and call options on securities and on securities indexes and may
write covered call options. The Portfolio may also enter into the following
types of transactions: financial futures contracts and options thereon;
instruments such as interest rate caps, floors, and collars; and interest rate
swaps. To hedge against fluctuations in currency exchange rates that affect
non-U.S. dollar-denominated securities, the Portfolio may enter into spot (or
cash) transactions in currency, forward currency contracts, options on foreign
currency contracts, foreign currency futures and options thereon, and currency
swaps. The Portfolio may invest up to 5% of its assets in structured notes to
hedge interest rate or currency risk. The Portfolio may enter into swaps,
caps, floors, collars, structured notes, and non-exchange traded options only
with counterparties that have outstanding securities rated A or better by
Moody's or S&P or that have outstanding short-term securities rated P-2 or
better by Moody's or A-2 or better by S&P, or, if not rated by Moody's or S&P,
of equivalent quality.
Since the Portfolio principally invests in fixed income securities of both
U.S. and foreign issuers, it may be affected by a number of risks, including
the following: First, the value of the Portfolio may fall when interest rates
rise. Changes in interest rates may have a significant effect on this
Portfolio because it may invest in securities with medium or long terms to
maturity and may use interest-sensitive derivatives. Bonds with longer
durations tend to be more sensitive to changes in interest rates, usually
making them more volatile than bonds with shorter durations. The Portfolio may
also invest in mortgage-related securities, which can be paid off early if the
owners of underlying mortgages pay off their mortgages sooner than scheduled.
If interest rates are falling, the Portfolio will be forced to reinvest this
money at lower yields. Stripped mortgage-backed securities can be particularly
sensitive to changes in interest rates. Second, the Portfolio could lose money
if the issuer of a fixed income security is unable to meet its financial
obligations or goes bankrupt. By investing in high-yield bonds, the Portfolio
may be particularly subject to credit risk, especially during periods of
economic uncertainty or during economic downturns.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio could lose money or not realize potential gains if it
cannot sell an investment at the time and price that would be most beneficial
to the Portfolio. Securities whose credit ratings have been lowered, or that
have been issued in emerging market countries, may be particularly difficult
to sell. Second, the Portfolio may also be subject to the risks associated
with foreign investments, including changes in currency exchange rates,
unstable political and economic conditions, a lack of adequate company
information, differences in the way securities markets operate,
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less secure foreign banks or securities depositories than those in the United
States, and foreign controls on investment. Third, the Portfolio may use
options, futures contracts and other investment techniques to help it achieve
its investment goal. These techniques can potentially reduce returns or
increase the Portfolio's volatility.
Equity Portfolio
In pursuing its investment objective, the Portfolio invests, under normal
circumstances, at least 90% of its total assets in equity securities of U.S.
issuers. The Portfolio may also invest in U.S. government securities;
corporate bonds; money market instruments; precious metals-related securities;
mortgage-related and asset-backed securities; rights; bank obligations;
variable and floating rate securities; firm commitment agreements and when-
issued securities; and enter in repurchase agreements. The Portfolio will not
engage in "short sales against the box," in which the Portfolio sells short a
security it owns, if, at the time of investment, the total market value of all
securities sold and held short would exceed 25% of the Portfolio's net assets.
The Portfolio may also lend its portfolio securities, in an amount not to
exceed 33 1/3% of the value of its total assets, to brokers, dealers, and
other financial institutions to earn income, and may borrow money for
temporary administrative or emergency purposes. The Portfolio may also invest
in restricted securities and up to 15% of its net assets in illiquid
securities.
The Portfolio may also purchase and sell put and call options on securities
and stock indices and enter into stock index futures contracts and options
thereon. The Portfolio may also purchase Standard & Poor's Depository Receipts
("SPDRs"), which represent ownership interests in the SPDR Trust, a long-term
unit investment trust established to accumulate and hold a portfolio of common
stocks that is intended to track the price performance and dividend yield of
the Standard & Poor's 500 Composite Stock Price Index ("S&P 500").
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests principally in large companies, which
tend to have less volatile prices than smaller companies. In addition, the
Portfolio invests in companies that the portfolio management team thinks have
the potential for rapid growth, which may give the Portfolio a higher risk of
price volatility than a Portfolio that invests principally in equities that
are "undervalued."
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may use index options, futures contracts and other
investment techniques to help it achieve its investment goal. These techniques
can potentially reduce returns or increase the Portfolio's volatility. Second,
the Portfolio may engage in short-term trading, which could result in higher-
trading costs.
I-Net Tollkeeper Portfolio
In addition to the securities identified in the Prospectus, the Portfolio
may invest in preferred stocks; interests in real estate investment trusts;
mortgage-related securities; high-yield bonds; convertible debt obligations;
convertible preferred stocks; equity interests in trusts; partnerships; joint
ventures; limited liability companies and similar enterprises; warrants and
stock purchase rights. Securities may be sold when the portfolio management
team believes that the market price fully reflects or exceeds the securities'
fundamental valuation or when other more attractive investments are
identified.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. While equity securities may offer the potential for greater
long-term growth than most fixed-income securities, they generally have higher
volatility. In addition, the Portfolio may invest in companies that may be
unseasoned, which may give the Portfolio a higher risk of price volatility,
than a portfolio that invests in companies with a longer operating record.
Because the Portfolio invests in equity securities of Internet companies and
Internet related companies such as those in the media, telecommunications, and
technology sectors, the Portfolio may be affected by a number of
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risks, including the following factors. First, the legal obligations of online
service providers is unclear under both United States and foreign law with
respect to freedom of expression, defamation, libel, invasion of privacy,
advertising, copyright or trademark infringement, information security, or
other areas based on the nature and content of the materials disseminated
through online service providers. Moreover, legislation has been proposed that
imposes liability for, or prohibits the transmission over, the Internet of
certain types of information. It is possible that now or in the future,
related claims could be made against online services companies. These
liability issues, as well as possibly other legal issues, could impact the
growth of Internet use.
For example, it is possible that laws and regulations may be adopted with
respect to the Internet or other online service providers with respect to the
imposition of sales tax collection obligations on Internet companies and the
use of personal user information. The nature of this governmental action and
the manner in which it may be interpreted and enforced cannot be predicted.
Changes to existing laws or the passage or proposed passage of new laws
intended to address these and other issues, could create uncertainty in the
marketplace that could reduce demand for the services of an Internet company
or increase the costs of doing business as a result of actual or anticipated
litigation costs or increased service delivery costs, or could in some other
manner have a material adverse effect on an Internet company's business,
results of operations and financial condition.
The success of many Internet companies depends, in large part, upon the
development and maintenance of the infrastructure of the World Wide Web
("Web") for providing reliable Web access and services. There can be no
assurances that the infrastructure or complementary products or services
necessary to make the Web a viable commercial marketplace for the long term
will be developed, or, if they are developed, that the Web will become a
viable commercial marketplace for services such as those offered by Internet
companies.
The market for the purchase of products and services over the Internet is a
new and emerging market. If acceptance and growth of Internet use does not
occur, an Internet company's business and financial performance may suffer.
Although there has been substantial interest in the commercial possibilities
for the Internet, many businesses and consumers have been slow to purchase
Internet access services for a number of reasons, including inconsistent
quality of service, lack of availability of cost-effective, high-speed
service, a limited number of local access points for corporate users,
inability to integrate business applications on the Internet, the need to deal
with multiple and frequently incompatible vendors, inadequate protection of
the confidentiality of stored data and information moving across the Internet
and a lack of tools to simplify Internet access and use. It is possible that a
sufficiently broad base of consumers may not adopt, or continue to use, the
Internet as a medium of commerce.
Despite the implementation of security measures, an Internet company's
networks may be vulnerable to unauthorized access, computer viruses and other
disruptive problems. Internet companies have in the past experienced, and may
in the future experience, interruptions in service as a result of the
accidental or intentional actions of Internet users, current and former
employees or others. Unauthorized access could also potentially jeopardize the
security of confidential information stored in the computer systems of a
company and its subscribers. These events may result in liability of the
company to its subscribers and also may deter potential subscribers.
The I-Net Tollkeeper Portfolio may invest in companies which have operated
less than three years. The securities of such companies may have limited
liquidity, which can result in their being priced higher or lower than might
otherwise be the case. In addition, investments in unseasoned companies are
more speculative and entail greater risk than do investments in companies with
an established operating record.
Multi-Strategy Portfolio
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may also invest in equity securities of small
companies and foreign issuers; high yield bonds; repurchase agreements; ADRs;
bank obligations; variable and floating rate securities; and firm commitment
agreements and when-issued securities. The Portfolio's equity securities may
or may not pay dividends and may or may not carry voting
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rights. The Portfolio may also invest up to 10% of its assets in debt
securities of foreign issuers which may be denominated in foreign currencies.
Fixed income securities in which the portfolio may invest include debentures,
asset-backed securities and money market instruments. The Portfolio may also
invest in restricted securities and up to 15% of its net assets in illiquid
securities.
The Portfolio may purchase and sell put and call options on securities and
stock indexes and may purchase or sell interest rate and stock index futures
contracts and options thereon. The Portfolio may also engage in forward
currency contracts in anticipation of or to protect itself against
fluctuations in currency exchange rates with respect to investments in
securities of foreign issuers. The Portfolio may also lend its portfolio
securities, in an amount not to exceed 33 1/3% of the value of its total
assets, to brokers, dealers, and other financial institutions to earn income,
and may borrow money for temporary administrative or emergency purposes.
The equity securities in which the Portfolio invests offer the potential for
greater long-term growth than most fixed-income securities, but they also have
higher volatility. The Portfolio invests mostly in large and medium-sized
companies, which tend to have less volatile prices than smaller companies. The
Portfolio may also invest in small-capitalization companies.
Fixed income securities are affected primarily by the financial condition of
the issuer and changes in interest rates. The value of the Portfolio may fall
when interest rates rise. In addition, the Portfolio could lose money if the
issuer of a fixed income security is unable to meet its financial obligations
or goes bankrupt.
The Portfolio may also be affected by the following additional risk factors.
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment. Second, the Portfolio may use index options, futures contracts and
other investment techniques to help it achieve its investment goal. These
techniques can potentially reduce returns or increase the Portfolio's
volatility. Third, the Portfolio may engage in short-term trading, which could
result in higher-trading costs.
Equity Income Portfolio
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may also invest in ADRs and in various foreign
securities if they are listed on a U.S. exchange. To invest temporary cash
balances, to maintain liquidity to meet redemptions or expenses, or for
temporary defensive purposes, the Portfolio may invest in money market
instruments, including U.S. government securities, short term bank obligations
rated in the highest two rating categories by Moody's, S&P, or, if not rated
by Moody's or S&P, determined to be of equal quality by the Portfolio Manager,
certificates of deposit, time deposits and banker's acceptances issued by U.S.
and foreign banks and savings and loan institutions with assets of at least
$500 million as of the end of their most recent fiscal year; and commercial
paper and corporate obligations, including variable and floating rate
securities, that are issued by U.S. and foreign issuers and that are rated in
the highest two rating categories by Moody's or S&P, or if not rated by
Moody's or S&P, determined to be of equal quality by the Portfolio Manager.
The Portfolio may also invest in high yield and convertible bonds; repurchase
agreements; warrants and rights; firm commitment agreements and when-issued
securities; and other fixed income securities including but not limited to
high yield/high risk debt securities. The Portfolio may also invest in
restricted securities and up to 15% of its net assets in illiquid securities.
In addition to the derivatives described in the Prospectus, the Portfolio
may also purchase and sell put and call options on securities and stock
indexes and may purchase or sell stock index futures contracts and options
thereon. The Portfolio may also lend its portfolio securities, in an amount
not to exceed 33 1/3% of the value of its total assets, to brokers, dealers,
and other financial institutions to earn income, and may borrow money for
temporary administrative or emergency purposes.
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Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The portfolio manager tries to control price volatility by
investing in many different companies in a wide range of industries.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may use options, futures contracts and other investment
techniques to help it achieve its investment goal. These techniques can
potentially reduce returns or increase the Portfolio's volatility. Second, the
Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment.
Growth LT Portfolio
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may also invest in warrants; preferred stocks;
certificates of deposit; mortgage related and asset-backed securities;
commercial paper; rights; bank obligations; convertible securities; variable
and floating rate securities; firm commitment agreements and when-issued
securities; and reverse repurchase agreements when the Portfolio Manager
perceives an opportunity for capital growth from such securities or so that
the Portfolio may receive a return on idle cash. The Portfolio may also invest
in money market funds, including those managed by Janus Capital Corporation
("Janus") as a means of receiving a return on idle cash, pursuant to an
exemptive order received by Janus from the Securities and Exchange Commission
("SEC"). The Portfolio may also invest up to 10% of its assets, measured at
the time of investment, in debt securities that are lower rated bonds, i.e.,
rated below investment grade by one of the primary rating agencies. The
Portfolio may also invest in restricted securities and up to 15% of its net
assets in illiquid securities.
The Portfolio may invest up to 25% of its assets in foreign securities
denominated in a foreign currency and not publicly traded in the United
States. In addition, the Portfolio may purchase ADRs, EDRs, and GDRs, and
other types of receipts evidencing ownership of the underlying foreign
securities. In pursuing its investment objective, the Portfolio may engage in
the purchase and writing of put and call options on securities, stock indexes,
and foreign currencies. In addition, the Portfolio may purchase and sell
interest rate, stock index, and foreign currency futures contracts and options
thereon. The Portfolio may also engage in forward foreign currency contracts.
The Portfolio may also lend its portfolio securities, in an amount not to
exceed 33 1/3% of the value of its total assets, to brokers, dealers, and
other financial institutions to earn income, and may borrow money for
temporary administrative or emergency purposes.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. In addition, the Portfolio invests in companies that the
portfolio management team thinks have the potential for rapid growth, which
may give the Portfolio a higher risk of price volatility than a Portfolio that
invests principally in equities that are "undervalued." Small and medium-sized
companies may be more susceptible to larger price swings than larger companies
because they have fewer financial resources, limited product and market
diversification and many are dependent on a few key managers.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment. Second, the Portfolio may use options, futures contracts and other
investment techniques to help it achieve its investment goal. These techniques
can potentially reduce returns or increase the Portfolio's volatility. Third,
the Portfolio may engage in short-term trading, which could result in higher-
trading costs.
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Mid-Cap Value Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
The equity securities in which the Portfolio may invest include common
stocks, preferred stocks, securities convertible into or exchangeable for
common stocks, rights and warrants, ADRs, and GDRs. The Portfolio may also
invest a portion of its assets in investment grade debt securities, including
U.S. Government Securities, commercial paper; mortgage-related securities;
variable and floating rate securities; and other short-term corporate and bank
obligations.
The Portfolio may borrow for investment purposes in an amount up to 33 1/3%
of the value of its total assets and may enter into reverse repurchase
agreements with banks, brokers or dealers. The Portfolio may also invest up to
15% of its total assets, determined at the time of investment, in foreign
equity or debt securities. The Portfolio will not engage in "short sales," in
which the Portfolio sells a security it does not own, and "short sales against
the box," in which the Portfolio sells short a security it owns, if, at the
time of investment, the total market value of all securities sold and held
short would exceed 25% of the Portfolio's net assets. The Portfolio may also
lend its portfolio securities, in an amount not to exceed 33 1/3% of the value
of its total assets, to brokers, dealers, and other financial institutions to
earn income.
In pursuing its investment objective, the Portfolio may also purchase and
sell put and call options on securities, stock indexes and foreign currencies
and may purchase cash-settled options on interest rate swaps and equity index
swaps. In addition, the Portfolio may purchase or sell futures contracts on
securities, stock indexes, currency futures, and options thereon. The
Portfolio may engage in foreign currency transactions: (1) to fix in U.S.
dollars the value of a security the Portfolio has agreed to buy or sell
between the trade and settlement dates; and (2) to hedge the U.S. dollar value
of securities the Portfolio already owns. The Portfolio may also invest in
equity real estate investment trusts ("REITs"), although it currently intends
to limit its investments in REITs to no more than 5% of its assets. The
Portfolio may also invest in firm commitment agreements and when-issued
securities; repurchase agreements; illiquid securities (up to 15% of its net
assets) and restricted securities.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests in medium-sized companies, which are more
susceptible to price swings than larger companies, but usually have more
stable prices than smaller companies.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment. Second, the Portfolio may use options, futures contracts and other
investment techniques to help it achieve its investment goal. These techniques
can potentially reduce returns or increase the Portfolio's volatility. Third,
by borrowing money to purchase securities, the Portfolio can magnify the gain
and the loss of the security. The Portfolio will be charged interest on any
money it borrows. The lender will have priority over shareholders against the
Portfolio's assets.
Equity Index Portfolio
The Portfolio may purchase and sell stock index futures, purchase options on
stock indexes, and purchase options on stock index futures that are based on
stock indexes which the Portfolio attempts to track or which tend to move
together with stocks included in the index. The Portfolio may also invest in
foreign equity securities if U.S. exchange listed to the extent included in
the S&P 500; ADRs; convertible securities; firm commitment agreements and
when-issued securities; and reverse repurchase agreements. The Portfolio may
temporarily invest cash balances, maintained for liquidity purposes or pending
investment, in short-term high quality debt
9
<PAGE>
instruments, including commercial paper; variable and floating rate
securities; repurchase agreements; bank obligations; and U.S. Government
securities, its agencies and instrumentalities. Temporary investments are not
made for defensive purposes in the event of or in anticipation of a general
decline in the market price of stocks in which the Portfolio invests. The
Portfolio may also lend its portfolio securities, in an amount not to exceed
33 1/3% of the value of its total assets, to brokers, dealers, and other
financial institutions to earn income, and may borrow for temporary
administrative or emergency purposes. The Portfolio may also invest up to 15%
of its net assets in illiquid securities.
The Fund reserves the right to change the index whose performance the
Portfolio will attempt to replicate or for the Portfolio to seek its
investment objective by means other than attempting to replicate an index,
such as by operating the Portfolio as a managed fund, and reserves the right
to do so without seeking shareholder approval, but only if operating the
Portfolio as described above is not permitted under applicable law for an
investment company that serves as an investment medium for variable insurance
contracts, or otherwise involves substantial legal risk.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests principally in large companies, which
tend to have less volatile prices than smaller companies.
The Portfolio may also be affected by the following additional risk factors:
First, because the Portfolio is not actively managed, and invests in
securities included in the S&P 500 regardless of their investment merit, the
portfolio management team cannot change this investment strategy, even
temporarily to protect the Portfolio from loss during poor economic
conditions. This means the Portfolio is susceptible to a general decline in
the U.S. stock market. Second, the Portfolio frequently uses index options,
futures contracts and other investment techniques to help it achieve its
investment goal. These techniques can potentially reduce returns or increase
the Portfolio's volatility.
Small-Cap Index Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
Under normal conditions, the Portfolio invests at least 80% of the value of
its total assets in the common stock of companies included in the Russell 2000
Small Stock Index ("Russell 2000"). The Portfolio will be managed in an
attempt to minimize the degree to which the investment results of the
Portfolio (before taking into account the Portfolio's expenses) differ from
the results of the Russell 2000.
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may purchase and sell stock index futures and
options thereon and options on stock indexes that are based on the Russell
2000 or other indexes of small capitalization companies.
The Portfolio may invest in foreign equity securities if U.S. exchange
listed to the extent included in the Russell 2000. The Portfolio is also
permitted to invest in ADRs; repurchase agreements; rights; REITs;
U.S. Government securities, its agencies or instrumentalities; bank
obligations; variable and floating rate securities; firm commitment agreements
and when-issued securities; warrants; and securities that are convertible into
common stock. The Portfolio may also invest in illiquid securities (up to 15%
of its net assets) and in restricted securities. The Portfolio may also lend
its portfolio securities, in an amount not to exceed 33 1/3% of the value of
its total assets, to brokers, dealers, and other financial institutions to
earn income, and may borrow money for temporary administrative or emergency
purposes.
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<PAGE>
The Portfolio may maintain a portion to its assets in short-term debt
securities and money market instruments to meet redemption requests or pending
investment in the securities of the Russell 2000. These investments will not
be made in anticipation of a general decline in the market prices of stocks in
which the Portfolio invests.
The Fund reserves the right to change the index whose performance the
Portfolio will attempt to replicate or for the Portfolio to seek its
investment objective by means other than attempting to replicate an index,
such as by operating the Portfolio as a managed fund, and reserves the right
to do so without seeking shareholder approval, but only if operating the
Portfolio as described above is not permitted under applicable law for an
investment company that serves as an investment medium for variable insurance
contracts, or otherwise involves substantial legal risk.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests principally in small-cap companies, which
tend to have higher price swings than larger companies because they have fewer
financial resources, limited product and market diversification and many are
dependent on a few key managers.
The Portfolio may also be affected by the following additional risk factors:
First, because the Portfolio is not actively managed, and invests in
securities included in the Russell 2000 regardless of their investment merit,
the portfolio management team cannot change this investment strategy, even
temporarily to protect the Portfolio from loss during poor economic
conditions. This means the Portfolio is susceptible to a general decline in
the U.S. stock market. Second, the Portfolio frequently uses index options,
futures contracts and other investment techniques to help it achieve its
investment goal. These techniques can potentially reduce returns or increase
the Portfolio's volatility.
REIT Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
The Portfolio is a "non-diversified" portfolio. For purposes of the
Portfolio's investment policies, a company is principally engaged in the real
estate industry if: (1) it derives at least 50% of its revenues or profits
from the ownership, construction, management, financing or sale of
residential, commercial or industrial real estate; or (2) it has at least 50%
of the fair market value of its assets invested in residential, commercial, or
industrial real estate.
During periods when the Portfolio Manager believes that changes in economic,
financial, or political conditions make it advisable, the Portfolio may, for
temporary defensive purposes, invest up to 100% of its total assets in
investment grade short-term and medium-term debt obligations or hold cash.
The Portfolio may buy and sell put and call options on securities and may
purchase and sell futures contracts on interest rates. The Portfolio may also
invest in the following: ADRs; bank obligations; U.S. Government securities;
convertible securities; variable and floating rate securities; firm commitment
agreements and when-issued securities; foreign securities; preferred stock;
repurchase agreements; interest rate derivative products, such as swaps, caps,
collars and floors; and structured notes. The Portfolio may also lend its
portfolio securities, in an amount not to exceed 33 1/3% of the value of its
total assets, to brokers, dealers, and other financial institutions to earn
income, and may borrow money for administrative or emergency purposes. The
Portfolio may also invest in restricted securities and up to 15% of its net
assets in illiquid securities.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests in companies investing in the real
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<PAGE>
estate industry. The prices of these companies are affected by real estate
cycles, cash flows, availability of mortgage financing, changes in interest
rates, overbuilding, property taxes and operating expenses, environmental
regulation and changes in zoning laws and regulations.
The Portfolio may also be affected by the following additional risk factors:
First, by investing in REITs, the Portfolio is exposed to the risks of the
real estate market. For example, some REITs may invest in a limited number of
properties, in a narrow geographic area, or in a single property type, which
increases the risk that the Portfolio could be unfavorably affected by the
poor performance of a single investment. Borrowers could default on or sell
investments the REIT holds, which could reduce the cash flow needed to make
distributions to investors. Second, the Portfolio may also be subject to the
risks associated with foreign investments, including changes in currency
exchange rates, unstable political and economic conditions, a lack of adequate
company information, differences in the way securities markets operate, less
secure foreign banks or securities depositories than those in the United
States, and foreign controls on investment. Third, the Portfolio may use
options, futures contracts and other investment techniques such as interest-
sensitive derivative products and structured notes to help it achieve its
investment goal. These techniques can potentially reduce returns or increase
the Portfolio's volatility. When it invests in structured notes and other
derivatives, the Portfolio is particularly sensitive to the risk that the
other party to the derivative cannot meet its financial obligations to pay the
Portfolio.
International Value Portfolio
Other than when in a defensive posture, at least 70% of the Portfolio's
assets will consist of equity securities, primarily common stock and, to a
lesser degree, securities convertible into common stock. The Portfolio may
invest up to 5% of its assets, measured at the time of investment, in debt
securities that are rated below investment grade, or if not rated, of
equivalent quality.
The Portfolio may also hold cash (in United States dollars or foreign
currencies) or short-term corporate or U.S. Government obligations and bank
certificates of deposit denominated in such currencies to provide for
redemptions; it is generally not expected that such reserve for redemptions
will exceed 10% of the Portfolio assets. Securities which may be held for
defensive purposes include nonconvertible preferred stock, debt securities,
government securities issued by U.S. and foreign countries and money market
securities. The Portfolio is subject to guidelines for diversification of
foreign security investments that prescribe the minimum number of countries in
which the Portfolio's assets may be invested. These guidelines are discussed
under "Foreign Securities."
The Portfolio may also enter into repurchase agreements and may lend its
portfolio securities, in an amount not to exceed 33 1/3% of the value of its
total assets, to brokers, dealers, and other financial institutions to earn
income and may borrow money for administrative or emergency purposes. The
Portfolio may also invest in ADRs; GDRs; EDRs; variable and floating rate
securities; firm commitment agreements and when-issued securities; and may
purchase and sell financial futures contracts, stock index futures contracts,
and foreign currency futures contracts and options thereon. The Portfolio may
also engage in foreign currency transactions in anticipation of or to protect
itself against fluctuations in currency exchange rates. The Portfolio may
enter into forward currency contracts and may purchase and write put and call
options on foreign currencies. The portfolio may also invest in restricted
securities and up to 15% of its net assets in illiquid securities.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio may invest in small-cap and mid-cap companies
that may be more susceptible to larger price swings than larger companies
because they have fewer financial resources, limited product and market
diversification and many are dependent on a few key managers.
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities
12
<PAGE>
markets operate, less secure foreign banks or securities depositories than
those in the United States, and foreign controls on investment. Second, the
Portfolio may invest in foreign currency transactions, forward foreign currency
contracts or options, index options, futures and other investment techniques to
help it achieve its investment goal. These techniques can potentially reduce
returns or increase the Portfolio's volatility.
Government Securities Portfolio
In addition to its investments in U.S. government securities and related
investments, as described in the Prospectus, the Portfolio may invest up to 35%
of its assets in the following: corporate debt securities of domestic issuers
rated Aa or better by Moody's or AA or better by S&P, or, if not rated by
Moody's or S&P, of comparable quality as determined by the Portfolio Manager;
mortgage-related securities, including collateralized mortgage obligations and
mortgage-backed bonds; asset-backed securities; repurchase agreements and
reverse repurchase agreements; bank obligations; convertible securities;
variable and floating rate securities; firm commitment agreements and when-
issued securities; ADRs; and in cash or high quality money market instruments.
The Portfolio may also invest in restricted securities and up to 15% of its net
assets in illiquid securities.
The Portfolio may also purchase and sell put and call options on debt
securities and spread transactions; enter into interest rate, interest rate
index, and currency exchange rate swap agreements and purchase and sell options
thereon; engage in forward currency contracts, options on foreign currency
contracts, and foreign currency futures and options thereon; and purchase and
sell interest rate futures contracts and options thereon. In addition, the
Portfolio may invest up to 20% of its total assets in debt securities of
foreign issuers, which may be denominated in foreign currencies. The Portfolio
may also lend its portfolio securities, in an amount not to exceed 33 1/3% of
the value of its total assets, to brokers, dealers, and other financial
institutions to earn income, and may borrow money for temporary administrative
or emergency purposes.
Since the Portfolio principally invests in fixed income securities, it may be
affected by a number of risks, including the following: First, changes in
interest rates may have a significant effect on this Portfolio because it may
invest in securities with medium or long terms to maturity and may use
interest-sensitive derivatives. Bonds with longer durations tend to be more
sensitive to changes in interest rates, usually making them more volatile than
bonds with shorter durations. The Portfolio may also invest in mortgage-related
securities, which can be paid off early if the owners of underlying mortgages
pay off their mortgages sooner than scheduled. If interest rates are falling,
the Portfolio will be forced to reinvest this money at lower yields. Stripped
mortgage-backed securities can be particularly sensitive to changes in interest
rates. Second, the Portfolio could lose money if the issuer of a fixed income
security is unable to meet its financial obligation or goes bankrupt. Third,
the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences in
the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment. Fourth, the Portfolio frequently uses options, futures, and forward
contracts and other investment techniques to help it achieve its investment
goal. These techniques can potentially reduce returns or increase the
Portfolio's volatility. Fifth, the Portfolio may engage in short-term trading,
which could result in higher-trading costs.
Managed Bond Portfolio
In addition to the securities identified in the Prospectus, the Portfolio may
also invest in obligations issued or guaranteed by the U.S. Government, its
agencies, or instrumentalities; asset-backed securities; variable and floating
rate debt securities; bank obligations; convertible securities; firm commitment
agreements and when-issued securities; ADRs; U.S. dollar-denominated
obligations of international agencies (such as the International Bank for
Reconstruction and Development); and repurchase and reverse repurchase
agreements. The Portfolio may invest up to 20% of its assets in debt securities
of foreign issuers denominated in foreign currencies. The Portfolio may also
invest in restricted securities and up to 15% of its net assets in illiquid
securities.
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<PAGE>
The Portfolio, except as provided below, may invest only in securities rated
Baa or better by Moody's or BBB or better by S&P or, if not rated by Moody's
or S&P, determined by the Portfolio Manager to be of comparable quality. The
dollar-weighted average quality of all fixed income securities held by the
Portfolio will be A or higher as rated by Moody's and S&P. The Portfolio may
also invest up to 10% of its assets in debt securities that are below
investment grade, but rated B or higher by Moody's or S&P, or, if not rated by
Moody's or S&P, of equivalent quality. In the event that a security owned by
the Portfolio is downgraded to below a B rating, the Portfolio may nonetheless
retain the security. See the Appendix for a description of Moody's and S&P
ratings applicable to fixed income securities. For the year ended December 31,
1998, the amount of the Portfolio's average total assets, measured on the
basis of month-end values, invested in debt securities rated less than
investment grade was approximately 6.84%. The asset composition after this
time may or may not be the same as shown in 1998.
In pursuing its investment objective, the Portfolio may purchase and sell
put and call options on debt securities; purchase and sell spread
transactions; and enter into interest rate, interest rate index, and currency
exchange rate swap agreements, and purchase and sell options thereon. The
Portfolio may also purchase or sell interest rate futures contracts and
options thereon. The Portfolio may also lend its portfolio securities, in an
amount not to exceed 33 1/3% of the value of its total assets, to brokers,
dealers, and other financial institutions to earn income, and may borrow money
for temporary administrative or emergency purposes.
Furthermore, the Portfolio may engage in forward currency contracts, options
on foreign currency contracts, and foreign currency futures and options
thereon, in anticipation of or to protect itself against fluctuations in
currency exchange rates with respect to investments in securities of foreign
issuers.
Since the Portfolio principally invests in fixed income securities, it may
be affected by a number of risks, including the following: First, changes in
interest rates may have a significant effect on this Portfolio because it may
invest in securities with medium or long terms to maturity and may use
interest-sensitive derivatives. Bonds with longer durations tend to be more
sensitive to changes in interest rates, usually making them more volatile than
bonds with shorter durations. The Portfolio may also invest in mortgage-
related securities, which can be paid off early if the owners of underlying
mortgages pay off their mortgages sooner than scheduled. If interest rates are
falling, the Portfolio will be forced to reinvest this money at lower yields.
Stripped mortgage-backed securities can be particularly sensitive to changes
in interest rates. Second, the Portfolio could lose money if the issuer of a
fixed income security is unable to meet its financial obligation or goes
bankrupt. The Portfolio may invest in high-yield bonds which may make it
particularly subject to credit risk, especially during periods of economic
uncertainty or during economic downturns. Third, the Portfolio may also be
subject to the risks associated with foreign investments, including changes in
currency exchange rates, unstable political and economic conditions, a lack of
adequate company information, differences in the way securities markets
operate, less secure foreign banks or securities depositories than those in
the United States, and foreign controls on investment. Fourth, the Portfolio
frequently uses options, futures, and forward contracts and other investment
techniques to help it achieve its investment goal. These techniques can
potentially reduce returns or increase the Portfolio's volatility. Fifth, the
Portfolio may engage in short-term trading, which could result in higher-
trading costs.
Money Market Portfolio
The Portfolio invests at least 95% of its total assets, measured at the time
of investment, in a diversified portfolio of money market securities that are
in the highest rating category for short-term instruments. The Portfolio may
invest only in U.S. dollar denominated securities that present minimal credit
risk. The Adviser shall determine whether a security presents minimal credit
risk under procedures adopted by the Fund's Board of Trustees that conform to
SEC rules for money market funds.
A money market instrument will be considered to be highest quality (1) if
the instrument (or other comparable short-term instrument of the same issuer)
is rated in the highest rating category, (i.e., Aaa or Prime-1
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<PAGE>
by Moody's, AAA or A-1 by S&P) by (i) any two NRSROs or, (ii) if rated by only
one NRSRO, by that NRSRO; (2) an unrated security that is of comparable
quality to a security in the highest rating category as determined by the
Adviser; or (3) a U.S. Government security. With respect to 5% of its total
assets, measured at the time of investment, the Portfolio may also invest in
money market instruments that are in the second-highest rating category for
short-term debt obligations (i.e., rated Aa or Prime-2 by Moody's or AA or A-2
by S&P). A money market instrument will be considered to be in the second-
highest rating category under the criteria described above with respect to
instruments considered highest quality, as applied to instruments in the
second-highest rating category. The quality of securities subject to
guarantees may be determined based solely on the quality of the guarantee.
Additional eligibility restrictions apply with respect to guarantees and
demand features.
The Portfolio may not invest more than 5% of its total assets, measured at
the time of investment, in securities of any one issuer that are of the
highest quality, except that this limitation shall not apply to U.S.
Government securities and repurchase agreements thereon. The Portfolio may not
invest more than the greater of 1% of its total assets or $1,000,000, measured
at the time of investment, in securities of any one issuer that are in the
second-highest rating category. In addition, securities subject to guarantees
not issued by a person in a control relationship with the issuer of such
securities are not subject to the preceding diversification requirements.
However, the Portfolio must generally, with respect to 75% of its total
assets, invest no more than 10% of its total assets in securities issued by or
subject to guarantees or demand features from the same entity. In the event
that an instrument acquired by the Portfolio is downgraded or otherwise ceases
to be of the quality that is eligible for the Portfolio, the Adviser, under
procedures approved by the Board of Trustees shall promptly reassess whether
such security presents minimal credit risk and determine whether or not to
retain the instrument.
In addition to the securities identified in the Prospectus, the Portfolio
may also invest in short-term corporate debt securities, bank obligations,
savings and loan obligations, and repurchase agreements involving these
securities. The Portfolio may also invest in restricted securities and up to
10% of its net assets in illiquid securities. The Portfolio's investments are
limited to securities that mature within 13 months or less from the date if
purchase (except that securities held subject to repurchase agreements having
terms of 13 months or less from the date of delivery may mature in excess of
13 months from such date). The Portfolio is subject to diversification
standards applicable to money market funds under SEC rules.
The Portfolio may be adversely affected by changes in interest rates and by
the risk that the Portfolio could lose money if an issuer of a money market
instrument is unable to meet its financial obligation or goes bankrupt.
High Yield Bond Portfolio
The Portfolio invests primarily in fixed-income securities rated Baa or
lower by Moody's, or BBB or lower by S&P, or, if not rated by Moody's or S&P,
of equivalent investment quality as determined by the Adviser. The Portfolio
may also invest in: U.S. Government securities (including securities of U.S.
agencies and instrumentalities); bank obligations; commercial paper; mortgage-
related and asset-backed securities; variable and floating rate debt
securities; firm commitment agreements and when-issued securities; ADRs;
rights; repurchase and reverse repurchase agreements; foreign securities--U.S.
dollar-denominated debt securities issued by foreign issuers and foreign
branches of U.S. banks; dividend-paying common stocks (including up to 10% of
the market value of the Portfolio's total assets in warrants to purchase
common stocks) that are considered by Pacific Life to be consistent with the
investment objective of current income; and higher quality corporate bonds.
The Portfolio may also invest in restricted securities and up to 15% of its
net assets in illiquid securities.
In seeking higher income or a reduction in principal volatility, the
Portfolio may purchase and sell put and call options on debt securities,
purchase or sell interest rate futures contracts and options thereon, and
invest up to 5% of its total assets in spread transactions, which give the
Portfolio the right to sell or receive a security or a
15
<PAGE>
cash payment with respect to an index at a fixed dollar spread or yield spread
in relationship to another security or index which is used as a benchmark. The
Portfolio may also lend its portfolio securities, in an amount not to exceed
33 1/3% of the value of its total assets, to brokers, dealers, and other
financial institutions to earn income, and may borrow money for temporary
administrative or emergency purposes.
In an effort to reduce credit risk, the Portfolio diversifies its holdings
among many issuers. As of December 31, 1998, the Portfolio held securities of
152 corporate issuers, excluding short-term obligations. As of December 31,
1998, the amount of the Portfolio's average total assets, measured on the
basis of month-end values, invested in bonds rated lower than Baa by Moody's
or BBB by S&P or, if not rated by Moody's or S&P, determined to be of
equivalent quality by Pacific Life, was approximately 92.93%. The asset
composition after this time may or may not be the same as shown in 1998.
Since the Portfolio's principal strategy is to invest in low and medium
quality fixed income securities, it may be affected by a number of risks,
including the following factors: First, the Portfolio could lose money if an
issuer of a fixed income security fails to meet its financial obligation or
goes bankrupt. The Portfolio may be subject to more credit risk than other
Portfolios offered by the Fund because it invests in high yield bonds. This is
especially true during periods of economic uncertainty or economic downturns.
Second, the value of the Portfolio's investments may fall when interest rates
rise. Third, the high yield bonds in which the Portfolio invests may be less
liquid than higher quality investments. Fourth, the Portfolio may also be
subject to the risks associated with foreign investments, including changes in
currency exchange rates, unstable political and economic conditions, a lack of
adequate company information, differences in the way securities markets
operate, less secure foreign banks or securities depositories than those in
the United States, and foreign controls on investment.
Large-Cap Value Portfolio
This Portfolio is not available for:
. Pacific Corinthian variable annuity contracts
. Pacific Select variable life insurance policies.
In addition to the investment policies and techniques described in the
Prospectus, the Portfolio may invest a portion of its assets in short-term
fixed income securities, such as repurchase agreements: commercial paper;
U.S. Government securities, its agencies or instrumentalities; bank
obligations; cash or cash equivalents, to meet operating expenses, to serve as
collateral in connection with certain investment techniques, or to meet
anticipated redemption requests. The Portfolio may invest in mortgage-related
securities; ADRs; variable and floating rate securities; firm commitment
agreements and when-issued securities; and up to 20% of its net assets,
measured at the time of investment, in foreign companies. In addition, the
Portfolio may invest without limit in convertible securities rated below
investment grade, and may, from time to time, invest up to 5% of its net
assets in non-convertible debt securities rated below investment grade by S&P
or Moody's. The Portfolio may also lend its portfolio securities, in an amount
not to exceed 33 1/3% of the value of its total assets, to brokers, dealers,
and other financial institutions to earn income, and may borrow money for
temporary administrative or emergency purposes.
The Portfolio may also purchase put and call options on securities and
securities indexes and enter into the following: stock, index and currency
futures contracts and options thereon and currency forward contracts, currency
swaps, and options on currencies. The Portfolio may also invest in equity
REITs, restricted securities, and up to 15% of its net assets in illiquid
securities.
Because the Portfolio invests principally in equity securities, the value of
its investments can increase or decrease in value, sometimes rapidly and
unpredictably. The Portfolio invests in large companies, which tend to have
more stable prices than smaller companies.
16
<PAGE>
The Portfolio may also be affected by the following additional risk factors:
First, the Portfolio may also be subject to the risks associated with foreign
investments, including changes in currency exchange rates, unstable political
and economic conditions, a lack of adequate company information, differences
in the way securities markets operate, less secure foreign banks or securities
depositories than those in the United States, and foreign controls on
investment. Second, the Portfolio may use options, futures contracts and other
investment techniques to help it achieve its investment goal. These techniques
can potentially reduce returns or increase the Portfolio's volatility.
Diversification Versus Non-Diversification
Each of the Portfolios, other than the REIT Portfolio, are diversified, so
that with respect to 75% of each such Portfolio's assets (100% for the Money
Market Portfolio), it may not invest more than 5% of its assets (taken at
market value at the time of investment) in securities of any one issuer,
except that this restriction does not apply to U.S. Government securities.
The REIT Portfolio is "non-diversified," which means that the proportion of
the Portfolio's assets that may be invested in the securities of a single
issuer is not limited by the Investment Company Act of 1940, as amended ("1940
Act"). However, to meet Federal tax requirements, the REIT Portfolio may not
have more than 25% of its total assets invested in any one issuer and, with
respect to 50% of its total assets, no more than 5% of its total assets
invested in any one issuer, except that this restriction does not apply to
U.S. Government securities. Nonetheless, because the REIT Portfolio may invest
in a smaller number of companies than a diversified fund, an investment in
this Portfolio may, under certain circumstances, present greater risk to an
investor than an investment in a diversified fund. This risk includes greater
exposure to potential poor earnings or default of fewer issuers than would be
the case for a more diversified fund.
SECURITIES AND INVESTMENT TECHNIQUES
Unless otherwise stated in the prospectus, many investment techniques,
including various hedging techniques and techniques which may be used to help
add incremental income, are discretionary. That means Portfolio Managers may
elect to engage or not to engage in the various techniques at their sole
discretion. Hedging may not be cost-effective or Portfolio Managers may simply
elect not to engage in hedging and have the Portfolio assume full risk of the
investments. Investors should not assume that any Portfolio will be hedged at
all times or that it will be hedged at all; nor should investors assume that
any particular discretionary investment technique or strategy will be employed
at all times, or ever employed.
U.S. Government Securities
All Portfolios may invest in U.S. Government securities. U.S. Government
securities are obligations of, or guaranteed by, the U.S. Government, its
agencies, or instrumentalities. Treasury bills, notes, and bonds are direct
obligations of the U.S. Treasury and they differ with respect to certain items
such as coupons, maturities, and dates of issue. Treasury bills have a
maturity of one year or less. Treasury notes have maturities of one to ten
years and Treasury bonds generally have a maturity of greater than ten years.
Securities guaranteed by the U.S. Government include federal agency
obligations guaranteed as to principal and interest by the U.S. Treasury (such
as GNMA certificates (described below) and Federal Housing Administration
debentures). In guaranteed securities, the payment of principal and interest
is unconditionally guaranteed by the U.S. Government, and thus they are of the
highest credit quality. Such direct obligations or guaranteed securities are
subject to variations in market value due to fluctuations in interest rates,
but, if held to maturity, the U.S. Government is obligated to or guarantees to
pay them in full.
Securities issued by U.S. Government instrumentalities and certain federal
agencies are neither direct obligations of, nor guaranteed by, the U.S.
Treasury. However, they involve federal sponsorship in one way or another:
some are backed by specific types of collateral; some are supported by the
issuer's right to borrow from
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the U.S. Treasury; some are supported by the discretionary authority of the
U.S. Treasury to purchase certain obligations of the issuer; others are
supported only by the credit of the issuing government agency or
instrumentality. These agencies and instrumentalities include, but are not
limited to Federal National Mortgage Association, Federal Home Loan Bank,
Federal Land Banks, Farmers Home Administration, Central Bank for
Cooperatives, Federal Intermediate Credit Banks, Federal Financing Bank, Farm
Credit Banks, and the Tennessee Valley Authority.
Real Estate Investment Trusts
REITs are primary investments for the REIT Portfolio. The Large-Cap Value,
International Large-Cap, Mid-Cap Value, Diversified Research, and Small-Cap
Index Portfolios may also invest in equity REITs. The I-Net Tollkeeper
Portfolio may invest in equity, mortgage or hybrid REITs.
REITs pool investors' funds for investment primarily in income-producing
real estate or in loans or interests related to real estate. A REIT is not
taxed on income distributed to its shareholders or unitholders if it complies
with a regulatory requirement that it distributes to its shareholders or
unitholders at least 95% of its taxable income for each taxable year.
Generally, REITs can be classified as equity REITs, mortgage REITs or hybrid
REITs. Equity REITs invest a majority of their assets directly in real
property and derive their income primarily from rents and capital gains from
appreciation realized through property sales. Equity REITs are further
categorized according to the types of real estate securities they own, e.g.,
apartment properties, retail shopping centers, office and industrial
properties, hotels, health-care facilities, manufactured housing and mixed-
property types. Mortgage REITs invest a majority of their assets in real
estate mortgages and derive their income primarily from income payments.
Hybrid REITs combine the characteristics of both equity and mortgage REITs.
REITs depend generally on their ability to generate cash flow to make
distributions to shareholders or unitholders, and may be subject to changes in
the value of their underlying properties, defaults by borrowers, and to self-
liquidations. Some REITs may have limited diversification and may be subject
to risks inherent in investments in a limited number of properties, in a
narrow geographic area, or in a single property type. Equity REITs may be
affected by changes in underlying property values. Mortgage REITs may be
affected by the quality of the credit extended. REITs are dependent upon
specialized management skills and incur management expenses. In addition, the
performance of a REIT may be affected by its failure to qualify for tax-free
pass-through of income under the Internal Revenue Code of 1986, as amended, or
its failure to maintain an exemption from registration under the 1940 Act.
REITs also involve risks such as refinancing, changes in property values,
general or specific economic risk on the real estate industry, dependency on
management skills, and other risks similar to small company investing.
Mortgage-Related Securities
Mortgage-related securities are interests in pools of mortgage loans made to
residential home buyers, including mortgage loans made by savings and loan
institutions, mortgage banks, commercial banks, and others. Pools of mortgage
loans are assembled as securities for sale to investors by various
governmental, government-related, and private organizations. The High Yield
Bond, Managed Bond, Government Securities, Aggressive Equity, Growth LT,
Multi-Strategy, Large-Cap Value, Mid-Cap Value, Equity, I-Net Tollkeeper, Bond
and Income Portfolios, and the Money Market Portfolio, subject to its
investment policies, may invest in mortgage-related securities as well as debt
securities which are secured with collateral consisting of mortgage-related
securities, and in other types of mortgage-related securities. For information
concerning the characterization of mortgage-related securities (including
collateralized mortgage obligations) for various purposes including the Fund's
policies concerning diversification and concentration, see "Concentration
Policy".
Mortgage Pass-Through Securities. These are securities representing
interests in "pools" of mortgages in which payments of both interest and
principal on the securities are made periodically, in effect "passing through"
periodic payments made by the individual borrowers on the residential mortgage
loans which underlie the securities (net of fees paid to the issuer or
guarantor of the securities). Early repayment of principal on
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mortgage pass-through securities (arising from prepayments of principal due to
sale of the underlying property, refinancing, or foreclosure, net of fees and
costs which may be incurred) may expose a Portfolio to a lower rate of return
upon reinvestment of principal. Payment of principal and interest on some
mortgage pass-through securities may be guaranteed by the full faith and
credit of the U.S. Government (in the case of securities guaranteed by the
Government National Mortgage Association, or "GNMAs"); or guaranteed by
agencies or instrumentalities of the U.S. Government (in the case of
securities guaranteed by the Federal National Mortgage Association ("FNMA") or
the Federal Home Loan Mortgage Corporation ("FHLMC"), which are supported only
by the discretionary authority of the U.S. Government to purchase the agency's
obligations). Mortgage pass-through securities created by nongovernmental
issuers (such as commercial banks, savings and loan institutions, private
mortgage insurance companies, mortgage bankers, and other secondary market
issuers) may be supported by various forms of insurance or guarantees,
including individual loan, title, pool and hazard insurance and letters of
credit, which may be issued by governmental entities, private insurers, or the
mortgage poolers.
GNMA Certificates. GNMA certificates are mortgage-backed securities
representing part ownership of a pool of mortgage loans on which timely
payment of interest and principal is guaranteed by the full faith and credit
of the U.S. Government. GNMA is a wholly-owned U.S. Government corporation
within the Department of Housing and Urban Development. GNMA is authorized to
guarantee, with the full faith and credit of the U.S. Government, the timely
payment of principal and interest on securities issued by institutions
approved by GNMA (such as savings and loan institutions, commercial banks, and
mortgage bankers) and backed by pools of mortgages insured by the Federal
Housing Administration ("FHA"), or guaranteed by the Department of Veterans
Affairs ("VA"). GNMA certificates differ from typical bonds because principal
is repaid monthly over the term of the loan rather than returned in a lump sum
at maturity. Because both interest and principal payments (including
prepayments) on the underlying mortgage loans are passed through to the holder
of the certificate, GNMA certificates are called "pass-through" securities.
Interests in pools of mortgage-related securities differ from other forms of
debt securities, which normally provide for periodic payment of interest in
fixed amounts with principal payments at maturity or specified call dates.
Instead, these securities provide a periodic payment which consists of both
interest and principal payments. In effect, these payments are a "pass-
through" of the periodic payments made by the individual borrowers on the
residential mortgage loans, net of any fees paid to the issuer or guarantor of
such securities. Additional payments are caused by repayments of principal
resulting from the sale of the underlying residential property, refinancing or
foreclosure, net of fees or costs which may be incurred. Mortgage-related
securities issued by GNMA are described as "modified pass-through" securities.
These securities entitle the holder to receive all interest and principal
payments owed on the mortgage pool, net of certain fees, at the scheduled
payment dates regardless of whether or not the mortgagor actually makes the
payment. Although GNMA guarantees timely payment even if homeowners delay or
default, tracking the "pass-through" payments may, at times, be difficult.
Expected payments may be delayed due to the delays in registering the newly
traded paper securities. The custodian's policies for crediting missed
payments while errant receipts are tracked down may vary. Other mortgage-
backed securities such as those of FHLMC and FNMA trade in book-entry form and
are not subject to the risk of delays in timely payment of income.
Although the mortgage loans in the pool will have maturities of up to 30
years, the actual average life of the GNMA certificates typically will be
substantially less because the mortgages will be subject to normal principal
amortization and may be prepaid prior to maturity. Early repayments of
principal on the underlying mortgages may expose a Portfolio to a lower rate
of return upon reinvestment of principal. Prepayment rates vary widely and may
be affected by changes in market interest rates. In periods of falling
interest rates, the rate of prepayment tends to increase, thereby shortening
the actual average life of the GNMA certificates. Conversely, when interest
rates are rising, the rate of prepayment tends to decrease, thereby
lengthening the actual average life of the GNMA certificates. Accordingly, it
is not possible to accurately predict the average life of a particular pool.
Reinvestment of prepayments may occur at higher or lower rates than the
original yield on the certificates. Due to the prepayment feature and the need
to reinvest prepayments of principal at current rates, GNMA
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certificates can be less effective than typical bonds of similar maturities at
"locking in" yields during periods of declining interest rates, although they
may have comparable risks of decline in value during periods of rising
interest rates.
FNMA and FHLMC Mortgage-Backed Obligations. Government-related guarantors
(i.e., not backed by the full faith and credit of the U.S. Government) include
FNMA and FHLMC. FNMA, a federally chartered and privately-owned corporation,
issues pass-through securities representing interests in a pool of
conventional mortgage loans. FNMA guarantees the timely payment of principal
and interest but this guarantee is not backed by the full faith and credit of
the U.S. Government. FNMA is a government sponsored corporation owned entirely
by private stockholders. It is subject to general regulation by the Secretary
of Housing and Urban Development. FNMA purchases conventional (i.e., not
insured or guaranteed by any government agency) residential mortgages from a
list of approved seller/servicers which include state and federally-chartered
savings and loan associations, mutual savings banks, commercial banks and
credit unions, and mortgage bankers. FHLMC, a corporate instrumentality of the
United States, was created by Congress in 1970 for the purpose of increasing
the availability of mortgage credit for residential housing. Its stock is
owned by the 12 Federal Home Loan Banks. FHLMC issues Participation
Certificates ("PCs") which represent interests in conventional mortgages from
FHLMC's national portfolio. FHLMC guarantees the timely payment of interest
and ultimate collection of principal and maintains reserves to protect holders
against losses due to default, but PCs are not backed by the full faith and
credit of the U.S. Government. As is the case with GNMA certificates, the
actual maturity of and realized yield on particular FNMA and FHLMC pass-
through securities will vary based on the prepayment experience of the
underlying pool of mortgages.
Collateralized Mortgage Obligations (CMOs). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal is paid, in most cases, semiannually. CMOs may
be collateralized by whole mortgage loans but are more typically
collateralized by portfolios of mortgage pass-through securities guaranteed by
GNMA, FHLMC, or FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments,
generally is first returned to investors holding the shortest maturity class.
Investors holding the longer maturity classes receive principal only after the
first class has been retired. An investor is partially guarded against a
sooner than desired return of principal because of the sequential payments.
In a typical CMO transaction, a corporation ("issuer") issues multiple
series (e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond
offering are used to purchase mortgages or mortgage pass-through certificates
("Collateral"). The Collateral is pledged to a third party trustee as security
for the Bonds. Principal and interest payments from the Collateral are used to
pay principal on the Bonds in the order A, B, C, Z. The series A, B, and C
Bonds all bear current interest. Interest on the series Z Bond is accrued and
added to principal and a like amount is paid as principal on the series A, B,
or C Bond currently being paid off. When the series A, B, and C Bonds are paid
in full, interest and principal on the series Z Bond begins to be paid
currently. With some CMOs, the issuer serves as a conduit to allow loan
originators (primarily builders or savings and loan associations) to borrow
against their loan portfolios.
FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations
of FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are
made semiannually, as opposed to monthly. The amount of principal payable on
each semiannual payment date is determined in accordance with FHLMC's
mandatory sinking fund schedule, which, in turn, is equal to approximately
100% of FHA prepayment experience applied to the mortgage collateral pool. All
sinking fund payments in the CMOs are allocated to the retirement of the
individual classes of bonds in the order of their
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stated maturities. Payment of principal on the mortgage loans in the
collateral pool in excess of the amount of FHLMC's minimum sinking fund
obligation for any payment date are paid to the holders of the CMOs as
additional sinking fund payments. Because of the "pass-through" nature of all
principal payments received on the collateral pool in excess of FHLMC's
minimum sinking fund requirement, the rate at which principal of the CMOs is
actually repaid is likely to be such that each class of bonds will be retired
in advance of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage loans
during any semiannual payment period is not sufficient to meet FHLMC's minimum
sinking fund obligation on the next sinking fund payment date, FHLMC agrees to
make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are identical
to those of FHLMC PCs. FHLMC has the right to substitute collateral in the
event of delinquencies and/or defaults.
Other Mortgage-Related Securities. Commercial banks, savings and loan
institutions, private mortgage insurance companies, mortgage bankers, and
other secondary market issuers also create pass-through pools of conventional
residential mortgage loans. Such issuers may, in addition, be the originators
and/or servicers of the underlying mortgage loans as well as the guarantors of
the mortgage-related securities. Pools created by such non-governmental
issuers generally offer a higher rate of interest than government and
government-related pools because there are no direct or indirect government or
agency guarantees of payments in the former pools. However, timely payment of
interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance, and letters of credit. The insurance and guarantees are issued by
governmental entities, private insurers, and the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will
be considered in determining whether a mortgage-related security meets a
Portfolio's investment quality standards. There can be no assurance that the
private insurers or guarantors can meet their obligations under the insurance
policies or guarantee arrangements. A Portfolio may buy mortgage-related
securities without insurance or guarantees, if, in an examination of the loan
experience and practices of the originator/servicers and poolers, the Adviser
or Portfolio Manager determines that the securities meet a Portfolio's quality
standards. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable. A Portfolio will not purchase mortgage-related securities or any
other assets which in the opinion of the Adviser or Portfolio Manager are
illiquid if, as a result, more than 15% of the value of a Portfolio's net
assets (10% for the Money Market Portfolio) will be illiquid. It is expected
that governmental, government-related, or private entities may create mortgage
loan pools and other mortgage-related securities offering mortgage pass-
through and mortgage collateralized investments in addition to those described
above. As new types of mortgage-related securities are developed and offered
to investors, the Adviser or Portfolio Manager will, consistent with a
Portfolio's investment objectives, policies, and quality standards, consider
making investments in such new types of mortgage-related securities.
CMO Residuals. CMO residuals are derivative mortgage securities issued by
agencies or instrumentalities of the U.S. Government or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs
is applied first to make required payments of principal and interest on the
CMOs and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess
cash flow remaining after making the foregoing payments. Each payment of such
excess cash flow to a holder of the related CMO residual represents income
and/or a return of capital. The amount of residual cash flow resulting from a
CMO will depend on, among other things, the characteristics of the mortgage
assets, the coupon rate of each class of CMO, prevailing interest rates, the
amount of administrative expenses and the prepayment experience on the
mortgage assets. In particular, the yield to maturity on CMO residuals is
extremely sensitive to prepayments on the related underlying mortgage assets,
in the same manner as an interest-only ("IO") class of stripped
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mortgage-backed securities. See "Other Mortgage-Related Securities--Stripped
Mortgage-Backed Securities." In addition, if a series of a CMO includes a
class that bears interest at an adjustable rate, the yield to maturity on the
related CMO residual will also be extremely sensitive to changes in the level
of the index upon which interest rate adjustments are based. As described
below with respect to stripped mortgage-backed securities, in certain
circumstances a Portfolio may fail to recoup fully its initial investment in a
CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and CMO residuals currently
may not have the liquidity of other more established securities trading in
other markets. Transactions in CMO residuals are generally completed only
after careful review of the characteristics of the securities in question. CMO
residuals may or, pursuant to an exemption therefrom, may not have been
registered under the Securities Act of 1933, as amended. CMO residuals,
whether or not registered under such Act, may be subject to certain
restrictions on transferability, and may be deemed "illiquid" and subject to a
Portfolio's limitations on investment in illiquid securities.
In addition, the Bond and Income Portfolio may invest in inverse floaters
and "IO" and "PO" tranches of planned amortization class ("PAC") certificates.
PAC certificates are parallel-pay real estate mortgage investment conduit
("REMIC") certificates that generally require that specified amounts of
principal be applied on each payment date to one or more classes of REMIC
certificates, even though all other principal payments and prepayments of the
mortgage assets are then required to be applied to one or more other classes
of the certificates. The scheduled principal payments for the PAC certificates
generally have the highest priority on each payment date after interest due
has been paid to all classes entitled to receive interest currently.
Shortfalls, if any, are added to the amount payable on the next payment date.
The PAC certificate payment schedule is taken into account in calculating the
final distribution date of each class of the PAC certificate. In order to
create PAC Tranches, generally one or more tranches must be created that
absorb most of the volatility in the underlying mortgage assets. These
tranches tend to have market prices and yields that are much more volatile
than other PAC classes. The I-Net Tollkeeper Portfolio also may invest in
REMIC certificates.
A PAC IO is a PAC bond that pays an extremely high coupon rate, such as
200%, on its outstanding principal balance, and pays down according to a
designated PAC schedule. Due to their high-coupon interest, PAC IO's are
priced at very high premiums to par. Due to the nature of PAC prepayment bands
and PAC collars, the PAC IO has a greater call (contraction) potential and
thus would be impacted negatively by a sustained increase in prepayment
speeds.
Stripped Mortgage-Backed Securities. Stripped mortgage-backed securities
("SMBS") are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private
originators of, or investors in, mortgage loans, including savings and loan
associations, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of SMBS will have one class receiving some of the
interest and most of the principal from the mortgage assets, while the other
class will receive most of the interest and the remainder of the principal. In
the most extreme case, one class will receive all of the interest (the IO
class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yield to maturity on an IO class is
extremely sensitive to the rate of principal payments (including prepayments)
on the related underlying mortgage assets, and a rapid rate of principal
payments may have a material adverse effect on the Portfolio's yield to
maturity from these securities. If the underlying mortgage assets experience
greater than anticipated prepayments of principal, a Portfolio may fail to
fully recoup its initial investment in these securities even if the security
is in one of the highest rating categories.
Although SMBS are purchased and sold by institutional investors through
several investment banking firms acting as brokers or dealers, these
securities were only recently developed. As a result, established trading
markets have not yet developed and, accordingly, these securities may be
deemed "illiquid" and subject to a Portfolio's limitations on investment in
illiquid securities.
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Mortgage Dollar Rolls. The Bond and Income Portfolio may enter into mortgage
"dollar rolls" in which the Portfolio sells securities for delivery in the
current month and simultaneously contracts with the same counterparty to
repurchase substantially similar (same type, coupon and maturity) but not
identical securities on a specified future date. During the roll period, the
Portfolio loses the right to receive principal and interest paid on the
securities sold. However, the Portfolio would benefit to the extent of any
difference between the price received for the securities sold and the lower
forward price for the future purchase or fee income plus the interest earned
on the cash proceeds of the securities sold until the settlement date for the
forward purchase. Unless such benefits exceed the income, capital appreciation
and gain or loss due to mortgage prepayments that would have been realized on
the securities sold as part of the mortgage dollar roll, the use of this
technique will diminish the investment performance of the Portfolio. The
Portfolio will hold and maintain in a segregated account until the settlement
date cash or liquid assets in an amount equal to the forward purchase price.
For financial reporting and tax purposes, the Portfolio treats mortgage dollar
rolls as two separate transactions; one involving the purchase of a security
and a separate transaction involving a sale. The Portfolio does not currently
intend to enter into mortgage dollar rolls that are accounted for as a
financing.
Other Asset-Backed Securities
In addition to mortgage-related securities, the High Yield Bond, Managed
Bond, Government Securities, Aggressive Equity, Growth LT, Multi-Strategy,
Equity, I-Net Tollkeeper, Bond and Income Portfolios, and the Money Market
Portfolio, subject to its investment policies, may invest in other asset-
backed securities which are securities that directly or indirectly represent a
participation interest in, or are secured by and payable from a stream of
payments generated by particular assets such as automobile loans or
installment sales contracts, home equity loans, computer and other leases,
credit card receivables, or other assets. Generally, the payments from the
collateral are passed through to the security holder. Due to the possibility
that prepayments (on automobile loans and other collateral) will alter cash
flow on asset-backed securities, generally it is not possible to determine in
advance the actual final maturity date or average life of many asset-backed
securities. Faster prepayment will shorten the average life and slower
prepayment will lengthen it. However, it may be possible to determine what the
range of that movement could be and to calculate the effect that it will have
on the price of the security. Other risks relate to limited interests in
applicable collateral. For example, credit card debt receivables are generally
unsecured and the debtors are entitled to the protection of a number of state
and federal consumer credit laws, many of which give such debtors the right to
set off certain amounts on credit card debt thereby reducing the balance due.
Additionally, holders of asset-backed securities may also experience delays in
payments or losses if the full amounts due on underlying sales contracts are
not realized. The securities market for asset-backed securities may not, at
times, offer the same degree of liquidity as markets for other types of
securities with greater trading volume.
High Yield Bonds
The High Yield Bond, Managed Bond (up to 10% of its assets), Growth LT (up
to 10% of its assets), Equity Income, Multi-Strategy, Large-Cap Value (no
limit on convertible high yield securities, and up to 5% of its net assets in
non-convertible high yield securities), Bond and Income (up to 20% of its
assets, 15% of which may be invested in debt securities of foreign governments
or their agencies that are from emerging market countries), I-Net Tollkeeper
(no limit), and International Value (up to 5% of its assets) Portfolios,
measured at the time of investment, may invest in high risk debt securities
rated lower than Baa or BBB, or, if not rated by Moody's or S&P, of equivalent
quality (although the Managed Bond Portfolio may not invest in securities
rated lower than B) ("high yield bonds," which are commonly referred to as
"junk bonds").
In general, high yield bonds are not considered to be investment grade, and
investors should consider the risks associated with high yield bonds before
investing in the pertinent Portfolio, and in particular the High Yield Bond
and Bond and Income Portfolios. Investment in such securities generally
provides greater income and increased opportunity for capital appreciation
than investments in higher quality securities, but they also typically entail
greater price volatility and principal and income risk.
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Investment in high yield bonds involves special risks in addition to the
risks associated with investments in higher rated debt securities. High yield
bonds are regarded as predominately speculative with respect to the issuer's
continuing ability to meet principal and interest payments. A severe economic
downturn or increase in interest rates might increase defaults in high yield
securities issued by highly leveraged companies. An increase in the number of
defaults could adversely affect the value of all outstanding high yield
securities, thus disrupting the market for such securities. Analysis of the
creditworthiness of issuers of debt securities that are high yield bonds may
be more complex than for issuers of higher quality debt securities, and the
ability of a Portfolio to achieve its investment objective may, to the extent
of investment in high yield bonds, be more dependent upon such
creditworthiness analysis than would be the case if the Portfolio were
investing in higher quality bonds.
Included among the emerging market debt obligations in which the Bond and
Income Portfolio may invest are "Brady Bonds," which are created through the
exchange of existing commercial bank loans to sovereign entities for new
obligations in connection with debt restructuring under a plan introduced by
former U.S. Secretary of the Treasury, Nicholas F. Brady (the "Brady Plan").
Brady Bonds are not considered U.S. Government securities and are considered
speculative. Brady Bonds have been issued relatively recently, and
accordingly, do not have a long payment history. They may be collateralized or
uncollateralized, or have collateralized or uncollateralized elements, and
issued in various currencies (although most are U.S. dollar- denominated), and
they are traded in the over-the-counter secondary market.
Brady Bonds involve various risk factors including residual risk and the
history of defaults with respect to commercial bank loans by public and
private entities of countries issuing Brady Bonds. There can be no assurance
that Brady Bonds in which the Portfolio may invest will not be subject to
restructuring arrangements or to requests for new credit, which may cause the
Portfolio to suffer a loss of interest or principal on any of its holdings.
High yield bonds may be more susceptible to real or perceived adverse
economic and competitive industry conditions than investment grade bonds. The
prices of high yield bonds have been found to be less sensitive to interest-
rate changes than higher-rated investments, but more sensitive to adverse
economic downturns or individual corporate developments. A projection of an
economic downturn or of a period of rising interest rates, for example, could
cause a decline in high yield bond prices because the advent of a recession
could lessen the ability of a highly leveraged company to make principal and
interest payments on its debt securities. If an issuer of high yield bonds
defaults, in addition to risking payment of all or a portion of interest and
principal, a Portfolio may incur additional expenses to seek recovery. In the
case of high yield bonds structured as zero-coupon or pay-in-kind securities,
their market prices are affected to a greater extent by interest rate changes,
and therefore tend to be more volatile than securities which pay interest
periodically and in cash.
The secondary market on which high yield bonds are traded may be less liquid
than the market for higher grade bonds. Less liquidity in the secondary
trading market could adversely affect the price at which a Portfolio could
sell a high yield bond, and could adversely affect and cause large
fluctuations in the daily net asset value of the Portfolio's shares. Adverse
publicity and investor perceptions, whether or not based on fundamental
analysis, may decrease the values and liquidity of high yield bonds,
especially in a thinly-traded market. When secondary markets for high yield
bonds are less liquid than the market for higher grade bonds, it may be more
difficult to value the securities because such valuation may require more
research, and elements of judgment may play a greater role in the valuation
because there is less reliable, objective data available.
There are also certain risks involved in using credit ratings for evaluating
high yield bonds. For example, credit ratings evaluate the safety of principal
and interest payments, not the market value risk of high yield bonds. Also,
credit rating agencies may fail to timely reflect subsequent events.
Bank Obligations
Bank obligations in which all Portfolios may invest include certificates of
deposit, bankers' acceptances, fixed time deposits, and loans or credit
agreements. Each Portfolio may also hold funds on deposit with its
sub-custodian bank in an interest-bearing account for temporary purposes.
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Certificates of deposit are negotiable certificates issued against funds
deposited in a commercial bank for a definite period of time and earning a
specified return. Bankers' acceptances are negotiable drafts or bills of
exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning, in effect, that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Fixed time deposits are bank obligations payable at a stated maturity date and
bearing interest at a fixed rate. Fixed time deposits may be withdrawn on
demand by the investor, but may be subject to early withdrawal penalties which
vary depending upon market conditions and the remaining maturity of the
obligation. There are no contractual restrictions on the right to transfer a
beneficial interest in a fixed time deposit to a third party, although there
is no market for such deposits. A Portfolio will not invest in fixed time
deposits which (i) are not subject to prepayment, or (ii) incur withdrawal
penalties upon prepayment (other than overnight deposits) if, in the
aggregate, more than 15% of its net assets (10% for the Money Market
Portfolio) would be invested in such deposits, repurchase agreements maturing
in more than seven days, and other illiquid assets.
The Portfolio may purchase loans or participation interests in loans made by
U.S. banks and other financial institutions to large corporate customers.
Loans are made by a contract called a credit agreement. Loans are typically
secured by assets pledged by the borrower, but there is no guarantee that the
value of the collateral will be sufficient to cover the loan, particularly in
the case of a decline in value of the collateral. Loans may be floating rate
or amortizing. See "Variable and Floating Rate Securities" below for more
information. Some loans may be traded in the secondary market among banks,
loan funds, and other institutional investors.
A Portfolio will not invest in any security or bank loan/credit agreement
issued by a commercial bank unless: (i) the bank has total assets of at least
U.S. $1 billion (U.S. $500 million in the case of the Equity Income Portfolio
and U.S. $2 billion in the case of the Bond and Income Portfolio), or the
equivalent in other currencies, or, in the case of domestic banks which do not
have total assets of at least U.S. $1 billion, the aggregate investment made
in any one such bank is limited to an amount, currently U.S. $100,000, insured
in full by the Federal Deposit Insurance Corporation ("FDIC"); (ii) in the
case of U.S. banks, it is a member of the FDIC; and (iii) in the case of
foreign banks, the security is, in the opinion of the Adviser or the Portfolio
Manager, of an investment quality comparable with other debt securities of
similar maturities which may be purchased by the Portfolio. These limitations
do not prohibit investments in securities issued by foreign branches of U.S.
banks, provided such U.S. banks meet the foregoing requirements.
All Portfolios may invest in short-term debt obligations of savings and loan
associations provided that the savings and loan association issuing the
security (i) has total assets of at least $1 billion (U.S. $500 million in the
case of the Equity Income Portfolio and U.S. $2 billion in the case of the
Bond and Income Portfolio), or, in the case of savings and loan associations
which do not have total assets of at least $1 billion, the aggregate
investment made in any one savings and loan association is insured in full,
currently up to $100,000, by the Savings Association Insurance Fund ("SAIF");
(ii) the savings and loan association issuing the security is a member of the
Federal Home Loan Bank System; and (iii) the institution is insured by the
SAIF.
A Portfolio will not purchase any security of a small bank or savings and
loan association which is not readily marketable if, as a result, more than
15% of the value of its net assets (10% for the Money Market Portfolio) would
be invested in such securities, other illiquid securities, or securities
without readily available market quotations, such as restricted securities and
repurchase agreements maturing in more than seven days.
The International Value Portfolio may only invest in obligations of foreign
banks (including U.S. branches of foreign banks) which at the time of
investment (i) have more than U.S. $1 billion, or the equivalent in other
currencies, in total assets; and (ii) in the opinion of the Portfolio Manager,
are of an investment quality comparable to fixed income obligations in which
the Portfolio may invest. The Aggressive Equity and Emerging Markets
Portfolios may only invest in obligations of foreign banks (including U.S.
branches of foreign banks) which at the time of investment (i) have more than
$10 billion, or the equivalent in other currencies, in total assets; (ii) in
terms of assets are among the 75 largest foreign banks in the world; (iii)
have branches or agencies (limited purpose offices which do not offer all
banking services) in the U.S.; and (iv) in the opinion of the
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Portfolio Manager, are of an investment quality comparable to obligations of
U.S. banks in which the Portfolios may invest. The I-Net Tollkeeper Portfolio
may invest in obligations issued or guaranteed by U.S. or foreign banks. There
is no limitation on the amount of a Portfolio's assets which may be invested
in obligations of foreign banks if the bank obligations meet the appropriate
conditions set forth above.
Obligations of foreign banks involve somewhat different investment risks
than those affecting obligations of U.S. banks, including: (i) the
possibilities that their liquidity could be impaired because of future
political and economic developments; (ii) their obligations may be less
marketable than comparable obligations of U.S. banks; (iii) a foreign
jurisdiction might impose withholding taxes on interest income payable on
those obligations; (iv) foreign deposits may be seized or nationalized; (v)
foreign governmental restrictions, such as exchange controls, may be adopted
which might adversely affect the payment of principal and interest on those
obligations; and (vi) the selection of those obligations may be more difficult
because there may be less publicly available information concerning foreign
banks or the accounting, auditing, and financial reporting standards,
practices and requirements applicable to foreign banks may differ from those
applicable to U.S. banks. Foreign banks are not generally subject to
examination by any U.S. Government agency or instrumentality.
The International Value Portfolio's investments in convertible securities,
described below, that are purchased in furtherance of the Portfolio's
investment objective, are not subject to the limitations described above with
respect to bank obligations.
Municipal Securities
The Bond and Income Portfolio may invest up to 5% of its net assets in
municipal securities. Municipal securities consist of bonds, notes and other
instruments issued by or on behalf of states, territories and possessions of
the United States (including the District of Columbia) and their political
subdivisions, agencies or instrumentalities, the interest on which is exempt
from regular federal income tax. Municipal securities are often issued to
obtain funds for various public purposes. Municipal securities also include
"private activity bonds" or industrial development bonds, which are issued by
or on behalf of public authorities to obtain funds for privately operated
facilities, such as airports and waste disposal facilities, and, in some
cases, commercial and industrial facilities.
The yields and market values of municipal securities are determined
primarily by the general level of interest rates, the creditworthiness of the
issuers of municipal securities and economic and political conditions
affecting such issuers. Due to their tax exempt status, the yields and market
prices of municipal securities may be adversely affected by changes in tax
rates and policies, which may have less effect on the market for taxable fixed
income securities. Moreover, certain types of municipal securities, such as
housing revenue bonds, involve prepayment risks which could affect the yield
on such securities.
Investments in municipal securities are subject to the risk that the issuer
could default on its obligations. Such a default could result from the
inadequacy of the sources or revenues from which interest and principal
payments are to be made or the assets collateralizing such obligations.
Revenue bonds, including private activity bonds, are backed only by specific
assets or revenue sources and not by the full faith and credit of the
governmental issuer.
Small Capitalization Stocks
The Small-Cap Equity, Aggressive Equity, Growth LT. Equity, Small-Cap Index,
International Value, and Emerging Markets Portfolios, and to a lesser degree,
the Equity Income, Multi-Strategy, Large-Cap Value and Mid-Cap Value
Portfolios, may invest in small capitalization stocks. Investments in larger
companies present certain advantages in that such companies generally have
greater financial resources, more extensive research and development,
manufacturing, marketing and service capabilities, more stability and greater
depth of management and technical personnel. Investments in smaller, less
seasoned companies may present greater opportunities for growth but also
involve greater risks than customarily are associated with more established
companies. The securities of smaller companies may be subject to more abrupt
or erratic market movements than
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larger, more established companies. These companies may have limited product
lines, markets or financial resources, or they may be dependent upon a limited
management group. Their securities may be traded only in the over-the-counter
market or on a regional securities exchange and may not be traded every day or
in the volume typical of trading on a major securities exchange. As a result,
the disposition by a Portfolio of securities to meet redemptions, or
otherwise, may require the Portfolio to sell these securities at a discount
from market prices or to sell during a period when such disposition is not
desirable or to make many small sales over a lengthy period of time.
Corporate Debt Securities
All Portfolios may invest in U.S. dollar-denominated corporate debt
securities of domestic issuers and the Money Market, High Yield Bond, Managed
Bond, Government Securities, International Large-Cap, Aggressive Equity,
Growth LT, Multi-Strategy, Mid-Cap Value, Bond and Income, International
Value, Emerging Markets and Diversified Research, Portfolios may invest in
U.S. dollar-denominated debt securities of foreign issuers. The Aggressive
Equity, Growth LT, Mid-Cap Value, International Value, and Emerging Markets
Portfolios, and, to the extent of 20% of their assets, the Managed Bond and
Government Securities Portfolios, and to the extent of 10% of their assets,
the Multi-Strategy, Mid-Cap Value, and Bond and Income Portfolios, may also
invest in debt securities of foreign issuers denominated in foreign
currencies. The debt securities in which any Portfolio, other than the Money
Market Portfolio, may invest are limited to corporate debt securities
(corporate bonds, debentures, notes, and other similar corporate debt
instruments) which meet the minimum ratings criteria set forth for that
particular Portfolio, or, if not so rated, are, in the Portfolio Manager's
opinion, comparable in quality to corporate debt securities in which a
Portfolio may invest. The debt securities in which the Money Market Portfolio
may invest are described in the discussion of the investment objective and
policies of that Portfolio.
The investment return on corporate debt securities reflects interest
earnings and changes in the market value of the security. The market value of
corporate debt obligations may be expected to rise and fall inversely with
interest rates generally. There also exists the risk that the issuers of the
securities may not be able to meet their obligations on interest or principal
payments at the time called for by an instrument.
The High Yield Bond, Managed Bond, Aggressive Equity, Growth LT, Equity
Income, Multi-Strategy, Bond and Income, International Value, and Emerging
Markets Portfolios may invest in corporate debt securities rated Baa (Moody's)
or BBB (S&P), or, if not rated by Moody's or S&P, of equivalent quality. Such
securities are considered medium grade, and do not have economic
characteristics that provide the high degree of security with respect to
payment of principal and interest associated with higher rated bonds, and
generally have some speculative characteristics. A bond will be placed in this
rating category where interest payments and principal security appear adequate
for the present, but economic characteristics that provide longer term
protection may be lacking.
The High Yield Bond, Equity Income and Multi-Strategy Portfolios and, to the
extent of 10% of their assets, the Managed Bond and Growth LT Portfolios, and,
to the extent of 20% of its assets, the Bond and Income Portfolio and to the
extent of 5% of its assets, the Large-Cap Value (no limit on below investment
grade convertible securities), International Value and I-Net Tollkeeper
Portfolios, may invest in debt securities rated lower than Baa or BBB
(although the Managed Bond Portfolio may not invest in securities rated lower
than B), or, if not rated by Moody's or S&P, of equivalent quality. Such
securities are not considered to be investment grade, and are regarded as
predominately speculative with respect to the issuer's continuing ability to
meet principal and interest payments. For more information on the risks of
such securities, see the discussion of "High Yield Bonds" above.
Variable and Floating Rate Securities
All Portfolios, except for the Diversified Research and International Large-
Cap Portfolios, may invest in variable and floating rate securities which
provide for a periodic adjustment in the interest rate paid on obligations.
The terms of such obligations must provide that interest rates are adjusted
periodically based upon
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an appropriate interest rate adjustment index as provided in the respective
obligations. The adjustment intervals may be regular, and range from daily to
annually, or may be event based, such as based on a change in the prime rate.
The interest rate on a floating rate debt instrument ("floater") is a
variable rate which is tied to another interest rate, such as a money market
index or Treasury bill rate. The interest rate on a floater resets
periodically, typically every six months. While, because of the interest rate
reset feature, floaters provide Portfolios with a certain degree of protection
against rises in interest rates, Portfolios investing in floaters will
participate in any declines in interest rates as well.
The interest rate on a leveraged inverse floating rate debt instrument
("inverse floater") resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher degree of leverage inherent in inverse floaters is
associated with greater volatility in their market values. Accordingly,
duration of an inverse floater may exceed its stated final maturity. Certain
inverse floaters may be deemed to be illiquid securities for purposes of a
Portfolio's limitations on investments in such securities.
The Bond and Income Portfolio may invest in super floating rate CMOs ("super
floaters"). A super floater is a leveraged floating-rate tranche in a CMO
issue. At each monthly reset date, a super floater's coupon rate is determined
by a slated formula. Typically, the rate is a multiple of some index minus a
fixed-coupon amount. When interest rates rise, a super floater is expected to
outperform regular floating rate CMOs because of its leveraging factor and
higher lifetime caps. Conversely, when interest rates fall, a super floater is
expected to underperform floating rate CMOs because its coupon rate drops by
the leveraging factor. In addition, a super floater may reach its cap as
interest rates increase and may no longer provide the benefits associated with
increasing coupon rates.
Commercial Paper
All of the Portfolios may invest in commercial paper (including variable
amount master demand notes). Each Portfolio, other than the Money Market and
Equity Portfolios may invest in commercial paper denominated in U.S. dollars,
issued by U.S. corporations or foreign corporations and (1) rated at the date
of investment Prime-1 or Prime-2 by Moody's or A-1 or A-2 by S&P or (2) if not
rated by either Moody's or S&P, issued by a corporation having an outstanding
debt issue rated Aa or better by Moody's or AA or better by S&P or (3) if not
rated, are determined to be of an investment quality comparable to rated
commercial paper in which a Portfolio may invest. If issued by a foreign
corporation, such commercial paper is U.S. dollar-denominated and not subject
at the time of purchase to foreign tax withholding. The Aggressive Equity,
International Value, International Large-Cap, and Emerging Markets Portfolios
may, however, invest in commercial paper denominated in foreign currencies.
The Money Market Portfolio may invest in commercial paper that meets the
standards for money market securities that Portfolio may acquire as described
in the Prospectus and in "Additional Investment Policies of the Portfolios"
above. The Equity Portfolio may invest in commercial paper (1) rated at the
time of purchase Prime-1 by Moody's or A-1 by S&P or (2) if not rated by
either Moody's or S&P, issued by a corporation having an outstanding debt
issue rated Aa or better by Moody's or AA or better by S&P.
Commercial paper obligations may include variable amount master demand
notes. These are obligations that permit the investment of fluctuating amounts
at varying rates of interest pursuant to direct arrangements between a
Portfolio, as lender, and the borrower. These notes permit daily changes in
the amounts borrowed. The lender has the right to increase the amount under
the note at any time up to the full amount provided by the note agreement, or
to decrease the amount, and the borrower may prepay up to the full amount of
the note without penalty. Because variable amount master demand notes are
direct lending arrangements between the lender and borrower, it is not
generally contemplated that such instruments will be traded and there is no
secondary market for these notes. However, they are redeemable (and thus
immediately repayable by the borrower) at face value, plus accrued interest,
at any time. In connection with master demand note arrangements, the Adviser
or Portfolio
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Manager will monitor, on an ongoing basis, the earning power, cash flow, and
other liquidity ratios of the borrower and its ability to pay principal and
interest on demand. The Adviser or Portfolio Manager also will consider the
extent to which the variable amount master demand notes are backed by bank
letters of credit. These notes generally are not rated by Moody's or S&P; a
Portfolio, other than the Money Market Portfolio, may invest in them only if
the Adviser or Portfolio Manager believes that at the time of investment the
notes are of comparable quality to the other commercial paper in which the
Portfolio may invest. With respect to the Money Market Portfolio,
determination of eligibility for the Portfolio will be in accordance with the
standards described in the discussion of the Portfolio in the Prospectus and
in "Additional Investment Policies of the Portfolios" above. Master demand
notes are considered by the Portfolio to have a maturity of one day unless the
Adviser or Portfolio Manager has reason to believe that the borrower could not
make immediate repayment upon demand. See the Appendix for a description of
Moody's and S&P ratings applicable to commercial paper.
Convertible Securities
All Portfolios except the Money Market Portfolio may invest in convertible
securities. The convertible securities in the Portfolio's portfolios are
fixed-income securities which may be converted or exchanged at a stated
exchange ratio into underlying shares of common stock. The exchange ratio for
any particular convertible security may be adjusted from time to time due to
stock splits, dividends, spin-offs, other corporate distributions, or
scheduled changes in the exchange ratio. Convertible bonds and convertible
preferred stocks, until converted, have general characteristics similar to
both fixed-income and equity securities. Although to a lesser extent than with
fixed-income securities generally, the market value of convertible securities
tends to decline as interest rates increase and, conversely, tends to increase
as interest rates decline. In addition, because of the conversion or exchange
feature, the market value of convertible securities tends to vary with
fluctuations in the market value of the underlying common stocks, and,
therefore, also will react to variations in the general market for equity
securities. A unique feature of convertible securities is that as the market
price of the underlying common stock declines, convertible securities tend to
trade increasingly on a yield basis, and so may not experience market value
declines to the same extent as the underlying common stock. When the market
price of the underlying common stock increases, the prices of the convertible
securities tend to rise as a reflection of the value of the underlying common
stock. While no securities investments are without risk, investments in
convertible securities generally entail less risk than investments in common
stock of the same issuer.
As fixed-income securities, convertible securities are investments which
provide for a stable stream of income with generally higher yields than common
stocks. Of course, like all fixed-income securities, there can be no assurance
of current income because the issuers of the convertible securities may
default in their obligations. Convertible securities, however, generally offer
lower interest or dividend yields than non-convertible securities of similar
quality because of the potential for capital appreciation.
A convertible security, in addition to providing fixed-income, offers the
potential for capital appreciation through the conversion feature which
enables the holder to benefit from increases in the market price of the
underlying common stock. In selecting the securities for a Portfolio, the
Adviser or Portfolio Manager gives substantial consideration to the potential
for capital appreciation of the common stock underlying the convertible
securities. However, there can be no assurance of capital appreciation because
securities prices fluctuate.
Convertible securities generally are subordinated to other similar but
nonconvertible securities of the same issuer although convertible bonds, as
corporate debt obligations, enjoy seniority in right of payment to all equity
securities, and convertible preferred stock is senior to common stock, of the
same issuer. However, because of the subordination feature, convertible bonds
and convertible preferred stock typically have lower ratings than similar non-
convertible securities.
A "synthetic convertible" is created by combining distinct securities which
possess the two principal characteristics of a true convertible, i.e., fixed-
income ("fixed-income component") and the right to acquire equity securities
("convertibility component"). This combination is achieved by investing in
nonconvertible fixed-income securities (nonconvertible bonds and preferred
stocks) and in warrants, granting the holder the right to purchase a specified
quantity of securities within a specified period of time at a specified price.
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However, the synthetic convertible differs from the true convertible
security in several respects. Unlike a true convertible, which is a single
security having a unitary market value, a synthetic convertible is comprised
of two distinct securities, each with its own market value. Therefore, the
"market value" of a synthetic convertible is the sum of the values of its
fixed-income component and its convertibility component. For this reason, the
value of a synthetic convertible and a true convertible security will respond
differently to market fluctuations.
More flexibility is possible in the assembly of a synthetic convertible than
in the purchase of a convertible security in that its two components may be
purchased separately. For example, a Portfolio Manager may purchase a warrant
for inclusion in a synthetic convertible but temporarily hold short-term
investments while postponing purchase of a corresponding bond pending
development of more favorable market conditions.
A holder of a synthetic convertible faces the risk that the price of the
stock underlying the convertibility component will decline, causing a decline
in the value of the warrant; should the price of the stock fall below the
exercise price and remain there throughout the exercise period, the entire
amount paid for the warrant would be lost. Since a synthetic convertible
includes the fixed-income component as well, the holder of a synthetic
convertible also faces the risk that interest rates will rise, causing a
decline in the value of the fixed-income instrument.
Repurchase Agreements
All Portfolios may invest in repurchase agreements, which entail the
purchase of a portfolio eligible security from a bank or broker-dealer that
agrees to repurchase the security at the Portfolio's cost plus interest within
a specified time (normally one day). Repurchase agreements permit an investor
to maintain liquidity and earn income over periods of time as short as
overnight. If a Portfolio acquires securities from a bank or broker-dealer it
may simultaneously enter into a repurchase agreement with the seller wherein
the seller agrees at the time of sale to repurchase the security at a mutually
agreed upon time and price. The term of such an agreement is generally quite
short, possibly overnight or for a few days, although it may extend over a
number of months (up to one year) from the date of delivery. The resale price
is in excess of the purchase price by an amount which reflects an agreed upon
market rate of return, effective for the period of time the Portfolio is
invested in the security. This results in a fixed rate of return protected
from market fluctuations during the period of the agreement. This rate is not
tied to the coupon rate on the security subject to the repurchase agreement.
If the party agreeing to repurchase should default and if the value of the
securities held by a Portfolio should fall below the repurchase price, a loss
could be incurred. Repurchase agreements will be entered into only where the
underlying security is within the three highest credit categories assigned by
established rating agencies (Aaa, Aa, or A by Moody's or AAA, AA, or A by S&P)
or, if not rated by Moody's or S&P, are of equivalent investment quality as
determined by the Adviser or Portfolio Manager, except that the Money Market
Portfolio will enter into repurchase agreements only where the underlying
securities are of the quality that is eligible for the Portfolio as described
in the discussion of that Portfolio's investment objective and policies.
Under the 1940 Act, repurchase agreements are considered to be loans by the
purchaser collateralized by the underlying securities. The Adviser or
Portfolio Manager to a Portfolio monitors the value of the underlying
securities at the time the repurchase agreement is entered into and at all
times during the term of the agreement to ensure that its value always equals
or exceeds the agreed upon repurchase price to be paid to the Portfolio. The
Adviser or Portfolio Manager, in accordance with procedures established by the
Board of Trustees, also evaluates the creditworthiness and financial
responsibility of the banks and brokers or dealers with which the Portfolio
enters into repurchase agreements.
A Portfolio may not enter into a repurchase agreement having more than seven
days remaining to maturity if, as a result, such agreements, together with any
other securities which are not readily marketable, would exceed 15% of the net
assets of the Portfolio (10% for the Money Market Portfolio). If the seller
should become bankrupt or default on its obligations to repurchase the
securities, a Portfolio may experience delay or difficulties in exercising its
rights to the securities held as collateral and might incur a loss if the
value of the securities should decline. A Portfolio also might incur
disposition costs in connection with liquidating the securities. The
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Equity and Bond and Income Portfolios may, together with other registered
investment companies managed by Goldman Sachs Asset Management or its
affiliates, transfer uninvested cash balances into a single joint account, the
daily aggregate balance of which will be invested in one or more repurchase
agreements.
Borrowing
Each Portfolio may borrow up to certain limits. A Portfolio may not borrow
if, as a result of such borrowing, the total amount of all money borrowed by
the Portfolio exceeds 33 1/3% of the value of its total assets (at the time of
such borrowing), including reverse repurchase agreements. This borrowing may
be unsecured. Borrowing may exaggerate the effect on net asset value of any
increase or decrease in the market value of a Portfolio. Money borrowed will
be subject to interest costs which may or may not be recovered by appreciation
of the securities purchased. A Portfolio also may be required to maintain
minimum average balances in connection with such borrowing or to pay a
commitment or other fee to maintain a line of credit; either of these
requirements would increase the cost of borrowing over the stated interest
rate. Reverse repurchase agreements will be included as borrowing subject to
the borrowing limitations described above.
The Mid-Cap Value Portfolio may borrow for investment purposes
("leveraging") to the extent permitted under the 1940 Act, which permits an
investment company to engage in borrowing, provided that it maintains
continuous asset coverage of 300% of the amount borrowed. If the required
coverage should decline as a result of market fluctuations or other reasons,
the Mid-Cap Value Portfolio may be required to sell some of its portfolio
securities within three days to reduce the amount of its borrowings and to
restore the 300% asset coverage, even though it may be disadvantageous from an
investment standpoint to sell securities at that time.
Reverse Repurchase Agreements and Other Borrowings
Among the forms of borrowing in which the High Yield Bond, Managed Bond,
Government Securities, Aggressive Equity, Growth LT, Mid-Cap Value, Bond and
Income, Equity Index, Emerging Markets, Diversified Research and International
Large-Cap Portfolios may engage and enter into are reverse repurchase
agreements. Reverse repurchase agreements which involve the sale of a debt
security held by the Portfolio, with an agreement by that Portfolio to
repurchase the security at a stated price, date and interest payment.
A Portfolio will use the proceeds of a reverse repurchase agreement to
purchase other money market instruments which either mature at a date
simultaneous with or prior to the expiration of the reverse repurchase
agreement or which are held under an agreement to resell maturing as of that
time. The use of reverse repurchase agreements by a Portfolio creates leverage
which increases a Portfolio's investment risk. If the income and gains on
securities purchased with the proceeds of reverse repurchase agreements exceed
the cost of the agreements, the Portfolio's earnings or net asset value will
increase faster than otherwise would be the case; conversely, if the income
and gains fail to exceed the costs, earnings or net asset value would decline
faster than otherwise would be the case. A Portfolio will enter into a reverse
repurchase agreement only when the interest income to be earned from the
investment of the proceeds of the transaction is greater than the interest
expense of the transaction. However, reverse repurchase agreements involve the
risk that the market value of securities retained by the Portfolio may decline
below the repurchase price of the securities sold by the Portfolio which it is
obligated to repurchase.
A Portfolio may enter into reverse repurchase agreements with banks or
broker-dealers. Entry into such agreements with broker-dealers requires the
creation and maintenance of a segregated account consisting of U.S. Government
securities, cash or liquid securities marked-to-market daily at least equal in
value to its obligations in respect of reverse repurchase agreements.
Firm Commitment Agreements and When-Issued Securities
All Portfolios may enter into firm commitment agreements for the purchase of
securities at an agreed upon price on a specified future date. A Portfolio may
purchase new issues of securities on a "when-issued" basis, whereby the
payment obligation and interest rate on the instruments are fixed at the time
of the transaction. Such
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transactions might be entered into, for example, when the Adviser or Portfolio
Manager to a Portfolio anticipates a decline in the yield of securities of a
given issuer and is able to obtain a more advantageous yield by committing
currently to purchase securities to be issued or delivered later.
Except for the Mid-Cap Value Portfolio, a Portfolio will not enter into such
a transaction for the purpose of investment leverage. Liability for the
purchase price--and all the rights and risks of ownership of the securities--
accrue to the Portfolio at the time it becomes obligated to purchase such
securities, although delivery and payment occur at a later date. Accordingly,
if the market price of the security should decline, the effect of the
agreement would be to obligate the Portfolio to purchase the security at a
price above the current market price on the date of delivery and payment.
During the time the Portfolio is obligated to purchase such securities it will
maintain in a segregated account U.S. Government securities, cash or liquid
securities marked-to-market daily of an aggregate current value sufficient to
make payment for the securities.
Loans of Portfolio Securities
For the purpose of realizing additional income, each Portfolio may make
secured loans of its portfolio securities to broker-dealers or U.S. banks
provided: (i) such loans are secured continuously by collateral consisting of
cash, cash equivalents, or U.S. Government securities maintained on a daily
marked-to-market basis in an amount or at a market value at least equal to the
current market value of the securities loaned; (ii) the Portfolio may at any
time call such loans and obtain the securities loaned; (iii) the Portfolio
will receive an amount in cash at least equal to the interest or dividends
paid on the loaned securities; and (iv) the aggregate market value of
securities loaned will not at any time exceed 33 1/3% of the total assets of
the Portfolio. In addition, it is anticipated that the Portfolio may share
with the borrower some of the income received on the collateral for the loan
or that it will be paid a premium for the loan. It should be noted that in
connection with the lending of its portfolio securities, the Portfolio is
exposed to the risk of delay in recovery of the securities loaned or possible
loss of rights in the collateral should the borrower become insolvent. The
Fund has contracted with State Street Bank & Trust Company to engage in
securities lending of domestic securities and The Chase Manhattan Bank
("Chase") to engage in securities lending of foreign securities (collectively,
the "Lending Agents"). In determining whether to lend securities, the Lending
Agents consider all relevant facts and circumstances, including the
creditworthiness of the borrower. Voting rights attached to the loaned
securities may pass to the borrower with the lending of portfolio securities.
The Portfolio may recall securities if the Portfolio Manager wishes to vote on
matters put before shareholders.
Short Sales
The Mid-Cap Value Portfolio may engage in short sales. A short sale is a
transaction in which a Portfolio sells a security it does not own in
anticipation of a decline in the market price. Even during normal or favorable
market conditions, the Portfolio may make short sales in an attempt to
maintain portfolio flexibility and facilitate the rapid implementation of
investment strategies if the Portfolio Manager believes that the price of a
particular security or group of securities is likely to decline.
When the Portfolio makes a short sale, the Portfolio must arrange through a
broker to borrow the security to deliver to the buyer; and, in so doing, the
Portfolio becomes obligated to replace the security borrowed at its market
price at the time of replacement, whatever that price may be. The Portfolio
may have to pay a premium to borrow the security. The Portfolio must also pay
any dividends or interest payable on the security until the Portfolio replaces
the security.
The Portfolio's obligation to replace the security borrowed in connection
with the short sale will be secured by collateral deposited with the broker,
consisting of cash, U.S. Government securities or other securities acceptable
to the broker. In addition, with respect to any short sale, other than short
sales against the box, the Portfolio will be required to deposit collateral
consisting of cash or liquid securities, marked-to-market daily, in a
segregated account with its custodian in an amount such that the value of the
sum of both collateral deposits is at all times equal to at least 100% of the
current market value of the securities sold short.
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Short Sales Against the Box
The Aggressive Equity, Mid-Cap Value and Equity Portfolios may enter into
short sales "against the box." A short sale is "against the box" when a
Portfolio enters into a transaction to sell a security short as described
above, while at all times during which a short position is open, maintaining
an equal amount of such securities, or owning securities giving it the right,
without payment of future consideration, to obtain an equal amount of
securities sold short. The Portfolio's obligation to replace the securities
sold short is then completed by purchasing the securities at their market
price at time of replacement. No more than 15% of the value of a Portfolio's
net assets will be subject to such short sales at any time.
Illiquid and Restricted Securities (Private Placements)
All Portfolios may acquire illiquid securities. Generally, a security is
considered illiquid if it cannot be disposed of within seven days. Its
illiquidity might prevent the sale of such security at a time when a Portfolio
Manager might wish to sell, and these securities could have the effect of
decreasing the overall level of a Portfolio's liquidity. Further, the lack of
an established secondary market may make it more difficult to value illiquid
securities, requiring the Fund to rely on judgments that may be somewhat
subjective in determining value, which could vary from the amount that a
Portfolio could realize upon disposition.
All Portfolios except the Equity Index Portfolio may invest in restricted
securities (including privately placed securities) but a Portfolio will not
acquire such securities if they are illiquid and other securities that are
illiquid, such as repurchase agreements maturing in more than seven days, if
as a result they would comprise more than 15% of the value of the Portfolio's
net assets, and in the case of the Money Market Portfolio, 10% of the value of
its Portfolio assets. The privately placed securities in which these
Portfolios may invest are called restricted securities because there are
restrictions or conditions attached to their resale.
Restricted securities may be sold only in a public offering with respect to
which a registration statement is in effect under the Securities Act of 1933
or in a transaction exempt from such registration such as certain privately
negotiated transactions. Where registration is required, the Portfolio may be
obligated to pay all or part of the registration expenses and a considerable
period may elapse between the time of the decision to sell and the time the
Portfolio may be permitted to sell a security under an effective registration
statement. If, during such a period, adverse market conditions were to
develop, the Portfolio might obtain a less favorable price than prevailed when
it decided to sell. Restricted securities will be priced at fair value as
determined in good faith under the direction of the Board of Trustees. If
through the appreciation of restricted securities or the depreciation of
unrestricted securities, the Portfolio should be in a position where more than
15% of the value of its net assets are invested in restricted securities that
are illiquid and other securities that are illiquid, the Portfolio Manager
will consider whether steps should be taken to assure liquidity.
Certain restricted securities may be purchased by certain "qualified
institutional buyers" without the necessity for registration of the
securities. A Portfolio may acquire such a security without the security being
treated as illiquid for purposes of the above-described limitation on
acquisition of illiquid assets if the Portfolio Manager determines that the
security is liquid under guidelines adopted by the Fund's Board of Trustees.
Investing in such restricted securities could have the effect of increasing
the level of the Portfolio's illiquidity to the extent that qualified
institutional buyers become, for a time, uninterested in purchasing these
securities.
Precious Metals-Related Securities
The Equity Portfolio, and possibly other Portfolios that invest in equity
securities, may invest in precious metals-related securities. Precious metals-
related securities are considered equity securities of U.S. and foreign
companies involved in the exploration, mining, development, production, or
distribution of gold or other natural resources, including minerals and metals
such as copper, aluminum, silver, platinum, uranium, strategic metals,
diamonds, coal, oil, and phosphates.
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The value of these securities may be affected by worldwide financial and
political factors, and prices may fluctuate sharply over short time periods.
For example, precious metals securities may be affected by changes in
inflation expectations in various countries, metal sales by central banks of
governments or international agencies, governmental restrictions on the
private ownership of certain precious metals or minerals and other factors.
Foreign Securities
The Money Market, High Yield Bond, Managed Bond, Government Securities,
Aggressive Equity, Growth LT, Multi-Strategy, Large-Cap Value, Mid-Cap Value,
Bond and Income, REIT, International Value, and Emerging Markets Portfolios
may invest directly in U.S. dollar-denominated corporate debt securities of
foreign issuers, certain foreign bank obligations and U.S. dollar-denominated
obligations of foreign governments, foreign government agencies and
international agencies. The Small-Cap Equity, Growth LT, Equity Income,
Multi-Strategy and Equity Index Portfolios may invest in equity securities of
foreign issuers if U.S. exchange listed or if otherwise included in the S&P
500. The Growth LT Portfolio may invest up to 25% of its assets in foreign
securities denominated in a foreign currency and not publicly traded in the
United States. The Aggressive Equity Portfolio may invest in securities of
foreign issuers that are traded in U.S. securities markets and may invest up
to 20% of its assets in securities that are traded principally in securities
markets outside of the United States. The International Value and Emerging
Markets Portfolios may invest in equity securities of foreign corporations,
nonconvertible fixed income securities denominated in foreign currencies, and
in securities represented by EDRs, GDRs, or other securities convertible into
equity securities of foreign issuers. The I-Net Tollkeeper Portfolio may
invest up to 25% of its assets in foreign securities. The Growth LT Portfolio
may also invest in EDRs and GDRs and other types of receipts of shares
evidencing ownership of the underlying foreign securities. The Managed Bond
and Government Securities Portfolios may each invest up to 20% of their assets
in non-U.S. dollar-denominated debt securities of foreign issuers. The Large-
Cap Value Portfolio may invest up to 20% of its net assets in securities of
foreign companies, the Mid-Cap Value Portfolio may invest up to 15% of its
total assets in foreign equity or debt securities, and the REIT Portfolio may
invest up to 10% of its assets in foreign equity or debt securities, which may
include GDRs. The Multi-Strategy and Bond and Income Portfolios may invest up
to 10% of their assets in non-U.S. dollar-denominated debt securities of
foreign issuers. The Small-Cap Index Portfolio may invest in foreign equity
securities if they are U.S. exchange listed and if they are included in the
Russell 2000 Index. The Diversified Research Portfolio may invest in foreign
issuers whose principal markets are in the U.S., which include American
Depositary Receipts and foreign securities registered in the U.S., and up to
15% of its total assets in companies domiciled outside the U.S. and not
included in the S&P 500. The International Large-Cap Portfolio normally
invests at least 80% of its net assets in companies located outside the U.S.
All Portfolios, except the Equity Portfolio, may purchase ADRs which are
dollar-denominated receipts issued generally by domestic banks and
representing the deposit with the bank of a security of a foreign issuer. ADRs
are publicly-traded on exchanges or over-the-counter in the United States. The
I-Net Tollkeeper Portfolio also may invest in GDRs, EDRs or other similar
instruments representing securities of foreign issuers. EDRs and GDRs are
receipts evidencing an arrangement with a non-U.S. bank similar to that for
ADRs and are designed for use in the non-U.S. securities markets. EDRs and
GDRs are not necessarily quoted in the same currency as the underlying
security.
Investing in the securities of foreign issuers involves special risks and
considerations not typically associated with investing in U.S. companies.
These risks are intensified with respect to investments in emerging market
countries. These include differences in accounting, auditing and financial
reporting standards, generally higher commission rates on foreign portfolio
transactions, the possibility of expropriation, nationalization, or
confiscatory taxation, adverse changes in investment or exchange control
regulations, trade restrictions, political instability (which can affect U.S.
investments in foreign countries), and potential restrictions on the flow of
international capital. It may be more difficult to obtain and enforce
judgments against foreign entities. Additionally, income (including dividends
and interest) from foreign securities may be subject to foreign taxes,
including foreign withholding taxes, and other foreign taxes may apply with
respect to securities transactions.
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Transactions on foreign exchanges or over-the-counter markets may involve
greater time from the trade date until settlement than for domestic securities
transactions and, if the securities are held abroad, may involve the risk of
possible losses through the holding of securities in custodians and
depositories in foreign countries. Foreign securities often trade with less
frequency and volume than domestic securities and therefore may exhibit
greater price volatility. Changes in foreign exchange rates will affect the
value of those securities which are denominated or quoted in currencies other
than the U.S. dollar. Investing in ADRs, EDRs and GDRs may involve many of the
same special risks associated with investing in securities of foreign issuers
other than liquidity risks.
There is generally less publicly available information about foreign
companies comparable to reports and ratings that are published about companies
in the United States. Foreign companies are also generally not subject to
uniform accounting and auditing and financial reporting standards, practices,
and requirements comparable to those applicable to U.S. companies.
It is contemplated that most foreign securities will be purchased in over-
the-counter markets or on stock exchanges located in the countries in which
the respective principal offices of the issuers of the various securities are
located, if that is the best available market. Foreign stock markets are
generally not as developed or efficient as those in the United States. While
growing in volume, they usually have substantially less volume than the New
York Stock Exchange, and securities of some foreign companies are less liquid
and more volatile than securities of comparable U.S. companies. Similarly,
volume and liquidity in most foreign bond markets is less than in the United
States and at times, volatility of price can be greater than in the United
States. Fixed commissions on foreign stock exchanges are generally higher than
negotiated commissions on U.S. exchanges, although the Portfolio will endeavor
to achieve the most favorable net results on its portfolio transactions. There
is generally less government supervision and regulation of stock exchanges,
brokers, and listed companies than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations,
nationalization, expropriation or confiscatory taxation, limitations on the
removal of funds or other assets of the Portfolio, political or social
instability, or diplomatic developments which could affect United States
investments in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the United States' economy in such
respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency, and balance of payments position.
The dividends and interest payable on certain of the Portfolios' foreign
portfolio securities may be subject to foreign withholding taxes, thus
reducing the net amount of income available for distribution.
Investors should understand that the expense ratio of the International
Value, International Large-Cap and Emerging Markets Portfolios can be expected
to be higher than investment companies investing in domestic securities since
the cost of maintaining the custody of foreign securities and the rate of
advisory fees paid by the Portfolios are higher.
Each of the emerging countries, including Asia and Eastern Europe, may be
subject to a substantially greater degree of economic, political and social
instability and disruption than is the case in the United States, Japan and
most Western European countries. This instability may result from, among other
things, the following: (i) authoritarian governments or military involvement
in political and economic decision making, including changes or attempted
changes in governments through extra-constitutional means; (ii) popular unrest
associated with demands for improved political, economic or social conditions;
(iii) internal insurgencies; (iv) hostile relations with neighboring
countries; (v) ethnic, religious and racial disaffection or conflict; and (vi)
the absence of developed legal structures governing foreign private
investments and private property. Such economic, political and social
instability could disrupt the principal financial markets in which the
Portfolios may invest and adversely affect the value of the Portfolios'
assets. A Portfolio's investments could in the future be adversely affected by
any increase in taxes or by political, economic or diplomatic developments.
The I-Net Tollkeeper Portfolio may seek investment opportunities within former
"east bloc" countries in Eastern Europe. All or a substantial portion of such
investments may be considered "not readily marketable" for purposes of the
limitation on illiquid securities set forth above.
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Investment in foreign securities also involves the risk of possible losses
through the holding of securities in custodian banks and securities
depositories in foreign countries. The Fund has entered into a Custody
Agreement with Investors Fiduciary Trust Company ("IFTC"), a trust company
chartered under the laws of Missouri, which has entered into a Subcustodial
Agreement with Chase under which Chase, together with certain of its foreign
branches and agencies and foreign banks and securities depositories acting as
subcustodian to Chase, will maintain custody of the securities and other
assets of foreign issuers for the Fund. Under these agreements, Chase and IFTC
have agreed (i) to use reasonable care in the safekeeping of these securities,
(ii) to indemnify and hold harmless the Fund from and against any loss which
shall occur as a result of the failure of a foreign bank or securities
depository holding such securities and (iii) to exercise reasonable care in
the safekeeping of such securities to the same extent as if the securities
were held in New York. Pursuant to requirements of the SEC, Chase is required
to use reasonable care in the selection of foreign subcustodians, and to
consider the financial strength of the foreign subcustodian, its general
reputation and standing (for depository, its operating history and number of
participants), its ability to provide efficiently the custodial services
required, its relative costs for the services to be rendered, and the Fund's
ability to obtain jurisdiction over the foreign subcustodian to enforce
judgments. No assurance can be given that expropriation, nationalization,
freezes, or confiscation of assets, which would impact assets of the
Portfolio, will not occur, and shareholders bear the risk of losses arising
from these or other events.
The International Value, International Large-Cap, and Emerging Markets
Portfolios' foreign investments will be allocated to at least three countries
at all times. In addition, each Portfolio may not invest more than 50% of its
assets in any one second tier country or more than 25% of its assets in any
one third tier country. First tier countries are: Germany, the United Kingdom,
Japan, the United States, France, Canada, and Australia. Second tier countries
are all countries not in the first or third tier. Third tier countries are
countries identified as "emerging" or "developing" by the International Bank
for Reconstruction and Development ("World Bank") or International Finance
Corporation. The Portfolios are not subject to any limit upon investment in
issuers domiciled or primarily traded in the United States. Less
diversification among countries may create an opportunity for higher returns,
but may also result in higher risk of loss because of greater exposure to a
market decline in a single country.
Furthermore, there are greater risks involved in investing in emerging
market countries and/or their securities markets, such as less diverse and
less mature economic structures, less stable political systems, more
restrictive foreign investment policies, smaller-sized securities markets and
low trading volumes. Such risks can make investments illiquid and more
volatile than investments in developed countries and such securities may be
subject to abrupt and severe price declines. The Year 2000 problem also may be
especially acute in emerging market countries, which may adversely affect the
value of the Portfolio's investments. Moreover, securities issued by European
issuers may be adversely impacted by the use of the "Euro" as a common
currency in 11 European Monetary Union member states. The Euro may result in
various legal and accounting differences, tax treatments, the creation and
implementation of suitable clearing and settlement systems and other
operational problems, that may cause market disruptions that could adversely
affect investments quoted in the Euro.
Foreign Currency Transactions and Forward Foreign Currency Contracts
Generally, the foreign exchange transactions of the Managed Bond, Government
Securities, Aggressive Equity, Growth LT, Multi-Strategy, Large-Cap Value,
Mid-Cap Value, Bond and Income, International Value, I-Net Tollkeeper,
Emerging Markets, Diversified Research, and International Large-Cap Portfolios
will be conducted on a spot, i.e., cash, basis at the spot rate for purchasing
or selling currency prevailing in the foreign exchange market. This rate,
under normal market conditions, differs from the prevailing exchange rate in
an amount generally less than 0.15 of 1% due to the costs of converting from
one currency to another. However, the Portfolios have authority to deal in
forward foreign exchange transactions to hedge and manage currency exposure
against possible fluctuations in foreign exchange rates. This is accomplished
through contractual agreements to purchase or sell a specified currency at a
specified future date and price set at the time of the contract.
A Portfolio's dealings in forward foreign exchange transactions may include
hedging involving either specific transactions or portfolio positions. A
Portfolio may purchase and sell forward foreign currency contracts
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in combination with other transactions in order to gain exposure to an
investment in lieu of actually purchasing such investment. Transaction hedging
is the purchase or sale of forward foreign currency contracts with respect to
specific receivables or payables of a Portfolio arising from the purchase and
sale of portfolio securities, the sale and redemption of shares of a
Portfolio, or the payment of dividends and distributions by a Portfolio.
Position hedging is the sale of forward foreign currency contracts with
respect to portfolio security positions denominated in or exposed to a foreign
currency. In connection with either of these types of hedging, a Portfolio may
also engage in proxy hedging. Proxy hedging entails entering into a forward
contract to buy or sell a currency whose changes in value are generally
considered to be moving in correlation with a currency or currencies in which
portfolio securities are or are expected to be denominated. Proxy hedging is
often used when a currency in which portfolio securities are denominated is
difficult to hedge. The precise matching of a currency with a proxy currency
will not generally be possible and there may be some additional currency risk
in connection with such hedging transactions. The Portfolios will not
speculate in forward foreign exchange.
A Portfolio may enter into forward foreign currency contracts only under the
following circumstances: First, when a Portfolio enters into a contract for
the purchase or sale of a security denominated in or exposed to a foreign
currency, it may desire to "lock in" the U.S. dollar price of the security. By
entering into a forward contract for the purchase or sale of the amount of
foreign currency involved in the underlying security transactions (or a proxy
currency considered to move in correlation with that currency) for a fixed
amount of dollars, a Portfolio may be able to protect itself against a
possible loss resulting from an adverse change in the relationship between the
U.S. dollar and the subject foreign currency during the period between the
date the security is purchased or sold and the date on which payment is made
or received. Second, when the Portfolio Manager of a Portfolio believes that
the currency of a particular foreign country may suffer a substantial movement
against another currency, it may enter into a forward contract to sell or buy
the amount of the former foreign currency (or a proxy currency considered to
move in correlation with that currency), approximating the value of some or
all of the Portfolio's portfolio securities denominated in or exposed to such
foreign currency. The precise matching of the forward contract amounts and the
value of the securities involved will not generally be possible since the
future value of such securities in foreign currencies will change as a
consequence of market movements in the value of those securities between the
date the forward contract is entered into and the date it matures. The
projection of short-term currency market movements is extremely difficult and
the successful execution of a short-term hedging strategy is highly uncertain.
In no event will a Portfolio enter into forward contracts or maintain a net
exposure to such contracts, where the consummation of the contracts would
obligate the Portfolio to deliver an amount of foreign currency in excess of
the value of that Portfolio's holdings denominated in or exposed to that
foreign currency (or a proxy currency considered to move in correlation with
that currency), or exposed to a particular securities market, or futures
contracts, options or other derivatives on such holdings. In addition, in no
event will a Portfolio enter into forward contracts under this second
circumstance, if, as a result, the Portfolio will have more than 25% of the
value of its total assets committed to the consummation of such contracts.
Under normal circumstances, consideration of the prospect for currency
parities will be incorporated into the longer term investment decisions made
with regard to overall diversification strategies. The Portfolios will cover
outstanding forward currency contracts by maintaining liquid portfolio
securities or other assets denominated in or exposed to the currency
underlying the forward contract or the currency being hedged. To the extent
that a Portfolio is not able to cover its forward currency positions with
underlying portfolio securities, the Portfolio's custodian bank will place
cash or liquid equity or debt securities in a separate account of the
Portfolio in an amount equal to the value of the Portfolio's total assets
committed to the consummation of forward foreign currency exchange contracts.
If the value of the securities used to cover a position or the value of assets
placed in the separate account declines, a Portfolio will find alternative
cover or additional cash or securities will be placed in the account on a
daily basis so that the value of the segregated assets will equal the amount
of the Portfolio's commitments with respect to such contracts.
When a Portfolio Manager of a Portfolio believes that the currency of a
particular foreign country may suffer a decline against the U.S. dollar, that
Portfolio may enter into a forward contract to sell the amount of foreign
currency approximating the value of some or all of the Portfolio's holdings
denominated in or exposed to such foreign currency. At the maturity of the
forward contract to sell, the Portfolio may either sell the portfolio
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security and make delivery of the foreign currency or it may retain the
security and terminate its contractual obligation to deliver the foreign
currency by purchasing an "offsetting" contract with the same currency trader
obligating the Portfolio to purchase, on the same maturity date, the same
amount of the foreign currency.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of the contract. Accordingly, it may be
necessary for a Portfolio to purchase additional foreign currency on the spot
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Portfolio is
obligated to deliver and if a decision is made to sell the security and make
delivery of the foreign currency. Conversely, it may be necessary to sell on
the spot market some of the foreign currency received upon the sale of the
portfolio security if its market value exceeds the amount of foreign currency
the Portfolio is obligated to deliver.
If a Portfolio retains the portfolio security and engages in an offsetting
transaction, the Portfolio will incur a gain or a loss (as described below) to
the extent that there has been movement in forward contract prices. If the
Portfolio engages in an offsetting transaction, it may subsequently enter into
a new forward contract to sell the foreign currency. Should forward prices
decline during the period between the Portfolio's entering into a forward
contract for the sale of a foreign currency and the date it enters into an
offsetting contract for the purchase of the foreign currency, the Portfolio
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should
forward prices increase, the Portfolio will suffer a loss to the extent the
price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
A Portfolio is not required to enter into such transactions with regard to
their foreign currency denominated securities and will not do so unless deemed
appropriate by its Portfolio Manager. It also should be realized that this
method of protecting the value of a Portfolio's holdings in securities against
a decline in the value of a currency does not eliminate fluctuations in the
underlying prices of the securities. It simply establishes a rate of exchange
which one can achieve at some future point in time. Additionally, although
such contracts tend to minimize the risk of loss due to a decline in the value
of the hedged currency, at the same time they tend to limit any potential gain
which might result from the value of such currency increase.
Although a Portfolio values its shares in terms of U.S. dollars, it does not
intend to convert its holdings of foreign currencies into U.S. dollars on a
daily basis. It will do so from time to time, and investors should be aware of
the costs of currency conversion. Although foreign exchange dealers do not
charge a fee for conversion, they do realize a profit based on the difference
(the "spread") between the prices at which they are buying and selling various
currencies. Thus, a dealer may offer to sell a foreign currency to a Portfolio
at one rate, while offering a lesser rate of exchange should the Portfolio
desire to resell that currency to the dealer.
The Managed Bond, Government Securities, Aggressive Equity, Growth LT,
Large-Cap Value, Mid-Cap Value, Bond and Income, International Value, I-Net
Tollkeeper, Emerging Markets, Diversified Research, and International
Large-Cap Portfolios may also purchase and write options on foreign
currencies, invest in foreign currency futures contracts, and purchase and
write options thereon, as described below.
Options
In pursuing their investment objectives, the High Yield Bond, Managed Bond,
Government Securities, Aggressive Equity, Growth LT, Equity Income, Multi-
Strategy, Large-Cap Value, Mid-Cap Value, Equity, Bond and Income, REIT,
Emerging Markets, Diversified Research, and International Large-Cap Portfolios
may engage in the purchase and writing of put and call options on securities.
The I-Net Tollkeeper Portfolio may write covered call and put options on any
securities in which it may invest. In pursuing their investment objectives,
the Aggressive Equity, Growth LT, Equity Income, Multi-Strategy, Large-Cap
Value, Mid-Cap Value, Equity, Bond and Income, Equity Index, Small-Cap Index,
International Value, Emerging Markets, Diversified Research, and International
Large-Cap Portfolios may purchase put and call options on stock indexes and
the Aggressive
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Equity, Growth LT, Equity Income, Multi-Strategy, Mid-Cap Value, Equity, Bond
and Income, International Value, I-Net Tollkeeper and Emerging Markets
Portfolios may write put and call options on securities indexes.
Purchasing and Writing Options on Securities. The High Yield Bond, Managed
Bond, Government Securities, Aggressive Equity, Growth LT, Equity Income,
Multi-Strategy, Large-Cap Value, Mid-Cap Value, Equity, Bond and Income, REIT,
Emerging Markets, Diversified Research, and International Large-Cap Portfolios
may purchase and write put and call options on securities. A Portfolio may
purchase and sell (write) (i) both put and call options on debt or other
securities in standardized contracts traded on national securities exchanges,
boards of trade, similar entities, or for which an established over-the-
counter market exists; and (ii) agreements, sometimes called cash puts, which
may accompany the purchase of a new issue of bonds from a dealer.
An option on a security is a contract that gives the holder of the option,
in return for a premium, the right to buy from (in the case of a call) or sell
to (in the case of a put) the writer of the option the security underlying the
option at a specified exercise price at any time during the term of the
option. The writer of an option on a security has the obligation upon exercise
of the option to deliver the underlying security upon payment of the exercise
price or to pay the exercise price upon delivery of the underlying security. A
Portfolio may purchase put options on securities to protect holdings in an
underlying or related security against a substantial decline in market value.
Securities are considered related if their price movements generally correlate
to one another. For example, the purchase of put options on debt securities
held in a Portfolio will enable a Portfolio to protect, at least partially, an
unrealized gain in an appreciated security without actually selling the
security. In addition, the Portfolio will continue to receive interest income
on such security.
A Portfolio may purchase call options on securities to protect against
substantial increases in prices of securities the Portfolio intends to
purchase pending its ability to invest in such securities in an orderly
manner. A Portfolio may sell put or call options it has previously purchased,
which could result in a net gain or loss depending on whether the amount
realized on the sale is more or less than the premium and other transaction
costs paid on the put or call option which is sold. A Portfolio may also allow
options to expire unexercised.
In order to earn additional income on its portfolio securities or to protect
partially against declines in the value of such securities, a Portfolio may
write covered call options. The exercise price of a call option may be below,
equal to, or above the current market value of the underlying security at the
time the option is written. During the option period, a covered call option
writer may be assigned an exercise notice by the broker-dealer through whom
such call option was sold requiring the writer to deliver the underlying
security against payment of the exercise price. This obligation is terminated
upon the expiration of the option period or at such earlier time in which the
writer effects a closing purchase transaction. Closing purchase transactions
will ordinarily be effected to realize a profit on an outstanding call option,
to prevent an underlying security from being called, to permit the sale of the
underlying security, or to enable the Portfolio to write another call option
on the underlying security with either a different exercise price or
expiration date or both.
In order to earn additional income or to facilitate its ability to purchase
a security at a price lower than the current market price of such security, a
Portfolio may write secured put options. During the option period, the writer
of a put option may be assigned an exercise notice by the broker-dealer
through whom the option was sold requiring the writer to purchase the
underlying security at the exercise price.
A Portfolio may write call options and put options only if they are
"covered" or "secured." In the case of a call option on a security, the option
is "covered" if the Portfolio owns the security underlying the call or has an
absolute and immediate right to acquire that security without additional cash
consideration (or, if additional cash consideration is required, cash or cash
equivalents in such amount are placed in a segregated account by its
custodian) upon conversion or exchange of other securities held by the
Portfolio, or, if the Portfolio has a call on the same security if the
exercise price of the call held (i) is equal to or less than the exercise
price of the call written or (ii) is greater than the exercise price of the
call written, if the difference is maintained by the Portfolio
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in cash, U.S. Government securities or liquid securities marked-to-market
daily in a segregated account with the Fund's custodian. A put is secured if
the Portfolio maintains cash, U.S. Government securities or liquid securities
marked-to-market daily with a value equal to the exercise price in a
segregated account or holds a put on the same underlying security at an equal
or greater exercise price.
Prior to the earlier of exercise or expiration, an option may be closed out
by an offsetting purchase or sale of an option of the same series (type,
exchange, underlying security, exercise price, and expiration). There can be
no assurance, however, that a closing purchase or sale transaction can be
effected when the Portfolio desires.
A Portfolio will realize a capital gain from a closing purchase transaction
if the cost of the closing option is less than the premium received from
writing the option, or, if it is more, the Portfolio will realize a capital
loss. If the premium received from a closing sale transaction is more than the
premium paid to purchase the option, the Portfolio will realize a capital gain
or, if it is less, the Portfolio will realize a capital loss. The principal
factors affecting the market value of a put or a call option include supply
and demand, interest rates, the current market price of the underlying
security in relation to the exercise price of the option, the volatility of
the underlying security, and the time remaining until the expiration date.
The premium paid for a put or call option purchased by a Portfolio is an
asset of the Portfolio. The premium received for an option written by a
Portfolio is recorded as a deferred credit. The value of an option purchased
or written is marked-to-market daily and is valued at the closing price on the
exchange on which it is traded or, if not traded on an exchange or no closing
price is available, at the mean between the last bid and asked prices.
Purchasing and Writing Options on Stock Indexes. The Aggressive Equity,
Growth LT, Equity Income, Multi-Strategy, Large-Cap Value, Mid-Cap Value,
Equity, Bond and Income, Equity Index, International Value Emerging Markets,
Diversified Research, and International Large-Cap Portfolios may purchase put
and call options on stock indexes which are standardized and traded on a U.S.
exchange or board of trade, or for which an established over-the-counter
market exists. The Aggressive Equity, Growth LT, Equity Income,
Multi-Strategy, Mid-Cap Value, Equity, Bond and Income, International Value,
Emerging Markets, Diversified Research, and International Large-Cap Portfolios
may sell put and call options on securities indexes that are exchange traded
or traded on over-the-counter markets. The I-Net Tollkeeper Portfolio may
write covered call and put options on any securities index consisting of
securities in which it may invest. Like other options listed on United States
securities exchanges, index options are issued by the Options Clearing
Corporation ("OCC"). The Small-Cap Index Portfolio may purchase and sell
options on stock indexes that are based on the Russell 2000 or other indexes
of small capitalization companies.
A stock index is a method of reflecting in a single number the market values
of many different stocks or, in the case of value weighted indices that take
into account prices of component stocks and the number of shares outstanding,
the market values of many different companies. Stock indexes are compiled and
published by various sources, including securities exchanges. An index may be
designed to be representative of the stock market as a whole, of a broad
market sector (e.g., industrials), or of a particular industry (e.g.,
electronics). An index may be based on the prices of all, or only a sample, of
the stocks whose value it is intended to represent.
A stock index is ordinarily expressed in relation to a "base" established
when the index was originated. The base may be adjusted from time to time to
reflect, for example, capitalization changes affecting component stocks. In
addition, stocks may from time to time be dropped from or added to an index
group. These changes are within the discretion of the publisher of the index.
Different stock indexes are calculated in different ways. Often the market
prices of the stocks in the index group are "value weighted;" that is, in
calculating the index level, the market price of each component stock is
multiplied by the number of shares outstanding. Because of this method of
calculation, changes in the stock prices of larger corporations will generally
have a greater influence on the level of a value weighted (or sometimes
referred to as a capitalization weighted) index than price changes affecting
smaller corporations.
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In general, index options are very similar to stock options, and are
basically traded in the same manner. However, when an index option is
exercised, the exercise is settled by the payment of cash--not by the delivery
of stock. The assigned writer of a stock option is obligated to pay the
exercising holder cash in an amount equal to the difference (expressed in
dollars) between the closing level of the underlying index on the exercise
date and the exercise price of the option, multiplied by a specified index
"multiplier." A multiplier of 100, for example, means that a one-point
difference will yield $100.
Gains or losses on the Portfolios' transactions in securities index options
depend primarily on price movements in the stock market generally (or, for
narrow market indexes, in a particular industry or segment of the market)
rather than the price movements of individual securities held by a Portfolio
of the Fund. A Portfolio may sell securities index options prior to expiration
in order to close out its positions in stock index options which it has
purchased. A Portfolio may also allow options to expire unexercised.
Risks of Options Transactions. There are several risks associated with
transactions in options. For example, there are significant differences
between the securities and options markets that could result in an imperfect
correlation between these markets, causing a given transaction not to achieve
its objectives. A decision as to whether, when, and how to use options
involves the exercise of skill and judgment, and even a well-conceived
transaction may be unsuccessful to some degree because of market behavior or
unexpected events.
There can be no assurance that a liquid market will exist when a Portfolio
seeks to close out an option position. If a Portfolio were unable to close out
an option it had purchased on a security, it would have to exercise the option
to realize any profit or the option may expire worthless. If a Portfolio were
unable to close out a covered call option it had written on a security, it
would not be able to sell the underlying security unless the option expired
without exercise. As the writer of a covered call option, a Portfolio forgoes,
during the option's life, the opportunity to profit from increases in the
market value of the security covering the call option above the sum of the
premium and the exercise price of the call.
If trading were suspended in an option purchased by a Portfolio, the
Portfolio would not be able to close out the option. If restrictions on
exercise were imposed, the Portfolio might be unable to exercise an option it
has purchased.
With respect to index options, current index levels will ordinarily continue
to be reported even when trading is interrupted in some or all of the stocks
in an index group. In that event, the reported index levels will be based on
the current market prices of those stocks that are still being traded (if any)
and the last reported prices for those stocks that are not currently trading.
As a result, reported index levels may at times be based on non-current price
information with respect to some or even all of the stocks in an index group.
Exchange rules permit (and in some instances require) the trading of index
options to be halted when the current value of the underlying index is
unavailable or when trading is halted in stocks that account for more than a
specified percentage of the value of the underlying index. In addition, as
with other types of options, an exchange may halt the trading of index options
whenever it considers such action to be appropriate in the interests of
maintaining a fair and orderly market and protecting investors. If a trading
halt occurs, whether for these or for other reasons, holders of index options
may be unable to close out their positions and the options may expire
worthless.
Spread Transactions. The High Yield Bond, Managed Bond and Government
Securities Portfolios may enter into spread transactions with securities
dealers. Such spread transactions are not generally exchange listed or traded.
Spread transactions may occur in the form of options, futures, forwards or
swap transactions. The purchase of a spread transaction gives a Portfolio the
right to sell or receive a security or a cash payment with respect to an index
at a fixed dollar spread or fixed yield spread in relationship to another
security or index which is used as a benchmark. The risk to a Portfolio in
purchasing spread transactions is the cost of the premium paid for the spread
transaction and any transaction costs. The sale of a spread transaction
obligates a Portfolio to purchase or deliver a security or a cash payment with
respect to an index at a fixed dollar spread or fixed yield spread in
relationship to another security or index which is used as a benchmark. In
addition, there is no
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assurance that closing transactions will be available. The purchase and sale
of spread transactions will be used in furtherance of a Portfolio's objectives
and to protect a Portfolio against adverse changes in prevailing credit
quality spreads, i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of the spread
transaction. The Fund does not consider a security covered by a spread
transaction to be "pledged" as that term is used in the Fund's policy limiting
the pledging or mortgaging of its assets. The sale of spread transactions will
be "covered" or "secured" as described in the "Options", "Options on Foreign
Currencies", "Futures Contracts and Options on Futures Contracts", and "Swap
Agreements and Options on Swap Agreements" sections.
Options on Foreign Currencies
The Managed Bond, Government Securities, Aggressive Equity, Growth LT,
Large-Cap Value, Mid-Cap Value, Bond and Income, International Value, I-Net
Tollkeeper, Emerging Markets, Diversified Research, and International Large
Cap Portfolios may purchase and sell options on foreign currencies for hedging
purposes in a manner similar to that in which futures or forward contracts on
foreign currencies will be utilized. For example, a decline in the U.S. dollar
value of a foreign currency in which portfolio securities are denominated will
reduce the U.S. dollar value of such securities, even if their value in the
foreign currency remains constant. In order to protect against such
diminutions in the value of portfolio securities, a Portfolio may buy put
options on the foreign currency. If the value of the currency declines, the
Portfolio will have the right to sell such currency for a fixed amount in U.S.
dollars and will offset, in whole or in part, the adverse effect on its
portfolio.
Conversely, when a rise in the U.S. dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, a Portfolio may buy call options thereon. The
purchase of such options could offset, at least partially, the effects of the
adverse movements in exchange rates. As in the case of other types of options,
however, the benefit to the Portfolio from purchases of foreign currency
options will be reduced by the amount of the premium and related transaction
costs. In addition, if currency exchange rates do not move in the direction or
to the extent desired, the Portfolio could sustain losses on transactions in
foreign currency options that would require the Portfolio to forgo a portion
or all of the benefits of advantageous changes in those rates.
A Portfolio may write options on foreign currencies for hedging purposes.
For example, to hedge against a potential decline in the U.S. dollar value of
foreign currency denominated securities due to adverse fluctuations in
exchange rates, the Portfolio could, instead of purchasing a put option, write
a call option on the relevant currency. If the expected decline occurs, the
option will most likely not be executed and the diminution in value of
portfolio securities will be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against a potential
increase in the U.S. dollar cost of securities to be acquired, the Portfolio
could write a put option on the relevant currency which, if rates move in the
manner projected, will expire unexercised and allow the Portfolio to hedge the
increased cost up to the amount of the premium. As in the case of other types
of options, however, the writing of a foreign currency option will constitute
only a partial hedge up to the amount of the premium. If exchange rates do not
move in the expected direction, the option may be exercised and the Portfolio
would be required to buy or sell the underlying currency at a loss which may
not be offset by the amount of the premium. Through the writing of options on
foreign currencies, the Portfolio also may lose all or a portion of the
benefits which might otherwise have been obtained from favorable movements in
exchange rates.
A Portfolio may write covered call and put options on foreign currencies. A
call option written on a foreign currency by the Portfolio is "covered" if the
Portfolio (i) owns the underlying foreign currency covered by the call; (ii)
has an absolute and immediate right to acquire that foreign currency without
additional cash consideration (or for additional cash consideration held in a
segregated account by the Fund's custodian) upon conversion or exchange of
other foreign currency held in its portfolio; (iii) has a call on the same
foreign currency and in the same principal amount as the call written if the
exercise price of the call held (a) is equal to
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or less than the exercise price of the call written, or (b) is greater than
the exercise price of the call written, if the difference is maintained by the
Portfolio in government securities, cash or liquid securities marked-to-market
daily of that foreign currency, and/or cash, U.S. Government securities, or
liquid securities marked-to-market daily in a segregated account with the
Fund's custodian; or (iv) cross-hedges the call option by segregating and
marking-to-market cash or liquid assets equal to the value of the underlying
foreign currency. A put option written on a foreign currency by a Portfolio is
"covered" if the option is secured by (i) government securities, cash or
liquid securities marked-to-market daily of that foreign currency, and/or U.S.
Government securities, cash or liquid securities marked-to-market daily at
least equal to the exercise price in a segregated account, or (ii) a put on
the same underlying currency at an equal or greater exercise price.
A Portfolio also may write call options on foreign currencies for cross-
hedging purposes that would not be deemed to be covered. A call option on a
foreign currency is for cross-hedging purposes if it is not covered but is
designed to provide a hedge against a decline due to an adverse change in the
exchange rate in the U.S. dollar value of a security which the Portfolio owns
or has the right to acquire and which is denominated in the currency
underlying the option. In such circumstances, the Portfolio collateralizes the
option by maintaining, in a segregated account with the Fund's custodian,
cash, U.S. Government Securities, and/or liquid securities marked-to-market
daily in an amount not less than the value of the underlying foreign currency
in U.S. dollars marked-to-market daily.
Foreign currency options are subject to the risks of the availability of a
liquid secondary market described above, as well as the risks regarding
adverse market movements, margining of options written, the nature of the
foreign currency market, possible intervention by governmental authorities and
the effects of other political and economic events. In addition, exchange-
traded options on foreign currencies involve certain risks not presented by
the over-the-counter market. For example, exercise and settlement of such
options must be made exclusively through the OCC, which has established
banking relationships in applicable foreign countries for this purpose. As a
result, the OCC may, if it determines that foreign governmental restrictions
or taxes would prevent the orderly settlement of foreign currency option
exercises, or would result in undue burdens on the OCC or its clearing member,
impose special procedures on exercise and settlement, such as technical
changes in the mechanics of delivery of currency, the fixing of dollar
settlement prices or prohibitions on exercise.
In addition, options on foreign currencies may be traded on foreign
exchanges and over-the-counter in foreign countries. Such transactions are
subject to the risk of governmental actions affecting trading in or the prices
of foreign currencies or securities. The value of such positions also could be
adversely affected by (i) other complex foreign political and economic
factors, (ii) lesser availability than in the United States of data on which
to make trading decisions, (iii) delays in a Portfolio's ability to act upon
economic events occurring in foreign markets during non-business hours in the
United States, (iv) the imposition of different exercise and settlement terms
and procedures and margin requirements than in the United States, and (v) low
trading volume.
Investments in Other Investment Company Securities
Under the 1940 Act, a Portfolio may not own more than 3% of the outstanding
voting stock of an investment company, invest more than 5% of its total assets
in any one investment company, or invest more than 10% of its total assets in
the securities of investment companies. As the shareholder of another
investment company, a Portfolio would bear, along with other shareholders, its
pro rata portion of the other investment company's expenses, including
advisory fees. Such expenses are in addition to the expenses a Portfolio pays
in connection with its own operations.
SPDRs. The Equity and the I-Net Tollkeeper Portfolios may also invest in
SPDRs in compliance with the 1940 Act. SPDRs are interests in a unit
investment trust ("UIT") that may be obtained from the UIT or purchased in the
secondary market (SPDRs are listed on the American Stock Exchange). The UIT
has been established to accumulate and hold a portfolio of common stocks that
is intended to track the price performance and dividend yields of the S&P 500.
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Individual investments in SPDRs are not redeemable, except upon termination
of the UIT. However, large quantities of SPDRs known as "Creation Units" are
redeemable from the sponsor of the UIT. The liquidity of small holdings of
SPDRs, therefore, will depend upon the existence of a secondary market.
The price of SPDRs is derived from and based upon the securities held by the
UIT. Accordingly, the level of risk involved in the purchase or sale of a SPDR
is similar to the risk involved in the purchase or sale of traditional common
stock, with the exception that the pricing mechanism for SPDRs is based on a
basket of stocks. Disruptions in the markets for the securities underlying
SPDRs purchased or sold by the Equity Portfolio could result in losses on
SPDRs. Trading in SPDRs involves risks similar to those risks, described under
"Risks of Options Transactions."
WEBS and OPALS. The Emerging Markets, and the I-Net Tollkeeper Portfolios
may invest in WEBS ("World Equity Benchmark Shares") and OPALS ("Optimised
Portfolios as Listed Securities"). WEBS have been listed on the American Stock
Exchange since 1996 and are issued by Foreign Fund, Inc., an open-end
investment company registered under the 1940 Act. WEBS are designed to
replicate the composition and performance of publicly traded issuers in
particular foreign countries. The market prices of WEBS are expected to
fluctuate in accordance with both changes in the net asset values of their
underlying indices and the supply and demand of WEBS on the American Stock
Exchange. Investments in WEBS are managed by BZW Barclays Global Fund
Advisors.
OPALS track the performance of adjustable baskets of stocks owned by Morgan
Stanley Capital (Luxembourg) S.A. (the "Counterparty") until a specified
maturity date. Holders of OPALS will receive semi-annual distributions
corresponding to dividends received on shares contained in the underlying
basket of stocks, net of expenses. On the maturity date of the OPALS, the
holders will receive the physical securities comprising the underlying
baskets. OPALS represent an unsecured obligation and therefore carry with them
the risk that the Counterparty will default and the Portfolio may not be able
to recover the current value of its investment.
Investments in WEBS and OPALS will be limited to the percentage restrictions
set forth above for investments in investment company securities.
Futures Contracts and Options on Futures Contracts
The Large-Cap Value, Mid-Cap Value, I-Net Tollkeeper, and Emerging Markets
Portfolios may invest in futures contracts on securities and options thereon.
The High Yield Bond, Managed Bond, Government Securities, Growth LT, Multi-
Strategy, Bond and Income, REIT, and International Value Portfolios may invest
in interest rate futures and options thereon. The Aggressive Equity, Growth
LT, Equity Income, Multi-Strategy, Large-Cap Value, Mid-Cap Value, Equity,
Equity Index, Small-Cap Index, International Value, I-Net Tollkeeper, and
Emerging Markets Portfolios may invest in stock index futures and options
thereon.
There are several risks associated with the use of futures and futures
options. While a Portfolio hedging transactions may protect the Portfolio
against adverse movements in the general level of interest rates or stock or
currency prices, such transactions could also preclude the opportunity to
benefit from favorable movements in the level of interest rates or stock or
currency prices. A hedging transaction may not correlate perfectly with price
movements in the assets being hedged. An incorrect correlation could result in
a loss on both the hedged assets in a Portfolio and/or the hedging vehicle, so
that the Portfolio's return might have been better had hedging not been
attempted.
There can be no assurance that a liquid market will exist at a time when a
Portfolio seeks to close out a futures contract or a futures option position.
Most futures exchanges and boards of trade limit the amount of fluctuation
permitted in futures contract prices during a single day; once the daily limit
has been reached on a particular contract, no trades may be made that day at a
price beyond that limit. In addition, certain of these instruments are
relatively new and lack a deep secondary market. Lack of a liquid market for
any reason may prevent a Portfolio from liquidating an unfavorable position
and the Portfolio would remain obligated to meet margin requirements until the
position is closed.
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If a fund buys a futures contract to gain exposure to securities, the fund
is exposed to the risk of change in the value of the futures contract, which
may be caused by a change in the value of the underlying securities.
Interest Rate Futures. (The High Yield Bond, Managed Bond, Government
Securities, Growth LT, Multi-Strategy, Bond and Income, REIT, I-Net
Tollkeeper, and International Value Portfolios.) An interest rate futures
contract is an agreement between two parties (buyer and seller) to take or
make delivery of a specified quantity of financial instruments (such as GNMA
certificates or Treasury bonds) at a specified price at a future date. In the
case of futures contracts traded on U.S. exchanges, the exchange itself or an
affiliated clearing corporation assumes the opposite side of each transaction
(i.e., as buyer or seller). A futures contract may be satisfied or closed out
by delivery or purchase, as the case may be, of the financial instrument or by
payment of the change in the cash value of the index. Frequently, using
futures to effect a particular strategy instead of using the underlying or
related security will result in lower transaction costs being incurred. A
public market exists in futures contracts covering various financial
instruments including U.S. Treasury bonds, U.S. Treasury notes, GNMA
certificates, three month U.S. Treasury bills, 90 day commercial paper, bank
certificates of deposit, and Eurodollar certificates of deposit.
As a hedging strategy a Portfolio might employ, a Portfolio would purchase
an interest rate futures contract when it is not fully invested in long-term
debt securities but wishes to defer their purchase for some time until it can
orderly invest in such securities or because short-term yields are higher than
long-term yields. Such purchase would enable the Portfolio to earn the income
on a short-term security while at the same time minimizing the effect of all
or part of an increase in the market price of the long-term debt security
which the Portfolio intended to purchase in the future. A rise in the price of
the long-term debt security prior to its purchase either would be offset by an
increase in the value of the futures contract purchased by the Portfolio or
avoided by taking delivery of the debt securities under the futures contract.
A Portfolio would sell an interest rate futures contract in order to
continue to receive the income from a long-term debt security, while
endeavoring to avoid part or all of the decline in market value of that
security which would accompany an increase in interest rates. If interest
rates did rise, a decline in the value of the debt security held by the
Portfolio would be substantially offset by the ability of the Portfolio to
repurchase at a lower price the interest rate futures contract previously
sold. While the Portfolio could sell the long-term debt security and invest in
a short-term security, ordinarily the Portfolio would give up income on its
investment, since long-term rates normally exceed short-term rates.
Stock Index Futures. (The Aggressive Equity, Growth LT, Equity Income,
Multi-Strategy, Large-Cap Value, Mid-Cap Value, Equity, Equity Index, Small-
Cap Index, International Value, I-Net Tollkeeper, and Emerging Markets
Portfolios.) A stock index is a method of reflecting in a single number the
market values of many different stocks or, in the case of capitalization
weighted indices that take into account both stock prices and the number of
shares outstanding, many different companies. An index fluctuates generally
with changes in the market values of the common stocks so included. A stock
index futures contract is a bilateral agreement pursuant to which two parties
agree to take or make delivery of an amount of cash equal to a specified
dollar amount multiplied by the difference between the stock index value at
the close of the last trading day of the contract and the price at which the
futures contract is originally purchased or sold. No physical delivery of the
underlying stocks in the index is made.
A Portfolio may purchase and sell stock index futures contracts to hedge its
securities portfolio. A Portfolio may engage in transactions in futures
contracts only in an effort to protect it against a decline in the value of
the Portfolio's portfolio securities or an increase in the price of securities
that the Portfolio intends to acquire. For example, a Portfolio may sell stock
index futures to protect against a market decline in an attempt to offset
partially or wholly a decrease in the market value of securities that the
Portfolio intends to sell. Similarly, to protect against a market advance when
the Portfolio is not fully invested in the securities market, the Portfolio
may purchase stock index futures that may partly or entirely offset increases
in the cost of securities that the Portfolio intends to purchase.
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Futures Options. The High Yield Bond, Managed Bond, Government Securities,
Growth LT, Multi-Strategy, Bond and Income, REIT, and International Value
Portfolios may purchase and sell (write) call and put options on interest rate
futures. Futures options possess many of the same characteristics as options
on securities. A futures option gives the holder the right, in return for the
premium paid, to assume a long position (call) or short position (put) in a
futures contract at a specified exercise price at any time during the period
of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
The Aggressive Equity, Growth LT, Equity Income, Multi-Strategy, Large-Cap
Value, Mid-Cap Value, Equity, Equity Index, Small-Cap Index, International
Value, I-Net Tollkeeper, and Emerging Markets Portfolios may purchase and sell
put and call options on stock index futures. Options on stock index futures
contracts give the purchaser the right, in return for the premium paid, to
assume a position in a stock index futures contract (a long position if the
option is a call and a short position if the option is a put) at a specified
exercise price at any time during the period of the option. Upon exercise of
the option, the delivery of the futures position by the writer of the option
to the holder of the option will be accompanied by delivery of the accumulated
balance in the writer's futures margin account which represents the amount by
which the market price of the stock index 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 stock index futures contract. If an option
is exercised on the last trading day prior to the expiration date of the
option, the settlement will be made entirely in cash equal to the difference
between the exercise price of the option and the closing level of the index on
which the futures contract is based on the expiration date. Purchasers of
options who fail to exercise their options prior to the exercise date suffer a
loss of the premium paid. During the option period, the covered call writer
(seller) has given up the opportunity to profit from a price increase in the
underlying securities above the exercise price. The writer of an option has no
control over the time when it may be required to fulfill its obligation as a
writer of the option.
The High Yield Bond, Multi-Strategy, Equity Income, Large-Cap Value, Mid-Cap
Value, Equity, Equity Index and Small-Cap Index Portfolios will only enter
into futures contracts and futures options which are standardized and traded
on a U.S. exchange, board of trade, or similar entity, or in the case of
futures options, for which an established over-the-counter market exists.
If a purchase or sale of a futures contract is made by a Portfolio, the
Portfolio is required to deposit with its custodian (or broker, if legally
permitted) a specified amount of cash or U.S. Government securities ("initial
margin"). The margin required for a futures contract is set by the exchange on
which the contract is traded and may be modified during the term of the
contract. The initial margin is in the nature of a performance bond or good
faith deposit on the futures contract which is returned to the Portfolio upon
termination of the contract, assuming all contractual obligations have been
satisfied. Each investing Portfolio expects to earn interest income on its
initial margin deposits. A futures contract held by a Portfolio is valued
daily at the official settlement price of the exchange on which it is traded.
Each day the Portfolio pays or receives cash, called "variation margin," equal
to the daily change in value of the futures contract. This process is known as
"marking-to-market." Variation margin does not represent a borrowing or loan
by a Portfolio but is instead settlement between the Portfolio and the broker
of the amount one would owe the other if the futures contract expired. In
computing daily net asset value, each Portfolio will mark-to-market its open
futures positions.
A Portfolio is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Portfolio.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security, and delivery month). If an offsetting purchase
price is less than the original sale price, the Portfolio realizes a capital
gain, or if it is more, the Portfolio realizes a capital loss. Conversely, if
an offsetting sale price is more than the original purchase price, the
Portfolio realizes a capital gain, or if it is less, the Portfolio realizes a
capital loss. The transaction costs must also be included in these
calculations.
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<PAGE>
Limitations. The Fund will comply with certain regulations of the Commodity
Futures Trading Commission ("CFTC") under which an investment company may
engage in futures transactions and qualify for an exclusion from being a
"commodity pool." Under these regulations, a Portfolio may only enter into a
futures contract or purchase an option thereon (1) for bona fide hedging
purposes and (2) for other purposes if, immediately thereafter, the initial
margin deposits for futures contracts held by that Portfolio plus premiums
paid by it for open futures option positions, less the amount by which any
such positions are "in-the-money," would not exceed 5% of the Portfolio's
total assets. A call option is "in-the-money" if the value of the futures
contract that is the subject of the option exceeds the exercise price. A put
option is "in-the-money" if the exercise price exceeds the value of the
futures contract that is the subject of the option.
When purchasing a futures contract, a Portfolio must maintain in a
segregated account (or broker, if legally permitted) cash, U.S. Government
securities and/or other liquid securities marked-to-market daily (including
any margin) equal to the price of such contract or will "cover" its position
by holding a put option permitting the Portfolio to sell the same futures
contract with a strike price equal to or higher than the price of the futures
contract held. When writing a call option on a futures contract, the Portfolio
similarly will maintain government securities, cash and/or liquid securities
marked-to-market daily of that foreign currency, and/or, U.S. Government
securities, cash, or other liquid securities marked-to-market daily (including
any margin) equal to the amount such option is in-the-money until the option
expires or is closed out by the Portfolio or will "cover" its position by (1)
owning the same futures contract at a price no higher than the strike price of
the call option, or (2) owning the commodity (financial or otherwise)
underlying the futures contract, or (3) holding a call option permitting the
Portfolio to purchase the same futures contract at a price no higher than the
strike price of the call option sold by the Portfolio. When selling a futures
contract or selling a put option on a futures contract, the Portfolio is
required to maintain government securities, cash and/or liquid securities
marked-to-market daily of that foreign currency, and/or U.S. Government
securities, cash, or other liquid securities marked-to-market daily (including
any margin) equal to the market value of such contract or exercise price of
such option or to "cover" its position, when selling a futures contract, by
(1) owning the commodity (financial or otherwise) underlying the futures
contract or (2) holding a call option permitting the Portfolio to purchase the
same futures contract at a price no higher than the price at which the short
position was established, and, when selling a put option on the futures
contract, by (1) selling the futures contract underlying the put option at the
same or higher price than the strike price of the put option or (2) purchasing
a put option, if the strike price of the purchased option is the same or
higher than the strike price of the put option sold by the Portfolio.
A Portfolio may not maintain open short positions in futures contracts or
call options written on futures contracts if, in the aggregate, the market
value of all such open positions exceeds the current value of its portfolio
securities, plus or minus unrealized gains and losses on the open positions,
adjusted for the historical relative volatility of the relationship between
the Portfolio and the positions. For this purpose, to the extent the Portfolio
has written call options on specific securities it owns, the value of those
securities will be deducted from the current market value of the securities
portfolio.
The Fund reserves the right to engage in other types of futures transactions
in the future and to use futures and related options for other than hedging
purposes to the extent permitted by regulatory authorities. If other types of
options, futures contracts, or futures options are traded in the future, a
Portfolio may also use such investment techniques, provided that the Board of
Trustees determines that their use is consistent with the Portfolio's
investment objective.
Risks Associated with Futures and Futures Options. There are several risks
associated with the use of futures contracts and futures options as hedging
techniques. A purchase or sale of a futures contract may result in losses in
excess of the amount invested in the futures contract. There can be
significant differences between the securities and futures markets that could
result in an imperfect correlation between the markets, causing a given hedge
not to achieve its objectives. The degree of imperfection of correlation
depends on circumstances such as variations in speculative market demand for
futures and futures options on securities, including technical influences in
futures trading and futures options, and differences between the portfolio
securities being hedged
47
<PAGE>
and the instruments underlying the hedging vehicle in such respects as
interest rate levels, maturities, conditions affecting particular industries,
and creditworthiness of issuers. A decision as to whether, when, and how to
hedge involves the exercise of skill and judgment and even a well-conceived
hedge may be unsuccessful to some degree because of market behavior or
unexpected interest rate trends.
The price of futures contracts may not correlate perfectly with movement in
the underlying security or stock index, due to certain market distortions.
This might result from decisions by a significant number of market
participants holding stock index futures positions to close out their futures
contracts through offsetting transactions rather than to make additional
margin deposits. Also, increased participation by speculators in the futures
market may cause temporary price distortions. These factors may increase the
difficulty of effecting a fully successful hedging transaction, particularly
over a short time frame. With respect to a stock index futures contract, the
price of stock index futures might increase, reflecting a general advance in
the market price of the index's component securities, while some or all of the
portfolio securities might decline. If a Portfolio had hedged its portfolio
against a possible decline in the market with a position in futures contracts
on an index, it might experience a loss on its futures position until it could
be closed out, while not experiencing an increase in the value of its
portfolio securities. If a hedging transaction is not successful, the
Portfolio might experience losses which it would not have incurred if it had
not established futures positions. Similar risk considerations apply to the
use of interest rate and other futures contracts.
Futures exchanges may limit the amount of fluctuation permitted in certain
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of the
current trading session. Once the daily limit has been reached in a futures
contract subject to the limit, no more trades may be made on that day at a
price beyond that limit. The daily limit governs only price movements during a
particular trading day and therefore does not limit potential losses because
the limit may work to prevent the liquidation of unfavorable positions. For
example, futures prices have occasionally moved to the daily limit for several
consecutive trading days with little or no trading, thereby preventing prompt
liquidation of positions and subjecting some holders of futures contracts to
substantial losses.
The Managed Bond, Government Securities, Aggressive Equity, Growth LT,
Large-Cap Value, Mid-Cap Value, Bond and Income, International Value, I-Net
Tollkeeper, and Emerging Markets Portfolios may trade futures contracts and
options on futures contracts not only on U.S. domestic markets, but also on
exchanges located outside of the United States. Foreign markets may offer
advantages such as trading in indices that are not currently traded in the
United States. Foreign markets, however, may have greater risk potential than
domestic markets. Unlike trading on domestic commodity exchanges, trading on
foreign commodity exchanges is not regulated by the CFTC and may be subject to
greater risk than trading on domestic exchanges. For example, some foreign
exchanges are principal markets so that no common clearing facility exists and
a trader may look only to the broker for performance of the contract. Trading
in foreign futures or foreign options contracts may not be afforded certain of
the protective measures provided by the Commodity Exchange Act, the CFTC's
regulations, and the rules of the National Futures Association and any
domestic exchange, including the right to use reparations proceedings before
the CFTC and arbitration proceedings provided by the National Futures
Association or any domestic futures exchange. Amounts received for foreign
futures or foreign options transactions may not be provided the same
protection as funds received in respect of transactions on United States
futures exchanges. In addition, any profits that the Portfolio might realize
in trading could be eliminated by adverse changes in the exchange rate of the
currency in which the transaction is denominated, or the Portfolio could incur
losses as a result of changes in the exchange rate. Transactions on foreign
exchanges may include both commodities that are traded on domestic exchanges
or boards of trade and those that are not.
There can be no assurance that a liquid market will exist at a time when a
Portfolio seeks to close out a futures or a futures option position, and that
Portfolio would remain obligated to meet margin requirements until the
position is closed. In addition, many of the contracts discussed above are
relatively new instruments without a significant trading history. As a result,
there can be no assurance that an active secondary market will develop or
continue to exist.
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<PAGE>
Foreign Currency Futures and Options Thereon
The Managed Bond, Government Securities, Aggressive Equity, Growth LT,
Multi-Strategy, Large-Cap Value, Mid-Cap Value, Bond and Income, International
Value, I-Net Tollkeeper, Emerging Markets, Diversified Research, and
International Large-Cap Portfolios may enter into contracts for the purchase
or sale for future delivery of foreign currencies ("foreign currency futures")
and may purchase and write options on foreign currency futures. In addition, a
Portfolio may engage in cross-hedging activities, which involve the sale of a
futures contract on one foreign currency to hedge against changes in exchange
rates for a different ("proxy") currency if there is an established historical
pattern of correlation between the two currencies. These investment techniques
will be used only to hedge against anticipated future changes in exchange
rates which otherwise might adversely affect the value of the Portfolio's
securities or adversely affect the prices of securities that the Portfolio has
purchased or intends to purchase at a later date. The successful use of
foreign currency futures will usually depend on the Portfolio Manager's
ability to forecast currency exchange rate movements correctly. Should
exchange rates move in an unexpected manner, the Portfolio may not achieve the
anticipated benefits of foreign currency futures or may realize losses.
Swap Agreements and Options on Swap Agreements
The Mid-Cap Value and Emerging Markets Portfolio may enter into equity index
swap agreements. The Managed Bond, Government Securities, Mid-Cap Value, and
REIT Portfolios may enter into interest rate, and interest rate index, and/or
currency exchange rate swap agreements, and the Managed Bond, Government
Securities and Mid-Cap Value Portfolios may purchase and sell options thereon.
The Large-Cap Value Portfolio may enter into currency swaps. A Portfolio's
current obligations (or rights) under a swap agreement will generally be equal
only to the net amount to be paid or received under the agreement based on the
relative values of the positions held by each party to the agreement (the "net
amount"). A Portfolio's current obligations under a swap agreement will be
accrued daily (offset against any amounts owing to the Portfolio) and any
accrued but unpaid net amounts owed to a swap counterparty will be covered by
the maintenance of a segregated account consisting of cash, U.S. Government
securities, and/or liquid securities marked-to-market daily, to avoid any
potential leveraging of a Portfolio. The Bond and Income Portfolio may invest
in the following types of swap agreements: (1) "interest rate caps," under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates exceed a specified rate, or "cap"; (2)
"interest rate floors," under which, in return for a premium, one party agrees
to make payments to the other to the extent that interest rates fall below a
certain level, or "floor"; (3) "interest rate collars," under which one party
sells a cap and purchases a floor or vice-versa in an attempt to protect
itself against interest rate movements exceeding given minimum or maximum
levels; and (4) "currency exchange rate swap agreements."
Generally, the swap agreement transactions in which a Portfolio will engage
are not regulated as futures or commodity option transactions under the
Commodity Exchange Act or by the Commodity Futures Trading Commission.
Risks of Swap Agreements. Whether a Portfolio's use of swap agreements will
be successful in furthering its investment objective will depend on a
Portfolio Manager's ability to predict correctly whether certain types of
investments are likely to produce greater returns than other investments.
Because they are two-party contracts and because they may have terms of
greater than seven days, swap agreements may be considered to be illiquid
investments. It may not be possible to enter into a reverse swap or close out
a swap position prior to its original maturity and, therefore, a Portfolio may
bear the risk of such position until its maturity. Moreover, a Portfolio bears
the risk of loss of the amount expected to be received under a swap agreement
in the event of the default or bankruptcy of a swap agreement counterparty. A
Portfolio will enter into swap agreements only with counterparties that meet
certain standards for creditworthiness (generally, such counterparties would
have to be eligible counterparties under the terms of a Portfolio's repurchase
agreement guidelines unless otherwise specified in the investment policies of
the Portfolio). Certain tax considerations may limit a Portfolio's ability to
use swap agreements. The swaps market is a relatively new market and is
largely unregulated. It is possible that
49
<PAGE>
developments in the swaps market, including potential government regulation,
could adversely affect a Portfolio's ability to terminate existing swap
agreements or to realize amounts to be received under such agreements. See
"Taxation".
Structured Notes
The Bond and Income and REIT Portfolios may invest in structured notes. The
value of the principal of and/or interest on such securities is determined by
reference to changes in the value of specific currencies, interest rates,
commodities, indices, or other financial indicators (the "Reference") or the
relative change in two or more References. The interest rate or the principal
amount payable upon maturity or redemption may be increased or decreased
depending upon changes in the applicable Reference. The terms of the
structured notes may provide that in certain circumstances no principal is due
at maturity and, therefore, result in the loss of a Portfolio's investment.
Structured notes may be positively or negatively indexed, so that appreciation
of the Reference may produce an increase or decrease in the interest rate or
value of the security at maturity. In addition, changes in the interest rates
or the value of the security at maturity may be a multiple of changes in the
value of the Reference. Consequently, structured securities may entail a
greater degree of market risk than other types of fixed-income securities.
Structured notes may also be more volatile, less liquid and more difficult to
accurately price than less complex securities.
Warrants and Rights
The High Yield Bond, Growth LT, Equity Income, Multi-Strategy, Mid-Cap
Value, Equity, Bond and Income, Small-Cap Index, REIT, Diversified Research,
and International Large-Cap Portfolios may invest in warrants; however, not
more than 10% of the market value of a Portfolio's assets (at the time of
purchase), and in the case of the Equity Portfolio 5%, may be invested in
warrants other than warrants acquired in units or attached to other
securities. The Mid-Cap Value Portfolio may invest up to 5% of its total
assets in rights. The Aggressive Equity and Emerging Markets Portfolios each
may invest up to 5% of its net assets in warrants or rights (valued at the
lower of cost or market) to purchase securities, provided that no more than 2%
of its net assets are invested in warrants not listed on the New York or
American Stock Exchanges. The I-Net Tollkeeper Portfolio may invest in
warrants or rights without restriction. Each of these Portfolios may invest in
warrants or rights acquired as part of a unit or attached to securities at the
time of purchase without limitation. Warrants may be considered speculative in
that they have no voting rights, pay no dividends, and have no rights with
respect to the assets of the corporation issuing them. Warrants basically are
options to purchase equity securities at a specific price valid for a specific
period of time. They do not represent ownership of the securities, but only
the right to buy them. Warrants differ from call options in that warrants are
issued by the issuer of the security which may be purchased on their exercise,
whereas call options may be written or issued by anyone. The prices of
warrants do not necessarily move parallel to the prices of the underlying
securities.
Duration
Duration is a measure of average life of a bond on a present value basis,
which was developed to incorporate a bond's yield, coupons, final maturity and
call features into one measure. Duration is one of the fundamental tools that
may be used by the Adviser or Portfolio Manager in fixed income security
selection. In this discussion, the term "bond" is generally used to connote
any type of debt instrument.
Most notes and bonds have provided interest ("coupon") payments in addition
to a final ("par") payment at maturity. Some obligations also feature call
provisions. Depending on the relative magnitude of these payments, debt
obligations may respond differently to changes in the level and structure of
interest rates. Traditionally, a debt security's "term to maturity" has been
used as a proxy for the sensitivity of the security's price to changes in
interest rates (which is the "interest rate risk" or "volatility" of the
security). However, "term to maturity" measures only the time until a debt
security provides its final payment, taking no account of the pattern of the
security's payments prior to maturity.
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Duration is a measure of the average life of a fixed-income security on a
present value basis. Duration takes the length of the time intervals between
the present time and the time that the interest and principal payments are
scheduled or, in the case of a callable bond, expected to be received, and
weights them by the present values of the cash to be received at each future
point in time. For any fixed-income security with interest payments occurring
prior to the payment of principal, duration is always less than maturity. In
general, all other things being the same, the lower the stated or coupon rate
of interest of a fixed-income security, the longer the duration of the
security; conversely, the higher the stated or coupon rate of interest of a
fixed-income security, the shorter the duration of the security.
Although frequently used, the "term of maturity" of a bond is not a useful
measure of the longevity of a bond's cash flow because it refers only to the
time remaining to the repayment of principal or corpus and disregards earlier
coupon payments. Thus, for example, three bonds with the same maturity may not
have the same investment characteristics (such as risk or repayment time). One
bond may have large coupon payments early in its life, whereas another may
have payments distributed evenly throughout its life. Some bonds (such as zero
coupon bonds) make no coupon payments until maturity. Clearly, an investor
contemplating investing in these bonds should consider not only the final
payment or sum of payments on the bond, but also the timing and magnitude of
payments in order to make an accurate assessment of each bond. Maturity, or
the term to maturity, does not provide a prospective investor with a clear
understanding of the time profile of cash flows over the life of a bond.
Another way of measuring the longevity of a bond's cash flow is to compute a
simple average time to payment, where each year is weighted by the number of
dollars the bond pays that year. This concept is termed the "dollar-weighted
mean waiting time," indicating that it is a measure of the average time to
payment of a bond's cash flow. The critical shortcoming of this approach is
that it assigns equal weight to each dollar paid over the life of a bond,
regardless of when the dollar is paid. Since the present value of a dollar
decreases with the amount of time which must pass before it is paid, a better
method might be to weight each year by the present value of the dollars paid
that year. This calculation puts the weights on a comparable basis and creates
a definition of longevity which is known as duration.
A bond's duration depends upon three variables: (i) the maturity of the
bond; (ii) the coupon payments attached to the bond; and (iii) the bond's
yield to maturity. Yield to maturity, or investment return as used here,
represents the approximate return an investor purchasing a bond may expect if
he holds that bond to maturity. In essence, yield to maturity is the rate of
interest which, if applied to the purchase price of a bond, would be capable
of exactly reproducing the entire time schedule of future interest and
principal payments.
Increasing the size of the coupon payments on a bond, while leaving the
maturity and yield unchanged, will reduce the duration of the bond. This
follows from the fact that because bonds with higher coupon payments pay
relatively more of their cash flows sooner, they have shorter durations.
Increasing the yield to maturity on a bond (e.g., by reducing its purchase
price), while leaving the terms to maturity and coupon payments unchanged,
also reduces the duration of the bond. Because a higher yield leads to lower
present values for more distant payments relative to earlier payments, and, to
relatively lower weights attached to the years remaining to those payments,
the duration of the bond is reduced.
There are some situations where even the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or
more years; however, their interest rate exposure corresponds to the frequency
of the coupon reset. Another example where the interest rate exposure is not
properly captured by duration is mortgage pass-throughs. The stated final
maturity is generally 30 years but current prepayment rates are more critical
in determining the securities' interest rate exposure. In these and other
similar situations, the Adviser or Portfolio Manager to a Portfolio will use
more sophisticated analytical techniques which incorporate the economic life
of a security into the determination of its interest rate exposure.
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Futures, options, and options on futures have durations which, in general,
are closely related to the duration of the securities which underlie them.
Holding long futures or call option positions (backed by a segregated account
of cash and cash equivalents) will lengthen the portfolio duration if interest
rates go down and bond prices go up by approximately the same amount that
holding an equivalent amount of the underlying securities would.
Short futures or put option positions have durations roughly equal to the
negative duration of the securities that underlie those positions, and have
the effect of reducing portfolio duration if interest rates go up and bond
prices go down by approximately the same amount that selling an equivalent
amount of the underlying securities would.
INVESTMENT RESTRICTIONS
Fundamental Investment Restrictions
Each Portfolio's investment goal as set forth under "About the Portfolios,"
in the Prospectus, and the investment restrictions as set forth below, are
fundamental policies of each Portfolio and may not be changed with respect to
any Portfolio without the approval of a majority of the outstanding voting
shares of that Portfolio. The vote of a majority of the outstanding voting
securities of a Portfolio means the vote, at an annual or special meeting of
(a) 67% or more of the voting securities present at such meeting, if the
holders of more than 50% of the outstanding voting securities of such
Portfolio are present or represented by proxy; or (b) more than 50% of the
outstanding voting securities of such Portfolio, whichever is the less. Under
these restrictions, a Portfolio may not:
(i) except for the REIT Portfolio and the I-Net Tollkeeper Portfolio, invest
in a security if, as a result of such investment, more than 25% of its total
assets (taken at market value at the time of such investment) would be
invested in the securities of issuers in any particular industry, except that
this restriction does not apply to securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities (or repurchase agreements with
respect thereto). This restriction does not apply to the REIT Portfolio, which
will normally invest more than 25% of its total assets in securities of
issuers of real estate investment trusts and in industries related to real
estate. This restriction also does not apply to the I-Net Tollkeeper
Portfolio, which will normally invest more than 25% of its total assets in
Internet Companies, or the media, telecommunications or technology industries;
(ii) with respect to 75% of its total assets (or, in the case of the REIT
Portfolio, with respect to 50% of its assets), invest in a security if, as a
result of such investment, more than 5% of its total assets (taken at market
value at the time of such investment) would be invested in the securities of
any one issuer, except that this restriction does not apply to securities
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities, and does not apply to the I-Net Tollkeeper Portfolio;
(iii) invest in a security if, as a result of such investment, it would hold
more than 10% (taken at the time of such investment) of the outstanding voting
securities of any one issuer;
(iv) purchase or sell real estate (although it may purchase securities
secured by real estate or interests therein, or securities issued by companies
which invest in real estate, or interests therein);
(v) borrow money or pledge, mortgage or hypothecate its assets, except that
a Portfolio may: (a) borrow from banks but only if immediately after each
borrowing and continuing thereafter there is asset coverage of 300%; and (b)
enter into reverse repurchase agreements and transactions in options, futures,
and options on futures as described in the Prospectus and in the Statement of
Additional Information (the deposit of assets in escrow in connection with the
writing of covered put and call options and the purchase of securities on a
"when-issued" or delayed delivery basis and collateral arrangements with
respect to initial or variation margin deposits for futures contracts will not
be deemed to be pledges of a Portfolio's assets);
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(vi) lend any funds or other assets, except that a Portfolio may, consistent
with its investment objective and policies: (a) invest in debt obligations
including bonds, debentures or other debt securities, bankers' acceptances,
and commercial paper, even though the purchase of such obligations may be
deemed to be the making of loans; (b) enter into repurchase agreements and
reverse repurchase agreements; and (c) lend its portfolio securities to the
extent permitted under applicable law;
(vii) act as an underwriter of securities of other issuers, except, when in
connection with the disposition of portfolio securities, it may be deemed to
be an underwriter under the federal securities laws; and
Nonfundamental Investment Restrictions
Each Portfolio is also subject to the following restrictions and policies
(which are not fundamental and may therefore be changed without shareholder
approval) relating to the investment of its assets and activities. Unless
otherwise indicated, a Portfolio may not:
(i) invest for the purpose of exercising control or management;
(ii) sell property short, sell securities short, except the Mid-Cap Value
Portfolio, sell short against the box, except the Aggressive Equity, Equity,
I-Net Tollkeeper and Mid-Cap Value Portfolios;
(iii) purchase warrants if immediately after and as a result of such
purchase more than 10% of the market value of the total assets of the
Portfolio would be invested in such warrants, except for the Diversified
Research, I-Net Tollkeeper, and International Large-Cap Portfolios;
(iv) except the Growth LT, I-Net Tollkeeper, and Mid-Cap Value Portfolios,
purchase securities on margin (except for use of short-term credit necessary
for clearance of purchases and sales of portfolio securities) but it may make
margin deposits in connection with transactions in options, futures, and
options on futures;
(v) except the Growth LT and Mid-Cap Value Portfolios, maintain a short
position, or purchase, write, or sell puts, calls, straddles, spreads, or
combinations thereof, except as set forth in the Prospectus and in the SAI for
transactions in options, futures, and options on futures;
(vi) invest in securities that are illiquid, or in repurchase agreements
maturing in more than seven days, if as a result of such investment, more than
15% of the net assets of the Portfolio (taken at market value at the time of
such investment) would be invested in such securities, and with respect to the
Money Market Portfolio, more than 10% of the total assets of the Portfolio
(taken at market value at the time of such investment) would be invested in
such securities; and
(vii) purchase or sell commodities or commodities contracts, except that
subject to restrictions described in the Prospectus and in the SAI, (a) each
Portfolio other than the Money Market and Small-Cap Equity Portfolios may
engage in futures contracts and options on futures contracts; and (b) all
Portfolios may enter into foreign forward currency contracts.
Unless otherwise indicated, as in the restriction for borrowing or
hypothecating assets of a Portfolio, for example, all percentage limitations
listed above apply to each Portfolio only at the time into which a transaction
is entered. Accordingly, if a percentage restriction is adhered to at the time
of investment, a later increase or decrease in the percentage which results
from a relative change in values or from a change in a Portfolio's net assets
will not be considered a violation. For purposes of fundamental restriction
(v) and nonfundamental restriction (vii) as set forth above, an option on a
foreign currency shall not be considered a commodity or commodity contract.
For purposes of nonfundamental restriction (v), a short sale "against the box"
shall not be considered a short position.
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ORGANIZATION AND MANAGEMENT OF THE FUND
The Fund was organized as a Massachusetts business trust on May 4, 1987, and
currently consists of eighteen separate Portfolios. The assets of each
Portfolio are segregated, and your interest is limited to the Portfolio to
which proceeds from your Variable Contract's Accumulated Value is allocated.
The business and affairs of the Fund are managed under the direction of the
Board of Trustees under the Fund's Agreement and Declaration of Trust.
Trustees and Officers
The Trustees and Executive Officers of the Fund, their business address, and
principal occupations during the past five years are:
<TABLE>
<CAPTION>
Business Affiliates and
Name and Address Position with the Fund Principal Occupations
---------------- ---------------------- -----------------------
<C> <C> <S>
Thomas C. Sutton* Chairman of the Chairman of the Board,
700 Newport Center Drive Board and Trustee Director and Chief Executive
Newport Beach, CA 92660 Officer of Pacific Life,
Age 57 Pacific Mutual Holding
Company and Pacific
LifeCorp; and similar
positions with other
subsidiaries and affiliates
of Pacific Life; Director of
Newhall Land & Farming;
Director of The Irvine
Company; Director of Edison
International; Management
Board Member of PIMCO
Advisors L.P.; Former Equity
Board Member of PIMCO
Advisors L.P.
Lucie H. Moore Trustee Former Partner with Gibson,
1825 Port Manleigh Place Dunn & Crutcher.
Newport Beach, CA 92660
Age 43
Richard L. Nelson Trustee Business Consultant; retired
8 Cherry Hills Lane Partner with Ernst & Young
Newport Beach, CA 92660 LLP; Director of Wynn's
Age 70 International, Inc.
Lyman W. Porter Trustee Professor Emeritus of
University of California Management in the Graduate
at Irvine School of Management at the
Irvine, CA 92717 University of California,
Age 69 Irvine. Former Member of the
Academic Advisory Board of
the Czechoslovak Management
Center and of the Board of
Trustees of the American
University of Armenia.
Alan Richards Trustee Retired Chairman of E. F.
7381 Elegans Place Hutton Insurance Group;
Carlsbad, CA 92009 Former Director of E. F.
Age 69 Hutton and Company, Inc.;
Chairman of IBIS Capital,
LLC; Director of Inspired
Arts, Inc.; Former Director
of Western National
Corporation.
Glenn S. Schafer President President and Director of
700 Newport Center Drive Pacific Life, Pacific Mutual
Newport Beach, CA 92660 Holding Company and Pacific
Age 50 LifeCorp and similar
positions with other
subsidiaries and affiliates
of Pacific Life; Management
Board Member of PIMCO
Advisors L.P.; Former Equity
Board Member of PIMCO
Advisors L.P.
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
Business Affiliates and
Name and Address Position with the Fund Principal Occupations
---------------- ---------------------- -----------------------
<C> <C> <S>
Brian D. Klemens Vice President Vice President and Treasurer
700 Newport Center Drive and Treasurer (12/98 to present); and
Newport Beach, CA 92660 Assistant Controller (4/94
Age 43 to 12/98) of Pacific Life.
Vice President and Treasurer
with other subsidiaries and
affiliates of Pacific Life.
Diane N. Ledger Vice President Vice President, Variable
700 Newport Center Drive and Assistant Regulatory Compliance,
Newport Beach, CA 92660 Secretary Corporate Law of Pacific
Age 60 Life.
Sharon A. Cheever Vice President Vice President and
700 Newport Center Drive and General Investment Counsel of
Newport Beach, CA 92660 Counsel Pacific Life.
Age 44
Audrey L. Milfs Secretary Vice President, Director and
700 Newport Center Drive Corporate Secretary of
Newport Beach, CA 92660 Pacific Life; and similar
Age 54 positions with other
subsidiaries of Pacific
Life.
</TABLE>
- --------
* Mr. Sutton is an "interested person" of the Fund (as that term is defined
in the Investment Company Act) because of his position with Pacific Life as
shown above.
Trustees other than those affiliated with Pacific Life Insurance Company
("Pacific Life" or the "Adviser", formerly known as Pacific Mutual Life
Insurance Company) or a Portfolio Manager, currently receive an annual fee of
$15,000 and $1,500 for each Board of Trustees meeting attended, including each
Audit, Policy, or Nominating Committee meeting attended, plus reimbursement of
related expenses. In addition, the Chairman of the Fund's Audit, Policy and
Nominating Committees each receive an additional annual fee of $2,000. The
following table summarizes the aggregate compensation paid by the Fund to each
Trustee who was not affiliated with Pacific Life or a Portfolio Manager in
1999. The table also shows total compensation paid to these Trustees in 1999
by the Fund and PIMCO Funds: Multi-Manager Series, an investment company
managed by an affiliate of Pacific Life for which Messrs. Nelson, Porter, and
Richards (but not Mr. Sutton or Ms. Moore) also serve as trustees
(collectively, "Fund Complex").
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Estimated Compensation
Accrued Annual from Fund
Aggregate as Part of Benefits Complex
Compensation Fund Upon Paid to
Name of Trustee from Fund Expenses Retirement Trustees
- --------------- ------------ ---------- ---------- ------------
<S> <C> <C> <C> <C>
Richard L. Nelson............... $ 0 0 $
Lyman W. Porter................. $ 0 0 $
Alan Richards................... $ 0 0 $
Lucie H. Moore.................. $ 0 0 N/A
</TABLE>
None of the Trustees or Officers directly own shares of the Fund. As of
March 19, 1999, the Trustees and Officers as a group owned Variable Contracts
that entitled them to give voting instructions with respect to less than 1% of
the outstanding shares of the Fund.
Investment Adviser
Pacific Life serves as Investment Adviser to the Fund pursuant to an
Investment Advisory Agreement ("Advisory Contract") between Pacific Life and
the Fund.
Pacific Life is a life insurance company that is domiciled in California.
Along with subsidiaries and affiliates, Pacific Life's operations include life
insurance, annuities, pension and institutional products, group
55
<PAGE>
employee benefits, broker-dealer operations and investment advisory services.
As of the end of 1998, Pacific Life had $89.6 billion of individual life
insurance in force and total admitted assets of approximately $37.6 billion.
Pacific Life has been ranked according to admitted assets as the 18th largest
life insurance carrier in the nation based on December 31, 1998 assets. The
Pacific Life family of companies has total assets and funds under management
of over $290 billion as of December 31, 1998. Pacific Life is authorized to
conduct life insurance and annuity business in the District of Columbia and
all states except New York. Its principal offices are located at 700 Newport
Center Drive, Newport Beach, California 92660.
Pacific Life was originally organized on January 2, 1868, under the name
"Pacific Mutual Life Insurance Company of California" and reincorporated as
"Pacific Mutual Life Insurance Company" on July 22, 1936. On September 1,
1997, Pacific Life converted from a mutual life insurance company to a stock
life insurance company ultimately controlled by a mutual holding company.
Pacific Life is a subsidiary of Pacific LifeCorp, a holding company which, in
turn, is a subsidiary of Pacific Mutual Holding Company, a mutual holding
company. Under their respective charters, Pacific Mutual Holding Company must
always hold at least 51% of the outstanding voting stock of Pacific LifeCorp,
and Pacific LifeCorp must always own 100% of the voting stock of Pacific Life.
Owners of Pacific Life's annuity contracts and life insurance policies have
certain membership interests in Pacific Mutual Holding Company, consisting
principally of the right to vote on the election of the Board of Directors of
the mutual holding company and on other matters and certain rights upon
liquidation or dissolutions of the mutual holding company.
Pacific Life is responsible for administering the affairs of and supervising
the investment program for the Fund. Pacific Life also furnishes to the Board
of Trustees, which has overall responsibility for the business and affairs of
the Fund, periodic reports on the investment performance of each Portfolio.
Under the terms of the Advisory Contract, Pacific Life is obligated to
manage the Fund's Portfolios in accordance with applicable laws and
regulations.
The Advisory Contract will continue in effect until December 31, 1999, and
from year to year thereafter, provided such continuance is approved annually
by (i) the holders of a majority of the outstanding voting securities of the
Fund or by the Board of Trustees, and (ii) a majority of the Trustees who are
not parties to such Advisory Contract or "interested persons", as defined in
the Investment Company Act of 1940 (the "1940 Act"), of any such party. The
Advisory Contract was originally approved by the Board of Trustees, including
a majority of the Trustees who are not parties to the Advisory Contract, or
interested persons of such parties, at its meeting held on July 21, 1987, and
by the shareholders of the Fund at a Meeting of Shareholders held on
October 28, 1988. The Advisory Contract was also approved by the shareholders
of the Equity Index Portfolio of the Fund at a Meeting of Shareholders of the
Equity Index Portfolio held on April 21, 1992. An Addendum to the Advisory
Contract was approved by the Board of Trustees, including a majority of the
Trustees who are not parties to the Contract, or interested persons of such
parties, at a meeting held on October 28, 1988. An Addendum to the Advisory
Contract which increased the advisory fee schedule with respect to the High
Yield Bond, Managed Bond, Government Securities, Small-Cap Equity, Equity
Income, Multi-Strategy, and International Value Portfolios, and which included
the Growth LT Portfolio as a Portfolio to which the Adviser will perform
services under the Advisory Contract, was approved by the Board of Trustees,
including a majority of the Trustees who are not parties to the Contract, or
interested persons of such parties, at a meeting held on September 29, 1993,
and was approved by shareholders of the High Yield Bond, Managed Bond,
Government Securities, Small-Cap Equity, Equity Income, Multi-Strategy, and
International Value Portfolios at a Special Meeting of Shareholders on
December 13, 1993. An Addendum to the Advisory Contract for the Equity and
Bond and Income Portfolios was approved by the Board of Trustees, including a
majority of the Trustees who are not parties to the Advisory Contract or
interested persons of such parties, at a meeting held on August 12, 1994, and
by the sole shareholder of those Portfolios on September 6, 1994. An Addendum
to the Advisory Contract for the Aggressive Equity and Emerging Markets
Portfolios was approved by the Board of Trustees, including a majority of the
Trustees who are not parties to the Advisory Contract or interested persons of
such
56
<PAGE>
parties, at a meeting held on November 17, 1995, and by the sole shareholder
of those Portfolios on January 30, 1996. An Addendum to the Advisory Contract
for the Large-Cap Value, Mid-Cap Value, Small-Cap Index, and REIT Portfolios
was approved by the Board of Trustees, including a majority of the Trustees
who are not parties to the Advisory Contract or interested persons of such
parties, at a meeting held on August 6, 1998, and by the sole shareholder of
those Portfolios on December 21, 1998. An Addendum to the Advisory Contract
for the Diversified Research and International Large-Cap Portfolios was
approved by the Board of Trustees, including a majority of the Trustees who
are not parties to the Advisory Contract or interested persons of such
parties, at a meeting held on August 27, 1999, and by the sole shareholder of
those Portfolios on December 14, 1999. An Addendum to the Advisory Contract
for the I-Net Tollkeeper Portfolio was approved by the Board of Trustees,
including a majority of the Trustees who are not parties to the Advisory
Contract or interested persons of such parties, at a meeting held on January
28, 2000 and by the sole shareholder of the Portfolio on . The Advisory
Contract may be terminated without penalty by vote of the Trustees or the
shareholders of the Fund, or by the Adviser, on 60 days' written notice by
either party to the Advisory Contract and will terminate automatically if
assigned.
The Fund pays the Adviser, for its services under the Agreement, a fee based
on an annual percentage of the average daily net assets of each Portfolio. For
the Money Market Portfolio, the Fund pays to the Adviser a fee at an annual
rate of .40% of the first $250 million of the average daily net assets of the
Portfolio, .35% of the next $250 million of the average daily net assets of
the Portfolio, and .30% of the average daily net assets of the Portfolio in
excess of $500 million. For the High Yield Bond, Managed Bond, Government
Securities, and Bond and Income Portfolios, the Fund pays .60% of the average
daily net assets of each of the Portfolios. For the Small-Cap Equity, Equity
Income, Multi-Strategy, and Equity Portfolios, the Fund pays .65% of the
average daily net assets of each of the Portfolios. For the Aggressive Equity
Portfolio, the Fund pays .80% of the average daily net assets of the
Portfolio. For the Growth LT Portfolio, the Fund pays .75% of the average
daily net assets of the Portfolio. For the Equity Index Portfolio, the Fund
pays .25% of the average daily net assets of the Portfolio. For the
Diversified Research Portfolio, the Fund pays .90% of the average daily net
assets of the Portfolio. For the International Large-Cap Portfolio, the Fund
pays 1.05% of the average daily net assets of the Portfolio. For the Small-Cap
Index Portfolio, the Fund pays 0.50% of the average daily net assets of the
Portfolio. For the Large-Cap Value, Mid-Cap Value and International Value
Portfolios, the Fund pays .85% of the average daily net assets of the
Portfolio. For the REIT and Emerging Markets Portfolios, the Fund pays to the
Adviser a fee at an annual rate of 1.10% of the average daily net assets of
the Portfolio. For the I-Net Tollkeeper Portfolio, the Fund pays to the
Advisor a fee at an annual rate of 1.50% of the average daily net assets of
the Portfolio. The fee shall be computed and accrued daily and paid monthly.
Net advisory fees paid or owed to Pacific Life for 1999 were as follows:
Aggressive Equity Portfolio--$ , Emerging Markets Portfolio--$ ,
Small-Cap Equity Portfolio--$ , Bond and Income Portfolio--$ ,
Equity Portfolio--$ , Multi-Strategy Portfolio--$ , Equity Income
Portfolio--$ , Growth LT Portfolio--$ , Mid-Cap Value Portfolio--
$ , Equity Index Portfolio--$ , Small-Cap Index Portfolio--
$ , REIT Portfolio--$ , International Value Portfolio--$ ,
Government Securities Portfolio--$ , Managed Bond Portfolio--$ ,
Money Market Portfolio--$ , High Yield Bond Portfolio--$ , and
Large-Cap Value Portfolio--$ .
Net advisory fees paid or owed to Pacific Life for 1998 were as follows:
Aggressive Equity Portfolio--$1,301,554, Emerging Markets Portfolio--
$1,135,155, Small-Cap Equity Portfolio--$1,647,286, Bond and Income
Portfolio--$867,006, Equity Portfolio--$2,577,278, Multi-Strategy Portfolio--
$2,986,639, Equity Income Portfolio--$6,578,365, Growth LT Portfolio--
$6,762,035, Equity Index Portfolio--$1,888,470, International Value
Portfolio--$7,820,564, Government Securities Portfolio--$915,619, Managed Bond
Portfolio--$3,687,063, Money Market Portfolio--$1,802,788 and High Yield Bond
Portfolio--$2,126,319.
Net advisory fees paid or owed to Pacific Life for 1997 were as follows:
Aggressive Equity Portfolio--$684,226, Emerging Markets Portfolio--$868,075,
Small-Cap Equity Portfolio--$1,355,092, Bond and Income Portfolio--$568,647,
Equity Portfolio--$1,818,664, Multi-Strategy Portfolio--$1,866,445, Equity
Income
57
<PAGE>
Portfolio--$4,062,587, Growth LT Portfolio--$4,193,552, Equity Index
Portfolio--$1,080,856, International Value Portfolio--$5,353,459, Government
Securities Portfolio--$645,820, Managed Bond Portfolio--$2,055,929, Money
Market Portfolio--$1,521,271 and High Yield Bond Portfolio--$1,466,135.
Pacific Life has agreed, until at least December 31, 2000, to waive its fees
or otherwise reimburse each Portfolio for its operating expenses to the extent
that such expenses, exclusive of advisory fees, additional custodial charges
associated with holding foreign securities, foreign taxes on dividends,
interest, or gains, and extraordinary expenses, exceed 0.25% of the
Portfolio's average daily net assets. Pacific Life began this expense
reimbursement policy in April 1989. There can be no assurance that this policy
will be continued beyond December 31, 2000.
Other Expenses of the Fund
The Fund bears all costs of its operations. These costs may include expenses
for custody, audit fees, fees and expenses of the independent trustees,
organizational expenses and other expenses of its operations, including the
cost of support services, and may, if applicable, include extraordinary
expenses such as expenses for special consultants or legal expenses.
The Fund is also responsible for bearing the expense of various matters,
including, among other things, the expense of registering and qualifying the
Fund on state and federal levels, legal and accounting services, maintaining
the Fund's legal existence, shareholders' meetings and expenses associated
with preparing, printing and distributing reports, proxies and prospectuses to
shareholders.
The Fund and Pacific Life entered into an Agreement for Support Services
effective October 1, 1995, pursuant to which Pacific Life provides support
services such as those described above. Under the terms of the Agreement for
Support Services, it is not intended that Pacific Life will profit from these
services to the Fund.
Fund expenses directly attributable to a Portfolio are charged to that
Portfolio; other expenses are allocated proportionately among all the
Portfolios in relation to the net assets of each Portfolio.
The Fund paid Pacific Life $ for its services under the Agreement for
Support Services during 1999, $229,510 during 1998, and $165,000 during 1997,
representing %, 0.003%, and 0.004%, respectively, of the Fund's average
daily net assets and anticipates that fees to be paid for 2000 under said
Agreement will be approximately % of the Fund's average daily net assets.
Portfolio Management Agreements
Pacific Life directly manages both the Money Market and the High Yield Bond
Portfolios. For the other nineteen Portfolios Pacific Life employs other
investment advisory firms as Portfolio Manager, subject to Portfolio
Management Agreements, the terms of which are discussed below.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Pacific Investment Management Company ("PIMCO"), 840 Newport Center Drive,
Suite 300, Newport Beach, California 92660, PIMCO is the Portfolio Manager and
provides investment advice and makes and implements investment decisions with
respect to the Managed Bond Portfolio and Government Securities Portfolio. For
the services provided in 1997, Pacific Life pays PIMCO a fee based on an
annual percentage of the combined average daily net assets of the Portfolios
according to the following schedule:
Managed Bond and Government Securities Portfolios
<TABLE>
<CAPTION>
Rate % Break Point (assets)
------ --------------------
<S> <C>
.50% On first $25 million
.375% On next $25 million
.25% On excess
</TABLE>
58
<PAGE>
On October 31, 1999, PIMCO Advisors, PAH and Allianz AG ("Allianz")
announced that they had reached a definitive agreement under which Allianz
would acquire majority ownership of PIMCO Advisors and its subsidiaries (the
"Allianz Transaction"). PIMCO is a subsidiary of PIMCO Advisors. The Allianz
Transaction is expected to be completed by April 2000. Under the terms of the
transaction, Allianz would acquire all of PAH, the publicly traded general
partner of PIMCO Advisors. Pacific Life would retain an approximate 30%
interest in PIMCO Advisors. After the Allianz Transaction is completed, the
Allianz Group (which includes Allianz and PIMCO) would collectively have over
$650 billion in assets under management.
Once the Transaction is consummated, absent an order from the SEC or other
relief, the Managed Bond and Government Securities Portfolios generally cannot
engage in principal transactions with "Affiliated Brokers" of Allianz,
including Dresdner Bank AG, Deutsche Bank AG, Bankers Trust Company, BT Alex
Brown, Inc., and certain other affiliated entities. As a result, the
Portfolios' ability to purchase securities underwritten by an Affiliated
Broker or to utilize the Affiliated Brokers for agency transactions will be
subject to regulatory restrictions. PIMCO has advised that it does not believe
that the above restrictions on transactions with the Affiliated Brokers would
materially adversely affect its ability to provide services to the Portfolios,
the Portfolios' ability to take advantage of market opportunities, or their
overall performance.
PIMCO is an investment counseling firm founded in 1971, and had
approximately $157 billion in assets under management as of December 31, 1999.
PIMCO is a subsidiary partnership of PIMCO Advisors L.P. ("PIMCO Advisors").
The general partners of PIMCO Advisors are PIMCO Partners, G.P. and PIMCO
Advisors Holdings L.P. ("PAH"). PIMCO Partners, G.P. is a general partnership
between PIMCO Holding LLC, a Delaware limited liability company and an
indirect wholly-owned subsidiary of Pacific Life Insurance Company, and PIMCO
Partners LLC, a California limited liability company controlled by the current
Managing Directors and two former Managing Directors of PIMCO. PIMCO Partners,
G.P. is the sole general partner of PAH. PIMCO also provides investment
advisory services to PIMCO Funds and several other mutual fund portfolios and
to private accounts for pension and profit sharing plans. PIMCO is registered
as an investment adviser with the SEC and a commodity trading adviser with the
CFTC. Net fees paid or owed by Pacific Life to PIMCO in 1999 were $
for the Managed Bond Portfolio and $ for the Government Securities
Portfolio, in 1998 were $1,613,407 for the Managed Bond Portfolio and $400,557
for the Government Securities Portfolio, and in 1997 were $929,041 for the
Managed Bond Portfolio and $292,079 for the Government Securities Portfolio.
Pursuant to Portfolio Management Agreements between the Fund, the Adviser,
and Capital Guardian Trust Company ("Capital Guardian"), a wholly-owned
subsidiary of Capital Group International, Inc., which itself is wholly-owned
by The Capital Group Companies, Inc. all of which are located at 333 South
Hope Street, Los Angeles, California 90071, Capital Guardian is the Portfolio
Manager and provides investment advisory services to the Small-Cap Equity
Portfolio, Diversified Research Portfolio and International Large-Cap
Portfolio. For the services provided, Pacific Life pays Capital Guardian a fee
based on an annual percentage of the average daily net assets of the Small-Cap
Equity Portfolio, Diversified Research Portfolio, and International Large-Cap
Portfolio according to the following schedules:
Small-Cap Equity Portfolio
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- --------------------
<S> <C>
.50% On first $30 million
.40% On next $30 million
.30% On excess
</TABLE>
59
<PAGE>
Diversified Research Portfolio
<TABLE>
<CAPTION>
Rate (%) Break-Point (assets)
-------- ---------------------
<S> <C>
.50% On first $150 million
.45% On next $150 million
.35% On next $200 million
.30% On next $500 million
.275% On next $1 billion
.25% On excess
</TABLE>
International Large-Cap Portfolio
<TABLE>
<CAPTION>
Rate (%) Break-Point (assets)
-------- ---------------------
<S> <C>
.65% On first $150 million
.55% On next $150 million
.45% On next $200 million
.40% On next $500 million
.375% On next $1 billion
.35% On excess
Capital Guardian is a California state chartered trust company organized in
1968 which provides fiduciary and investment management services to a limited
number of large accounts such as employee benefit plans, college endowment
funds, foundations, and individuals. Accounts managed by Capital Guardian had
combined assets, as of December 31, 1999, in excess of $ billion. Capital
Guardian's research activities are conducted by affiliated companies that have
research facilities in Los Angeles, San Francisco, New York, Washington, D.C.,
Atlanta, London, Geneva, Hong Kong, Montreal, Singapore, and Tokyo.
Net fees paid or owed by Pacific Life to Capital Guardian for the Small-Cap
Equity Portfolio in 1999 were $ , in 1998 were $850,462, and in 1997 were
$716,070.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Alliance Capital Management, L.P. ("Alliance Capital"), 1345 Avenue of the
Americas, New York, NY 10105, which became effective May 1, 1998, Alliance
Capital is the Portfolio Manager and provides investment advisory services to
the Aggressive Equity Portfolio. For the services provided, Pacific Life pays
a fee to Alliance Capital based on an annual percentage of the average daily
net assets according to the following schedule:
Aggressive Equity Portfolio
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.60% On first $100 million
.45% On next $400 million
.40% On excess
For the services provided for the year 1997 and from January 1, 1998 through
April 30, 1998, Pacific Life paid a fee to Columbus Circle Investors based on
an annual percentage of the average daily net assets according to the
following schedule:
Aggressive Equity Portfolio
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.55% On first $100 million
.50% On next $150 million
.45% On next $250 million
.40% On excess
</TABLE>
60
<PAGE>
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser
and Alliance Capital as described above, which became effective January 1,
2000, Alliance Capital is the Portfolio Manager and provides investment
advisory services to the Emerging Markets Portfolio. For these services,
Pacific Life pays to Alliance Capital a monthly fee based on the average daily
net assets of the Emerging Markets Portfolio at an annual rate, according to
the following schedule:
Emerging Markets Portfolio
<TABLE>
<CAPTION>
Rate
(%) Break Point (assets)
---- --------------------
<S> <C>
.85% On first $50 million
.75% On next $50 million
.70% On next $50 million
.65% On next $50 million
.60% On excess
From April 1, 1996 to December 31, 1999, pursuant to a Portfolio Management
Agreement between the Fund, the Adviser and Blairlogie Capital Management
("Blairlogie"), 4th Floor, 125 Princes Street, Edinburgh EH2 4AD, Scotland,
Blairlogie served as the Portfolio Manager and provided investment advisory
services to the Emerging Markets Portfolio. For the services provided in 1998
and 1999, Pacific Life paid a monthly fee to Blairlogie based on an annual
percentage of the Emerging Market Portfolio's average daily net assets
according to the following schedule:
Emerging Markets Portfolio
<CAPTION>
Rate
(%) Break Point (assets)
---- --------------------
<S> <C>
.85% On first $50 million
.75% On next $50 million
.70% On next $50 million
.65% On next $50 million
.60% On excess
</TABLE>
Alliance Capital Management Corporation ("ACMC") is the general partner of
Alliance and a wholly owned subsidiary of The Equitable Life Assurance Society
of the United States ("Equitable"). As of November 1, 1999, Equitable and its
subsidiaries were the beneficial owners of an approximately 55.38% partnership
interest in Alliance, and Alliance Capital Management Holding L.P. ("Alliance
Holding") owned an approximately 41.87% partnership interest in Alliance.
Equity interests in Alliance Holding are traded on the New York Stock Exchange
in the form of units. Approximately 98% of Alliance Holding's units are owned
by the public and management or employees of Alliance and approximately 2% are
owned by Equitable. The general partner of Alliance Holding is ACMC.
Equitable, a New York life insurance company, has total assets as at June 30,
1999 of approximately US$93.9 billion and is a wholly owned subsidiary of AXA
Financial, Inc. ("AXA Financial"), a Delaware corporation whose shares are
traded on the New York Stock Exchange. As of June 30, 1999, AXA, a French
insurance holding company, owned approximately 58.2% of the issued and
outstanding shares of the common stock of AXA Financial.
Alliance Capital currently serves as investment adviser to other mutual
funds as well as individual, corporate, retirement, and charitable accounts.
As of December 31, 1999, Alliance Capital was retained as an investment
manager of employee benefit fund assets for 31 of the top 100 of America's
Fortune 500 companies.
Net fees paid or owed by Pacific Life to Alliance Capital for the Emerging
Markets Portfolio in 1999 were $ . Net fees paid or owed by Pacific Life
to Blairlogie for the Emerging Markets Portfolio in 1998 were $821,133, and in
1997 were $642,976.
61
<PAGE>
From April 1, 1996 through April 30, 1998, pursuant to a Portfolio
Management Agreement between the Fund, the Adviser and Columbus Circle
Investors, Metro Center, One Station Place, 8th Floor, Stamford, Connecticut
06902, Columbus Circle Investors was the Portfolio Manager and provided
investment advisory services to the Aggressive Equity Portfolio.
Net fees paid or owed by Pacific Life to Alliance Capital in 1999 were
$ , from May 1, 1998 through December 31, 1998 were $622,812. Net fees
paid or owed by Pacific Life to Columbus Circle Investors from January 1, 1998
through April 30, 1998 were $251,083, in 1997 were $468,441.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Janus Capital Corporation ("Janus"), 100 Fillmore Street, Denver, Colorado
80206-4928, Janus is the Portfolio Manager and provides investment advisory
services to the Growth LT Portfolio.
Effective January 1, 1997, for the services provided, Pacific Life pays
Janus a fee based on an annual percentage of the average daily net assets of
the Growth LT Portfolio according to the following schedule:
Growth LT Portfolio
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.55% On first $100 million
.50% On next $400 million
.45% On excess
</TABLE>
Janus serves as investment adviser to the Janus Funds, as well as other
mutual funds and individual, corporate, charitable, and retirement accounts.
Kansas City Southern Industries, Inc. ("KCSI") indirectly through its wholly-
owned subsidiary, Stilwell Financial, Inc., owns approximately 82% of the
outstanding voting stock of Janus. KCSI is a publicly traded holding company
whose primary subsidiaries are engaged in transportation and financial
services. KCSI has announced its intention to separate its transportation and
financial services businesses. KCSI anticipates the separation to be completed
in the first half of 2000. Net fees paid or owed by Pacific Life to Janus for
the Growth LT Portfolio in 1999 were $ , in 1998 were $4,364,703 and in
1997 were $2,813,259.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and J.P. Morgan Investment Management Inc. ("J.P. Morgan Investment"), 522
Fifth Avenue, New York, New York 10036, J.P. Morgan Investment is the
Portfolio Manager and provides investment advisory services to the Equity
Income Portfolio and the Multi-Strategy Portfolio.
Effective January 1, 1997, for the services provided, Pacific Life pays J.P.
Morgan Investment a fee based on an annual percentage of the combined average
daily net assets of the Equity Income and Multi-Strategy Portfolios according
to the following schedule:
Equity Income and Multi-Strategy Portfolios
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.45% On first $100 million
.40% On next $100 million
.35% On next $200 million
.30% On next $350 million
.20% On excess
</TABLE>
J.P. Morgan Investment is an investment manager for corporate, public, and
union employee benefit funds, foundations, endowments, insurance companies,
government agencies and the accounts of other institutional investors. A
wholly-owned subsidiary of J.P. Morgan & Co. Incorporated ("Morgan"), J.P.
Morgan Investment was incorporated in the state of Delaware on February 7,
1984 and commenced operations on July 2, 1984. It was formed from the
Institutional Investment Group of Morgan Guaranty Trust Company of New York,
also a subsidiary of Morgan.
62
<PAGE>
Morgan acquired its first tax-exempt client in 1913 and its first pension
account in 1940. As of December 31, 1999, Morgan, through J.P. Morgan
Investment and its other subsidiaries, has assets under management of
approximately $ billion. With offices around the globe, J.P. Morgan
Investment draws from a worldwide resources base to provide comprehensive
service to an international group of clients.
Net fees paid or owed by Pacific Life to J.P. Morgan Investment in 1999 were
$ for the Equity Income Portfolio and $ for the Multi-Strategy
Portfolio, in 1998 were $2,783,163 for the Equity Income Portfolio and
$1,263,563 for the Multi-Strategy Portfolio, and in 1997 were $1,998,776 for
the Equity Income Portfolio and $920,564 for the Multi-Strategy Portfolio.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Salomon Brothers Asset Management, Inc. ("SaBAM"), Seven World Trade
Center, New York, New York 10048, which became effective December 18, 1998,
SaBAM is the Portfolio Manager and provides investment advisory services to
the Large-Cap Value Portfolio. For the services provided under this Agreement,
Pacific Life pays a fee to SaBAM based on an annual percentage of the average
daily net assets according to the following schedule:
Large-Cap Value Portfolio
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.45% On first $100 million
.40% On next $100 million
.35% On next $200 million
.30% On next $350 million
.25% On next $250 million
.20% On excess
</TABLE>
SaBAM, a wholly-owned subsidiary of Citigroup, Inc. was incorporated in 1987
and, together with SaBAM affiliates in London, Frankfurt, Tokyo and Hong Kong,
provides a broad range of fixed-income and equity investment advisory services
to various individuals and institutional clients located throughout the world,
and serves as investment adviser to various investment companies. As of
December 31, 1999, SaBAM and such affiliates managed approximately $ billion
of assets.
Net fees paid or owed by Pacific Life to SaBAM for the Large-Cap Value
Portfolio in 1999 were $ .
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Lazard Asset Management ("Lazard"), 30 Rockefeller Plaza, New York, New
York 10112, which became effective December 18, 1998, Lazard is the Portfolio
Manager and provides investment advisory services to the Mid-Cap Value
Portfolio. For the services provided under this Agreement, Pacific Life pays a
fee to Lazard based on a percentage of an annual average daily net assets
according to the following schedule:
Mid-Cap Value Portfolio
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.55% On first $200 million
.50% On next $200 million
.45% On next $200 million
.40% On next $200 million
.30% On next $200 million
.25% On excess
</TABLE>
Lazard, a division of Lazard Freres & Co. LLC ("Lazard Freres"), a New York
limited liability company, which is registered as an investment adviser with
the SEC and is a member of the New York, American and Midwest Stock Exchanges.
Lazard Freres provides its clients with a wide variety of investment banking,
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<PAGE>
brokerage and related services. Lazard and its affiliates provide investment
management services to client discretionary accounts with assets totaling
approximately $ billion as of December 31, 1999. Lazard's clients are both
individuals and institutions, some of whose accounts have investment policies
similar to those of the Portfolio.
Net fees paid or owed by Pacific Life to Lazard for the Mid-Cap Value
Portfolio in 1999 were $ .
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Goldman Sachs Asset Management ("Goldman Sachs"), 32 Old Slip, New York,
New York 10005, which became effective May 1, 1998, Goldman Sachs is the
Portfolio Manager and provides investment advisory services to the Equity and
Bond and Income Portfolios. Pursuant to a Portfolio Management Agreement
between the Fund, the Adviser, and Goldman Sachs, which became effective May
1, 2000, Goldman Sachs is the Portfolio Manager and provides investment
advisory services to the I-Net Tollkeeper Portfolio. For these services,
Pacific Life pays a fee to Goldman Sachs based on an annual percentage of the
average daily net assets of the Equity Portfolio, Bond and Income Portfolio
and I-Net Tollkeeper Portfolio according to the following schedule:
Equity and Bond and Income Portfolios
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.35% On first $100 million
.30% On next $100 million
.25% On next $800 million
.20% On excess
</TABLE>
I-Net Tollkeeper Portfolio
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.95% On first $1 billion
.90% On excess
</TABLE>
Goldman Sachs, a unit of the Investment Management Division of Goldman,
Sachs & Co. Goldman Sachs and its affiliates are the investment management
division of Goldman, Sachs & Co., which was founded in 1869. As of
December 31, 1999, Goldman Sachs and its affiliates manage, administer and
distribute over $ billion for institutional and individual investors
worldwide, including fixed income assets in excess of $ billion for which
they acted as investment adviser.
The Goldman Sachs Group, L.P., which controlled Goldman Sachs Asset
Management, merged into the Goldman Sachs Group, Inc. as a result of an
initial public offering.
From January 1, 1995 through April 30, 1998, pursuant to a Portfolio
Management Agreement between the Fund, the Adviser, and Greenwich Street
Advisors Division of Smith Barney Mutual Funds Management Inc. ("Greenwich
Street Advisors"), 388 Greenwich Street, 23rd Floor, New York, New York 10048,
Greenwich Street Advisors was the Portfolio Manager and provided investment
advisory service to the Equity Portfolio and Bond and Income Portfolio. For
the services provided, for the year 1997, Pacific Life paid a fee to Greenwich
Street Advisors based on an annual percentage of the combined average daily
net assets of the Equity and Bond and Income Portfolios according to the
following schedule:
Equity and Bond and Income Portfolios
<TABLE>
<CAPTION>
Rate(%) Break Point (assets)
------- ---------------------
<S> <C>
.45% On first $100 million
.40% On next $100 million
.35% On next $200 million
.30% On next $600 million
.20% On excess
</TABLE>
Net Fees paid or owed by Pacific Life to Goldman Sachs in 1999 was $
for the Equity Portfolio and $ for the Bond and Income Portfolio, from
May 1, 1998 through December 31, 1998 were $772,931
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<PAGE>
for the Equity Portfolio and $290,917 for the Bond and Income Portfolio. Net
fees paid or owed to Greenwich Street Advisors from January 1, 1998 through
April 30, 1998 were $437,389 for the Equity Portfolio and $147,029 for the
Bond and Income Portfolio and in 1997 were $1,088,097 for the Equity Portfolio
and $368,846 for the Bond and Income Portfolio.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser
and Fund Asset Management, L.P., doing business as Mercury Asset Management US
("Mercury"), a subsidiary of Merrill Lynch & Company, Inc., World Financial
Center, 225 Liberty Street, New York, NY 10080, which became effective January
1, 2000, Mercury is the Portfolio Manager and provides investment advisory
services to the Equity Index and Small-Cap Index Portfolios. For these
services, Pacific Life pays to Mercury a monthly fee based on an annual
percentage of the combined average daily net assets of the Equity Index and
Small-Cap Index Portfolios, according to the following schedule:
Equity Index and Small-Cap Index Portfolios
<TABLE>
<CAPTION>
Rate (%) Break-Point (assets)
-------- ---------------------
<S> <C>
.08% On first $100 million
.04% On next $100 million
.02% On excess
From January 30, 1991, in the case of the Equity Index Portfolio, and
January 1, 1999, in the case of the Small-Cap Index Portfolio, through
December 31, 1999, pursuant to a Portfolio Management Agreement between the
Fund, the Adviser and Bankers Trust Company ("BTCo"), a wholly-owned-
subsidiary of Bankers Trust Corporation, and an indirect subsidiary of
Deutsche Bank AG, 130 Liberty Street, New York, New York 10006, BTCo was the
Portfolio Manager and provided investment advisory services to the Equity
Index and Small-Cap Index Portfolios. For the services provided in 1998 and
1999, Pacific Life paid to BTCo, at the beginning of each calendar quarter, a
fee based on an annual percentage of the combined daily net assets of the
Equity Index and Small-Cap Index Portfolios, according to the following
schedule, subject to a minimum fee of $100,000:
Equity Index and Small-Cap Index Portfolios
<CAPTION>
Rate (%) Break-Point (assets)
-------- ---------------------
<S> <C>
.08% On first $100 million
.04% On next $100 million
.02% On excess
For the services provided, for the year 1997 with respect to the Equity
Index Portfolio, Pacific Life paid a quarterly fee in advance to BTCo, based
on the net assets of the Equity Index Portfolio at the beginning of each
calendar quarter at an annual rate in accordance with the following schedule:
Equity Index Portfolio
<CAPTION>
Rate (%) Break Point (assets)
-------- ---------------------
<S> <C>
.07% On first $100 million
.03% On next $100 million
.01% On excess
</TABLE>
As was the case with the current fee, this fee was subject to a minimum
annual fee of $100,000 for the calendar year 1997.
BTCo is a wholly-owned subsidiary of Bankers Trust Corporation, the seventh
largest bank holding company in the United States. BTCo is responsible for the
management of the Equity Index Portfolio. As of December 31, 1999, BTCo
managed assets approximating $ billion. BTCo is also the investment
manager to several other mutual fund portfolios and to private accounts for
pension and profit sharing plans.
65
<PAGE>
Net fees paid or owed by Pacific Life to BTCo for the Equity Index Portfolio
in 1999 were $ , and for the Small-Cap Index Portfolio were $ . Net
fees paid or owed by Pacific Life to BTCo for the Equity Index Portfolio in
1998 were $188,793, and in 1997 were $135,863.
Pursuant to a Portfolio Management Agreement between the Fund, the Adviser,
and Morgan Stanley Asset Management ("MSAM"), a subsidiary of Morgan Stanley
Dean Witter & Co., whose address is 1221 Avenue of the Americas, New York, New
York 10020, MSAM is the Portfolio Manager and provides investment advisory
services to the REIT and International Value Portfolios. On December 1, 1998
Morgan Stanley Asset Management Inc. changed its name to Morgan Stanley Dean
Witter Investment Management Inc. but continues to do business in certain
instances using the name Morgan Stanley Asset Management.
For the services provided under the Agreement for the International Value
Portfolio, which became effective June 1, 1997, Pacific Life pays a fee to
MSAM at an annual rate of 0.35% based on the average daily net assets of the
International Value Portfolio.
From January 1, 1995 through May 31, 1997, pursuant to a Portfolio
Management Agreement between the Fund, the Adviser, and Templeton Investment
Counsel, Inc. ("Templeton"), Broward Financial Centre, Suite 2100, Fort
Lauderdale, Florida 33394-3091, Templeton was the Portfolio Manager and
provided investment advice with respect to the International Value Portfolio.
For the services provided, for the period January 1, 1997 through May 31,
1997, Pacific Life paid a fee to Templeton based on an annual percentage of
the Portfolio's average daily net assets according to the following fee
schedule:
International Value Portfolio
<TABLE>
<CAPTION>
Rate (%) Break Point (assets)
-------- -------------------------
<S> <C>
.70% On first $25 million
.55% On next $25 million
.50% On next $50 million
.40% On excess
Net fees paid or owed by Pacific Life to MSAM for the International Value
Portfolio in 1999 were $ , in 1998 were $3,222,413, and from June 1,
1997 through December 31, 1997 were $1,478,065. Net fees paid or owed by
Pacific Life to Templeton for the International Value Portfolio from January
1, 1997 to May 31, 1997 were $945,379.
For the services provided under the Agreement for the REIT Portfolio, which
became effective December 18, 1998, Pacific Life pays a fee to MSAM based on
an annual percentage of the REIT Portfolio's average daily net assets
according to the following schedule:
REIT Portfolio
<CAPTION>
Rate (%) Break Point (assets)
-------- -------------------------
<S> <C>
.60% On first $100 million
.45% On next $150 million
.40% On next $250 million
.35% On next $500 million
.30% On excess over $1 billion
</TABLE>
Net fees paid or owed by Pacific Life to MSAM for the REIT Portfolio in 1999
were $ .
MSAM, together with its affiliated asset management companies, conducts a
worldwide portfolio management business and provides a broad range of
portfolio management services to customers in the
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<PAGE>
United States and abroad. As of December 31, 1999 MSAM, together with its
affiliated institutional asset management companies, had approximately $
billion in assets under management as an investment manager or as a fiduciary
adviser.
The Portfolio Management Agreements are not exclusive, and PIMCO, Capital
Guardian, Alliance Capital, Janus, J.P. Morgan Investment, SaBAM, Lazard,
Goldman Sachs, MSAM, and Mercury may provide and currently are providing
investment advisory services to other clients, including other investment
companies.
Distribution of Fund Shares
Pacific Mutual Distributors, Inc. ("PMD") serves as the Fund's Distributor
pursuant to a Distribution Contract (the "Distribution Contract") with the
Fund. The Distributor is not obligated to sell any specific amount of Fund
shares. PMD bears all expenses of providing services pursuant to the
Distribution Contract including the costs of sales presentations, mailings,
advertising, and any other marketing efforts by PMD in connection with the
distribution or sale of the shares.
The expenses incurred by the Fund with respect to each Portfolio in
connection with the Fund's organization, its registration with the SEC and any
states where registered, and the public offering of its shares were advanced
on behalf of the Fund by the Adviser. These organizational expenses were
deferred and amortized by the Fund's Portfolios over a period of 60 months.
Similarly, the organizational expenses of Portfolios of the Fund that have
been organized after the Fund commenced operations have been advanced on
behalf of the Fund by the Adviser, and are deferred and amortized by the
pertinent Portfolio over a period of 60 months from the commencement of
operations of the Portfolio. See "Financial Statements."
As of , 2000, Pacific Life beneficially owned 0% of the outstanding
shares of the Portfolios of the Fund. Pacific Asset Management LLC ("PAM"), a
wholly-owned subsidiary of Pacific Life, beneficially owned % of the
outstanding shares of the Large-Cap Value Portfolio, % of the outstanding
shares of the Mid-Cap Value Portfolio, % of the outstanding shares of the
Small-Cap Index Portfolio, % of the outstanding shares of the REIT
Portfolio, % of the outstanding shares of the Diversified Research
Portfolio, and % of the outstanding shares of the International Large-Cap
Portfolio, including monies paid in connection with the initial capital
advances made to the Fund, and 0%, of the outstanding shares of the other
fourteen Portfolios of the Fund. As of , 2000, Pacific Life owned 100%
of the outstanding shares of the I-Net Tollkeeper Portfolio. Pacific Life and
PAM would exercise voting rights attributable to any shares of the Fund owned
by them in accordance with voting instructions received by Owners of the
Policies issued by Pacific Life. To this extent, as of , 2000, Pacific
Life did not exercise control over any Portfolio.
Purchases and Redemptions
Shares of the Fund are not sold directly to the general public. Shares of
the Fund are currently offered only for purchase by the Separate Accounts to
serve as an investment medium for the Variable Contracts issued or
administered by Pacific Life or its affiliates. For information on purchase of
a Variable Contract, consult a prospectus for the Separate Account. The shares
of the Large-Cap Value, Mid-Cap Value, Small-Cap Index, Diversified Research,
International Large-Cap, and REIT Portfolios are not available for Pacific
Select variable universal life insurance policies. The shares of the Large-Cap
Value, Mid-Cap Value, Small-Cap Index, REIT, Small-Cap Equity, Aggressive
Equity, Emerging Markets, Diversified Research, and International Large-Cap
Portfolios are not available for Pacific Corinthian variable annuity
contracts.
Currently, each Portfolio offers shares of a single class. However, the Fund
is authorized to offer up to four additional classes of shares for each
Portfolio. These classes may be offered in the future to investors in
connection with individual retirement accounts, and certain other types of
qualified plans.
Shares of any Portfolio may be redeemed on any business day upon receipt of
a request for redemption from the insurance company whose separate account
owns the shares. Redemptions are effected at the per share
67
<PAGE>
net asset value next determined after receipt of the redemption request.
Redemption proceeds will ordinarily be paid within seven days following
receipt of instructions in proper form, or sooner, if required by law. The
right of redemption may be suspended by the Fund or the payment date postponed
beyond seven days when the New York Stock Exchange is closed (other than
customary weekend and holiday closings) or for any period during which trading
thereon is restricted because an emergency exists, as determined by the SEC,
making disposal of portfolio securities or valuation of net assets not
reasonably practicable, and whenever the SEC has by order permitted such
suspension or postponement for the protection of shareholders. If the Board of
Trustees should determine that it would be detrimental to the best interests
of the remaining shareholders of a Portfolio to make payment wholly or partly
in cash, the Portfolio may pay the redemption price in whole or part by a
distribution in kind of securities from the Portfolio, in lieu of cash, in
conformity with applicable rules of the SEC. If shares are redeemed in kind,
the redeeming shareholder might incur brokerage costs in converting the assets
into cash. Under the Investment Company Act of 1940, the Fund is obligated to
redeem shares solely in cash up to the lesser of $250,000 or 1 percent of its
net assets during any 90-day period for any one shareholder. The Fund may
suspend the right of redemption of shares of any Portfolio and may postpone
payment for more than seven days for any period: (i) during which the New York
Stock Exchange is closed other than customary weekend and holiday closings or
during which trading on the New York Stock Exchange is restricted; (ii) when
the SEC determines that a state of emergency exists which may make payment or
transfer not reasonably practicable; (iii) as the SEC may by order permit for
the protection of the security holders of the Fund; or (iv) at any other time
when the Fund may, under applicable laws and regulations, suspend payment on
the redemption of its shares. If the Board of Trustees should determine that
it would be detrimental to the best interests of the remaining shareholders of
a Portfolio to make payment wholly or partly in cash, the Portfolio may pay
the redemption price in whole or in part by a distribution in kind of
securities from the portfolio of the Portfolio, in lieu of cash, in conformity
with applicable rules of the SEC. If shares are redeemed in kind, the
redeeming shareholder might incur brokerage costs in converting the assets
into cash.
Exchanges Among the Portfolios
Variable Contract Owners do not deal directly with the Fund to purchase,
redeem, or exchange shares of a Portfolio, and Variable Contract Owners should
refer to the Prospectus for the applicable Separate Account for information on
the allocation of premiums and on transfers of accumulated value among options
available under the contract.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Investment Decisions
Investment decisions for the Fund and for the other investment advisory
clients of the Adviser, or applicable Portfolio Manager, are made with a view
to achieving their respective investment objectives. Investment decisions are
the product of many factors in addition to basic suitability for the
particular client involved (including the Fund). Thus, a particular security
may be bought or sold for certain clients even though it could have been
bought or sold for other clients at the same time. It also sometimes happens
that two or more clients simultaneously purchase or sell the same security, in
which event each day's transactions in such security are, insofar as possible,
averaged as to price and allocated between such clients in a manner which in
the opinion of the Adviser or Portfolio Manager is equitable to each and in
accordance with the amount being purchased or sold by each. There may be
circumstances when purchases or sales of portfolio securities for one or more
clients will have an adverse effect on other clients.
Brokerage and Research Services
The Adviser or Portfolio Manager for a Portfolio places all orders for the
purchase and sale of portfolio securities, options, and futures contracts and
other investments for a Portfolio through a substantial number of brokers and
dealers or futures commission merchants selected at its discretion. In
executing transactions, the
68
<PAGE>
Adviser or Portfolio Manager will attempt to obtain the best net results for a
Portfolio taking into account such factors as price (including the applicable
brokerage commission or dollar spread), size of order, the nature of the
market for the security, the timing of the transaction, the reputation,
experience and financial stability of the broker-dealer involved, the quality
of the service, the difficulty of execution and operational facilities of the
firms involved, and the firm's risk in positioning a block of securities. In
transactions on stock exchanges in the United States, payments of brokerage
commissions are negotiated. In effecting purchases and sales of portfolio
securities in transactions on United States stock exchanges for the account of
the Fund, the Adviser or Portfolio Manager may pay higher commission rates
than the lowest available when the Adviser or Portfolio Manager believes it is
reasonable to do so in light of the value of the brokerage and research
services provided by the broker effecting the transaction. In the case of
securities traded on some foreign stock exchanges, brokerage commissions may
be fixed and the Adviser or Portfolio Manager may be unable to negotiate
commission rates for these transactions. In the case of securities traded on
the over-the-counter markets, there is generally no stated commission, but the
price includes an undisclosed commission or markup. Consistent with the policy
of obtaining the best net results, a portion of a Portfolio's brokerage and
futures transactions, including transactions on a national securities
exchange, may be conducted through an affiliated broker. The brokerage
commissions paid to an affiliated broker will not exceed 25% of the brokerage
commission incurred per year by the Portfolio.
There is generally no stated commission in the case of fixed-income
securities, which are traded in the over-the-counter markets, but the price
paid by the Fund usually includes an undisclosed dealer commission or mark-up.
In underwritten offerings, the price paid by the Fund includes a disclosed,
fixed commission or discount retained by the underwriter or dealer.
Transactions on U.S. stock exchanges and other agency transactions involve the
payment by the Fund of negotiated brokerage commissions. Such commissions vary
among different brokers. Also, a particular broker may charge different
commissions according to such factors as the difficulty and size of the
transaction. In the case of securities traded on some foreign stock exchanges,
brokerage commissions may be fixed and the Adviser or Portfolio Manager may be
unable to negotiate commission rates for these transactions.
Some securities considered for investment by the Fund's Portfolios may also
be appropriate for other clients served by the Adviser or Portfolio Manager.
If a purchase or sale of securities consistent with the investment policies of
a Portfolio and one or more of these clients served by the Adviser or
Portfolio Manager is considered at or about the same time, transactions in
such securities will be allocated among the Portfolio and clients in a manner
deemed fair and reasonable by the Adviser or Portfolio Manager. Although there
is no specified formula for allocating such transactions, the various
allocation methods used by the Adviser or Portfolio Manager, and the results
of such allocations, are subject to periodic review by the Fund's Adviser and
Board of Trustees.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional
investors to receive research services from broker-dealers which execute
portfolio transactions for the clients of such advisers. Consistent with this
practice, the Adviser or Portfolio Manager for a Portfolio may receive
research services from many broker-dealers with which the Adviser or Portfolio
Manager places the Portfolio's portfolio transactions. These services, which
in some cases may also be purchased for cash, include such matters as general
economic and security market reviews, industry and company reviews,
evaluations of securities and recommendations as to the purchase and sale of
securities. Some of these services may be of value to the Adviser or Portfolio
Manager in advising its various clients (including the Portfolio), although
not all of these services are necessarily useful and of value in managing a
Portfolio. The advisory fee paid by the Portfolio is not reduced because the
Adviser or Portfolio Manager and its affiliates receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, the
Adviser or Portfolio Manager may cause a Portfolio to pay a broker-dealer,
which provides "brokerage and research services" (as defined in the Act) to
the Adviser or Portfolio Manager, an amount of disclosed commission for
effecting a securities transaction for the Portfolio in excess of the
commission which another broker-dealer would have charged for effecting that
transaction.
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<PAGE>
During the years 1999, 1998, and 1997, respectively, the following
Portfolios incurred brokerage commissions as follows: the High Yield Bond
Portfolio--$ , $2,720 and $2,500, the Managed Bond Portfolio--$ ,
$122,103 and $41,315, the Government Securities Portfolio--$ , $29,467 and
$21,349, the Small-Cap Equity Portfolio--$ , $251,753 and $225,232, the
Aggressive Equity Portfolio--$ , $855,826 and $296,940, the Growth LT
Portfolio--$ , $1,517,836 and $1,057,621, the Equity Income Portfolio--
$ , $1,529,206 and $1,162,083, the Multi-Strategy Portfolio--$ ,
$455,757 and $283,791, the Equity Portfolio--$ , $725,654 and $706,250
of which $ ( %) and $8,633 (1.2%) was paid to Goldman, Sachs & Co. in
1999 and 1998 respectively, an affiliate of Goldman Sachs Asset Management,
and $6,900 (0.95%) and $61,512 (8.71%) was paid to Smith Barney Inc. and
$4,500 (0.62%) and $23,700 (3.36%) was paid to Robinson Humphrey Co., Inc., in
1998 and 1997 respectively, affiliates of Greenwich Street Advisors, the Bond
and Income Portfolio--$ , $14,193 and $0, of which $ and $14,193 (100%)
was paid to Goldman, Sachs & Co. in 1999 and 1998 respectively, an affiliate
of Goldman Sachs Asset Management, the Equity Index Portfolio--$ ,
$140,167 and $157,624, the International Value Portfolio--$ , $2,177,935
and $1,606,247 of which $ ( %), $41,033 (1.88%) and $39,617 (2.47%) was
paid to Morgan Stanley & Co., respectively, an affiliate of Morgan Stanley
Asset Management and the Emerging Markets Portfolio--$ , $373,834 and
$712,505.
On December 31, 1999, the Government Securities Portfolio held securities of
valued at ; the Managed Bond Portfolio held securities of
valued at ; the Equity Income Portfolio held securities of
valued at ; the Multi-Strategy Portfolio held securities of
valued at ; the International Value Portfolio held securities
of valued at ; the Equity Index Portfolio held securities of
valued at ; the Equity Portfolio held securities of
valued at ; and the Bond and Income Portfolio held securities of
valued at , each of which is a broker or dealer regularly used
for brokerage transactions by that Portfolio.
Portfolio Turnover
For reporting purposes, each Portfolio's portfolio turnover rate is
calculated by dividing the value of the lesser of purchases or sales of
portfolio securities for the fiscal year by the monthly average of the value
of portfolio securities owned by the Portfolio during the fiscal year. In
determining such portfolio turnover, long-term U.S. Government securities are
included. Short-term U.S. Government securities and all other securities whose
maturities at the time of acquisition were one year or less are excluded. A
100% portfolio turnover rate would occur, for example, if all of the
securities in the portfolio (other than short-term securities) were replaced
once during the fiscal year. The portfolio turnover rate for each of the
Portfolios will vary from year to year, depending on market conditions.
The portfolio turnover rates are not expected to exceed: 0% for the Money
Market Portfolio; 400% for the Managed Bond and Government Securities
Portfolios; and 150% for all other Portfolios. For the Portfolios other than
the Money Market Portfolio, portfolio turnover could be greater in periods of
unusual market movement and volatility.
NET ASSET VALUE
Shares of each Portfolio are sold at their respective net asset values
(without a sales charge) computed after receipt of a purchase order. Net asset
value of a share is determined by dividing the value of a Portfolio's net
assets by the number of its shares outstanding. That determination is made
once each business day, Monday through Friday, exclusive of federal holidays
usually at or about 4:00 p.m. Eastern time, on each day that the
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<PAGE>
New York Stock Exchange is open for trading. The New York Stock Exchange and
other exchanges usually close for trading at 4:00 p.m. Eastern time. In the
event that the New York Stock Exchange or other exchanges close early, the
Fund normally will deem the closing price of each Portfolio's assets to be the
price of those assets at 4:00 p.m., Eastern time. Net asset value will not be
determined on the following holidays: New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day. To calculate a Portfolio's net asset
value, a Portfolio's assets are valued and totaled, liabilities are
subtracted, and the balance, called net assets, is divided by the number of
shares outstanding. In general, the value of assets is based on actual or
estimated market value, with special provisions for assets not having readily
available market quotations and short-term debt securities. With respect to
the Portfolios that invest in foreign securities, the value of foreign
securities that are traded on stock exchanges outside the United States are
based upon the price on the exchange as of the close of business of the
exchange immediately preceding the time of valuation. Securities traded in
over-the-counter markets outside the United States are valued at the last
available price in the over-the-counter market prior to the time of valuation.
Trading in securities on exchanges and over-the-counter markets in European
and Pacific Basin countries is normally completed well before 4:00 P.M.,
Eastern time. In addition, European and Pacific Basin securities trading may
not take place on all business days in New York. Furthermore, trading takes
place in Japanese markets on certain Saturdays and in various foreign markets
on days which are not business days in New York and on which the Fund's net
asset value is not calculated. Quotations of foreign securities in foreign
currencies are converted to U.S. dollar equivalents using the foreign exchange
quotation in effect at the time net asset value is computed. The calculation
of the net asset value of any Portfolio which invests in foreign securities
which are principally traded in a foreign market may not take place
contemporaneously with the determination of the prices of portfolio securities
of foreign issuers used in such calculation. Further, under the Fund's
procedures, the prices of foreign securities are determined using information
derived from pricing services and other sources every day that the Fund values
its shares. Prices derived under these procedures will be used in determining
net asset value. Information that becomes known to the Fund or its agents
after the time that net asset value is calculated on any business day (which
may be after 4:00 p.m. Eastern time) may be assessed in determining net asset
value per share after the time of receipt of the information, but will not be
used to retroactively adjust the price of the security so determined earlier
or on a prior day. Events affecting the values of portfolio securities that
occur between the time their prices are determined and the time a Portfolio's
net asset value is determined may not be reflected in the calculation of net
asset value. If events materially affecting net asset value occur during such
period, the securities would be valued at fair market value as determined by
the management and approved in good faith by the Board of Trustees of the
Fund. In determining the fair value of securities, the Fund may consider
available information including information that becomes known after 4:00 p.m.
Eastern time, and the values that are determined will be deemed to be the
price at 4:00 p.m. Eastern time.
The Money Market Portfolio's portfolio securities are valued using the
amortized cost method of valuation. This involves valuing a security at cost
on the date of acquisition and thereafter assuming a constant accretion of a
discount or amortization of a premium to maturity, regardless of the impact of
fluctuating interest rates on the market value of the instrument. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
Portfolio would receive if it sold the instrument. During such periods the
yield to investors in the Portfolio may differ somewhat from that obtained in
a similar investment company which uses available market quotations to value
all of its portfolio securities.
The Commission's regulations require the Money Market Portfolio to adhere to
certain conditions. The Portfolio is required to maintain a dollar-weighted
average portfolio maturity of 90 days or less, to limit its investments to
instruments having remaining maturities of 13 months or less (except
securities held subject to repurchase agreements having 13 months or less to
maturity) and to invest only in securities that meet specified quality and
credit criteria.
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All other Portfolios are valued as follows:
Portfolio securities for which market quotations are readily available are
stated at market value. Market value is determined on the basis of last
reported sales price, or, if no sales are reported, the mean between
representative bid and asked quotations obtained from a quotation reporting
system or from established market makers. In other cases, securities are
valued at their fair value as determined in good faith by the Board of
Trustees of the Fund, although the actual calculations may be made by persons
acting under the direction of the Board. Money market instruments are valued
at market value, except that instruments maturing in sixty days or less are
valued using the amortized cost method of valuation.
The value of a foreign security is determined in its national currency based
upon the price on the foreign exchange as of its close of business immediately
preceding the time of valuation. Securities traded in over-the-counter markets
outside the United States are valued at the last available price in the over-
the-counter market prior to the time of valuation.
Debt securities, including those to be purchased under firm commitment
agreements (other than obligations having a maturity of sixty days or less at
their date of acquisition), are normally valued on the basis of quotes
obtained from brokers and dealers or pricing services, which take into account
appropriate factors such as institutional-size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics, and other market data. Debt obligations having a maturity of
sixty days or less are generally valued at amortized cost unless the amortized
cost value does not approximate market value. Certain debt securities for
which daily market quotations are not readily available may be valued,
pursuant to guidelines established by the Board of Trustees, with reference to
debt securities whose prices are more readily obtainable and whose durations
are comparable to the securities being valued.
When a Portfolio writes a put or call option, the amount of the premium is
included in the Portfolio's assets and an equal amount is included in its
liabilities. The liability thereafter is adjusted to the current market value
of the option. The premium paid for an option purchased by the Portfolio is
recorded as an asset and subsequently adjusted to market value. The values of
futures contracts are based on market prices. Quotations of foreign securities
in foreign currency are converted to U.S. dollar equivalents at the prevailing
market rates quoted by the custodian on the morning of valuation.
PERFORMANCE INFORMATION
The Fund may, from time to time, include the yield and effective yield of
its Money Market Portfolio, the yield of the remaining Portfolios, and the
total return of all Portfolios in advertisements, sales literature, or reports
to shareholders or prospective investors. Total return information for the
Fund will not be advertised or included in sales literature unless accompanied
by comparable performance information for a Separate Account to which the Fund
offers its shares.
Current yield for the Money Market Portfolio will be based on the change in
the value of a hypothetical investment (exclusive of capital charges) over a
particular 7-day period, less a pro-rata share of Portfolio expenses accrued
over that period (the "base period"), and stated as a percentage of the
investment at the start of the base period (the "base period return"). The
base period return is then annualized by multiplying by 365/7, with the
resulting yield figure carried to at least the nearest hundredth of one
percent. "Effective yield" for the Money Market Portfolio assumes that all
dividends received during an annual period have been reinvested. Calculation
of "effective yield" begins with the same "base period return" used in the
calculation of yield, which is then annualized to reflect weekly compounding
pursuant to the following formula:
Effective Yield = [(Base Period Return + 1) (To the power of 365/7)]-1
For the 7-day period ending December 31, 1999, the current yield of the
Money Market Portfolio was % and the effective yield of the Portfolio was
%.
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Quotations of yield for the remaining Portfolios will be based on all
investment income per share earned during a particular 30-day period
(including dividends and interest), less expenses accrued during the period
("net investment income"), and are computed by dividing net investment income
by the maximum offering price per share on the last day of the period,
according to the following formula:
2[(a-b + 1) (To the power of 6) - 1]
---
cd
where
a = dividends and interest earned during the period,
b = expenses accrued for the period (net of reimbursements),
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends, and
d = the maximum offering price per share on the last day of the period.
For the 30 day period ended December 31, 1999, the yield of the remaining
Portfolios that had commenced operations on or before that date was as
follows: % for the High Yield Bond Portfolio, % for the Managed Bond
Portfolio, % for the Government Securities Portfolio, % for the Small-
Cap Equity Portfolio, % for the Aggressive Equity Portfolio, % for
the Growth LT Portfolio, % for the Equity Income Portfolio, % for the
Multi-Strategy Portfolio, % for the Equity Portfolio, % for the Bond
and Income Portfolio, % for the Equity Index Portfolio, % for the
International Value Portfolio, and % for the Emerging Markets Portfolio.
Quotations of average annual total return for a Portfolio will be expressed
in terms of the average annual compounded rate of return of a hypothetical
investment in the Portfolio over certain periods that will include a period of
one year (or, if less, up to the life of the Portfolio), calculated pursuant
to the following formula: P (1 + T)n = ERV (where P = a hypothetical initial
payment of $1,000, T = the total return for the period, n = the number of
periods, and ERV = the ending redeemable value of a hypothetical $1,000
payment made at the beginning of the period). Quotations of total return may
also be shown for other periods. All total return figures reflect the
deduction of a proportional share of Portfolio expenses on an annual basis,
and assume that all dividends and distributions are reinvested when paid.
For the one year period ended December 31, 1999, the total return for each
Portfolio that had commenced operations on or before that date was as follows:
% for the Money Market Portfolio, % for the High Yield Bond Portfolio,
% for the Managed Bond Portfolio, % for the Government Securities
Portfolio, % for the Small-Cap Equity Portfolio, % for the Aggressive
Equity Portfolio, % for the Growth LT Portfolio, % for the Equity
Income Portfolio, % for the Multi-Strategy Portfolio, % for the
Equity Portfolio, % for the Bond and Income Portfolio, % for the
Equity Index Portfolio, % for the International Value Portfolio, %
for the Large-Cap Value Portfolio, % for the Mid-Cap Value Portfolio,
% for the Small-Cap Index Portfolio and % for the REIT Portfolio,
and % for the Emerging Markets Portfolio. The Diversified Research and
the International Large-Cap Portfolios did not begin operations until January
3, 2000 and the I-Net Tollkeeper Portfolio did not begin operations until May
1, 2000.
For the five year period ended December 31, 1999, the average annual total
return for each Portfolio that had commenced operations on or before that date
was as follows: % for the Money Market Portfolio, % for the High Yield
Bond Portfolio, % for the Managed Bond Portfolio, % for the Government
Securities Portfolio, % for the Small-Cap Equity Portfolio, % for
the Equity Income Portfolio, % for the Multi-Strategy Portfolio, %
for the Equity Portfolio, % for the Bond and Income Portfolio, % for
the Equity Index Portfolio, % for the Growth LT Portfolio, and % for
the International Value Portfolio. The Aggressive Equity and Emerging Markets
Portfolios did not begin operations until April 1, 1996. The Large-Cap Value,
Mid-Cap Value, Small-Cap Index and REIT Portfolios did not begin operations
until January 4, 1999. The Diversified Research and the International Large-
Cap Portfolios did not begin operations until January 3, 2000 and the I-Net
Tollkeeper Portfolio did not begin operations until May 1, 2000.
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For the ten year period ended December 31, 1999, the average annual total
returns for each Portfolio, except the Growth LT, Aggressive Equity, Equity
Index and Emerging Markets Portfolios, was as follows: % for the Money
Market Portfolio, % for the High Yield Bond Portfolio, % for the
Managed Bond Portfolio, % for the Government Securities Portfolio, %
for the Small-Cap Equity Portfolio, % for the Equity Income Portfolio,
% for the Multi-Strategy Portfolio, % for the Equity Portfolio,
% for the Bond and Income Portfolio, and % for the International
Value Portfolio. Based upon the period from the commencement of operations of
the Growth LT Portfolio on January 4, 1994 until December 31, 1999, the
average annual total return for the Growth LT Portfolio was %. Based upon
the period from the commencement of operations of the Equity Index Portfolio
on January 30, 1991 until December 31, 1999, the average annual total return
for the Equity Index Portfolio was %. Based upon the period from the
commencement of operations of the Aggressive Equity and Emerging Markets
Portfolios on April 1, 1996 until December 31, 1999, the average annual total
return for each of these Portfolios was % and %, respectively. Based
upon the period from the commencement of operations of the Large-Cap Value,
Mid-Cap Value, Small-Cap Index and REIT Portfolios on January 4, 1999 until
December 31, 1999, the average annual total return for each of these
Portfolios was %, %, % and %, respectively. The
Diversified Research and the International Large-Cap Portfolios did not begin
operations until January 3, 2000 and the I-Net Tollkeeper Portfolio did not
begin operations until May 1, 2000.
The performance results for the Aggressive Equity, Equity Income, Multi-
Strategy, Equity, Bond and Income, and International Value Portfolios are
based, in part, on performance results when these Portfolios were advised by
different Portfolio Managers. Alliance Capital began serving as Portfolio
Manager to the Aggressive Equity Portfolio on May 1, 1998, J.P. Morgan
Investment began serving as Portfolio Manager to the Equity Income and Multi-
Strategy Portfolios on January 1, 1994, Morgan Stanley began serving as
Portfolio Manager to the International Value Portfolio on June 1, 1997, and
Goldman Sachs began serving as Portfolio Manager to the Equity and Bond and
Income Portfolios on May 1, 1998. The performance results for the Equity
Portfolio and Bond and Income Portfolio are based, in part, on the performance
results of the predecessor series of Pacific Corinthian Variable Fund, the
assets of which were acquired by the Fund on December 31, 1994.
Performance information for a Portfolio may be compared, in advertisements,
sales literature, and reports to shareholders to (i) various indices so that
investors may compare a Portfolio's results with those of a group of unmanaged
securities widely regarded by investors as representative of the securities
markets in general; (ii) other groups of mutual funds tracked by Lipper
Analytical Services Inc., a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, or
tracked by other services, companies, publications, or persons who rank mutual
funds on overall performance or other criteria; and (iii) the Consumer Price
Index (measure for inflation) to assess the real rate of return from an
investment in the Portfolio. Unmanaged indexes may assume the reinvestment of
dividends but generally do not reflect deductions for administrative and
management costs and expenses.
Quotations of yield or total return for the Fund will not take into account
charges and deductions against any Separate Accounts to which the Fund shares
are sold or charges and deductions against the Contracts issued or
administered by Pacific Life. The Portfolio's yield and total return should
not be compared with mutual funds that sell their shares directly to the
public since the figures provided do not reflect charges against the Separate
Accounts or the Contracts. Performance information for any Portfolio reflects
only the performance of a hypothetical investment in the Portfolio during the
particular time period on which the calculations are based. Performance
information should be considered in light of the Portfolio's investment
objectives and policies, characteristics and quality of the portfolios and the
market conditions during the given time period, and should not be considered
as a representation of what may be achieved in the future.
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TAXATION
Each Portfolio intends to qualify annually and to elect to be treated as a
regulated investment company under the Internal Revenue Code of 1986 (the
"Code").
To qualify as a regulated investment company, each Portfolio generally must,
among other things: (i) derive in each taxable year at least 90% of its gross
income from dividends, interest, payments with respect to securities loans,
and gains from the sale or other disposition of stock, securities or foreign
currencies, or other income derived with respect to its business of investing
in such stock, securities or currencies; (ii) diversify its holdings so that,
at the end of each quarter of the taxable year, (a) at least 50% of the market
value of the Portfolio's assets is represented by cash, U.S. Government
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer limited for the
purposes of this calculation to an amount not greater than 5% of the value of
the Portfolio's total assets and 10% of the outstanding voting securities of
such issuer, and (b) not more than 25% of the value of its total assets is
invested in the securities of any one issuer (other than U.S. Government
securities or the securities of other regulated investment companies); and
(iii) distribute at least 90% of its investment company taxable income (which
includes, among other items, dividends, interest, and net short-term capital
gains in excess of any net long-term capital losses) each taxable year.
As a regulated investment company, a Portfolio generally will not be subject
to U.S. federal income tax on its investment company taxable income and net
capital gains (any net long-term capital gains in excess of the sum of net
short-term capital losses and capital loss carryovers from prior years), if
any, that it distributes to shareholders. Each Portfolio intends to distribute
to its shareholders, at least annually, substantially all of its investment
company taxable income and any net capital gains. In addition, amounts not
distributed by a Portfolio on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax. To
avoid the tax, a Portfolio must distribute (or be deemed to have distributed)
during each calendar year, (i) at least 98% of its ordinary income (not taking
into account any capital gains or losses) for the calendar year, (ii) at least
98% of its capital gains in excess of its capital losses for the twelve month
period ending on October 31 of the calendar year (adjusted for certain
ordinary losses), and (iii) all ordinary income and capital gains for previous
years that were not distributed during such years. To avoid application of the
excise tax, each Portfolio intends to make its distributions in accordance
with the calendar year distribution requirement. A distribution will be
treated as paid on December 31 of the calendar year if it is declared by a
Portfolio during October, November, or December of that year to shareholders
of record on a date in such a month and paid by the Portfolio during January
of the following calendar year. Such distributions will be taxable to
shareholders (the Separate Accounts) for the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received.
Each Portfolio also intends to comply with diversification regulations under
Section 817(h) of the Code, that apply to mutual funds underlying variable
contracts. Generally, a Portfolio will be required to diversify its
investments so that on the last day of each quarter of a calendar year no more
than 55% of the value of its total assets is represented by any one
investment, no more than 70% is represented by any two investments, no more
than 80% is represented by any three investments, and no more than 90% is
represented by any four investments. For this purpose, securities of a given
issuer generally are treated as one investment, but each U.S. Government
agency and instrumentality is treated as a separate issuer. Compliance with
the diversification rules under Section 817(h) of the Code generally will
limit the ability of any Portfolio, and in particular, the Government
Securities Portfolio, to invest greater than 55% of its total assets in direct
obligations of the U.S. Treasury (or any other issuer) or to invest primarily
in securities issued by a single agency or instrumentality of the
U.S. Government.
If a Portfolio invests in shares of a foreign investment company, the
Portfolio may be subject to U.S. federal income tax on a portion of an "excess
distribution" from, or of the gain from the sale of part or all of the shares
in, such company. In addition, an interest charge may be imposed with respect
to deferred taxes arising from such distributions or gains. The Portfolio may
be eligible to elect alternative tax treatment that would mitigate the effects
of owning foreign investment company stock.
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Under the Code, gains or losses attributable to fluctuations in exchange
rates which occur between the time a Portfolio accrues income or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time that Portfolio actually collects such receivables or
pays such liabilities generally are treated as ordinary income or ordinary
loss. Similarly, on disposition of debt securities denominated in a foreign
currency and on disposition of certain futures contracts, forward contracts,
and options, gains or losses attributable to fluctuations in the value of
foreign currency between the date of acquisition of the security or contract
and the date of disposition also are treated as ordinary gain or loss. These
gains or losses, referred to under the Code as "Section 988" gains or losses,
may increase or decrease the amount of a Portfolio's investment company
taxable income to be distributed to its shareholders as ordinary income.
The Treasury Department announced that it would issue future regulations or
rulings addressing the circumstances in which a variable contract owner's
control of the investments of a separate account may cause the contract owner,
rather than the insurance company, to be treated as the owner of the assets
held by the separate account. If the contract owner is considered the owner of
the securities underlying the separate account, income and gains produced by
those securities would be included currently in the contract owner's gross
income. It is not known what standards will be set forth in the regulations or
rulings.
In the event that the rules or regulations are adopted there can be no
assurance that the Portfolios will be able to operate as currently described
in the Prospectus, or that the Trust will not have to change any Portfolio's
investment objective or investment policies. While each Portfolio's investment
objective is fundamental and may be changed only by a vote of a majority of
its outstanding shares, the Trustees have reserved the right to modify the
investment policies of the Portfolios as necessary to prevent any such
prospective rules and regulations from causing the contract owners to be
considered the owners of the shares of the Portfolios underlying the Separate
Accounts.
Distributions
Distributions by a Portfolio of any investment company taxable income (which
includes, among other items, dividends, interest, and any net realized short-
term capital gains in excess of net realized long-term capital losses),
whether received in cash or reinvested in additional Portfolio shares, will be
treated as ordinary income for tax purposes in the hands of a shareholder (a
Separate Account). Distributions of net capital gains (the excess of any net
long-term capital gains over net short-term capital losses), whether received
in cash or reinvested in additional Portfolio shares, will generally be
treated by a Separate Account as either "20% Rate Gain" or "28% Rate Gain,"
depending upon the Portfolio's holding period for the assets sold, regardless
of the length of time a Separate Account has held Portfolio shares.
Hedging Transactions
The diversification requirements applicable to a Portfolio's assets may
limit the extent to which a Portfolio will be able to engage in transactions
in options, futures contracts, or forward contracts.
OTHER INFORMATION
Concentration Policy
Under each Portfolio's investment restrictions, except the REIT and the I-
Net Tollkeeper Portfolios', a Portfolio may not invest in a security if, as a
result of such investment, more than 25% of its total assets (taken at market
value at the time of such investment) would be invested in the securities of
issuers in any particular industry, except securities issued or guaranteed by
the U.S. Government or its agencies or instrumentalities (or repurchase
agreements with respect thereto). Mortgage-related securities, including CMOs,
that are issued or guaranteed by the U.S. Government, its agencies or
instrumentalities ("government issued") are considered government securities.
The Portfolios take the position that mortgage-related securities, whether
government issued or privately issued, do not represent interests in any
particular "industry" or group of industries, and
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therefore, the concentration restriction noted above does not apply to such
securities. For purposes of complying with this restriction, the Fund, in
consultation with its Portfolio Managers, utilizes its own industry
classifications.
Brokerage Enhancement Plan
The Fund has adopted a Brokerage Enhancement Plan (the "Plan") pursuant to
Rule 12b-1 under the 1940 Act, under which the Fund may enter into agreements
or arrangements with brokers or dealers, pursuant to which brokerage
transactions can be directed on behalf of a Portfolio to the participating
broker-dealer to execute the transaction in return for credits or other types
of benefits to be awarded to the Portfolio. These credits generally will not
take the form of a cash payment or a rebate to the Fund, but rather as a
"credit" towards another service or benefit provided by the broker-dealer.
The directed-brokerage and other credits or benefits earned by each
Portfolio can be used in a number of ways to promote the distribution of the
Fund's shares. These ways include placing securities trades with a broker-
dealer that: (i) permits PMD to participate in or sponsor seminars, sales
meetings, conferences, and other events held by the broker-dealer; (ii) is
conducting due diligence on the Fund or the variable contracts (to help that
broker-dealer defray the expenses of its due diligence); (iii) is
disseminating sales literature about the Fund or the variable contracts (to
help defray its related expenses); or (iv) is placing the Fund or the variable
contracts on a list of eligible funds or variable contracts that may be
offered by that broker-dealer's registered representatives (to help compensate
it for the associated expenses).
PMD can indirectly benefit from the Plan in that securities brokerage
allocated to a broker-dealer may help defray, in whole or in part,
distribution expenses that otherwise would be borne by PMD or an affiliate.
The Plan also permits credits generated by securities transactions from one
Portfolio to inure to the benefits of that Portfolio, of any other Portfolio,
or to the Fund as a whole.
The Plan provides that it is subject to annual renewal by the Board,
including those Trustees of the Fund who are not "interested persons" of the
Fund (as defined in the 1940 Act) and who have no direct or indirect financial
interest in the operation of the Plan or any agreements related to it (the
"Rule 12b-1 Trustees"), and that PMD provide the Trustees with a written
report of securities transactions directed under the Plan, currently on a
quarterly basis. The Plan also provides that it may be terminated at any time
by the vote of a majority of the Rule 12b-1 Trustees, and that all material
Plan amendments must be approved by a vote of the Rule 12b-1 Trustees.
Capitalization
The Fund is a Massachusetts business trust established under a Declaration
of Trust dated May 4, 1987. The capitalization of the Fund consists solely of
an unlimited number of shares of beneficial interest with a par value of
$0.001 each. The Board of Trustees may establish additional Portfolios (with
different investment objectives and fundamental policies) at any time in the
future. Establishment and offering of additional Portfolios will not alter the
rights of the Fund's shareholders. When issued, shares are fully paid,
redeemable, freely transferable, and non-assessable by the Fund. Shares do not
have preemptive rights or subscription rights. In liquidation of a Portfolio
of the Fund, each shareholder is entitled to receive his pro rata share of the
net assets of that Portfolio.
Under Massachusetts law, shareholders could under certain circumstances, be
held personally liable for the obligations of the Fund. However, the
Declaration of Trust disclaims liability of the shareholders, Trustees, or
officers of the Fund for acts or obligations of the Fund, which are binding
only on the assets and property of the Fund and requires that notice of the
disclaimer be given in each contract or obligation entered into or executed by
the Fund or the Trustees. The Declaration of Trust provides for
indemnification out of Fund property for all loss and expense of any
shareholder held personally liable for the obligations of the Fund. The risk
of a shareholder incurring financial loss on account of shareholder liability
is limited to circumstances in which the Fund itself would be unable to meet
its obligations and thus should be considered remote.
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Expenses incurred in connection with the Fund's organization and
establishment of the Aggressive Equity Portfolio (1996), and Emerging Markets
Portfolio (1996) and the public offering of the shares of those Portfolios,
aggregated approximately $23,410, $3,952, and $23,410, respectively. These
costs have been deferred by the Aggressive Equity, Growth LT, and Emerging
Markets Portfolios and are being amortized by them over a period of five years
from the beginning of operations of each of those Portfolios.
Expenses incurred in connection with the Fund's organization and
establishment of the Diversified Research and International Large-Cap
Portfolios in 1999 and the public offering of the shares of those Portfolios,
aggregated approximately $60,000 per Portfolio. These costs will be expensed
and charged separately to each of the Portfolios during each Portfolio's first
year of operations.
Voting Rights
Shareholders of the Fund are given certain voting rights. Each share of each
Portfolio will be given one vote, unless a different allocation of voting
rights is required under applicable law for a mutual fund that is an
investment medium for variable insurance products.
Under the Declaration of Trust and Massachusetts business trust law, the
Fund is not required to hold annual meetings of Fund shareholders to elect
Trustees or for other purposes. It is not anticipated that the Fund will hold
shareholders' meetings unless required by law, although special meetings may
be called for a specific Portfolio, or for the Fund as a whole, for purposes
such as electing or removing Trustees, changing fundamental policies, or
approving a new or amended advisory contract or portfolio management
agreement. In this regard, the Fund will be required to hold a meeting to
elect Trustees to fill any existing vacancies on the Board if, at any time,
fewer than a majority of the Trustees have been elected by the shareholders of
the Fund. In addition, the Declaration of Trust provides that the holders of
not less than two-thirds of the outstanding shares or other voting interests
of the Fund may remove a person serving as Trustee either by declaration in
writing or at a meeting called for such purpose. The Trustees are required to
call a meeting for the purpose of considering the removal of a person serving
as Trustee, if requested in writing to do so by the holders of not less than
10% of the outstanding shares or other voting interests of the Fund. In
accordance with current laws, it is anticipated that an insurance company
issuing a Variable Contract that participates in the Fund will request voting
instructions from Variable Contract Owners and will vote shares or other
voting interests in the Separate Account in proportion to the voting
instructions received. The Fund's shares do not have cumulative voting rights.
Custodian and Transfer Agency and Dividend Disbursing Services
Investors Fiduciary Trust Company ("IFTC") serves as Custodian for assets of
the Fund. The address of IFTC is 801 Pennsylvania, Kansas City, MO 64105-1716.
Pursuant to a sub-custody agreement between IFTC and Chase, Chase serves as
subcustodian of the Fund for the custody of the foreign securities acquired by
the Fund. Under the agreement, and in accordance with applicable regulations,
Chase may hold the foreign securities at its principal office at 270 Park
Avenue, New York, New York 10081, at Chase's branches, at a foreign branch of
a qualified U.S. bank, an eligible foreign subcustodian, or an eligible
foreign securities depository. Pursuant to rules or other exemptions under the
1940 Act, the Fund may maintain foreign securities and cash for the Fund in
the custody of certain eligible foreign banks and securities depositories.
Pacific Life provides dividend disbursing and transfer agency services to
the Fund.
Financial Statements
The financial statements of the Fund as of December 31, 1999, including the
notes thereto, are incorporated by reference in this Statement of Additional
Information from the Annual Report of the Fund dated as of December 31, 1999.
The financial statements have been audited by Deloitte & Touche LLP,
independent auditors.
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Independent Auditors
Deloitte & Touche LLP serves as the independent auditors for the Fund. The
address of Deloitte & Touche LLP is 695 Town Center Drive, Suite 1200, Costa
Mesa, California 92626.
Counsel
Dechert Price & Rhoads, 1775 Eye Street, N.W., Washington, D.C. 20006-2401,
passes upon certain legal matters in connection with the shares offered by the
Fund and also acts as outside counsel to the Fund.
Registration Statement
This Statement of Additional Information and the Prospectus do not contain
all the information included in the Fund's Registration Statement filed with
the SEC under the Securities Act of 1933 with respect to the securities
offered hereby, certain portions of which have been omitted pursuant to the
rules and regulations of the SEC. The Registration Statement, including the
exhibits filed therewith, may be examined at the offices of the SEC in
Washington, D.C.
Statements contained herein and in the Prospectus as to the contents of any
contract or other documents referred to are not necessarily complete, and, in
each instance, reference is made to the copy of such contract or other
documents filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference.
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APPENDIX
Description of Bond Ratings
Corporate Bonds: Bonds rated Aa by Moody's are judged by Moody's to be of
high quality by all standards. Together with bonds rated Aaa (Moody's highest
rating) they comprise what are generally known as high-grade bonds. Aa bonds
are rated lower than Aaa bonds because margins of protection may not be as
large as those of Aaa bonds, 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 those applicable to Aaa securities.
Bonds which are rated A by Moody's possess many favorable investment
attributes and are to be considered as upper medium-grade obligations. Factors
giving security to principal and interest are considered adequate, but
elements may be present which suggest a susceptibility to impairment sometime
in the future.
Moody's Baa rated bonds are considered as medium-grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and, in
fact, have speculative characteristics as well.
Bonds rated AA by Standard & Poor's are judged by Standard & Poor's to be
high-grade obligations and in the majority of instances differ only in small
degree from issues rated AAA (Standard & Poor's highest rating). Bonds rated
AAA are considered by Standard & Poor's to be the highest grade obligations
and possess the ultimate degree of protection as to principal and interest.
With AA bonds, as with AAA bonds, prices move with the long-term money market.
Bonds rated A by Standard & Poor's, regarded as upper medium grade, have a
strong capacity and interest, although they are somewhat more susceptible to
the adverse effects of changes in circumstances and economic conditions.
Standard & Poor's BBB rated bonds, or medium-grade category bonds, are
borderline between definitely sound obligations and those where the
speculative element begins to predominate. These bonds have adequate asset
coverage and normally are protected by satisfactory earnings. Their
susceptibility to changing conditions, particularly to depressions,
necessitates constant watching. These bonds generally are more responsive to
business and trade conditions than to interest rates. This group is the lowest
which qualifies for commercial bank investment.
The ratings from AA to CCC may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within the rating categories.
Moody's Ba rated bonds 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 rated Ba. Bonds which are rated B by Moody's generally
lack characteristics of the desirable investment. Assurance of interest and
principal payments or of maintenance of other terms of the contract over any
long period of time may be small.
Bonds rated Caa by Moody's are considered to be of poor standing. Such
issues may be in default or there may be elements of danger with respect to
principal or interest. Bonds rated Ca are considered by Moody's to be
speculative in a high degree, often in default. Bonds rated C, the lowest
class of bonds under Moody's bond ratings, are regarded by Moody's as having
extremely poor prospects.
Moody's also applies numerical indicators 1, 2 and 3 to rating categories.
The modifier 1 indicates that the security is in the higher end of its rating
category; 2 indicates a mid-range ranking; and 3 indicates a ranking toward
the lower end of the category.
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A bond rated BB, B, CCC, and CC by Standard & Poor's is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposure to adverse conditions.
Commercial Paper: The Prime rating is the highest commercial paper rating
assigned by Moody's. Among the factors considered by Moody's in assigning
ratings are the following: (1) evaluation of the management of the issuer; (2)
economic evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation
of the issuer's products in relation to competition and customer acceptance;
(4) liquidity; (5) amount and quality of long-term debt; (6) trend of earnings
over a period of ten years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition by management
of obligations which may be present or may arise as a result of public
interest questions and preparations to meet such obligations. Issuers with
this Prime category may be given ratings 1, 2 or 3, depending on the relative
strengths of these factors.
Commercial paper rated A by Standard & Poor's has the following
characteristics: (i) liquidity ratios are adequate to meet cash requirements;
(ii) long-term senior debt rating should be A or better, although in some
cases BBB credits may be allowed if other factors outweigh the BBB rating,
(iii) the issuer should have access to at least two additional channels of
borrowing; (iv) basic earnings and cash flow should have an upward trend with
allowances made for unusual circumstances; and (v) typically the issuer's
industry should be well established and the issuer should have a strong
position within its industry and the reliability and quality of management
should be unquestioned. Issuers rated A are further referred to by use of
numbers 1, 2 and 3 to denote relative strength with this highest
classification.
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Form No. 15-22138-00
Form No. 1705-0A
