STATEMENT OF ADDITIONAL INFORMATION
COVA SERIES TRUST
ONE TOWER LANE, SUITE 3000
OAKBROOK TERRACE, ILLINOIS 60181-4644
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS BUT SHOULD BE
READ IN CONJUNCTION WITH THE PROSPECTUS FOR COVA SERIES TRUST, DATED MAY 1,
1996 (the "PROSPECTUS"). A COPY OF THE PROSPECTUS MAY BE OBTAINED WITHOUT
CHARGE BY CALLING (800) 831-LIFE, OR WRITING COVA FINANCIAL SERVICES LIFE
INSURANCE COMPANY AT ONE TOWER LANE, SUITE 3000, OAKBROOK TERRACE, ILLINOIS
60181-4644.
The Prospectus and this Statement of Additional Information omit certain of
the information contained in the registration statement filed with the
Securities and Exchange Commission, Washington, D.C. These items may be
obtained from the Commission upon payment of the fee prescribed, or inspected
at the Commission's office at no charge.
THIS STATEMENT OF ADDITIONAL INFORMATION IS
DATED MAY 1, 1996.
TABLE OF CONTENTS
PAGE
INVESTMENT OBJECTIVES AND POLICIES
STOCK INDEX PORTFOLIO - MONITORING PROCEDURES
INVESTMENT LIMITATIONS
DESCRIPTION OF SECURITIES RATINGS
OFFICERS AND TRUSTEES
SUBSTANTIAL SHAREHOLDERS
OWNERSHIP BY CERTAIN BENEFICIAL OWNERS
CUSTODIAN
PERFORMANCE DATA
LEGAL COUNSEL AND INDEPENDENT AUDITORS
INVESTMENT ADVISORY AGREEMENT
PORTFOLIO TRANSACTIONS
FINANCIAL STATEMENTS
INVESTMENT OBJECTIVES AND POLICIES
OBJECTIVES
For a description of the objectives of the Portfolios, see "Prospectus -
Investment Objectives." The following information is provided for those
investors wishing to have more comprehensive information than that contained
in the Prospectus.
Additional Information - Investment Objectives and Policies of Portfolios
Managed by J.P. Morgan Investment Management Inc.
QUALITY BOND PORTFOLIO. The Quality Bond Portfolio is designed to be an
economical and convenient means of making substantial investments in a broad
range of corporate and government debt obligations and related investments of
domestic and foreign issuers, subject to certain quality and other
restrictions. See "Quality and Diversification Requirements." The Portfolio's
investment objective is to provide a high total return consistent with
moderate risk of capital and maintenance of liquidity. Although the net asset
value of the Portfolio will fluctuate, the Portfolio attempts to conserve the
value of its investments to the extent consistent with its objective.
The Portfolio attempts to achieve its investment objective by investing
in high grade corporate and government debt obligations and related securities
of domestic and foreign issuers described in the Prospectus and this Statement
of Additional Information.
INVESTMENT PROCESS
Duration/yield curve management: The Sub-Adviser's duration decision
begins with an analysis of real yields, which its research indicates are
generally a reliable indicator of longer term interest rate trends. Other
factors the Sub-Adviser studies in regard to interest rates include economic
growth and inflation, capital flows and monetary policy. Based on this
analysis, the Sub-Adviser forms a view of the most likely changes in the level
and shape of the yield curve -- as well as the timing of those changes -- and
sets the Portfolio's duration and maturity structure accordingly. The
Sub-Adviser typically limits the overall duration of the Portfolio to a range
between one year shorter and one year longer than that of the Salomon Brothers
Broad Investment Grade Bond Index, the benchmark index.
Sector allocations: Sector allocations are driven by the Sub-Adviser's
fundamental and quantitative analysis of the relative valuation of a broad
array of fixed income sectors. Specifically, the Sub-Adviser utilizes market
and credit analysis to assess whether the current risk-adjusted yield spreads
of various sectors are likely to widen or narrow. The Sub-Adviser then
overweights (underweights) those sectors its analysis indicates offer the most
(least) relative value, basing the speed and magnitude of these shifts on
valuation considerations.
Security selection: Securities are selected by the portfolio manager,
with substantial input from the Sub-Adviser's fixed income analysts and
traders. Using quantitative analysis as well as traditional valuation methods,
the Sub-Adviser's applied research analysts aim to optimize security selection
within the bounds of the Portfolio's investment objective. In addition, credit
analysts -- supported by the Sub-Adviser's equity analysts -- assess the
creditworthiness of issuers and counterparties. A dedicated trading desk
contributes to security selection by tracking new issuance, monitoring dealer
inventories, and identifying attractively priced bonds. The traders also
handle all transactions for the Portfolio.
SELECT EQUITY PORTFOLIO AND LARGE CAP STOCK PORTFOLIO. These Portfolios
are designed for investors who want an actively managed portfolio of selected
equity securities that seeks to outperform the S&P 500 Index. The investment
objective of each Portfolio is to provide a high total return from a portfolio
of selected equity securities.
In normal circumstances, at least 65% of each Portfolio's net assets will
be invested in equity securities consisting of common stocks and other
securities with equity characteristics comprised of preferred stock, warrants,
rights, convertible securities, trust certificates, limited partnership
interests and equity participations (collectively, "Equity Securities"). Each
Portfolio's primary equity investments are the common stock of large and
medium sized U.S. corporations and, to a limited extent, similar securities of
foreign corporations.
INVESTMENT PROCESS
Fundamental research: The Sub-Adviser's domestic equity analysts, each an
industry specialist, follow 700 predominantly large- and medium-sized U.S.
companies -- 500 of which form the universe for each Portfolio's investments.
Their research goal is to forecast normalized, longer term earnings and
dividends for the most attractive companies among those they cover. In doing
this, they may work in concert with the Sub-Adviser's international equity
analysts in order to gain a broader perspective for evaluating industries and
companies in today's global economy.
Systematic valuation: The analysts' forecasts are converted into
comparable expected returns by a dividend discount model, which calculates
those expected returns by comparing a company's current stock price with the
"fair value" price forecasted by its estimated long term earnings power.
Within each sector, companies are ranked by their expected return and grouped
into quintiles: those with the highest expected returns (Quintile 1) are
deemed the most undervalued relative to their long-term earnings power, while
those with the lowest expected returns (Quintile 5) are deemed the most
overvalued.
Disciplined portfolio construction: A diversified portfolio is
constructed using disciplined buy and sell rules. The specific names selected
reflect the portfolio manager's judgment concerning the soundness of the
underlying forecasts, the likelihood that the perceived misvaluation will be
corrected within a reasonable time frame and the magnitude of the risks versus
the rewards. The portfolio seeks to hold sector weightings close to those of
the S&P 500 Index, reflecting the Sub-Adviser's belief that its research has
the potential to add value at the individual stock level, but not at the
sector level. Sector neutrality is also seen as a way to help protect the
portfolio from macroeconomic risks, and -- together with diversification --
represents an important element of the Sub-Adviser's risk control strategy. A
dedicated trading desk handles all transactions for the Portfolio.
SMALL CAP STOCK PORTFOLIO. This Portfolio is designed for investors who
are willing to assume the somewhat higher risk of investing in small companies
in order to seek a higher return over time than might be expected from a
portfolio of stocks of large companies. The Portfolio's investment objective
is to provide a high total return from a portfolio of Equity Securities of
small companies.
The Portfolio attempts to achieve its investment objective by investing
primarily in the common stock of small U.S. companies included in the Russell
2000 Index, which is composed of 2000 common stocks of U.S. companies with
market capitalizations ranging between $100 million and $1.5 billion.
INVESTMENT PROCESS
Fundamental Research: The Sub-Adviser's domestic equity analysts -- each
an industry specialist -- continuously monitor the small cap stocks in their
respective sectors with the aim of identifying companies that exhibit superior
financial strength and operating returns. Meetings with management and on-site
visits play a key role in shaping their assessments. Their research goal is to
forecast normalized, long-term earnings and dividends for the most attractive
small cap companies among those they monitor -- a universe that generally
contains a total of 300-350 names. Because the Sub-Adviser's analysts follow
both the larger and smaller companies in their industries -- in essence,
covering their industries from top to bottom -- they are able to bring broad
perspective to the research they do on both.
Systematic valuation: The analysts' forecasts are converted into
comparable expected returns by the Sub-Adviser's dividend discount model,
which calculates those returns by comparing a company's current stock price
with the "fair value" price forecasted by its estimated long-term earnings
power. Within each industry, companies are ranked by their expected returns
and grouped into quintiles: those with the highest expected returns (Quintile
1) are deemed the most undervalued relative to their long-term earnings power,
while those with the lowest expected returns (Quintile 5) are deemed the most
overvalued.
Disciplined portfolio construction: A diversified portfolio is
constructed using disciplined buy and sell rules. Purchases are concentrated
among the stocks in the top two quintiles of the rankings: the specific names
selected reflect the portfolio manager's judgment concerning the soundness of
the underlying forecasts, the likelihood that the perceived misevaluation will
soon be corrected and the magnitude of the risks versus the rewards. Once a
stock falls into the third quintile -- because its price has risen or its
fundamentals have deteriorated -- it generally becomes a sale candidate. The
portfolio manager seeks to hold sector weightings close to those of the
Russell 2000 Index, the Portfolio's benchmark, reflecting the Sub-Adviser's
belief that its research has the potential to add value at the individual
stock level, but not at the sector level. Sector neutrality is also seen as a
way to help to protect the portfolio from macroeconomic risks, and -- together
with diversification -- represents an important element of the Sub-Adviser's
investment strategy.
INTERNATIONAL EQUITY PORTFOLIO. This Portfolio is designed for investors
with a long-term investment horizon who want to diversify their portfolios by
investing in an actively managed portfolio of non-U.S. securities that seeks
to outperform the Morgan Stanley Capital International Europe, Australia and
Far East Index (the "EAFE Index"). The Portfolio's investment objective is to
provide a high total return from a portfolio of Equity Securities of foreign
corporations.
The Portfolio seeks to achieve its investment objective by investing
primarily in the Equity Securities of foreign corporations. Under normal
circumstances, the Portfolio expects to invest at least 65% of its total
assets in such securities. The Portfolio does not intend to invest in U.S.
securities (other than money market instruments), except temporarily, when
extraordinary circumstances prevailing at the same time in a significant
number of developed foreign countries render investments in such countries
inadvisable.
INVESTMENT PROCESS
Country allocation: The Sub-Adviser's country allocation decision begins
with a forecast of equity risk premiums, which provide a valuation signal by
measuring the relative attractiveness of stocks versus bonds. Using a
proprietary approach, the Sub-Adviser calculates this risk premium for each of
the nations in the Portfolio's universe, determines the extent of its
deviation -- if any -- from its historical norm, and then ranks countries
according to the size of those deviations. Countries with high (low) rankings
are overweighted (underweighted) in comparisons to the EAFE Index to reflect
the above-average (below-average) attractiveness of their stock markets. In
determining weightings, the Sub-Adviser analyzes a variety of qualitative
factors as well -- including the liquidity, earnings momentum and interest
rate climate of the market at hand. These qualitative assessments can change
the magnitude but not the direction of the country allocations called for by
the risk premium forecast. The Sub-Adviser places limits on the total size of
the Portfolio's country over- and under-weightings relative to the EAFE Index.
Stock selection: The Sub-Adviser's international equity analysts, each an
industry and country specialist, forecast normalized earnings and dividend
payouts for roughly 1,000 non-U.S. companies -- taking a long-term perspective
rather than the short time frame common to consensus estimates. These
forecasts are converted into comparable expected returns by a dividend
discount model, and then companies are ranked from most to least attractive by
industry and country. A diversified portfolio is constructed using disciplined
buy and sell rules. The portfolio manager's objective is to concentrate the
purchases in the top third of the rankings, and to keep sector weightings
close to those of the EAFE Index, the Portfolio's benchmark. Once a stock
falls into the bottom third of the rankings, it generally becomes a sales
candidate. Where available, warrants and convertibles may be purchased instead
of common stock if they are deemed a more attractive means of investing in an
undervalued company.
Currency management: Currency is actively managed, in conjunction with
country and stock allocation, with the goal of protecting and possibly
enhancing the Portfolio's return. The Sub-Adviser's currency decisions are
supported by a proprietary tactical mode which forecasts currency movements
based on an analysis of four fundamental factors -- trade balance trends,
purchasing power parity, real short-term interest differentials and real bond
yields -- plus a technical factor designed to improve the timing of
transactions. Combining the output of this model with a subjective assessment
of economic, political and market factors, the Sub-Adviser's currency group
recommends currency strategies that are implemented in conjunction with the
Portfolio's investment strategy.
MONEY MARKET INSTRUMENTS
As discussed in the Prospectus, each Portfolio may invest in money market
instruments to the extent consistent with its investment objective and
policies. A description of the various types of money market instruments that
may be purchased by the Portfolios appears below. See "Quality and
Diversification Requirements."
U.S. TREASURY SECURITIES. Each of the Portfolios may invest in direct
obligations of the U.S. Treasury, including Treasury bills, notes and bonds,
all of which are backed as to principal and interest payments by the full
faith and credit of the United States.
ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. Each of the Portfolios may invest
in obligations issued or guaranteed by U.S. Government agencies or
instrumentalities. These obligations may or may not be backed by the "full
faith and credit" of the United States. In the case of securities not backed
by the full faith and credit of the United States, each Portfolio must look
principally to the federal agency issuing or guaranteeing the obligations for
ultimate repayment, and may not be able to assert a claim against the United
States itself in the event the agency or instrumentality does not meet its
commitments. Securities in which each Portfolio may invest that are not backed
by the full faith and credit of the United States include, but are not limited
to, obligations of the Tennessee Valley Authority, the Federal Home Loan
Mortgage Corporation and the U.S. Postal Service, each of which has the right
to borrow from the U.S. Treasury to meet its obligations, and obligations of
the Federal Farm Credit System and the Federal Home Loan Banks, both of whose
obligations may be satisfied only by the individual credits of each issuing
agency. Securities which are backed by the full faith and credit of the United
States include obligations of the Government National Mortgage Association,
the Farmers Home Administration, and the Export-Import Bank.
FOREIGN GOVERNMENT OBLIGATIONS. Each of the Portfolios, subject to its
applicable investment policies, may also invest in short-term obligations of
foreign sovereign governments or of their agencies, instrumentalities,
authorities or political subdivisions. These securities may be denominated in
the U.S. dollar or in another currency. See "Foreign Investments."
BANK OBLIGATIONS. Each of the Portfolios, unless otherwise noted in the
Prospectus or below, may invest in negotiable certificates of deposit, time
deposits and bankers' acceptances of (i) banks, savings and loan associations
and savings banks which (for those Portfolios managed by J.P. Morgan
Investment Management Inc. except the International Equity Portfolio) have
more than $2 billion in total assets and are organized under the laws of the
United States or any state, (ii) foreign branches of these banks or of foreign
banks of equivalent size (Euros) and (iii) U.S. branches of foreign banks of
equivalent size (Yankees) with respect to the Portfolios managed by J.P.
Morgan Investment Management Inc. See "Foreign Investments." The Portfolios
will not invest in obligations for which J.P. Morgan Investment Management
Inc., or any of its affiliated persons, is the ultimate obligor or accepting
bank. Each of the Portfolios may also invest in obligations of international
banking institutions designated or supported by national governments to
promote economic reconstruction, development or trade between nations (e.g.,
the European Investment Bank, the Inter-American Development Bank, or the
World Bank).
COMMERCIAL PAPER. Each of the Portfolios may invest in commercial paper,
including master demand obligations. Master demand obligations are obligations
that provide for a periodic adjustment in the interest rate paid and permit
daily changes in the amount borrowed. The monies loaned to the borrower come
from accounts managed by a Sub-Adviser or its affiliates, pursuant to
arrangements with such accounts. Interest and principal payments are credited
to such accounts. The Sub-Adviser, or its affiliates, acting as a fiduciary on
behalf of its clients, has the right to increase or decrease the amount
provided to the borrower under an obligation. The borrower has the right to
pay without penalty all or any part of the principal amount then outstanding
on an obligation together with interest to the date of payment. Since these
obligations typically provide that the interest rate is tied to the Federal
Reserve commercial paper composite rate, the rate on master demand obligations
is subject to change. Repayment of a master demand obligation to participating
accounts depends on the ability of the borrower to pay the accrued interest
and principal of the obligations on demand which is continuously monitored by
the Sub-Adviser. Since master demand obligations typically are not rated by
credit rating agencies, the Portfolios may invest in such unrated obligations
only if at the time of an investment the obligation is determined by the
Sub-Adviser to have a credit quality which satisfies the Portfolio's quality
restrictions. See "Quality and Diversification Requirements." Although there
is no secondary market for master demand obligations, such obligations are
considered by the Portfolios to be liquid because they are payable upon
demand. The Portfolios do not have any specific percentage limitation on
investments in master demand obligations.
REPURCHASE AGREEMENTS. Each of the Portfolios may enter into repurchase
agreements with brokers, dealers or banks that meet the credit guidelines
approved by the Trustees of the Trust. In a repurchase agreement, a Portfolio
buys a security from a seller that has agreed to repurchase the same security
at a mutually agreed upon date and price. The resale price normally is in
excess of the purchase price, reflecting an agreed upon interest rate. This
interest rate is effective for the period of time the Portfolio is invested in
the agreement and is not related to the coupon rate on the underlying
security. A repurchase agreement may also be viewed as a fully collateralized
loan of money by a Portfolio to the seller. The period of these repurchase
agreements will usually be short, from overnight to one week, and at no time
will the Portfolios invest in repurchase agreements for more than thirteen
months. The securities which are subject to repurchase agreements, however,
may have maturity dates in excess of thirteen months from the effective date
of the repurchase agreement. The Portfolios will always receive securities as
collateral whose market value is, and during the entire term of the agreement
remains, at least equal to 100% of the dollar amount invested by the
Portfolios in each agreement plus accrued interest, and the Portfolios will
make payment for such securities only upon physical delivery or upon evidence
of book entry transfer to the account of the Custodian. The Money Market
Portfolio will be fully collateralized within the meaning of paragraph (a)(3)
of Rule 2a-7 under the Investment Company Act of 1940, as amended (the "1940
Act"). If the seller defaults, a Portfolio might incur a loss if the value of
the collateral securing the repurchase agreement declines and might incur
disposition costs in connection with liquidating the collateral. In addition,
if bankruptcy proceedings are commenced with respect to the seller of the
security, realization upon disposal of the collateral by a Portfolio may be
delayed or limited.
Each of the Portfolios may make investments in other debt securities with
remaining effective maturities of not more than thirteen months, including
without limitation corporate and foreign bonds, asset-backed securities and
other obligations described in the prospectus or this Statement of Additional
Information.
CORPORATE BONDS AND OTHER DEBT SECURITIES
As discussed in the Prospectus, certain of the Portfolios may invest in bonds
and other debt securities of domestic and foreign issuers to the extent
consistent with their investment objectives and policies. A description of
these investments appears in the prospectus and below. See "Quality and
Diversification Requirements." For information on short-term investments in
these securities, see "Money Market Instruments."
ASSET-BACKED SECURITIES. Asset-backed securities directly or indirectly
represent a participation interest in, or are secured by and payable from, a
stream of payments generated by particular assets such as motor vehicle or
credit card receivables. Payments of principal and interest may be guaranteed
up to certain amounts and for a certain time period by a letter of credit
issued by a financial institution unaffiliated with the entities issuing the
securities. The asset-backed securities in which a Portfolio may invest are
subject to the Portfolio's overall credit requirements. However, asset-backed
securities, in general, are subject to certain risks. Most of these risks are
related to limited interests in applicable collateral. For example, credit
card debt receivables are generally unsecured and the debtors are entitled to
the protection of a number of state and federal consumer credit laws, many of
which give such debtors the right to set off certain amounts on credit card
debt thereby reducing the balance due. Additionally, if the letter of credit
is exhausted, holders of asset-backed securities may also experience delays in
payments or losses if the full amounts due on underlying sales contracts are
not realized. Because asset-backed securities are relatively new, the market
experience in these securities is limited and the market's ability to sustain
liquidity through all phases of the market cycle has not been tested.
EQUITY INVESTMENTS
As discussed in the prospectus, certain of the Portfolios invest primarily in
Equity Securities. The Equity Securities in which these Portfolios invest
include those listed on any domestic or foreign securities exchange or traded
in the over-the-counter market as well as certain restricted or unlisted
securities. A discussion of the various types of equity investments which may
be purchased by these Portfolios appears in the prospectus and below. See
"Quality and Diversification Requirements."
EQUITY SECURITIES. The Equity Securities in which these Portfolios may
invest may or may not pay dividends and may or may not carry voting rights.
Common stock occupies the most junior position in a company's capital
structure.
The convertible securities in which these Portfolios may invest include
any debt securities or preferred stock which may be converted into common
stock or which carry the right to purchase common stock. Convertible
securities entitle the holder to exchange the securities for a specified
number of shares of common stock, usually of the same company, at specified
prices within a certain period of time.
The terms of any convertible security determine its ranking in a
company's capital structure. In the case of subordinated convertible
debentures, the holders' claims on assets and earnings are subordinated to the
claims of other creditors, and are senior to the claims of preferred and
common shareholders. In the case of convertible preferred stock, the holders'
claims on assets and earnings are subordinated to the claims of all creditors
and are senior to the claims of common shareholders.
COMMON STOCK WARRANTS
Certain of the Portfolios may invest in common stock warrants that entitle the
holder to buy common stock from the issuer of the warrant at a specific price
(the strike price) for a specific period of time. The market price of warrants
may be substantially lower than the current market price of the underlying
common stock, yet warrants are subject to similar price fluctuations. As a
result, warrants may be more volatile investments than the underlying common
stock.
Warrants generally do not entitle the holder to dividends or voting rights
with respect to the underlying common stock and do not represent any rights in
the assets of the issuer company. A warrant will expire worthless if it is not
exercised on or prior to the expiration date.
FOREIGN INVESTMENTS
Each of the Portfolios may invest in foreign securities. The International
Equity Portfolio makes substantial investments in foreign countries. The
Quality Bond, Select Equity, Large Cap Stock, Small Cap Stock and Quality
Income Portfolios may invest in certain foreign securities. The Quality Bond
Portfolio may invest in U.S. and non-U.S. dollar-denominated fixed income
securities of foreign issuers. The Select Equity and Large Cap Stock
Portfolios may invest in equity securities of foreign corporations listed on a
U.S. securities exchange. The Small Cap Stock Portfolio may invest in equity
securities of foreign issuers that are listed on a national securities
exchange or denominated or principally traded in the U.S. dollar. The Quality
Bond Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio and the
Small Cap Stock Portfolio do not expect to invest more than 25%, 5%, 5%, and
5%, respectively, of their total assets at the time of purchase in securities
of foreign issuers. All investments of the Money Market Portfolio must be U.S.
dollar-denominated. In the case of the Quality Bond Portfolio, any foreign
commercial paper must not be subject to foreign withholding tax at the time of
purchase. Foreign investments may be made directly in securities of foreign
issuers or in the form of American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"). Generally, ADRs and EDRs are receipts issued by
a bank or trust company that evidence ownership of underlying securities
issued by a foreign corporation and that are designed for use in the domestic,
in the case of ADRs, or European, in the case of EDRs, securities markets.
Since investments in foreign securities may involve foreign currencies, the
value of a Portfolio's assets as measured in U.S. dollars may be affected
favorably or unfavorably by changes in currency rates and in exchange control
regulations, including currency blockage. Certain of the Portfolios may enter
into forward commitments for the purchase or sale of foreign currencies in
connection with the settlement of foreign securities transactions or to manage
the Portfolios' currency exposure related to foreign investments. The
Portfolios will not enter into such commitments for speculative purposes.
For a description of the risks associated with investing in foreign
securities, see "Investment Practices" and "Risk Factors" in the Prospectus.
ADDITIONAL INVESTMENTS
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each of the Portfolios may
purchase securities on a when-issued or delayed delivery basis. For example,
delivery of and payment for these securities can take place a month or more
after the date of the purchase commitment. The purchase price and the interest
rate payable, if any, on the securities are fixed on the purchase commitment
date or at the time the settlement date is fixed. The value of such securities
is subject to market fluctuation and no interest accrues to a Portfolio until
settlement takes place. At the time a Portfolio makes the commitment to
purchase securities on a when-issued or delayed delivery basis, it will record
the transaction, reflect the value each day of such securities in determining
its net asset value and, if applicable, calculate the maturity for the
purposes of average maturity from that date. At the time of settlement a
when-issued security may be valued at less than the purchase price. To
facilitate such acquisitions, each Portfolio will maintain with the Custodian
a segregated account with liquid assets, consisting of cash, U.S. Government
securities or other appropriate securities, in an amount at least equal to
such comments. On delivery dates for such transactions, each Portfolio will
meet its obligations from maturities or sales of the securities held in the
segregated account and/or from cash flow. If a Portfolio chooses to dispose of
the right to acquire a when-issued security prior to its acquisition, it
could, as with the disposition of any other portfolio obligation, incur a gain
or loss due to market fluctuation. It is the current policy of each Portfolio
not to enter into when-issued commitments exceeding in the aggregate 15% of
the market value of the Portfolio's total assets, less liabilities other than
the obligations created by when-issued commitments.
INVESTMENT COMPANY SECURITIES. Securities of other investment companies
may be acquired by each of the Portfolios to the extent permitted under the
1940 Act. These limits require that, as determined immediately after a
purchase is made, (i) not more than 5% of the value of a Portfolio's total
assets will be invested in the securities of any one investment company, (ii)
not more than 10% of the value of its total assets will be invested in the
aggregate in securities of investment companies as a group, and (iii) not more
than 3% of the outstanding voting stock of any one investment company will be
owned by a Portfolio.
REVERSE REPURCHASE AGREEMENTS. Each of the Portfolios may enter into
reverse repurchase agreements. In a reverse repurchase agreement, a Portfolio
sells a security and agrees to repurchase the same security at a mutually
agreed upon date and price. For purposes of the 1940 Act it is also considered
as a borrowing of money by the Portfolio and, therefore, a form of leverage.
The Portfolios will invest the proceeds of borrowings under reverse repurchase
agreements. In addition, a Portfolio will enter into a reverse repurchase
agreement only when the interest income to be earned from the investment of
the proceeds is greater than the interest expense of the transaction. A
Portfolio will not invest the proceeds of a reverse repurchase agreement for a
period which exceeds the duration of the reverse repurchase agreement. A
Portfolio may not enter into reverse repurchase agreements exceeding in the
aggregate one-third of the market value of its total assets, less liabilities
other than the obligations created by reverse repurchase agreements. Each
Portfolio will establish and maintain with the Custodian a separate account
with a segregated portfolio of securities in an amount at least equal to its
purchase obligations under its reverse repurchase agreements.
MORTGAGE DOLLAR ROLL TRANSACTIONS. Certain of the Portfolios of the Trust
may engage in mortgage dollar roll transactions with respect to mortgage
securities issued by the Government National Mortgage Association, the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation,
In a mortgage dollar roll transaction, the Portfolio sells a mortgage backed
security and simultaneously agrees to repurchase a similar security on a
specified future date at an agreed upon price. During the roll period, the
Portfolio will not be entitled to receive any interest or principal paid on
the securities sold. The Portfolio is compensated for the lost interest on the
securities sold by the difference between the sales price and the lower price
for the future repurchase as well as by the interest earned on the
reinvestment of the sales proceeds. The Portfolio may also be compensated by
receipt of a commitment fee. When the Portfolio enters into a mortgage dollar
roll transaction, liquid assets in an amount sufficient to pay for the future
repurchase are segregated with the Custodian. Mortgage dollar roll
transactions are considered reverse repurchase agreements for purposes of the
Portfolio's investment restrictions.
LOANS OF PORTFOLIO SECURITIES. Each of the Portfolios may lend its
securities if such loans are secured continuously by cash or equivalent
collateral or by a letter of credit in favor of the Portfolio at least equal
at all times to 100% of the market value of the securities loaned, plus
accrued interest. While such securities are on loan, the borrower will pay the
Portfolio any income accruing thereon. Loans will be subject to termination by
the Portfolios in the normal settlement time, generally five business days
after notice, or by the borrower on one day's notice. Borrowed securities must
be returned when the loan is terminated. Any gain or loss in the market price
of the borrowed securities which occurs during the term of the loan inures to
a Portfolio and its respective investors. The Portfolios may pay reasonable
finders' and custodial fees in connection with a loan. In addition, a
Portfolio will consider all facts and circumstances including the
creditworthiness of the borrowing financial institution, and no Portfolio will
make any loans in excess of one year.
PRIVATELY PLACED AND CERTAIN UNREGISTERED SECURITIES. The Portfolios may
invest in privately placed, restricted, Rule 144A or other unregistered
securities as described in the Prospectus.
As to illiquid investments, a Portfolio is subject to a risk that should
the Portfolio decide to sell them when a ready buyer is not available at a
price the Portfolio deems representative of their value, the value of the
Portfolio's net assets could be adversely affected. Where an illiquid security
must be registered under the Securities Act of 1933, as amended (the "1933
Act") before it may be sold, a Portfolio may be obligated to pay all or part
of the registration expenses, and a considerable period may elapse between the
time of the decision to sell and the time the Portfolio may be permitted to
sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, a Portfolio might obtain a
less favorable price than prevailed when it decided to sell.
QUALITY AND DIVERSIFICATION REQUIREMENTS
Each of the Portfolios intends to meet the diversification requirements of the
1940 Act. To meet these requirements, 75% of the assets of these Portfolios is
subject to the following fundamental limitations: (1) the Portfolio may not
invest more than 5% of its total assets in the securities of any one issuer,
except obligations of the U.S. Government, its agencies and instrumentalities,
and (2) the Portfolio may not own more than 10% of the outstanding voting
securities of any one issuer. As for the other 25% of the Portfolio's assets
not subject to the limitation described above, there is no limitation on
investment of these assets under the 1940 Act, so that all of such assets may
be invested in securities of any one issuer, subject to the limitation of any
applicable state securities laws, or with respect to the Money Market
Portfolio, as described below. Investments not subject to the limitations
described above could involve an increased risk to a Portfolio should an
issuer, or a state or its related entities, be unable to make interest or
principal payments or should the market value of such securities decline.
QUALITY BOND AND QUALITY INCOME PORTFOLIOS. These Portfolios invest
principally in a diversified portfolio of "high grade" and "investment grade"
securities. Investment grade debt is rated, on the date of investment, within
the four highest ratings of Moody's, currently Aaa, Aa, A and Baa, or of
Standard & Poor's, currently AAA, AA, A and BBB, while high grade debt is
rated, on the date of the investment, within the two highest of such ratings.
The Quality Bond Portfolio may also invest up to 5% of its total assets in
securities which are "below investment grade." Such securities must be rated,
on the date of investment, Ba by Moody's or BB by Standard & Poor's. The
Portfolios may invest in debt securities which are not rated or other debt
securities to which these ratings are not applicable, if in the opinion of the
Sub-Adviser, such securities are of comparable quality to the rated securities
discussed above. In addition, at the time the Portfolios invest in any
commercial paper, bank obligation or repurchase agreement, the issuer must
have outstanding debt rated A or higher by Moody's or Standard & Poor's, the
issuer's parent corporation, if any, must have outstanding commercial paper
rated Prime-1 by Moody's or A-1 by Standard & Poor's, or if no such ratings
are available, the investment must be of comparable quality in the
Sub-Adviser's opinion.
CONVERTIBLE AND OTHER DEBT SECURITIES. Certain of the Portfolios may
invest in convertible debt securities, for which there are no specific quality
requirements. In addition, at the time a Portfolio invests in any commercial
paper, bank obligation or repurchase agreement, the issuer must have
outstanding debt rated A or higher by Moody's or Standard & Poor's, the
issuer's parent corporation, if any, must have outstanding commercial paper
rated Prime-1 by Moody's or A-1 by Standard & Poor's, of ir no such ratings
are available, the investment must be of comparable quality in the
Sub-Adviser's opinion. At the time the Portfolio invests in any other
short-term debt securities, they must be rated A or higher by Moody's or
Standard & Poor's, or if unrated, the investment must be of comparable quality
in the Sub-Adviser's opinion.
In determining suitability of investment in a particular unrated
security, the Sub-Adviser takes into consideration asset and debt service
coverage, the purpose of the financing, history of the issuer, existence of
other rated securities of the issuer, and other relevant conditions, such as
comparability to other issuers.
GNMA CERTIFICATES
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION. The Government National
Mortgage Association is a wholly-owned corporate instrumentality of the United
States within the U.S. Department of Housing and Urban Development. GNMA's
principal programs involve its guarantees of privately issued securities
backed by pools of mortgages.
NATURE OF GNMA CERTIFICATES. GNMA Certificates are mortgage-backed
securities. The Certificates evidence part ownership of a pool of mortgage
loans. The Certificates which the Portfolio purchases are of the modified
pass-through type. Modified pass-through Certificates entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
fees paid to the GNMA Certificate issuer and GNMA, regardless of whether or
not the mortgagor actually makes the payment.
GNMA Certificates are backed by mortgages and, unlike most bonds, their
principal amount is paid back by the borrower over the length of the loan
rather than in a lump sum at maturity. Principal payments received by the
Portfolio will be reinvested in additional GNMA Certificates or in other
permissible investments.
GNMA Guarantee. The National Housing Act authorizes GNMA to guarantee the
timely payment of principal of and interest on securities backed by a pool of
mortgages insured by the Federal Housing Administration or the Farmers Home
Administration or guaranteed by the Veterans Administration. The GNMA
guarantee is backed by the full faith and credit of the United States. GNMA is
also empowered to borrow without limitation from the U.S. Treasury if
necessary to make any payments required under its guarantee. The net asset
value and return of the Portfolio will, however, fluctuate depending on market
conditions and other factors.
LIFE OF GNMA CERTIFICATES. The average life of a GNMA Certificate is
likely to be substantially less than the original maturity of the mortgage
pools underlying the securities. Prepayments of principal by mortgagors and
mortgage foreclosures will result in the return of a portion of principal
invested before the maturity of the mortgages in the pool.
As prepayment rates of individual mortgage pools will vary widely, it is
not possible to predict accurately the average life of a particular issue of
GNMA Certificates. However, statistics published by the Federal Housing
Administration are normally used as an indicator of the expected average life
of GNMA Certificates. These statistics indicate that the average life of
single-family dwelling mortgages with 25-30 year maturities (the type of
mortgages backing the vast majority of GNMA Certificates) is approximately 12
years. For this reason, it is customary for pricing purposes to consider GNMA
Certificates as 30-year mortgage-backed securities which prepay fully in the
twelfth year.
YIELD CHARACTERISTICS OF GNMA CERTIFICATES. The coupon rate of interest of
GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or
FHA-insured mortgages underlying the Certificates, but only by the amount of
the fees paid to GNMA and the GNMA Certificate issuer. For the most common
type of mortgage pool, containing single-family dwelling mortgages, GNMA
receives an annual fee of 0.06 of 1% of the outstanding principal for
providing its guarantee, and the GNMA Certificate issuer is paid an annual
servicing fee of 0.44 of 1% for assembling the mortgage pool and for passing
through monthly payments of interest and principal to Certificate holders.
The coupon rate by itself, however, does not indicate the yield which
will be earned on the Certificates for the following reasons:
1. Certificates are usually issued at a premium or discount, rather than
at par.
2. After issuance, Certificates usually trade in the secondary market at
a premium or discount.
3. Interest is paid monthly rather than semi-annually as is the case for
traditional bonds. Monthly compounding has the effect of raising the effective
yield earned on GNMA Certificates.
4. The actual yield of each GNMA Certificate is influenced by the
prepayment experience of the mortgage pool underlying the Certificate. If
mortgagors prepay their mortgages, the principal returned to Certificate
holders may be reinvested at higher or lower rates.
In quoting yields for GNMA Certificates, the customary practice is to
assume that the Certificates will have a 12-year life. Compared on this basis,
GNMA Certificates have historically yielded roughly 1/4 of 1% more than high
grade corporate bonds and 1/2 of 1% more than U.S. Government and U.S.
Government agency bonds. As the life of individual pools may vary widely,
however, the actual yield earned on any issue of GNMA Certificates may differ
significantly from the yield estimated on the assumption of a 12-year life.
MARKET FOR GNMA CERTIFICATES. Since the inception of the GNMA
mortgage-backed securities program in 1970, the amount of GNMA Certificates
outstanding has grown rapidly. The size of the market and the active
participation in the secondary market by securities dealers and many types of
investors make GNMA Certificates highly liquid instruments. Quotes for GNMA
Certificates are readily available from securities dealers and depend on,
among other things, the level of market rates, the Certificate's coupon rate
and the prepayment experience of the pool of mortgages backing each
Certificate.
LOWER GRADE SECURITIES
Certain of the Portfolios may invest in lower-grade income securities. (The
High Yield Portfolio may invest a substantial portion of its assets in medium
and lower grade corporate debt securities entailing certain risks. See
"Special Risks of High Yield Investing" in the Prospectus.) Such lower grade
securities are rated BB or B by S&P or Ba or B by Moody's and are commonly
referred to as "junk bonds." Investment in such securities involves special
risks, as described herein. Liquidity relates to the ability of the Portfolio
to sell a security in a timely manner at a price which reflects the value of
that security. As discussed below, the market for lower grade securities is
considered generally to be less liquid than the market for investment grade
securities. The relative illiquidity of some of the Portfolio's portfolio
securities may adversely affect the ability of the Portfolio to dispose of
such securities in a timely manner and at a price which reflects the value of
such security in the Sub-Adviser's judgment. The market for less liquid
securities tends to be more volatile than the market for more liquid
securities and market values of relatively illiquid securities may be more
susceptible to change as a result of adverse publicity and investor
perceptions than are the market values of higher grade, more liquid
securities.
The Portfolio's net asset value will change with changes in the value of its
portfolio securities. Because the Portfolio will invest in fixed income
securities, the Portfolio's net asset value can be expected to change as
general levels of interest rates fluctuate. When interest rates decline, the
value of a portfolio invested in fixed income securities can be expected to
rise. Conversely, when interest rates rise, the value of a portfolio invested
in fixed income securities can be expected to decline. Net asset value and
market value may be volatile due to the Portfolio's investment in lower grade
and less liquid securities. Volatility may be greater during periods of
general economic uncertainty.
The Portfolio's investments are valued pursuant to guidelines adopted and
periodically reviewed by the Board of Trustees. To the extent that there is no
established retail market for some of the securities in which the Portfolio
may invest, during periods of reduced market liquidity and in the absence of
readily available market quotations for securities held in the Portfolio's
portfolio, the valuation of such securities becomes more difficult and
judgment may play a greater role in the valuation of the Portfolio's
securities due to the reduced availability of reliable objective data. To the
extent that the Portfolio invests in illiquid securities and securities which
are restricted as to resale, the Portfolio may incur additional risks and
costs. Illiquid and certain restricted securities are particularly difficult
to dispose of.
Lower grade securities generally involve greater credit risk than higher grade
securities. A general economic downturn or a significant increase in interest
rates could severely disrupt the market for lower grade securities and
adversely affect the market value of such securities. In addition, in such
circumstances, the ability of issuers of lower grade securities to repay
principal and to pay interest, to meet projected financial goals and to obtain
additional financing may be adversely affected. Such consequences could lead
to an increased incidence of default for such securities and adversely affect
the value of the lower grade securities in the Portfolio's portfolio and thus
the Portfolio's net asset value. The secondary market prices of lower grade
securities are less sensitive to changes in interest rates than are those for
higher rated securities, but are more sensitive to adverse economic changes or
individual issuer developments. Adverse publicity and investor perceptions,
whether or not based on rational analysis, may also affect the value and
liquidity of lower grade securities.
Yields on the Portfolio's portfolio securities can be expected to fluctuate
over time. In addition, periods of economic uncertainty and changes in
interest rates can be expected to result in increased volatility of the market
prices of the lower grade securities in the Portfolio's portfolio and thus in
the net asset value of the Portfolio. Net asset value and market value may be
volatile due to the Portfolio's investment in lower grade and less liquid
securities. Volatility may be greater during periods of general economic
uncertainty. The Portfolio may incur additional expenses to the extent it is
required to seek recovery upon a default in the payment of interest or a
repayment of principal on its portfolio holdings, and the Portfolio may be
unable to obtain full recovery thereof. In the event that an issuer of
securities held by the Portfolio experiences difficulties in the timely
payment of principal or interest and such issuer seeks to restructure the
terms of its borrowings, the Portfolio may incur additional expenses and may
determine to invest additional capital with respect to such issuer or the
project or projects to which the Portfolio's portfolio securities relate.
The Portfolio will rely on the Sub-Adviser's judgment, analysis and experience
in evaluating the creditworthiness of an issue. In this evaluation, the
Sub-Adviser will take into consideration, among other things, the issuer's
financial resources, its sensitivity to economic conditions and trends, its
operating history, the quality of the issuer's management and regulatory
matters. The Sub-Adviser also may consider, although it does not rely
primarily on, the credit ratings of S&P and Moody's in evaluating fixed-income
securities. Such ratings evaluate only the safety of principal and interest
payments, not market value risk. Additionally, because the creditworthiness of
an issuer may change more rapidly than is able to be timely reflected in
changes in credit ratings, the Sub-Adviser continuously monitors the issuers
of such securities held in the Portfolio's portfolio. The Portfolio may, if
deemed appropriate by the Sub-Adviser, retain a security whose rating has been
downgraded below B by S&P or below B by Moody's, or whose rating has been
withdrawn.
With respect to Portfolios which may invest in these unrated income
securities, achievement by the Portfolio of its investment objective may be
more dependent upon the Sub-Adviser's investment analysis than would be the
case if the Portfolio were investing exclusively in rated securities.
STRATEGIC TRANSACTIONS
As described in the Prospectus, certain Portfolios of the Trust may, but are
not required to, utilize various other investment strategies as described
below to hedge various market risks (such as interest rates, currency exchange
rates and broad or specific market movements) or to manage the effective
maturity or duration of a Portfolio's income securities. Such strategies are
generally accepted by modern portfolio managers and are regularly utilized by
many mutual funds and other institutional investors. Techniques and
instruments may change over time as new instruments and strategies are
developed or regulatory changes occur.
In the course of pursuing these investment strategies, a Portfolio may
purchase and sell exchange-listed and over-the-counter put and call options on
securities, equity and income indices and other financial instruments,
purchase and sell financial futures contracts and options thereon, enter into
various interest rate transactions such as swaps, caps, floors or collars and
enter into various currency transactions such as currency forward contracts,
currency futures contracts, currency swaps or options on currencies or
currency futures (collectively, all the above are called "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's portfolio resulting
from securities markets or exchange rate fluctuations, 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 maturity or duration of a Portfolio's portfolio, 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 Sub-Adviser's
ability to predict pertinent market movements, which cannot be assured. A
Portfolio 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 Sub-Adviser'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 or purchase of portfolio securities at
inopportune times or for prices other than 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
substantial losses, if at all. Although the use of futures and options
transactions for hedging 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. Income earned or deemed to
be earned, if any, by a Portfolio from its Strategic Transactions will
generally be taxable income of the Trust. See "Tax Status" in the Prospectus.
GENERAL CHARACTERISTICS OF OPTIONS. Put options and call options
typically have similar structural characteristics and operational mechanics
regardless of the underlying instrument on which they are purchased or sold.
Thus, the following general discussion relates to each of the particular types
of options discussed in greater detail below. In addition, many Strategic
Transactions involving options require segregation of Portfolio assets in
special accounts, as described below under "Use of Segregated and Other
Special Accounts."
A put option gives the purchaser of the option, upon payment of a
premium, the right to sell, and the writer the obligation to buy, the
underlying security, commodity, index, currency or other instrument at the
exercise price. For instance, a Portfolio's purchase of a put option on a
security might be designed to protect its holdings in the underlying
instrument (or, in some cases, a similar instrument) against a substantial
decline in the market value by giving the Portfolio the right to sell such
instrument at the option exercise price. A call option, upon payment of a
premium, gives the purchaser of the option the right to buy, and the seller
the obligation to sell, the underlying instrument at the exercise price. A
Portfolio's purchase of a call option on a security, financial future, index,
currency or other instrument might be intended to protect the Portfolio
against an increase in the price of the underlying instrument that it intends
to purchase in the future by fixing the price at which it may purchase such
instrument. An American style put or call option may be exercised at any time
during the option period while a European style put or call option may be
exercised only upon expiration or during a fixed period prior thereto. As
described in the Prospectus, certain Portfolios of the Trust are authorized to
purchase and sell exchange listed options and over-the-counter options ("OTC
options"). Exchange listed options are issued by a regulated intermediary such
as the Options Clearing Corporation ("OCC"), which guarantees the performance
of the obligations of the parties to such options. The discussion below uses
the OCC as a paradigm, but is also applicable to other financial
intermediaries.
With certain exceptions, OCC issued and exchange listed options generally
settle by physical delivery of the underlying security or currency, although
in the future cash settlement may become available. Index options and
Eurodollar instruments are cash settled for the net amount, if any, by which
the option is "in-the-money" (i.e., where the value of the underlying
instrument exceeds, in the case of a call option, or is less than, in the case
of a put option, the exercise price of the option) at the time the option is
exercised. Frequently, rather than taking or making delivery of the underlying
instrument through the process of exercising the option, listed options are
closed by entering into offsetting purchase or sale transactions that do not
result in ownership of the new option.
A Portfolio's ability to close out its position as a purchaser or seller
of an OCC or exchange listed put or call option is dependent, in part, upon
the liquidity of the option market. Among the possible reasons for the absence
of a liquid option market on an exchange are: (i) insufficient trading
interest in certain options; (ii) restrictions on transactions imposed by an
exchange; (iii) trading halts, suspensions or other restrictions imposed with
respect to particular classes or series of options or underlying securities
including reaching daily price limits; (iv) interruption of the normal
operations of the OCC or an exchange; (v) inadequacy of the facilities of an
exchange or OCC to handle current trading volume; or (vi) a decision by one or
more exchanges to discontinue the trading of options (or a particular class or
series of options), in which event the relevant market for that option on that
exchange would cease to exist, although outstanding options on that exchange
would generally continue to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours
during which the underlying financial instruments are traded. To the extent
that the option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of
an OTC option, including such terms as method of settlement, term, exercise
price, premium, guarantees and security, are set by negotiation of the
parties. A Portfolio will only sell OTC options (other than OTC currency
options) that are subject to a buy-back provision permitting the Portfolio to
require the Counterparty to sell the option back to the Portfolio at a formula
price within seven days. The Portfolios expect generally to enter into OTC
options that have cash settlement provisions, although they are not required
to do so.
Unless the parties provide for it, there is no central clearing or
guaranty function in an OTC option. As a result, if the Counterparty fails to
make or take delivery of the security, currency or other instrument underlying
an OTC option it has entered into with a Portfolio or fails to make a cash
settlement payment due in accordance with the terms of that option, the
Portfolio will lose any premium it paid for the option as well as any
anticipated benefit of the transaction. Accordingly, the Sub-Adviser must
assess the creditworthiness of each such Counterparty or any guarantor or
credit enhancement of the Counterparty's credit to determine the likelihood
that the terms of the OTC option will be satisfied. A Portfolio will engage in
OTC option transactions only with United States government securities dealers
recognized by the Federal Reserve Bank of New York as "primary dealers", or
broker dealers, domestic or foreign banks or other financial institutions
which have received (or the guarantors of the obligation of which have
received) a short-term credit rating of "A-1" from Standard & Poor's
Corporation or "P-1" from Moody's Investors Service, Inc. or an equivalent
rating from any other nationally recognized statistical rating organization
("NRSRO"). The staff of the SEC currently takes the position that, in general,
OTC options on securities other than U.S. government securities purchased by a
Portfolio, and portfolio securities "covering" the amount of the Portfolio's
obligation pursuant to an OTC option sold by it (the cost of the sell-back
plus the in-the-money amount, if any) are illiquid, and are subject to each
Portfolio's limitation on investing no more than 10% of its assets in
restricted securities (15% with respect to the World Equity Portfolio and the
Utility Portfolio).
If a Portfolio sells a call option, the premium that it receives may
serve as a partial hedge, to the extent of the option premium, against a
decrease in the value of the underlying securities or instruments in its
portfolio or will increase a Portfolio's income. The sale of put options can
also provide income.
A Portfolio may purchase and sell call options on securities, including
U.S. Treasury and agency securities, municipal obligations, mortgage-backed
securities, corporate debt securities, equity securities (including
convertible securities) and Eurodollar instruments that are traded on U.S. and
foreign securities exchanges and in the over-the-counter markets and or
securities indices, currencies and futures contracts. All calls sold by a
Portfolio must be "covered" (i.e., the Portfolio must own the securities or
futures contract subject to the call) or must meet the asset segregation
requirements described below as long as the call is outstanding. Even though a
Portfolio will receive the option premium to help protect it against loss, a
call sold by a Portfolio exposes the Portfolio during the term of the option
to possible loss of opportunity to realize appreciation in the market price of
the underlying security or instrument and may require the Portfolio to hold a
security or instrument which it might otherwise have sold. In selling calls on
securities not owned by the Portfolio, the Portfolio may be required to
acquire the underlying security at a disadvantageous price in order to satisfy
its obligations with respect to the call.
A Portfolio may purchase and sell put options on securities including
U.S. Treasury and agency securities, mortgage-backed securities, municipal
obligations, corporate debt securities, equity securities (including
convertible securities) and Eurodollar instruments (whether or not it holds
the above securities in its portfolio) and on securities indices, currencies
and futures contracts other than futures on individual corporate debt and
individual equity securities. A Portfolio will not sell put options if, as a
result, more than 50% of the Portfolio's assets would be required to be
segregated to cover its potential obligations under such put options other
than those with respect to futures and options thereon. In selling put
options, there is a risk that a Portfolio may be required to buy the
underlying security at a disadvantageous price above the market price.
GENERAL CHARACTERISTICS OF FUTURES. Certain Portfolios of the Trust may
enter into financial futures contracts or purchase or sell put and call
options on such futures as a hedge against anticipated interest rate,
currency, equity or income market changes, for duration management and for
risk management purposes. Futures are generally bought and sold on the
commodities exchanges where they are listed with payment of initial and
variation margin as described below. The purchase of a futures contract
creates a firm obligation by a Portfolio, as purchaser, to take delivery from
the seller of the specific type of financial instrument called for in the
contract at a specific future time for a specified price (or, with respect to
index futures and Eurodollar instruments, the net cash amount). The sale of a
futures contract creates a firm obligation by the Portfolio, as seller, to
deliver to the buyer the specific type of financial instrument called for in
the contract at a specific future time for a specified price (or, with respect
to index futures and Eurodollar instruments, the net cash amount). Options on
futures contracts are similar to options on securities except that an option
on a futures contract gives the purchaser the right in return for the premium
paid to assume a position in a futures contract and obligates the seller to
deliver such option.
The Portfolio's use of financial futures and options thereon will in all
cases be consistent with applicable regulatory requirements and, in
particular, with the rules and regulations of the Commodity Futures Trading
Commission. Typically, maintaining a futures contract or selling an option
thereon requires the Portfolio to deposit with a financial intermediary, as
security for its obligations, an amount of cash or other specified assets
(initial margin) which initially is typically 1% to 10% of the face amount of
the contract (but may be higher in some circumstances). Additional cash or
assets (variation margin) may be required to be deposited thereafter on a
daily basis as the mark to market value of the contract fluctuates. The
purchase of options on financial futures involves payment of a premium for the
option without any further obligation on the part of the Portfolio. If the
Portfolio exercises an option on a futures contract it will be obligated to
post initial margin (and potential subsequent variation margin) for the
resulting futures position just as it would for any position. Futures
contracts and options thereon are generally settled by entering into an
offsetting transaction but there can be no assurance that the position can be
offset prior to settlement at an advantageous price nor that delivery will
occur.
A Portfolio will not enter into a futures contract or related option
(except for closing transactions) for other than bona fide hedging purposes
if, immediately thereafter, the sum of the amount of its initial margin and
premiums on open futures contracts and options thereon would exceed 5% of the
Portfolio's total assets (taken at current value); however, in the case of an
option that is in-the-money at the time of the purchase, the in-the-money
amount may be excluded in calculating the 5% limitation. The segregation
requirements with respect to futures contracts and options thereon are
described below.
OPTIONS ON SECURITIES INDICES AND OTHER FINANCIAL INDICES. A Portfolio
also may purchase and sell call and put options on securities indices and
other financial indices and in so doing can achieve many of the same
objectives it would achieve through the sale or purchase of options on
individual securities or other instruments. Options on securities indices and
other financial indices are similar to options on a security or other
instrument except that, rather than settling by physical delivery of the
underlying instrument, they settle by cash settlement, i.e., an option on an
index gives the holder the right to receive, upon exercise of the option, an
amount of cash if the closing level of the index upon which the option is
based exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option (except if, in the case of an OTC option,
physical delivery is specified). This amount of cash is equal to the excess of
the closing price of the index over the exercise price of the option, which
also may be multiplied by a formula value. The seller of the option is
obligated, in return for the premium received, to make delivery of this
amount. The gain or loss on an option on an index depends on price movements
in the instruments making up the market, market segment, industry or other
composite on which the underlying index is based, rather than price movements
in individual securities, as is the case with respect to options on
securities.
CURRENCY TRANSACTIONS. Certain Portfolios of the Trust may engage in
currency transactions with Counterparties in order to hedge the value of
portfolio holdings denominated in particular currencies against fluctuations
in relative value. Currency transactions include forward currency contracts,
exchange listed currency futures, exchange listed and OTC options on
currencies, and currency swaps. A forward currency contract involves a
privately negotiated obligation to purchase or sell (with delivery generally
required) a specific currency at a future date, which may be any fixed number
of days from the date of the contract agreed upon by the parties, at a price
set at the time of the contract. A currency swap is an agreement to exchange
cash flows based on the notional difference among two or more currencies and
operates similarly to an interest rate swap, which is described below. A
Portfolio may enter into currency transactions with Counterparties which have
received (or the guarantors of the obligations of such Counterparties have
received) a credit rating of A-1 or P-1 by S&P or Moody's, respectively, or
that have an equivalent rating from an NRSRO or (except for OTC currency
options) are determined to be of equivalent credit quality by the Sub-Adviser.
Dealings by the Portfolios in forward currency contracts and other
currency transactions such as futures, options, options on futures and swaps
will be limited to hedging involving either specific transactions or portfolio
positions. Transaction hedging is entering into a currency transaction with
respect to specific assets or liabilities of the Portfolio, which will
generally arise in connection with the purchase or sale of its portfolio
securities or the receipt of income therefrom. Position hedging is entering
into a currency transaction with respect to portfolio security positions
denominated or generally quoted in that currency.
A Portfolio will not enter into a transaction to hedge currency exposure
to an extent greater, after netting all transactions intended to wholly or
partially offset other transactions, than the aggregate market value (at the
time of entering into the transaction) of the securities held in its portfolio
that are denominated or generally quoted in or currently convertible into such
currency other than with respect to cross hedging and proxy hedging as
described below.
A Portfolio may cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which the Portfolio has or in which the
Portfolio expects to have portfolio exposure.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, a Portfolio may also engage in
proxy hedging. Proxy hedging is often used when the currency to which the
Portfolio's portfolio is exposed is difficult to hedge or to hedge against the
dollar. Proxy hedging entails entering into a forward contract to sell a
currency whose changes in value are generally considered to be linked to a
currency or currencies in which some or all of the Portfolio's portfolio
securities are or are expected to be denominated, and to buy U.S. dollars. For
example, if the Sub-Adviser considers the Austrian schilling as being linked
to the German deutschemark (the "D-mark") and the Trust holds securities
denominated in schillings and the Sub-Adviser believes that the value of
schillings will decline against the U.S. dollar, the Sub-Adviser may enter
into a contract to sell D-marks and buy dollars. Currency hedging involves
some of the same risks and considerations as other transactions with similar
instruments. Currency transactions can result in losses to a Portfolio if the
currency being hedged fluctuates in value to a degree or in a direction that
is not anticipated. Further, there is the risk that the perceived linkage
between various currencies may not be present or may not be present during the
particular time that the Portfolio is engaging in proxy hedging. If a
Portfolio enters into a currency hedging transaction, the Portfolio will
comply with the asset segregation requirements described below.
RISKS OF CURRENCY TRANSACTIONS. Currency transactions are subject to
risks different from those of other portfolio transactions. Because currency
control is of great importance to the issuing governments and influences
economic planning and policy, purchases and sales of currency and related
instruments can be negatively affected by government exchange controls,
blockages, and manipulations or exchange restrictions imposed by governments.
These can result in losses to a Portfolio if it is unable to deliver or
receive currency or funds in settlement of obligations and could also cause
hedges it has entered into to be rendered useless, resulting in full currency
exposure as well as incurring transaction costs. Buyers and sellers of
currency futures are subject to the same risks that apply to the use of
futures generally. Further, settlement of a currency futures contract for the
purchase of most currencies must occur at a bank based in the issuing nation.
Trading options on currency futures is relatively new, and the ability to
establish and close out positions on such options is subject to the
maintenance of a liquid market which may not always be available. Currency
exchange rates may fluctuate based on factors extrinsic to that country's
economy.
COMBINED TRANSACTIONS. Certain Portfolios of the Trust may enter into
multiple transactions, including multiple options transactions, multiple
futures transactions, multiple currency transactions (including forward
currency contracts), multiple interest rate transactions and any combination
of futures, options, currency and interest rate transactions ("component"
transactions), instead of a single Strategic Transaction, as part of a single
or combined strategy when, in the opinion of the Sub-Adviser, it is in the
best interest of the Portfolio to do so. A combined transaction will usually
contain elements of risk that are present in each of its component
transactions. Although combined transactions are normally entered into based
on the Sub-Adviser's judgment that the combined strategies will reduce risk or
otherwise more effectively achieve the desired portfolio management goal, it
is possible that the combination will instead increase such risks or hinder
achievement of the portfolio management objective.
SWAPS, CAPS, FLOORS AND COLLARS. Among the Strategic Transactions into
which certain Portfolios may enter are interest rate, currency and index swaps
and the purchase or sale of related caps, floors and collars. The Portfolios
expect to enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of their portfolios, to protect
against currency fluctuations, as a duration management technique or to
protect against any increase in the price of securities the Portfolio
anticipates purchasing at a later date. The Portfolios intend to use these
transactions as hedges and not as speculative investments and will not sell
interest rate caps or floors where they do not own securities or other
instruments providing the income stream the Portfolios may be obligated to
pay. Interest rate swaps involve the exchange by the Portfolio with another
party of their respective commitments to pay or receive interest, e.g., an
exchange of floating rate payments for fixed rate payments with respect to a
notional amount of principal. A currency swap is an agreement to exchange
cashflows on a notional amount of two or more currencies based on the relative
value differential among them. An index swap is an agreement to swap cash
flows on a notional amount based on changes in the values of the reference
indices. The purchase of a cap entitles the purchaser to receive payments on a
notional principal amount from the party selling such cap to the extent that a
specified index exceeds a predetermined interest rate or amount. The purchase
of a floor entitles the purchaser to receive payments on a notional principal
amount from the party selling such floor to the extent that a specified index
falls below a predetermined interest rate or amount. A collar is a combination
of a cap and a floor that preserves a certain return within a predetermined
range of interest rates or values.
A Portfolio will usually enter into swaps on a net basis, i.e., the two
payment streams are netted out in a cash settlement on the payment date or
dates specified in the instrument, with the Portfolio receiving or paying, as
the case may be, only the net amount of the two payments. Inasmuch as these
swaps, caps, floors and collars are entered into for good faith hedging
purposes, the Sub-Adviser and the Portfolio believe such obligations do not
constitute senior securities under the Investment Company Act of 1940, as
amended, and, accordingly, will not treat them as being subject to its
borrowing restrictions. A Portfolio will not enter into any swap, cap, floor
or collar transaction unless, at the time of entering into such transaction,
the unsecured long-term debt of the Counterparty, combined with any credit
enhancements, is rated at least "A" by S&P or Moody's or has an equivalent
equity rating from an NRSRO or is determined to be of equivalent credit
quality by the Sub-Adviser. If there is a default by the Counterparty, the
Portfolio may have contractual remedies pursuant to the agreements related to
the transaction. The swap market has grown substantially in recent years with
a large number of banks and investment banking firms acting both as principals
and agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
EURODOLLAR INSTRUMENTS. Certain Portfolios of the Trust may make
investments in Eurodollar instruments. Eurodollar instruments are U.S.
dollar-denominated futures contracts or options thereon which are linked to
the London Interbank Offered Rate ("LIBOR"), although foreign
currency-denominated instruments are available from time to time. Eurodollar
futures contracts enable purchasers to obtain a fixed rate for the lending of
funds and sellers to obtain a fixed rate for borrowings. A Portfolio might use
Eurodollar futures contracts and options thereon to hedge against changes in
LIBOR, to which many interest rate swaps and income instruments are linked.
RISKS OF STRATEGIC TRANSACTIONS OUTSIDE THE UNITED STATES. When conducted
outside the United States, Strategic Transactions may not be regulated as
rigorously as in the United States, may not involve a clearing mechanism and
related guarantee, and are subject to the risk of governmental actions
affecting trading in, or the prices of, foreign securities, currencies and
other instruments. The value of such positions also could be adversely
affected by: (i) other complex foreign political, legal and economic factors,
(ii) lesser availability than in the United States of data on which to make
trading decisions, (iii) delays in a Portfolio's ability to act upon economic
events occurring in foreign markets during non-business hours in the United
States, (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the United States, and (v) lower
trading volume and liquidity.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS. Many Strategic
Transactions, in addition to other requirements, require that the Portfolio
segregate liquid high-grade assets with its custodian to the extent Portfolio
obligations are not otherwise "covered" through ownership of the underlying
security, financial instrument or currency. In general, either the full amount
of any obligation by the Portfolio to pay or deliver securities or assets must
be covered at all times by the securities, instruments or currency required to
be delivered, or, subject to any regulatory restrictions, an amount of cash or
liquid high-grade debt securities at least equal to the current amount of the
obligation must be segregated with the custodian. The segregated assets cannot
be sold or transferred unless equivalent assets are substituted in their place
or it is no longer necessary to segregate them. For example, a call option
written by a Portfolio will require the Portfolio to hold the securities
subject to the call (or securities convertible into the needed securities
without additional consideration) or to segregate liquid high-grade debt
securities sufficient to purchase and deliver the securities if the call is
exercised. A call option sold by a Portfolio on an index will require the
Portfolio to own portfolio securities which correlate with the index or to
segregate liquid high-grade assets equal to the excess of the index value over
the exercise price on a current basis. A put option written by a Portfolio
requires the Portfolio to segregate liquid, high-grade assets equal to the
exercise price.
Except when a Portfolio enters into a forward contract for the purchase
or sale of a security denominated in a particular currency, which requires no
segregation, a currency contract which obligates the Portfolio to buy or sell
currency will generally require the Portfolio to hold an amount of that
currency or liquid securities denominated in that currency equal to the
Portfolio's obligations or to segregate liquid high-grade assets equal to the
amount of the Portfolio's obligation.
OTC options entered into by a Portfolio, including those on securities,
currencies, financial instruments or indices and OCC issued and exchange
listed index options, will generally provide for cash settlement. As a result,
when a Portfolio sells these instruments it will only segregate an amount of
assets equal to its accrued net obligations, as there is no requirement for
payment or delivery of amounts in excess of the net amount. These amounts will
equal 100% of the exercise price in the case of a non cash-settled put, the
same as an OCC guaranteed listed option sold by the Portfolio, or the
in-the-money amount plus any sell-back formula amount in the case of a
cash-settled put or call. In addition, when the Portfolio sells a call option
on an index at a time when the in-the-money amount exceeds the exercise price,
the Portfolio will segregate, until the option expires or is closed out, cash
or cash equivalents equal in value to such excess. OCC issued and exchange
listed options sold by the Portfolio other than those above generally settle
with physical delivery or with an election of either physical delivery or cash
settlement, and the Portfolio will segregate an amount of assets equal to the
full value of the option. OTC options settling with physical delivery, or with
an election of either physical delivery or cash settlement, will be treated
the same as other options settling with physical delivery.
In the case of a futures contract or an option thereon, the Portfolio
must deposit initial margin and possible daily variation margin in addition to
segregating assets sufficient to meet its obligation to purchase or provide
securities or currencies, or to pay the amount owed at the expiration of an
index-based futures contract. Such assets may consist of cash, cash
equivalents, liquid debt securities or other acceptable assets.
With respect to swaps, a Portfolio will accrue the net amount of the
excess, if any, of its obligations over its entitlements with respect to each
swap on a daily basis and will segregate an amount of cash or liquid
high-grade securities having a value equal to the accrued excess. Caps, floors
and collars require segregation of assets with a value equal to a Portfolio's
net obligation, if any.
Strategic Transactions may be covered by other means when consistent with
applicable regulatory policies. A Portfolio may also enter into offsetting
transactions so that its combined position, coupled with any segregated
assets, equals its net outstanding obligation in related options and Strategic
Transactions. For example, a Portfolio could purchase a put option if the
strike price of that option is the same or higher than the strike price of a
put option sold by the Portfolio. Moreover, instead of segregating assets if
the Portfolio held a futures or forward contract, it could purchase a put
option on the same futures or forward contract with a strike price as high or
higher than the price of the contract held. Other Strategic Transactions may
also be offset in combinations. If the offsetting transaction terminates at
the time of or after the primary transaction, no segregation is required.
However, if it terminates prior to such time, assets equal to any remaining
obligation would need to be segregated.
The Trust's activities involving Strategic Transactions may be limited by
the requirements of Subchapter M of the Internal Revenue Code for
qualification as a regulated investment company. See "Tax Status" in the
Prospectus.
GROWTH AND INCOME PORTFOLIO - DEBT SECURITIES INVESTMENTS
The Growth and Income Portfolio may invest up to 5% of its assets in
various debt securities. These include 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. These securities may also include
corporate debt securities, some of which may be medium and lower grade
quality. Lower grade corporate debt securities are commonly known as "junk
bonds" and involve a significant degree of risk.
STOCK INDEX PORTFOLIO - MONITORING PROCEDURES
MONITORING PROCEDURES
The Board of Trustees of the Trust reviews the correlation between the
Portfolio and the Index on a quarterly basis. The Board of Trustees has
adopted monitoring procedures which it believes are reasonably designed to
assure a high degree of correlation between the performance of the Portfolio
and the S&P 500 Index. The procedures, which are reviewed and reconfirmed
annually by the Board, provide that in the event that the correlation between
the performance of the Portfolio and that of the S&P 500 Index falls below
95%, the Sub-Adviser will promptly notify the Board which shall consider what
action, if any, should be taken.
INVESTMENT LIMITATIONS
The Trust has adopted the following restrictions and policies relating to the
investment of assets of the Portfolios and their activities. These are
fundamental policies 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 such Portfolio.
QUALITY INCOME, HIGH YIELD, MONEY MARKET, GROWTH AND INCOME AND STOCK INDEX
PORTFOLIOS
Each of the Quality Income, High Yield, Money Market, Growth and Income and
Stock Index Portfolios of the Trust may not:
1. Borrow money which is in excess of one-third of the value of its total
assets taken at market value (including the amount borrowed) (except the Money
Market Portfolio which is limited to 10% of the value of its total assets) and
then only from banks as a temporary measure for extraordinary or emergency
purposes. This borrowing provision is not for investment leverage but solely
to facilitate management of the Portfolio by enabling the Trust to meet
redemption requests where the liquidation of the Portfolio's investment is
deemed to be inconvenient or disadvantageous. Monies used to pay interest on
borrowed funds will not be available for investment. The Portfolio will not
make additional investments while it has borrowings outstanding;
2. Underwrite securities of other issuers;
3. Invest 25% or more of a Portfolio's assets taken at market value in
any one industry. Investing in cash items (including bank time and demand
deposits such as certificates of deposit), U.S. Treasury bills or securities
issued or guaranteed by the U.S. government, its agencies or
instrumentalities, or instruments secured by those money market instruments,
such as repurchase agreements, will not be considered investments in any one
industry;
4. Purchase or sell commodities, commodity contracts, foreign exchange or
real estate, or invest in oil, gas or other mineral development or exploration
programs, except as noted in connection with hedging transactions. (This does
not prohibit investment in the securities of corporations which own interests
in commodities, foreign exchange, real estate or oil, gas or other mineral
development or exploration programs);
5. Invest more than 5% of the value of the assets of a Portfolio in
securities of any one issuer (except in the case of the securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities), or, if,
as a result, the Portfolio would hold more than 10% of the outstanding voting
securities of an issuer except that up to 25% of the Portfolio's total assets
may be invested without regard to such limitations;
6. Invest in securities of a company for the purpose of exercising
control or management;
7. Invest in securities issued by any other registered investment
company;
8. Purchase or sell real estate, except the Portfolios may purchase
securities which are issued by companies which invest in real estate or
interests therein;
9. Issue senior securities as defined in the Investment Company Act of
1940, except insofar as a Portfolio may be deemed to have issued a senior
security by reason of (a) entering into any repurchase agreement; (b)
borrowing money in accordance with restrictions described above; (c) lending
Portfolio securities; (d) purchasing securities on a when-issued or delayed
delivery basis; (e) accommodating short sales; (f) implementing the hedging
transactions described above. If the asset coverage falls below 300%, when
taking into account items (a) through (e), the Portfolio may be required to
liquidate investments to be in compliance with the Investment Company Act of
1940;
10. Lend portfolio securities in excess of twenty-five percent (25%) of
the value of a Portfolio's assets. Any loans of a Portfolio's securities will
be made according to guidelines established by the Trustees, including
maintenance of collateral of the borrower at least equal at all times to the
current market value of the securities loaned;
11. Invest in securities subject to legal or contractual restrictions on
resale and repurchase agreements maturing in more than seven days if, as a
result of the investment, more than 10% of the total assets of the Portfolio
(taken at market value at the time of such investment) would be invested in
the securities;
12. Make loans (the acquisition of a portion of an issue of publicly
distributed bonds, debentures, notes and other securities as permitted by the
investment objectives of the Portfolios will not be deemed to be the making of
loans) except that the Portfolios may purchase securities subject to
repurchase agreements under policies established by the Trustees or lend
portfolio securities pursuant to restriction 10 above;
13. Purchase securities on margin (but the Portfolios may obtain such
short-term credits as may be necessary for the clearance of transactions or to
implement the hedging transactions described above); and
14. Make short sales of securities or maintain a short position, unless
not more than 10% of the Portfolio's net assets (taken at current value) is
held as collateral for the sales at any one time, or unless at all times when
a short position is open the Portfolio owns an equal amount of the securities
or securities convertible into or exchangeable, without payment of any further
consideration (or for additional cash consideration held in a segregated
account by the Trust's custodian), for securities of the same issue as, and
equal in amount to, the securities sold short ("short sale against-the-box").
ADDITIONAL INVESTMENT LIMITATION - STOCK INDEX PORTFOLIO
The Stock Index Portfolio may not invest more than 5% of assets in the
securities of companies that have a continuous operating history of less than
3 years. However, such period of three years may include the operation of any
predecessor company or companies, partnership or individual enterprise if the
company whose securities are proposed as an investment for funds of the
Portfolio has come into existence as the result of a merger, consolidation,
reorganization or the purchase of substantially all of the assets of such
predecessor company or companies, partnership or individual enterprise.
ADDITIONAL INVESTMENT LIMITATIONS - MONEY MARKET PORTFOLIO
Rule 2a-7 under the Investment Company Act of 1940, which contains certain
requirements relating to the diversification, quality and maturity of a money
market fund's investments, was recently amended by the Securities and Exchange
Commission. The Board of Trustees of the Trust has modified its Rule 2a-7
procedures in order to comply with the Rule, as amended. As part of that
modification, the Board has adopted certain additional investment restrictions
pertaining to the diversification of the investments of the Money Market
Portfolio. These investment limitations, which are not fundamental policies
and which therefore may be changed without shareholder approval, are as
follows:
The Money Market Portfolio shall not acquire any instrument, including puts,
repurchase agreements and bank instruments, which, as measured at the time of
acquisition, would cause the Portfolio to:
1. invest, at any time, more than 5% of its total assets in the First
Tier Securities (as that term is defined in the Trust Prospectus) of a single
issuer (including puts written by, and repurchase agreements entered into
with, such issuer); except that the Portfolio may invest more than 5% of its
total assets in Government securities; and, for purposes of this calculation,
entering into a repurchase agreement shall be deemed to be an acquisition of
the underlying securities to the extent that the repurchase agreement is
collateralized fully;
2. invest, at any time, more than 5% of its total assets in securities
which when acquired by the Portfolio were Second Tier Securities (as that term
is defined in the Trust Prospectus); or
3. invest, at any time, more than the greater of 1% of the Portfolio's
total assets or $1,000,000 in securities of a single issuer which were Second
Tier Securities when acquired by the Portfolio.
QUALITY BOND PORTFOLIO
The Quality Bond Portfolio of the Trust may not:
1. Borrow money, except from banks for extraordinary or emergency
purposes and then only in amounts up to 30% of the value of the Portfolio's
total assets, taken at cost at the time of such borrowing and except in
connection with reverse repurchase agreements permitted by Investment
Restriction No. 8. Mortgage, pledge, or hypothecate any assets except in
connection with any such borrowing in amounts up to 30% of the value of the
Portfolio's net assets at the time of such borrowing. The Portfolio will not
purchase securities while borrowings (including reverse repurchase agreements)
exceed 5% of the Portfolio's total assets. This borrowing provision
facilitates the orderly sale of portfolio securities, for example, in the
event of abnormally heavy redemption requests. This provision is not for
investment purposes. Collateral arrangements for premium and margin payments
in connection with the Portfolio's's hedging activities are not deemed to be a
pledge of assets;
2. Purchase the securities or other obligations of any one issuer if,
immediately after such purchase, more than 5% of the value of the Portfolio's
total assets would be invested in securities or other obligations of any one
such issuer. This limitation shall not apply to securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities or to
permitted investments of up to 25% of the Portfolio's total assets;
3. Purchase the securities of an issuer if, immediately after such
purchase, the Portfolio owns more than 10% of the outstanding voting
securities of such issuer. This limitation shall not apply to permitted
investments of up to 25% of the Portfolio's total assets;
4. Purchase securities or other obligations of issuers conducting their
principal business activity in the same industry if, immediately after such
purchase the value of its investments in such industry would exceed 25% of the
value of the Portfolio's total assets. For purposes of industry concentration,
there is no percentage limitation with respect to investments in U.S.
Government securities;
5. Make loans, except through the purchase or holding of debt obligations
(including privately placed securities) or the entering into of repurchase
agreements, or loans of portfolio securities in accordance with the
Portfolio's investment objective and policies;
6. Purchase or sell puts, calls, straddles, spreads, or any combination
thereof, real estate, commodities, commodity contracts, except for the
Portfolio's interest in hedging activities as described under "Investment
Objectives and Policies"; or interests in oil, gas, or mineral exploration or
development programs. However, the Portfolio may purchase debt obligations
secured by interests in real estate or issued by companies which invest in
real estate or interests therein including real estate investment trusts;
7. Purchase securities on margin, make short sales of securities, or
maintain a short position in securities, except in the course of the
Portfolio's hedging activities, unless at all times when a short position is
open the Portfolio owns an equal amount of such securities, provided that this
restriction shall not be deemed to be applicable to the purchase or sale of
when-issued securities or delayed delivery securities;
8. Issue any senior security, except as appropriate to evidence
indebtedness which constitutes a senior security and which the Portfolio is
permitted to incur pursuant to Investment Restriction No. 1 and except that
the Portfolio may enter into reverse repurchase agreements, provided that the
aggregate of senior securities, including reverse repurchase agreement, shall
not exceed one-third of the market value of the Portfolio's total assets, less
liabilities other than obligations created by reverse repurchase agreements.
The Portfolio's arrangements in connection with its hedging activities as
described in "Investment Objectives and Policies" shall not be considered
senior securities for purposes hereof;
9. Acquire securities of other investment companies, except as permitted
by the 1940 Act; or
10. Act as an underwriter of securities.
SELECT EQUITY, LARGE CAP STOCK AND SMALL CAP STOCK PORTFOLIOS
Each of the Select Equity, Large Cap Stock and Small Cap Stock Portfolios
may not:
1. Purchase the securities or other obligations of issuers conducting
their principal business activity in the same industry if, immediately after
such purchase the value of its investments in such industry would exceed 25%
of the value of the Portfolio's total assets. For purposes of industry
concentration, there is no percentage limitation with respect to investments
in U.S. Government securities;
2. Borrow money, except from banks for extraordinary or emergency
purposes and then only in amounts not to exceed 10% of the value of the
Portfolio's total assets, taken at cost, at the time of such borrowing.
Mortgage, pledge, or hypothecate any assets except in connection with any such
borrowing and in amounts not to exceed 10% of the value of the Portfolio's net
assets at the time of such borrowing. The Portfolio will not purchase
securities while borrowings exceed 5% of the Portfolio's total assets. This
borrowing provision is included to facilitate the orderly sale of portfolio
securities, for example, in the event of abnormally heavy redemption requests,
and is not for investment purposes. Collateral arrangements for premium and
margin payments in connection with the Portfolio's hedging activities are not
deemed to be a pledge of assets;
3. Purchase the securities or other obligations of any one issuer if,
immediately after such purchase, more than 5% of the value of the Portfolio's
total assets would be invested in securities or other obligations of any one
such issuer. This limitation shall not apply to issues of the U.S. Government,
its agencies or instrumentalities and to permitted investments of up to 25% of
the Portfolio's total assets;
4. Purchase the securities of an issuer if, immediately after such
purchase, the Portfolio owns more than 10% of the outstanding voting
securities of such issuer;
5. Make loans, except through the purchase or holding of debt obligations
(including privately placed securities), or the entering into of repurchase
agreements, or loans of portfolio securities in accordance with the
Portfolio's investment objective and policies (see "Investment Objectives and
Policies");
6. Purchase or sell puts, calls, straddles, spreads, or any combination
thereof, real estate, commodities, or commodity contracts, except for the
Portfolio's interest in hedging activities as described under "Investment
Objectives and Policies"; or interests in oil, gas, or mineral exploration or
development programs. However, the Portfolio may purchase securities or
commercial paper issued by companies which invest in real estate or interests
therein, including real estate investment trusts;
7. Purchase securities on margin, make short sales of securities, or
maintain a short position, except in the course of the Portfolio's hedging
activities, provided that this restriction shall not be deemed to be
applicable to the purchase or sale of when-issued securities or delayed
delivery securities;
8. Acquire securities of other investment companies, except as permitted
by the 1940 Act;
9. Act as an underwriter of securities;
10. Issue any senior security, except as appropriate to evidence
indebtedness which the Portfolio is permitted to incur pursuant to Investment
Restriction No. 2. The Portfolio's arrangements in connection with its hedging
activities as described in "Investment Objectives and Policies" shall not be
considered senior securities for purposes hereof; or
11. Purchase any equity security if, as a result, the Portfolio would
then have more than 5% of its total assets invested in securities of companies
(including predecessors) that have been in continuous operation for fewer than
three years.
INTERNATIONAL EQUITY PORTFOLIO
The International Equity Portfolio may not:
1. Borrow money, except from banks for extraordinary or emergency
purposes and then only in amounts up to 30% of the value of the Portfolio's
net assets at the time of borrowing, and except in connection with reverse
repurchase agreements and then only in amounts up to 33 1/3% of the value of
the Portfolio's net assets; or purchase securities while borrowings, including
reverse repurchase agreements, exceed 5% of the Portfolio's total assets. The
Portfolio will not mortgage, pledge, or hypothecate any assets except in
connection with any such borrowing and in amounts not to exceed 30% of the
value of the Portfolio's net assets at the time of such borrowing;
2. Purchase the securities or other obligations of any one issuer if,
immediately after such purchase, more than 5% of the value of the Portfolio's
total assets would be invested in securities or other obligations of any one
such issuer. This limitation shall not apply to securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities or to
permitted investments of up to 25% of the Portfolio's total assets;
3. Purchase the securities of an issuer if, immediately after such
purchase, the Portfolio owns more than 10% of the outstanding voting
securities of such issuer. This limitation shall not apply to permitted
investments of up to 25% of the Portfolio's total assets;
4. Purchase the securities or other obligations of issuers conducting
their principal business activity in the same industry if, immediately after
such purchase, the value of its investments in such industry would exceed 25%
of the value of the Portfolio's total assets. For purposes of industry
concentration, there is no percentage limitation with respect to investments
in U.S. Government securities;
5. Make loans, except through the purchase or holding of debt obligations
(including restricted securities), or the entering into of repurchase
agreements, or loans of portfolio securities in accordance with the
Portfolio's investment objective and policies, see "Investment Practices" in
the Prospectus and "Investment Objectives and Policies" in this Statement of
Additional Information;
6. Purchase or sell puts, calls, straddles, spreads, or any combination
thereof, real property, including limited partnership interests, commodities,
or commodity contracts, except for the Portfolio's interests in hedging and
foreign exchange activities as described under "Investment Practices" in the
Prospectus; or interests in oil, gas, mineral or other exploration or
development programs or leases. However, the Portfolio may purchase securities
or commercial paper issued by companies that invest in real estate or
interests therein including real estate investment trusts;
7. Purchase securities on margin, make short sales of securities, or
maintain a short position in securities, except to obtain such short-term
credit as necessary for the clearance of purchases and sales of securities,
provided that this restriction shall not be deemed to apply to the purchase or
sale of when-issued securities or delayed delivery securities;
8. Acquire securities of other investment companies, except as permitted
by the 1940 Act;
9. Act as an underwriter of securities, except insofar as the Portfolio
may be deemed to be an underwriter under the 1933 Act by virtue of disposing
of portfolio securities; or
10. Issue any senior security, except as appropriate to evidence
indebtedness which the Portfolio is permitted to incur pursuant to Investment
Restriction No. 1. The Portfolio's arrangements in connection with its hedging
activities as described in "Investment Practices" in the Prospectus shall not
be considered senior securities for purposes hereof.
BOND DEBENTURE PORTFOLIO
The Bond Debenture Portfolio of the Trust may not:
1. Sell short or buy on margin, although it may obtain short-term credit
as needed to clear purchases of securities;
2. Buy or sell put or call options, although it may buy, hold or sell
warrants acquired with debt securities;
3. Borrow in excess of 5% of the Portfolio's gross assets taken at cost or
market value whichever is lower at the time of borrowing, and then only as a
temporary measure for extraordinary or emergency purposes;
4. Act as an underwriter of securities issued by others, except where it
may be deemed to be an underwriter by selling a portfolio security requiring
registration under the Securities Act of 1933;
5. Invest knowingly more than 15% of its gross assets in illiquid
securities;
6. Make loans, except for (a) time or demand deposits with banks, (b)
purchasing commercial paper or publicly-offered debt securities at original
issue or otherwise, (c) short-term repurchase agreements with sellers of
securities the Portfolio has bought and (d) loans of portfolio securities to
registered broker-dealers if 100% secured by cash or cash equivalents, made in
full compliance with applicable regulations and which, in management's
opinion, do not expose the Portfolio to significant risks or impair its
qualification for pass-through tax treatment under the Internal Revenue Code;
7. Pledge, mortgage, or hypothecate its assets;
8. Buy or sell real estate (including limited partnership interests but
excluding securities of companies, such as real estate investment trusts,
which deal in real estate or interests therein) or oil, gas or other mineral
leases, or commodities, or commodity contracts although it may buy securities
of companies that deal in such interests (however, the Portfolio may hold and
sell any of the aforementioned or any other property acquired through
ownership of other securities, although the Portfolio may not purchase
securities for the purpose of acquiring those interests);
9. Buy securities issued by any other open-end investment company (except
pursuant to a plan of merger, consolidation or acquisition of assets),
although it may invest up to 5% of its gross assets, taken at market value at
the time of investment, in closed-end investment companies, provided such
purchase is made in the open market and does not involve the payment of a fee
or commission greater than the customary broker's commission;
10. Invest more than 5% of its gross assets, taken at market value at the
time of investment in securities of companies with less than three years'
continuous operation, including predecessor companies;
11. With respect to 75% of its gross assets, buy the securities of any
issuer if the purchase causes it (a) to have more than 5% of its gross assets
invested in the securities of such issuer (except obligations of the United
States, its agencies or instrumentalities) or (b) to own more than 10% of the
outstanding voting securities of such issuer;
12. Hold securities of any issuer, any of whose officers, directors or
security holders is an officer, director or partner of the Adviser or
Sub-Adviser or an officer or director of the Portfolio, if after the purchase
of the securities of such issuer, one or more of such persons owns
beneficially more than 1/2 of 1% of the securities of such issuer and such
persons together own beneficially more than 5% of such securities;
13. Concentrate its investments in a particular industry, though, if it
is deemed appropriate to its investment objective, up to 25% of the market
value of its gross assets at the time of investment may be invested in any one
industry classification used for investment purposes;
14. Buy from or sell to any of the Trust's directors, employees, or the
Investment Adviser or Sub-Adviser or any of its officers, directors, partners
or employees, any securities other than shares of the Portfolio's common
stock; or
15. Invest more than 10% of the market value of its gross assets at the
time of investment in debt securities which are in default as to interest or
principal.
With respect to investment restriction 5. above, securities subject to legal
or contractual restrictions on resale, which are determined by the Board of
Trustees, or by the Sub-Adviser pursuant to delegated authority, to be liquid
are considered liquid securities.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS - QUALITY BOND PORTFOLIO, SELECT
EQUITY PORTFOLIO, LARGE CAP STOCK PORTFOLIO AND INTERNATIONAL EQUITY PORTFOLIO
The investment restriction described below is not a fundamental policy of
these Portfolios and may be changed by the Trustees. This non-fundamental
investment policy requires that each such Portfolio may not:
(i) acquire any illiquid securities, such as repurchase agreements with
more than seven days to maturity or fixed time deposits with a duration of
over seven calendar days, if as a result thereof, more than 15% of the market
value of the Portfolio's total assets would be in investments that are
illiquid;
(ii) Purchase any security if, as a result, the Portfolio would then have
more than 5% of its total assets invested in securities of companies
(including predecessors) that have been in continuous operation for fewer than
three years;
(iii) Invest in warrants (other than warrants acquired by the Portfolio
as part of a unit or attached to securities at the time of purchase) if, as a
result, the investments (valued at the lower of cost or market) would exceed
5% of the value of the Portfolio's net assets or if, as a result, more than 2%
of the Portfolio's net assets would be invested in warrants not listed on a
recognized U.S. or foreign stock exchange, to the extent permitted by
applicable state securities laws; or
(iv) Purchase or retain securities of any issuer if, to the knowledge of
the Portfolio, any of the Portfolio's officers or Trustees or any officer of
the Advisor individually owns more than 1/2 of 1% of the issuer's outstanding
securities and such persons owning more than 1/2 of 1% of such securities
together beneficially own more than 5% of such securities, all taken at
market.
DESCRIPTION OF SECURITIES RATINGS
A description of Corporate Bond Ratings is found in the Appendix to the
Prospectus.
COMMERCIAL PAPER RATINGS
COMMERCIAL PAPER
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt having an original maturity of no
more than 365 days. Ratings are graded into four categories, ranging from "A"
for the highest quality obligations to "D" for the lowest. The four categories
are as follows:
<TABLE>
<CAPTION>
<S> <C>
A Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are
delineated with the numbers 1, 2 and 3 to indicate the relative
degree of safety. Those issues determined to possess overwhelming
safety characteristics are denoted with a plus (+) sign designation.
A-1 This designation indicates that the degree of safety regarding
timely payment is very strong.
A-2 Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as
overwhelming as for issues designated "A-1."
A-3 Issues carrying this designation have a satisfactory capacity for
timely of payment. They are, however, somewhat more vulnerable to
the adverse effects changes in circumstances than obligations
carrying the higher designations.
B Issues rated "B" are regarded as having only an adequate capacity
for timely payment. However, such capacity may be damaged by
changing conditions or short-term adversities.
C&D These ratings indicate that the issue is either in default or is
expected to be in default upon maturity.
</TABLE>
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations.
Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations.
Issuers rated Not Prime do not fall within any of the Prime rating categories.
VARIABLE RATE DEMAND BOND RATINGS
Standard & Poor's assigns "dual" ratings to all long-term debt issues that
have as part of their provisions a variable rate demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, 'AAA/A-1') or if the nominal maturity is short, a rating
of 'SP-1+/AAA' is assigned.
NOTES
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive
a note rating. Notes maturing beyond 3 years will most likely receive a
long-term debt rating. The following criteria will be used in making that
assignment:
- - Amortization schedule (the longer the final maturity relative to
other maturities the more likely it will be treated as a note).
- - Source of payment (the more dependent the issue ison the market for
its refinancing, the more likely it will be treated as a note). Note rating
symbols are as follows:
SP-1 Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety characteristics will be
given a plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest.
SP-3 Speculative capacity to pay principal and interest.
PREFERRED STOCK RATINGS (STANDARD & POOR'S)
AAA This is the highest rating that may be assigned by Standard & Poor's
to a preferred stock issue and indicates an extremely strong capacity to pay
the preferred stock obligations.
AA A preferred stock issue rated 'AA' also qualifies as a high-quality
fixed income security. The capacity to pay preferred stock obligations is very
strong, although not as overwhelming as for issues rated 'AAA'.
A An issue rated 'A' is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions.
BBB An issue rated 'BBB' is regarded as backed by an adequate capacity
to pay the preferred stock obligations. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity to make payments for a
preferred stock in this category than for issues in the 'A' category.
BB Preferred stock rated 'BB', 'B' and 'CCC' is regarded, on balance, as
B Predominantly speculative with respect to the issuer's capacity to pay
CCC preferred stock obligations. 'BB' indicates the lowest degree of
speculation and 'CCC' the highest degree of speculation. While such issues
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse
conditions.
CC The rating 'CC' is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments, but that is currently paying.
C A preferred stock rated 'C' is a non-paying issue.
D A preferred stock rated 'D' is a non-paying issue with the issuer in
default on debt instruments.
PLUS (+) OR MINUS (-): To provide more detailed indications of preferred
stock quality, the ratings from 'AA' to 'B' may be modified by the addition of
a plus or minus sign to show relative standing within the major rating
categories.
NR This indicates that 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.
A preferred stock 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 to S&P 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 based on other circumstances.
MOODY'S INVESTORS SERVICE, INC. - A brief description of the applicable
Moody's Investors Service, Inc. rating symbols with respect to preferred stock
and their meanings (as published by Moody's Investors Service, Inc.) follows:
PREFERRED STOCK RATINGS (MOODY'S)
Preferred stock rating symbols and their definitions are as follows:
aaa: An issue which is rated 'aaa' is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least
risk of dividend impairment within the universe of preferred stocks.
aa: An issue which is rated 'aa' is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance the earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
a: An issue which is rated 'a' is considered to be an upper-medium
preferred stock. While risks are judged to be somewhat greater than in the
'aaa' and 'aa' classifications, earnings and asset protection are,
nevertheless, expected to be maintained at adequate levels.
baa: An issue which is rated 'baa' is considered to be a medium grade
preferred stock, neither highly protected nor poorly secured. Earnings and
asset protection appear adequate at present but may be questionable over any
great length of time.
ba: An issue which is rated 'ba' is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse
periods. Uncertainty of position characterizes preferred stocks in this class.
b: An issue which is rated 'b' generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
caa: An issue which is rated 'caa' is likely to be in arrears on
dividend payments. This rating designation does not purport to indicate the
future status of payments.
ca: An issue which is rated 'ca' is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual
payment.
c: This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
NOTE: Beginning May 3, 1982, Moody's began applying numerical modifiers
1, 2 and 3 in each rating classification from "aa" through "b" in its
preferred stock rating system. The modifier 1 indicates that the security
ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the issue
ranks in the lower end of its generic rating category.
OFFICERS AND TRUSTEES
MANAGEMENT OF THE TRUST
<TABLE>
<CAPTION>
<S> <C> <C>
Lorry J. Stensrud* President and Chief President of Cova Financial Services
One Tower Lane, Suite 3000 Executive Officer Life Insurance Company ("Cova Life")
Oakbrook Terrace, IL 60181-4644 since June, 1995; prior thereto,
Age: 47 Executive Vice President of Cova Life
William C. Mair* Vice President, Treasurer, Vice President and Controller of
One Tower Lane, Suite 3000 Controller, Chief Cova Life; Vice President, Treasurer
Oakbrook Terrace, IL 60181-4644 Financial Officer, Chief and Controller of Cova Investment
Age: 54 Accounting Officer and Advisory Corporation
Trustee
Stephen M. Alderman Trustee Partner in the law firm of Garfield
211 West Wacker Drive & Merel
Chicago, IL 60606
Age: 36
Theodore A. Myers Trustee Executive Vice President and Chief
1940 East 6th Street Financial Officer of Qualitech
Cleveland, OH 44114 Steel Corporation, a producer of
Age: 65 high quality engineered steels for
automotive, transportation and capital
goods industries; Director of McClouth
Steel Co.; Prior to August, 1993,
Senior Vice President, Chief Financial
Officer and a Director of Doskocil
Companies, Inc., a food processing and
distribution company; Trustee of other
investment companies advised by VKAC
Deborah A. Vohasek Trustee Principal, Vohasek Oetjen Marketing
601 South LaSalle Street
Chicago, IL 60605
Age: 32
R. Kevin Williams Trustee Partner in the law firm of
20 North Wacker Drive O'Donnell, Byrne & Williams from
Chicago, IL 60606 June 1993 through the present;
Age: 41 Associate Attorney, Sonnenberg,
Anderson, O'Donnell & Rodriguez,
September 1988 through May 1993
William H. Wilton Vice President Vice President & Actuary of Cova
One Tower Lane, Suite 3000 Life; Prior to October, 1992,
Oakbrook Terrace, IL 60181-4844 Associate Actuary, Allstate Life
Age: 35 Insurance Co., Northbrook, IL
Jeffery K. Hoelzel Senior Vice President and Senior Vice President, General
One Tower Lane, Suite 3000 Secretary Counsel, Secretary and Director of
Oakbrook Terrace, IL 60181-4644 Cova Life; Secretary and Director of
Age: 32 Cova Investment Advisory Corporation;
prior to June, 1992, Associate Attorney
with the law firm of Lord, Bissell &
Brook in Chicago
<FN>
* Interested person of the Trust within the meaning of the 1940 Act.
</TABLE>
Each Trustee of the Trust who is not an interested person of the Trust or
Adviser or Sub-Adviser receives an annual fee of $10,000 and an additional fee
of $1,000 for each Trustees' meeting attended. In addition, disinterested
Trustees who are members of any Board committees will receive a separate
$1,000 fee for attendance of any committee meeting that is held on a day on
which no Board meeting is held.
SUBSTANTIAL SHAREHOLDERS
Shares of the Trust are issued and redeemed only in connection with
investments in and payments under certain variable annuity contracts
("variable contracts") issued by Cova Financial Services Life Insurance
Company and its affiliated insurance companies. On March 31, 1996, Cova
Variable Annuity Account One, a separate account of Cova Life, was known to
the Board of Trustees and the management of the Trust to own of record 98.85%
of the shares of the Trust and Cova Variable Annuity Account Five, a separate
account of Cova Financial Life Insurance Company, was known to own of record
1.15%. Cova Life contributed the initial capital to the Trust.
OWNERSHIP BY CERTAIN BENEFICIAL OWNERS
Cova Life has advised the Trust that as of April 23, 1996, there were no
persons owning variable contracts which would entitle them to instruct Cova
Life with respect to more than 5% of the voting securities of any Portfolio of
the Trust.
CUSTODIAN
Investors Bank & Trust Company, 89 South Street, Boston, Massachusetts 02111,
is the custodian of the Trust and has custody of all securities and cash of
the Trust. The custodian, among other things, attends to the collection of
principal and income, and payment for and collection of proceeds of securities
bought and sold by the Trust.
PERFORMANCE DATA
As required by regulations of the Securities and Exchange Commission, the
annualized total return of the Growth and Income, Money Market, Quality
Income, High Yield and Stock Index Portfolios for a period is computed by
assuming a hypothetical initial payment of $1,000. It is then assumed that all
of the dividends and distributions by the Portfolio over the period are
reinvested. It is then assumed that at the end of the period, the entire
amount is redeemed. The annualized total return is then calculated by
determining the annual rate required for the initial payment to grow to the
amount which would have been received upon redemption.
Investment operations for the Portfolios depicted below commenced on December
11, 1989 for the Quality Income and High Yield Portfolios; July 1, 1991 for
the Money Market Portfolio; November 1, 1991 for the Stock Index Portfolio;
and May 1, 1992 for the Growth and Income Portfolio. The average annual total
return computations for these Portfolios are calculated from the first day of
the month following the month in which the investment operations commenced.
The performance figures shown for the Portfolios in the chart below reflect
the actual fees and expenses paid by the Portfolios.
AVERAGE ANNUAL TOTAL RETURN FOR THE PERIODS ENDED 12/31/95
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Portfolio Performance
----------------------
Portfolio 1 year 5 years Since Inception
- ----------------- ---------------------- --------- ----------------
Growth and Income 32.24% -- 12.26%
Money Market 6.01% -- 4.47%
Quality Income 17.99% 9.12% 8.93%
High Yield 16.69% 15.14% 13.35%
Stock Index 36.87% -- 14.59%
</TABLE>
LEGAL COUNSEL AND INDEPENDENT AUDITORS
Blazzard, Grodd & Hasenauer, P.C., Westport, Connecticut is counsel to the
Trust and passes upon the legality of the Trust's shares.
The independent auditors for the Trust are KPMG Peat Marwick, LLP. The
selection of independent auditors was ratified by the shareholders of the
Trust at a Special Meeting of Shareholders of the Trust held on February 9,
1996.
INVESTMENT ADVISORY AGREEMENT
Cova Investment Advisory Corporation (the "Investment Adviser"), One Tower
Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644 is an Illinois
corporation which was incorporated on August 31, 1993 under the name Oakbrook
Investment Advisory Corporation and which is registered with the Securities
and Exchange Commission as an investment adviser under the Investment Advisers
Act of 1940. The Investment Adviser is a wholly-owned subsidiary of Cova Life
Management Company, a Delaware corporation, which in turn, is a wholly-owned
subsidiary of Cova Corporation, a Missouri corporation, which in turn, is a
wholly-owned subsidiary of General American Life Insurance Company ("General
American"), a St. Louis-based mutual company. General American has more than
$235 billion of life insurance in force and approximately $9.6 billion in
assets.
The Investment Adviser commenced providing investment advisory services to all
Portfolios of the Trust as of May 1, 1996 pursuant to an Investment Advisory
Agreement dated April 1, 1996 ("Investment Advisory Agreement"). Prior to this
date, VKAC had acted as the investment adviser to all Portfolios of the Trust.
The Investment Advisory Agreement, between the Investment Adviser and the
Trust, was approved by shareholders of the Trust at a Special Meeting of
Shareholders held on February 9, 1996 and was also approved by the Board of
Trustees of the Trust on that same date.
As described in the Prospectus, the Investment Adviser has retained
Sub-Advisers to assist it in managing the Portfolios. The Sub-Advisory
Agreement between the Investment Adviser and Van Kampen American Capital
Investment Advisory Corp. was approved by the Board of Trustees, including a
majority of the independent Trustees, at a meeting held on February 9, 1996
and was also approved by the shareholders of the Trust at the Special Meeting
held on that same date. The Sub-Advisory Agreements between the Investment
Adviser and Lord, Abbett & Co. and J. P. Morgan Investment Management Inc.,
respectively, were approved by the Board of Trustees, including a majority of
the independent Trustees, on February 9, 1996. Cova Financial Services Life
Insurance Company, as sole shareholder of the Portfolios for which J. P.
Morgan Investment Management Inc. and Lord, Abbett & Co. act as Sub-Advisers,
approved the Sub-Advisory Agreements between the Investment Adviser and each
of these two Sub-Advisers by way of corporate resolutions adopted in April of
1996.
Under the terms of the Investment Advisory Agreement, the Investment Adviser
is obligated to (i) manage the investment and reinvestment of the assets of
each Portfolio of the Trust in accordance with each Portfolio's investment
objective and policies and limitations, or (ii) in the event that the
Investment Adviser shall retain a sub-adviser or sub-advisers, to supervise
and implement the investment activities of any Portfolio for which any such
sub-adviser has been retained, including responsibility for overall management
and administrative support including managing, providing for and compensating
any sub-advisers; and to administer the Trust's affairs. The Investment
Advisory Agreement further provides that the Investment Adviser agrees, among
other things, to administer the business affairs of each Portfolio, to furnish
offices and necessary facilities and equipment to each Portfolio, to provide
administrative services for each Portfolio, to render periodic reports to the
Board of Trustees of the Trust with respect to each Portfolio, and to permit
any of its officers or employees, or those of any sub-adviser to serve without
compensation as trustees or officers of the Portfolio if elected to such
positions.
The Investment Advisory Agreement provides that the Investment Adviser will
not be liable for any error in judgment or of law, or for any loss suffered by
the Trust in connection with the matters to which the agreement relates,
except a loss resulting from willful misfeasance, bad faith, or gross
negligence on the part of the Investment Adviser in the performance of its
obligations and duties, or by reason of its reckless disregard of its
obligations and duties under the Agreement.
The Investment Adviser's activities are subject to the review and supervision
of the Trust's Trustees to whom the Investment Adviser renders periodic
reports of the Trust's investment activities.
The Investment Advisory Agreement may be terminated without penalty upon 60
days written notice by either party and will automatically terminate in the
event of assignment.
INVESTMENT DECISIONS
Investment decisions for the Trust and for the other investment advisory
clients of the Sub-Advisers are made with a view to achieving their respective
investment objectives and after consideration of such factors as their current
holdings, availability of cash for investment, and the size of their
investments generally. Frequently, a particular security may be bought or sold
for only one client or in different amounts and at different times for more
than one but less than all clients. Likewise, a particular security may be
bought for one or more clients when one or more other clients are selling the
security. In addition, purchases or sales of the same security may be made for
two or more clients of a Sub-Adviser on the same day. In such event, such
transactions will be allocated among the clients in a manner believed by the
Sub-Adviser to be equitable to each. In some cases, this procedure could have
an adverse effect on the price or amount of the securities purchased or sold
by the Trust. Purchase and sale orders for the Trust may be combined with
those of other clients of a Sub-Adviser in the interest of achieving the most
favorable net results for the Trust.
PORTFOLIO TRANSACTIONS
Transactions on U.S. stock exchanges and other agency transactions involve the
payment by the Trust of negotiated brokerage commissions. Such commissions
vary among different brokers. Also, a particular broker may charge different
commissions according to such factors as the difficulty and size of the
transaction. Transactions in foreign securities often involve the payment of
fixed brokerage commissions, which are generally higher than those in the
United States. There is generally no stated commission in the case of
securities traded in the over-the-counter markets, but the price paid by the
Trust usually includes an undisclosed dealer commission or mark-up. In
underwritten offerings, the price paid by the Trust includes a disclosed,
fixed commission or discount retained by the underwriter or dealer. It is
currently intended that the Sub-Advisers will place all orders for the
purchase and sale of portfolio securities for the Trust and buy and sell
securities for the Trust through a substantial number of brokers and dealers.
In so doing, the Sub-Advisers will use their best efforts to obtain for the
Trust the best price and execution available. In seeking the best price and
execution, the Sub-Advisers, having in mind the Trust's best interests, will
consider all factors they deem relevant, including, by way of illustration,
price, the size of the transaction, the nature of the market for the security,
the amount of the commission, the timing of the transaction taking into
account market prices and trends, the reputation, experience, and financial
stability of the broker-dealer involved, and the quality of service rendered
by the broker-dealer in other transactions.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional
investors to receive research, statistical, and quotation services from
broker-dealers who execute portfolio transactions for the clients of such
advisers. Consistent with this practice, the Sub-Advisers may receive
research, statistical, and quotation services from any broker-dealers with
whom they place the Trust's portfolio transactions. These services, which in
some cases may also be purchased for cash, include such matters as general
economic and security market reviews, industry and company reviews,
evaluations of securities, and recommendations as to the purchase and sale of
securities. Some of these services may be of value to the Sub-Advisers and/or
their affiliates in advising various other clients (including the Trust),
although not all of these services are necessarily useful and of value in
managing the Trust. The management fees paid by the Trust are not reduced
because the Sub-Advisers and/or their affiliates may receive such services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, a
Sub-Adviser may cause a Portfolio to pay a broker-dealer who provides
brokerage and research services to the Sub-Adviser an amount of disclosed
commission for effecting a securities transaction for the Portfolio in excess
of the commission which another broker- dealer would have charged for
effecting that transaction provided that the Sub-Adviser determines in good
faith that such commission was reasonable in relation to the value of the
brokerage and research services provided by such broker-dealer viewed in terms
of that particular transaction or in terms of all of the accounts over which
investment discretion is so exercised. A Sub-Adviser's authority to cause a
Portfolio to pay any such greater commissions is also subject to such policies
as the Adviser or the Trustees may adopt from time to time.
FINANCIAL STATEMENTS
The financial statements, notes and reports of the Independent Auditors for
each of the Portfolios of the Trust are included herein.
Van Kampen Merritt Series Trust Quality Income Portfolio
For the 12-month period ended 12/31/95
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders of the Quality Income
Portfolio of the Van Kampen Merritt Series Trust:
We have audited the accompanying statement of assets and liabilities of the
Quality Income Portfolio (one of the portfolios comprising the Van Kampen
Merritt Series Trust) (the "Fund"),including the portfolio of investments, as
of December 31, 1995, and the related statement of operations for the year
then ended, the statement of changes in net assets for each of the two years
in the period then ended, and the financial highlights for each of the periods
presented. These financial statements and financial highlights are the responsi-
bility of the Fund's management. Our responsibility is to express an opinion on
these financial statements and financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of December 31, 1995, by correspondence with the
custodian and brokers. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Quality Income Portfolio of the Van Kampen Merritt Series Trust as of
December 31, 1995, the results of its operations for the year then ended, the
changes in its net assets for each of the two years in the period then ended,
and the financial highlights for each of the periods presented, in conformity
with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois
January 30, 1996, except as to
Note 6, which is as of February 9, 1996
Van Kampen Merritt Series Trust Quality Income Portfolio
<TABLE>
Portfolio of Investments
December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------
Par Amount
in Local
Currency U.S. $
(000) Description Coupon Maturity Market Value
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Domestic Bonds and Debt Securities 83.9%
Agencies 3.0%
250 Guaranteed Export Trust 95-A 6.28 % 06/15/04 $ 255,045
1,000 New England Education Loan Marketing Corp. 6.125 07/17/98 1,009,410
--------------
1,264,455
--------------
Asset-Backed Securities 3.6%
1,000 American Express Master Trust Ser 93-1A 5.375 07/15/01 986,269
500 Signet Master Trust Ser 94-4A 6.800 12/15/00 511,515
--------------
1,497,784
--------------
Bonds 47.0%
2,000 Allegheny Generating Co. 6.875 09/01/23 2,006,856
2,000 AT & T Corp. 8.250 01/11/00 2,173,220
3,000 Bank of Boston Corp. 5.925 08/26/98 2,978,100
1,500 Cyprus Amax Minerals Co. 7.375 05/15/07 1,605,318
16,000 DLJ Mortgage Acceptance Corp. - Interest Only 3.833 09/25/25 1,012,501
3,000 Exxon Capital Corp. * 11/15/04 1,780,320
2,000 Florida Gas Transmission Co. 7.750 11/01/97 2,060,460
1,000 General Electric Capital Corp. 5.800 04/01/08 1,122,540
630 Greyhound Financial Corp. 8.500 02/15/99 678,606
1,928 Jet Equipment Trust Ser A3 8.160 12/15/96 1,966,020
2,000 Sandoz Corp. 6.625 07/28/05 2,059,000
--------------
19,442,941
--------------
Medium-Term Securities 5.4%
1,000 General Motors Acceptance Corp. 8.875 06/01/10 1,220,967
1,000 MBNA Corp. 6.500 09/15/00 1,024,682
--------------
2,245,649
--------------
Mortgage-Backed Securities 12.8%
1,500 Citicorp Mortgage Securities Inc. #94-11A2 6.250 08/25/24 1,498,717
667 FHLB 4.140 06/04/98 646,821
74 FHLMC 8.000 09/01/08 76,564
2,000 FNMA 6.630 09/03/98 2,015,440
85 FNMA 8.000 09/01/03 87,686
73 FNMA 8.500 07/01/19 76,270
100 FNMA REMIC #89-94G PAC 7.500 12/25/19 103,350
171 GNMA 9.000 01/15/20 181,836
600 Prudential Home Mortgage Securities Co. #93-28A7 7.375 08/25/23 610,875
--------------
5,297,559
--------------
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments
December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------
Par Amount
in Local
Currency U.S. $
(000) Description Coupon Maturity Market Value
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Treasury Securities 12.1%
1,650 U.S. T-Bonds 6.250 % 08/15/23 $ 1,699,945
400 U.S. T-Notes 6.000 08/31/97 405,000
2,750 U.S. T-Notes 6.875 03/31/00 2,907,135
--------------
5,012,080
--------------
Total Domestic Bonds and Debt Securities 34,760,468
--------------
Foreign Bonds and Debt Securities 12.3%
Cayman Islands 9.7%
1,500 Banco Bilbao Vizcaya International Finance (US$) 6.875 10/27/05 1,531,875
1,500 Santander Financial Issuances (US$) 6.775 09/30/49 1,383,750
1,000 Santander Financial Issuances Limited (US$) 7.875 04/15/05 1,102,986
--------------
4,018,611
--------------
Colombia 2.6%
1,060 Financiera Energet (US$) 6.625 12/13/96 1,058,675
--------------
Total Foreign Bonds and Debt Securities 5,077,286
--------------
Total Long-Term Investment 96.2%
(Cost $38,465,877) <F1> 39,837,754
Repurchase Agreement 4.8%
State Street Bank & Trust, U.S. T-Note, $1,705,000 par, 7.50%
coupon, due 11/15/16, dated 12/29/95,to be sold on 01/02/96
at $1,968,257 1,967,000
Liabilities in Excess of Other Assets -1.0% (413,891)
--------------
Net Assets 100.0% $ 41,390,863
==============
*Zero coupon bond
<FN>
<F1> At December 31, 1995, cost for federal income tax purposes is $38,465,877; the aggregate
gross unrealized appreciation is $1,376,727 and the aggregate gross unrealized depreciation is
$4,850, resulting in net unrealized appreciation of $1,371,877.
</TABLE>
See Notes to Financial Statements
<TABLE>
The following table summarizes the portfolio composition at December 31, 1995,
based upon quality ratings issued by Standard & Poor's. For securities not rated by
Standard and Poor's, the Moody's rating is used.
Portfolio Composition by Credit Quality
--------------------------------------------------------------------------------------------
<S> <C>
U.S. Govt. and Agency Obligations 21.7 %
AAA 20.6
AA 11.0
A 21.9
BBB 19.4
NR 5.4
------------
100.0 %
============
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST QUALITY INCOME PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- -----------------------------------------------------------------------
<S> <C>
ASSETS:
Investments, at Market Value
(Cost $38,465,877) (Note 1) $ 39,837,754
Repurchase Agreements (Note 1) 1,967,000
Cash 406
Interest Receivable 685,422
-------------
Total Assets 42,490,582
-------------
LIABILITIES:
Payables:
Investments Purchased 1,064,501
Investment Advisory Fee (Note 2) 17,366
Fund Shares Repurchased 420
Accrued Expenses 17,432
--------------
Total Liabilities 1,099,719
--------------
NET ASSETS $ 41,390,863
==============
NET ASSETS CONSIST OF:
Paid In Surplus (Note 3) $ 41,324,208
Net Unrealized Appreciation on Investments 1,371,877
Accumulated Net Realized Loss on Investments (1,305,222)
--------------
NET ASSETS $ 41,390,863
==============
NET ASSET VALUE PER SHARE
($41,390,863 divided by 3,807,302 shares
outstanding; an unlimited number of shares without
par value are authorized) (Note 3) $10.87
==============
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST QUALITY INCOME PORTFOLIO
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1995
- -----------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Interest $ 2,746,403
-------------
EXPENSES:
Investment Advisory Fee (Note 2) 195,378
Custody 36,034
Trustees Fees and Expenses (Note 2) 21,153
Audit 18,879
Legal (Note 2) 9,961
Other 10,332
-------------
Total Operating Expenses 291,737
Interest Expense (Note 4) 18,102
-------------
Total Expenses 309,839
Less Expenses Reimbursed by Cova Life 57,283
-------------
Net Expenses 252,556
-------------
NET INVESTMENT INCOME $ 2,493,847
=============
REALIZED AND UNREALIZED GAIN/LOSS ON INVESTMENTS:
Realized Gain/Loss on Investments:
Proceeds from Sales $ 81,937,725
Cost of Securities Sold (81,484,103)
-------------
Net Realized Gain on Investments 453,622
-------------
Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period (1,792,274)
End of the Period 1,371,877
-------------
Net Unrealized Appreciation on Investments
During the Period 3,164,151
-------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS $ 3,617,773
=============
NET INCREASE IN NET ASSETS FROM OPERATIONS $ 6,111,620
=============
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST QUALITY INCOME PORTFOLIO
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1995 and 1994
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Operations:
Net Investment Income $ 2,493,847 $ 2,355,865
Net Realized Gain/Loss on Investments 453,622 (1,758,844)
Net Unrealized Appreciation/Depreciation on
Investments During the Period 3,164,151 (2,283,981)
--------------- ----------------
Change in Net Assets from Operations 6,111,620 (1,686,960)
Distributions from Net Investment Income (2,493,847) (2,355,865)
--------------- ----------------
NET CHANGE IN NET ASSETS FROM
INVESTMENT ACTIVITIES 3,617,773 (4,042,825)
--------------- ----------------
FROM CAPITAL TRANSACTIONS (Note 3):
Proceeds from Shares Sold 22,566,180 40,415,842
Net Asset Value of Shares Issued Through
Dividend Reinvestment 2,493,847 2,355,865
Cost of Shares Repurchased (21,223,354) (55,910,839)
--------------- ----------------
NET CHANGE IN NET ASSETS FROM CAPITAL
TRANSACTIONS 3,836,673 (13,139,132)
--------------- ----------------
TOTAL INCREASE/DECREASE IN NET ASSETS 7,454,446 (17,181,957)
NET ASSETS:
Beginning of the Period 33,936,417 51,118,374
--------------- ----------------
End of the Period $ 41,390,863 $ 33,936,417
=============== ================
</TABLE>
See Notes to Financial Statements
<TABLE>
Van Kampen Merritt Series Trust Quality Income Portfolio
Financial Highlights
The following schedule presents financial highlights for one share of the Fund
outstanding throughout the periods indicated.
- -----------------------------------------------------------------------------------------------------------------------------
December 11, 1989
(Commencement of
Years Ended December 31, Investment
------------------------ Operations) to
1995 1994 1993 1992 1991 1990 December 31, 1989
----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $9.815 $10.886 $10.699 $10.618 $9.969 $9.930 $10.000
------- ------- ------- ------- ------- ------ -------
Net Investment Income .667 .603 .641 .696 .753 .713 .043
Net Realized and Unrealized Gain/Loss on
Investments 1.056 (1.071) .518 .081 .649 .039 (.070)
------- ------- ------- ------- ------- ------ -------
Total from Investment Operations 1.723 (.468) 1.159 .777 1.402 .752 (.027)
------- ------- ------- ------- ------- ------ -------
Less:
Distributions from Net Investment Income .667 .603 .641 .696 .753 .713 .043
Distributions from Net Realized Gain on
Investments .000 .000 .331 .000 .000 .000 .000
------- ------- ------- ------- ------- ------ -------
Total Distributions .667 .603 .972 .696 .753 .713 .043
------- ------- ------- ------- ------- ------ -------
Net Asset Value, End of Period $10.871 $9.815 $10.886 $10.699 $10.618 $9.969 $9.930
======= ======= ======= ======= ======= ====== =======
Total Return * 17.99% (4.33%) 11.04% 7.61% 14.71% 7.99% (.27%) **
Net Assets at End of Period (In millions) $41.4 $33.9 $51.1 $24.1 $6.8 $6.1 $2.5
Ratio of Operating Expenses to Average Net
Assets* (Annualized) .60% .59% .60% .60% .60% .74% .70%
Ratio of Interest Expenses to Average Net
Assets* (Annualized) (Note 4) .05% N/A N/A N/A N/A N/A N/A
Ratio of Net Investment Income to
Average Net Assets* (Annualized) 6.42% 5.69% 5.82% 6.87% 7.45% 7.64% 7.83%
Portfolio Turnover 219.46% 177.63% 318.40% 231.91% 12.86% 59.25% .00%
*If certain expenses had not been assumed by
Cova Life, total return would have been
lower and the ratios would have been as
follows:
Ratio of Operating Expenses to Average Net
Assets (Annualized) .75% .68% .70% .88% 1.10% 1.53% 9.15%
Ratio of Net Investment Income to Average
Net Assets (Annualized) 6.27% 5.60% 5.73% 6.59% 6.96% 6.85% (.62%)
** Non-annualized
</TABLE>
N/A - Prior to 1995, interest expense was immaterial and subsequently
netted against interest income.
See Notes to Financial Statements
VAN KAMPEN MERRITT
SERIES TRUST QUALITY INCOME PORTFOLIO
Notes to Financial Statements
December 31, 1995
1. Significant Accounting Policies
Van Kampen Merritt Series Trust (the "Trust"), under which the Quality Income
Portfolio (the "Fund") is organized as a separate sub-trust, is registered as
a diversified open-end management investment company under the Investment
Company Act of 1940, as amended. The Fund's investment objective 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 Trust and Fund commenced investment operations on December
11, 1989.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A. Security Valuation - Investments are stated at value using market
quotations, or if such valuations are not available, estimates obtained from
yield data relating to instruments or securities with similar characteristics
in accordance with procedures established in good faith by the Board of
Trustees. Short-term securities with remaining maturities of less than 60
days are valued at amortized cost.
B. Security Transactions - Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis.
The Fund may purchase and sell securities on a "when issued" or "delayed
delivery" basis, with settlement to occur at a later date. The value of the
security so purchased is subject to market fluctuations during this period.
The Fund will maintain in a segregated account with its custodian assets
having an aggregate value at least equal to the amount of the when issued or
delayed delivery purchase commitments until payment is made. At December 31,
1995, there were no when issued or delayed delivery purchase commitments.
C. Investment Income and Expense - Interest income and expenses are recorded
on an accrual basis. Bond premium and original issue discount are amortized
over the expected life of each applicable security.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
D. Federal Income Taxes - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Therefore, no provision for federal income taxes is
required.
The Fund intends to utilize provisions of the Federal income tax laws
which allow it to carry a realized capital loss forward for eight years
following the year of the loss and offset such losses against any future
realized capital gains. At December 31, 1995, the Fund had an accumulated
capital loss carryforward for tax purposes of $1,305,222 which will expire on
December 31, 2002.
E. Distribution of Income and Gains - The Fund declares and pays dividends
monthly from net investment income. Net realized gains, if any, are
distributed annually. Distributions are automatically reinvested in Fund
Shares. Distributions from net realized gains for book purposes may include
short-term capital gains which are included in ordinary income for tax
purposes.
2. Investment Advisory Agreement and Other Transactions with Affiliates
Under the terms of the Fund's Investment Advisory Agreement, Van Kampen
American Capital Investment Advisory Corp. (the "Adviser") will provide
investment advice and facilities to the Fund for an annual fee payable
monthly as follows:
<TABLE>
Average Net Assets % Per Annum
<S> <C>
- ------------------------------ --------------
First $500 million .50 of 1%
Over $500 million .45 of 1%
</TABLE>
Cova Variable Annuity Accounts One and Five are separate investment
accounts offered by Cova Financial Services Life Insurance Co. and Cova
Financial Life Insurance Co. (collectively "Cova Life"), respectively. At
December 31, 1995, Cova Variable Annuity Accounts One and Five owned all
shares beneficial interest of the Fund.
Certain officers and trustees of the Fund are also officers and directors
of Van Kampen American Capital Distributors, Inc. or its affiliates
(collectively "VKAC"). The Fund does not compensate its officers or trustees
who are officers of VKAC.
The Fund has implemented a retirement plan which covers those trustees who
are not officers of VKAC. The Fund's liability under the retirement plan at
December 31, 1995, was approximately $7,300.
For the year ended December 31, 1995, the Fund recognized expenses of
approximately $12,100, representing VKAC's cost of providing accounting and
legal services.
3. Capital Transactions
At December 31, 1995 and 1994, paid in surplus aggregated $41,324,208 and
$37,487,535, respectively.
VAN KAMPEN MERRITT
SERIES TRUST QUALITY INCOME PORTFOLIO
Notes to Financial Statements (Continued)
December 31, 1995
Transactions in shares were as follows:
<TABLE>
Year Year
Ended Ended
December 31, December 31,
1995 1994
<S> <C> <C>
--------------- --------------
Beginning Shares 3,457,435 4,695,907
--------------- --------------
Shares Sold 2,141,344 3,968,977
Shares Issued through
Dividend Reinvestment 238,868 231,691
Shares Repurchased (2,030,345) (5,439,140)
--------------- --------------
Net Increase/Decrease in
Shares Outstanding 349,867 (1,238,472)
--------------- --------------
Ending Shares 3,807,302 3,457,435
--------------- --------------
--------------- --------------
</TABLE>
4. Investment Transactions
Aggregate purchases and cost of sales of investment securities, excluding
short-term notes, for the year ended December 31, 1995, were $83,985,046 and
$81,484,103, respectively.
The Fund utilizes an investment technique called reverse repurchase
agreements for cash management purposes. In a reverse repurchase agreement,
the Fund sells securities and agrees to repurchase them at a mutually agreed
upon date and price. During the reverse repurchase agreement period, the Fund
continues to receive principal and interest payments on these securities but
pay interest to the counter-party based upon a short-term interest rate. The
average daily balance of reverse repurchase agreements during the period was
approximately $304,000 with an average interest rate of 5.955%.
5. Mortgage and Asset Backed Securities
A Mortgage Backed Security (MBS) is a pass-through security created by pooling
mortgages and selling participations in the principal and interest payments
received from borrowers. Most of these securities are guaranteed by federally
sponsored agencies -- Government National Mortgage Association (GNMA), Federal
National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation
(FHLMC) or Federal Home Loan Bank (FHLB).
A Collateralized Mortgage Obligation (CMO) is a bond which is
collateralized by a pool of MBS's. The Fund also invests in REMIC's (Real
Estate Mortgage Investment Conduit) which are simply another form of CMO.
These MBS pools are divided into classes or tranches with each class having
its own characteristics. For instance, a PAC (Planned Amortization Class) is
a specific class of mortgages with the most stable cash flows and the lowest
prepayment risk.
Asset Backed Securities are similar to MBS but made up of pools of other
assets, such as credit card receivables, which are grouped together for
investment purposes. Payments of principal and interest on the securities are
made from the cash flows of the group of assets.
An Interest Only security is another class of MBS representing ownership
in the cash flows of the interest payments made from a specified pool of MBS.
The cash flow on this instrument decreases as the mortgage principal balance
is repaid by the borrower.
6. Subsequent Events
On February 9, 1996, shareholders approved a change in the Trust's name to
Cova Series Trust. A new investment advisory agreement was entered into with
Cova Investment Advisory Corp. A sub-advisory agreement between Cova
Investment Advisory Corp. and Van Kampen American Capital Investment Advisory
Corp. was also approved. The investment advisory fee schedule was not
modified by this change. All of the above changes will take effect on May 1,
1996.
Van Kampen Merritt Series Trust High Yield Portfolio
For the 12-month period ened 12/31/95
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders of the High Yield Portfolio of the
Van Kampen Merritt Series Trust:
We have audited the accompanying statement of assets and liabilities of the
High Yield Portfolio (one of the portfolios comprising the Van Kampen
Merritt Series Trust) (the "Fund"), including the portfolio of investments,
as of December 31, 1995, and the related statement of operations for the
year then ended, the statement of changes in net assets for each of the two
years in the period then ended, and the financial highlights for each of
the periods presented. These financial statements and financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of December 31, 1995, by correspondence with the
custodian and brokers. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position
of the High Yield Portfolio of the Van Kampen Merritt Series Trust as of
December 31, 1995, the results of its operations for the year then ended,
the changes in its net assets for each of the two years in the period then
ended, and the financial highlights for each of the periods presented, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois
February 6, 1996, except as to
Note 6, which is as of February 9, 1996
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST HIGH YIELD PORTFOLIO
Portfolio of Investments
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Par
Amount
in Local
Currency S & P Moody's U.S.$
(000) Description Rating Rating Coupon Maturity Market Value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Corporate Bonds 77.1%
Aerospace & Defense 1.4%
150 Sequa Corp. BB B1 9.625% 10/15/99 $ 148,500
400 Sequa Corp. B+ B3 9.375 12/15/03 377,000
--------------
525,500
--------------
Automobile 1.0%
350 Exide Corp. NR NR 10.000 04/15/05 379,750
--------------
Beverage, Food & Tobacco 1.0%
100 Fleming Cos. Inc. (Var. Rate Cpn.) BB- Ba1 8.125 12/15/01 86,000
300 Pilgrims Pride Corp. B- B3 10.875 08/01/03 268,500
--------------
354,500
--------------
Buildings & Real Estate 8.2%
400 American Standard Inc. BB- Ba3 10.875 05/15/99 443,000
200 American Standard Inc. BB- Ba3 11.375 05/15/04 221,500
550 Building Material Corp. <F2> BB B1 0/11.750 07/01/04 374,000
450 Schuller International Group Inc. BB- Ba3 10.875 12/15/04 508,500
400 Southdown Inc. B B2 14.000 10/15/01 440,000
500 Value Property Trust NR NR 11.125 09/29/02 505,000
500 Walter Industries Inc. NR NR 12.190 03/15/00 506,250
--------------
2,998,250
--------------
Chemicals, Plastics & Rubber 0.5%
250 G I Holdings Inc. B+ Ba3 * 10/01/98 193,125
--------------
Containers, Packaging & Glass 4.5%
50 Anchor Glass Container Corp. B- B2 10.250 06/30/02 40,750
50 Anchor Glass Container Corp. CCC+ B3 9.875 12/15/08 30,500
300 Atlantis Group Inc. B- B2 11.000 02/15/03 262,500
50 Owens Illinois Inc. B+ B2 10.250 04/01/99 51,750
100 Owens Illinois Inc. B+ B2 10.500 06/15/02 106,500
350 Owens Illinois Inc. BB Ba3 11.000 12/01/03 397,250
200 S.D. Warren Co. B+ B1 12.000 12/15/04 221,000
563 Silgan Holdings Inc. <F2> B- B3 0/13.250 12/15/02 539,072
--------------
1,649,322
--------------
Diversified/Conglomerate Manufacturing 4.9%
200 Communications & Power Industries Inc. <F3> NR B3 12.000 08/01/05 206,000
361 IMO Industries Inc. B- Caa 12.250 08/15/97 362,805
500 Jordan Industries Inc. B+ B3 10.375 08/01/03 425,000
250 Republic Engineered Steels Inc. B+ B2 9.875 12/15/01 225,625
</TABLE>
1 See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Par
Amount
in Local
Currency S & P Moody's U.S.$
(000) Description Rating Rating Coupon Maturity Market Value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Corporate Bonds (Continued)
Diversified/Conglomerate Manufacturing (Continued)
200 Talley Industries Inc. <F2> B- B2 0/12.250% 10/15/05 $ 149,500
400 Talley Manufacturing & Technology Inc. B B2 10.750 10/15/03 402,000
--------------
1,770,930
--------------
Ecological 1.8%
500 Envirosource Inc. B B3 9.750 06/15/03 437,500
200 Norcal Waste Systems Inc. <F2> NR NR 12.50/13.50 11/15/05 202,500
--------------
640,000
--------------
Electronics 1.6%
500 Bell & Howell Holdings Co. <F2> B B3 0/11.500 03/01/05 328,750
250 Computervision B- B3 11.375 08/15/99 263,125
--------------
591,875
--------------
Farming & Agriculture 0.8%
320 Trans Resources Inc. B- B2 11.875 07/01/02 296,000
--------------
Grocery 3.7%
500 Pantry Inc. B+ B3 12.000 11/15/00 492,500
450 Pathmark Stores Inc. B- B2 9.625 05/01/03 437,625
300 Purity Supreme Inc. BBB- Ba1 11.750 08/01/99 329,250
100 Safeway Inc. BB+ Ba2 9.350 03/15/99 107,250
--------------
1,366,625
--------------
Healthcare 3.5%
100 Merit Behavioral Care Corp. NR B3 11.500 11/15/05 104,000
500 Ornda Healthcorp B- B2 11.375 08/15/04 562,500
150 Paracelsus Healthcare Corp. B B1 9.875 10/15/03 151,500
400 Tenet Healthcare Corp. BB- Ba3 10.125 03/01/05 443,000
--------------
1,261,000
--------------
Hotel, Motel, Inns & Gaming 4.0%
475 California Hotel Finance Corp. BB- B2 11.000 12/01/02 503,500
325 GB Property Funding Corp. B+ B2 10.875 01/15/04 286,813
400 Hollywood Casino Inc. B+ B2 12.750 11/01/03 364,000
300 Trump Plaza Funding Inc. B+ B3 10.875 06/15/01 312,000
--------------
1,466,313
--------------
</TABLE>
2 See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Par
Amount
in Local
Currency S & P Moody's U.S.$
(000) Description Rating Rating Coupon Maturity Market Value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Corporate Bonds (Continued)
Insurance 2.6%
350 American Annuity Group Inc. B+ Ba3 11.125% 02/01/03 $ 378,875
275 Americo Life Inc. <F4> BB+ Ba2 9.250 06/01/05 262,625
300 Nacolah Holding Corp. BB- B1 9.500 12/01/03 315,000
--------------
956,500
--------------
Leisure 1.4%
500 Alliance Entertainment Corp. B- B3 11.250 07/15/05 503,750
--------------
Mining, Steel, Iron & Non-Precious Metal 2.7%
300 Armco Inc. B B2 11.375 10/15/99 307,500
200 Carbide/Graphite Group Inc. B+ B3 11.500 09/01/03 217,000
350 Easco Corp. B B1 10.000 03/15/01 351,750
100 Magma Copper Co. BB+ Ba3 11.500 01/15/02 106,250
--------------
982,500
--------------
Oil & Gas 6.8%
175 Clark R & M Holdings Inc. NR NR * 02/15/00 116,813
375 Giant Industries Inc. B+ B2 9.750 11/15/03 379,687
500 Global Marine Inc. B+ B1 12.750 12/15/99 555,000
350 Petroleum Heat & Power Inc. B+ B2 12.250 02/01/05 390,250
150 Plains Resources Inc. B- B3 12.000 10/01/99 157,125
450 TransTexas Gas Corp. BB- B2 11.500 06/15/02 463,500
50 Triton Energy Corp. B+ B1 * 11/01/97 43,250
360 Triton Energy Corp. <F2> B+ B1 0/9.750 12/15/00 340,200
25 United Meridian Corp. B B2 10.375 10/15/05 26,500
--------------
2,472,325
--------------
Personal & Non-Durable 2.1%
50 Herff Jones Inc. NR B2 11.000 08/15/05 53,500
210 Playtex Family Products Corp. B+ B2 9.000 12/15/03 185,325
540 Revlon Consumer Products Corp. B B2 9.375 04/01/01 545,400
--------------
784,225
--------------
Printing, Publishing & Broadcasting 10.2%
200 American Telecasting Inc. <F2> CCC+ Caa 0/14.500 06/15/04 137,500
250 Century Communications Corp. BB- Ba3 9.750 02/15/02 258,750
200 Century Communications Corp. B+ B2 11.875 10/15/03 215,000
250 Comcast Corp. B+ B1 9.375 05/15/05 263,125
500 Insight Communications Co. L.P. <F2> B- Caa 8.25/11.25 03/01/00 502,500
225 K-III Communications Corp. BB- Ba3 10.625 05/01/02 240,750
</TABLE>
3 See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Par
Amount
in Local
Currency S & P Moody's U.S.$
(000) Description Rating Rating Coupon Maturity Market Value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Corporate Bonds (Continued)
Printing, Publishing & Broadcasting (Continued)
200 K-III Communications Corp. BB- Ba3 10.250% 06/01/04 $ 215,000
500 SCI Television Inc. NR NR 11.000 06/30/05 532,500
250 Storer Communications Inc. B+ B1 10.000 05/15/03 250,625
500 Viacom International Inc. BB- B1 10.250 09/15/01 575,000
100 Young Broadcasting Inc. B B2 11.750 11/15/04 112,000
400 Young Broadcasting Inc. B B2 10.125 02/15/05 424,000
--------------
3,726,750
--------------
Retail 2.7%
250 Hosiery Corp. America Inc.
(Including 250 common stock warrants) B- B3 13.750 08/01/02 270,625
400 Thrifty Payless Inc. B B2 11.750 04/15/03 434,000
275 Waban Inc. BB- Ba3 11.000 05/15/04 281,875
--------------
986,500
--------------
Telecommunications 7.8%
50 Cablevision Systems Corp. B B3 10.750 04/01/04 53,000
500 Centennial Cellular Corp. B B2 10.125 05/15/05 527,500
300 Continental Cablevision Inc. BB+ NR 8.300 05/15/06 301,500
350 Intermedia Communications of Florida, Inc.
(Including 350 common stock warrants) B- B3 13.500 06/01/05 392,000
250 IXC Communications Inc.(Var. Rate Cpn.) NR B3 13.000 10/01/05 267,500
300 Metrocall Inc. B- B2 10.375 10/01/07 319,500
400 Mobilemedia Communications Inc. <F2> B- B3 0/10.500 12/01/03 312,000
100 Mobilemedia Communications Inc. B- B3 9.375 11/01/07 103,500
300 Panamsat L.P. <F2> B B3 0/11.375 08/01/03 244,500
300 Pricellular Wireless Corp. <F2> CCC+ Caa 0/14.000 11/15/01 264,000
100 Pricellular Wireless Corp. <F2> CCC+ B3 0/12.250 10/01/03 77,250
--------------
2,862,250
--------------
Textiles 1.1%
420 Dan River Inc. B B3 10.125 12/15/03 388,500
--------------
Transportation 1.4%
500 U.S. Air B+ B1 8.625 09/01/98 492,500
--------------
Utilities 1.4%
200 California Energy Inc. BB- Ba3 9.875 06/30/03 209,500
300 Midland Funding Corp. II B- B2 11.750 07/23/05 314,250
--------------
523,750
--------------
Total Corporate Bonds 28,172,740
--------------
</TABLE>
4 See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Par
Amount
in Local
Currency S & P Moody's U.S.$
(000) Description Rating Rating Coupon Maturity Market Value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Foreign Bonds and Debt Securities 6.3%
Argentina 0.7%
450 Federal Republic of Argentina (Var. Rate Cpn.) (US$) BB- B2 5.000 % 03/31/23 $ 257,625
--------------
Brazil 0.6%
400 Federal Republic of Brazil (Var. Rate Cpn.) (US$) NR NR 4.250 04/15/24 212,500
--------------
Canada 1.8%
200 Doman Industries Ltd. (US$) BB- Ba3 8.750 03/15/04 193,000
450 Rogers Communications Inc. (US$) BB- B2 10.875 04/15/04 470,250
--------------
663,250
--------------
Colombia 1.0%
350 Oleoducto Central South America (US$) NR NR 9.350 09/01/05 355,250
--------------
United Kingdom 0.8%
200 International Cabletel Inc. (US$) <F2> B B3 0/12.750 04/15/05 127,500
300 Telewest Plc (US$) <F2> BB B1 0/11.000 10/01/07 180,750
--------------
308,250
--------------
Poland 0.6%
300 Government of Poland (Var. Rate Cpn.) (US$) NR NR 6.875 10/27/24 226,125
--------------
Indonesia 0.8%
180 Indah Kiat International Finance Co. B.V. (US$) BB Ba3 11.875 06/15/02 182,250
100 Tjiwi Kimia International Finance (US$) BB Ba3 13.250 08/01/01 109,000
--------------
291,250
--------------
Total Foreign Bonds and Debt Securities 2,314,250
--------------
U.S. Government Obligations 1.4%
500 U.S. T-Note NR Aaa 9.375 04/15/96 505,760
--------------
Total Debt Securities 30,992,750
--------------
Equities 2.1%
American Telecasting Inc. (930 common stock warrants) 2,790
Cablevision Systems Corp. (4,118 preferred shares) 425,132
Casino America Inc. (653 common stock warrants) 652
Panamsat L.P. (212 preferred shares) 238,500
Supermarkets General Holdings Corp. (3,177 preferred shares) 91,736
--------------
Total Equities 758,810
--------------
</TABLE>
5 See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Par
Amount
in Local
Currency S & P Moody's U.S.$
(000) Description Rating Rating Coupon Maturity Market Value
<S> <C> <C> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------------------
Total Long-Term Investments 86.9%
(Cost $31,007,997) <F1> $ 31,751,560
Repurchase Agreement 10.6%
State Street Bank & Trust, U.S. T-Note, $3,340,000 par, 7.500% coupon due
11/15/16, dated 12/29/95, to be sold on 01/02/96 at $3,860,465 3,858,000
Other Assets in Excess of Liabilities 2.5% 905,860
--------------
Net Assets 100% 36,515,420
==============
*Zero coupon bond
<FN>
<F1>At December 31, 1995, cost for federal income tax purposes is $31,007,997;
the aggregate gross unrealized appreciation is $1,030,946 and the
aggregate gross unrealized depreciation is $287,383, resulting in net
unrealized appreciation of $743,563.
<F2>Security is a "step-up" bond where the coupon increases or steps up at a
predetermined date.
<F3>Securities purchased on a when issued or delayed delivery basis.
<F4>Assets segregated as collateral for when issued or delayed delivery
purchase commitments.
</TABLE>
6 See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST HIGH YIELD PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- ------------------------------------------------------------------------------------
<S> <C>
ASSETS:
Investments, at Market Value (Cost $31,007,997) (Note 1) $ 31,751,560
Repurchase Agreement (Note 1) 3,858,000
Cash 377
Receivables:
Interest 668,318
Investments Sold 464,718
Other 823
-------------
Total Assets 36,743,796
-------------
LIABILITIES:
Payables:
Investments Purchased 173,428
Fund Shares Repurchased 32,144
Investment Advisory Fee (Note 2) 22,804
-------------
Total Liabilities 228,376
-------------
NET ASSETS $ 36,515,420
=============
NET ASSETS CONSIST OF:
Paid In Surplus (Note 3) $ 37,281,871
Net Unrealized Appreciation on Investments 743,563
Accumulated Undistributed Net Investment Income 7,484
Accumulated Net Realized Loss on Investments (1,517,498)
-------------
NET ASSETS $ 36,515,420
=============
NET ASSET VALUE PER SHARE
($36,515,420 divided by 3,495,538 shares outstanding; an
unlimited number of shares without par value are authorized) $10.45
=============
</TABLE>
7 See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST HIGH YIELD PORTFOLIO
STATEMENT OF OF OPERATIONS
For the Year Ended December 31, 1995
- ------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Interest $ 2,934,803
Dividends 11,665
Other 48,825
-------------
Total Income 2,995,293
-------------
EXPENSES:
Investment Advisory Fee (Note 2) 219,052
Custody 46,759
Trustees Fees and Expenses (Note 2) 21,062
Audit 18,879
Legal (Note 2) 7,381
Other 1,892
-------------
Total Expenses 315,025
Less Expenses Reimbursed by Cova Life 66,766
-------------
Net Expenses 248,259
-------------
NET INVESTMENT INCOME $ 2,747,034
=============
REALIZED AND UNREALIZED GAIN/LOSS ON INVESTMENTS:
Realized Gain/Loss on Investments:
Proceeds from Sales $ 29,060,092
Cost of Securities Sold (28,922,790)
-------------
Net Realized Gain on Investments (Including realized loss on
expired option transactions of $3,162) 137,302
-------------
Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period (779,999)
End of the Period 743,563
-------------
Net Unrealized Appreciation on Investments During the Period 1,523,562
-------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS $ 1,660,864
-------------
NET INCREASE IN NET ASSETS FROM OPERATIONS $ 4,407,898
=============
</TABLE>
8 See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST HIGH YIELD PORTFOLIO
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1995 and 1994
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Operations:
Net Investment Income $ 2,747,034 $ 1,901,381
Net Realized Gain/Loss on Investments 137,302 (1,654,800)
Net Unrealized Appreciation/Depreciation on
Investments During the Period 1,523,562 (1,233,657)
--------------- ---------------
Change in Net Assets from Operations 4,407,898 (987,076)
Distributions from Net Investment Income (2,739,550) (1,901,381)
--------------- ---------------
NET CHANGE IN NET ASSETS FROM
INVESTMENT ACTIVITIES 1,668,348 (2,888,457)
--------------- ---------------
FROM CAPITAL TRANSACTIONS (Note 3):
Proceeds from Shares Sold 14,408,614 10,939,186
Net Asset Value of Shares Issued Through
Dividend Reinvestment 2,739,550 1,901,381
Cost of Shares Repurchased (1,956,676) (9,145,332)
--------------- ---------------
NET CHANGE IN NET ASSETS FROM CAPITAL
TRANSACTIONS 15,191,488 3,695,235
--------------- ---------------
TOTAL INCREASE IN NET ASSETS 16,859,836 806,778
NET ASSETS:
Beginning of the Period 19,655,584 18,848,806
--------------- ---------------
End of the Period (Including undistributed net
investment income of $7,484 and $0, respectively) $ 36,515,420 $ 19,655,584
=============== ===============
</TABLE>
9 See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST HIGH YIELD PORTFOLIO
FINANCIAL HIGHLIGHTS
The following schedule presents financial highlights for one share of the Fund
outstanding throughout the periods indicated.
- --------------------------------------------------------------------------------------------------------------------------------
December 11,1989
(Commencement of
Investment
Year Ended December 31, Operations) to
1995 1994 1993 1992 1991 1990 December 31,1989
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $9.823 $11.287 $10.445 $10.410 $9.073 $9.974 $10.000
------- ------- ------- ------- ------- ------- -------
Net Investment Income .949 .978 1.028 1.250 1.124 1.085 .053
Net Realized and Unrealized Gain/Loss
on Investments .621 (1.464) 1.170 .658 1.337 (.901) (.026)
------- ------- ------- ------- ------- ------- -------
Total from Investment Operations 1.570 (.486) 2.198 1.908 2.461 .184 .027
------- ------- ------- ------- ------- ------- -------
Less:
Distributions from Net Investment Income .947 .978 1.028 1.250 1.124 1.085 .053
Distributions from Net Realized Gain
on Investments .000 .000 .328 .623 .000 .000 .000
------- ------- ------- ------- ------- ------- -------
Total Distributions .947 .978 1.356 1.873 1.124 1.085 .053
------- ------- ------- ------- ------- ------- -------
Net Asset Value, End of Period $10.446 $9.823 $11.287 $10.445 $10.410 $9.073 $9.974
======= ======= ======= ======= ======= ======= =======
Total Return * 16.69% (4.52%) 21.98% 19.12% 28.31% 1.86% .23% **
Net Assets at End of Period (In millions) $36.5 $19.7 $18.8 $5.4 $3.8 $2.9 $2.5
Ratio of Expenses to Average Net Assets*
(Annualized) .86% .86% .84% .87% .86% 1.01% .95%
Ratio of Net Investment Income to Average
Net Assets* (Annualized) 9.50% 9.48% 8.97% 11.67% 11.31% 11.43% 9.67%
Portfolio Turnover 118.90% 200.06% 213.09% 157.42% 147.57% 28.32% .00%
* If certain expenses had not been assumed
by Cova Life, total return would have
been lower and the ratios would have been
as follows:
Ratio of Expenses to Average Net Assets
(Annualized)
1.09% 1.16% 1.38% 1.79% 1.91% 2.42% 9.42%
Ratio of Net Investment Income to Average
Net Assets (Annualized) 9.27% 9.18% 8.43% 10.75% 10.25% 10.01% 1.19%
</TABLE>
** Non-annualized
10 See Notes to Financial Statements
Van Kampen Merritt Series Trust High Yield Portfolio
Notes to Financial Statements December 31, 1995
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Van Kampen Merritt Series Trust (the "Trust"), under which the High Yield
Portfolio (the "Fund") is organized as a separate sub-trust, is registered as
a diversified open-end management investment company under the Investment
Company Act of 1940, as amended. The Fund's investment objective is to seek
high current income by investing in a portfolio of medium and lower grade
domestic corporate debt securities. The Portfolio may invest up to 35% of its
assets in foreign government and corporate debt securities of similar quality.
The Trust and Fund commenced investment operations on December 11, 1989.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A. Security Valuation - Investments are stated at value using market
quotations, or if such valuations are not available, estimates obtained from
yield data relating to instruments or securities with similar characteristics
in accordance with procedures established in good faith by the Board of
Trustees. Short-term securities with remaining maturities of less than 60
days are valued at amortized cost.
B. Security Transactions - Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis.
The Fund may purchase and sell securities on a "when issued" or "delayed
delivery" basis, with settlement to occur at a later date. The value of the
security so purchased is subject to market fluctuations during this period.
The Fund will maintain in a segregated account with its custodian assets
having an aggregate value at least equal to the amount of the when issued or
delayed delivery purchase commitments until payment is made.
C. Investment Income and Expense - Interest income and expenses are recorded
on an accrual basis. Dividend income is recorded on the ex-dividend date.
Bond discount is amortized over the expected life of each applicable
security.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liablilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
D. Federal Income Taxes - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Therefore, no provision for federal income taxes is
required.
The Fund intends to utilize provisions of the Federal income tax laws
which allow it to carry a realized capital loss forward for eight years
following the year of the loss and offset such losses against any future
realized capital gains. At December 31, 1995, the Fund had an accumulated
capital loss carryforward for tax purposes of $1,517,498 which will expire on
December 31, 2002.
E. Distribution of Income and Gains - The Fund declares and pays dividends
monthly from net investment income. Net realized gains, if any, are
distributed annually. All distributions are automatically reinvested in Fund
shares. Distributions from net realized gains for book purposes may include
short-term capital gains, which are included as ordinary income for tax
purposes.
2. Investment Advisory Agreement and Other Transactions with Affiliates
Under the terms of the Fund's Investment Advisory Agreement, Van Kampen
American Capital Investment Advisory Corp. (the "Adviser") will provide
investment advice and facilities to the Fund for an annual fee payable monthly
as follows:
<TABLE>
Average Net Assets % Per Annum
<S> <C>
- --------------------------------------- -----------
First $500 million .75 of 1%
Over $500 million .65 of 1%
</TABLE>
Cova Variable Annuity Accounts One and Five are separate investment
accounts offered by Cova Financial Services Life Insurance Co. and Cova
Financial Life Insurance Co.(collectively "Cova Life"), respectively. At
December 31, 1995, Cova Variable Annuity Accounts One and Five owned all
shares of beneficial interest of the Fund.
Certain officers and trustees of the Fund are also officers and directors
of Van Kampen American Capital Distributors, Inc. or its affiliates
(collectively "VKAC"). The Fund does not compensate its officers or trustees
who are officers of VKAC.
The Fund has implemented a retirement plan which covers those trustees
who are not officers of VKAC. The Fund had no liability under the retirement
plan at December 31, 1995.
For the year ended December 31, 1995, the Fund recognized expenses of
approximately $9,200 representing VKAC's cost of providing accounting and
legal services.
3. Capital Transactions
At December 31, 1995, and 1994, paid in surplus aggregated $37,281,871 and
$22,090,383, respectively.
11
Van Kampen Merritt Series Trust High Yield Portfolio
Notes to Financial Statements (Continued) December 31, 1995
- --------------------------------------------------------------------------------
Transactions in shares were as follows:
<TABLE>
Year Year
Ended Ended
December 31, December 31,
1995 1994
<S> <C> <C>
----------------- ---------------
Beginning Shares 2,000,944 1,669,943
----------------- ---------------
Shares Sold 1,420,820 1,006,022
Shares Issued Through
Dividend Reinvestment 267,010 182,215
Shares Repurchased (193,236) (857,236)
----------------- ---------------
Net Increase in Shares
Outstanding 1,494,594 331,001
----------------- ---------------
Ending Shares 3,495,538 2,000,944
================= ===============
</TABLE>
4. Investment Transactions
Aggregate purchases and cost of sales of investment securities, excluding
short-term notes, for the year ended December 31, 1995, were $42,405,268 and
$28,922,790 respectively.
5. Derivative Financial Instruments
A derivative financial instrument in very general terms refers to a security
whose value is "derived" from the value of an underlying asset, reference rate
or index.
The Fund has a variety of reasons to use derivative instruments, such as
to attempt to protect the Fund against possible changes in the market value
of its portfolio, manage the portfolio's effective yield, maturity and
duration or to generate potential gain. All of the Fund's portfolio holdings,
including derivative instruments, are marked to market each day with the
change in value reflected in the unrealized appreciation/depreciation on
investments. Upon disposition, a realized gain or loss is recognized
accordingly, except for exercised option contracts where the recognition of
gain or loss is postponed until the disposal of the security underlying the
option contract.
During the period, the Fund entered into option contracts, a type of
derivative. An option contract gives the buyer the right but not the
obligation, to buy (call) or sell (put) an underlying item at a fixed exercise
price during a specified period. These contracts are generally used by the
Fund to manage the portfolio's effective maturity and duration.
Transactions in options for the year ended December 31, 1995, were as follows:
<TABLE>
Contracts Premium
<S> <C> <C>
----------- ------------
Outstanding at
December 31, 1994 0 $0
Options Written (Net) 115 (3,162)
Options Expired (Net) (115) 3,162
----------- ------------
Outstanding at
December 31, 1995 0 $0
=========== ============
</TABLE>
6. Subsequent Events
On February 9, 1996, shareholders approved a change in the Trust's name to
Cova Series Trust. A new investment advisory agreement was entered into with
Cova Investment Advisory Corp. A sub-advisory agreement between Cova
Investment Advisory Corp. and Van Kampen American Capital Investment Advisory
Corp. was also approved. The investment advisory fee schedule was not
modified by this change. All of the above changes will take effect on May 1,
1996.
Van Kampen Merritt Series Trust Growth and Income Portfolio
For the 12-month period ended 12/31/95
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders of the Growth and Income
Portfolio of the Van Kampen Merritt Series Trust:
We have audited the accompanying statement of assets and liabilities of the
Growth and Income Portfolio (one of the portfolios comprising the Van Kampen
Merritt Series Trust) (the "Fund"), including the portfolio of investments, as
of December 31, 1995, and the related statement of operations for the year then
ended, the statement of changes in net assets for each of the two years in the
period then ended, and the financial highlights for each of the periods
presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1995, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Growth and Income Portfolio of the Van Kampen Merritt Series Trust as of
December 31, 1995, the results of its operations for the year then ended, the
changes in its net assets for each of the two years in the period then ended,
and the financial highlights for each of the periods presented, in conformity
with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois
January 30, 1996, except as to
Note 6, which is as of February 9, 1996
<TABLE>
Van Kampen Merrit Series Trust Growth And Income Portfolio
Portfolio of Investments
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common and Preferred Stocks 86.5%
Aerospace & Defense 2.4%
Boeing Co. 2,300 $ 180,263
Loral Corp. 5,000 176,875
McDonnell Douglas Corp. 1,300 119,600
-------------
476,738
-------------
Automobile 1.8%
Chrysler Corp. 2,300 127,363
General Motors Corp. 4,400 232,650
-------------
360,013
-------------
Banking 3.2%
BancOne Corp. 4,000 151,000
Bank of Boston Corp. - Including Stock Rights 250 11,563
Bankers Trust NY Corp. 3,800 252,700
State Street Boston Corp. 4,700 211,500
-------------
626,763
-------------
Beverage, Food & Tobacco 7.6%
Coca Cola Co. 1,800 133,650
CPC International Inc. 800 54,900
Interstate Bakeries Corp. 700 15,663
McDonalds Corp. 3,700 166,962
Nabisco Holdings Corp. 8,900 290,362
Philip Morris Cos. Inc. 3,600 325,800
Quaker Oats Co. - Including Stock Rights 3,300 113,850
Ralston Purina Co. 3,200 199,600
RJR Nabisco Holdings Corp. 2,300 71,013
Wendys International Inc. 5,600 119,000
-------------
1,490,800
-------------
Chemical 3.3%
Air Products & Chemicals Inc. 1,055 55,651
Grace, W. R. & Co. 2,000 118,250
Monsanto Co. 2,000 245,000
Praxair Inc. 4,200 141,225
Sigma Aldrich 1,800 89,100
-------------
649,226
-------------
</TABLE>
See Notes to Financial Statements
Van Kampen Merrit Series Trust Growth And Income Portfolio
<TABLE>
Portfolio of Investments (continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Consumer Non-Durables 3.5%
Corning Delaware LP 1,400 $ 70,525
Eastman Kodak Co. 700 46,900
General Mills Inc. 1,300 75,075
Gillette Co. 1,700 88,613
Nike Inc. 2,360 164,315
Procter & Gamble Co. 2,290 190,070
Sunbeam Oster Inc. 3,500 53,375
-------------
688,873
-------------
Diversified/Conglomerate Manufacturing 2.1%
Allied Signal Inc. 2,800 133,000
General Electric Co. 2,400 172,800
Illinois Tool Works Inc. 1,700 100,300
-------------
406,100
-------------
Diversified/Conglomerate Service 0.5%
Browning Ferris Industries Inc. <F2> 3,000 94,125
-------------
Ecological 0.8%
WMX Technologies Inc. <F3> 5,400 161,325
-------------
Electronics 1.4%
General Signal Corp. - Including Stock Rights 2,100 67,988
Honeywell Inc. - Including Stocks Rights 2,600 126,425
Perkin Elmer Corp. 2,200 83,050
-------------
277,463
-------------
Energy 1.8%
Texaco Inc. 4,600 361,100
-------------
Engineering & Construction 1.3%
Fluor Corp. - Including Stock Rights 2,500 165,000
Foster Wheeler Corp. - Including Stock Rights 2,100 89,250
-------------
254,250
-------------
Entertainment 0.4%
Time Warner Financing Trust - Preferred 2,500 78,125
-------------
</TABLE>
See Notes to Financial Statements
Van Kampen Merrit Series Trust Growth And Income Portfolio
<TABLE>
Portfolio of Investments (continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Financial Services 5.7%
Ahmanson H.F. & Co. 1,400 $ 37,100
Chubb Corp. 1,700 164,475
DeBartolo Realty Corp. 2,900 37,700
Federal National Mtg Assn. 3,100 384,787
Healthcare Realty Trust Inc. 8,300 190,900
J.P. Morgan & Co. Inc. 3,900 312,975
-------------
1,127,937
-------------
Grocery 0.3%
Vons Cos. Inc. <F2> 2,100 59,325
-------------
Healthcare 3.1%
Baxter International Inc. 2,000 83,750
Charter Medical Corp. <F2> 6,200 148,800
Merck & Co. Inc. 4,280 281,410
Tenet Healthcare Corp. <F2> 4,500 93,375
-------------
607,335
-------------
Home & Office Furnishings 0.4%
Harris Corp. 1,600 87,400
-------------
Insurance 4.0%
American International Group Inc. 2,700 249,750
Horace Mann Educators Corp. 4,500 140,625
Prudential Reinsurance Holdings Inc. 6,700 156,613
Travelers Inc. 3,900 245,212
-------------
792,200
-------------
Leisure 0.8%
Walt Disney Co. 2,600 153,400
-------------
Machinery 0.7%
Stewart & Stevenson Services Inc. 2,400 60,600
York International Corp. 1,800 84,600
-------------
145,200
-------------
</TABLE>
See Notes to Financial Statements
Van Kampen Merrit Series Trust Growth And Income Portfolio
<TABLE>
Portfolio of Investments (continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Medical Supplies 0.9%
United Healthcare Corp. 1,600 $ 104,800
Vencor Inc. <F2> 2,300 74,750
-------------
179,550
-------------
Mining, Steel, Iron & Non-Precious Metal 0.6%
Aluminum Company America 2,300 121,613
-------------
Oil & Gas 3.7%
Exxon Corp. 3,600 288,450
Mobil Corp. - Including Stock Rights <F3> 3,300 369,600
Panhandle Eastern Corp. 2,700 75,262
-------------
733,312
-------------
Packaging & Container 0.6%
Bemis Inc. - Including Stock Rights 2,775 71,109
Crown Cork & Seal Inc. <F2> 1,000 41,750
-------------
112,859
-------------
Paper 1.6%
James River Corp. 3,300 77,138
James River Corp. - Including Stock Rights 3,800 91,675
Kimberly Clark Corp. 1,660 137,365
-------------
306,178
-------------
Pharmaceuticals 3.8%
Amgen Inc. <F2> 3,300 195,937
Pfizer Inc. 2,800 176,400
Pharmacia & Upjohn Inc. 4,500 174,375
Schering Plough Corp. 3,500 191,625
-------------
738,337
-------------
Printing, Publishing & Broadcasting 1.4%
Capital Cities/ABC Inc. - Including Stock Rights 1,000 123,375
Omnicom Group 2,200 81,950
U.S. West Media Group 1,900 67,925
-------------
273,250
-------------
</TABLE>
See Notes to Financial Statements
Van Kampen Merrit Series Trust Growth And Income Portfolio
<TABLE>
Portfolio of Investments (continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Retail 4.7%
AnnTaylor Stores Corp. <F2> 1,700 $ 17,425
Dayton Hudson Corp. 1,000 75,000
Federated Dept. Stores Inc. <F2> 8,000 220,000
Gap Inc. 1,900 79,800
Home Depot Inc. 1,300 62,237
May Department Stores Co. 4,800 202,800
Nine West Group Inc. <F2> 1,050 39,375
Nordstrom Inc. 1,900 76,950
Sears Roebuck & Co. 4,000 156,000
-------------
929,587
-------------
Technology 5.1%
Adobe Systems Inc. 1,800 111,600
Compaq Computer Corp. <F2> 300 14,400
Computer Associates International Inc. 3,200 182,000
Digital Equipment Corp. - Including Stock Rights <F2> 2,500 160,312
Hewlett Packard Co. 1,100 92,125
International Business Machines 800 73,400
Microsoft Corp. <F2> 1,200 105,300
Motorola Inc. 1,100 62,700
Xerox Corp. 1,500 205,500
-------------
1,007,337
-------------
Telecommunications 4.9%
Ameritech Corp. 3,000 177,000
AT & T Corp. 4,900 317,275
Frontier Corp. 5,225 156,750
MCI Communications Corp. 6,680 174,515
Viacom Inc. <F2> 2,900 137,387
-------------
962,927
-------------
Transportation 0.7%
Union Pacific Corp. 2,200 145,200
-------------
Utilities 5.3%
Central & South West Corp. 3,940 109,827
Cincinnati Bell Inc. 3,000 104,250
DPL Inc. 3,450 85,388
</TABLE>
See Notes to Financial Statements
Van Kampen Merrit Series Trust Growth And Income Portfolio
<TABLE>
Portfolio of Investments (continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Utilities (continued)
Duke Power Co. 900 $ 42,638
Nipsco Inc. 2,500 95,625
Pacific Enterprises - Including Stock Rights 5,600 158,200
Peco Energy Co. 3,650 109,956
SBC Communications Inc. 1,200 69,000
Southern NE Telecomm Corp. 2,000 79,500
U.S. West Communications Inc. <F2> 1,900 36,100
Williams Cos. Inc. - Preferred 2,200 162,525
-------------
1,053,009
-------------
Foreign 8.1%
Adidas - ADR (Germany) 3,000 80,437
Astra AB- ADR (Sweden) 4,000 158,000
British Petroleum PLC - ADR (UK) 1,400 142,975
Canadian National Railway Co. (Canada) 700 10,500
Canadian Pacific Ltd. (Canada) 5,200 94,250
GCR Holdings Ltd. (Bermuda) <F2> 1,500 33,750
National Power PLC - ADR (UK) <F2> 5,400 49,950
Newbridge Networks Corp. (Canada) <F2> 1,200 49,650
News Corporation Limited - ADR (Australia) 200 4,275
Nokia Corporation - ADR (Finland) 1,500 58,313
Powergen PLC - ADR (UK) 5,150 67,594
Royal Dutch Petroleum Co. (Netherlands) 2,700 381,037
Telefonos De Mexico SA - ADR (Mexico) 5,000 159,375
Teva Pharmaceutical Inds Ltd. - ADR (Israel) 2,800 129,850
Total S. A. - ADR (France) 3,300 112,200
Zeneca Group PLC - ADR (UK) 1,100 64,213
-------------
1,596,369
-------------
Total Common and Preferred Stocks 17,057,226
-------------
Fixed-Income Securities 6.8%
ADT Operations Inc. - Liquid Yield Option Note ($350,000 par,
0% coupon, 07/06/10 maturity, S&P rating BB+)
166,250
Equitable Cos Inc. - Convertible into Common Stock ($200,000
par, 6.125% coupon, 12/15/24 maturity, S&P rating A)
226,000
Federated Dept Stores Inc. - Convertible into Common Stock
($75,000 par, 5.00% coupon, 10/01/03 maturity, S&P rating
BB-)
75,844
Grand Metropolitan Public Ltd. - Convertible into Common Stock
($150,000 par, 6.50% coupon, 01/31/00 maturity, S&P rating
AA) 174,000
</TABLE>
See Notes to Financial Statements
Van Kampen Merrit Series Trust Growth And Income Portfolio
<TABLE>
Portfolio of Investments (continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security Shares Market Value
Description
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Fixed-Income Securities (continued)
News America Holdings Inc. - Liquid Yield Option Note
($200,000 par, 0% coupon, 03/11/13 maturity, S&P rating BBB)
$ 91,000
Roche Holdings Inc. - Liquid Yield Option Note ($400,000 par,
0% coupon, 04/20/10 maturity, S&P rating NR)
177,500
Sandoz Cao Bvi Ltd. - Convertible into Common Stock ($50,000
par, 2.00% coupon, 10/06/02 maturity, S&P rating NR)
47,437
United States Cellular Corp. - Liquid Yield Option Note
($420,000 par, 0% coupon, 06/15/15 maturity, S&P rating
BBB-)
149,100
United Technologies Corp. - Convertible into Common Stock
($180,000 par, 0% coupon, 09/08/97 maturity, S&P rating A+) 234,675
-------------
Total Fixed-Income Securities 1,341,806
-------------
Total Long-Term Investments 93.3%
(Cost $16,643,935) <F1> 18,399,032
Short-Term Investments 6.2%
Federal Home Ln Mtg Corp. Disc Nts ($1,230,000 par, yielding
5.75%, maturing 01/02/96) 1,229,804
Other Assets in Excess of Liabilities 0.5% 95,471
-------------
Net Assets 100% $ 19,724,307
=============
<FN>
<F1>At December 31, 1995, cost for federal income tax purposes is $16,643,935;
the aggregate gross unrealized appreciation is $1,994,297 and the aggregate
gross unrealized depreciation is $246,050, resulting in net
unrealized appreciation including futures transactions of $1,748,247.
<F2>Non-income producing security as this stock currently does not declare
dividends.
<F3>Assets segregated for open futures transactions.
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST GROWTH AND INCOME PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- --------------------------------------------------------------------------------
<S> <C>
ASSETS:
Investments, at Market Value (Cost $16,643,935) (Note 1) $ 18,399,032
Short-Term Investments (Note 1) 1,229,804
Cash 5,129
Receivables:
Investments Sold 570,240
Dividends 47,493
Fund Shares Sold 25,117
Interest 7,653
Margin on Futures (Note 5) 700
Other 3,220
-------------
Total Assets 20,288,388
-------------
LIABILITIES:
Payables:
Investments Purchased 554,395
Investment Advisory Fee (Note 2) 9,686
-------------
Total Liabilities 564,081
-------------
NET ASSETS $ 19,724,307
==============
NET ASSETS CONSIST OF:
Paid In Surplus (Note 3) $ 17,969,650
Net Unrealized Appreciation on Investments 1,748,247
Accumulated Net Realized Gain on Investments 6,410
-------------
NET ASSETS $ 19,724,307
==============
NET ASSET VALUE PER SHARE ($19,724,307 divided by
1,576,436 shares outstanding; an unlimited number of shares
without par value are authorized) (Note 3) $12.51
==============
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST GROWTH AND INCOME PORTFOLIO
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1995
- --------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Dividends (Net of foreign withholding taxes of $5,713) $ 320,603
Interest 62,420
-------------
Total Income 383,023
-------------
EXPENSES:
Investment Advisory Fee (Note 2) 83,035
Custody 41,635
Trustees Fees and Expenses (Note 2) 16,917
Audit 14,096
Legal (Note 2) 7,667
Other 2,993
-------------
Total Expenses 166,343
Less Expenses Reimbursed by Cova Life 69,469
-------------
Net Expenses 96,874
-------------
NET INVESTMENT INCOME $ 286,149
=============
REALIZED AND UNREALIZED GAIN/LOSS ON INVESTMENTS:
Realized Gain/Loss on Investments:
Proceeds from Sales $ 25,568,050
Cost of Securities Sold (23,966,281)
--------------
Net Realized Gain on Investments (Including realized gain
on closed and expired option transactions of $113,371
and realized loss on futures transactions of $112,172) 1,601,769
--------------
Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period (224,826)
End of the Period (Including unrealized depreciation
on open futures transactions of $6,850) 1,748,247
--------------
Net Unrealized Appreciation on Investments During the Period 1,973,073
--------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS $ 3,574,842
==============
NET INCREASE IN NET ASSETS FROM OPERATIONS $ 3,860,991
==============
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST GROWTH AND INCOME PORTFOLIO
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1995 and 1994
- -------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, 1995 December 31, 1994
------------------- -----------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Operations:
Net Investment Income $ 286,149 $ 337,412
Net Realized Gain/Loss on Investments 1,601,769 (318,342)
Net Unrealized Appreciation/Depreciation
on Investments During the Period 1,973,073 (483,559)
--------------- --------------
Change in Net Assets from Operations 3,860,991 (464,489)
Distributions from Net Investment Income (294,561) (329,231)
Distributions from Net Realized Gain on
Investments (1,277,017) (8,412)
---------------- --------------
NET CHANGE IN NET ASSETS FROM
INVESTMENT ACTIVITIES 2,289,413 (802,132)
---------------- --------------
FROM CAPITAL TRANSACTIONS (Note 3):
Proceeds from Shares Sold 6,076,696 6,301,797
Net Asset Value of Shares Issued
Through Dividend Reinvestment 1,571,578 337,642
Cost of Shares Repurchased (1,155,316) (1,423,903)
---------------- --------------
NET CHANGE IN NET ASSETS FROM CAPITAL
TRANSACTIONS 6,492,958 5,215,536
---------------- --------------
TOTAL INCREASE IN NET ASSETS 8,782,371 4,413,404
NET ASSETS:
Beginning of the Period 10,941,936 6,528,532
---------------- -------------
End of the Period (Including undistributed
net investment income of $0 and
$8,412, respectively) $ 19,724,307 $ 10,941,936
=============== ==============
</TABLE>
<TABLE>
Van Kampen Merritt Series Trust Growth and Income Portfolio
Financial Highlights
The following schedule presents financial highlights for one
share of the Fund outstanding throughout the periods indicated.
- ---------------------------------------------------------------------------------------------------------------------------
May 1, 1992
(Commencement of
Year Ended December 31 Investment
------------------------------------------ Operations) to
1995 1994 1993 December 31, 1992
- --------------------------------------------------------- -------------- -------------- ------------ ------------------
<S> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.306 $11.170 $10.282 $10.000
-------------- ------------- ----------- ----------------
Net Investment Income .224 .331 .182 .125
Net Realized and Unrealized Gain/Loss on Investments 3.089 (.864) 1.371 .444
-------------- ------------- ----------- ----------------
Total from Investment Operations 3.313 (.533) 1.553 .569
-------------- ------------- ----------- ----------------
Less:
Distributions from Net Investment Income .232 .323 .182 .125
Distributions from Net Realized Gain on Investments .875 .008 .483 .162
-------------- ------------- ----------- ---------------
Total Distributions 1.107 .331 .665 .287
-------------- ------------- ----------- ---------------
Net Asset Value, End of Period $12.512 $10.306 $11.170 $10.282
============== ============= =========== ===============
Total Return* 32.24% (4.54%) 15.01% 5.67%**
Net Assets at End of Period (In millions) $19.7 $10.9 $6.5 $2.6
Ratio of Expenses to Average Net Assets*
(Annualized) .69% .70% .69% .70%
Ratio of Net Investment Income to Average Net Assets*
(Annualized) 2.05% 3.47% 1.84% 2.27%
Portfolio Turnover 180.11% 326.01% 135.92% 99.93%
*If certain expenses had not been assumed by Cova Life,
total return would have been lower and the ratios
would have been as follows:
Ratio of Expenses to Average Net Assets (Annualized) 1.19% 1.49% 2.05% 3.69%
Ratio of Net Investment Income to Average Net Assets
(Annualized) 1.55% 2.68% .47% (.73%)
**Non-Annualized
</TABLE>
See Notes to Financial Statements
Van Kampen Merritt Series Trust Growth and Income Portfolio
Notes to Financial Statements
December 31, 1995
1. Significant Accounting Policies
Van Kampen Merritt Series Trust (the "Trust"), under which the Growth and
Income Portfolio (the "Fund") is organized as a separate sub-trust, is
registered as a diversified open-end management investment company under the
Investment Company Act of 1940, as amended. 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 Trust commenced operations on December 11, 1989. The Fund
commenced investment operations on May 1, 1992.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A. Security Valuation - Investments in securities listed on a securities
exchange are valued at their sale price as of the close of such securities
exchange. Investments in securities not listed on a securities exchange are
valued based on their last quoted bid price or, if not available, their fair
value as determined by the Board of Trustees. Fixed income investments are
stated at values using market quotations or, if such valuations are not
available, estimates obtained from yield data relating to instruments or
securities with similar characteristics in accordance with procedures
established in good faith by the Board of Trustees. Short-term securities
with remaining maturities of less than 60 days are valued at amortized
cost.
B. Security Transactions - Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis.
C. Investment Income and Expenses - Dividend income is recorded on the
ex-dividend date and interest income, and expenses are recorded on an accrual
basis.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
D. Federal Income Taxes - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Therefore, no provision for federal income taxes is
required.
Net realized gains or losses may differ for financial and tax reporting
purposes primarily as a result of timing differences related to open option
and futures transactions at year end.
E. Distribution of Income and Gains - The Fund declares and pays dividends
semi-annually from net investment income. Net realized gains, if any, are
distributed annually. Distributions are automatically reinvested in Fund
shares. Distributions from net realized gains for book purposes may include
short-term capital gains and gains on option and futures transactions. Any
short-term capital gains and a portion of option and futures gains would be
included in ordinary income for tax purposes.
2. Investment Advisory Agreement and Other Transactions with Affiliates
Under the terms of the Fund's Investment Advisory Agreement, Van Kampen
American Capital Investment Advisory Corp. (the "Adviser") will provide
investment advice and facilities to the Fund for an annual fee payable
monthly as follows:
<TABLE>
Average Net Assets % Per Annum
- ------------------------------------ -----------
<S> <C>
First $500 million .60 of 1%
Over $500 million .50 of 1%
</TABLE>
Cova Variable Annuity Accounts One and Five are separate investment
accounts offered by Cova Financial Services Life Insurance Co. and Cova
Financial Life Insurance Co. (collectively "Cova Life"), respectively. At
December 31, 1995, Cova Variable Annuity Accounts One and Five owned all
shares of beneficial interest of the Fund.
Certain officers and trustees of the Fund are also officers and directors
of Van Kampen American Capital Distributors, Inc. or its affiliates
(collectively "VKAC"). The Fund does not compensate its officers or trustees
who are officers of VKAC.
The Fund has implemented a retirement plan which covers those trustees who
are not officers of VKAC. Due to the current size of the Fund, the trustees
have waived their annual fee and therefore, the Fund has no liability under
the retirement plan.
For the year ended December 31, 1995, the Fund recognized expenses of
approximately $9,100 representing VKAC's cost of providing accounting and
legal services.
3. Capital Transactions
At December 31, 1995 and 1994, paid in surplus aggregated $17,969,650 and
$11,476,692, respectively.
Transactions in shares were as follows:
<TABLE>
Year Ended Year Ended
December 31, 1995 December 31, 1994
------------------ -----------------
<S> <C> <C>
Beginning Shares 1,061,698 584,482
------------------ -----------------
Shares Sold 489,524 576,486
Shares Issued through
Dividend Reinvestment 126,226 32,783
Shares Repurchased (101,012) (132,053)
------------------ -----------------
Net Increase in Shares
Outstanding 514,738 477,216
------------------ -----------------
Ending Shares 1,576,436 1,061,698
================== =================
</TABLE>
Van Kampen Merritt Series Trust Growth and Income Portfolio
Notes to Financial Statements
December 31, 1995 (Continued)
4. Investment Transactions
Aggregate purchases and cost of sales of investment securities, excluding
short-term notes, for the year ended December 31, 1995, were $29,610,171 and
$23,966,281, respectively.
5. Derivative Financial Instruments
A derivative financial instrument in very general terms refers to a security
whose value is "derived" from the value of an underlying asset, reference rate
or index.
The Fund has a variety of reasons to use derivative instruments, such as
to attempt to protect the Fund against possible changes in the market value of
its portfolio or generate potential gain. All of the Fund's portfolio
holdings, including derivative instruments, are marked to market each day with
the change in value reflected in the unrealized appreciation/depreciation on
investments. Upon disposition, a realized gain or loss is recognized
accordingly, except for exercised option contracts where the recognition of
gain or loss is postponed until the disposal of the security underlying the
option contract.
Summarized below are the specific types of derivative financial instruments
used by the Fund.
A. Option Contracts - An option contract gives the buyer the right, but not
the obligation to buy (call) or sell (put) an underlying item at a fixed
exercise price during a specified period. These contracts are generally used
by the Fund to provide the return of an index without purchasing all of the
securities underlying the index or as a substitute for purchasing or selling
specific securities.
Transactions in options for the year ended
December 31, 1995, were as follows:
<TABLE>
Contracts Premium
------------- ----------
<S> <C> <C>
Outstanding at
December 31, 1994 4,000 $ 491,415
Options Written and
Purchased (Net) 1,940 (265,085)
Options Terminated in Closing
Transactions (Net) (1,886) 248,723
Options Expired (Net) (2,000) (89,235)
Options Exercised (Net) (2,054) (385,818)
------------- ----------
Outstanding at
December 31, 1995 0 $ 0
============ ============
</TABLE>
B. Futures Contracts - A futures contract is an agreement involving the
delivery of a particular asset on a specified future date at an agreed upon
price. The Fund generally invests in financial and stock index futures.
These contracts are generally used to provide the return of an index without
purchasing all of the securities underlying the index or as a substitute for
purchasing or selling specific securities.
The fluctuation in market value of the contracts is settled daily through
a cash margin account.
Transactions in futures contracts for the year ended December 31, 1995,
were as follows:
<TABLE>
Contracts
------------
<S> <C>
Outstanding at
December 31, 1994 0
Futures Opened 2,063
Futures Closed (2,061)
------------
Outstanding at
December 31, 1995 2
============
</TABLE>
The futures contracts outstanding as of December 31, 1995 and the
description and unrealized depreciation is as follows:
<TABLE>
Unrealized
Contracts Depreciation
- ----------------------------------------------------------------
<S> <C> <C>
S&P 500 Index Futures
Mar 1996 - Buys to Open 2 $ 6,850
============= ===========
</TABLE>
6. Subsequent Events
On February 9, 1996, shareholders approved a change in the Trust's name to
Cova Series Trust. A new investment advisory agreement was entered into with
Cova Investment Advisory Corp. A sub-advisory agreement between Cova
Investment Advisory Corp. and Van Kampen American Capital Investment Advisory
Corp. was also approved. The investment advisory fee schedule was not
modified by this change. All of the above changes will take effect on May 1,
1996.
Van Kampen Merritt Series Trust Money Market Portfolio
For the 12-month period ended 12/31/95
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders of the Money Market
Portfolio of the Van Kampen Merritt Series Trust:
We have audited the accompanying statement of assets and liabilities of the
Money Market Portfolio (one of the portfolios comprising the Van Kampen
Merritt Series Trust) (the "Fund"), including the portfolio of investments,
as of December 31, 1995, and the related statement of operations for the year
then ended, the statement of changes in net assets for each of the two years
in the period then ended, and the financial highlights for each of the periods
presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1995, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of the
Money Market Portfolio of the Van Kampen Merritt Series Trust as of
December 31, 1995, the results of its operations for the year then ended, the
changes in its net assets for each of the two years in the period then ended,
and the financial highlights for each of the periods presented, in conformity
with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois
January 30, 1996, except as to
Note 4, which is as of February 9, 1996
Van Kampen Merritt Series Trust Money Market Portfolio
Portfolio of Investments
December 31, 1995
<TABLE>
- -----------------------------------------------------------------------------------------------------------------------------
Discount
Par Yield on
Amount Maturity Date of Amortized
(000) Security Description Date Purchase Cost
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Agency 29.0%
$ 220 Student Loan Marketing Assn. 01/03/96 5.400% $ 220,604
325 Federal Home Loan Bank 01/17/96 5.930 324,143
1,500 Federal Farm Credit Bank 02/01/96 5.660 1,500,000
2,000 Federal Home Loan Mtg Corp. Disc Note 02/01/96 5.420 1,990,666
2,000 Federal National Mtg Assn. Disc Note 03/01/96 5.360 1,982,133
1,000 Federal National Mtg Assn. Disc Note 03/22/96 5.390 987,873
2,000 Federal Home Loan Bank 03/27/96 5.330 1,974,534
1,000 Federal Home Loan Bank 08/16/96 6.000 1,000,000
---------------
Total Agency 9,979,953
---------------
Bankers Acceptances 4.8%
452 Northern Trust Bank 01/19/96 5.690 450,824
1,200 Union Bank of Los Angeles 02/09/96 5.650 1,192,655
---------------
Total Bankers Acceptances 1,643,479
---------------
Commercial Paper 34.9%
1,500 Heller Financial Inc. 01/05/96 5.800 1,499,033
1,000 General Electric Capital Corp. 01/11/96 5.760 1,000,000
1,500 IBM Credit Corp. 01/17/96 5.790 1,500,000
1,500 Merrill Lynch & Co. Inc. 01/29/96 5.760 1,493,280
1,500 AT & T Capital Corp. 01/30/96 5.670 1,493,149
1,000 Ford Motor Credit Co. 02/12/96 5.620 1,000,000
1,500 John Deere Capital Corp. 02/20/96 5.510 1,500,000
1,000 American General Finance Corp. 02/26/96 5.420 991,569
1,500 American Express Credit Corp. 03/13/96 5.530 1,500,000
---------------
Total Commercial Paper 11,977,031
---------------
Variable Rate Demand Obligations 11.2%
1,150 Catholic Healthcare West (Gtd: Toronto Dominion Bank) 01/03/96 6.050 1,150,000
300 Health Insurance Plan Greater New York (L.O.C. Morgan
Gty) 01/03/96 5.950 300,000
800 Mississippi Business Finance Corp. 01/03/96 5.900 800,000
1,600 Virginia State Housing Development Authority 01/03/96 5.950 1,600,000
---------------
Total Variable Rate Demand Obligations 3,850,000
---------------
</TABLE>
See Notes to Financial Statements
Van Kampen Merritt Series Trust Money Market Portfolio
Portfolio of Investments (Continued)
December 31, 1995
<TABLE>
Amortized
Security Description Cost
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Repurchase Agreement 19.9%
State Street Bank and Trust, U.S. T-Bill, $7,340,000
par, 0% coupon, due 12/12/96, dated 12/29/95, to be
sold on 01/02/96 at $6,855,377
$ 6,851,000
---------------
Total Investments - 99.8% <F1> 34,301,463
Other Assets in Excess of Liabilities - 0.2% 81,033
---------------
Net Assets - 100.0% $ 34,382,496
---------------
---------------
<FN>
<F1>At December 31, 1995, cost is identical for both book and federal income tax purposes.
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST MONEY MARKET PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- ------------------------------------------------------------------------------------
<S> <C>
ASSETS:
Investments at Amortized Cost Which Approximates
Market (Note 1) $ 34,301,463
Cash 487
Receivables:
Interest 103,126
Fund Shares Sold 25,017
-------------
Total Assets 34,430,093
-------------
LIABILITIES:
Accrued Expenses 36,412
Payable for Fund Shares Repurchased 11,185
-------------
Total Liabilities 47,597
-------------
NET ASSETS $ 34,382,496
-------------
-------------
NET ASSETS CONSIST OF:
Paid In Surplus $ 34,458,054
Accumulated Net Realized Loss on Investments (75,558)
-------------
NET ASSETS
(Equivalent to $1.00 per share on 34,458,054 shares
outstanding; an unlimited number of shares without
par value are authorized) (Note 3) $ 34,382,496
-------------
-------------
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST MONEY MARKET PORTFOLIO
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1995
- ------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Interest $ 3,110,220
-------------
EXPENSES:
Investment Advisory Fee (Note 2) 259,159
Custody 27,283
Trustees Fees and Expenses (Note 2) 26,354
Legal (Note 2) 9,976
Other 23,087
-------------
Total Expenses 345,859
Less Fees Waived by the Adviser and Expenses
Reimbursed by Cova Life ($259,159 and $28,672,
respectively) 287,831
-------------
Net Expenses 58,028
-------------
NET INVESTMENT INCOME $ 3,052,192
-------------
-------------
Realized Gain/Loss on Investments:
Proceeds from Sales $ 31,558,663
Cost of Securities Sold (31,524,318)
-------------
NET REALIZED GAIN ON INVESTMENTS 34,345
-------------
NET INCREASE IN NET ASSETS FROM OPERATIONS $ 3,086,537
-------------
-------------
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST MONEY MARKET PORTFOLIO
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1995 and 1994
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Operations:
Net Investment Income $ 3,052,192 $ 2,528,826
Net Realized Gain/Loss on Investments 34,345 (77,617)
-------------- --------------
Change in Net Assets from Operations 3,086,537 2,451,209
Distributions from Net Investment Income (3,052,192) (2,528,826)
-------------- --------------
NET CHANGE IN NET ASSETS FROM
INVESTMENT ACTIVITIES 34,345 (77,617)
-------------- --------------
FROM CAPITAL TRANSACTIONS (Note 3):
Proceeds from Shares Sold 27,981,115 127,080,727
Net Asset Value of Shares Issued
through Dividend Reinvestment 3,052,192 2,528,826
Cost of Shares Repurchased (72,571,677) (60,198,925)
-------------- --------------
NET CHANGE IN NET ASSETS FROM
CAPITAL TRANSACTIONS (41,538,370) 69,410,628
-------------- --------------
TOTAL INCREASE/DECREASE IN NET ASSETS (41,504,025) 69,333,011
NET ASSETS:
Beginning of the Period 75,886,521 6,553,510
-------------- --------------
End of the Period $ 34,382,496 $ 75,886,521
-------------- --------------
-------------- --------------
</TABLE>
See Notes to Financial Statements
<TABLE>
Van Kampen Merritt Series Trust Money Market Portfolio
Financial Highlights
The following schedule presents financial highlights for one share of
the Fund outstanding throughout the periods indicated.
- -------------------------------------------------------------------------------------------------------------------
July 1, 1991
(Commencement of
Years Ended December 31 Investment
------------------------------------ Operations) to
1995 1994 1993 1992 December 31, 1991
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ----- ----- -------
Net Investment Income .059 .041 .032 .038 .027
Less Distributions from Net Investment Income .059 .041 .032 .038 .027
----- ----- ----- ----- -------
Net Asset Value, End of Period $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ----- ----- -------
----- ----- ----- ----- -------
Total Return* 6.01% 4.23% 3.24% 3.88% 2.75%**
Net Assets at End of Period (In millions) $34.4 $75.9 $6.6 $4.0 $5.4
Ratio of Expenses to Average Net
Assets *(Annualized) .11% .10% .10% .10% .09%
Ratio of Net Investment Income to Average
Net Assets* (Annualized) 5.68% 4.37% 3.23% 3.63% 5.11%
*If certain expenses had not been assumed by
the Adviser and Cova Life, total return would
have been lower and the ratios would have
been as follows:
Ratio of Expenses to Average Net Assets (Annualized) .64% .68% .86% 1.30% 1.11%
Ratio of Net Investment Income to Average Net Assets
(Annualized) 5.25% 3.79% 2.47% 2.43% 4.10%
** Non-annualized
</TABLE>
VAN KAMPEN MERRITT
SERIES TRUST MONEY MARKET PORTFOLIO
Notes to Financial Statements
December 31, 1995
1. Significant Accounting Policies
Van Kampen Merritt Series Trust (the "Trust"), under which the Money Market
Portfolio (the "Fund") is organized as a separate sub-trust, is registered as
a diversified open-end management investment company under the Investment
Company Act of 1940, as amended. The investment objective of the 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.
The Trust commenced investment operations on December 11, 1989 and the Fund
commenced investment operations on July 1, 1991.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A. Security Valuation - Investments are valued at amortized cost, which
approximates market. Under this valuation method, a portfolio instrument is
valued at cost and any discount or premium is amortized on a straight line
basis to the maturity of the instrument.
B. Security Transactions - Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis.
Interest income and expenses are recorded on an accrual basis.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
C. Distribution of Income and Gains - The Fund declares dividends from net
investment income daily and automatically reinvests such dividends daily. Net
realized gains, if any, are distributed annually.
D. Federal Income Taxes - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Therefore, no provision for federal income taxes is
required.
The Fund intends to utilize the provisions of the federal income tax laws
which allow it to carry a realized capital loss forward for eight years
following the year of the loss and offset such losses against any future
realized capital gains. At December 31, 1995 the Fund had an accumulated
capital loss carryforward of $75,558 which will expire on December 31,
2002.
2. Investment Advisory Agreement and Other Transactions with Affiliates
Under the terms of the Fund's Investment Advisory Agreement, Van Kampen
American Capital Investment Advisory Corp. (the "Adviser") will provide
investment advice and facilities to the Fund for an annual fee payable monthly
as follows:
<TABLE>
Average Net Assets % Per Annum
<S> <C>
- ------------------ ------------
First $500 million .500 of 1%
Over $500 million .400 of 1%
</TABLE>
Cova Variable Annuity Accounts One and Five are separate investment
accounts offered by Cova Financial Services Life Insurance Co. and Cova
Financial Life Insurance Co. (collectively "Cova Life"), respectively. At
December 31, 1995, Cova Variable Annuity Accounts One and Five owned all
shares of beneficial interest of the Fund.
Certain officers and trustees of the Fund are also officers and directors
of Van Kampen American Capital Distributors, Inc. or its affiliates
(collectively "VKAC"). The Fund does not compensate its officers or trustees
who are officers of VKAC. The Fund has implemented a retirement plan which
covers those trustees who are not officers of VKAC. The Fund's liability
under the retirement plan at December 31, 1995, was approximately $6,200.
For the year ended December 31, 1995, the Fund recognized expenses of
approximately $12,200, representing VKAC's cost of providing accounting and
legal services.
3. Capital Transactions
At December 31, 1995 and 1994, paid in surplus aggregated $34,458,054 and
$75,996,424, respectively.
Transactions in shares were as follows:
<TABLE>
Year Year
Ended Ended
December 31, December 31,
1995 1994
<S> <C> <C>
----------------- ----------------
Beginning Shares 75,996,424 6,585,796
----------------- ----------------
Shares Sold 27,981,115 127,080,727
Shares Issued Through
Dividend Reinvestment 3,052,192 2,528,826
Shares Repurchased (72,571,677) (60,198,925)
----------------- ----------------
Net Increase/Decrease
in Shares Outstanding (41,538,370) 69,410,628
----------------- ----------------
Ending Shares 34,458,054 75,996,424
----------------- ----------------
----------------- ----------------
</TABLE>
4. Subsequent Events
On February 9, 1996, shareholders approved a change in the Trust's name to
Cova Series Trust. A new investment advisory agreement was entered into with
Cova Investment Advisory Corp. A sub-advisory agreement between Cova
Investment Advisory Corp. and Van Kampen American Capital Investment Advisory
Corp. was also approved. The investment advisory fee schedule was not
modified by this change. All of the above changes will take effect on May 1,
1996.
Van Kampen Merritt Series Trust Stock Index Portfolio
For the 12-month period ended 12/31/95
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders of the Stock Index
Portfolio of the Van Kampen Merritt Series Trust:
We have audited the accompanying statement of assets and liabilities of the
Stock Index Portfolio (one of the portfolios comprising the Van Kampen
Merritt Series Trust) (the "Fund"), including the portfolio of investments,
as of December 31, 1995, and the related statement of operations for the year
then ended, the statement of changes in net assets for each of the two years
in the period then ended, and the financial highlights for each of the periods
presented. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express
an opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included
confirmation of securities owned as of December 31, 1995, by correspondence
with the custodian. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position
of the Stock Index Portfolio of the Van Kampen Merritt Series Trust as of
December 31, 1995, the results of its operations for the year then ended,
the changes in its net assets for each of the two years in the period then
ended, and the financial highlights for each of the periods presented, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Chicago, Illinois
January 30, 1996, except as to
Note 6, which is as of February 9, 1996
Van Kampen Merritt Series Trust Stock Index Portfolio
Portfolio of Investments
December 31, 1995
<TABLE>
- -----------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Common and Preferred Stocks
Basic Industries 7.2%
Air Products & Chemicals Inc. 2,400 $126,600
Alcan Aluminum Ltd. 6,100 189,862
Allied Signal Inc. 5,600 266,000
Aluminum Company America 4,200 222,075
Avery Dennison Corp. 1,400 70,175
Barrick Gold Corp. 6,400 168,800
Crown Cork & Seal Inc. <F2> 1,800 75,150
Cyprus Amax Minerals Co. 2,100 54,863
Dow Chemical Co. 5,300 372,987
Du Pont (E. I.) De Nemours Co. 10,300 719,712
Eastman Chemical Co. 1,700 106,463
Eaton Corp. 1,500 80,438
FMC Corp. <F2> 1,100 74,388
Genuine Parts Co. 3,300 135,300
Georgia Pacific Corp. 2,200 150,975
Grace, W. R. & Co. 1,800 106,425
Grainger Inc. 1,000 66,250
Hercules Inc. 2,000 112,750
Homestake Mining Co. 3,600 56,250
Illinois Tool Works Inc. 2,600 153,400
Inco Ltd. 2,400 79,800
Ingersoll Rand Co. 2,200 77,275
International Paper Co. 6,800 257,550
Kimberly Clark Corp. 5,106 422,521
Louisiana Pacific Corp. 2,300 55,775
Monsanto Co. 2,200 269,500
Morton International Inc. 3,300 118,387
Nalco Chemical Co. 1,500 45,188
Newmont Mining Corp. 2,200 99,550
Nucor Corp. 1,600 91,400
Pall Corp. 2,200 59,125
Phelps Dodge Corp. 1,900 118,275
Pioneer Hi Bred International Inc. 1,700 94,563
Placer Dome Inc. 4,600 110,975
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- ------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Basic Industries (Continued)
PPG Inds. Inc. 4,200 $192,150
Reynolds Metals Co. 1,900 107,587
Temple Inland Inc. 1,300 57,363
Union Camp Corp. 1,800 85,725
Union Carbide Corp. 2,900 108,750
USX US Steel 1,600 49,200
Wachovia Corp. 3,300 150,975
Westvaco Corp. 2,200 61,050
Weyerhaeuser Co. 4,500 194,625
-----------
6,216,172
-----------
Capital Goods 6.4%
Boeing Co. 6,200 485,925
Browning Ferris Inds. Inc. 4,200 123,900
Brunswick Corp. 1,900 45,600
Caterpillar Inc. 3,900 229,125
Champion International Corp. 2,200 92,400
Cooper Inds. Inc. 2,200 80,850
Dana Corp. 2,100 61,425
Deere & Co. 5,100 179,775
Dover Corp. 2,600 95,875
Emerson Electric Co. 4,500 367,875
Engelhard Corp. 2,700 58,725
General Dynamics Corp. 1,400 82,775
General Electric Co. 30,700 2,210,400
ITT Inds. Inc. 2,100 50,400
Johnson Controls Inc. 1,100 75,625
Lockheed Martin Corp. 3,700 292,300
Parker Hannifin Corp. 1,600 54,800
Pitney Bowes Inc. 3,100 145,700
Praxair Inc. 2,800 94,150
Raytheon Co. 4,400 207,900
Rockwell International Corp. 4,000 211,500
Textron Inc. 1,800 121,500
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- -------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Capital Goods (Continued)
Tyco Interest Limited 3,200 $114,000
-----------
5,482,525
-----------
Consumer Durables 2.7%
Black & Decker Corp. 1,700 59,925
Chrysler Corp. 7,100 393,163
Ford Motor Co. 19,600 568,400
General Motors Corp. 13,700 724,387
Goodyear Tire & Rubber Co. 3,200 145,200
Masco Corp. 2,900 90,988
Newell Co. 3,400 87,975
Westinghouse Electric Corp. 7,200 118,800
Whirlpool Corp. 1,600 85,200
-----------
2,274,038
-----------
Consumer Non-Durables 12.8%
American Brands Inc. 3,700 165,113
American Stores Co. 2,900 77,575
Anheuser Busch Cos. Inc. 4,700 314,312
Archer Daniels Midland Co. 9,700 174,600
Avon Products Inc. 1,500 113,063
Campbell Soup Co. 4,800 288,000
Clorox Co. 1,200 85,950
Coca Cola Co. <F3> 23,100 1,715,175
Colgate Palmolive Co. 2,700 189,675
ConAgra Inc. 4,800 198,000
Conrail Inc. 1,600 112,000
CPC International Inc. 2,700 185,288
CUC International Inc. <F2> 3,400 116,025
De Luxe Corp. 1,800 52,200
Eastman Kodak Co. 6,100 408,700
General Mills Inc. 2,800 161,700
Gillette Co. 8,200 427,425
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- --------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Consumer Non-Durables (Continued)
Hasbro Inc. 1,900 $58,900
Heinz, H. J. & Co. 5,850 193,781
Hershey Foods Corp. 1,700 110,500
International Flavours 2,000 96,000
Kellogg Co. 3,600 278,100
Mattel Inc. 4,600 141,450
Mead Corp. 1,000 52,250
Melville Corp. 2,400 73,800
Nike Inc. 2,700 187,988
Pepsico Inc. 14,100 787,837
Philip Morris Cos. Inc. 15,300 1,384,650
Premark International Inc. 1,200 60,750
Procter & Gamble Co. 12,400 1,029,200
Quaker Oats Co. 2,700 93,150
Ralston Purina Co. 1,800 112,275
Reebok International Ltd. 1,600 45,200
Rubbermaid Inc. 3,000 76,500
Sara Lee Corp. 8,300 264,562
Seagram Ltd. 7,000 242,375
Sherwin Williams Co. 1,700 69,275
Unilever 3,000 422,250
UST Inc. 3,800 126,825
VF Corp. 1,400 73,850
Winn Dixie Stores Inc. 3,000 110,625
Wrigley Wm Junior Co. 2,100 110,250
-----------
10,987,144
-----------
Consumer Services 9.6%
Albertsons Inc. 4,700 154,512
Automatic Data Processing Inc. 2,900 215,325
Block H & R Inc. 2,100 85,050
Capital Cities/ABC Inc. 2,900 357,787
Circuit City Stores Inc. 1,700 46,963
Comcast Corp. 4,600 83,663
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Consumer Services (Continued)
Computer Sciences Corp. <F2> 1,300 $91,325
Darden Restaurants Inc. 3,300 39,188
Dayton Hudson Corp. 1,500 112,500
Dillard Department Stores Inc. 2,400 68,400
Donnelley R.R. & Sons Co. 3,300 129,937
Dow Jones & Co. Inc. 2,300 91,713
Dun & Bradstreet Corp. 3,400 220,150
Federal Express Corp. <F2> 1,100 81,263
Gannett Inc. 2,900 177,987
Gap Inc. 2,800 117,600
Harcourt General Inc. 1,400 58,625
Harrahs Entertainment Inc. 2,200 53,350
Hilton Hotels Corp. 1,100 67,650
Home Depot Inc. 8,800 421,300
Interpublic Group Cos. Inc. 1,400 60,725
ITT Corp. <F2> 2,100 111,300
Kmart Corp. 8,600 62,350
Knight Ridder Inc. 1,100 68,750
Kroger Co. <F2> 2,500 93,750
Limited Inc. 6,800 118,150
Lowes Cos. Inc. 3,100 103,850
Marriot International Inc. 2,400 91,800
May Department Stores Co. 5,000 211,250
McDonalds Corp. 12,400 559,550
MCI Communications Corp. 12,100 316,112
Moore Corp. Ltd. 2,300 42,838
Nordstrom Inc. 1,800 72,900
Penney, J.C. Inc. 4,400 209,550
Price Costco Inc. <F2> 4,100 62,525
Schweitzer Mauduit International Inc. <F2> 300 6,938
Sears Roebuck & Co. 6,900 269,100
Service Corp. International 2,000 88,000
Tele Communications Inc. 12,200 242,475
Time Warner Inc. 7,200 272,700
Toys R Us Inc. <F2> 5,200 113,100
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Consumer Services (Continued)
Tribune Co. 1,400 $85,575
TRW Inc. 1,500 116,250
Viacom Inc. <F2> 6,400 303,200
Wal-Mart Stores Inc. 43,300 968,837
Walgreen Co. 4,300 128,462
Walt Disney Co. 9,400 554,600
WMX Technologies Inc. 8,800 262,900
-----------
8,271,825
-----------
Energy 9.3%
Amerada Hess Corp. 1,900 100,700
Amoco Corp. 9,200 661,250
Ashland Inc. 1,500 52,688
Atlantic Richfield Co. 2,900 321,175
Baker Hughes Inc. 2,900 70,688
Burlington Resources Inc. 2,500 98,125
Chevron Corp. 12,100 635,250
Coastal Corp. 2,200 81,950
Dresser Inds. Inc. 4,000 97,500
Enron Corp. 4,500 171,562
Exxon Corp. <F3> 22,100 1,770,762
Halliburton Co. 2,000 101,250
Kerr McGee Corp. 1,300 82,550
Mobil Corp. 7,300 817,600
Occidental Petroleum Corp. 6,300 134,662
Phillips Petroleum Co. 5,100 174,037
Royal Dutch Petroleum Co. 10,000 1,411,250
Schlumberger Ltd. 4,500 311,625
Sonat Inc. 2,000 71,250
Sun Inc. 1,900 52,013
Texaco Inc. 5,200 408,200
Unocal Corp. 5,500 160,187
USX Marathon Group 5,200 101,400
Western Atlas Inc. 1,000 50,500
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Energy (Continued)
Williams Cos. Inc. 1,900 $83,363
-----------
8,021,537
-----------
Financial Services 12.4%
Aetna Life & Casualty Co. 2,200 152,350
Ahmanson H.F. & Co. 2,600 68,900
Allstate Corp. 8,000 329,000
American Express Co. 9,100 376,512
American General Corp. 3,900 136,013
American International Group Inc. 8,400 777,000
BancOne Corp. 7,100 268,025
Bank of New York Inc. 3,500 170,625
Bank of Boston Corp. 2,000 92,500
Bankamerica Corp. 6,700 433,825
Bankers Trust NY Corp. 1,600 106,400
Barnett Banks Inc. 2,000 118,000
Beneficial Corp. 1,400 65,275
Boatmens Bancshares Inc. 2,400 98,100
Chase Manhattan Corp. 3,300 200,062
Chemical Banking Corp. 4,700 276,125
Chubb Corp. 1,700 164,475
Cigna Corp. 1,400 144,550
Citicorp 7,400 497,650
Corestates Financial Corp. 2,600 98,475
Dean Witter Discover & Co. 3,300 155,100
Federal Home Loan Mortgage Corp. 3,500 292,250
Federal National Mortgage Assn. 5,100 633,037
First Chicago NBD Corp. 5,253 207,493
First Fidelity Bancorp 1,500 113,063
First Interstate Bancorp 1,500 204,750
First Union Corp. 2,900 161,312
Fleet Financial Group Inc. 4,862 198,126
General Reinsurance Corp. 1,500 232,500
Golden West Financial Corp. 1,100 60,775
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Financial Services (Continued)
Great Western Financial Corp. 2,800 $71,400
Household International Inc. 2,000 118,250
ITT Hartford Group Inc. <F2> 2,100 101,588
Jefferson Pilot Corp. 1,500 69,750
Keycorp 4,300 155,875
Lincoln National Corp. Inc. 2,100 112,875
Loews Corp. 2,600 203,775
Marsh & Mclennan Co. Inc. 1,300 115,375
MBNA Corp. 2,500 92,188
McGraw Hill Inc. 1,200 104,550
Mellon Bank Corp. 2,800 150,500
Merrill Lynch & Co. Inc. 3,300 168,300
Morgan, J.P. & Co. Inc. 3,600 288,900
National City Corp. 3,000 99,375
NationsBank Corp. 5,000 348,125
Norwest Corp. 5,600 184,800
PNC Bank Corp. 4,000 129,000
Providian Corp. 2,100 85,575
Safeco Corp. 2,600 89,700
Salomon Inc. 2,000 71,000
St. Paul Cos. Inc. 1,700 94,563
SunTrust Banks Inc. 2,300 157,550
Torchmark Inc. 1,500 67,875
Transamerica Corp. 1,300 94,738
Travelers Inc. 5,900 370,962
Unum Corp. 1,400 77,000
Wells Fargo & Co. 900 194,400
-----------
10,650,257
-----------
Healthcare 10.1%
Abbott Labs 14,400 601,200
Alco Standard Corp. 2,200 100,375
American Home Products Corp. 5,700 552,900
Amgen Inc. <F2> 4,900 290,937
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Healthcare (Continued)
Baxter International Inc. 5,200 $217,750
Becton Dickinson & Co. 1,400 105,000
Boston Scientific Corp. <F2> 2,800 137,200
Bristol Myers Squibb Co. 9,200 790,050
Columbia / HCA Healthcare Corp. 8,500 431,375
Eli Lilly & Co. 9,800 551,250
Johnson & Johnson 11,600 993,250
Mallinckrodt Group Inc. 1,800 65,475
Medtronic Inc. 4,200 234,675
Merck & Co. Inc. 22,300 1,466,225
Pfizer Inc. 11,400 718,200
Pharmacia & Upjohn Inc. 9,100 352,625
Schering-Plough Corp. 6,700 366,825
Tenet Healthcare Corp. <F2> 3,700 76,775
U.S. Healthcare Inc. 2,800 130,200
United Healthcare Corp. 3,300 216,150
Warner Lambert Co. 2,500 242,813
-----------
8,641,250
-----------
Public Utilities 8.6%
American Electric Power Inc. 3,200 129,600
Ameritech Corp. 9,800 578,200
Baltimore Gas & Electric Co. 3,100 88,350
Bell Atlantic Corp. 7,700 514,937
Bellsouth Corp. 17,400 756,900
Carolina Power & Light Co. 2,500 86,250
Central & South West Corp. 3,600 100,350
Cinergy Corp. 2,600 79,625
Consolidated Edison Co. 3,900 124,800
Consolidated Natural Gas Co. 1,800 81,675
Detroit Edison Co. 2,800 96,600
Dominion Resources Inc. 3,400 140,250
Duke Power Co. 3,500 165,813
Entergy Corp. 4,100 119,925
</TABLE>
See Notes to Financial Institutions
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Public Utilities (Continued)
FPL Group Inc. 3,600 $166,950
General Public Utilities Corp. 2,300 78,200
GTE Corp. 17,400 765,600
Houston Inds. Inc. 5,000 121,250
Northern STS Power Co. 1,500 73,688
Nynex Corp. 7,500 405,000
Ohio Edison Co. 3,400 79,900
Pacific Gas & Electric Co. 7,800 221,325
Pacific Telesis Group 7,500 252,187
Pacificorp 4,000 85,000
Panhandle Eastern Corp. 2,900 80,838
Peco Energy Co. 3,800 114,475
Public Service Enterprise Group 4,400 134,750
SCE Corp. 7,400 131,350
Southern Co. 12,300 302,887
Sprint Corp. 6,400 255,200
Tenneco Inc. 3,700 183,613
Texas Utilities Co. 3,900 160,388
U.S. West Inc. 8,200 293,150
Unicom Corp. 3,500 114,625
Union Electric Co. 1,900 79,325
United Technologies Corp. 2,500 237,187
-----------
7,400,163
-----------
Technology 13.1%
Advanced Micro Devices Inc. <F2> 1,900 31,350
Airtouch Communications Inc. <F2> 9,400 265,550
AMP Inc. 4,400 168,850
Apple Computer 2,200 70,125
Applied Materials Inc. <F2> 3,400 133,875
AT & T Corp. 28,700 1,858,325
Cisco Systems Inc. <F2> 5,000 373,125
Compaq Computer Corp. <F2> 4,900 235,200
Computer Associates International Inc. 4,400 250,250
</TABLE>
See Notes to Financial Institutions
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Technology (Continued)
Corning Inc. 4,300 $137,600
Digital Equipment Corp. <F2> 2,800 179,550
DSC Communications Corp. <F2> 2,300 84,812
First Data Corp. 4,100 274,187
Fluor Corp. 1,700 112,200
Great Lakes Chemical Corp. 1,400 100,800
Hewlett Packard Co. 9,500 795,625
Honeywell Inc. 2,600 126,425
Intel Corp. 15,200 862,600
International Business Machines 10,100 926,675
Loral Corp. 3,200 113,200
McDonnell Douglas Corp. 2,000 184,000
Micron Technology Inc. 3,800 150,575
Microsoft Corp. <F2> 10,600 930,150
Minnesota Mining & Manufacturing Co. 8,100 536,625
Motorola Inc. 11,100 632,700
National Semiconductor Corp. <F2> 2,500 55,625
Northern Telecom Ltd. 4,600 197,800
Northrop Corp. 1,100 70,400
Novell Inc. <F2> 7,100 101,175
Oracle Systems Corp. <F2> 8,000 339,000
Rohm & Haas Co. 1,300 83,688
Silicon Graphics Inc. <F2> 2,900 79,750
Sun Microsystems Inc. <F2> 3,600 164,250
Sysco Corp. 3,300 107,250
Tandy Corp. 1,200 49,800
Texas Instruments Inc. 3,700 191,475
Xerox Corp. 2,100 287,700
-----------
11,262,287
-----------
</TABLE>
See Notes to Financial Statements
<TABLE>
Portfolio of Investments (Continued)
December 31, 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Security
Description Shares Market Value
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Telecommunications 1.0%
Alltel Corp. 3,700 $109,150
SBC Communications Inc. 10,800 621,000
US West Inc. <F2> 8,600 163,400
-----------
893,550
-----------
Transportation 1.3%
AMR Corp. <F2> 1,600 118,800
Burlington Northern Santa Fe 2,800 218,400
CSX Corp. 4,200 191,625
Delta Air Lines Inc. 1,100 81,263
Norfolk Southern Corp. 2,500 198,437
Southwest Airlines Co. 2,900 67,425
Union Pacific Corp. 3,800 250,800
-----------
1,126,750
-----------
Total Long-Term Investments 94.5%
(Cost $67,139,734) <F1> 81,227,498
Repurchase Agreement 5.4%
State Street Bank & Trust, U.S. T-Note, $4,015,000 par,
7.500% coupon, due 11/15/16, dated 12/29/95, to be sold
on 01/02/96 at $4,638,962. 4,636,000
Other Assets in Excess of Liabilities 0.1% 119,902
-----------
Net Assets 100% $85,983,400
-----------
-----------
<FN>
<F1>At December 31, 1995, cost for federal income tax purposes is $67,139,734; the
aggregate gross unrealized appreciation is $14,860,196 and the aggregate gross
unrealized depreciation is $806,855, resulting in net unrealized appreciation
including open option and futures transactions of $14,053,341.
<F2>Non-income producing security as this stock currently does not declare
dividends.
<F3>Assets segregated for open option and futures transactions.
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST STOCK INDEX PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1995
- ------------------------------------------------------------------------------------
<S> <C>
ASSETS:
Investments, at Market Value (Cost $67,139,734) (Note 1) $ 81,227,498
Repurchase Agreements (Note 1) 4,636,000
Cash 200
Receivables:
Dividends 160,895
Fund Shares Sold 4,710
Margin on Futures (Note 5) 3,850
Interest 2,221
Options at Market Value (Net premiums paid of $23,298) (Note 5) 24,075
-------------
Total Assets 86,059,449
-------------
LIABILITIES:
Investment Advisory Fee Payable (Note 2) 38,629
Accrued Expenses 37,420
-------------
Total Liabilities 76,049
-------------
NET ASSETS $ 85,983,400
-------------
-------------
NET ASSETS CONSIST OF:
Paid In Surplus (Note 3) $ 71,895,636
Net Unrealized Appreciation on Investments 14,053,341
Accumulated Net Realized Gain on Investments 34,423
-------------
NET ASSETS $ 85,983,400
-------------
-------------
NET ASSET VALUE PER SHARE
($85,983,400 divided by 6,210,939 shares outstanding;
an unlimited number of shares without par value are
authorized) (Note 3) $13.84
-------------
-------------
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST STOCK INDEX PORTFOLIO
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1995
- ------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Dividends (Net of foreign withholding taxes of $8,900) $ 1,299,662
Interest 496,725
-------------
Total Income 1,796,387
-------------
EXPENSES:
Investment Advisory Fee (Note 2) 296,648
Custody 93,697
Audit 33,879
Trustees Fees and Expenses (Note 2) 20,206
Legal (Note 2) 13,721
Other 7,843
-------------
Total Expenses 465,994
Less Expenses Reimbursed by Cova Life 103,824
-------------
Net Expenses 362,170
-------------
NET INVESTMENT INCOME $ 1,434,217
-------------
-------------
REALIZED AND UNREALIZED GAIN/LOSS ON INVESTMENTS:
Realized Gain/Loss on Investments:
Proceeds from Sales $ 4,307,481
Cost of Securities Sold (2,019,570)
-------------
Net Realized Gain on Investments (Including realized
gain on closed option and futures transactions of
$60,351 and $2,124,689, respectively) 2,287,911
-------------
Unrealized Appreciation/Depreciation on Investments:
Beginning of the Period (363,126)
End of the Period (Including unrealized appreciation
on open option transactions of $777 and unrealized
depreciation on open futures transactions of $35,200) 14,053,341
-------------
Net Unrealized Appreciation on Investments During the Period 14,416,467
-------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS $ 16,704,378
-------------
-------------
NET INCREASE IN NET ASSETS FROM OPERATIONS $ 18,138,595
-------------
-------------
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST STOCK INDEX PORTFOLIO
STATEMENT OF CHANGES IN NET ASSETS
For the Years Ended December 31, 1995 and 1994
- ----------------------------------------------------------------------------------------------------------
Year Ended Year Ended
December 31, 1995 December 31, 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
FROM INVESTMENT ACTIVITIES:
Operations:
Net Investment Income $ 1,434,217 $ 1,218,783
Net Realized Gain on Investments 2,287,911 311,001
Net Unrealized Appreciation/Depreciation
on Investments During the Period 14,416,467 (2,393,977)
--------------- ---------------
Change in Net Assets from Operations 18,138,595 (864,193)
--------------- ---------------
Distributions from Net Investment Income (1,434,217) (1,218,783)
Distributions from Net Realized Gain on Investments (2,274,444) (623,624)
Return of Capital Distribution 0 (20,956)
--------------- ---------------
Total Distributions (3,708,661) (1,863,363)
--------------- ---------------
NET CHANGE IN NET ASSETS FROM
INVESTMENT ACTIVITIES 14,429,934 (2,727,556)
--------------- ---------------
FROM CAPITAL TRANSACTIONS (Note 3):
Proceeds from Shares Sold 50,283,187 14,386,901
Net Asset Value of Shares Issued
through Dividend Reinvestment 3,708,661 1,863,363
Cost of Shares Repurchased (19,249,305) (67,994,792)
--------------- ---------------
NET CHANGE IN NET ASSETS FROM CAPITAL
TRANSACTIONS 34,742,543 (51,744,528)
--------------- ---------------
TOTAL INCREASE/DECREASE IN NET ASSETS 49,172,477 (54,472,084)
NET ASSETS:
Beginning of the Period 36,810,923 91,283,007
--------------- ---------------
End of the Period $ 85,983,400 $ 36,810,923
--------------- ---------------
--------------- ---------------
</TABLE>
See Notes to Financial Statements
<TABLE>
VAN KAMPEN MERRITT SERIES TRUST STOCK INDEX PORTFOLIO
FINANCIAL HIGHLIGHTS
The following schedule presents financial highlights for one share of the Fund
outstanding throughout the periods indicated.
- -------------------------------------------------------------------------------------------------------------------
November 1,1991
(Commencement of
Investment
Year Ended December 31, Operations) to
1995 1994 1993 1992 December 31,1991
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of the Period $10.587 $11.115 $10.552 $10.572 $10.000
------- ------- ------- ------- -------
Net Investment Income .260 .311 .205 .172 .038
Net Realized and Unrealized Gain/Loss on Investments 3.637 (.337) .726 .477 .534
------- ------- ------- ------- -------
Total from Investment Operations 3.897 (.026) .931 .649 .572
------- ------- ------- ------- -------
Less:
Distributions from Net Investment Income .260 .311 .205 .210 .000
Distributions from Net Realized Gain on Investments .380 .185 .163 .459 .000
Return of Capital Distributions .000 .006 .000 .000 .000
------- ------- ------- ------- -------
Total Distributions .640 .502 .368 .669 .000
------- ------- ------- ------- -------
Net Asset Value, End of the Period $13.844 $10.587 $11.115 $10.552 $10.572
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Total Return* 36.87% (.11%) 8.84% 6.22% 5.70%**
Net Assets at End of the Period (In millions) $86.0 $36.8 $91.3 $35.0 $6.8
Ratio of Expenses to Average Net Assets *(Annualized) .61% .58% .60% .59% .40%
Ratio of Net Investment Income to Average Net
Assets* (Annualized) 2.41% 2.23% 2.29% 2.54% 3.02%
Portfolio Turnover 3.94% 47.05% 44.09% 85.73% .00%
* If certain expenses had not been assumed by
Cova Life, total return would have been lower
and the ratios would have been as follows:
Ratio of Expenses to Average Net Assets (Annualized) .78% .80% .74% 1.21% 1.84%
Ratio of Net Investment Income to Average Net Assets
(Annualized) 2.24% 2.01% 2.15% 1.92% 1.58%
**Non-Annualized
</TABLE>
See Notes to Financial Statements
VAN KAMPEN MERRITT SERIES TRUST STOCK INDEX PORTFOLIO
Notes to Financial Statements
December 31, 1995
1. Significant Accounting Policies
Van Kampen Merritt Series Trust (the "Trust"), under which the Stock Index
Portfolio (the "Fund") is organized as a separate sub-trust, is registered as
a diversified open-end management investment company under the Investment
Company Act of 1940, as amended. The Trust's investment objective is to
achieve investment results that approximate the aggregate price and yield
performance of the Standard & Poor's 500 Composite Stock Price Index by
investing in common stocks, stock index futures contracts and options on stock
index futures contracts, and certain short-term fixed income securities such
as cash reserves. The Trust commenced investment operations on December 11,
1989. The Fund commenced investment operations on November 1, 1991.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A. Security Valuation - Investments in securities listed on a securities
exchange are valued at their sale price as of the close of such securities
exchange. Investments in securities not listed on a securities exchange are
valued based on their last quoted bid price or, if not available, their fair
value as determined by the Board of Trustees. Short-term securities with
remaining maturities of less than 60 days are valued at amortized cost.
B. Security Transactions - Security transactions are recorded on a trade date
basis. Realized gains and losses are determined on an identified cost basis.
C. Investment Income and Expenses - Dividend income is recorded on the
ex-dividend date and interest income and expenses are recorded on an accrual
basis.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
D. Federal Income Taxes - It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute substantially all of its taxable income to its
shareholders. Therefore, no provision for federal income taxes is
required.
Net realized gains or losses may differ for financial and tax reporting
purposes primarily as a result of timing differences related to open option
and futures transactions at year end.
E. Distribution of Income and Gains - The Fund declares and pays dividends
semi-annually from net investment income. Net realized gains, if any, are
distributed annually. Distributions from net realized gains for book purposes
may include short-term capital gains and gains on option and futures
transactions. Any short-term capital gains and a portion of option and
futures gains would be included in ordinary income for tax purposes.
Distributions are automatically reinvested in Fund shares.
2. Investment Advisory Agreement and Other Transactions with Affiliates
Under the terms of the Fund's Investment Advisory Agreement, Van Kampen
American Capital Investment Advisory Corp. (the "Adviser") will provide
investment advice and facilities to the Fund for an annual fee payable
monthly of .50% of the average net assets of the Fund.
Cova Variable Annuity Accounts One and Five are separate investment
accounts offered by Cova Financial Services Life Insurance Co. and Cova
Financial Life Insurance Co. (collectively "Cova Life"), respectively. At
December 31, 1995, Cova Variable Annuity Accounts One and Five owned all
shares of beneficial interest of the Fund.
Certain officers and trustees of the Fund are also officers and directors
of Van Kampen American Capital Distributors, Inc. or its affiliates
(collectively "VKAC"). The Fund does not compensate its officers or trustees
who are officers of VKAC.
The Fund has implemented a retirement plan which covers those trustees
who are not officers of VKAC. The Fund's liability under the retirement plan
at December 31, 1995, was approximately $6,200.
For the year ended December 31, 1995, the Fund recognized expenses of
approximately $16,500 representing VKAC's cost of providing accounting and
legal services.
3. Capital Transactions
At December 31, 1995 and 1994, paid in surplus aggregated $71,895,636 and
$37,153,093, respectively.
Transactions in shares were as follows:
<TABLE>
Year Year
Ended Ended
December 31, December 31,
1995 1994
<S> <C> <C>
----------------- ----------------
Beginning Shares 3,477,141 8,212,885
----------------- ----------------
Shares Sold 3,889,063 1,323,458
Shares Issued through
Dividend Reinvestment 271,456 176,442
Shares Repurchased (1,426,721) (6,235,644)
------------------ ---------------
Net Increase/Decrease in
Shares Outstanding 2,733,798 (4,735,744)
----------------- ---------------
Ending Shares 6,210,939 3,477,141
------------------ ---------------
</TABLE>
VAN KAMPEN MERRITT SERIES TRUST STOCK INDEX PORTFOLIO
Notes to Financial Statements (Continued)
December 31, 1995
4. Investment Transactions
Aggregate purchases and cost of sales of investment securities, excluding
short-term notes, for the year ended December 31, 1995, were $34,676,159 and
$2,019,570, respectively.
5. Derivative Financial Instruments
A derivative financial instrument in very general terms refers to a security
whose value is "derived" from the value of an underlying asset, reference rate
or index.
The Fund has a variety of reasons to use derivative instruments, such as
to attempt to protect the Fund against possible changes in the market value of
its portfolio or to generate potential gain. All of the Fund's portfolio
holdings, including derivative instruments, are marked to market each day with
the change in value reflected in the unrealized appreciation/depreciation on
investments. Upon disposition, a realized gain or loss is recognized
accordingly, except for exercised option contracts where the recognition of
gain or loss is postponed until the disposal of the security underlying the
option contract.
Summarized below are the specific types of derivative financial instruments
used by the Fund.
A. Option Contracts - An option contract gives the buyer the right, but not
the obligation to buy (call) or sell (put) an underlying item at a fixed
exercise price during a specified period. These contracts are generally used
by the Fund to provide the return of an index without purchasing all of the
securities underlying the index or as a substitute for purchasing or selling
specific securities.
Transactions in options for the year ended December 31, 1995, were as
follows:
<TABLE>
Contracts Premium
<S> <C> <C>
------------------------
Outstanding at
December 31, 1994 6 $169
Options Written
and Purchased (Net) 156 (60,040)
Options Terminated
in Closing Transactions
(Net) (126) 36,573
------------ -----------
Outstanding at
December 31, 1995 36 ($23,298)
------------ ----------
------------ ----------
</TABLE>
The related futures contracts of the options outstanding at December 31, 1995,
and their descriptions and market values are as follows:
<TABLE>
Expiration
Month/ Market
Exercise Value
Contracts Price of Options
<S> <C> <C> <C>
------------------------------------
S&P 500
Index Futures
Written Puts 18 Mar/605 $ (14,063)
Purchased Calls 18 Mar/605 38,138
----------- ------------
36 $ 24,075
----------- ------------
</TABLE>
B. Futures Contracts - A futures contract is an agreement involving the
delivery of a particular asset on a specified future date at an agreed upon
price. The Fund generally invests in futures on the S&P 500 Index and
typically closes the contract prior to the delivery date. These contracts are
generally used to provide the return of an index without purchasing or selling
all of the securities underlying the index.
The fluctuation in market value of the contracts is settled daily through
a cash margin account. Realized gains and losses are recognized when the
contracts are closed or expire.
Transactions in futures contracts for the year ended December 31, 1995,
were as follows:
<TABLE>
Contracts
<S> <C>
-----------
Outstanding at
December 31, 1994 11
Futures Opened 227
Futures Closed
(227)
-----------
Outstanding at
December 31, 1995
11
-----------
-----------
</TABLE>
The futures contracts outstanding at December 31, 1995, and the description
and unrealized depreciation is as follows:
<TABLE>
Unrealized
Contracts Depreciation
<S> <C> <C>
----------- --------------
S&P 500 Index Futures
Mar 1996 - Buys to Open 11 $ 35,200
----------- --------------
----------- --------------
</TABLE>
6. Subsequent Events
On February 9, 1996, shareholders approved a change in the Trust's name to
Cova Series Trust. A new investment advisory agreement was entered into with
Cova Investment Advisory Corp. A sub-advisory agreement between Cova
Investment Advisory Corp. and Van Kampen American Capital Investment Advisory
Corp. was also approved. The investment advisory fee schedule was not
modified by this change. All of the above changes will take effect on May 1,
1996.
VAN KAMPEN MERRITT SERIES TRUST
STATEMENTS OF ASSETS AND LIABILITIES OF
BOND DEBENTURE PORTFOLIO
QUALITY BOND PORTFOLIO
SMALL CAPITAL STOCK PORTFOLIO
LARGE CAPITAL STOCK PORTFOLIO
SELECT EQUITY PORTFOLIO
INTERNATIONAL EQUITY PORTFOLIO
APRIL 1, 1996
<TABLE>
<CAPTION>
BOND QUALITY SMALL CAPITAL LARGE CAPITAL SELECT INTERNATIONAL
DEBENTURE BOND STOCK STOCK EQUITY EQUITY
PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO PORTFOLIO
<S> <C> <C> <C> <C> <C> <C>
ASSETS
Cash $500,000 $5,000,000 $5,000,000 $15,000,000 $5,000,000 $5,000,000
-------- ---------- ---------- ----------- ---------- ----------
Total Assets $500,000 $5,000,000 $5,000,000 $15,000,000 $5,000,000 $5,000,000
======== ========== ========== =========== ========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
- - - - - -
======== ========== ========== =========== ========== ==========
NET ASSETS $500,000 $5,000,000 $5,000,000 $15,000,000 $5,000,000 $5,000,000
======== ========== ========== =========== ========== ==========
NET ASSETS CONSIST OF:
Paid in Capital $500,000 $5,000,000 $5,000,000 $15,000,000 $5,000,000 $5,000,000
======== ========== ========== =========== ========== ==========
NET ASSET VALUE AND REDEMPTION PRICE PER SHARE $10.00 $10.00 $10.00 $10.00 $10.00 $10.00
======== ========== ========== =========== ========== ==========
NUMBER OF FUND SHARES OUTSTANDING 50,000 500,000 500,000 1,500,000 500,000 500,000
======== ========== ========== =========== ========== ==========
</TABLE>
The accompanying notes are an integral part of this financial statement.
<PAGE>
Van Kampen Merritt Series Trust
Notes to the Statements of Assets and Liabilities
April 1, 1996
1. ORGANIZATION
The Van Kampen Merritt Series Trust (the "Trust") was established as a
Massachusetts business trust under a Declaration of Trust dated July 9, 1987.
The Trust is registered as an open-end management investment company under the
Investment Company Act of 1940, as amended. On February 9, 1996, shareholders
approved a change in the Trust's name to Cova Series Trust effective May 1,
1996. Also on February 9, 1996 the Board of Trustees voted to add six separate
diversified investment portfolios (the "Portfolios") to the existing investment
portfolios of the Trust. The new Portfolios are the Bond Debenture Portfolio,
Quality Bond Portfolio, Small Capital Stock Portfolio, Large Capital Stock
Portfolio, Select Equity Portfolio, and International Equity Portfolio.
The Portfolios have had no operations, other than those relating to
organizational matters, including the issuance of seed money shares, on April 1,
1996, to Cova Financial Services Life Insurance Company ("Cova"), the provider
of the Portfolios' initial capital and ultimate Company sponsor of variable
annuity contracts investing in the Portfolios.
The Portfolios are available through the purchase of variable annuity policies.
Bond Debenture Portfolio seeks high current income and the opportunity for
capital appreciation by investing in convertible and discount debt securities,
many of which will be lower rated. Quality Bond Portfolio seeks a high total
return consistent with a moderate risk of capital and maintenance of liquidity.
Small Capital Stock Portfolio seeks high total return from a portfolio of equity
securities of small companies. Large Capital Stock and Select Equity Portfolios
seek long-term growth of capital and income by investing in equity holdings of
large and medium sized companies. International Equity Portfolio seeks a high
total return from a portfolio of equity securities of foreign corporations.
Organizational costs incurred in connection with the initial registration and
public offering of shares of the Portfolios are being borne and directly
expensed by Cova.
2. AFFILIATED SERVICE PROVIDER
The Trust has entered into an investment advisory agreement (the
"Advisory Agreement") with Cova Investment Advisory Corporation (the "Adviser").
The Adviser is affiliated with Cova. Certain officers and directors of the
Adviser are also officers or trustees of the Trust. The Advisory Agreement
provides for the Fund to pay the Adviser an advisory fee based on the fund's
average daily net assets.
<PAGE>
The following annual rates represent total advisory fees for each Portfolio:
<TABLE>
<CAPTION>
PORTFOLIO TOTAL ADVISORY FEES
<S> <C>
Bond Debenture Portfolio 0.75%
Quality Bond Portfolio 0.55% on first $75 million
0.50% on amounts above $75 million
Small Capital Stock Portfolio 0.85%
Large Capital Stock Portfolio 0.65%
Select Equity Portfolio 0.75% on first $50 million
0.65% on amounts above $50 million
International Equity Portfolio 0.85% on first $50 million
0.75% on amounts above $50 million
</TABLE>
The Adviser has engaged Lord Abbett & Co. to act as sub-adviser to provide the
day-to-day portfolio management for Bond Debenture Portfolio. The Adviser has
also engaged J.P. Morgan Investment Management, Inc. to act as sub-adviser to
provide the day-to-day portfolio management for Quality Bond Portfolio, Small
Capital Stock Portfolio, Large Capital Stock Portfolio, Select Equity Portfolio,
and International Equity Portfolio.
3. INCOME TAXES
The Fund intends to comply with the requirements of the Internal
Revenue Code necessary to qualify as a regulated investment company and to make
the requisite distributions of taxable income to its shareholders which will be
sufficient to relieve it from all or substantially all federal income taxes.
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Trustees and Shareholders of the Van Kampen
Merritt Series Trust
We have audited the accompanying opening statements of assets and liabilities of
the Bond Debenture, Quality Bond, Small Capital Stock, Large Capital Stock,
Select Equity and International Equity Portfolio funds (the Portfolios) of the
Van Kampen Merritt Series Trust (the "Trust") as of April 1, 1996. This
financial statement is the responsibility of the Trust's management. Our
responsibility is to express an opinion on this financial statement based on our
audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statement is free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. Our procedures included
confirmation of cash balances as of April 1, 1996, by correspondence with the
custodian. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statement referred to above presents fairly, in
all material respects, the financial position of the Portfolios of the Van
Kampen Merritt Series Trust as of April 1, 1996 in conformity with generally
accepted accounting principles.
/s/ KPMG Peat Marwick LLP
St. Louis, Missouri
April 15, 1996
