VIA EDGAR
_________
May 22, 1995
Securities and Exchange Commission
Division of Investment Management
Office of Insurance Products and Legal Compliance
450 Fifth Street, N.W.
Washington, D.C. 20549
RE: Van Kampen Merritt Series Trust
File Nos. 33-16005 and 811-5252
_______________________________
Dear Sir/Madam:
Pursuant to Rule 497(c) under the Securities Act of 1933, enclosed for
filing please find one copy of the Prospectus dated May 1, 1995 for the
above-referenced Registrant.
If you have any questions or comments, please feel free to contact the
undersigned.
Sincerely,
BLAZZARD, GRODD & HASENAUER, P.C.
By: /s/ RAYMOND A. O'HARA III
_________________________
Raymond A. O'Hara III
a:0323
<PAGE>
VAN KAMPEN MERRITT SERIES TRUST
ONE PARKVIEW PLAZA
OAKBROOK TERRACE, ILLINOIS 60181
VAN KAMPEN MERRITT SERIES TRUST ("Trust") is intended to meet differing
investment objectives with its separate Portfolios: Quality Income Portfolio,
High Yield Portfolio, Growth and Income Portfolio, Money Market Portfolio,
Stock Index Portfolio, World Equity Portfolio and Utility Portfolio. SHARES
OF THE WORLD EQUITY PORTFOLIO AND THE UTILITY PORTFOLIO ARE NOT CURRENTLY
AVAILABLE FOR SALE. The Trustees may provide for additional Portfolios from
time to time. Each Portfolio issues its own class of shares which has rights
separate from the other classes of shares.
This Prospectus concisely sets forth the information about the Trust that a
prospective investor should know before investing. Investors should read and
retain this Prospectus for future reference.
A Statement of Additional Information, dated May 1, 1995, containing
information about the Trust has been filed with the Securities and Exchange
Commission and is hereby incorporated by reference into this Prospectus. A
copy of the Statement of Additional Information may be obtained without charge
by calling (800) 831-LIFE, or writing Xerox Life Sales Company, the
distributor of the Trust's shares, at One Tower Lane, Suite 3000, Oakbrook
Terrace, Illinois 60181-4644.
PURCHASERS SHOULD BE AWARE THAT AN INVESTMENT IN THE MONEY MARKET PORTFOLIO IS
NEITHER INSURED NOR GUARANTEED BY THE U. S. GOVERNMENT. THERE CAN BE NO
ASSURANCE THAT THE MONEY MARKET PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE
NET ASSET VALUE OF $1.00 PER SHARE.
THE HIGH YIELD PORTFOLIO OF THE TRUST MAY INVEST A SUBSTANTIAL PORTION OF ITS
ASSETS IN LOWER GRADE CORPORATE DEBT SECURITIES COMMONLY KNOWN AS "JUNK
BONDS." INVESTORS SHOULD BE AWARE THAT SUCH INVESTMENTS INVOLVE A SIGNIFICANT
DEGREE OF RISK. SEE "INVESTMENT OBJECTIVES - HIGH YIELD PORTFOLIO - SPECIAL
RISKS OF HIGH YIELD INVESTING."
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
THIS PROSPECTUS IS DATED: MAY 1, 1995.
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
PAGE
----
FINANCIAL HIGHLIGHTS 3
ADDITIONAL PERFORMANCE INFORMATION 8
THE TRUST 8
INVESTMENT OBJECTIVES 8
Money Market Portfolio 8
Quality Income Portfolio 11
High Yield Portfolio 13
Stock Index Portfolio 16
Growth and Income Portfolio 20
World Equity Portfolio 21
Utility Portfolio 23
INVESTMENT PRACTICES 28
Investment Limitations 33
RISK FACTORS 33
Tax Considerations 33
Special Considerations Relating to Foreign Securities 34
PORTFOLIO TURNOVER RATES 35
Money Market Portfolio and Quality Income Portfolio 35
High Yield Portfolio 35
Stock Index Portfolio 36
Growth and Income Portfolio 36
World Equity Portfolio And Utility Portfolio 36
MANAGEMENT OF THE TRUST 36
The Trustees 36
The Investment Advisor 37
Portfolio Management 38
Expenses of the Trust 39
DESCRIPTION OF THE TRUST 39
Shareholder Rights 39
Inquiries 40
Distribution and Redemption of Shares 41
Dividends 41
Tax Status 41
Net Asset Values 42
FUND PERFORMANCE 42
APPENDIX DESCRIPTION OF CORPORATE BOND RATINGS 44
</TABLE>
2
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents financial highlights for one share of the
Portfolio throughout the periods indicated. The financial highlights have been
audited by KPMG Peat Marwick LLP, independent auditors, for each of the
periods through December 31, 1994 presented below, and their report thereon
appears in the Portfolio's related Statement of Additional Information. This
information should be read in conjunction with the financial statements and
related notes thereto included in the Statement of Additional Information, a
copy of which may be obtained without charge as indicated elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
QUALITY INCOME PORTFOLIO
December 11, 1989
(Commencement of
Year Ended December 31 Investment Operations) to
-------- -------- ---------- -------
1994 1993 1992 1991 1990 December 31, 1989
-------- -------- -------- ---------- ------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.886 $10.699 $10.618 $ 9.969 $9.930 $ 10.000
-------- -------- -------- ---------- ------- ---------------------------
Net Investment Income .603 .641 .696 .753 .713 .043
Net Realized and Unrealized Gain/Loss on
Investments (1.071) .518 .081 .649 .039 (.070)
-------- -------- -------- ---------- ------- ---------------------------
Total from Investment Operations (.468) 1.159 .777 1.402 .752 (.027)
-------- -------- -------- ---------- ------- ---------------------------
Less:
Distributions from Net Investment Income .603 .641 .696 .753 .713 .043
Distributions from Net Realized Gain on
Investments .000 .331 .000 .000 .000 .000
-------- -------- -------- ---------- ------- ---------------------------
Total Distributions .603 .972 .696 .753 .713 .043
-------- -------- -------- ---------- ------- ---------------------------
Net Asset Value, End of Period $ 9.815 $10.886 $10.699 $ 10.618 $9.969 $ 9.930
======== ======== ======== ========== ======= ===========================
Total Investment Return (Non-Annualized) (4.33%) 11.04% 7.61% 14.71% 7.99% (.27%)
Net Assets at End of Period (in millions) $ 33.9 $ 51.1 $ 24.1 $ 6.8 $ 6.1 $ 2.5
Ratio of Expenses to Average Net Assets*
(Annualized) .59% .60% .60% .60% .74% .70%
Ratio of Net Investment Income to Average
Net Assets* (Annualized) 5.69% 5.82% 6.87% 7.45% 7.64% 7.83%
Portfolio Turnover 177.63% 318.40% 231.91% 12.86% 59.25% .00%
*If certain expenses had not been assumed
by Xerox Life, total investment return would
have been lower and the ratios would have
been as follows :
Ratio of Expenses to Average Net Assets
(Annualized) .68% .70% .88% 1.10% 1.53% 9.15%
Ratio of Net Investment Income to Average
Net Assets (Annualized) 5.60% 5.73% 6.59% 6.96% 6.85% N/A
</TABLE>
See Financial Statements and Notes Thereto
3
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents financial highlights for one share of the
Portfolio throughout the periods indicated. The financial highlights have been
audited by KPMG Peat Marwick LLP, independent auditors, for each of the
periods through December 31, 1994 presented below, and their report thereon
appears in the Portfolio's related Statement of Additional Information. This
information should be read in conjunction with the financial statements and
related notes thereto included in the Statement of Additional Information, a
copy of which may be obtained without charge as indicated elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
HIGH YIELD PORTFOLIO
December 11, 1989
(Commencement of
Year Ended December 31 Investment Operations) to
-------- -------- ---------- -------
1994 1993 1992 1991 1990 December 31, 1989
-------- -------- -------- ---------- ------- ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $11.287 $10.445 $10.410 $ 9.073 $9.974 $ 10.000
-------- -------- -------- ---------- ------- ---------------------------
Net Investment Income .978 1.028 1.250 1.124 1.085 .0533
Net Realized and Unrealized
Gain/Loss on Investments (1.464) 1.170 .658 1.337 (.901) (.026)
-------- -------- -------- ---------- ------- ---------------------------
Total from Investment Operations (.486) 2.198 1.908 2.461 .184 .027
-------- -------- -------- ---------- ------- ---------------------------
Less:
Distributions from Net Investment Income .978 1.028 1.250 1.124 1.085 .053
Distributions from Net Realized Gain on
Investments .000 .328 .623 .000 .000 .000
-------- -------- -------- ---------- ------- ---------------------------
Total Distributions .978 1.356 1.873 1.124 1.085 .053
-------- -------- -------- ---------- ------- ---------------------------
Net Asset Value, End of Period $ 9.823 $11.287 $10.445 $ 10.410 $9.073 $ 9.974
======== ======== ======== ========== ======= ===========================
Total Investment Return (Non- Annualized) (4.52%) 21.98% 19.12% 28.31% 1.86% .23%
Net Assets at End of Period (in millions) $ 19.7 $ 18.8 $ 5.4 $ 3.8 $ 2.9 $ 2.5
Ratio of Expenses to Average Net Assets*
(Annualized) .86% .84% .87% .86% 1.01% .95%
Ratio of Net Investment Income to Average
Net Assets* (Annualized) 9.48% 8.97% 11.67% 11.31% 11.43% 9.67%
Portfolio Turnover 200.06% 213.09% 157.42% 147.57% 28.32% .00%
*If certain expenses had not been assumed
by Xerox Life, total investment return would
have been lower and the ratios would have
been as follows:
Ratio of Expenses to Average Net Assets
(Annualized) 1.16% 1.38% 1.79% 1.91% 2.42% 9.42%
Ratio of Net Investment Income to
Average Net Assets (Annualized) 9.18% 8.43% 10.75% 10.25% 10.01% 1.19%
</TABLE>
See Financial Statements and Notes Thereto
4
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents financial highlights for one share of the
Portfolio throughout the periods indicated. The financial highlights have been
audited by KPMG Peat Marwick LLP, independent auditors, for each of the
periods through December 31, 1994 presented below, and their report thereon
appears in the Portfolio's related Statement of Additional Information. This
information should be read in conjunction with the financial statements and
related notes thereto included in the Statement of Additional Information, a
copy of which may be obtained without charge as indicated elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
GROWTH AND INCOME PORTFOLIO
May 1, 1992
(Commencement of
Year Ended December 31 Investment Operations)
------------ -------------
1994 1993 to December 31, 1992
------------ ------------- -----------------------
<S> <C> <C> <C>
Net Asset Value, Beginning of Period $ 11.170 $ 10.282 $ 10.000
------------ ------------- -----------------------
Net Investment Income .331 .182 .125
Net Realized and Unrealized Gain/Loss on Investments (.864) 1.371 .444
------------ ------------- -----------------------
Total from Investment Operations (.533) 1.553 .569
------------ ------------- -----------------------
Less:
Distributions from Net Investment Income .323 .182 .125
Distributions from Net Realized Gain on Investments .008 .483 .162
------------ ------------- -----------------------
Total Distributions .331 .665 .287
------------ ------------- -----------------------
Net Asset Value, End of Period $ 10.306 $ 11.170 $ 10.282
============ ============= =======================
Total Investment Return (Non-Annualized) (4.54%) 15.01% 5.67%
Net Assets at End of Period (in millions) $ 10.9 $ 6.5 $ 2.6
Ratio of Expenses to Average Net Assets* (Annualized) .70% .69% .70%
Ratio of Net Investment Income to Average Net Assets*
(Annualized) 3.47% 1.84% 2.27%
Portfolio Turnover 326.01% 135.92% 99.93%
*If certain expenses had not been assumed by Xerox Life,
total investment return would have been lower and the
ratios would have been as follows:
Ratio of Expenses to Average Net Assets (Annualized) 1.49% 2.05% 3.69%
Ratio of Net Investment Income to Average Net
Assets (Annualized) 2.68% .47% (.73%)
</TABLE>
See Financial Statements and Notes Thereto
5
<PAGE>
FINANCIAL HIGHTLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents financial highlights for one share of the
Portfolio throughout the periods indicated. The financial highlights have been
audited by KPMG Peat Marwick LLP, independent auditors, for each of the
periods through December 31, 1994 presented below, and their report thereon
appears in the Portfolio's related Statement of Additional Information. This
information should be read in conjunction with the financial statements and
related notes thereto included in the Statement of Additional Information, a
copy of which may be obtained without charge as indicated elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
July 1, 1991
(Commencement of
Investment
Year Ended December 31 Operations) to
------------ -------------
1994 1993 1992 December 31, 1991
------ ------------ ------------- -------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $1.00 $ 1.00 $ 1.00 $ 1.00
------ ------------ ------------- -------------------
Net Investment Income .041 .032 .038 .027
------ ------------ ------------- -------------------
Less Distributions from Net Investment Income .041 .032 .038 .027
------ ------------ ------------- -------------------
Net Asset Value, End of Period $1.00 $ 1.00 $ 1.00 $ 1.00
====== ============ ============= ===================
Total Investment Return * (Non-Annualized) 4.23% 3.24% 3.88% 2.75%
Net Assets at End of Period (in millions) $75.9 $ 6.6 $ 4.0 $ 5.4
Ratio of Expenses to Average Net
Assets* (Annualized) .10% .10% .10% .09%
Ratio of Net Investment Income to
Average Net Assets* (Annualized) 4.37% 3.23% 3.63% 5.11%
*If certain expenses had not been assumed by
Xerox Life, total investment return would have
been lower and the ratios would have been
as follows:
Ratio of Expenses to Average Net
Assets (Annualized) .68% .86% 1.30% 1.11%
Ratio of Net Investment Income to
Average Net Assets (Annualized) 3.79% 2.47% 2.43% 4.10%
</TABLE>
See Financial Statements and Notes Thereto
6
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR ONE SHARE OUTSTANDING THROUGHOUT THE PERIOD)
The following schedule presents selected per share data and related ratios for
one share of the Portfolio throughout the periods indicated. The financial
highlights have been audited by KPMG Peat Marwick LLP, independent auditors,
for each of the periods through December 31, 1994 presented below, and their
report thereon appears in the Portfolio's related Statement of Additional
Information. This information should be read in conjunction with the financial
statements and related notes thereto included in the Statement of Additional
Information, a copy of which may be obtained without charge as indicated
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
STOCK INDEX PORTFOLIO
November 1, 1991
(Commencement of
Year Ended December 31 Investment Operations) to
------------ -------------
1994 1993 1992 December 31, 1991
-------- ------------ ------------- ---------------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $11.115 $ 10.552 $ 10.572 $ 10.000
-------- ------------ ------------- ---------------------------
Net Investment Income .311 .205 .172 .038
Net Realized and Unrealized Gain/Loss on Investments (.337) .726 .477 .534
-------- ------------ ------------- ---------------------------
Total from Investment Operations (.026) .931 .649 .572
-------- ------------ ------------- ---------------------------
Less:
Distributions from Net Investment Income .311 .205 .210 .000
Distributions from Net Realized Gain on
Investments .185 .163 .459 .000
Return of Capital Distributions .006 .000 .000 .000
-------- ------------ ------------- ---------------------------
Total Distributions .502 .368 .669 .000
-------- ------------ ------------- ---------------------------
Net Asset Value, End of Period $10.587 $ 11.115 $ 10.552 $ 10.572
======== ============ ============= ===========================
Total Investment Return (Non-Annualized) (.11%) 8.84% 6.22% 5.70%
Net Assets at End of Period (in millions) $ 36.8 $ 91.3 $ 35.0 $ 6.8
Ratio of Expenses to Average Net Assets*
(Annualized) .58% .60% .59% .40%
Ratio of Net Investment Income to
Average Net Assets* (Annualized) 2.23% 2.29% 2.54% 3.02%
Portfolio Turnover 47.05% 44.09% 85.73% .00%
*If certain expenses had not been assumed by Xerox Life,
have been lower total investment return would
and the ratios would have been as follows:
Ratio of Expenses to Average Net Assets
(Annualized) .80% .74% 1.21% 1.84%
Ratio of Net Investment Income to
Average Net Assets (Annualized) 2.01% 2.15% 1.92% 1.58%
</TABLE>
See Financial Statements and Notes Thereto
7
<PAGE>
ADDITIONAL PERFORMANCE INFORMATION
Further information about the Trust's performance is contained in the Annual
Report to shareholders which may be obtained, without charge, by calling (800)
831-LIFE, or writing Xerox Life Sales Company, the distributor of the Trust's
shares, at One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644.
THE TRUST
VAN KAMPEN MERRITT SERIES TRUST (the "Trust") is a diversified open-end
management investment company established as a Massachusetts business trust
under a Declaration of Trust dated July 9, 1987. The Trust is currently
comprised of seven separate Portfolios: Money Market Portfolio, Quality Income
Portfolio, High Yield Portfolio, Growth and Income Portfolio, Stock Index
Portfolio, World Equity Portfolio and Utility Portfolio. HOWEVER, SHARES OF
THE WORLD EQUITY PORTFOLIO AND THE UTILITY PORTFOLIO ARE NOT CURRENTLY BEING
OFFERED FOR SALE. The Trustees may provide for additional Portfolios from time
to time. Each Portfolio issues a separate class of shares. The Declaration of
Trust permits the Trustees to issue an unlimited number of full or fractional
shares of each class of stock.
INVESTMENT OBJECTIVES
Each Portfolio of the Trust has a different investment objective which it
pursues through separate investment policies as described below. Each
Portfolio is managed separately by Van Kampen American Capital Investment
Advisory Corp. (F/K/A Van Kampen Merritt Investment Advisory Corp.) (the
"Investment Advisor"). The risks and opportunities of each Portfolio should be
examined separately. The differences in objectives and policies among the
Portfolios can be expected to affect the return of each Portfolio and the
degree of market and financial risk of each Portfolio.
There is no assurance that the investment objectives of the various Portfolios
will be met.
MONEY MARKET PORTFOLIO
The investment objective of the Money Market Portfolio is to provide high
current income consistent with the preservation of capital and liquidity
through investment in a broad range of money market instruments that will
mature within 12 months of the date of purchase.
INVESTMENT PROGRAM
__________________
The Money Market Portfolio seeks to achieve its objective by investing only in
the following securities and instruments: (a) obligations of or guaranteed by
the U.S. government, its agencies or instrumentalities ("U.S. Government
Securities"); (b) obligations of banks subject to U.S. government regulation
as well as such other bank obligations as are insured by a U.S. government
agency ("Bank Obligations"); (c) commercial paper (including variable amount
master demand notes); and (d) debt obligations (other than commercial paper)
of corporate issuers.
U.S. Government Securities include Treasury Bills, Notes and Bonds issued by
the U.S. government and backed by the full faith and credit of the U.S.
government, as well as securities issued or guaranteed as to principal and
interest by agencies and instrumentalities of the U.S.
8
<PAGE>
government. Bank Obligations include certificates of deposit and bankers'
acceptances of domestic banks (or Euro-dollar obligations of foreign branches
of those domestic banks) subject to U.S. government regulation and time
deposits of federal and state banks whose accounts are insured by a government
agency as well as the accounts themselves.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
The Portfolio may lend portfolio securities. The Portfolio may also enter into
repurchase agreements but only if the underlying securities are either
Government securities or First Tier Securities (see "Investment Quality" and
"Portfolio Maturity", below). The Portfolio may purchase and sell securities
on a "when issued" and "delayed delivery" basis. The Portfolio may borrow up
to 10% of its net assets in order to pay for redemptions when liquidation of
portfolio securities is considered disadvantageous or inconvenient and may
pledge up to 10% of its net assets to secure borrowings. The Portfolio may
invest up to 10% of its net assets in restricted securities. A more complete
description of these investments and transactions is contained under
"Investment Practices".
The Portfolio may also invest in Floating Rate Securities. Floating Rate
Securities provide for automatic adjustment of the interest rate whenever some
specified interest rate index changes. The interest rate on Floating Rate
Securities is ordinarily determined by reference to or is a percentage of a
bank's prime rate, the 90-day U.S. Treasury bill rate, the rate of return on
commercial paper or bank certificates of deposit, an index of short-term
interest rates, or some other objective measure. Floating Rate Securities
often include a demand feature which entitles the holder to sell the
securities to the issuer at par. In many cases, the demand feature can be
exercised at any time on seven days' notice; in other cases, the demand
feature is exercisable at any time on 30 days' notice or on similar notice at
intervals of not more than one year. With respect to Floating Rate Securities,
the financial institution issuing the instrument is considered the issuer.
However, where the securities are backed by an irrevocable letter of credit or
by insurance, without which the securities would not qualify for purchase
under the Portfolio's quality restrictions, the issuer of the letter of credit
will be considered the issuer of the securities.
Although the securities in which the Portfolio invests are of high quality and
the transactions which it enters into entail low risk, there is still the
possibility of loss of principal. Corporate issuers may default on their
obligations. Repurchase agreements may be deemed to be collateralized loans
and the Portfolio could experience delay and expenses in liquidating
collateral in the event of the failure of the repurchasing party to honor its
agreement to repurchase. Agencies or instrumentalities of the U.S. government
could also default on their securities which may not be guaranteed by or be
backed by the full faith and credit of the U.S. government.
INVESTMENT QUALITY
__________________
(a) Eligible Securities
The Money Market Portfolio will invest only in United States
dollar-denominated instruments which, at the time of acquisition, are
determined to be eligible securities
9
<PAGE>
("Eligible Securities") by the Investment Advisor and which are determined by
the Investment Advisor to present minimal credit risks.
An Eligible Security is any security that has a remaining maturity of less
than one year and (i) which is rated in one of the two highest rating
categories for short-term debt obligations by any two nationally recognized
statistical rating organizations ("NRSROs") that have issued a rating with
respect to a security or class of debt obligations of an issuer, or if only
one NRSRO has issued a rating, that NRSRO ("Requisite NRSROs"); or (ii) has a
security that has been issued by an issuer that has outstanding short-term
debt obligations (or security within that class) that are comparable in
priority and security with the security ("CPS Security") which is rated, or
the issuer of which is rated, by the Requisite NRSROs in one of the two
highest rating categories for short-term debt obligations. An unrated security
may also be an Eligible Security if it is determined by the Investment Advisor
to be of comparable quality ("Comparable Quality Security") to either a First
Tier Security or Second Tier Security, as those terms are defined below.
A First Tier Security is an Eligible Security that (i) is itself rated, has a
CPS Security rated or the issuer of which security is rated by the Requisite
NRSROs in the highest rating category for short-term debt obligations or (ii)
is a Comparable Quality Security which is determined by the Investment Advisor
to be of comparable quality to a First Tier Security.
A Second Tier Security is (i) an Eligible Security that is itself rated, has a
CPS Security rated or the issuer of which security is rated by the Requisite
NRSROs in the second highest rating category for short-term debt obligations,
(ii) an instrument that has been rated in the highest rating category for
short-term debt obligations by one NRSRO and has been rated in the second
highest rating category for short-term debt obligations by one or more other
NRSROs or (iii) a Comparable Quality Security which is determined by the
Investment Advisor to be of comparable quality to a Second Tier Security.
(b) Guidelines for Purchasing Eligible Securities
The Investment Advisor, on behalf of the Money Market Portfolio, may (i)
acquire any First Tier Security that, at the time of acquisition, has received
the highest rating from any two NRSROs; (ii) acquire any Second Tier Security
that, at the time of acquisition, has received the second highest rating from
any two NRSROs, and (iii) acquire any First Tier Security or any Second Tier
Security that at time of purchase is rated by a single NRSRO, or any
Comparable Quality Security, subject to approval by the Board of Trustees of
the Trust.
PORTFOLIO MATURITY
__________________
The Money Market Portfolio may not purchase any instrument, other than a
Government security, with a remaining maturity of greater than one year. A
Government security is any security issued or guaranteed as to principal or
interest by the United States, or by a person controlled or supervised by and
acting as an instrumentality of the Government of the United States, or any
certificate of deposit for any of the above.
10
<PAGE>
The Money Market Portfolio maintains a dollar-weighted average portfolio
maturity of ninety (90) days or less. The Portfolio determines the maturity of
portfolio investments in accordance with Rule 2a-7, a valuation and pricing
rule under the Investment Company Act of 1940, as amended.
QUALITY INCOME PORTFOLIO
The investment objective of the Quality Income Portfolio is to seek a high
level of current income, consistent with safety of principal, by investing in
obligations issued or guaranteed by the U.S. government or its agencies or
instrumentalities or in various investment grade debt obligations including
mortgage pass-through certificates and collateralized mortgage obligations.
The Investment Advisor will use the Lehman Brothers Government/Corporate Bond
Index as a benchmark against which it will gauge the performance of the
Portfolio and determine risk measurement. The Lehman Brothers
Government/Corporate Bond Index is comprised of all publicly issued,
non-convertible, domestic debt of the U.S. Government or any agency thereof,
quasi-Federal corporation, or corporate debt guaranteed by the U.S. Government
and all publicly issued, fixed-rate, non-convertible, domestic debt of the
four major corporate classifications: industrial, utility, financial and
Yankee bond. Only notes and bonds with a minimum outstanding principal amount
of $50,000,000 and a minimum maturity of one year are included. Bonds included
must have a rating of at least Baa by Moody's Investors Service, Inc.
("Moody's"), BBB by Standard & Poor's Corporation ("S&P") or in the case of
bank bonds not rated by either Moody's or S&P, BBB by Fitch Investors Service,
Inc.
Depending on market conditions and subject to the special diversification
provisions imposed on the Portfolio (see "Risk Factors"), the Portfolio may
invest a substantial portion of its assets in Government National Mortgage
Association ("GNMA") Certificates of the modified pass-through type. These
GNMA Certificates are debt securities issued by a mortgage holder (such as a
mortgage banker) and represent an interest in a pool of mortgages insured by
the Federal Housing Administration or the Farmers Home Administration or
guaranteed by the Veterans Administration. GNMA guarantees the timely payment
of monthly installments of principal and interest on the GNMA Certificates.
These guarantees are backed by the full faith and credit of the U.S.
government.
To the extent the Portfolio acquires GNMA Certificates at par or at discount,
the GNMA Certificates offer a high degree of safety of the principal
investment because of the GNMA guarantee. If the Portfolio buys GNMA
Certificates at a premium, however, mortgage foreclosures and repayments of
principal by mortgagors (which may be made at any time without penalty) may
result in some loss of the Portfolio's principal investment to the extent of
the premium paid. To avoid loss of this premium and of any gain in value of
its GNMA Certificates resulting from a decrease in interest rates generally,
the Portfolio may sell its GNMA Certificates which are selling at a
substantial premium. This practice may increase the Portfolio's portfolio
turnover rate. A more complete description of GNMA Certificates is contained
in the Statement of Additional Information.
The Portfolio, subject to the limitations on investments as described in "Risk
Factors", may invest in other obligations issued or guaranteed by the U.S.
government or by its agencies or instrumentalities. These instruments may be
either direct obligations of the Treasury (such as U.S. Treasury Notes, Bills
or Bonds) or securities issued or guaranteed by government
11
<PAGE>
agencies or instrumentalities. Of the obligations issued or guaranteed by
agencies or instrumentalities of the U.S. government, some are backed by the
full faith and credit of the U.S. government (such as Maritime Administration
Title XI Ship Financing Bonds) and others are backed only by the rights of the
issuer to borrow from the U.S. Treasury (such as Federal Home Loan Bank Bonds
and Federal National Mortgage Association Bonds).
The Portfolio may also invest in one or more of the following:
<TABLE>
<CAPTION>
<C> <S>
(1) Marketable straight-debt securities of domestic issuers, and of foreign issuers
(payable in U.S. dollars) rated at the time of purchase within the four highest
grades assigned by Moody's (Aaa, Aa, A or Baa) or by S&P (AAA, AA, A or
BBB);
(2) Commercial paper rated at time of purchase Prime-3 by Moody's or A-3 by
S&P;
(3) Bank obligations (including repurchase agreements and those denominated in
Eurodollars) of banks having total assets in excess of $1 billion;
(4) Mortgage pass-through certificates and collateralized mortgage obligations.
</TABLE>
Securities rated Baa or BBB may have speculative characteristics and changes
in economic conditions or other circumstances are more likely to lead to a
weakened capacity to make principal and interest payments than is the case
with higher grade bonds. For a further description of the above investments
and the ratings used, see "Appendix - Description of Corporate Bond Ratings"
herein and "Description of Securities Ratings - Commercial Paper Ratings" in
the Statement of Additional Information.
The Portfolio may invest up to 35% of its assets in securities of foreign
issuers. These investments will be marketable straight-debt securities of
foreign issuers payable in U.S. dollars and rated at the time of purchase
within the four highest grades assigned by Moody's or by S&P. Investments in
foreign securities present certain risks not ordinarily found in investments
in securities of U.S. issuers. See "Risk Factors - Special Considerations
Relating to Foreign Securities."
The Portfolio may lend portfolio securities. The Portfolio may borrow under
certain circumstances. The Portfolio may also enter into repurchase
agreements, reverse repurchase agreements and may sell securities short. The
Portfolio may purchase and sell securities on a "when issued" and "delayed
delivery" basis. The Portfolio may invest in restricted securities. A more
complete description of these investments and transactions is contained under
"Investment Practices."
If the Investment Advisor deems it appropriate to seek to partially hedge the
Portfolio's assets against market value changes, the Portfolio may enter into
various hedging transactions, such as futures contracts, financial index
futures contracts, and the related put or call options contracts on futures
contracts. Hedging is a means of offsetting, or neutralizing, the price
12
<PAGE>
movement of an investment by making another investment, the price of which
should tend to move in the opposite direction from that of the original
investment. See "Investment Practices - Strategic Transactions" and the
Statement of Additional Information for a more complete description of these
transactions.
The Portfolio will be affected by general changes in interest rates resulting
in increases or decreases in the value of the Portfolio securities. Market
prices of debt securities tend to rise when interest rates fall and market
prices tend to fall when interest rates rise. Repurchase agreements may be
deemed to be collateralized loans and the Portfolio could experience delay and
expenses in liquidating such collateral in the event of the failure of the
repurchasing party to honor its agreement to repurchase. Agencies or
instrumentalities of the U.S. government could also default on their
securities which may not be guaranteed by or be backed by the full faith and
credit of the U.S. government.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
HIGH YIELD PORTFOLIO
The investment objective of the High Yield Portfolio is the maximization of
total investment return through income and capital appreciation.
The High Yield Portfolio will pursue its investment objective by investing in
a portfolio substantially consisting of medium and lower grade domestic
corporate debt securities. The Portfolio may also invest up to 35% of its
assets in foreign government and foreign corporate debt securities of similar
quality. The Portfolio may also, from time to time, invest in cash or cash
equivalents due to market conditions or for other defensive purposes.
Lower grade corporate debt securities are commonly known as "junk bonds" and
involve a significant degree of risk. See "Special Risks of High Yield
Investing," below.
Medium grade corporate securities are generally regarded as having adequate,
but not outstanding, capacity to pay interest and repay principal. Medium
grade securities are obligations that are rated A and Baa by Moody's or A and
BBB by S&P, or which are not rated by either Moody's or S&P but are considered
by the Investment Advisor to be of comparable quality. Securities rated Baa or
BBB may have speculative characteristics and changes in economic conditions or
other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case with higher grade bonds.
Lower grade corporate securities are those that are rated Ba or B by Moody's
or BB or B by S&P, or which are unrated or considered by the Investment
Advisor to be of comparable quality. If the Investment Advisor deems it
appropriate, the Portfolio may invest in domestic corporate debt securities of
a higher quality. For a further description of these ratings, see "Appendix -
Description of Corporate Bond Ratings."
Many issuers of medium and lower grade securities choose not to have a rating
assigned to their obligations by one of the rating agencies. Therefore, the
Portfolio's assets may at times consist of a high proportion of unrated
securities. The Portfolio will purchase only those unrated securities which
the Investment Advisor believes are comparable to rated securities that
qualify for purchase by the Portfolio pursuant to criteria established by the
Board of Trustees. Although the Portfolio will invest primarily in medium and
lower grade securities, from time to time the
13
<PAGE>
Portfolio may also invest in higher grade securities if the Investment Advisor
considers it appropriate, as when the difference in return between different
grades of securities is very narrow, when the Investment Advisor expects
interest rates to increase, or when the availability of medium and lower grade
securities is limited. These investments may result in a lower current income
than if the Portfolio were fully invested in medium and lower grade
securities.
The Portfolio may invest up to 35% of its assets in foreign government and
foreign corporate debt securities of similar quality. Investments in foreign
securities present certain risks not ordinarily found in investments in
securities of U.S. issuers. See "Risk Factors - Special Considerations
Relating to Foreign Securities."
If the Investment Advisor deems it appropriate to seek to partially hedge the
Portfolio's assets against market value changes resulting from changes in
interest rates or (with respect to the foreign securities which the Portfolio
invests in) currency fluctuations, the Portfolio may also enter into various
hedging transactions, such as futures contracts, financial index futures
contracts, and related put or call options contracts on these contracts and
foreign currency contracts. In addition, if the Investment Advisor deems it
appropriate, the Portfolio may enter into other hedging transactions, such as
forward foreign currency contracts, currency futures contracts, and related
options contracts in order to protect the U.S. dollar equivalent values of
those foreign securities in which the Portfolio invests against declines
resulting from currency value fluctuations.
Hedging is a means of offsetting, or neutralizing, the price movement of an
investment by making another investment, the price of which should tend to
move in the opposite direction from that of the original investment. See
"Investment Practices - Strategic Transactions" and the Statement of
Additional Information for a more complete discussion of these transactions.
The Portfolio may purchase and sell securities on a "when issued" and "delayed
delivery" basis. See the Statement of Additional Information for a discussion
of these transactions.
The Portfolio may lend portfolio securities. The Portfolio may borrow under
certain circumstances. The Portfolio may also enter into repurchase agreements
and reverse repurchase agreements. Repurchase agreements may be deemed to be
collateralized loans and the Portfolio could experience delay and expenses in
liquidating such collateral in the event of the failure of the repurchasing
party to honor its agreement to repurchase. The Portfolio may invest in
restricted securities. The Portfolio may purchase and sell securities on a
"when issued" and "delayed delivery" basis. A more complete description of
these investments and transactions is contained under "Investment Practices."
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
SPECIAL RISKS OF HIGH YIELD INVESTING
_____________________________________
As indicated above, the High Yield Portfolio intends to invest a substantial
portion of its assets in medium and lower grade corporate debt securities.
Debt securities which are in those medium and lower grade categories generally
offer a higher current yield than is offered by securities which are in the
higher grade categories, but they also generally involve greater price
volatility and greater credit and market risk. Credit risk relates
14
<PAGE>
to the issuer's ability to make timely payments of principal and interest when
due as well as fundamental developments in an issuer's business. Market risk
relates to the changes in market value that occur as a result of variation in
the level of prevailing interest rates and yield relationships in the
securities market. Typically, market prices tend to fall as interest rates
rise and tend to rise as interest rates fall. Generally, prices tend to
fluctuate more for lower grade issues than for higher grade issues, and, for
any given change in interest rates, prices for longer maturity issues tend to
fluctuate more than for shorter maturity issues. Yields on lower-rated
securities will fluctuate over time.
The prices of lower-grade securities, while generally less sensitive to
interest rate changes than higher-rated investments, tend to be more sensitive
to adverse economic changes or individual corporate developments. During an
economic downturn or substantial period of rising interest rates, the ability
of a highly leveraged issuer to service its principal and interest payment
obligations, to meet projected business goals and to obtain additional
financing may be adversely affected. An economic downturn could disrupt the
market for high yield bonds, adversely affect the value of outstanding bonds
and the ability of the issuers of such bonds to repay principal and interest,
cause increased volatility in the market prices of high yield bonds and the
Portfolio's net asset value and may result in a higher incidence of defaults
by issuers on bond obligations. If the issuer of a bond defaults, the
Portfolio may incur additional expenses to seek recovery. The Portfolio will
seek to reduce risk through portfolio diversification, credit analysis, and
attention to current developments and trends in the industries and with the
issuers involved. The Investment Advisor will continuously monitor the
condition of the economy and the financial and credit markets.
To the extent that there is no established retail secondary market for high
yield bonds, such bonds may be thinly traded, making the bonds less liquid
than investment grade bonds. 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. In the
event of an illiquid secondary market, or in the absence of readily available
market quotations, the responsibility of the Board of Trustees of the Trust to
value the securities becomes more difficult and will involve a greater degree
of judgment in that there is less reliable, objective data available.
If the market for high yield bonds is restricted by the enactment of
legislation, or if steps are taken to limit the use of such securities, or
other advantages of such securities, the value of the securities and the
Portfolio's ability to acquire them may be adversely affected.
A description of the corporate bond ratings is contained in the Appendix.
Purchasers should be aware, however, that credit ratings evaluate the safety
of principal and interest payments and not the market value risk of high yield
bonds. In addition, credit ratings may not always be modified on a timely
basis to reflect events subsequent to the most recent ratings which may have a
material impact on the securities rated. However, the Investment Advisor will
continuously monitor the issuers of high yield bonds in the Portfolio to
determine if the issuers will have sufficient cash flow and profits to meet
required principal and interest payments, and to assure the bonds' liquidity.
Achievement of the investment objective of the Portfolio may be more dependent
on the credit analysis of the Investment Advisor than is the case with higher
quality bonds.
As described above, the Portfolio may also invest in unrated corporate
securities. Although unrated securities are not necessarily of lower quality
than rated securities, the market for them
15
<PAGE>
may not be as broad and, accordingly, they may carry greater risk and higher
yield than rated securities.
ASSET COMPOSITION
_________________
At December 31, 1994, the High Yield Portfolio was invested in bonds rated by
Moody's as follows:
<TABLE>
<CAPTION>
Percentage of Total Bond
Moody's Ratings Investments in the Portfolio
<S> <C>
Caa 6.2%
Ba1 1.2%
Ba2 1.4%
Ba3 12.3%
B1 25.2%
B2 31.0%
B3 21.5%
Other 1.2%
</TABLE>
STOCK INDEX PORTFOLIO
INVESTMENT OBJECTIVE
____________________
The investment objective of the Stock Index Portfolio is to achieve investment
results that approximate the aggregate price and yield performance of the
Standard & Poor's 500 Composite Stock Price Index (the "S&P 500 Index" or the
"Index").
The S&P 500 Index represents more than 70% of the total market value of all
publicly-traded common stocks, and is widely viewed among investors as a good
representative of the aggregate performance of publicly-traded common stocks.
"Standard & Poor's", "S&P", "S&P 500", "Standard & Poor's 500", and "500" are
trademarks of McGraw-Hill Inc. and have been licensed for use by Xerox
Financial Services Life Insurance Company and its affiliates ("Xerox Life").
The Stock Index Portfolio is not sponsored, endorsed, sold or promoted by
Standard & Poor's Corporation ("S&P") and S&P makes no representation or
warranty, express or implied, to the owners of the Stock Index Portfolio or
any member of the public regarding the advisability of investing in securities
generally or in the Stock Index Portfolio particularly or the ability of the
S&P 500 Index to track general stock market performance. S&P's only
relationship to Xerox Life is the licensing of certain trademarks and trade
names of S&P and of the S&P 500 Index which is determined, composed and
calculated by S&P without regard to Xerox Life or the Stock Index Portfolio.
S&P has no obligation to take the needs of Xerox Life or the owners of the
Stock Index Portfolio into consideration in determining, composing or
calculating the S&P 500 Index. S&P is not responsible for and has not
participated in the determination of the prices and amount of the Stock Index
Portfolio or the timing of the issuance or sale of the Stock Index Portfolio
or in the determination or calculation of the equation by which the Stock
Index Portfolio is to be
16
<PAGE>
converted into cash. S&P has no obligation or liability in connection with the
administration, marketing or trading of the Stock Index Portfolio.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500
INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY
ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY XEROX LIFE, OWNERS OF THE STOCK INDEX
PORTFOLIO, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR
ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND
EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA
INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P
HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL
DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH
DAMAGES.
INVESTMENT POLICIES
___________________
The Stock Index Portfolio is not managed according to traditional methods of
"active" investment management, which involve the buying and selling of
securities based upon economic, financial and market analysis and investment
judgment. Instead, the Portfolio, utilizing a "passive" or "indexing"
investment approach, attempts to duplicate the investment performance of the
respective index through statistical procedures.
The Investment Advisor believes that the "indexing" approach described above
is an effective method of substantially duplicating percentage changes in the
S&P 500 Index. It is a reasonable expectation that the correlation between the
performance of the Portfolio and that of the Index will be approximately 98%;
a figure of 100% would indicate perfect correlation. Perfect correlation would
be achieved when the net asset value per share of the Portfolio increases and
decreases in exact proportion to changes in the Index. The Board of Trustees
of the Trust will review the correlation between the Portfolio and the Index
on a quarterly basis. See the Statement of Additional Information for a
description of the monitoring procedures established by the Board.
In pursuing its investment objective, the Portfolio will invest in no fewer
than 100 stocks with the majority of the Portfolio consisting of those stocks
having the largest weightings in the Index. The Investment Advisor will select
stocks for the Portfolio after taking into account their individual weights in
the Index and the weights in the Index of the industry groups to which they
belong.
Although the Portfolio will attempt to remain fully invested in common stocks,
it may also invest in certain short-term fixed income securities such as cash
reserves.
As described further below under "Implementation of Policies", the Portfolio
may also enter into stock index futures contracts and options on stock indexes
and stock index futures contracts for various reasons including to hedge
against changes in security prices. Hedging is a means of offsetting, or
neutralizing, the price movement of an investment by making another
investment, the price of which should tend to move in the opposite direction
from that of the
17
<PAGE>
original investment. See the Statement of Additional Information for a more
complete description of hedging and for a discussion of the risks involved
therein.
IMPLEMENTATION OF POLICIES
__________________________
The S&P 500 Index is composed of 500 common stocks which are chosen by S&P to
be included in the unmanaged Index. Market value, liquidity and industry
representation are considered in the selection process. The inclusion of a
stock in the S&P 500 Index in no way implies that S&P believes the stock to be
an attractive investment. The 500 securities, 95% of which trade on the New
York Stock Exchange, represent approximately 75% of the market value of all
U.S. common stocks. Each stock in the S&P 500 Index is weighted by its market
value: its market price per share times the number of shares outstanding.
Because of the market-value weighting, the 50 largest companies in the S&P 500
Index currently account for approximately 50% of the Index. Typically,
companies included in the S&P 500 Index are the largest and most dominant
firms in their respective industries.
Although the Portfolio will normally seek to remain substantially fully
invested in common stocks, the Portfolio may invest temporarily in certain
short-term fixed income securities. Such securities may be used to invest
uncommitted cash balances or to maintain liquidity to meet shareholder
redemptions. These securities include: obligations of the United States
government and its agencies or instrumentalities; commercial paper, bank
certificates of deposit and bankers' acceptances; and repurchase agreements
and reverse repurchase agreements collateralized by these securities.
Repurchase agreements may be deemed to be collateralized loans and the
Portfolio could experience delay and expenses in liquidating such collateral
in the event of the failure of the repurchasing party to honor its agreement
to repurchase.
The Portfolio will employ a combination of an indexing strategy known as
"sampling" and stock index futures contracts and options. Sampling is a method
that is used to attempt to replicate the return of the Index without having to
purchase a weighted portfolio containing all 500 stocks in the Index. This
process selects stocks for the Portfolio so that various industry weightings,
market capitalizations and fundamental characteristics (e.g. price to book,
price to earnings, debt to asset ratios and dividend yields) match those of
the Index. The use of sampling involves certain risks with respect to the
ability of the Portfolio to achieve the desired correlation with the Index.
(See "Risk Factors - Stock Index Portfolio - Sampling", below).
As indicated above, the Portfolio may utilize stock index futures contracts
and options on stock indexes and stock index futures contracts. Specifically,
the Portfolio may enter into futures contracts provided that not more than 5%
of its assets are required as a futures contract deposit.
Stock index futures contracts and options may be used for several reasons: to
maintain cash reserves while remaining fully invested, to facilitate trading,
to reduce transaction costs, to hedge against changes in securities prices, or
to seek higher investment returns when a futures contract is priced more
attractively than the underlying equity security or the Index.
The Portfolio may lend its investment securities to qualified institutional
investors for the purpose of realizing additional income. Loans of securities
by the Portfolio will be collateralized by cash or securities issued or
guaranteed by the U.S. government or its agencies. The
18
<PAGE>
collateral will equal at least 100% of the current market value of the loaned
securities. The Portfolio may borrow money from a bank but only for temporary
or emergency purposes. The Portfolio may borrow money up to one-third of the
value of its total assets taken at current value. The Portfolio would borrow
money only to meet redemption requests prior to the settlement of securities
already sold or in the process of being sold by the Portfolio. To the extent
that the Portfolio borrows money prior to selling securities, the Portfolio
may be leveraged; at such times, the Portfolio may appreciate or depreciate in
value more rapidly than the Index. The Portfolio may purchase and sell
securities on a "when issued" and "delayed delivery" basis. The Portfolio may
invest in restricted securities and may sell securities short. See "Investment
Practices" for a description of these investments and transactions.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
RISK FACTORS - STOCK INDEX PORTFOLIO
____________________________________
FUTURES CONTRACTS AND OPTIONS
_____________________________
The primary risks associated with the use of futures contracts and options
are: (i) imperfect correlation between the change in market value of the
stocks held by the Portfolio and the prices of futures contracts and options;
and (ii) possible lack of a liquid secondary market for a futures contract and
the resulting inability to close a futures position when desired. The risk of
imperfect correlation will be minimized by investing only in those contracts
whose behavior is expected to resemble that of the Portfolio's underlying
securities. The risk that the Portfolio will be unable to close out a futures
position will be minimized by entering into such transactions on a national
exchange with an active and liquid secondary market. See the Statement of
Additional Information for a more complete discussion of the risks involved
with respect to investment in stock index futures contracts and options on
stock indexes and stock index futures contracts.
MARKET RISK
___________
As the Portfolio invests primarily in common stocks, the Portfolio is subject
to market risk - i.e. the possibility that common stock prices will decline
over short or even extended periods. The U.S. stock market tends to be
cyclical, with periods when stock prices generally rise and periods when
prices generally decline.
To illustrate the volatility of stock prices, the following table sets forth
the extremes for stock market returns as well as the average return for the
period from 1926 to 1990, as measured by the S&P 500 Index:
<TABLE>
<CAPTION>
U.S. STOCK MARKET RETURNS (1926-1990)
OVER VARIOUS TIME HORIZONS
One Five Ten Twenty
Year Years Years Years
------ ------ ------ -------
<S> <C> <C> <C> <C>
Best +53.9% +23.9% +20.1% +16.9%
Worst -43.3 -12.5 -0.9 +3.1
Average +12.0 +9.9 +10.2 +10.3
</TABLE>
20
<PAGE>
As shown, from 1926 to 1990, common stocks, as measured by the S&P 500 Index,
have provided an average annual total return (capital appreciation plus
dividend income) of +12.0%. While this average return can be used as a guide
for setting reasonable expectations for future stock market returns, it may
not be useful for forecasting future returns in any particular period, as
stock returns are quite volatile from year to year.
SAMPLING
The use of the sampling technique may, particularly under certain market
conditions, result in a lower correlation between the Portfolio and the Index
than if the Portfolio owned all 500 stocks in the Index. The sampling
technique, when employed successfully, is effective primarily due to the
existence of long-term correlations between groups of stocks and whole
industry sectors within the Index. Sampling, by definition, creates a bias
toward the purchase by the Portfolio of the stocks of larger capitalization
companies. As a result, the Portfolio can be negatively impacted by the use of
sampling in a market where the stocks of smaller capitalization companies are
outperforming those of larger capitalization companies. When this happens, it
may result in the Portfolio underperforming the Index and not achieving its
anticipated degree of correlation with the Index. The Investment Advisor will
actively monitor the effectiveness of its sampling technique and will
undertake corrective actions should the use of the sampling technique result
in underperformance or undercorrelation with respect to the Index. Such
corrective actions may include, but not necessarily be limited to, increasing
the number of companies represented in the Portfolio to incorporate more
secondary issues. As described under "Investment Policies" above, the Board of
Trustees of the Trust reviews the correlation between the Portfolio and the
Index on a quarterly basis. The Board has adopted monitoring procedures which
require, among other things, that the Investment Advisor notify the Board in
the event that the correlation between the performance of the Portfolio and
that of the Index falls below 95%.
GROWTH AND INCOME PORTFOLIO
The investment objective of the Growth and Income Portfolio is to seek
long-term growth of both capital and income by investing in a portfolio of
common stocks which are considered by the Investment Advisor to have potential
for capital appreciation and dividend growth. The Portfolio may also invest up
to 35% of its assets in common stocks which are considered by the Investment
Advisor to have potential for capital appreciation but which are issued by
foreign corporations.
The Portfolio seeks to achieve its objective by investing primarily in a
diversified portfolio of dividend paying common stocks of large established
companies which are considered by the Investment Advisor to have potential for
both capital appreciation and dividend growth. The Portfolio's stocks are
actively traded in U.S. domestic markets, primarily on national securities
exchanges, and are selected principally on the basis of fundamental investment
values as determined by the Investment Advisor. The Portfolio's investments
are usually viewed by the Investment Advisor as having comparatively low
price-earning ratios and anticipated higher dividends than the S&P 500 average
and, at the time of purchase, are considered by the Investment Advisor to be
undervalued in the marketplace.
The Portfolio may invest up to 35% of its assets in dividend paying common
stocks of large established companies which are considered by the Investment
Advisor to have potential for both capital appreciation and dividend growth
but which are issued by foreign corporations of
21
<PAGE>
the same type as the U.S. securities described above. There is no current
intention that these investments will exceed 20% of the Portfolio's assets.
Investments in foreign securities present certain risks not ordinarily found
in investments in securities of U.S. issuers. See "Risk Factors - Special
Considerations Relating to Foreign Securities".
If the Investment Advisor deems it appropriate to seek to partially hedge the
Portfolio's assets against market value changes resulting from changes in
interest rates or (with respect to the foreign securities which the Portfolio
invests in) currency fluctuations, the Portfolio may enter into various
hedging transactions, such as futures contracts, financial index futures
contracts, and related put or call options contracts on these contracts and
foreign currency contracts. In addition, if the Investment Advisor deems it
appropriate, the Portfolio may enter into other hedging transactions, such as
forward foreign currency contracts, currency futures contracts, and related
options contracts in order to protect the U.S. dollar equivalent values of
those foreign securities in which the Portfolio invests against declines
resulting from currency value fluctuations. Hedging is a means of offsetting,
or neutralizing, the price movement of an investment by making another
investment, the price of which should tend to move in the opposite direction
from that of the original investment. See "Investment Practices - Strategic
Transactions" and the Statement of Additional Information for a more complete
description of these transactions.
The Portfolio may lend portfolio securities. The Portfolio may borrow under
certain circumstances. The Portfolio may also enter into repurchase
agreements, reverse repurchase agreements and may sell securities short. The
Portfolio may also invest in restricted securities. The Portfolio may purchase
and sell securities on a "when issued" and "delayed delivery" basis. A more
complete description of these investments and transactions is contained under
"Investment Practices".
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
As the Portfolio invests primarily in common stocks, the Portfolio is subject
to market risk - i.e. the possibility that common stock prices will decline
over short or even extended periods. Stock markets tend to be cyclical, with
periods when stock prices generally rise and periods when prices generally
decline.
The Portfolio's policy of investing in securities that have a potential for
growth means that the assets of the Portfolio generally will be subject to
greater risk than may be involved in investing in securities which are not
selected for such growth characteristics. Repurchase agreements may be deemed
to be collateralized loans and the Portfolio could experience delay and
expenses in liquidating such collateral in the event of the failure of the
repurchasing party to honor its agreement to repurchase.
WORLD EQUITY PORTFOLIO
The investment objective of the World Equity Portfolio is to seek maximum
long-term total return normally by investing at least 65% of its total assets
in an internationally diversified portfolio of equity securities consisting of
common and preferred stock, securities (bonds or preferred stock) convertible
into common stock, warrants and securities representing underlying
international securities such as American Depository Receipts ("ADRs") and
European Depository Receipts ("EDRs"). In selecting portfolio securities, the
Portfolio attempts
22
<PAGE>
to take advantage of the difference between economic trends and the
anticipated performance of securities and securities markets in various
countries. Warrants entitle the holder to buy equity securities at a specific
price for a specified period of time. Warrants tend to be more volatile than
their underlying securities. Also, the value of the warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date. ADRs
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.
EDRs are receipts issued by a European financial institution evidencing a
similar arrangement and generally are designed for use in European securities
markets.
The Portfolio may invest in securities of issuers in, but not limited to, the
following countries: Australia, Austria, Belgium, Canada, Denmark, France,
Germany, Hong Kong, Indonesia, Italy, Japan, Korea, Malaysia, the Netherlands,
New Zealand, Norway, Singapore, Spain, Sweden, Switzerland, Taiwan, Thailand,
the United Kingdom and the United States. Normally, the Portfolio will invest
at least 65% of its total assets in securities traded in at least three
foreign countries, including the countries listed herein. It is anticipated
that the Portfolio will initially invest primarily in securities traded in
securities markets located in Germany, Japan and the United States.
The Portfolio may invest the remainder of its assets in securities of the U.S.
Government or of any foreign government or any supranational entity, in debt
securities of any issuer rated A or better at the time of purchase by Standard
& Poor's Corporation or Moody's Investors Service, Inc. or of comparable
quality as determined by the Investment Advisor, and in cash and money market
instruments. Examples of supranational entities include the International Bank
for Reconstruction and Development (the "World Bank"), the European Steel and
Coal Community, the Asian Development Bank and the InterAmerican Development
Bank.
The Investment Advisor will use various indices as benchmarks against which it
will gauge the performance of the different equity segments of the Portfolio
and determine risk measurement. The index used will depend upon the Portfolio
composition at the time of comparison with respect to the various countries.
Since the assets of the Portfolio initially will be primarily invested in
securities traded in Germany, Japan and the United States, it is anticipated
that the Investment Advisor will initially use the DAX 30-Stock Index
(Germany), the Nikkei 225- Stock Index (Japan) and the S&P 500 (the United
States) as benchmark indices. The DAX 30-Stock Index is a total rate of return
index of 30 selected German blue chip stocks traded on the Frankfurt Stock
Exchange. The Nikkei 225-Stock Index is a price-weighted index of 225
top-rated Japanese companies listed in the First Section of the Tokyo Stock
Exchange. For a description of the S&P 500 Index, see "Stock Index Portfolio -
Investment Objective". As the Portfolio begins to expand its international
diversification, other relevant indices may be used as benchmarks. Such
indices include, but are not limited to, the Morgan Stanley Capital
International Europe (Free) Index (a diversified, capitalization weighted
index comprised of companies located in thirteen European countries), the
Morgan Stanley Capital International Pacific Index (a diversified,
capitalization weighted index consisting of companies located in Australia,
Japan, Hong Kong, New Zealand and Singapore) and the Morgan Stanley Capital
International Europe, Australia and Far East (Free) Index (a broadly
diversified international index consisting of more than 1000 equity securities
of companies located outside of the United States). (The Portfolio is neither
sponsored by nor affiliated with Morgan Stanley Capital International).
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The Investment Advisor, in managing the investments of the Portfolio, may
purchase various forms of research including computer models to assist it in
achieving a balance between the various indices to achieve the most growth
potential.
Investments in foreign securities present certain risks not ordinarily found
in investments in securities of U.S. issuers. See "Risk Factors - Special
Considerations Relating to Foreign Securities."
The Portfolio may seek to hedge its portfolio against currency fluctuations
(with respect to the foreign securities the Portfolio may invest in) by
entering into various hedging transactions, such as foreign currency
contracts, forward foreign currency contracts, currency futures contracts, and
related options contracts in order to protect the U.S. dollar equivalent
values of those foreign securities against declines resulting from currency
value fluctuations. Hedging is a means of offsetting, or neutralizing, the
price movement of an investment by making another investment, the price of
which should tend to move in the opposite direction from that of the original
investment. See "Investment Practices - Strategic Transactions" and the
Statement of Additional Information for a more complete description of
strategic and foreign currency transactions.
The Portfolio may enter into various additional hedging transactions such as
futures contracts, financial index futures contracts, stock index futures
contracts, and the related put or call options contracts on futures contracts.
The Portfolio may purchase and write call and put options on stock indexes.
See "Investment Practices - Strategic Transactions" and the Statement of
Additional Information for a more complete description of these strategic
transactions including a discussion of the risks involved therein.
To help protect the value of its Portfolio from interest rate and currency
fluctuations, the Portfolio may enter into interest rate and currency swap
agreements and may purchase and sell interest rate "caps", "floors" and
"collars." The Portfolio will enter into these transactions primarily to
preserve a return or spread on a particular investment or portion of its
portfolio or to protect against any increase in the price of securities it
anticipates purchasing. The Portfolio intends to use these transactions as a
hedge and not as a speculative investment. Swap agreements typically involve
leverage, may be highly volatile and involve risks depending upon the other
party's creditworthiness and ability to perform, as well as the Portfolio's
ability to terminate its swap agreements or reduce its exposure through
offsetting transactions. See "Investment Practices - Strategic Transactions"
and the Statement of Additional Information for a more complete description of
these strategic transactions including a discussion of the risks involved
therein.
The Portfolio's engagement in certain strategic transactions, such as the
purchase and sale of options, futures and currency contracts as described
above involves certain risks. It is likely that during its initial phase of
operations the Portfolio may engage in such strategic transactions to a
greater degree than when the assets of the Portfolio have grown to a
sufficient size as to allow the Investment Advisor to make direct purchases of
equity securities in accordance with the Portfolio's investment objective. See
"Investment Practices - Strategic Transactions" and the Statement of
Additional Information for a more complete discussion of strategic
transactions and the risks involved in engaging in these transactions. The
Portfolio may lend portfolio securities. The Portfolio may borrow under
certain circumstances. The Portfolio may purchase and sell securities on a
"when issued" and "delayed delivery" basis. The Portfolio may also enter into
repurchase agreements, reverse repurchase agreements and may sell
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securities short. Repurchase agreements may be deemed to be collateralized
loans and the Portfolio could experience delay and expenses in liquidating
such collateral in the event of the failure of the repurchasing party to honor
its agreement to repurchase. The Portfolio may also invest in restricted
securities. A more complete description of these investments and transactions
is contained under "Investment Practices".
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
UTILITY PORTFOLIO
The investment objective of the Utility Portfolio is capital appreciation and
current income. The Portfolio will seek to achieve its investment objective by
investing in a diversified portfolio of common stock and income securities
issued by companies engaged in the utilities industry ("Utility Securities").
Companies engaged in the utilities industry include those engaged in the
production, transmission, or distribution of electric energy, gas,
telecommunications services or the provision of other utility or utility
related goods or services. Under normal market conditions, at least 80% of the
Portfolio's assets will be invested in Utility Securities. Under normal market
conditions, the Portfolio may invest up to 20% of its assets in other than
Utility Securities, including common stock and income securities of issuers
not engaged in the utilities industry, cash and money market instruments.
Income securities include preferred stock and debt securities of various
maturities. The Portfolio's investments in income securities will be rated, at
the time of investment, at least BBB by S&P, or at least Baa by Moody's or
comparably rated by any other nationally recognized statistical rating
organization; provided, however, the Portfolio may invest up to 20% of its
assets in income securities that are rated BB or B by S&P or Ba or B by
Moody's (or comparably rated by any other nationally recognized statistical
rating service) or unrated income securities determined by the Portfolio's
investment adviser to be of comparable or higher quality. Such lower rated or
unrated income securities are commonly referred to as "junk bonds" and are
regarded by the rating agencies, on balance, as predominantly speculative with
respect to capacity to pay interest and repay principal in accordance with the
terms of the obligation; assurance of interest and principal payments or
maintenance of other terms of the securities over any long period of time may
be small. While offering opportunities for higher yields, lower- grade
securities are considered below "investment grade" and involve a greater
degree of credit risk than investment grade income securities; although the
lower-grade income securities of an issuer generally involve a lower degree of
credit risk than its common stock. The Portfolio may invest up to 35% of its
assets in securities issued by non-U.S. issuers. The foregoing policies are
fundamental and cannot be changed without approval of the shareholders. There
can be no assurance that the Portfolio will achieve its investment objective.
The Investment Advisor believes that the historical performance of Utility
Securities, together with ongoing developments in the utilities industry,
indicate the potential for achieving both capital appreciation and current
income from investment in a diversified portfolio of Utility Securities. The
Investment Advisor believes that the historical characteristics of Utility
Securities which are common stocks indicate potential for capital
appreciation. The Investment Advisor also believes that many companies engaged
in the utilities industry have established a reputation for paying regular
quarterly dividends and for increasing their common stock dividends over time,
despite fluctuations in interest rates over time. The annual dividends per
share of the Utility Securities comprising the S&P Utilities Index, for the 10
year period 1982
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through 1992, have increased while interest rates during such period, as
measured by the six month U.S. Treasury rate, have fluctuated widely. The
Investment Advisor believes that the historical characteristics of Utility
Securities which are income securities indicate the potential for current
income.
In evaluating particular issuers of Utility Securities, the Investment Advisor
will consider a number of factors, including historical growth rates, rates of
return on capital, financial condition and resources, geographic location and
service area, management skills and such utilities industry factors as
regulatory environment, energy sources, the costs of alternative fuels and, in
the case of electric energy utilities, the extent and nature of their
involvement with nuclear power. The Investment Advisor will place special
emphasis on the potential for capital appreciation, current and projected
yields, prospective growth in earnings and dividends in relation to
price/earnings ratios and risk. The Investment Advisor believes that Utility
Securities provide above-average dividend returns and below-average
price/earnings ratios which in the view of the Investment Advisor are factors
that not only provide current income but also generally tend to moderate risk.
The Investment Advisor will buy and sell securities for the Portfolio with a
view toward seeking capital appreciation together with current income and will
select securities which the Investment Advisor believes entail reasonable
credit risk considered in relation to the investment policies of the
Portfolio. As a result, the Portfolio will not necessarily invest in the
highest yielding Utility Securities permitted by the investment policies if
the Investment Advisor determines that market risks or credit risks associated
with such investments would subject the Portfolio to excessive risk. Other
than for tax purposes, frequency of portfolio turnover generally will not be a
limiting factor if the Portfolio considers it advantageous to purchase or sell
securities. See "Investment Objectives and Policies" and "Investment
Limitations" in the Statement of Additional Information.
UTILITY PORTFOLIO SECURITIES
____________________________
UTILITY SECURITIES. Utility Securities are common stocks and income securities
of companies engaged in the utilities industry. Companies engaged in the
utilities industry include a variety of entities involved in (i) the
production, transmission or distribution of electric energy, (ii) the
provision of natural gas, (iii) the provision of telephone, mobile
communication and other telecommunications services or (iv) the provision of
other utility or utility related goods or services, including entities engaged
in cogeneration, waste disposal system provision, solid waste electric
generation, independent power producers and non- utility generators.
The public utilities industry has experienced significant changes in recent
years. Many issuers of Utility Securities have been favorably affected by
lower fuel and financing costs, deregulation, the full or near completion of
major construction programs and an increasing customer base. In addition, many
utility companies have generated cash flows in excess of current operating
expenses and construction expenditures, permitting some degree of
diversification into unregulated businesses. Some electric utilities have also
taken advantage of the right to sell power outside of their historical
territories.
The rates of return of issuers of Utility Securities generally are subject to
review and limitation by state public utilities commissions and tend to
fluctuate with marginal financing costs. Rate changes generally lag changes in
financing costs, and thus can favorably or unfavorably affect the earnings or
dividend payments on Utility Securities depending upon whether such rates and
costs are declining or rising.
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Companies engaged in the public utilities industry historically have been
subject to a variety of risks depending, in part, on such factors as the type
of utility company involved and its geographic location. Such risks include
increases in fuel and other operating costs, high interest expenses for
capital construction programs, costs associated with compliance with
environmental and nuclear safety regulations, service interruption due to
environmental, operational or other mishaps, the effects of economic
slowdowns, surplus capacity, competition and changes in the overall regulatory
climate. In particular, regulatory changes with respect to nuclear and
conventionally fueled generating facilities could increase costs or impair the
ability of utility companies to operate such facilities, thus reducing utility
companies' earnings or resulting in losses. There can be no assurance that
regulatory policies or accounting standard changes will not negatively affect
utility companies' earnings or dividends. Companies engaged in the public
utilities industry are subject to regulation by various authorities and may be
affected by the imposition of special tariffs and changes in tax laws. To the
extent that rates are established or reviewed by governmental authorities,
companies engaged in the public utilities industry are subject to the risk
that such authority will not authorize increased rates. In addition, because
of the Portfolio's policy of concentrating its investments in Utility
Securities, the Portfolio may be more susceptible than an investment company
without such a policy to any single economic, political or regulatory
occurrence affecting the public utilities industry. Under market conditions
that are unfavorable to the utilities industry, the Investment Advisor may
significantly reduce the Portfolio's investment in that industry.
GAS AND TELECOMMUNICATIONS UTILITIES. Gas transmission companies, gas
distribution companies and telecommunications companies are undergoing
significant changes. Gas utilities have been adversely affected by declines in
the prices of alternative fuels, oversupply conditions and competition.
Telephone utilities are still experiencing the effects of the break-up of
American Telephone & Telegraph Company, including increased competition and
rapidly developing technologies with which traditional telephone companies now
compete. Potential sources of competition and new products are cable
television systems, shared tenant services and other noncarrier systems which
are capable of by-passing traditional telephone services providers' local
plants, either completely or partially, through substitutions of special
access for switched access or through concentration of telecommunications
traffic on fewer of the traditional telephone services providers' lines.
Although there can be no assurance that increased competition and other
structural changes will not adversely affect the profitability of such
utilities, or that other negative factors will not develop in the future, in
the Investment Advisor's opinion, competition and technological advances may
over time result in providing better-positioned utility companies with
opportunities for enhanced profitability.
ELECTRIC UTILITIES. Electric utility companies in general have been favorably
affected by lower fuel costs, the full or near completion of major
construction programs and lower financing costs. Some electric utilities have
also taken advantage of the right to sell power outside of their historical
territories. Certain electric utilities with uncompleted nuclear power
facilities may have problems completing and licensing such facilities, and
there is increasing public, regulatory and governmental concern with the cost
and safety of nuclear power facilities in general. At this time, there are
certain institutional impediments to the wide-scale deregulation of electric
utilities including among other things, limitations on the redistribution of
power.
OTHER UTILITIES. Other issuers of Utility Securities are emerging as new
technologies develop and as old technologies are refined. Such issuers include
entities engaged in cogeneration,
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waste disposal system provision, solid waste electric generation, independent
power producers and non-utility generators.
COMMON STOCK. Common stocks are shares of a corporation or other entity that
entitle the holder to a pro rata share of the profits of the corporation, if
any, without preference over any other shareholder or class of shareholders,
after making required payments to holders of such entity's preferred stock and
other senior equity. Common stock usually carries with it the right to vote
and frequently an exclusive right to do so. In selecting common stocks for
investment, the Portfolio will focus both on the security's potential for
appreciation and on its dividend paying capacity.
The average dividend yield of Utility Securities which are common stocks
historically has exceeded the average dividend yield of common stocks of
industrial issuers by a significant amount. For example, the common stocks
comprising the S&P Utilities Index for calendar year 1992 had an average
dividend yield of 5.72%, or more than twice the 2.63% average dividend yield
for the common stocks comprising the S&P 400 Industrials Index. However, the
Portfolio will not necessarily reflect the securities which comprise the S&P
Utilities Index and there can be no assurance that the historical investment
performance for any industry (including the public utilities industry) is
indicative of future performance.
INCOME SECURITIES AND RISKS OF LOWER GRADE INCOME SECURITIES. The Portfolio
may invest its assets in income securities, which include preferred stocks,
debt securities of various maturities and securities convertible into, or
ultimately exchangeable for, Utility Securities. The Portfolio's investments
in income securities will be rated, at the time of investment, at least BBB by
S&P, or at least Baa by Moody's or comparably rated by any other nationally
recognized statistical rating organization; provided, however, the Portfolio
may invest up to 20% of its assets in income securities that are rated BB or B
by S&P or Ba or B by Moody's (or comparably rated by any other nationally
recognized statistical rating service) or unrated income securities determined
by the Portfolio's Investment Advisor to be of comparable or higher quality.
In normal circumstances, the Portfolio may invest up to 20% of its assets in
lower grade income securities (including downgraded securities) or in unrated
income securities considered by the Investment Advisor to be of comparable or
higher quality to such lower grade securities or of comparable quality to
investment grade securities. Lower grade income securities in which the
Portfolio may invest are rated between BB and B by S&P or between Ba and B by
Moody's. Income securities with such ratings from S&P and Moody's are commonly
referred to as "junk bonds" and are regarded by S&P and Moody's as
predominantly speculative with respect to the capacity to pay interest and/or
repay principal in accordance with their terms. Investment in lower grade
securities involves special risks as compared with investment in higher grade
securities. The market for lower grade securities is considered to be less
liquid than the market for investment grade securities which may adversely
affect the ability of the Portfolio to dispose of such securities in a timely
manner at a price which reflects the value of such security in the Investment
Advisor's judgment. Because issuers of lower grade securities frequently
choose not to seek a rating of their securities, the Portfolio will rely more
heavily on the Investment Advisor's ability to determine the relative
investment quality of such securities than if the Portfolio invested
exclusively in higher grade securities. For a description of the ratings
assigned to income securities, including lower grade income securities, please
see the Appendix.
The net asset value of the Portfolio will change with changes in the value of
its portfolio securities. The values of income securities may change as
interest rate levels fluctuate. To the
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extent that the Portfolio invests in income securities, the net asset value of
the Portfolio can be expected to change as general levels of interest rates
fluctuate. When interest rates decline, the value of a portfolio invested in
income securities generally can be expected to rise. Conversely, when interest
rates rise, the value of a portfolio invested in income securities generally
can be expected to decline. Volatility may be greater during periods of
general economic uncertainty.
The foregoing policies with respect to credit quality of portfolio investments
will apply only at the time of purchase of a security, and the Portfolio will
not be required to dispose of a security in the event that S&P or Moody's (or
any other nationally recognized statistical rating organization) or, in the
case of unrated income securities, the Investment Advisor, downgrades its
assessment of the credit characteristics of a particular issuer. In
determining whether the Portfolio will retain or sell such a security, in
addition to the factors described above, the Investment Advisor may consider
such factors as the Investment Advisor's assessment of the credit quality of
the issuer of such security, the price at which such security could be sold
and the rating, if any, assigned to such security by other nationally
recognized statistical rating organizations.
FOREIGN SECURITIES. The Portfolio may invest up to 35% of its assets in
securities issued by non-U.S. issuers of similar quality as the securities
described above as determined by the Investment Advisor. Investments in
foreign securities present certain risks not ordinarily found in investments
in securities of U.S. issuers. See "Risk Factors - Special Considerations
Relating to Foreign Securities."
The Investment Advisor believes that many foreign issuers of Utility
Securities have yet to experience the growth that certain issuers of Utility
Securities located in the United States have experienced and that as such
foreign issuers develop their domestic markets, they may become attractive
investments. In addition, the Investment Advisor believes that certain foreign
governments may engage in programs of privatization of issuers of Utility
Securities and that the Utility Securities issued by privatized companies may
offer attractive investment opportunities with the potential for long-term
growth. However, it is not possible to predict the terms of offerings by
privatized companies or the effect of privatizations in the domestic
securities market of such privatized companies. There can be no assurance that
securities of privatized companies will be offered to the public or to foreign
companies such as the Portfolio.
DEFENSIVE STRATEGIES. At times, conditions in the markets for Utility
Securities may, in the Investment Advisor's judgment, make pursuing the
Portfolio's basic investment strategy inconsistent with the best interests of
its shareholders. At such times, the Investment Advisor may use alternative
strategies primarily designed to reduce fluctuations in the value of the
Portfolio's assets. In implementing these "defensive" strategies, the
Portfolio may invest to a substantial degree in high-quality, short-term
obligations. Such taxable obligations may include: obligations of the U.S.
Government, its agencies or instrumentalities; other debt securities rated
within the four highest grades by either S&P or Moody's (or comparably rated
by any other nationally recognized statistical rating organization);
commercial paper rated in the highest grade by either rating service (or
comparably rated by any other nationally recognized statistical rating
organization); certificates of deposit and bankers' acceptances; repurchase
agreements with respect to any of the foregoing investments; or any other
fixed-income securities that the Investment Advisor considers consistent with
such strategy.
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The Utility Portfolio may engage in strategic transactions, enter currency
transactions, purchase and sell securities on a "when issued" and "delayed
delivery" basis, enter into repurchase and reverse repurchase agreements, lend
its portfolio securities and purchase restricted securities. See "Investment
Practices" below for a description of these investments and transactions.
INVESTMENT PRACTICES
In connection with the investment policies of the Portfolios described above,
the Portfolios may engage in certain investment practices subject to the
limitations set forth below. These investments entail risks.
STRATEGIC TRANSACTIONS. The Quality Income Portfolio, Growth and Income
Portfolio, High Yield Portfolio, World Equity Portfolio and Utility Portfolio
may purchase and sell exchange-listed and over-the-counter put and call
options on securities, financial futures, fixed-income indices and other
financial instruments and purchase and sell financial futures contracts. The
Growth and Income Portfolio, High Yield Portfolio, World Equity Portfolio and
Utility Portfolio may enter into various currency transactions such as
currency forward contracts, currency futures contracts, currency swaps or
options on currencies or currency futures. The Stock Index Portfolio may enter
into stock index futures contracts and options on stock indexes and stock
index futures contracts. Collectively, all of the above are referred to as
"Strategic Transactions." Strategic Transactions are hedging transactions
which may be used to attempt to protect against possible changes in the market
value of securities held in or to be purchased for a Portfolio, to protect a
Portfolio's unrealized gains in the value of its portfolio securities, to
facilitate the sale of such securities for investment purposes, to manage the
effective interest rate exposure of a Portfolio, to protect against changes in
currency exchange rates, or to establish a position in the derivatives markets
as a temporary substitute for purchasing or selling particular securities. Any
or all of these investment techniques may be used at any time and there is no
particular strategy that dictates the use of one technique rather than
another, as use of any Strategic Transaction is a function of numerous
variables including market conditions. The ability of a Portfolio to utilize
these Strategic Transactions successfully will depend on the Investment
Advisor's ability to predict pertinent market movements, which cannot be
assured. The Portfolios will comply with applicable regulatory requirements
when implementing these strategies, techniques and instruments.
Strategic Transactions have risks associated with them including possible
default by the other party to the transaction, illiquidity and, to the extent
the Investment Advisor's view as to certain market movements is incorrect, the
risk that the use of such Strategic Transactions could result in losses
greater than if they had not been used. Use of put and call options may result
in losses to a Portfolio, force the sale of portfolio securities at
inopportune times or for prices other than at current market values, limit the
amount of appreciation a Portfolio can realize on its investments or cause a
Portfolio to hold a security it might otherwise sell. The use of currency
transactions can result in a Portfolio incurring losses as a result of a
number of factors including the imposition of exchange controls, suspension of
settlements or the inability to deliver or receive a specified currency. The
use of options and futures transactions entails certain other risks. In
particular, the variable degree of correlation between price movements of
futures contracts and price movements in the related portfolio position of a
Portfolio creates the possibility that losses on the hedging instrument may be
greater than gains in the value of a Portfolio's position. In addition,
futures and options markets may not be liquid in all circumstances and certain
over-the-counter options may have no markets. As a result, in certain markets,
a Portfolio might not be able to close out a transaction without incurring
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substantial losses, if at all. Although the contemplated use of these futures
contracts and options thereon should tend to minimize the risk of loss due to
a decline in the value of the hedged position, at the same time they tend to
limit any potential gain which might result from an increase in value of such
position. Finally, the daily variation margin requirements for futures
contracts would create a greater ongoing potential financial risk than would
purchases of options, where the exposure is limited to the cost of the initial
premium. Losses resulting from the use of Strategic Transactions would reduce
net asset value, and possibly income, and such losses can be greater than if
the Strategic Transactions had not been utilized. The Strategic Transactions
that the Portfolios may use and some of their risks are described more fully
in the Statement of Additional Information.
Income earned or deemed to be earned, if any, by a Portfolio from its
Strategic Transactions will generally be taxable income of a Portfolio.
REPURCHASE AGREEMENTS. All of the Portfolios may enter into repurchase
agreements with selected commercial banks and broker-dealers, under which the
Portfolio acquires securities and agrees to resell the securities at an agreed
upon time and at an agreed upon price. The Portfolio accrues as interest the
difference between the amount it pays for the securities and the amount it
receives upon resale. At the time the Portfolio enters into a repurchase
agreement, the value of the underlying security including accrued interest
will be equal to or exceed the value of the repurchase agreement and, for
repurchase agreements that mature in more than one day, the seller will agree
that the value of the underlying security including accrued interest will
continue to be at least equal to the value of the repurchase agreement. The
Investment Advisor will monitor the value of the underlying security in this
regard. The Portfolio will enter into repurchase agreements only with
commercial banks whose deposits are insured by the Federal Deposit Insurance
Corporation and whose assets exceed $500 million or broker-dealers who are
registered with the SEC. In determining whether the Portfolio should enter
into a repurchase agreement with a bank or broker-dealer, the Investment
Advisor will take into account the credit-worthiness of the party and will
monitor its credit-worthiness on an ongoing basis in accordance with standards
established by the Board of Trustees. In the event of a default by the party,
the delays and expenses potentially involved in establishing the Portfolio's
rights to, and in liquidating, the security may result in a loss to the
Portfolio. The Portfolio's ability to invest in repurchase agreements that
mature in more than seven days is subject to an investment restriction that
limits the Portfolio's investment in restricted securities, including
repurchase agreements, to 10% of the Portfolio's net assets (15% with respect
to the World Equity Portfolio and Utility Portfolio). The Money Market
Portfolio may not invest in repurchase agreements which mature in more than
seven days.
There are additional limitations and restrictions relating to the ability of
the Money Market Portfolio to invest in repurchase agreements which have been
adopted by the Board of Trustees of the Trust and which relate primarily to
investment quality and diversification.
WHEN ISSUED AND DELAYED DELIVERY TRANSACTIONS. All Portfolios may purchase and
sell securities on a "when issued" and "delayed delivery" basis, that is,
obligate themselves to purchase or sell securities with delivery and payment
to occur at a later date in order to secure what is considered to be an
advantageous price and yield to the Portfolio at the time of entering into the
obligation. When a Portfolio engages in "when issued" and "delayed delivery"
transactions, the Portfolio relies on the buyer or seller, as the case may be,
to consummate the sale. Failure to do so may result in the Portfolio missing
the opportunity of obtaining a price or yield considered to be advantageous.
No income accrues to or is earned by the Portfolio on
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portfolio securities in connection with such transactions prior to the date
the Portfolio actually takes delivery of such securities. These transactions
are subject to market fluctuation; the value of such securities at delivery
may be more or less than their purchase price, and yields generally available
on such securities when delivery occurs may be higher than yields on such
securities obtained pursuant to such transactions. Because the Portfolio
relies on the buyer or seller, as the case may be, to consummate the
transaction, failure by the other party to complete the transaction may result
in the Portfolio missing the opportunity of obtaining a price or yield
considered to be advantageous. When the Portfolio is the buyer in such a
transaction, however, it will maintain, in a segregated account with its
custodian, cash or high-grade portfolio securities having an aggregate value
equal to the amount of such purchase commitments until payment is made. The
Portfolio will make commitments to purchase securities on such basis only with
the intention of actually acquiring these securities, but the Portfolio may
sell such securities prior to the settlement date if such sale is considered
to be advisable. To the extent the Portfolio engages in "when issued" and
"delayed delivery" transactions, it will do so for the purpose of acquiring
securities for the Portfolio consistent with the Portfolio's investment
objectives and policies and not for the purposes of investment leverage. No
specific limitation exists as to the percentage of any Portfolio's assets
which may be used to acquire securities on a "when issued" or "delayed
delivery" basis.
RESTRICTED SECURITIES. The Portfolios may each invest up to 10% (15% with
respect to the World Equity and Utility Portfolios) of their respective net
assets in securities the disposition of which is subject to substantial legal
or contractual restrictions on resale and securities that are not readily
marketable. The sale of restricted securities often requires more time and
results in higher brokerage charges or dealer discounts and other selling
expenses than does the sale of securities eligible for trading on national
securities exchanges or in the over-the-counter markets. Restricted securities
may sell at a price lower than similar securities that are not subject to
restrictions on resale. Restricted securities in all Portfolios will be valued
at fair value as determined in good faith by or at the direction of the
Trustees for the purposes of determining the net asset value of each
Portfolio. Restricted securities salable among qualified institutional buyers
without restriction pursuant to Rule 144A under the Securities Act of 1933
that are determined to be liquid by the Investment Advisor under guidelines
adopted by the Board of Trustees of the Trust (under which guidelines the
Investment Advisor will consider factors such as trading activities and the
availability of price quotations), will not be treated as restricted
securities by the Portfolios pursuant to such rules.
LOANS OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, all of the Portfolios may lend their securities to selected
commercial banks or broker-dealers up to a maximum of 25% of the assets of
each Portfolio (but up to 50% with respect to the Utility Portfolio). Such
loans must be callable at any time and be continuously secured by collateral
deposited by the borrower in a segregated account with the Trust's custodian
consisting of cash or of securities issued or guaranteed by the U.S.
Government or its agencies, which collateral is equal at all times to at least
100% of the value of the securities loaned, including accrued interest. A
Portfolio will receive amounts equal to earned income for having made the
loan. Any cash collateral pursuant to these loans will be invested in
short-term instruments. A Portfolio is the beneficial owner of the loaned
securities in that any gain or loss in the market price during the loan inures
to the Portfolio and its shareholders. Thus, when the loan is terminated, the
value of the securities may be more or less than their value at the beginning
of the loan. In determining whether to lend its portfolio securities to a bank
or broker-dealer, a Portfolio will take into account the credit-worthiness of
such borrower and will monitor such credit-worthiness on an ongoing basis in
as much as a default by the other party may cause
32
<PAGE>
delays or other collection difficulties. A Portfolio may pay finders' fees in
connection with loans of its portfolio securities.
REVERSE REPURCHASE AGREEMENTS AND BORROWINGS. All of the Portfolios may enter
into reverse repurchase agreements with selected commercial banks or
broker-dealers with respect to securities which could otherwise be sold by the
Portfolios. Reverse repurchase agreements involve sales by a Portfolio of
Portfolio assets concurrently with an agreement by the Portfolio to repurchase
the same assets at a later date at a fixed price which is greater than the
sales price. The difference between the amount the Portfolio receives for the
securities and the amount it pays on repurchase is deemed to be a payment of
interest by the Portfolio. The Portfolio will maintain, in a segregated
account with its custodian, cash, Treasury bills, or other U.S. government
securities having an aggregate value equal to the amount of commitment to
repurchase, including accrued interest, until payment is made. The Portfolio
will enter into reverse repurchase agreements only with commercial banks whose
deposits are insured by the Federal Deposit Insurance Corporation and whose
assets exceed $500 million or broker-dealers who are registered with the SEC.
In determining whether the Portfolio should enter into a reverse repurchase
agreement with a bank or broker-dealer, the Investment Advisor will take into
account the credit-worthiness of the party and will monitor the
credit-worthiness on an ongoing basis. During the reverse repurchase agreement
period, the Portfolio continues to receive principal and interest payments on
these securities. Reverse repurchase agreements involve the risk that the
market value of the securities retained by the Portfolio may decline below the
price of the securities the Portfolio has sold but is obligated to repurchase
under the agreement. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the
Portfolio's use of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to
enforce the Portfolio's obligation to repurchase the securities. Reverse
repurchase agreements create leverage and will be treated as borrowings for
the purposes of each Portfolio's investment restriction on borrowings.
The Quality Income Portfolio, High Yield Portfolio, Growth and Income
Portfolio, Stock Index Portfolio and World Equity Portfolio are permitted to
borrow money up to one-third of the value of their net assets taken at current
value. The Money Market Portfolio may borrow up to 10% of its net assets.
Borrowing by these Portfolios may be only from banks as a temporary measure
for extraordinary or emergency purposes and not for investment leverage. The
Portfolios (with the exception of the Utility Portfolio) may each enter into
reverse repurchase agreements in an amount not exceeding 5% of the net assets
of each such Portfolio at the time of entering into any agreement.
The Utility Portfolio is authorized to borrow money from banks or enter into
reverse repurchase agreements with banks in an amount up to 331/3% of the
Portfolio's total assets (after giving effect to any such borrowing) which
amount includes no more than 5% in borrowings and reverse repurchase
agreements from any entity for temporary purposes, such as clearances of
portfolio transactions, share repurchases and payment of dividends and
distributions. The Utility Portfolio has no current intention to borrow money
other than for such temporary purposes. Accordingly, the Utility Portfolio
will not acquire additional Utility Securities during any period in which its
borrowings exceed 5% of the Portfolio's total assets. The Utility Portfolio
will borrow only when the Investment Advisor believes that such borrowings
will benefit the Portfolio.
As a matter of operating policy, the Money Market Portfolio, the Quality
Income Portfolio, the
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<PAGE>
Stock Index Portfolio and the Growth and Income Portfolio will not borrow more
than 10% of their net asset value when borrowing is for any general purpose
and 25% of their net asset value when borrowing is a temporary measure to
facilitate redemptions.
Borrowing by a Portfolio creates an opportunity for increased net income but,
at the same time, creates special risk considerations such as changes in the
net asset value of the shares and in the yield on the Portfolio. Although the
principal of such borrowings will be fixed, the Portfolio's assets may change
in value during the time the borrowing is outstanding. Borrowing will create
interest expenses for the Portfolio which can exceed the income from the
assets retained. To the extent the income derived from securities purchased
with borrowed funds exceeds the interest the Portfolio will have to pay, the
Portfolio's net income will be greater than if borrowing were not used.
Conversely, if the income from the assets retained with borrowed funds is not
sufficient to cover the cost of borrowing, the net income of the Portfolio
will be less than if borrowing were not used.
SHORT SALES. The Quality Income Portfolio, Stock Index Portfolio, World Equity
Portfolio, and the Growth and Income Portfolio may utilize short sales on
securities to implement their investment objectives. The Utility Portfolio may
engage in short sales only in connection with Strategic Transactions. A short
sale is effected when it is believed that the price of a particular investment
will decline, and involves the sale of an investment which the Portfolio does
not own in the hope of purchasing the same investment at a later date at a
lower price. To make delivery to the buyer, the Portfolio must borrow the
investment, and the Portfolio is obligated to return the investment to the
lender, which is accomplished by a later purchase of the investment by the
Portfolio.
The Portfolio will incur a loss as a result of the short sale if the price of
the investment increases between the date of the short sale and the date on
which the Portfolio purchases the investment to replace the borrowed
investment. The Portfolio will realize a gain if the investment declines in
price between those dates. The amount of any gain will be decreased and the
amount of any loss increased by any premium or interest the Portfolio may be
required to pay in connection with a short sale. It should be noted that
possible losses from short sales differ from those that could arise from a
cash investment in that the former may be limitless while the latter can only
equal the total amount of the Portfolio's investment in the investment. For
example, if the Portfolio purchases a $10 investment, the most that can be
lost is $10. However, if the Portfolio sells a $10 investment short, it may
have to purchase the investment for return to the lender when the market value
is $50, thereby incurring a loss of $40. The amount of any gain or loss on a
short sale transaction is also dependent on brokerage and other transaction
costs.
INVESTMENT LIMITATIONS
In addition to the investment policies set forth above, certain additional
restrictive policies relating to the investment of assets of the Portfolios
have been adopted by the Trust. The Investment Limitations of the Trust are
deemed fundamental and may not be changed without the approval of the holders
of a majority of the outstanding voting shares of each Portfolio affected
(which for this purpose and under the Investment Company Act of 1940 means the
lesser of (i) 67% of the shares represented at a meeting at which more than
50% of the outstanding shares are present or represented by proxy and (ii)
more than 50% of the outstanding shares). A change in policy affecting only
one Portfolio may be effected with the approval of a majority of the
outstanding shares of the Portfolio. Details as to the policies are set forth
in the Statement of Additional Information.
34
RISK FACTORS
TAX CONSIDERATIONS
The Trust was established as the underlying investment for variable contracts
issued by Xerox Financial Services Life Insurance Company and any affiliated
insurance companies.
Section 817(h) of the Internal Revenue Code of 1986, as amended (the "Code"),
imposes certain diversification standards on the underlying assets of variable
contracts held in the Portfolios of the Trust. The Code provides that a
variable contract shall not be treated as an annuity contract for any period
(and any subsequent period) for which the investments are not, in accordance
with regulations prescribed by the Treasury Department, adequately
diversified. Disqualification of the variable contract as an annuity contract
would result in imposition of federal income tax on contract owners with
respect to earnings allocable to the variable contract prior to the receipt of
payments under the variable contract. Section 817(h)(2) of the Code is a safe
harbor provision which provides that contracts such as the variable contracts
meet the diversification requirements if, as of the close of each quarter, the
underlying assets meet the diversification standards for a regulated
investment company and no more than fifty-five percent (55%) of the total
assets consists of cash, cash items, U.S. government securities and securities
of other regulated investment companies.
On March 2, 1989, the Treasury Department issued Regulations (Treas. Reg.
1.817-5), which established diversification requirements for the investment
portfolios underlying variable contracts. The Regulations amplify the
diversification requirements for variable contracts set forth in Section
817(h) of the Code and provide an alternative to the safe harbor provision
described above. Under the Regulations, an investment portfolio will be deemed
adequately diversified if (i) no more than 55 percent of the value of the
total assets of the portfolio is represented by any one investment; (ii) no
more than 70 percent of such value is represented by any two investments;
(iii) no more than 80 percent of such value is represented by any three
investments; and (iv) no more than 90 percent of such value is represented by
any four investments. For purposes of these Regulations, all securities of the
same issuer are treated as a single investment.
The Code provides that for purposes of determining whether or not the
diversification standards imposed on the underlying assets of variable
contracts by Section 817(h) of the Code have been met, "each United States
government agency or instrumentality shall be treated as a separate issuer".
Each Portfolio of the Trust will be managed in such a manner as to comply with
these diversification requirements. It is possible that in order to comply
with the diversification requirements, less desirable investment decisions may
be made which would affect the investment performance of the Portfolios.
SPECIAL CONSIDERATIONS RELATING TO FOREIGN SECURITIES
All of the Portfolios may invest in foreign securities. The Stock Index
Portfolio, however, may only invest in foreign securities to the extent that
it invests in American Depository Receipts ("ADRs") for foreign securities.
ADRs 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
Growth and Income Portfolio, High Yield Portfolio and Quality Income Portfolio
may invest up to 35%
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in foreign securities. The World Equity Portfolio may invest without
limitation in foreign securities. However, the Trust has no current intention
that these investments will exceed 20% of a Portfolio's assets except with
respect to the World Equity Portfolio. Investments in the securities of
foreign entities and securities denominated in foreign currencies involve
risks not typically involved in domestic investment, including fluctuations in
foreign exchange rates, future foreign political and economic developments,
and the possible imposition of exchange controls or other foreign or United
States governmental laws or restrictions applicable to such investments. Where
a Portfolio invests in securities denominated or quoted in currencies other
than the United States dollar, changes in foreign currency exchange rates may
affect the value of investments in the Portfolio and the accrued income and
unrealized appreciation or depreciation of investments. Changes in foreign
currency exchange rates relative to the U.S. dollar will affect the U.S.
dollar value of a Portfolio's assets denominated in that currency and the
Portfolio's yield on such assets. With respect to certain foreign countries,
there is the possibility of expropriation of assets, confiscatory taxation,
political or social instability or diplomatic developments which could affect
investment in those countries. There may be less publicly available
information about a foreign security than about a United States security, and
foreign entities may not be subject to accounting, auditing and financial
reporting standards and requirements comparable to those of United States
entities. In addition, certain foreign investments made by a Portfolio may be
subject to foreign withholding taxes, which would reduce the Portfolio's total
return on such investments and the amounts available for distributions by the
Portfolio to its shareholders. Foreign financial markets, while growing in
volume, have, for the most part, substantially less volume than United States
markets, and securities of many foreign companies are less liquid and their
prices more volatile than securities of comparable domestic companies. The
foreign markets also have different clearance and settlement procedures and in
certain markets there have been times when settlements have been unable to
keep pace with the volume of securities transactions making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of a Portfolio are not invested and no return is earned
thereon. The inability of a Portfolio to make intended security purchases due
to settlement problems could cause the Portfolio to miss attractive investment
opportunities. Inability to dispose of portfolio securities due to settlement
problems could result either in losses to a Portfolio due to subsequent
declines in value of the portfolio security or, if a Portfolio has entered
into a contract to sell the security, could result in possible liability to
the purchaser. Costs associated with transactions in foreign securities,
including custodial costs and foreign brokerage commissions, are generally
higher than with transactions in United States securities. In addition, a
Portfolio will incur costs in connection with conversions between various
currencies. There is generally less government supervision and regulation of
exchanges, financial institutions and issuers in foreign countries than there
is in the United States.
As a matter of operating policy, the Money Market Portfolio, the Quality
Income Portfolio, the Stock Index Portfolio and the Growth and Income
Portfolio will comply with the following:
<TABLE>
<CAPTION>
<C> <S>
1. a Portfolio will be invested in a minimum of five different foreign countries at all
times. However, this minimum is reduced to four when foreign country
investments comprise less than 80% of the Portfolio's net asset value; to three
when less than 60% of such value; to two when less than 40% of such value
and to one when less than 20% of such value.
2. except as set forth in items 3 and 4 below, a Portfolio will have no more than
20% of its net asset value invested in securities of issuers located in any one
country.
3. a Portfolio may have an additional 15% of its value invested in securities of
issuers located in any one of the following countries: Australia, Canada,
France, Japan, the United Kingdom or West Germany.
4. a Portfolio's investments in United States issuers are not subject to the
foregoing operating policies.
</TABLE>
PORTFOLIO TURNOVER RATES
MONEY MARKET PORTFOLIO AND QUALITY INCOME PORTFOLIO
Although the Money Market and Quality Income Portfolios are not subject to
specific restrictions on portfolio turnover, they generally do not seek
profits by short-term trading. However, they may dispose of a portfolio
security prior to its maturity where disposition seems advisable because of a
revised credit evaluation of the issuer or other considerations. Because
brokerage commissions are not customarily charged on the investments invested
in by each of the two Portfolios, a high turnover rate should not affect the
net asset value.
HIGH YIELD PORTFOLIO
The Portfolio will not generally engage in trading of securities for the
purpose of realizing short-term profits, but it will adjust its portfolio as
it deems advisable in view of prevailing or anticipated market conditions to
accomplish the Portfolio's investment objectives. For example, the Portfolio
may sell securities in anticipation of a movement in interest rates or to
avoid loss of premiums paid and unrealized capital gains earned on GNMA
Certificates selling at a substantial premium. Frequency of portfolio turnover
will not be a limiting factor if the Investment Advisor considers it
advantageous to purchase or sell securities. The Portfolio anticipates that
the portfolio turnover rate of the Portfolio will normally be less than 200%,
and may be significantly less in a period of stable or rising interest rates.
For the years ended December 31, 1994 and 1993, the portfolio turnover rates
for the High Yield Portfolio were 200.06% and 213.09%, respectively. A high
rate of portfolio turnover involves correspondingly higher brokerage
commissions and transaction expenses than a lower rate, which expenses must be
borne by the Portfolio and its shareholders.
STOCK INDEX PORTFOLIO
Although the Portfolio generally seeks to invest for the long term, the
Portfolio retains the right to sell securities irrespective of how long they
have been held. However, because of the "passive" investment management
approach of the Portfolio, the portfolio turnover rate is expected to be under
50%, a generally lower turnover rate than for most other investment companies.
A portfolio turnover rate of 50% would occur if one-half of the Portfolio's
securities were sold within one year. Ordinarily, securities will be sold from
the Portfolio only to reflect certain administrative changes in the Index
(including mergers or changes in the composition of the Index) or to
accommodate cash flows into and out of the Portfolio while maintaining the
similarity of the Portfolio to the Index. For the years ended December 31,
1994 and 1993, the portfolio turnover rates for the Stock Index
Portfolio were 47.05% and 44.09%, respectively.
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<PAGE>
GROWTH AND INCOME PORTFOLIO
The Portfolio will not generally engage in trading of securities for the
purpose of realizing short-term profits, but it will adjust its portfolio as
it deem advisable in view of prevailing or anticipated market conditions to
accomplish the Portfolio's investment objectives. For example, the Portfolio
may sell portfolio securities in anticipation of a movement in interest rates.
Other than for tax purposes, frequency of portfolio turnover will not be a
limiting factor if the Portfolio considers it advantageous to purchase or sell
securities. The Portfolio anticipates that its annual portfolio turnover rate
will normally be less than 200%. A high rate of portfolio turnover involves
correspondingly higher brokerage commissions and transaction expenses than a
lower rate, which expenses must be borne by the Portfolio and its
shareholders. For the years ended December 31, 1994 and 1993, the portfolio
turnover rates for the Growth and Income Portfolio were 326.01% and
135.92%. The increase was dictated by market conditions during 1994.
WORLD EQUITY PORTFOLIO AND UTILITY PORTFOLIO
The Portfolios anticipate that their annual portfolio turnover rates will
generally be less than 100%. If their turnover rates do reach or exceed 100%,
the Portfolios' brokerage costs may increase.
MANAGEMENT OF THE TRUST
THE TRUSTEES
The Trust is organized as a Massachusetts business trust. The overall
responsibility for the supervision of the affairs of the Trust vests in the
Trustees. The Trustees have entered into an Investment Advisory Agreement with
the Investment Advisor to handle the day-to-day affairs of the Trust (see
below). The Trustees meet periodically to review the affairs of the Trust and
to establish certain guidelines which the Investment Advisor is expected to
follow in implementing the investment policies and objectives of the Trust.
THE INVESTMENT ADVISOR
Van Kampen American Capital Investment Advisory Corp. (the " Investment
Advisor") is the Trust's investment adviser. The Investment Advisor is
a wholly-owned subsidiary of Van Kampen American Capital, Inc. which in turn
is a wholly-owned subsidiary of VK/AC Holding, Inc. VK/AC Holding, Inc. is
indirectly controlled by Clayton & Dubilier Associates IV Limited Partnership,
the general partners of which are Joseph L. Rice, III, B. Charles Ames,
William A. Barbe, Alberto Cribiore, Donald J. Gogel, Leon J. Hendrix, Jr.,
Hubbard C. Howe and Andrall E. Pearson, each of whom is a principal of
Clayton, Dubilier & Rice, Inc., a New York based private investment
partnership. The Investment Advisor's principal office is located at
One Parkview Plaza, Oakbrook Terrace, Illinois 60181.
Van Kampen American Capital, Inc. is a diversified asset management company
with more than two million retail investor accounts, extensive capabilities
for managing institutional portfolios, and nearly $50 billion under
management or supervision. Van Kampen American Capital, Inc.'s over 40
open-end and 38 closed-end funds and more than 2,700 unit investment trusts
are professionally distributed by leading financial advisers nationwide. In
connection with advising the Trust, the Investment Advisor will utilize
at its own expense credit analysis and research services provided by its
affiliate, McCarthy, Crisanti & Maffei.
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<PAGE>
Pursuant to its investment advisory agreement with the Investment Advisor
("Investment Advisory Agreement") dated March 9, 1993, and approved by
shareholders of the Trust at a meeting held on January 14, 1993 (and amended
as of January 14, 1994 for purposes of the addition of the World Equity
Portfolio and the Utility Portfolio), the Trust will pay the Investment
Advisor the following fees (accrued daily and paid monthly) equal to a
percentage of the average daily net assets of the Portfolios:
<TABLE>
<CAPTION>
Average Daily
Portfolio Net Assets % Per Annum
<S> <C> <C>
Money Market Portfolio First $500 million .500 of 1%
Over $500 million .400 of 1%
Quality Income Portfolio First $500 million .500 of 1%
Over $500 million .450 of 1%
High Yield Portfolio First $500 million .750 of 1%
Over $500 million .650 of 1%
Growth and Income Portfolio First $500 million .600 of 1%
Over $500 million .500 of 1%
Stock Index Portfolio - .500 of 1%
World Equity Portfolio First $500 million .750 of 1%
Over 500 million .650 of 1%
Utility Portfolio First $500 million .650 of 1%
Over $500 million
but less than $1 billion .600 of 1%
Over $1 billion .550 of 1%
</TABLE>
The advisory fee of .750 of 1% to be deducted on the first $500 million of
assets of the High Yield Portfolio is higher than fees paid by many other
investment companies with similar investment objectives.
Under the Investment Advisory Agreement, the Investment Advisor regularly
provides each Portfolio of the Trust with investment advice and
recommendations and continuously furnishes the Portfolios of the Trust with an
investment program for each Portfolio's assets. Under the Investment Advisory
Agreement, the Trust has agreed to assume and pay the charges and expenses of
the Trust's operation, including the compensation of the Trustees of the Trust
(other than those who are interested persons, as defined in the Investment
Company Act of 1940, as amended, of the Investment Advisor or Xerox Life Sales
Company), the charges and expenses of independent accountants, legal counsel,
any transfer or dividend disbursing agent and the custodian (including fees
for safekeeping of securities), costs of calculating net asset value, costs of
acquiring and disposing of portfolio securities, interest (if any) on
obligations
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<PAGE>
incurred by the Trust, costs of share certificates, membership dues in the
Investment Company Institute or any similar organization, reports and notices
to shareholders, costs of registering shares of the Trust under the federal
securities laws, miscellaneous expenses and all taxes and fees to federal,
state or other governmental agencies.
PORTFOLIO MANAGEMENT
The day to day management of all Portfolios of the Trust except for the
Utility Portfolio is the responsibility of a committee composed of persons who
are officers or employees of the Investment Advisor and includes officers of
the Trust. Daniel Smith is an Assistant Vice President of the Investment
Advisor and is primarily responsible for the day to day management of the
Utility Portfolio. Mr. Smith has been employed by the Investment Advisor for
the past five years.
For the year ended December 31, 1994, the Investment Advisor was paid advisory
fees as follows: $200,948 with respect to the Quality Income Portfolio,
$153,084 with respect to the High Yield Portfolio, $266,474 with respect to
the Stock Index Portfolio and $58,701 with respect to the Growth and Income
Portfolio. The Investment Advisor waived its advisory fee of $293,512 with
respect to the Money Market Portfolio. There were no advisory fees paid with
respect to the World Equity Portfolio or the Utility Portfolio in that they
have not yet commenced investment operations.
EXPENSES OF THE TRUST
Although each Portfolio must bear the expenses directly attributable to it,
the Portfolios are expected to experience cost savings over the aggregate
amount that would be payable if each Portfolio were a separate fund, because
they have the same Trustees, accountants, attorneys and other general and
administrative expenses. Any expenses which are not directly attributable to a
specific Portfolio are allocated on the basis of the net assets of the
respective Portfolios.
For the year ended December 31, 1994, the expenses, taking into account the
waivers and expense assumptions, borne by the Quality Income Portfolio
amounted to $242,458 or .59% of its average net assets on an annualized basis;
the net expenses borne by the High Yield Portfolio amounted to $173,521 or
.86% of its average net assets on an annualized basis; the expenses borne by
the Money Market Portfolio amounted to $58,739 or .10% of its average net
assets on an annualized basis; the net expenses borne by the Stock Index
Portfolio amounted to $319,899 or .58% of its average net assets on an
annualized basis and the net expenses borne by the Growth and Income Portfolio
amounted to $68,495 or .70% of its average net assets on an annualized basis.
Xerox Financial Services Life Insurance Company may at its discretion, but is
not obligated to, assume all or any portion of Trust expenses. For the year
ended December 31, 1994, Xerox Financial Services Life Insurance Company
assumed expenses of $39,622 with respect to the Quality Income Portfolio;
$59,115 with respect to the High Yield Portfolio; $38,836 with respect to the
Money Market Portfolio; $118,434 with respect to the Stock Index Portfolio and
$76,816 with respect to the Growth and Income Portfolio.
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<PAGE>
DESCRIPTION OF THE TRUST
SHAREHOLDER RIGHTS
The Trust is an unincorporated business trust established under the laws of
the Commonwealth of Massachusetts by a Declaration of Trust dated July 9,
1987. The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares.
Each Portfolio issues its own class of shares. Each share represents an equal
proportionate interest in the assets of the Portfolio with each other share in
the Portfolio. On any matter submitted to a vote of shareholders, all shares
of the Trust then issued and outstanding and entitled to vote will be voted in
the aggregate and not by class except for matters concerning only one class.
The holders of each share of stock of the Trust will be entitled to one vote
for each full share and a fractional vote for each fractional share of stock.
Shares of one class may not bear the same economic relationship to the Trust
as another class.
In accordance with its view of present applicable law, the separate account(s)
of Xerox Financial Services Life Insurance Company and its affiliates ("Xerox
Life"), as shareholder(s) of the Trust, have the right to vote Trust shares at
any meeting of shareholders and will provide pass-through voting privileges to
all contract owners. Xerox Life will vote shares of the Trust held in the
separate account(s) for which no timely voting instructions from contract
owners are received, as well as shares it owns, in the same proportion as
those shares for which voting instructions are received. Additional
information concerning voting rights is described in the Variable Account
Prospectus attached hereto under the caption, "The Variable Account - Voting
Rights".
The Trust is not required to hold annual meetings of shareholders and does not
plan to do so. The Trustees may call special meetings of shareholders for
action by shareholder vote as may be required by the Investment Company Act of
1940, as amended, or the Declaration of Trust. The Trust will hold a
shareholder meeting to fill existing vacancies on the Board in the event that
less than a majority of Trustees were elected by the shareholders. The
Trustees shall also call a meeting of shareholders for the purpose of voting
upon the question of removal of any Trustee when requested in writing to do so
by the record holders of not less than 10 percent of the outstanding shares.
The Trust has an obligation to assist shareholder communications.
The Declaration of Trust provides that shareholders are not liable for any
liabilities of the Trust, requires inclusion of a clause to that effect in
every agreement entered into by the Trust and indemnifies shareholders against
any liability. Although shareholders of an unincorporated business trust
established under Massachusetts law may, under certain limited circumstances,
be held personally liable for the obligations of the Trust as though they were
general partners in a partnership, the provisions of the Declaration of Trust
described in the foregoing sentence make the likelihood of personal liability
remote.
The Trustees may amend the Declaration of Trust in any manner without
shareholder approval, except that the Trustees may not adopt any amendment
adversely affecting the rights of shareholders without approval by a majority
of the shares present at a meeting of shareholders (or higher vote as may be
required by the Investment Company Act of 1940, as amended, or other
applicable law) and except that the Trustees cannot amend the Declaration of
Trust to impose any liability on shareholders, make any assessment on shares,
or impose liabilities on
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<PAGE>
the Trustees without approval from each affected shareholder or Trustee, as
the case may be.
INQUIRIES
Any inquiries should be directed to Xerox Financial Services Life Insurance
Company, One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644.
The telephone number is (800) 831-LIFE.
DISTRIBUTION AND REDEMPTION OF SHARES
The distribution of Trust shares is through Xerox Life Sales Company, an
affiliate of Xerox Financial Services Life Insurance Company. Prior to May 1,
1993, the Trust's shares were distributed through Van Kampen Merritt Inc.
Shares of the Trust are currently issued and redeemed only in connection with
investment in and payments under certain variable annuity contracts ("variable
contracts") issued by Xerox Financial Services Life Insurance Company and its
affiliated insurance companies ("Xerox Life"). The shares of the Trust are
purchased and redeemed at net asset value (see below). Redemptions will be
effected by the separate accounts to meet obligations under the variable
contracts. Contract Owners do not deal directly with the Trust with respect to
acquisition or redemption of shares.
DIVIDENDS
All dividends are distributed to the separate accounts and will be
automatically reinvested in Trust shares. Dividends and distributions made by
the Portfolios are taxable, if at all, to Xerox Life; they are not taxable to
variable annuity contract owners.
TAX STATUS
It is the intention of the Trust to qualify as a "regulated investment
company" under Sub-chapter M of the Internal Revenue Code. If the Trust so
qualifies and distributes each year to its shareholders at least 90% of its
net investment income in each year, it will not be required to pay federal
income taxes on any income distributed to shareholders. Each Portfolio of the
Trust distributes all of its net income and gains to its shareholders (the
separate accounts). Each Portfolio is treated as a separate entity for Federal
income tax purposes and, therefore, the investments and results of the
Portfolio are determined separately for purposes of determining whether the
Trust qualifies as a "regulated investment company" and for purposes of
determining net ordinary income (or loss) and net realized capital gains (or
losses).
Some of the Trust's investment practices are subject to special provisions of
the Code that, among other things, may defer the use of certain losses of the
Trust and affect the holding period of the securities held by the Trust and
the character of the gains or losses realized by the Trust. These provisions
may also require the Trust to mark-to-market some of the positions in its
portfolio (i.e., treat them as if they were closed out), which may cause the
Trust to recognize income without receiving cash with which to make
distributions in amounts necessary to satisfy the 90% distribution requirement
and the distribution requirements for avoiding income and excise taxes. The
Trust will monitor its transactions and may make certain tax elections in
order to mitigate the effect of these rules and prevent disqualification of
the Trust as a regulated investment company.
Investments of the Trust in securities issued at a discount or providing for
deferred interest or payment of interest in kind are subject to special tax
rules that will affect the amount, timing and
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character of distributions to shareholders. For example, with respect to
securities issued at a discount, the Trust will be required to accrue as
income each year a portion of the discount and to distribute such income each
year in order to maintain its qualification as a regulated investment company
and to avoid income and excise taxes. In order to generate sufficient cash to
make distributions necessary to satisfy the 90% distribution requirement and
to avoid income and excise taxes, the Trust may have to dispose of securities
that it would otherwise have continued to hold.
The Trust's ability to dispose of portfolio securities may be limited by the
requirement for qualification as a regulated investment company that less than
30% of the Trust's annual gross income be derived from the disposition of
securities held for less than three months.
NET ASSET VALUES
Portfolio shares are sold and redeemed at a price equal to the share's net
asset value. The net asset value of a Portfolio is determined by calculating
the total value of the Portfolio's assets, deducting its total liabilities,
and dividing the result by the number of shares outstanding. The net asset
value for each Portfolio is computed once daily as of the close of the New
York Stock Exchange, Monday through Friday, except on customary business
holidays, or except on any day on which no purchase or redemption orders are
received, or there is not a sufficient degree of trading in the Portfolio's
investments so that the Portfolio's net asset value per share might be
materially affected. The Trust reserves the right to calculate the net asset
value and to adjust the public offering price based thereon more frequently
than once a day if deemed desirable.
Securities that are listed on a securities exchange are valued at their
closing sales price on the day of the valuation. Price valuations for listed
securities are based on market quotations where the security is primarily
traded or, if not available, are valued at the mean of the bid and asked
prices on any valuation date. Unlisted securities in a Portfolio are primarily
valued based on their latest quoted bid price or, if not available, are valued
by a method determined by the Trustees to accurately reflect fair value. Money
market instruments maturing in 60 days or less are valued on the basis of
amortized cost, which means that securities are valued at their acquisition
cost to reflect a constant amortization rate to maturity of any premium or
discount, rather than at current market value.
The Money Market Portfolio values its securities on the basis of amortized
cost, which means that securities are valued at their acquisition cost to
reflect a constant amortized rate to maturity of any premium or discount,
rather than at current market value. Calculations are made to compare the
amortized cost valuation of the securities with current market values. Money
market valuations are obtained by using market quotations provided by market
makers, estimates of market values, or values obtained from published yield
data of money market instruments. If a deviation of of 1% or more were to
occur between the net asset value calculated by reference to market values and
the Portfolio's $1.00 per share net asset value, or if there were any other
deviation which the Trustees believe would result in a material dilution to
shareholders, the Trustees would promptly consider what action, if any, should
be initiated. Other assets are valued at fair value as determined in good
faith by the Trustees. The method of calculating yields is described in the
Statement of Additional Information.
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FUND PERFORMANCE
From time to time advertisements and other sales materials for the Trust may
include information concerning the historical performance of the Trust. Such
advertisements will also describe the performance of the relevant insurance
company separate accounts. Any such information will include the average total
return of the Trust calculated on a compounded basis for specified periods of
time. Total return information will be calculated pursuant to rules
established by the Securities and Exchange Commission. In lieu of or in
addition to total return calculations, such information may include
performance rankings and similar information from independent organizations
such as Lipper Analytical Services, Inc., Morningstar, Business Week, Forbes
or other industry publications.
The Trust calculates average compounded total return by determining the
redemption value at the end of specified periods (assuming reinvestment of all
dividends and distributions) of a $1,000 investment in the Trust at the
beginning of the period, deducting the initial $1,000 investment, annualizing
the increase or decrease over the specified period and expressing the result
as a percentage.
Total return figures utilized by the Trust are based on historical performance
and are not intended to indicate future performance. Total return and net
asset value per share can be expected to fluctuate over time, and accordingly,
upon redemption, shares may be worth more or less than their original
cost.
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APPENDIX - DESCRIPTION OF CORPORATE BOND RATINGS
Standard & Poor's Corporation.
______________________________
A brief description of the applicable Standard & Poor's Corporation ("S&P")
rating symbols and their meanings (as published by S&P) follows:
An S&P corporate or municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligers such as guarantors, insurers,
or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or for other
circumstances.
The ratings are based, in varying degrees, on the following considerations:
<TABLE>
<CAPTION>
<C> <S>
1. Likelihood of default - capacity and willingness of the obligor as to the timely
payment of interest and repayment of principal in accordance with the terms of
the obligation;
2. Nature of and provisions of the obligation;
3. Protection afforded by, and relative position of, the obligation in the event of
bankruptcy, reorganization, or other arrangement under the laws of bankruptcy
and other laws affecting creditors' rights.
</TABLE>
LONG-TERM CORPORATE BONDS.
<TABLE>
<CAPTION>
<S> <C>
AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay principal
and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
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parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher rated categories.
BB Debt rated 'BB', 'B', 'CCC', or 'CC' is regarded,
B on balance, as predominantly speculative with
CCC respect to capacity to pay interest and repay
CC 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 debt will likely have some quality and protective characteristics,
these are outweighed by large uncertainties or major risk exposures to
adverse conditions.
C This rating is reserved for income bonds on which no interest is being paid.
D Debt rated 'D' is in default, and payment of interest and/or repayment of
principal is in arrears.
PLUS (+) OR MINUS (-): The ratings from 'A' to 'B' may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
PROVISIONAL RATINGS: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and timely
completion of the project. This rating, however, while addressing credit quality
subsequent to completion of the project, makes no comment on the likelihood
of, or the risk of default upon failure of, such completion. The investor should
exercise judgment with respect to such likelihood and risk.
L The letter 'L' indicates that the rating pertains to the principal amount of
those bonds where the underlying deposit collateral is fully insured by the
Federal Deposit Insurance Corp.
L Continuance of the rating is contingent upon S&P's receipt of closing
documentation confirming investments and cash flow.
* Continuance of the rating is contingent upon S&P's receipt of an
executed copy of the escrow agreement.
NR Indicates no rating has been requested, that there is insufficient information
on which to base a rating, or that S&P does not rate a particular type of
obligation as a matter of policy.
</TABLE>
Moody's Investors Service, Inc. A brief description of the applicable Moody's
Investors Service, Inc. rating symbols and their meanings (as published by
Moody's Investors Service, Inc.) follows:
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LONG-TERM CORPORATE BONDS.
AAA - Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge". Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
AA - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long term risks appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
BAA - Bonds which are rated Baa are considered as medium grade obligations,
i.e. they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA - Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
CA - Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
NOTE: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa
1, A 1, Baa 1, Ba 1 and B 1.
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