COVA SERIES TRUST
One Tower Lane, Suite 3000
Oakbrook Terrace, Illinois 60181-4644
COVA SERIES TRUST ("Trust") is intended to meet differing investment objectives
with its nineteen separate Portfolios, twelve of which are offered herein: Money
Market Portfolio, Quality Income Portfolio, Stock Index Portfolio, Bond
Debenture Portfolio, Quality Bond Portfolio, Small Cap Stock Portfolio, Large
Cap Stock Portfolio, Select Equity Portfolio, International Equity Portfolio,
Mid-Cap Value Portfolio, Large Cap Research Portfolio and Developing Growth
Portfolio. The Trustees may provide for additional Portfolios from time to time.
Each Portfolio issues its own class of shares which has rights separate from the
other classes of shares.
This Prospectus concisely sets forth the information about the Trust that a
prospective investor should know before investing. Investors should read and
retain this Prospectus for future reference.
A Statement of Additional Information, dated May 1, 1997, containing information
about the Trust has been filed with the Securities and Exchange Commission and
is hereby incorporated by reference into this Prospectus. A copy of the
Statement of Additional Information may be obtained without charge by calling
(800) 831-LIFE, or writing Cova Financial Services Life Insurance Company at One
Tower Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644.
PURCHASERS SHOULD BE AWARE THAT AN INVESTMENT IN THE MONEY MARKET PORTFOLIO IS
NEITHER INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE
THAT THE MONEY MARKET PORTFOLIO WILL BE ABLE TO MAINTAIN A STABLE NET ASSET
VALUE OF $1.00 PER SHARE.
THE BOND DEBENTURE PORTFOLIO MAY INVEST A SUBSTANTIAL PORTION OF ITS ASSETS IN
LOWER GRADE CORPORATE DEBT SECURITIES COMMONLY KNOWN AS "JUNK BONDS." INVESTORS
SHOULD BE AWARE THAT SUCH INVESTMENTS INVOLVE A SIGNIFICANT DEGREE OF RISK. SEE
"RISK FACTORS SPECIAL RISKS OF HIGH YIELD INVESTING."
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
This Prospectus is dated: May 1, 1997, as amended September 8, 1997.
TABLE OF CONTENTS Page
SUMMARY 3
The Trust 3
Investment Adviser and Sub-Advisers 3
The Portfolios 3
Investment Risks 4
Sales and Redemptions 5
FINANCIAL HIGHLIGHTS 6
THE TRUST 10
INVESTMENT OBJECTIVES AND
POLICIES OF THE PORTFOLIOS 10
Quality Bond Portfolio 10
Small Cap Stock Portfolio 11
Large Cap Stock Portfolio 12
Select Equity Portfolio 13
International Equity Portfolio 14
Bond Debenture Portfolio 15
Mid-Cap Value Portfolio 16
Large Cap Research Portfolio 16
Developing Growth Portfolio 18
Money Market Portfolio 19
Quality Income Portfolio 20
Stock Index Portfolio 21
INVESTMENT PRACTICES 24
Investment Limitations 27
RISK FACTORS 27
Tax Considerations 27
Special Considerations Relating to
Foreign Securities 28
Special Risks of High Yield Investing 29
PORTFOLIO TURNOVER RATES 30
Money Market Portfolio and
Quality Income Portfolio 30
Bond Debenture Portfolio 30
Stock Index Portfolio 30
Quality Bond, Small Cap Stock,
Select Equity, International Equity
and Large Cap Stock Portfolios 30
Mid-Cap Value, Large Cap Research
and Developing Growth Portfolios 30
MANAGEMENT OF THE TRUST 30
The Trustees 30
Adviser 31
Trust Administration 31
Portfolio Management 32
Expenses of the Trust 32
Sub-Advisers 32
Sub-Advisory Fees 34
DESCRIPTION OF THE TRUST 34
Shareholder Rights 34
Inquiries 35
Distribution and Redemption of Shares 35
Dividends 35
Tax Status 35
Net Asset Values 36
FUND PERFORMANCE 36
APPENDIX -- DESCRIPTION OF
CORPORATE BOND RATINGS 39
SUMMARY
The Trust
The Trust is an open-end management investment company established as a
Massachusetts business trust under a Declaration of Trust dated July 9, 1987.
Each Portfolio issues a separate class of shares. The Declaration of Trust
permits the Trustees to issue an unlimited number of full or fractional shares
of each class of stock.
Each Portfolio has distinct investment objectives and policies. (See "Investment
Objectives and Policies of the Portfolios.") Additional Portfolios may be added
to the Trust in the future. This Prospectus will be supplemented to reflect the
addition of new Portfolios.
Investment Adviser and Sub-Advisers
Subject to the authority of the Board of Trustees of the Trust, Cova Investment
Advisory Corporation (the "Adviser") serves as the Trust's investment adviser
and has responsibility for the overall management of the investment strategies
and policies of the Portfolios. The Adviser has engaged Sub-Advisers for each of
the Portfolios to make investment decisions and place orders. The Sub-Advisers
for the Portfolios are:
Sub-Adviser Name of Portfolio
J.P. Morgan Quality Bond Portfolio
Investment Small Cap Stock Portfolio
Management Inc. Large Cap Stock Portfolio
Select Equity Portfolio
International Equity Portfolio
Lord, Abbett & Co. Bond Debenture Portfolio
Mid-Cap Value Portfolio
Large Cap Research Portfolio
Developing Growth Portfolio
Van Kampen American Money Market Portfolio
Capital Investment Quality Income Portfolio
Advisory Corp. Stock Index Portfolio
For additional information concerning the Adviser and the Sub-Advisers,
including a description of advisory and sub-advisory fees, see "Management of
the Trust."
The Portfolios
Portfolios Managed by J.P. Morgan Investment Management Inc.:
Quality Bond Portfolio.
The investment objective of this Portfolio 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 preserve the value of its investments to the extent consistent
with its objective.
Small Cap Stock Portfolio.
The investment objective of this Portfolio is to provide a high total return
from a portfolio of equity securities of small companies. The Portfolio will
invest primarily in the common stock of small U.S. companies. The small
company holdings of the Portfolio will be primarily securities included in the
Russell 2000 Index.
Large Cap Stock Portfolio.
The investment objective of this Portfolio is long-term growth of capital and
income. The equity holdings of the Portfolio will be primarily stocks of
large- and medium-sized companies. The Portfolio will be highly diversified
and hold approximately 300 stocks.
Select Equity Portfolio.
The investment objective of this Portfolio is long-term growth of capital and
income. The equity holdings of the Portfolio will be primarily stocks of
large- and medium-sized companies. The Portfolio will typically hold between
60 and 90 stocks.
International Equity Portfolio.
The investment objective of this Portfolio is to provide a high total return
from a portfolio of equity securities of foreign corporations. The equity
holdings of the Portfolio will be primarily stocks of established companies
based in developed countries outside the United States. The Portfolio is
actively managed and seeks to outperform the Morgan Stanley Capital
International Europe, Australia and Far East Index.
Portfolios Managed by Lord, Abbett & Co.:
Bond Debenture Portfolio.
The investment objective of this Portfolio is high current income and the
opportunity for capital appreciation to produce a high total return through a
professionally-managed portfolio consisting primarily of convertible and
discount debt securities, many of which are lower-rated. These lower-rated
debt securities entail greater risks than investments in higher-rated debt
securities. Investors should carefully consider these risks set forth under
"Risk Factors - Special Risks of High Yield Investing" before investing.
Mid-Cap Value Portfolio.
The investment objective of this Portfolio is to seek capital appreciation
through investments, primarily in equity securities, which are believed to be
undervalued in the marketplace. Under normal circumstances, at least 65% of
the Portfolio's total assets will consist of investments in companies whose
outstanding equity securities have an aggregate market value of between $200
million and $5 billion.
Large Cap Research Portfolio.
The investment objective of this Portfolio is growth of capital and growth of
income consistent with reasonable risk. Production of current income is a
secondary consideration. Under normal circumstances, at least 65% of the
Portfolio's total assets will consist of investments in companies whose
outstanding equity securities have an aggregate market value of $1.5 billion
and above.
Developing Growth Portfolio.
The investment objective of this Portfolio is long-term growth of capital
through a diversified and actively-managed portfolio consisting of developing
growth companies, many of which are traded over the counter. The Portfolio
will invest primarily in the common stocks of companies with long-range growth
potential, particularly smaller companies considered to be in the developing
growth phase. Volatile price movement can be expected.
Portfolios Managed by Van Kampen American Capital Investment Advisory Corp.:
Money Market Portfolio.
The investment objective of this Portfolio is to provide high current income
consistent with the preservation of capital and liquidity through investment
in a broad range of money market instruments that will mature within 12 months
of the date of purchase. An investment in the Money Market Portfolio is
neither insured nor guaranteed by the U.S. Government.
Quality Income Portfolio.
The investment objective of this Portfolio is to seek a high level of current
income, consistent with safety of principal, by investing in obligations
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities or in various investment grade debt obligations including
mortgage pass-through certificates and collateralized mortgage obligations.
Stock Index Portfolio.
The investment objective of this Portfolio 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 indexes and stock index futures
contracts, and certain short-term fixed income securities such as cash
reserves.
"Standard & Poor's", "S&P", "S&P 500", "Standard & Poor's 500" and "500" are
trademarks of McGraw-Hill Inc. and have been licensed for use by Cova Financial
Services Life Insurance Company and its affiliates. The Stock Index Portfolio is
not sponsored, endorsed, sold or promoted by Standard & Poor's Corporation
("S&P") and S&P makes no representation regarding the advisability of investing
in the Stock Index Portfolio.
The investment objectives of a Portfolio and policies and restrictions
specifically cited as fundamental may not be changed without the approval of a
majority of the outstanding shares of that Portfolio. Other investment policies
and practices described in this Prospectus and in the Statement of Additional
Information are not fundamental, and the Board of Trustees may change them
without shareholder approval. A complete list of investment restrictions,
including those restrictions which cannot be changed without shareholder
approval, is contained in the Statement of Additional Information. There is no
assurance that a Portfolio will meet its stated objective.
Investment Risks
The value of a Portfolio's shares will fluctuate with the value of the
underlying securities in its portfolio, and in the case of debt securities, with
the general level of interest rates. When interest rates decline, the value of
an investment portfolio invested in fixed-income securities can be expected to
rise. Conversely, when interest rates rise, the value of an investment portfolio
invested in fixed-income securities can be expected to decline. In the case of
foreign currency denominated securities, these trends may be offset or amplified
by fluctuations in foreign currencies. Investments by a Portfolio in foreign
securities may be affected by adverse political, diplomatic, and economic
developments, changes in foreign currency exchange rates, taxes or other
assessments imposed on distributions with respect to those investments, and
other factors affecting foreign investments generally. High-yielding
fixed-income securities, which are commonly known as "junk bonds", are subject
to greater market fluctuations and risk of loss of income and principal than
investments in lower yielding fixed-income securities. Certain of the Portfolios
intend to employ, from time to time, certain investment techniques which are
designed to enhance income or total return or hedge against market or currency
risks but which themselves involve additional risks. These techniques include
options on securities, futures, options on futures, options on indexes, options
on foreign currencies, foreign currency exchange transactions, lending of
securities and when-issued securities and delayed-delivery transactions. The
Portfolios may have higher-than-average portfolio turnover which may result in
higher-than-average brokerage commissions and transaction costs.
Sales and Redemptions
The Trust sells shares only to the separate accounts of Cova Financial Services
Life Insurance Company and its affiliated life insurance companies
(collectively, "Cova Life") as a funding vehicle for the variable annuity
contracts and/or variable life insurance policies ("Variable Contracts") offered
by Cova Life. No fee is charged upon the sale or redemption of the Trust's
shares. Expenses of the Trust are passed through to the separate accounts of
Cova Life, and therefore, are ultimately borne by Variable Contract owners. In
addition, other fees and expenses are assessed by Cova Life at the separate
account level. (See the Prospectus for the Variable Contract for a description
of all fees and charges relating to the Variable Contract.)
FINANCIAL HIGHLIGHTS
(for one share of each Portfolio outstanding throughout the period)
The following schedule presents financial highlights for one share of each of
the Portfolios throughout the periods indicated. The financial highlights have
been audited by KPMG Peat Marwick LLP, independent auditors, for each of the
periods through December 31, 1996 presented below, and their report thereon
appears in the Portfolios' related Statement of Additional Information. This
information should be read in conjunction with the financial statements and
related notes thereto included in the Statement of Additional Information, a
copy of which may be obtained without charge as indicated elsewhere in this
Prospectus.
COVA SERIES TRUST
FINANCIAL HIGHLIGHTS
For Shares Held Throughout the Periods Indicated
For the Period from May 1, 1996 (date of initial public offering) to December
31, 1996
<TABLE>
<CAPTION>
Inter-
Small Cap Quality Select Large Cap national Bond
Stock Bond Equity Stock Equity Debenture
Portfolio Portfolio Portfolio Portfolio Portfolio Portfolio
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.512 $9.897 $10.084 $10.003 $10.215 $10.098
------- ------ ------- ------- ------- -------
Income from Investment Operations
Net investment income 0.057 0.459 0.081 0.124 0.096 0.345
Net realized and unrealized gains (losses) 0.843 0.102 0.771 1.304 0.755 0.949
----- ----- ----- ----- ----- -----
Total from investment operations 0.900 0.561 0.852 1.428 0.851 1.294
----- ----- ----- ----- ----- -----
Distributions
Dividends from net investment income (0.055) (0.376) (0.081) (0.122) (0.086) (0.342)
Distributions from net realized gains (0.435) _ _ (0.113) (0.197) (0.021) (0.080)
Distributions in excess of net
investment income _ _ _ _ [dagger] _ _ _ _ _ _
Return of capital distributions _ _ _ _ _ _ _ _ _ _ _ _
------- ------ ------- ------- ------- -------
Total distributions (0.490) (0.376) (0.194) (0.319) (0.107) (0.422)
------ ------ ------ ------ ------ ------
Net Asset Value, End of Period $10.922 $10.082 $10.742 $11.112 $10.959 $10.970
------- ------- ------- ------- ------- -------
Total Return 8.65%* 5.68%* 8.52%* 14.35%* 8.44%* 12.89%*
---- ---- ---- ----- ---- -----
Ratios/Supplemental Data:
Net Assets, end of period (in millions) $14.7 $5.8 $23.8 $16.8 $15.6 $7.7
Ratios to Average Net Assets (1):
Expenses 0.95%** 0.65%** 0.85%** 0.75%** 0.95%** 0.85%**
Net investment income 0.87%** 5.94%** 1.35%** 1.56%** 1.43%** 7.26%**
Portfolio Turnover Rate 102.4% 181.3% 123.9% 35.5% 48.2% 58.1%
Average Commission Rate Paid (2) $0.0371 N/A $0.0406 $0.0323 $0.0107 $0.0677
(1) If certain expenses had not been
reimbursed by the Adviser, total return
would have been lower and the ratios
would have been as follows:
Ratio of Expenses to Average Net Assets: 2.68%** 1.52%** 1.70%** 1.23%** 3.80%** 2.05%**
Ratio of Net Investment Income to
Average Net Assets: (0.86%)** 5.07%** 0.50%** 1.08%** (1.42%)** 6.06%**
(2) Average commission rate paid is computed by dividing the total dollar amount
of commissions paid during the period by the total number of shares purchased
and sold during the period for which commissions were charged.
<FN>
[dagger] Amount is less than .0005%
* Non-Annualized
** Annualized
N/A Not Applicable
</FN>
</TABLE>
See Notes to Financial Statements
<TABLE>
<CAPTION>
MONEY MARKET PORTFOLIO
July 1, 1991
(Commencement of
Investment
Year Ended December 31 Operations) to
1996 1995 1994 1993 1992 December 31, 1991
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ----- ----- ----- -----
Income from Investment Operations
Net investment income 0.053 0.059 0.041 0.032 0.038 0.027
Net realized and unrealized gains (losses) _ _ _ _ _ _ _ _ _ _ _ _
----- ----- ----- ----- ----- -----
Total from investment operations 0.053 0.059 0.041 0.032 0.038 0.027
----- ----- ----- ----- ----- -----
Distributions
Dividends from net investment income (0.053) (0.059) (0.041) (0.032) (0.038) (0.027)
Distributions from net realized gains _ _ _ _ _ _ _ _ _ _ _ _
Distributions in excess of net
investment income _ _ _ _ _ _ _ _ _ _ _ _
Return of capital distributions _ _ _ _ _ _ _ _ _ _ _ _
----- ----- ----- ----- ----- -----
Total distributions (0.053) (0.059) (0.041) (0.032) (0.038) (0.027)
------ ------ ------ ------ ------ ------
Net Asset Value, End of Period $1.00 $1.00 $1.00 $1.00 $1.00 $1.00
----- ----- ----- ----- ----- -----
Total Return 5.42% 6.01% 4.23% 3.24% 3.88% 2.75%*
---- ---- ---- ---- ---- ----
Ratios/Supplemental Data:
Net Assets, end of period (in millions) $31.0 $34.4 $75.9 $6.6 $4.0 $5.4
Ratios to Average Net Assets (1):
Expenses 0.11% 0.11% 0.10% 0.10% 0.10% 0.09%**
Net investment income 5.31% 5.68% 4.37% 3.23% 3.63% 5.11%**
Portfolio Turnover Rate N/A N/A N/A N/A N/A N/A
Average Commission Rate Paid (2) N/A N/A N/A N/A N/A N/A
(1) If certain expenses had not been
reimbursed by the Adviser, total return
would have been lower and the ratios
would have been as follows:
Ratio of Expenses to Average Net Assets: 0.74% 0.64% 0.68% 0.86% 1.30% 1.11%**
Ratio of Net Investment Income to
Average Net Assets: 4.68% 5.25% 3.79% 2.47% 2.43% 4.10%**
(2) Average commission rate paid is computed by dividing the total dollar amount
of commissions paid during the period by the total number of shares purchased
and sold during the period for which commissions were charged.
<FN>
* Non-Annualized
** Annualized
N/A Not Applicable
</FN>
</TABLE>
See Notes to Financial Statements
<TABLE>
<CAPTION>
QUALITY INCOME PORTFOLIO
Dec. 11, 1989
(Commence-
ment of
Investment
Year Ended December 31 Operations) to
1996 1995 1994 1993 1992 1991 1990 Dec. 31, 1989
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $10.871 $9.815 $10.886 $10.699 $10.618 $9.969 $9.930 $10.000
------- ------ ------- ------- ------- ------ ------ -------
Income from Investment Operations
Net investment income 0.651 0.667 0.603 0.641 0.696 0.753 0.713 0.043
Net realized and unrealized
gains (losses) (0.359) 1.056 (1.071) 0.518 0.081 0.649 0.039 (0.070)
------ ----- ------ ----- ----- ----- ----- ------
Total from investment operations 0.292 1.723 (0.468) 1.159 0.777 1.402 0.752 (0.027)
----- ----- ------ ----- ----- ----- ----- ------
Distributions
Dividends from net
investment income (0.471) (0.667) (0.603) (0.641) (0.696) (0.753) (0.713) (0.043)
Distributions from net realized gains (0.002) _ _ _ _ (0.331) _ _ _ _ _ _ _ _
Distributions in excess of net
investment income _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
Return of capital distributions _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
------- ------ ------- ------- ------- ------ ------ -------
Total distributions (0.473) (0.667) (0.603) (0.972) (0.696) (0.753) (0.713) (0.043)
------ ------ ------ ------ ------ ------ ------ ------
Net Asset Value, End of Period $10.690 $10.871 $9.815 $10.886 $10.699 $10.618 $9.969 $9.930
------- ------- ------ ------- ------- ------- ------ ------
Total Return 2.82% 17.99% (4.33%) 11.04% 7.61% 14.71% 7.99% (0.27%)*
---- ----- ----- ----- ---- ----- ---- -----
Ratios/Supplemental Data:
Net Assets, end of period
(in millions) $51.3 $41.4 $33.9 $51.1 $24.1 $6.8 $6.1 $2.5
Ratios to Average Net Assets (1):
Expenses 0.60% 0.60% 0.59% 0.60% 0.60% 0.60% 0.74% 0.70%**
Net investment income 6.06% 6.42% 5.69% 5.82% 6.87% 7.45% 7.64% 7.83%**
Portfolio Turnover Rate 320.3% 219.5% 177.6% 318.4% 231.9% 12.9% 59.3% 0.0%
Average Commission Rate Paid (2) N/A N/A N/A N/A N/A N/A N/A N/A
(1) If certain expenses had not been
reimbursed by the Adviser, total return
would have been lower and the ratios
would have been as follows:
Ratio of Expenses to Average
Net Assets: 0.71% 0.75% 0.68% 0.70% 0.88% 1.10% 1.53% 9.15%**
Ratio of Net Investment Income to
Average Net Assets: 5.95% 6.27% 5.60% 5.73% 6.59% 6.96% 6.85% (0.62%)**
(2) Average commission rate paid is computed by dividing the total dollar amount
of commissions paid during the period by the total number of shares purchased
and sold during the period for which commissions were charged.
<FN>
* Non-Annualized
** Annualized
N/A Not Applicable
</FN>
</TABLE>
See Notes to Financial Statements
<TABLE>
<CAPTION>
STOCK INDEX PORTFOLIO
November 1, 1991
(Commencement of
Investment
Year Ended December 31 Operations) to
1996 1995 1994 1993 1992 December 31, 1991
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net Asset Value, Beginning of Period $13.844 $10.587 $11.115 $10.552 $10.572 $10.000
------- ------- ------- ------- ------- -------
Income from Investment Operations
Net investment income 0.286 0.260 0.311 0.205 0.172 0.038
Net realized and unrealized gains (losses) 2.797 3.637 (0.337) 0.726 0.477 0.534
----- ----- ------ ----- ----- -----
Total from investment operations 3.083 3.897 (0.026) 0.931 0.649 0.572
----- ----- ------ ----- ----- -----
Distributions
Dividends from net investment income (0.284) (0.260) (0.311) (0.205) (0.210) _ _
Distributions from net realized gains (0.517) (0.380) (0.185) (0.163) (0.459) _ _
Distributions in excess of net
investment income _ _ _ _ _ _ _ _ _ _ _ _
Return of capital distributions _ _ _ _ (0.006) _ _ _ _ _ _
------- ------- ------- ------- ------- -------
Total distributions (0.801) (0.640) (0.502) (0.368) (0.669) _ _
------ ------ ------ ------ ------
Net Asset Value, End of Period $16.126 $13.844 $10.587 $11.115 $10.552 $10.572
------- ------- ------- ------- ------- -------
Total Return 22.48% 36.87% (0.11%) 8.84% 6.22% 5.70%*
----- ----- ----- ---- ---- ----
Ratios/Supplemental Data:
Net Assets, end of period (in millions) $86.6 $86.0 $36.8 $91.3 $35.0 $6.8
Ratios to Average Net Assets (1):
Expenses 0.60% 0.61% 0.58% 0.60% 0.59% 0.40%**
Net investment income 1.77% 2.41% 2.23% 2.29% 2.54% 3.02%**
Portfolio Turnover Rate 1.3% 3.9% 47.1% 44.1% 85.7% _ _
Average Commission Rate Paid (2) $0.0333 N/A N/A N/A N/A N/A
(1) If certain expenses had not been
reimbursed by the Adviser, total return
would have been lower and the ratios
would have been as follows:
Ratio of Expenses to Average Net Assets: 0.67% 0.78% 0.80% 0.74% 1.21% 1.84%**
Ratio of Net Investment Income to
Average Net Assets: 1.70% 2.24% 2.01% 2.15% 1.92% 1.58%**
(2) Average commission rate paid is computed by dividing the total dollar amount
of commissions paid during the period by the total number of shares purchased
and sold during the period for which commissions were charged.
<FN>
* Non-Annualized
** Annualized
N/A Not Applicable
</FN>
</TABLE>
See Notes to Financial Statements
THE TRUST
The Trust is currently comprised of nineteen separate Portfolios, twelve of
which are offered herein: Money Market Portfolio, Quality Income Portfolio,
Stock Index Portfolio, Bond Debenture Portfolio, Quality Bond Portfolio, Small
Cap Stock Portfolio, Large Cap Stock Portfolio, Select Equity Portfolio,
International Equity Portfolio, Mid-Cap Value Portfolio, Large Cap Research
Portfolio and Developing Growth Portfolio. The Trustees may provide for
additional Portfolios from time to time. Each Portfolio issues a separate class
of shares. The Declaration of Trust permits the Trustees to issue an unlimited
number of full or fractional shares of each class of stock.
INVESTMENT OBJECTIVES AND
POLICIES OF THE PORTFOLIOS
Each Portfolio of the Trust has a different investment objective which it
pursues through separate investment policies as described below. The risks and
opportunities of each Portfolio should be examined separately. The differences
in objectives and policies among the Portfolios can be expected to affect the
return of each Portfolio and the degree of market and financial risk of each
Portfolio.
There is no assurance that the investment objectives of the various Portfolios
will be met.
Portfolios Managed by J.P. Morgan Investment Management Inc.:
Quality Bond Portfolio.
The investment objective of the Portfolio is to provide a high total return
consistent with moderate risk of capital and maintenance of liquidity. Total
return will consist of income plus realized and unrealized capital gains and
losses.
The Portfolio is designed for investors who seek a total return over time that
is higher than that generally available from a portfolio of shorter-term
obligations while recognizing the greater price fluctuation of longer-term
instruments. It may also be a convenient way to add fixed income exposure to
diversify an existing portfolio.
The Sub-Adviser actively manages the Portfolio's duration, the allocation of
securities across market sectors, and the selection of specific securities
within sectors. Based on fundamental, economic and capital markets research, the
Sub-Adviser adjusts the duration of the Portfolio in light of market conditions
and the Sub-Adviser's interest rate outlook. For example, if interest rates are
expected to fall, the duration may be lengthened to take advantage of the
expected associated increase in bond prices. The Sub-Adviser also actively
allocates the Portfolio's assets among the broad sectors of the fixed income
market including, but not limited to, U.S. Government and agency securities,
corporate securities, private placements, and asset-backed and mortgage related
securities. Specific securities which the Sub-Adviser believes are undervalued
are selected for purchase within the sectors using advanced quantitative tools,
analysis of credit risk, the expertise of a dedicated trading desk, and the
judgment of fixed income portfolio managers and analysts. Under normal
circumstances, the Sub-Adviser intends to keep the Portfolio essentially fully
invested with at least 65% of the Portfolio's assets invested in bonds.
Duration is a measure of the weighted average maturity of the bonds held in the
Portfolio and can be used as a measure of the sensitivity of the Portfolio's
market value to changes in interest rates. Under normal market conditions the
Portfolio's duration will range between one year shorter and one year longer
than the duration of the U.S. investment grade fixed income universe, as
represented by Salomon Brothers Broad Investment Grade Bond Index, the
Portfolio's benchmark. As of May 1, 1997, the benchmark's duration was
approximately 4.78 years. The maturities of the individual securities in the
Portfolio may vary widely, however.
The Portfolio intends to manage its portfolio actively in pursuit of its
investment objective. Portfolio transactions are undertaken principally to
accomplish the Portfolio's objective in relation to expected movements in the
general level of interest rates, but the Portfolio may also engage in short-term
trading consistent with its objective. To the extent the Portfolio engages in
short-term trading, it may incur increased transaction costs.
Corporate Bonds, etc. The Portfolio may invest in a broad range of debt
securities of domestic and foreign issuers. These include debt securities of
various types and maturities, e.g., debentures, notes, mortgage securities,
equipment trust certificates and other collateralized securities and zero coupon
securities. Collateralized securities are backed by a pool of assets such as
loans or receivables which generate cash flow to cover the payments due on the
securities. Collateralized securities are subject to certain risks, including a
decline in the value of the collateral backing the security, failure of the
collateral to generate the anticipated cash flow or in certain cases more rapid
prepayment because of events affecting the collateral, such as accelerated
prepayment of mortgages or other loans backing these securities or destruction
of equipment subject to equipment trust certificates. In the event of any such
prepayment the Portfolio will be required to reinvest the proceeds of
prepayments at interest rates prevailing at the time of reinvestment, which may
be lower. In addition, the value of zero coupon securities which do not pay
interest is more volatile than that of interest bearing debt securities with the
same maturity. The Portfolio does not intend to invest in common stock but may
invest to a limited extent in convertible debt or preferred stock. The Portfolio
does not expect to invest more than 25% of its assets in securities of foreign
issuers. If the Portfolio invests in non-U.S. dollar denominated securities, it
hedges the foreign currency exposure into the U.S. dollar. See "Investment
Practices" and "Risk Factors" for further information on foreign investments and
convertible securities.
Government Obligations, etc. The Portfolio may invest in obligations issued or
guaranteed by the U.S. Government and backed by the full faith and credit of the
United States. These securities include Treasury securities, Government National
Mortgage Association ("GNMA") Certificates, and obligations of the Farmers Home
Administration and the Export Import Bank. GNMA Certificates are mortgage-backed
securities which evidence an undivided interest in mortgage pools. These
securities are subject to more rapid repayment than their stated maturity would
indicate because prepayments of principal on mortgages in the pool are passed
through to the holder of the securities. During periods of declining interest
rates, prepayments of mortgages in the pool can be expected to increase. The
pass-through of these prepayments would have the effect of reducing the
Portfolio's positions in these securities and requiring the Portfolio to
reinvest the prepayments at interest rates prevailing at the time of
reinvestment. The Portfolio may also invest in obligations issued or guaranteed
by U.S. Government agencies or instrumentalities where the Portfolio must look
principally to the issuing or guaranteeing agency for ultimate repayment; some
examples of agencies or instrumentalities issuing these obligations are the
Federal Farm Credit System, the Federal Home Loan Banks and the Federal National
Mortgage Association. Although these governmental issuers are responsible for
payments on their obligations, they do not guarantee their market value.
The Portfolio may also invest in municipal obligations which may be general
obligations of the issuer or payable only from specific revenue sources.
However, the Portfolio will invest only in municipal obligations that have been
issued on a taxable basis or have an attractive yield excluding tax
considerations. In addition, the Portfolio may invest in debt securities of
foreign governments and governmental entities. See "Investment Practices" and
"Risk Factors" for further information on foreign investments.
Money Market Instruments. The Portfolio may purchase money market instruments to
invest temporary cash balances or to maintain liquidity to meet withdrawals.
However, the Portfolio may also invest in money market instruments as a
temporary defensive measure taken during, or in anticipation of, adverse market
conditions. The money market investments permitted for the Portfolio include
U.S. Government Securities, other debt securities, commercial paper, bank
obligations and repurchase agreements. For more detailed information about these
money market investments, see "Investment Objectives and Policies" in the
Statement of Additional Information.
Quality Information. It is a current policy of the Portfolio that under normal
circumstances at least 65% of its total assets will consist of securities that
are rated at least A by Moody's Investors Service, Inc. ("Moody's") or Standard
& Poor's Corporation ("S&P") or that are unrated and in the Sub-Adviser's
opinion are of comparable quality. In the case of 30% of the Portfolio's
investments, the Portfolio may purchase debt securities that are rated Baa or
better by Moody's or BBB or better by S&P or are unrated and in the
Sub-Adviser's opinion are of comparable quality. The remaining 5% of the
Portfolio's assets may be invested in debt securities that are rated Ba or
better by Moody's or BB or better by S&P or are unrated and in the Sub-Adviser's
opinion are of comparable quality. Securities rated Baa by Moody's or BBB by S&P
are considered investment grade, but have some speculative characteristics.
Securities rated Ba by Moody's or BB by S&P are below investment grade and
considered to be speculative with regard to payment of interest and principal.
These standards must be satisfied at the time an investment is made. If the
quality of the investment later declines, the Portfolio may continue to hold the
investment. See "Appendix - Description of Corporate Bond Ratings" for more
detailed information on these ratings.
The Portfolio may also purchase and sell obligations on a when-issued or delayed
delivery basis, enter into repurchase and reverse repurchase agreements, loan
its portfolio securities, purchase certain privately placed securities and enter
into certain hedging transactions that may involve options on securities and
securities indexes, futures contracts and options on futures contracts. For a
discussion of these investments and investment techniques, see "Investment
Practices" and "Risk Factors."
Small Cap Stock Portfolio.
The investment objective of the Portfolio is to provide a high total return from
a portfolio of equity securities of small companies. Total return will consist
of realized and unrealized capital gains and losses plus income. The Portfolio
invests primarily in the common stock of small U.S. companies. The small company
holdings of the Portfolio are primarily companies included in the Russell 2000
Index.
The 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 may also serve as an efficient vehicle to diversify an existing
portfolio by adding the equities of smaller U.S. companies.
The Sub-Adviser seeks to enhance the Portfolio's total return relative to that
of the U.S. small company universe. To do so, the Sub-Adviser uses fundamental
research, systematic stock valuation and a disciplined portfolio construction
process. The Sub-Adviser continually screens the universe of small
capitalization companies to identify for further analysis those companies which
exhibit favorable characteristics such as significant and predictable cash flow
and high quality management. Based on fundamental research and using a dividend
discount model, the Sub-Adviser ranks these companies within economic sectors
according to their relative value. The Sub-Adviser then selects for purchase the
most attractive companies within each economic sector.
The Sub-Adviser uses a disciplined portfolio construction process to seek to
enhance returns and reduce volatility in the market value of the Portfolio
relative to that of the U.S. small company universe. The Sub-Adviser believes
that under normal market conditions, the Portfolio will have sector weightings
comparable to that of the U.S. small company universe, although it may
moderately under- or over-weight selected economic sectors. In addition, as a
company moves out of the market capitalization range of the small company
universe, it generally becomes a candidate for sale by the Portfolio.
The Portfolio intends to manage its investments actively in pursuit of its
investment objective. Since the Portfolio has a long-term investment
perspective, it does not intend to respond to short-term market fluctuations or
to acquire securities for the purpose of short-term trading; however, it may
take advantage of short-term trading opportunities that are consistent with its
objective. To the extent the Portfolio engages in short-term trading, it may
incur increased transaction costs.
Equity Investments. During ordinary market conditions, the Sub-Adviser intends
to keep the Portfolio essentially fully invested with at least 65% of the
Portfolio's net assets invested in equity securities consisting of common stocks
and other securities with equity characteristics such as preferred stocks,
warrants, rights and convertible securities. The Portfolio's primary equity
investments are the common stocks of small U.S. companies and, to a limited
extent, similar securities of foreign corporations. The common stock in which
the Portfolio may invest includes the common stock of any class or series or any
similar equity interest, such as trust or limited partnership interests. The
small company holdings of the Portfolio are primarily companies included in the
Russell 2000 Index. These equity investments may or may not pay dividends and
may or may not carry voting rights. The Portfolio invests in securities listed
on a securities exchange or traded in an over-the-counter market, and may invest
in certain restricted or unlisted securities.
Foreign Investments. The Portfolio may invest in equity securities of foreign
issuers that are listed on a national securities exchange or denominated or
principally traded in U.S. dollars. However, the Portfolio does not expect to
invest more than 5% of its assets at the time of purchase in foreign equity
securities. For further information on foreign investments and foreign currency
exchange transactions, see "Investment Practices" and "Risk Factors."
The Portfolio may also purchase and sell securities on a when-issued or delayed
delivery basis, enter into repurchase and reverse repurchase agreements, loan
its portfolio securities, purchase certain privately placed securities and money
market instruments, and enter into certain hedging transactions that may involve
options on securities and securities indexes, futures contracts and options on
futures contracts. For a discussion of these investments and investment
techniques, see "Investment Practices" and "Risk Factors."
Large Cap Stock Portfolio.
The investment objective of the Portfolio is long-term growth of capital and
income. The Portfolio seeks to achieve its objective consistent with reasonable
investment risk.
The Portfolio is designed for investors who want an actively managed portfolio
of medium- to large-cap equity securities that seeks to outperform the total
return of the S&P 500 Index ("S&P 500").
Ordinarily, the Portfolio pursues its investment objective by investing
primarily in dividend-paying common stock. The Portfolio may also invest in
other equity securities, consisting of, among other things, non-dividend-paying
common stock, preferred stock, and securities convertible into common stock,
such as convertible preferred stock and convertible bonds, and warrants. The
Portfolio may also invest in American Depositary Receipts ("ADRs") and in
various foreign securities if U.S. exchange-listed. (See "Risk Factors - Special
Considerations Relating to Foreign Securities.")
Stock Selection. The Portfolio is not subject to any limit on the size of
companies in which it may invest, but intends, under normal circumstances, to be
fully invested to the extent practicable in the stock of large- and medium-sized
companies typically represented by the S&P 500. In managing the Portfolio, the
potential for appreciation and dividend growth is given more weight than current
dividends. Nonetheless, the Sub-Adviser will normally strive for gross income
for the Portfolio at a level not less than 75% of the dividend income generated
on the stocks included in the S&P 500, although this income level is merely a
guideline and there can be no certainty that this income level will be achieved.
The Portfolio does not seek to achieve its objective with any individual
portfolio security, but rather it aims to manage the portfolio as a whole in
such a way as to achieve its objective. The Portfolio attempts to reduce risk by
investing in many different economic sectors, industries and companies.
Portfolio sector weightings will generally equal those of the S&P 500. In
selecting securities, the Sub-Adviser may emphasize securities that it believes
to be undervalued. Securities of a company may be undervalued for a variety of
reasons such as an overreaction by investors to unfavorable news about a
company, an industry, or the stock markets in general; or as a result of a
market decline, poor economic conditions, tax-loss selling, or actual or
anticipated unfavorable developments affecting a company.
The Sub-Adviser uses a dividend discount model to rank companies within economic
sectors according to their relative value and then separates them into quintiles
by sector. The Portfolio will normally be comprised, based on the dividend
discount model, of stocks in the first three quintiles. The Portfolio will be
highly diversified and will typically hold approximately 300 stocks.
Other Securities. During ordinary market conditions, the Sub-Adviser will keep
the Portfolio as fully invested as practicable in the equity securities
described above. The Portfolio may also invest in money market instruments,
including U.S. Government Securities, short term bank obligations rated in the
highest two rating categories by Moody's or S&P, or, if unrated, determined to
be of equal quality by the Sub-Adviser, certificates of deposit, time deposits
and banker's acceptances issued by U.S. and foreign banks and savings and loan
institutions with assets of at least $500 million as of the end of their most
recent fiscal year; and commercial paper and corporate obligations, including
variable rate demand notes, that are issued by U.S. and foreign issuers and that
are rated in the highest two rating categories by Moody's or S&P, or if unrated,
determined to be of equal quality by the Sub-Adviser. Under normal
circumstances, the Portfolio will invest in such money market instruments to
invest temporary cash balances or to maintain liquidity to meet redemptions or
expenses. The Portfolio may also, however, invest in these instruments, without
limitation, as a temporary defensive measure taken during, or in anticipation
of, adverse market conditions.
Convertible bonds and other fixed income securities (other than money market
instruments) in which the Portfolio may invest will, at the time of investment,
be rated Baa or better by Moody's or BBB or better by S&P or, if not rated by
Moody's or S&P, will be of comparable quality as determined by the Sub-Adviser.
In the event that an existing holding is downgraded below these ratings, the
Portfolio may nonetheless retain the security.
Other Techniques. In pursuing its investment objective, the Portfolio may
purchase and sell put and call options on securities and stock indexes. In
addition, the Portfolio may purchase or sell stock index futures contracts and
options thereon. These investment techniques may involve a greater degree or
different type of risk than those inherent in more conservative investment
approaches. See "Investment Practices" and "Risk Factors."
Select Equity Portfolio.
The investment objective of the Portfolio is long-term growth of capital and
income. The Portfolio seeks to achieve its objective consistent with reasonable
investment risk.
The Portfolio is designed for investors who want an actively managed portfolio
of selected equity securities that seeks to outperform the total return of the
S&P 500.
Ordinarily, the Portfolio pursues its investment objective by investing
primarily in dividend-paying common stock. The Portfolio may also invest in
other equity securities, consisting of, among other things, non-dividend-paying
common stock, preferred stock, and securities convertible into common stock,
such as convertible preferred stock and convertible bonds, and warrants. The
Portfolio may also invest in ADRs and in various foreign securities if U.S.
exchange-listed.
Stock Selection. The Portfolio is not subject to any limit on the size of
companies in which it may invest, but intends, under normal circumstances, to be
fully invested to the extent practicable in the stock of large- and medium-sized
companies primarily included in the S&P 500. In managing the Portfolio, the
potential for appreciation and dividend growth is given more weight than current
dividends. Nonetheless, the Sub-Adviser will normally strive for gross income
for the Portfolio at a level not less than 75% of the dividend income generated
on the stocks included in the S&P 500, although this income level is merely a
guideline and there can be no certainty that this income level will be achieved.
The Portfolio does not seek to achieve its objective with any individual
portfolio security, but rather it aims to manage the portfolio as a whole in
such a way as to achieve its objective. The Portfolio attempts to reduce risk by
investing in many different economic sectors, industries and companies. The
Sub-Adviser may under- or over-weight selected economic sectors against the S&P
500's sector weightings to seek to enhance the Portfolio's total return or
reduce fluctuations in market value relative to the S&P 500. In selecting
securities, the Sub-Adviser may emphasize securities that it believes to be
undervalued. Securities of a company may be undervalued for a variety of reasons
such as an overreaction by investors to unfavorable news about a company, an
industry, or the stock markets in general; or as a result of a market decline,
poor economic conditions, tax-loss selling, or actual or anticipated unfavorable
developments affecting a company.
The Sub-Adviser uses a dividend discount model to rank companies within economic
sectors according to their relative value and then separates them into quintiles
by sector. The Portfolio will primarily consist of stocks of companies from the
first and second quintiles. The Portfolio will typically hold between 60 and 90
stocks.
Other Securities. During ordinary market conditions, the Sub-Adviser will keep
the Portfolio as fully invested as practicable in the equity securities
described above. The Portfolio may also invest in money market instruments,
including U.S. Government Securities, short term bank obligations rated in the
highest two rating categories by Moody's or S&P, or, if unrated, determined to
be of equal quality by the Sub-Adviser, certificates of deposit, time deposits
and banker's acceptances issued by U.S. and foreign banks and savings and loan
institutions with assets of at least $500 million as of the end of their most
recent fiscal year; and commercial paper and corporate obligations, including
variable rate demand notes, that are issued by U.S. and foreign issuers and that
are rated in the highest two rating categories by Moody's or S&P, or if unrated,
determined to be of equal quality by the Sub-Adviser. Under normal
circumstances, the Portfolio will invest in such money market instruments to
invest temporary cash balances or to maintain liquidity to meet redemptions or
expenses. The Portfolio may also, however, invest in these instruments, without
limitation, as a temporary defensive measure taken during, or in anticipation
of, adverse market conditions.
Convertible bonds and other fixed income securities (other than money market
instruments) in which the Portfolio may invest will, at the time of investment,
be rated Baa or better by Moody's or BBB or better by S&P or, if not rated by
Moody's or S&P, will be of comparable quality as determined by the Sub-Adviser.
In the event that an existing holding is downgraded below these ratings, the
Portfolio may nonetheless retain the security.
Other Techniques. In pursuing its investment objective, the Portfolio may
purchase and sell put and call options on securities and stock indexes. In
addition, the Portfolio may purchase or sell stock index futures contracts and
options thereon. These investment techniques may involve a greater degree or
different type of risk than those inherent in more conservative investment
approaches. See "Investment Practices" and "Risk Factors."
International Equity Portfolio.
The investment objective of the Portfolio is to provide a high total return from
a portfolio of equity securities of foreign corporations. Total return will
consist of realized and unrealized capital gains and losses plus income.
The 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 seeks to achieve its investment objective through country
allocation, stock selection and management of currency exposure. The Sub-Adviser
uses a disciplined portfolio construction process to seek to enhance returns and
reduce volatility in the market value of the Portfolio relative to that of the
EAFE Index.
Based on fundamental research, quantitative valuation techniques, and
experienced judgment, the Sub-Adviser uses a structured decision-making process
to allocate the Portfolio primarily across the developed countries of the world
outside the United States by under- or over-weighting selected countries in the
EAFE Index. Currently, Japan has the heaviest weighting in the EAFE Index
(approximately 29% as of May 1, 1997). The Portfolio will not invest more than
25% of its net assets in Japan notwithstanding the Japan weighting in the EAFE
Index.
Using a dividend discount model and based on analysts' industry expertise,
securities within each country are ranked within economic sectors according to
their relative value. Based on this valuation, the Sub-Adviser selects the
securities which appear the most attractive for the Portfolio. The Sub-Adviser
believes that under normal market conditions, economic sector weightings
generally will be similar to those of the EAFE Index.
Finally, the Sub-Adviser actively manages currency exposure, in conjunction with
country and stock allocation, in an attempt to protect and possibly enhance the
Portfolio's market value. Through the use of forward foreign currency exchange
contracts, the Sub-Adviser will adjust the Portfolio's foreign currency
weightings to reduce its exposure to currencies deemed unattractive and, in
certain circumstances, increase exposure to currencies deemed attractive, as
market conditions warrant, based on fundamental research, technical factors, and
the judgment of a team of experienced currency managers. For further information
on foreign currency exchange transactions, see "Investment Practices" and "Risk
Factors."
The Portfolio intends to manage its portfolio actively in pursuit of its
investment objective. The Portfolio does not expect to trade in securities for
short-term profits; however, when circumstances warrant, securities may be sold
without regard to the length of time held. To the extent the Portfolio engages
in short-term trading, it may incur increased transaction costs.
Equity Investments. In normal circumstances, the Sub-Adviser intends to keep the
Portfolio essentially fully invested with at least 65% of the value of its total
assets in equity securities of foreign issuers, consisting of common stocks and
other securities with equity characteristics such as preferred stock, warrants,
rights and convertible securities. The Portfolio's primary equity investments
are the common stock of established companies based in developed countries
outside the United States. Such investments will be made in at least three
foreign countries. The common stock in which the Portfolio may invest includes
the common stock of any class or series or any similar equity interest such as
trust or limited partnership interests. The Portfolio may also invest in
securities of issuers located in developing countries. See "Investment
Practices" and "Risk Factors." The Portfolio invests in securities listed on
foreign or domestic securities exchanges and securities traded in foreign or
domestic over-the-counter markets, and may invest in certain restricted or
unlisted securities.
The Portfolio may also invest in money market instruments denominated in U.S.
dollars and other currencies, purchase and sell securities on a when-issued or
delayed delivery basis, enter into repurchase and reverse repurchase agreements,
loan its portfolio securities, purchase certain privately placed securities,
enter into forward contracts on foreign currencies and enter into certain
hedging transactions that may involve options on securities and securities
indexes, futures contracts and options on futures contracts. For a discussion of
these investments and investment techniques, see "Investment Practices" and
"Risk Factors."
Portfolios Managed by Lord, Abbett & Co.:
Bond Debenture Portfolio.
The investment objective of the Bond Debenture Portfolio is high current income
and the opportunity for capital appreciation to produce a high total return
through a professionally-managed portfolio consisting primarily of convertible
and discount debt securities, many of which are lower-rated. These lower-rated
debt securities entail greater risks than investments in higher-rated debt
securities. Investors should carefully consider these risks set forth under
"Risk Factors - Special Risks of High Yield Investing."
It is the belief of the Portfolio's management that a high total return (current
income and capital appreciation) may be derived from an actively-managed,
diversified debt- security portfolio. In no event will the Portfolio voluntarily
purchase any securities other than debt securities, if, at the time of such
purchase or acquisition, the value of the debt securities in the Portfolio is
less than 80% of the value of its total assets. The Portfolio seeks unusual
values, particularly in lower-rated debt securities, some of which are
convertible into common stocks or have warrants to purchase common stocks.
Higher yield on debt securities can occur during periods of inflation when the
demand for borrowed funds is high. Also, buying lower-rated bonds when the
credit risk is above average but, in the view of Portfolio management, likely to
decrease, can generate higher yields. Such debt securities normally will consist
of secured debt obligations of the issuer (i.e., bonds), general unsecured debt
obligations of the issuer (i.e., debentures) and debt securities which are
subordinate in right of payment to other debt of the issuer.
Capital appreciation potential is an important consideration in the selection of
portfolio securities. Capital appreciation may be obtained by (1) investing in
debt securities when the trend of interest rates is expected to be down; (2)
investing in convertible debt securities or debt securities with warrants
attached entitling the holder to purchase common stock; and (3) investing in
debt securities of issuers in financial difficulties when, in the view of
Portfolio management, the problems giving rise to such difficulties can be
successfully resolved, with a consequent improvement in the credit standing of
the issuers (such investments involve corresponding risks that interest and
principal payments may not be made if such difficulties are not resolved). In no
event will the Portfolio invest more than 10% of its gross assets at the time of
investment in debt securities which are in default as to interest or principal.
Normally, the Portfolio invests in long-term debt securities when the Portfolio
management believes that interest rates in the long run will decline and prices
of such securities generally will be higher. When Portfolio management believes
that long-term interest rates will rise, Portfolio management will endeavor to
shift the Portfolio into short-term debt securities whose prices might not be
affected as much by an increase in interest rates.
The following policies are subject to change without shareholder approval: (a)
the Portfolio must keep at least 20% of the value of its total assets in (1)
debt securities which, at the time of purchase, are rated within one of the four
highest grades determined either by Moody's or S&P, (2) debt securities issued
or guaranteed by the U.S. Government or its agencies or instrumentalities, (3)
cash or cash equivalents (short-term obligations of banks, corporations or the
U.S. Government), or (4) a combination of any of the foregoing; (b) the
Portfolio may invest up to 20% of its gross assets, at market value, in U.S.
dollar-denominated debt securities primarily traded in foreign countries - such
foreign debt securities normally will be limited to issues where there does not
appear to be substantial risk of nationalization, exchange controls,
confiscation or other government restrictions (see "Risk Factors - Special
Considerations Relating to Foreign Securities"); (c) subject to the percentage
limitations for purchases of other than debt securities described below, the
Portfolio may purchase common and preferred stocks; (d) the Portfolio may hold
or sell any property or securities which it may obtain through the exercise of
conversion rights or warrants or as a result of any reorganization,
recapitalization or liquidation proceedings for any issuer of securities owned
by it. In no event will the Portfolio voluntarily purchase any securities other
than debt securities, if, at the time of such purchase or acquisition, the value
of the property and securities, other than debt securities, in the Portfolio is
greater than 20% of the value of its gross assets. A purchase or acquisition
will not be considered "voluntary" if made in order to avoid loss in value of a
conversion or other premium; and (e) the Portfolio does not purchase securities
for short-term trading, nor does it purchase securities for the purpose of
exercising control of management.
The Portfolio may invest up to 15% of its net assets in illiquid securities.
Bonds which are subject to legal or contractual restrictions on resale, but
which have been determined by the Board of Trustees to be liquid, will not be
subject to this limit. Investment by the Portfolio in such securities, initially
determined to be liquid, could have the effect of diminishing the level of the
Portfolio's liquidity during periods of decreased market interest in such
securities.
The Portfolio may, but has no present intention to, commit more than 5% of its
gross assets to the lending of its portfolio securities.
The Portfolio will not change its investment objective without shareholder
approval.
The Portfolio may invest substantially in lower-rated bonds for their higher
yields which entail greater risks. Since the risk of default generally is higher
among lower-rated bonds, the research and analysis performed by the Sub-Adviser
are especially important in the selection of such bonds, which, if rated BB/Ba
or lower, often are described as "high-yield bonds" because of their generally
higher yields and referred to colloquially as "junk bonds" because of their
greater risks. In selecting lower-rated bonds for investment, the Sub-Adviser
does not rely upon ratings, which evaluate only the safety of principal and
interest, not market value risk, and which, furthermore, may not accurately
reflect an issuer's current financial condition. The Portfolio does not have any
minimum rating criteria for its investments in bonds and some issuers may
default as to principal and/or interest payments subsequent to the purchase of
their securities. Through portfolio diversification, good credit analysis and
attention to current developments and trends in interest rates and economic
conditions, investment risk can be reduced, although there is no assurance that
losses will not occur.
The Portfolio may invest in the securities markets of foreign countries.
Investments in foreign securities present certain risks not ordinarily found in
investments in securities of U.S. issuers. See "Risk Factors - Special
Considerations Relating to Foreign Securities."
Mid-Cap Value Portfolio.
The investment objective of the Mid-Cap Value Portfolio is to seek capital
appreciation through investments, primarily in equity securities, which are
believed to be undervalued in the marketplace.
The Portfolio invests primarily in common stocks (including securities
convertible into common stocks) of companies with good prospects for improvement
in earnings trends or asset values that are not yet fully recognized in the
investment community. Selection of stocks is based on appreciation potential,
without regard to current income. Under normal circumstances, at least 65% of
the Portfolio's total assets will consist of investments in mid-cap companies,
determined at the time of purchase. "Mid-cap" companies are defined for this
purpose as companies whose outstanding equity securities have an aggregate
market value of between $200 million and $5 billion.
It is intended that the investment portfolio will be diversified among many
issues representing many different industries. The holdings in the Portfolio
typically will be selected for their potential for significant market
appreciation from growing recognition of substantial improvement in the
company's financial results or increasing anticipation of such improvement. This
potential may derive from such factors as (i) changes in the economic and
financial environment, (ii) new or improved products or services, (iii) new or
rapidly expanding markets, (iv) changes in management or structure of the
company, (v) price increases due to shortages of resources or productive
capacity, (vi) improved efficiencies resulting from new technologies or changes
in distribution or (vii) changes in governmental regulations, political climate
or competitive conditions. The companies represented will have a strong or, in
the perception of Portfolio management, an improving financial position. The
outstanding stock of companies in the Portfolio ordinarily will have an
aggregate market value of not less than approximately $50 million. At the time
of purchase, the stocks may be largely neglected by the investment community or,
if widely followed, they may be out of favor or at least controversial.
Characteristically, the Portfolio will not carry a large cash position as an
investment strategy. While the Portfolio may take short-term gains if deemed
appropriate, normally the Portfolio will hold securities in order to realize
long-term capital gains. Although normally the Portfolio intends to be fully
invested in common stocks, it may temporarily put a portion of its assets in
cash or cash equivalents (short-term obligations of banks, corporations or the
U.S. Government) for liquidity purposes or to create reserve purchasing power
pending other investments. Since the Portfolio invests primarily in common
stocks with their inherent market risks, there is, of course, no assurance that
its investment objective will be achieved. If it is determined that the
Portfolio's objective can best be achieved by a substantive change in investment
policy or strategy, the Portfolio may make such a change without shareholder
approval by disclosing it in this Prospectus. The Portfolio may invest up to 10%
of its net assets in securities (of the type described above) which are
primarily traded in foreign countries.
Large Cap Research Portfolio.
The investment objective of the Large Cap Research Portfolio is growth of
capital and growth of income consistent with reasonable risk. Production of
current income is a secondary consideration.
The Portfolio invests primarily in common stocks (including securities
convertible into common stocks such as investment-grade convertible bonds or
convertible-preferred stocks) of large-cap companies defined for these purposes
as companies whose outstanding equity securities have an aggregate market value
of $1.5 billion and above. Under normal circumstances, at least 65% of the
Portfolio's total assets will consist of investments made in large-cap
companies, determined at the time of purchase. These companies will have good
prospects for improvement in earnings trends or asset values. The Portfolio will
invest in companies on the basis of the fundamental economic and business
factors (such as government, fiscal and monetary policies, employment levels,
demographics, retail sales and market share) which will affect future earnings
and which Portfolio management believes are the primary factors determining the
future market valuation of stocks. Although the prices of common stocks
fluctuate and their dividends vary, historically, common stocks have appreciated
in value and their dividends have increased when the companies they represent
have prospered and grown. There can be no assurance that stocks selected for the
Portfolio will appreciate in value or that their dividends will increase or be
maintained.
In selecting securities for investment, more weight is given to the
possibilities of capital growth and growth of income than to current income. In
seeking to fulfill its objective, the Portfolio will invest also in both small
and middle-sized companies, as measured by the value of their outstanding stock
guided by the policies mentioned herein. Stock prices of such small-sized
companies may be more volatile than those of large and middle-sized companies.
Portfolio management concentrates its research and stock selection on companies
that are undervalued or out of current investment favor and thus the investment
portfolio typically will encompass less market risk as measured by its
price-to-normal earnings and price-to-book value ratios. The Portfolio's
management process results in the sale of stocks that it judges to be overpriced
and reinvestment in other securities which it believes offer better values and
less market risk.
The Portfolio will be diversified among many issuers representing many different
industries. The Portfolio reflects the collective judgment of the Research
Department of the Sub-Adviser as to what securities represent the greatest
investment value, regardless of industry sector, market capitalization, or Wall
Street sponsorship. At the time of purchase, securities selected for the
Portfolio may be largely neglected by the investment community or, if widely
followed, they may be out of favor or at least controversial.
Up to 10% of the Portfolio's net assets (at the time of investment) may be
invested in foreign securities (of the type described herein) primarily traded
in foreign countries.
For securities in the Portfolio with a market value of up to 5% of its gross
assets at the time an option is written, the Portfolio may write covered call
options which are traded on a national securities exchange in an attempt to
increase its income and to provide greater flexibility in the disposition of
portfolio securities.
The Portfolio may engage in (a) lending of portfolio securities to
broker-dealers on a secured basis and (b) investing in rights and warrants to
purchase securities. The Portfolio has no present intention to commit more than
5% of gross assets to any one of these two identified practices. The term
"warrants" includes warrants which are not listed on the New York or American
Stock Exchanges. Such unlisted warrants may not exceed 2% of the Portfolio's
assets.
The Portfolio may invest in closed-end investment companies if bought in the
secondary market with a fee or commission no greater than the customary broker's
commission in compliance with the Investment Company Act of 1940, as amended
("1940 Act"). Shares of such investment companies sometimes trade at a discount
or premium in relation to their net asset value and there may be duplication of
fees, for example, to the extent that the Portfolio and the closed-end
investment company both charge a management fee.
The Portfolio will not borrow money, except as a temporary measure for
extraordinary or emergency purposes and then not in excess of 5% of gross assets
at the lower of cost or market value.
Neither an issuer's ceasing to be rated investment grade nor a rating reduction
below that grade will require elimination of a bond from the Portfolio. For
temporary defensive purposes, the Portfolio may invest in high quality,
short-term debt obligations of banks, corporations or the U.S. Government of the
type normally owned by a money market fund.
The Portfolio may invest up to 15% of its net assets in illiquid securities.
Securities determined by the Trust's Board of Trustees to be liquid pursuant to
Securities and Exchange Commission Rule 144A ("Rule 144A") will not be subject
to this limit. Under Rule 144A, a qualifying security may be resold to a
qualified institutional buyer without registration and without regard to whether
the seller originally purchased the security for investment. Investments in Rule
144A securities initially determined to be liquid could have the effect of
diminishing the level of liquidity during periods of decreased market interest
in such securities.
The Portfolio may deal in financial futures transactions with respect to the
type of securities described herein, including indices of such securities and
options on such financial futures. The Portfolio will not enter into any futures
contracts, or options thereon, if the aggregate market value of the securities
covered by futures contracts plus options on such financial futures exceeds 50%
of the Portfolio's total assets.
Convertible bonds and convertible-preferred stocks tend to be more volatile than
straight bonds but less volatile and more income-producing than their underlying
common stocks.
Developing Growth Portfolio.
The investment objective of the Developing Growth Portfolio is long-term growth
of capital through a diversified and actively-managed portfolio consisting of
developing growth companies, many of which are traded over the counter.
The Portfolio's present investment strategy, as developed by the Sub-Adviser, is
based on the four phases of corporate growth. As described below, only the
second (or developing growth) phase is characterized by a dramatic rate of
growth. The management of the Portfolio looks for companies in that phase and,
under normal circumstances, will invest at least 65% of the Portfolio's total
assets in securities of such companies. The Portfolio also may invest in
companies which are in their formative phase. Developing growth companies are
almost always small, usually young and their shares are generally traded over
the counter. Having, in the view of Portfolio management, passed the pitfalls of
the formative years, they are now in a position to grow rapidly in their market.
The Four Phases of Business Growth
(as perceived by the Sub-Adviser)
Phase 1 -- Formative: Phase 1 has high risk. Companies in this phase are
formative and the perils of infancy take a high toll during these years. Skill
of management and growth of revenues and earnings permit some companies to
survive and advance into the second phase.
Phase 2 -- Developing Growth: Phase 2 usually is a period of swift development,
when growth occurs at a rate rarely equaled by established companies in their
mature years. The management of the Portfolio focuses on companies which it
believes are strongly positioned in this phase. Of course, the actual growth of
a company cannot be foreseen and it may be difficult to determine in which phase
a company is presently situated.
Phase 3 -- Established Growth: Phase 3 is a time of established growth when
competitive forces, regulations and internal bureaucracy often begin to blunt
the sharp edge of success in the marketplace.
Phase 4 -- Maturity: Phase 4 is a time of maturity when companies ease into a
growth pattern that roughly reflects the increase in Gross Domestic Product.
At any given time, there are many hundreds of publicly-traded corporations in
the developing growth phase. In choosing from among them, Portfolio management
looks for special characteristics that will help their growth. These can include
a unique product or service for which management foresees a rising demand; a
special area of technological expertise; the ability to service a region that is
growing faster than average; a competitive advantage or new opportunities in
foreign trade or from shifts in government priorities and programs; or an
ability to take advantage of growth of consumers' discretionary income and
demographic changes.
The management of the Portfolio also looks for certain financial characteristics
such as: at least five years of higher-than-average growth of revenues and
earnings per share; higher-than-average returns on equity; ability to finance
growth in the form of a lower-than-average ratio of long-term debt to capital
and price/earnings ratios that are below expected growth rates.
The Portfolio also looks for certain characteristics of management in addition
to those that are implied by the financial data. The Portfolio looks for
management that is well-seasoned and diverse in its talent and that is
aggressive enough to seize the opportunities it perceives in each company's
future. Finally, the Portfolio looks for management that has demonstrated an
ability to manage through a full economic cycle. The Portfolio does not,
however, invest in order to control management.
Securities being considered for the Portfolio are analyzed solely on traditional
investment fundamentals. The Portfolio does not select securities based on
trends indicated by chartists' technical analyses. In addition to the financial
data already mentioned, the management of the Portfolio evaluates the market for
each company's products or services, the strengths and weaknesses of
competitors, the availability of raw materials, diversity of product mix, etc.
Finally, in assembling the investment portfolio, the management of the Portfolio
tries to diversify the Portfolio's investments. Within the bounds of other
criteria, the management of the Portfolio tries to invest in many securities and
industries so that any misjudgments it might make are adequately cushioned.
Up to 10% of the Portfolio's net assets (at the time of investment) may be
invested in foreign securities (of the type described above) primarily traded in
foreign countries.
Although the Portfolio has no present plans to change its policies, if it is
determined that the investment objective can best be achieved by a change in
investment policies or strategy, the Portfolio reserves the right to make such a
change without shareholder approval, provided it is not prohibited by the
Portfolio's investment restrictions or applicable law. Any material change will
first be disclosed in the current Prospectus.
There may be times when Portfolio management believes that economic conditions
or general levels of common stock prices are such that it would be advisable,
for defensive reasons, to curtail investments in common stocks. During such
periods, the Portfolio may invest a substantial portion of its assets in cash or
cash equivalents (short-term obligations of banks, corporations or the U.S.
Government).
An investment in the Portfolio is not intended as a complete investment program.
The Portfolio will not provide significant income. Moreover, because stocks of
developing growth companies are more risky and their prices more volatile than
those of mature companies, the Portfolio's net asset value per share is likely
to experience above-average fluctuations.
Portfolios Managed by Van Kampen American Capital Investment Advisory Corp.:
Money Market Portfolio.
The investment objective of the Money Market Portfolio is to provide high
current income consistent with the preservation of capital and liquidity through
investment in a broad range of money market instruments that will mature within
12 months of the date of purchase.
Investment Program
The Money Market Portfolio seeks to achieve its objective by investing only in
the following securities and instruments: (a) obligations of or guaranteed by
the U.S. government, its agencies or instrumentalities ("U.S. Government
Securities"); (b) obligations of banks subject to U.S. government regulation as
well as such other bank obligations as are insured by a U.S. government agency
("Bank Obligations"); (c) commercial paper (including variable amount master
demand notes); and (d) debt obligations (other than commercial paper) of
corporate issuers.
U.S. Government Securities include Treasury Bills, Notes and Bonds issued by the
U.S. government and backed by the full faith and credit of the U.S. government,
as well as securities issued or guaranteed as to principal and interest by
agencies and instrumentalities of the U.S. government. Bank Obligations include
certificates of deposit and bankers' acceptances of domestic banks (or
Euro-dollar obligations of foreign branches of those domestic banks) subject to
U.S. government regulation and time deposits of federal and state banks whose
accounts are insured by a government agency as well as the accounts themselves.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
The Portfolio may lend portfolio securities. The Portfolio may also enter into
repurchase agreements but only if the underlying securities are either
Government securities or First Tier Securities (see "Investment Quality" and
"Portfolio Maturity", below). The Portfolio may purchase and sell securities on
a "when issued" and "delayed delivery" basis. The Portfolio may borrow up to 10%
of its net assets in order to pay for redemptions when liquidation of portfolio
securities is considered disadvantageous or inconvenient and may pledge up to
10% of its net assets to secure borrowings. The Portfolio may invest up to 10%
of its net assets in restricted securities. A more complete description of these
investments and transactions is contained under "Investment Practices".
The Portfolio may also invest in Floating Rate Securities. Floating Rate
Securities provide for automatic adjustment of the interest rate whenever some
specified interest rate index changes. The interest rate on Floating Rate
Securities is ordinarily determined by reference to or is a percentage of a
bank's prime rate, the 90-day U.S. Treasury bill rate, the rate of return on
commercial paper or bank certificates of deposit, an index of short-term
interest rates, or some other objective measure. Floating Rate Securities often
include a demand feature which entitles the holder to sell the securities to the
issuer at par. In many cases, the demand feature can be exercised at any time on
seven days' notice; in other cases, the demand feature is exercisable at any
time on 30 days' notice or on similar notice at intervals of not more than one
year. With respect to Floating Rate Securities, the financial institution
issuing the instrument is considered the issuer. However, where the securities
are backed by an irrevocable letter of credit or by insurance, without which the
securities would not qualify for purchase under the Portfolio's quality
restrictions, the issuer of the letter of credit will be considered the issuer
of the securities.
Although the securities in which the Portfolio invests are of high quality and
the transactions which it enters into entail low risk, there is still the
possibility of loss of principal. Corporate issuers may default on their
obligations. Repurchase agreements may be deemed to be collateralized loans and
the Portfolio could experience delay and expenses in liquidating collateral in
the event of the failure of the repurchasing party to honor its agreement to
repurchase. Agencies or instrumentalities of the U.S. government could also
default on their securities which may not be guaranteed by or be backed by the
full faith and credit of the U.S. government.
Investment Quality
(a) Eligible Securities
The Money Market Portfolio will invest only in United States dollar-denominated
instruments which, at the time of acquisition, are determined to be eligible
securities ("Eligible Securities") by the Sub-Adviser and which are determined
by the Sub-Adviser to present minimal credit risks.
An Eligible Security is any security that has a remaining maturity of less than
one year and (i) which is rated in one of the two highest rating categories for
short-term debt obligations by any two nationally recognized statistical rating
organizations ("NRSROs") that have issued a rating with respect to a security or
class of debt obligations of an issuer, or if only one NRSRO has issued a
rating, that NRSRO ("Requisite NRSROs"); or (ii) has a security that has been
issued by an issuer that has outstanding short-term debt obligations (or
security within that class) that are comparable in priority and security with
the security ("CPS Security") which is rated, or the issuer of which is rated,
by the Requisite NRSROs in one of the two highest rating categories for
short-term debt obligations. An unrated security may also be an Eligible
Security if it is determined by the Sub-Adviser to be of comparable quality
("Comparable Quality Security") to either a First Tier Security or Second Tier
Security, as those terms are defined below.
A First Tier Security is an Eligible Security that (i) is itself rated, has a
CPS Security rated or the issuer of which security is rated by the Requisite
NRSROs in the highest rating category for short-term debt obligations or (ii) is
a Comparable Quality Security which is determined by the Sub-Adviser to be of
comparable quality to a First Tier Security.
A Second Tier Security is (i) an Eligible Security that is itself rated, has a
CPS Security rated or the issuer of which security is rated by the Requisite
NRSROs in the second highest rating category for short-term debt obligations,
(ii) an instrument that has been rated in the highest rating category for
short-term debt obligations by one NRSRO and has been rated in the second
highest rating category for short-term debt obligations by one or more other
NRSROs or (iii) a Comparable Quality Security which is determined by the
Sub-Adviser to be of comparable quality to a Second Tier Security.
(b) Guidelines for Purchasing Eligible Securities
The Sub-Adviser, on behalf of the Money Market Portfolio, may (i) acquire any
First Tier Security that, at the time of acquisition, has received the highest
rating from any two NRSROs; (ii) acquire any Second Tier Security that, at the
time of acquisition, has received the second highest rating from any two NRSROs,
and (iii) acquire any First Tier Security or any Second Tier Security that at
time of purchase is rated by a single NRSRO, or any Comparable Quality Security,
subject to approval by the Board of Trustees of the Trust.
Portfolio Maturity
The Money Market Portfolio may not purchase any instrument, other than a
Government security, with a remaining maturity of greater than one year. A
Government security is any security issued or guaranteed as to principal or
interest by the United States, or by a person controlled or supervised by and
acting as an instrumentality of the Government of the United States, or any
certificate of deposit for any of the above.
The Money Market Portfolio maintains a dollar-weighted average portfolio
maturity of ninety (90) days or less. The Portfolio determines the maturity of
portfolio investments in accordance with Rule 2a-7, a valuation and pricing rule
under the 1940 Act.
Quality Income Portfolio.
The investment objective of the Quality Income Portfolio is to seek a high level
of current income, consistent with safety of principal, by investing in
obligations issued or guaranteed by the U.S. government or its agencies or
instrumentalities or in various investment grade debt obligations including
mortgage pass-through certificates and collateralized mortgage obligations.
The Sub-Adviser will use the Lehman Brothers Government/Corporate Bond Index as
a benchmark against which it will gauge the performance of the Portfolio and
determine risk measurement. The Lehman Brothers Government/Corporate Bond Index
is comprised of all publicly issued, non-convertible, domestic debt of the U.S.
Government or any agency thereof, quasi-Federal corporation, or corporate debt
guaranteed by the U.S. Government and all publicly issued, fixed-rate,
non-convertible, domestic debt of the four major corporate classifications:
industrial, utility, financial and Yankee bond. Only notes and bonds with a
minimum outstanding principal amount of $50,000,000 and a minimum maturity of
one year are included. Bonds included must have a rating of at least Baa by
Moody's, BBB by S&P or in the case of bank bonds not rated by either Moody's or
S&P, BBB by Fitch Investors Service, Inc.
Depending on market conditions and subject to the special diversification
provisions imposed on the Portfolio (see "Risk Factors"), the Portfolio may
invest a substantial portion of its assets in GNMA Certificates of the modified
pass-through type. These GNMA Certificates are debt securities issued by a
mortgage holder (such as a mortgage banker) and represent an interest in a pool
of mortgages insured by the Federal Housing Administration or the Farmers Home
Administration or guaranteed by the Veterans Administration. GNMA guarantees the
timely payment of monthly installments of principal and interest on the GNMA
Certificates. These guarantees are backed by the full faith and credit of the
U.S. government.
To the extent the Portfolio acquires GNMA Certificates at par or at discount,
the GNMA Certificates offer a high degree of safety of the principal investment
because of the GNMA guarantee. If the Portfolio buys GNMA Certificates at a
premium, however, mortgage foreclosures and repayments of principal by
mortgagors (which may be made at any time without penalty) may result in some
loss of the Portfolio's principal investment to the extent of the premium paid.
To avoid loss of this premium and of any gain in value of its GNMA Certificates
resulting from a decrease in interest rates generally, the Portfolio may sell
its GNMA Certificates which are selling at a substantial premium. This practice
may increase the Portfolio's portfolio turnover rate. A more complete
description of GNMA Certificates is contained in the Statement of Additional
Information.
The Portfolio, subject to the limitations on investments as described in "Risk
Factors", may invest in other obligations issued or guaranteed by the U.S.
government or by its agencies or instrumentalities. These instruments may be
either direct obligations of the Treasury (such as U.S. Treasury Notes, Bills or
Bonds) or securities issued or guaranteed by government agencies or
instrumentalities. Of the obligations issued or guaranteed by agencies or
instrumentalities of the U.S. government, some are backed by the full faith and
credit of the U.S. government (such as Maritime Administration Title XI Ship
Financing Bonds) and others are backed only by the rights of the issuer to
borrow from the U.S. Treasury (such as Federal Home Loan Bank Bonds and Federal
National Mortgage Association Bonds).
The Portfolio may also invest in one or more of the following:
(1) Marketable straight-debt securities of domestic issuers, and of foreign
issuers (payable in U.S. dollars) rated at the time of purchase within the
four highest grades assigned by Moody's (Aaa, Aa, A or Baa) or by S&P (AAA,
AA, A or BBB);
(2) Commercial paper rated at time of purchase Prime-3 by Moody's or A-3 by
S&P;
(3) Bank obligations (including repurchase agreements and those denominated in
Eurodollars) of banks having total assets in excess of $1 billion; and
(4) Mortgage pass-through certificates and collateralized mortgage obligations.
Securities rated Baa or BBB may have speculative characteristics and changes in
economic conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than is the case with higher
grade bonds. For a further description of the above investments and the ratings
used, see "Appendix - Description of Corporate Bond Ratings" herein and
"Description of Securities Ratings - Commercial Paper Ratings" in the Statement
of Additional Information.
The Portfolio may invest up to 35% of its assets in securities of foreign
issuers. These investments will be marketable straight-debt securities of
foreign issuers payable in U.S. dollars and rated at the time of purchase within
the four highest grades assigned by Moody's or by S&P. Investments in foreign
securities present certain risks not ordinarily found in investments in
securities of U.S. issuers. See "Risk Factors - Special Considerations Relating
to Foreign Securities."
The Portfolio may lend portfolio securities. The Portfolio may borrow under
certain circumstances. The Portfolio may also enter into repurchase agreements,
reverse repurchase agreements and may sell securities short. The Portfolio may
purchase and sell securities on a "when issued" and "delayed delivery" basis.
The Portfolio may invest in restricted securities. A more complete description
of these investments and transactions is contained under "Investment Practices."
If the Sub-Adviser deems it appropriate to seek to partially hedge the
Portfolio's assets against market value changes, the Portfolio may enter into
various hedging transactions, such as futures contracts, financial index futures
contracts, and the related put or call options contracts on futures contracts.
Hedging is a means of offsetting, or neutralizing, the price movement of an
investment by making another investment, the price of which should tend to move
in the opposite direction from that of the original investment. See "Investment
Practices - Strategic Transactions" and the Statement of Additional Information
for a more complete description of these transactions.
The Portfolio will be affected by general changes in interest rates resulting in
increases or decreases in the value of the Portfolio securities. Market prices
of debt securities tend to rise when interest rates fall and market prices tend
to fall when interest rates rise. Repurchase agreements may be deemed to be
collateralized loans and the Portfolio could experience delay and expenses in
liquidating such collateral in the event of the failure of the repurchasing
party to honor its agreement to repurchase. Agencies or instrumentalities of the
U.S. government could also default on their securities which may not be
guaranteed by or be backed by the full faith and credit of the U.S. government.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
Stock Index Portfolio.
Investment Objective
The investment objective of the Stock Index Portfolio is to achieve investment
results that approximate the aggregate price and yield performance of the
Standard & Poor's 500 Composite Stock Price Index (the "S&P 500 Index" or the
"Index").
The S&P 500 Index represents more than 70% of the total market value of all
publicly-traded common stocks, and is widely viewed among investors as a good
representative of the aggregate performance of publicly-traded common stocks.
"Standard & Poor's", "S&P", "S&P 500", "Standard & Poor's 500", and "500" are
trademarks of McGraw-Hill Inc. and have been licensed for use by Cova Life. The
Stock Index Portfolio is not sponsored, endorsed, sold or promoted by Standard &
Poor's Corporation ("S&P") and S&P makes no representation or warranty, express
or implied, to the owners of the Stock Index Portfolio or any member of the
public regarding the advisability of investing in securities generally or in the
Stock Index Portfolio particularly or the ability of the S&P 500 Index to track
general stock market performance. S&P's only relationship to Cova Life is the
licensing of certain trademarks and trade names of S&P and of the S&P 500 Index
which is determined, composed and calculated by S&P without regard to Cova Life
or the Stock Index Portfolio. S&P has no obligation to take the needs of Cova
Life or the owners of the Stock Index Portfolio into consideration in
determining, composing or calculating the S&P 500 Index. S&P is not responsible
for and has not participated in the determination of the prices and amount of
the Stock Index Portfolio or the timing of the issuance or sale of the Stock
Index Portfolio or in the determination or calculation of the equation by which
the Stock Index Portfolio is to be converted into cash. S&P has no obligation or
liability in connection with the administration, marketing or trading of the
Stock Index Portfolio.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500 INDEX
OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY ERRORS,
OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED,
AS TO RESULTS TO BE OBTAINED BY COVA LIFE, OWNERS OF THE STOCK INDEX PORTFOLIO,
OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY DATA
INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY
DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE
OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT
LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY LIABILITY FOR ANY
SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS),
EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
Investment Policies
The Stock Index Portfolio is not managed according to traditional methods of
"active" investment management, which involve the buying and selling of
securities based upon economic, financial and market analysis and investment
judgment. Instead, the Portfolio, utilizing a "passive" or "indexing" investment
approach, attempts to duplicate the investment performance of the respective
index through statistical procedures.
The Sub-Adviser believes that the "indexing" approach described above is an
effective method of substantially duplicating percentage changes in the S&P 500
Index. It is a reasonable expectation that the correlation between the
performance of the Portfolio and that of the Index will be approximately 98%; a
figure of 100% would indicate perfect correlation. Perfect correlation would be
achieved when the net asset value per share of the Portfolio increases and
decreases in exact proportion to changes in the Index. The Board of Trustees of
the Trust will review the correlation between the Portfolio and the Index on a
quarterly basis. See the Statement of Additional Information for a description
of the monitoring procedures established by the Board.
In pursuing its investment objective, the Portfolio will invest in no fewer than
100 stocks with the majority of the Portfolio consisting of those stocks having
the largest weightings in the Index. The Sub-Adviser will select stocks for the
Portfolio after taking into account their individual weights in the Index and
the weights in the Index of the industry groups to which they belong.
Although the Portfolio will attempt to remain fully invested in common stocks,
it may also invest in certain short-term fixed income securities such as cash
reserves.
As described further below under "Implementation of Policies", the Portfolio may
also enter into stock index futures contracts and options on stock indexes and
stock index futures contracts for various reasons including to hedge against
changes in security prices. Hedging is a means of offsetting, or neutralizing,
the price movement of an investment by making another investment, the price of
which should tend to move in the opposite direction from that of the original
investment. See the Statement of Additional Information for a more complete
description of hedging and for a discussion of the risks involved therein.
Implementation of Policies
The S&P 500 Index is composed of 500 common stocks which are chosen by S&P to be
included in the unmanaged Index. Market value, liquidity and industry
representation are considered in the selection process. The inclusion of a stock
in the S&P 500 Index in no way implies that S&P believes the stock to be an
attractive investment. The 500 securities, 95% of which trade on the New York
Stock Exchange, represent approximately 75% of the market value of all U.S.
common stocks. Each stock in the S&P 500 Index is weighted by its market value:
its market price per share times the number of shares outstanding.
Because of the market-value weighting, the 50 largest companies in the S&P 500
Index currently account for approximately 50% of the Index. Typically, companies
included in the S&P 500 Index are the largest and most dominant firms in their
respective industries. As of December 31, 1996, the five largest companies in
the Index were: General Electric Co., Exxon Corp., Coca Cola Company, Intel
Corp. and Microsoft Corp. The largest industry categories were: international
oil, major regional banks, diversified healthcare, telephone and electrical
equipment.
Although the Portfolio will normally seek to remain substantially fully invested
in common stocks, the Portfolio may invest temporarily in certain short-term
fixed income securities. Such securities may be used to invest uncommitted cash
balances or to maintain liquidity to meet shareholder redemptions. These
securities include: obligations of the United States government and its agencies
or instrumentalities; commercial paper, bank certificates of deposit and
bankers' acceptances; and repurchase agreements and reverse repurchase
agreements collateralized by these securities. Repurchase agreements may be
deemed to be collateralized loans and the Portfolio could experience delay and
expenses in liquidating such collateral in the event of the failure of the
repurchasing party to honor its agreement to repurchase.
The Portfolio will employ a combination of an indexing strategy known as
"sampling" and stock index futures contracts and options. Sampling is a method
that is used to attempt to replicate the return of the Index without having to
purchase a weighted portfolio containing all 500 stocks in the Index. This
process selects stocks for the Portfolio so that various industry weightings,
market capitalizations and fundamental characteristics (e.g. price to book,
price to earnings, debt to asset ratios and dividend yields) match those of the
Index. The use of sampling involves certain risks with respect to the ability of
the Portfolio to achieve the desired correlation with the Index. (See "Risk
Factors - Stock Index Portfolio - Sampling", below).
As indicated above, the Portfolio may utilize stock index futures contracts and
options on stock indexes and stock index futures contracts. Specifically, the
Portfolio may enter into futures contracts provided that not more than 5% of its
assets are required as a futures contract deposit.
Stock index futures contracts and options may be used for several reasons: to
maintain cash reserves while remaining fully invested, to facilitate trading, to
reduce transaction costs, to hedge against changes in securities prices, or to
seek higher investment returns when a futures contract is priced more
attractively than the underlying equity security or the Index.
The Portfolio may lend its investment securities to qualified institutional
investors for the purpose of realizing additional income. Loans of securities by
the Portfolio will be collateralized by cash or securities issued or guaranteed
by the U.S. government or its agencies. The collateral will equal at least 100%
of the current market value of the loaned securities. The Portfolio may borrow
money from a bank but only for temporary or emergency purposes. The Portfolio
may borrow money up to one-third of the value of its total assets taken at
current value. The Portfolio would borrow money only to meet redemption requests
prior to the settlement of securities already sold or in the process of being
sold by the Portfolio. To the extent that the Portfolio borrows money prior to
selling securities, the Portfolio may be leveraged; at such times, the Portfolio
may appreciate or depreciate in value more rapidly than the Index. The Portfolio
may purchase and sell securities on a "when issued" and "delayed delivery"
basis. The Portfolio may invest in restricted securities and may sell securities
short. See "Investment Practices" for a description of these investments and
transactions.
See "Risk Factors - Tax Considerations" for a discussion of special
diversification standards which the Portfolio will meet.
Risk Factors - Stock Index Portfolio
Futures Contracts and Options
The primary risks associated with the use of futures contracts and options are:
(i) imperfect correlation between the change in market value of the stocks held
by the Portfolio and the prices of futures contracts and options; and (ii)
possible lack of a liquid secondary market for a futures contract and the
resulting inability to close a futures position when desired. The risk of
imperfect correlation will be minimized by investing only in those contracts
whose behavior is expected to resemble that of the Portfolio's underlying
securities. The risk that the Portfolio will be unable to close out a futures
position will be minimized by entering into such transactions on a national
exchange with an active and liquid secondary market. See the Statement of
Additional Information for a more complete discussion of the risks involved with
respect to investment in stock index futures contracts and options on stock
indexes and stock index futures contracts.
Market Risk
As the Portfolio invests primarily in common stocks, the Portfolio is subject to
market risk - i.e. the possibility that common stock prices will decline over
short or even extended periods. The U.S. stock market tends to be cyclical, with
periods when stock prices generally rise and periods when prices generally
decline.
To illustrate the volatility of stock prices, the following table sets forth the
extremes for stock market returns as well as the average return for the period
from 1926 to 1996, as measured by the S&P 500 Index:
U.S. Stock Market Returns (1926-1996)
Over Various Time Horizons
One Five Ten Twenty
Year Years Years Years
- --------------------------------------------------------------------------------
Best +53.99% +23.89% +20.06% +16.86%
Worst -43.34 -12.47 - 0.89 + 3.11
Average +12.67 +10.40 +10.77 +10.82
As shown, from 1926 to 1996, common stocks, as measured by the S&P 500 Index,
have provided an average annual total return (capital appreciation plus dividend
income) of +12.67%. While this average return can be used as a guide for setting
reasonable expectations for future stock market returns, it may not be useful
for forecasting future returns in any particular period, as stock returns are
quite volatile from year to year.
Sampling
The use of the sampling technique may, particularly under certain market
conditions, result in a lower correlation between the Portfolio and the Index
than if the Portfolio owned all 500 stocks in the Index. The sampling technique,
when employed successfully, is effective primarily due to the existence of
long-term correlations between groups of stocks and whole industry sectors
within the Index. Sampling, by definition, creates a bias toward the purchase by
the Portfolio of the stocks of larger capitalization companies. As a result, the
Portfolio can be negatively impacted by the use of sampling in a market where
the stocks of smaller capitalization companies are outperforming those of larger
capitalization companies. When this happens, it may result in the Portfolio
underperforming the Index and not achieving its anticipated degree of
correlation with the Index. The Sub-Adviser will actively monitor the
effectiveness of its sampling technique and will undertake corrective actions
should the use of the sampling technique result in underperformance or
undercorrelation with respect to the Index. Such corrective actions may include,
but not necessarily be limited to, increasing the number of companies
represented in the Portfolio to incorporate more secondary issues. As described
under "Investment Policies" above, the Board of Trustees of the Trust reviews
the correlation between the Portfolio and the Index on a quarterly basis. The
Board has adopted monitoring procedures which require, among other things, that
the Sub-Adviser notify the Board in the event that the correlation between the
performance of the Portfolio and that of the Index falls below 95%.
INVESTMENT PRACTICES
In connection with the investment policies of the Portfolios described above,
the Portfolios may engage in certain investment practices subject to the
limitations set forth below. These investments entail risks.
Strategic Transactions. Certain Portfolios may purchase and sell exchange-listed
and over-the-counter put and call options on securities, financial futures,
fixed-income and equity indices and other financial instruments and purchase and
sell financial futures contracts. Certain Portfolios may also enter into various
currency transactions such as currency forward contracts, currency futures
contracts, currency swaps or options on currencies or currency futures, stock
index futures contracts and options on stock indexes and stock index futures
contracts. Collectively, all of the above are referred to as "Strategic
Transactions." Strategic Transactions are hedging transactions which may be used
to attempt to protect against possible changes in the market value of securities
held in or to be purchased for a Portfolio, to protect a Portfolio's unrealized
gains in the value of its portfolio securities, to facilitate the sale of such
securities for investment purposes, to manage the effective interest rate
exposure of a Portfolio, to protect against changes in currency exchange rates,
or to establish a position in the derivatives markets as a temporary substitute
for purchasing or selling particular securities. Any or all of these investment
techniques may be used at any time and there is no particular strategy that
dictates the use of one technique rather than another, as use of any Strategic
Transaction is a function of numerous variables including market conditions. The
ability of a Portfolio to utilize these Strategic Transactions successfully will
depend on a Sub-Adviser's ability to predict pertinent market movements, which
cannot be assured. The Portfolios will comply with applicable regulatory
requirements when implementing these strategies, techniques and instruments.
Strategic Transactions have risks associated with them including possible
default by the other party to the transaction, illiquidity and, to the extent
the 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 of portfolio securities at inopportune times or for
prices other than at current market values, limit the amount of appreciation a
Portfolio can realize on its investments or cause a Portfolio to hold a security
it might otherwise sell. The use of currency transactions can result in a
Portfolio incurring losses as a result of a number of factors including the
imposition of exchange controls, suspension of settlements or the inability to
deliver or receive a specified currency. The use of options and futures
transactions entails certain other risks. In particular, the variable degree of
correlation between price movements of futures contracts and price movements in
the related portfolio position of a Portfolio creates the possibility that
losses on the hedging instrument may be greater than gains in the value of a
Portfolio's position. In addition, futures and options markets may not be liquid
in all circumstances and certain over-the-counter options may have no markets.
As a result, in certain markets, a Portfolio might not be able to close out a
transaction without incurring substantial losses, if at all. Although the
contemplated use of these futures contracts and options thereon should tend to
minimize the risk of loss due to a decline in the value of the hedged position,
at the same time they tend to limit any potential gain which might result from
an increase in value of such position. Finally, the daily variation margin
requirements for futures contracts would create a greater ongoing potential
financial risk than would purchases of options, where the exposure is limited to
the cost of the initial premium. Losses resulting from the use of Strategic
Transactions would reduce net asset value and possibly income. The Strategic
Transactions that the Portfolios may use and some of their risks are described
more fully in the Statement of Additional Information.
Repurchase Agreements. The Portfolios may enter into repurchase agreements with
selected commercial banks and broker-dealers, under which the Portfolio acquires
securities and agrees to resell the securities at an agreed upon time and at an
agreed upon price. The Portfolio accrues as interest the difference between the
amount it pays for the securities and the amount it receives upon resale. At the
time the Portfolio enters into a repurchase agreement, the value of the
underlying security including accrued interest will be equal to or exceed the
value of the repurchase agreement and, for repurchase agreements that mature in
more than one day, the seller will agree that the value of the underlying
security including accrued interest will continue to be at least equal to the
value of the repurchase agreement. Each Sub-Adviser will monitor the value of
the underlying security in this regard. The Portfolio will enter into repurchase
agreements only with commercial banks whose deposits are insured by the Federal
Deposit Insurance Corporation and whose assets exceed $500 million or
broker-dealers who are registered with the Securities and Exchange Commission.
In determining whether the Portfolio should enter into a repurchase agreement
with a bank or broker-dealer, the Sub-Adviser will take into account the
credit-worthiness of the party and will monitor its credit-worthiness on an
ongoing basis in accordance with standards established by the Board of Trustees.
In the event of a default by the party, the delays and expenses potentially
involved in establishing the Portfolio's rights to, and in liquidating, the
security may result in a loss to the Portfolio. The Money Market Portfolio may
not invest in repurchase agreements which mature in more than seven days. There
are additional limitations and restrictions relating to the ability of the Money
Market Portfolio to invest in repurchase agreements which have been adopted by
the Board of Trustees of the Trust and which relate primarily to investment
quality and diversification.
When Issued and Delayed Delivery Transactions. Certain Portfolios may purchase
and sell securities on a "when issued" and "delayed delivery" basis, that is,
obligate themselves to purchase or sell securities with delivery and payment to
occur at a later date in order to secure what is considered to be an
advantageous price and yield to the Portfolio at the time of entering into the
obligation. When a Portfolio engages in such transactions, the Portfolio relies
on the buyer or seller, as the case may be, to consummate the sale. No income
accrues to or is earned by the Portfolio on portfolio securities in connection
with such transactions prior to the date the Portfolio actually takes delivery
of such securities. These transactions are subject to market fluctuation; the
value of such securities at delivery may be more or less than their purchase
price, and yields generally available on such securities when delivery occurs
may be higher than yields on such securities obtained pursuant to such
transactions. Because the Portfolio relies on the buyer or seller, as the case
may be, to consummate the transaction, failure by the other party to complete
the transaction may result in the Portfolio missing the opportunity of obtaining
a price or yield considered to be advantageous. When the Portfolio is the buyer
in such a transaction, however, it will maintain, in a segregated account with
its custodian, cash or high-grade portfolio securities having an aggregate value
equal to the amount of such purchase commitments until payment is made. The
Portfolio will make commitments to purchase securities on such basis only with
the intention of actually acquiring these securities, but the Portfolio may sell
such securities prior to the settlement date if such sale is considered to be
advisable. To the extent the Portfolio engages in when issued and delayed
delivery transactions, it will do so for the purpose of acquiring securities for
the Portfolio consistent with the Portfolio's investment objective and policies
and not for the purposes of investment leverage. No specific limitation exists
as to the percentage of any Portfolio's assets which may be used to acquire
securities on a when issued or delayed delivery basis. See the Statement of
Additional Information for additional discussion of these transactions.
Restricted and Illiquid Securities. The Portfolios may each invest up to 15%
(10% with respect to the Portfolios for which Van Kampen American Capital
Investment Advisory Corp. acts as Sub-Adviser) of their respective net assets in
securities the disposition of which is subject to substantial legal or
contractual restrictions on resale and securities that are not readily
marketable. The sale of restricted and illiquid securities often requires more
time and results in higher brokerage charges or dealer discounts and other
selling expenses than does the sale of securities eligible for trading on
national securities exchanges or in the over-the-counter markets. Restricted
securities may sell at a price lower than similar securities that are not
subject to restrictions on resale. Restricted and illiquid securities in all
Portfolios will be valued at fair value as determined in good faith by or at the
direction of the Trustees for the purposes of determining the net asset value of
each Portfolio. Restricted securities salable among qualified institutional
buyers without restriction pursuant to Rule 144A under the Securities Act of
1933 that are determined to be liquid by the Sub-Adviser under guidelines
adopted by the Board of Trustees of the Trust (under which guidelines the
Sub-Adviser will consider factors such as trading activities and the
availability of price quotations) will not be treated as restricted securities
by the Portfolios pursuant to such rules.
Loans of Portfolio Securities. Consistent with applicable regulatory
requirements, all of the Portfolios may lend their securities to selected
commercial banks or broker-dealers up to a maximum of 25% of the assets of each
Portfolio. Such loans must be callable at any time and be continuously secured
by collateral deposited by the borrower in a segregated account with the Trust's
custodian consisting of cash or of securities issued or guaranteed by the U.S.
Government or its agencies, which collateral is equal at all times to at least
100% of the value of the securities loaned, including accrued interest. A
Portfolio will receive amounts equal to earned income for having made the loan.
Any cash collateral pursuant to these loans will be invested in short-term
instruments. A Portfolio is the beneficial owner of the loaned securities in
that any gain or loss in the market price during the loan inures to the
Portfolio and its shareholders. Thus, when the loan is terminated, the value of
the securities may be more or less than their value at the beginning of the
loan. In determining whether to lend its portfolio securities to a bank or
broker-dealer, a Portfolio will take into account the credit-worthiness of such
borrower and will monitor such credit-worthiness on an ongoing basis in as much
as a default by the other party may cause delays or other collection
difficulties. A Portfolio may pay finders' fees in connection with loans of its
portfolio securities.
Reverse Repurchase Agreements and Borrowings. The Portfolios may enter into
reverse repurchase agreements with selected commercial banks or broker-dealers
with respect to securities which could otherwise be sold by the Portfolios.
Reverse repurchase agreements involve sales by a Portfolio of Portfolio assets
concurrently with an agreement by the Portfolio to repurchase the same assets at
a later date at a fixed price which is greater than the sales price. The
difference between the amount the Portfolio receives for the securities and the
amount it pays on repurchase is deemed to be a payment of interest by the
Portfolio. Each Portfolio will maintain, in a segregated account with its
custodian, cash, Treasury bills, or other U.S. Government Securities having an
aggregate value equal to the amount of commitment to repurchase, including
accrued interest, until payment is made. Each Portfolio will enter into reverse
repurchase agreements only with commercial banks whose deposits are insured by
the Federal Deposit Insurance Corporation and whose assets exceed $500 million
or broker-dealers who are registered with the SEC. In determining whether a
Portfolio should enter into a reverse repurchase agreement with a bank or
broker-dealer, each Sub-Adviser will take into account the credit-worthiness of
the party and will monitor the credit-worthiness on an ongoing basis. During the
reverse repurchase agreement period, a Portfolio continues to receive principal
and interest payments on these securities. Reverse repurchase agreements involve
the risk that the market value of the securities retained by the Portfolio may
decline below the price of the securities the Portfolio has sold but is
obligated to repurchase under the agreement. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, a Portfolio's use of the proceeds of the agreement may be restricted
pending a determination by the other party, or its trustee or receiver, whether
to enforce the Portfolio's obligation to repurchase the securities. Reverse
repurchase agreements create leverage and will be treated as borrowings for the
purposes of each Portfolio's investment restriction on borrowings.
Each of the Quality Income and Stock Index Portfolios is permitted to borrow
money up to one-third of the value of its total assets taken at current value.
The Money Market Portfolio may borrow up to 10% of its total assets. Borrowing
by these Portfolios may be only from banks as a temporary measure for
extraordinary or emergency purposes and not for investment leverage. Each of the
Mid-Cap Value, Large Cap Research and Developing Growth Portfolios may borrow
from banks (as defined in the 1940 Act) in amounts up to 33-1/3% of its total
assets (including the amount borrowed) and may borrow up to an additional 5% of
its total assets for temporary purposes. Each of the Select Equity, Large Cap
Stock and Small Cap Stock Portfolios is permitted to borrow money for
extraordinary or emergency purposes in amounts up to 10% of the value of the
Portfolio's total assets. Each of the Quality Bond and International Equity
Portfolios is permitted to borrow money for extraordinary or emergency purposes
in amounts up to 30% of the value of the Portfolio's total assets and in
connection with reverse repurchase agreements. The Bond Debenture Portfolio is
permitted to borrow money for extraordinary or emergency purposes in amounts up
to 5% of the Portfolio's gross assets.
As a matter of operating policy, the Money Market Portfolio, the Quality Income
Portfolio and the Stock Index Portfolio will not borrow more than 10% of their
net asset value when borrowing is for any general purpose and 25% of their net
asset value when borrowing as a temporary measure to facilitate redemptions.
Borrowing by a Portfolio creates an opportunity for increased net income but, at
the same time, creates special risk considerations such as changes in the net
asset value of the shares and in the yield on the Portfolio. Although the
principal of such borrowings will be fixed, the Portfolio's assets may change in
value during the time the borrowing is outstanding. Borrowing will create
interest expenses for the Portfolio which can exceed the income from the assets
retained. To the extent the income derived from securities purchased with
borrowed funds exceeds the interest the Portfolio will have to pay, the
Portfolio's net income will be greater than if borrowing were not used.
Conversely, if the income from the assets retained with borrowed funds is not
sufficient to cover the cost of borrowing, the net income of the Portfolio will
be less than if borrowing were not used.
Short Sales. Certain Portfolios may utilize short sales on securities to
implement their investment objectives. A short sale is effected when it is
believed that the price of a particular investment will decline, and involves
the sale of an investment which the Portfolio does not own in the hope of
purchasing the same investment at a later date at a lower price. To make
delivery to the buyer, the Portfolio must borrow the investment, and the
Portfolio is obligated to return the investment to the lender, which is
accomplished by a later purchase of the investment by the Portfolio.
The Portfolio will incur a loss as a result of the short sale if the price of
the investment increases between the date of the short sale and the date on
which the Portfolio purchases the investment to replace the borrowed investment.
The Portfolio will realize a gain if the investment declines in price between
those dates. The amount of any gain will be decreased and the amount of any loss
increased by any premium or interest the Portfolio may be required to pay in
connection with a short sale. It should be noted that possible losses from short
sales differ from those that could arise from a cash investment in that the
former may be limitless while the latter can only equal the total amount of the
Portfolio's investment in the investment. For example, if the Portfolio
purchases a $10 investment, the most that can be lost is $10. However, if the
Portfolio sells a $10 investment short, it may have to purchase the investment
for return to the lender when the market value is $50, thereby incurring a loss
of $40. The amount of any gain or loss on a short sale transaction is also
dependent on brokerage and other transaction costs.
Convertible Securities. The convertible securities in which a Portfolio 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.
Warrants. A Portfolio may invest in warrants, which entitle the holder to buy
common stock from the issuer at a specific price (the strike price) for a
specific period of time. The strike price of warrants sometimes is much lower
than the current market price of the underlying securities, yet warrants are
subject to similar price fluctuations. As a result, warrants may be more
volatile investments than the underlying securities.
Warrants do not entitle the holder to dividends or voting rights with respect to
the underlying securities and do not represent any rights in the assets of the
issuing company. Also, the value of the warrant does not necessarily change with
the value of the underlying securities and a warrant ceases to have value if it
is not exercised prior to the expiration date.
Money Market Instruments. Certain Portfolios are permitted to invest in money
market instruments although they intend to stay invested in equity securities to
the extent practical in light of their objectives and long-term investment
perspective. These Portfolios may make money market investments pending other
investment or settlement, for liquidity or in adverse market conditions. The
money market investments permitted for these Portfolios include U.S. Government
Securities, other debt securities, commercial paper, bank obligations and
repurchase agreements. These Portfolios may also invest in short-term
obligations of sovereign foreign governments, their agencies, instrumentalities
and political subdivisions. For more detailed information about these money
market investments, see "Investment Objectives and Policies" in the Statement of
Additional Information.
Investment Limitations
In addition to the investment policies set forth above, certain additional
restrictive policies relating to the investment of assets of the Portfolios have
been adopted by the Trust. The Investment Limitations of the Trust are deemed
fundamental and may not be changed without the approval of the holders of a
majority of the outstanding voting shares of each Portfolio affected (which for
this purpose and under the 1940 Act means the lesser of (i) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares are
present or represented by proxy and (ii) more than 50% of the outstanding
shares). A change in policy affecting only one Portfolio may be effected with
the approval of a majority of the outstanding shares of the Portfolio. Details
as to the policies are set forth in the Statement of Additional Information.
RISK FACTORS
Tax Considerations
The Trust serves as the underlying investment for Variable Contracts issued by
Cova Life.
Section 817(h) of the Internal Revenue Code of 1986, as amended (the "Code"),
imposes certain diversification standards on the underlying assets of variable
contracts held in the Portfolios of the Trust. The Code provides that a variable
contract shall not be treated as an annuity contract for any period (and any
subsequent period) for which the investments are not, in accordance with
regulations prescribed by the Treasury Department, adequately diversified.
Disqualification of the variable contract as an annuity contract would result in
imposition of federal income tax on contract owners with respect to earnings
allocable to the variable contract prior to the receipt of payments under the
variable contract. Section 817(h)(2) of the Code is a safe harbor provision
which provides that contracts such as the Variable Contracts meet the
diversification requirements if, as of the close of each quarter, the underlying
assets meet the diversification standards for a regulated investment company and
no more than fifty-five percent (55%) of the total assets consists of cash, cash
items, U.S. government securities and securities of other regulated investment
companies.
On March 2, 1989, the Treasury Department issued Regulations (Treas. Reg.
1.817-5), which established diversification requirements for the investment
portfolios underlying variable contracts. The Regulations amplify the
diversification requirements for variable contracts set forth in Section 817(h)
of the Code and provide an alternative to the safe harbor provision described
above. Under the Regulations, an investment portfolio will be deemed adequately
diversified if (i) no more than 55 percent of the value of the total assets of
the portfolio is represented by any one investment; (ii) no more than 70 percent
of such value is represented by any two investments; (iii) no more than 80
percent of such value is represented by any three investments; and (iv) no more
than 90 percent of such value is represented by any four investments. For
purposes of these Regulations, all securities of the same issuer are treated as
a single investment.
The Code provides that for purposes of determining whether or not the
diversification standards imposed on the underlying assets of variable contracts
by Section 817(h) of the Code have been met, "each United States government
agency or instrumentality shall be treated as a separate issuer".
Each Portfolio of the Trust will be managed in such a manner as to comply with
these diversification requirements. It is possible that in order to comply with
the diversification requirements, less desirable investment decisions may be
made which would affect the investment performance of the Portfolios.
Special Considerations Relating to Foreign Securities
All of the Portfolios may invest in foreign securities. The Stock Index
Portfolio, however, may only invest in foreign securities which are issued by
companies in the S&P 500 Index. Certain Portfolios may invest in ADRs for
foreign securities. ADRs are dollar-denominated receipts issued generally by
domestic banks and representing the deposit with the bank of a security of a
foreign issuer. ADRs are publicly traded on exchanges or over-the-counter in the
United States. The Quality Income Portfolio may invest up to 35% in foreign
securities. The International Equity Portfolio may invest without limitation in
foreign securities. However, the Trust has no current intention that these
investments will exceed 20% of a Portfolio's assets except with respect to the
International Equity Portfolio. Investments in the securities of foreign
entities and securities denominated in foreign currencies involve risks not
typically involved in domestic investment, including fluctuations in foreign
exchange rates, future foreign political and economic developments, and the
possible imposition of exchange controls or other foreign or United States
governmental laws or restrictions applicable to such investments. Where a
Portfolio invests in securities denominated or quoted in currencies other than
the United States dollar, changes in foreign currency exchange rates may affect
the value of investments in the Portfolio and the accrued income and unrealized
appreciation or depreciation of investments. Changes in foreign currency
exchange rates relative to the U.S. dollar will affect the U.S. dollar value of
a Portfolio's assets denominated in that currency and the Portfolio's yield on
such assets. With respect to certain foreign countries, there is the possibility
of expropriation of assets, confiscatory taxation, political or social
instability or diplomatic developments which could affect investment in those
countries. There may be less publicly available information about a foreign
security than about a United States security, and foreign entities may not be
subject to accounting, auditing and financial reporting standards and
requirements comparable to those of United States entities. In addition, certain
foreign investments made by a Portfolio may be subject to foreign withholding
taxes, which would reduce the Portfolio's total return on such investments and
the amounts available for distributions by the Portfolio to its shareholders.
Foreign financial markets, while growing in volume, have, for the most part,
substantially less volume than United States markets, and securities of many
foreign companies are less liquid and their prices more volatile than securities
of comparable domestic companies. The foreign markets also have different
clearance and settlement procedures and in certain markets there have been times
when settlements have been unable to keep pace with the volume of securities
transactions making it difficult to conduct such transactions. Delays in
settlement could result in temporary periods when assets of a Portfolio are not
invested and no return is earned thereon. The inability of a Portfolio to make
intended security purchases due to settlement problems could cause the Portfolio
to miss attractive investment opportunities. Inability to dispose of portfolio
securities due to settlement problems could result either in losses to a
Portfolio due to subsequent declines in value of the portfolio security or, if a
Portfolio has entered into a contract to sell the security, could result in
possible liability to the purchaser. Costs associated with transactions in
foreign securities, including custodial costs and foreign brokerage commissions,
are generally higher than with transactions in United States securities. In
addition, a Portfolio will incur costs in connection with conversions between
various currencies. There is generally less government supervision and
regulation of exchanges, financial institutions and issuers in foreign countries
than there is in the United States.
As a matter of operating policy, each Portfolio will comply with the following:
1. a Portfolio will be invested in a minimum of five different foreign
countries at all times. However, this minimum is reduced to four when
foreign country investments comprise less than 80% of the Portfolio's net
asset value; to three when less than 60% of such value; to two when less
than 40% of such value; and to one when less than 20% of such value.
2. except as set forth in items 3 and 4 below, a Portfolio will have no more
than 20% of its net asset value invested in securities of issuers located
in any one country.
3. a Portfolio may have an additional 15% of its value invested in securities
of issuers located in any one of the following countries: Australia,
Canada, France, Japan, the United Kingdom or Germany.
4. a Portfolio's investments in United States issuers are not subject to the
foregoing operating policies.
Special Risks of High Yield Investing
The Bond Debenture Portfolio intends to invest a substantial portion of its
assets in medium and lower grade corporate debt securities.
Debt securities which are in those medium and lower grade categories generally
offer a higher current yield than is offered by securities which are in the
higher grade categories, but they also generally involve greater price
volatility and greater credit and market risk. Credit risk relates to the
issuer's ability to make timely payments of principal and interest when due as
well as fundamental developments in an issuer's business. Market risk relates to
the changes in market value that occur as a result of variation in the level of
prevailing interest rates and yield relationships in the securities market.
Typically, market prices tend to fall as interest rates rise and tend to rise as
interest rates fall. Generally, prices tend to fluctuate more for lower grade
issues than for higher grade issues, and, for any given change in interest
rates, prices for longer maturity issues tend to fluctuate more than for shorter
maturity issues. Yields on lower-rated securities will fluctuate over time.
The prices of lower-grade securities, while generally less sensitive to interest
rate changes than higher-rated investments, tend to be more sensitive to adverse
economic changes or individual corporate developments. During an economic
downturn or substantial period of rising interest rates, the ability of a highly
leveraged issuer to service its principal and interest payment obligations, to
meet projected business goals and to obtain additional financing may be
adversely affected. An economic downturn could disrupt the market for high yield
bonds, adversely affect the value of outstanding bonds and the ability of the
issuers of such bonds to repay principal and interest, cause increased
volatility in the market prices of high yield bonds and the Portfolio's net
asset value and may result in a higher incidence of defaults by issuers on bond
obligations. If the issuer of a bond defaults, the Portfolio may incur
additional expenses to seek recovery. The Portfolio will seek to reduce risk
through portfolio diversification, credit analysis, and attention to current
developments and trends in the industries and with the issuers involved. The
Portfolio's Sub-Adviser will continuously monitor the condition of the economy
and the financial and credit markets.
To the extent that there is no established retail secondary market for high
yield bonds, such bonds may be thinly traded, making the bonds less liquid than
investment grade bonds. Adverse publicity and investor perceptions, whether or
not based on fundamental analysis, may decrease the values and liquidity of high
yield bonds, especially in a thinly traded market. In the event of an illiquid
secondary market, or in the absence of readily available market quotations, the
responsibility of the Board of Trustees of the Trust to value the securities
becomes more difficult and will involve a greater degree of judgment in that
there is less reliable, objective data available.
If the market for high yield bonds is restricted by the enactment of
legislation, or if steps are taken to limit the use of such securities, or other
advantages of such securities, the value of the securities and a Portfolio's
ability to acquire them may be adversely affected.
A description of the corporate bond ratings is contained in the Appendix.
Purchasers should be aware, however, that credit ratings evaluate the safety of
principal and interest payments and not the market value risk of high yield
bonds. In addition, credit ratings may not always be modified on a timely basis
to reflect events subsequent to the most recent ratings which may have a
material impact on the securities rated. However, the Portfolio's Sub-Adviser
will continuously monitor the issuers of high yield bonds in the Portfolio to
determine if the issuers will have sufficient cash flow and profits to meet
required principal and interest payments, and to assure the bonds' liquidity.
Achievement of the investment objective of the Portfolio may be more dependent
on the credit analysis of the Portfolio's Sub-Adviser than is the case with
higher quality bonds.
The Portfolio may also invest in unrated corporate securities. Although unrated
securities are not necessarily of lower quality than rated securities, the
market for them may not be as broad and, accordingly, they may carry greater
risk and higher yield than rated securities.
PORTFOLIO TURNOVER RATES
Money Market Portfolio and Quality Income Portfolio
Although the Money Market and Quality Income Portfolios are not subject to
specific restrictions on portfolio turnover, they generally do not seek profits
by short-term trading. However, they may dispose of a portfolio security prior
to its maturity where disposition seems advisable because of a revised credit
evaluation of the issuer or other considerations. Because brokerage commissions
are not customarily charged on the investments invested in by each of the two
Portfolios, a high turnover rate should not affect the net asset value.
Bond Debenture Portfolio
The Bond Debenture Portfolio will not generally engage in trading of securities
for the purpose of realizing short-term profits, but it will adjust its
portfolio as it deems advisable in view of prevailing or anticipated market
conditions to accomplish its investment objective. For example, the Portfolio
may sell securities in anticipation of a movement in interest rates or to avoid
loss of premiums paid and unrealized capital gains earned on GNMA Certificates
selling at a substantial premium. Frequency of portfolio turnover will not be a
limiting factor if the Sub-Adviser considers it advantageous to purchase or sell
securities. The Portfolio anticipates that its portfolio turnover rate will
normally be less than 200%, and may be significantly less in a period of stable
or rising interest rates. For the period ended December 31, 1996, the portfolio
turnover rate for the Bond Debenture Portfolio was 58%. A high rate of portfolio
turnover involves correspondingly higher brokerage commissions and transaction
expenses than a lower rate, which expenses must be borne by the Portfolio and
its shareholders.
Stock Index Portfolio
Although the Portfolio generally seeks to invest for the long term, the
Portfolio retains the right to sell securities irrespective of how long they
have been held. However, because of the "passive" investment management approach
of the Portfolio, the portfolio turnover rate is expected to be under 50%, a
generally lower turnover rate than for most other investment companies. A
portfolio turnover rate of 50% would occur if one-half of the Portfolio's
securities were sold within one year. Ordinarily, securities will be sold from
the Portfolio only to reflect certain administrative changes in the Index
(including mergers or changes in the composition of the Index) or to accommodate
cash flows into and out of the Portfolio while maintaining the similarity of the
Portfolio to the Index. For the years ended December 31, 1996 and 1995, the
portfolio turnover rates for the Stock Index Portfolio were 1% and 4%,
respectively.
Quality Bond, Small Cap Stock, Select Equity,
International Equity and Large Cap Stock Portfolios
Portfolio transactions for these Portfolios will be undertaken principally to
accomplish their respective investment objectives, and the Portfolios may engage
in short-term trading consistent with their respective objectives. A portfolio
turnover rate of 100% indicates that the equivalent of all of a Portfolio's
assets have been sold and reinvested in a year. Overall, high portfolio turnover
may result in increased portfolio transaction costs and the realization of
substantial net capital gains or losses. To the extent net short term capital
gains are realized, any distributions resulting from such gains are considered
ordinary income for general income tax purposes. The Quality Bond Portfolio's
annual turnover rate is not expected to exceed 300%. The turnover rate for each
of the Small Cap Stock, Select Equity, Large Cap Stock and International Equity
Portfolios is not expected to exceed 100%. For the period ended December 31,
1996, the portfolio turnover rates for the Quality Bond, Small Cap Stock, Select
Equity, International Equity and Large Cap Stock Portfolios were 181%, 102%,
124%, 48% and 36%, respectively.
Mid-Cap Value, Large Cap Research
and Developing Growth Portfolios
Although the Portfolios will not normally engage in short-term trading, each
Portfolio reserves the right to do so if its Sub-Adviser believes that selling a
particular security is appropriate in light of the Portfolio's investment
objective. Investments may be sold for a variety of reasons, such as a more
favorable investment opportunity or other circumstances bearing on the
desirability of continuing to hold such investments. A high rate of portfolio
turnover involves correspondingly greater brokerage commission expenses and
other transaction costs, which must be borne directly by the Portfolio and
ultimately by its shareholders. Although the Portfolios cannot accurately
predict their respective annual portfolio turnover rates, such rates are not
expected to exceed 100%.
MANAGEMENT OF THE TRUST
The Trustees
The Trust is organized as a Massachusetts business trust. The overall
responsibility for the supervision of the affairs of the Trust vests in the
Trustees. The Trustees have entered into an Investment Advisory Agreement with
the Adviser to handle the day-to-day affairs of the Trust (see below). The
Trustees meet periodically to review the affairs of the Trust and to establish
certain guidelines which the Adviser is expected to follow in implementing the
investment policies and objectives of the Trust.
Adviser
Under an Investment Advisory Agreement dated April 1, 1996, as amended, the
Adviser, located at One Tower Lane, Suite 3000, Oakbrook Terrace, Illinois
60181-4644, manages the business and affairs of the Portfolios and the Trust,
subject to the control of the Trustees.
The Adviser is an Illinois corporation which was incorporated on August 31, 1993
under the name Oakbrook Investment Advisory Corporation and is registered with
the Securities and Exchange Commission as an investment adviser under the
Investment Advisers Act of 1940. The Adviser changed its name to its present
name on January 17, 1996. The 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 Adviser has acted as the investment adviser to the Trust since May
1, 1996.
Under the terms of the Investment Advisory Agreement, the 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 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 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.
As full compensation for its services under the Investment Advisory Agreement,
the Trust will pay the Adviser a monthly fee at the following annual rates shown
in the table below based on the average daily net assets of each Portfolio:
Average Daily
Portfolio Net Assets % Per Annum
- --------- ---------- -----------
Money Market First $500 million .50%
Over $500 million .40%
Quality Income First $500 million .50%
Over $500 million .45%
Stock Index _______________ .50%
Bond Debenture _______________ .75%
Quality Bond First $75 million .55%
Over $75 million .50%
International First $50 million .85%
Equity Over $50 million .75%
Select Equity First $50 million .75%
Over $50 million .65%
Small Cap _______________ .85%
Stock
Large Cap _______________ .65%
Stock
Mid-Cap Value _______________ 1.00%
Large Cap _______________ 1.00%
Research
Developing _______________ .90%
Growth
Cova Financial Services Life Insurance Company, Cova Life Management Company and
the Adviser have entered into an Investment Advisory Services Agreement, dated
April 1, 1996, the purpose of which is to ensure that the Adviser, which is
minimally capitalized, has adequate facilities and financing for the carrying on
of its business. Under the terms of the Agreement, Cova Financial Services Life
Insurance Company is obligated to provide the Adviser with adequate
capitalization in order for the Adviser to meet any minimum capital
requirements. Cova Financial Services Life Insurance Company is further
obligated to reimburse the Adviser or assume payment for any obligation incurred
by the Adviser. Cova Life Management Company is obligated to provide the Adviser
with facilities and personnel sufficient for the Adviser to perform its
obligations under the Investment Advisory Agreement.
Trust Administration
The Adviser retains Investors Bank & Trust Company ("IBTC"), a Massachusetts
trust company, to supervise various aspects of the Trust's administrative
operations and to perform certain specific services including, but not limited
to, the preparation and filing of Trust reports and tax returns, pursuant to an
Administration Agreement between the Trust, the Adviser and IBTC.
Portfolio Management
For the year ended December 31, 1996, the Adviser was paid advisory fees as
follows: $250,111, with respect to the Quality Income Portfolio, $434,880, with
respect to the Stock Index Portfolio, $20,291, with respect to the Bond
Debenture Portfolio, $24,070, with respect to the Quality Bond Portfolio,
$53,647, with respect to the International Equity Portfolio, $60,950, with
respect to the Select Equity Portfolio, $76,508, with respect to the Large Cap
Stock Portfolio and $51,031, with respect to the Small Cap Stock Portfolio. The
Adviser waived its advisory fees of $167,093, with respect to the Money Market
Portfolio.
Expenses of the Trust
Although each Portfolio must bear the expenses directly attributable to it, the
Portfolios are expected to experience cost savings over the aggregate amount
that would be payable if each Portfolio were a separate fund, because they have
the same Trustees, accountants, attorneys and other general and administrative
expenses. Any expenses which are not directly attributable to a specific
Portfolio are allocated on the basis of the net assets of the respective
Portfolios.
For the year ended December 31, 1996, the expenses, taking into account the
waivers and expense assumptions, borne by the Quality Income Portfolio amounted
to $300,306 or .60% of its average net assets on an annualized basis; the net
expenses borne by the Money Market Portfolio amounted to $36,593 or .11% of its
average net assets on an annualized basis; the net expenses borne by the Stock
Index Portfolio amounted to $523,890 or .60% of its average net assets on an
annualized basis; the Bond Debenture Portfolio amounted to $22,997 or .85% of
its average net assets on an annualized basis; the net expenses borne by the
Quality Bond Portfolio amounted to $28,446 or .65% of its average net assets on
an annualized basis; the net expenses borne by the International Equity
Portfolio amounted to $59,958 or .95% of its average net assets on an annualized
basis; the net expenses borne by the Select Equity Portfolio amounted to $69,076
or .85% of its average net assets on an annualized basis; the net expenses borne
by the Large Cap Stock Portfolio amounted to $88,276 or .75% of its average net
assets on an annualized basis; and the net expenses borne by the Small Cap Stock
Portfolio amounted to $57,031 or .95% of its average net assets on an annualized
basis.
Cova Life and/or the Adviser may at their discretion, but are not obligated to,
assume all or any portion of Trust expenses. For the year ended December 31,
1996, Cova Life and the Adviser together assumed expenses of $56,022 with
respect to the Quality Income Portfolio; $44,285 with respect to the Money
Market Portfolio; $59,573 with respect to the Stock Index Portfolio; $32,241
with respect to the Bond Debenture Portfolio; $34,737 with respect to the
Quality Bond Portfolio; $168,580, with respect to the International Equity
Portfolio, $66,275, with respect to the Select Equity Portfolio; $50,521, with
respect to the Large Cap Stock Portfolio; and $97,214, with respect to the Small
Cap Stock Portfolio.
Sub-Advisers
In accordance with each Portfolio's investment objective and policies and under
the supervision of Adviser and the Trust's Board of Trustees, each Portfolio's
Sub-Adviser is responsible for the day-to-day investment management of the
Portfolio, makes investment decisions for the Portfolio and places orders on
behalf of the Portfolio to effect the investment decisions made as provided in
separate Sub-Advisory Agreements among each Sub-Adviser, the Adviser and the
Trust. The following organizations act as Sub-Advisers to the Portfolios:
J.P. Morgan Investment Management Inc., 522 Fifth Avenue, New York, New York
10036, a Delaware corporation, and a wholly-owned subsidiary of J.P. Morgan &
Co., Incorporated, is the Sub-Adviser for the Quality Bond, International
Equity, Select Equity, Small Cap Stock and Large Cap Stock Portfolios of the
Trust.
Harriet T. Huber, Vice President of the Sub-Adviser. Ms. Huber is a portfolio
manager of active portfolios. Previously she worked in the insurance asset and
liability group at Salomon Brothers and prior to that she traded interest rate
swaps and sold taxable fixed income securities at First Boston. She was also an
Associate Member of the Chicago Board of Trade for two years. Ms. Huber received
a B.A. in mathematics from the University of Wisconsin, Madison, and an M.B.A.
from the University of Chicago.
Anne Richards, Assistant Vice President of the Sub-Adviser, is the Portfolio
Manager for the International Equity Portfolio. Ms. Richards joined J.P. Morgan
in 1994 as an international equity portfolio manager. Previously she has held
positions as an engineering analyst with Alliance Capital, a project engineer
for Cambridge Consultants and a research fellow for CERN, European Laboratory
for Particle Physics. Ms. Richards holds a BSc from the University of Edinburgh
and an MBA from INSEAD, France.
James B. Otness, Managing Director of the Sub-Adviser, is the Portfolio Manager
for the Small Cap Stock Portfolio. Mr. Otness is a member of the Equity and
Balanced Accounts Group. Mr. Otness co-manages Morgan's Small Company Fund and
other client portfolios employing a small company investment approach. Mr.
Otness joined Morgan in 1970 after graduation from Harvard University and
service in the U.S. Marine Corps Reserve. Prior to his current assignment, he
managed large capitalization equities and before that was unit head in the
Investment Research Department. Mr. Otness is a Chartered Financial Analyst with
24 years of investment experience.
James Wiess, Vice President of the Sub-Adviser, is the Portfolio Manager for the
Large Cap Stock Portfolio. Mr. Wiess is a member of the Equity and Balanced
Accounts Group, with responsibility for portfolio rebalancing and product
research and development in structured equity strategies. Prior to joining
Morgan in 1992, Mr. Wiess gained experience in stock index arbitrage during
seven years at Oppenheimer & Co. He also was a financial markets consultant at
Data Resources. Mr. Wiess earned his undergraduate degree from the Wharton
School at the University of Pennsylvania.
Michael J. Kelly, Vice President of the Sub-Adviser, is the Portfolio Manager
for the Select Equity Portfolio. Mr. Kelly is an institutional portfolio manager
with responsibility for a number of employee benefit, foundation, and endowments
clients. Prior to assuming his current position, he was in the Equity Research
Group covering capital goods, electrical equipment, and conglomerates. Mr. Kelly
also served as the group's generalist. Before joining Morgan in 1985, he held a
position at the economic firm Townsend-Greenspan & Co., Inc. Mr. Kelly served as
President of the Machinery Analysts of New York, Vice President of the
Electrical Products Group, committee member for the AIMR and is a member of the
Money Marketeers of New York. Mr. Kelly has an undergraduate degree from
Gettysburg College and an M.B.A. from The Wharton School. Mr. Kelly is a
Chartered Financial Analyst.
Lord, Abbett & Co. ("Lord Abbett"), The General Motors Building, 767 Fifth
Avenue, New York, New York 10153-0203. Lord Abbett has been an investment
manager for over 67 years and currently manages approximately $22 billion in a
family of mutual funds and other advisory accounts. Lord Abbett is the
Sub-Adviser for the Bond Debenture, Mid-Cap Value, Large Cap Research and
Developing Growth Portfolios.
Christopher J. Towle, Executive Vice President of the Sub-Adviser, is Portfolio
Manager for the Bond Debenture Portfolio. Mr. Towle joined Lord Abbett in 1987
as Assistant Fixed Income Portfolio Manager and assumed full responsibilities as
Fixed Income Portfolio Manager in August, 1995. Prior to joining Lord Abbett,
Mr. Towle was an Assistant Vice President and Portfolio Manager with American
International Group. He earned a B.A. degree in economics from Rutgers
University and is a Chartered Financial Analyst.
Edward K. von der Linde is primarily responsible for the day-to-day management
of the Mid-Cap Value Portfolio. Mr. von der Linde has been with Lord Abbett
since 1988 and has over 10 years of investment experience.
Robert G. Morris, Lord Abbett partner, is primarily responsible for the
day-to-day management of the Large Cap Research Portfolio. Prior to joining Lord
Abbett in 1991, Mr. Morris was Vice President and Manager of Chase Manhattan
Bank, N.A. Mr. Morris delegates management duties to a committee consisting, at
any time, of three Lord Abbett employees from the Research Department. The
members of the committee have staggered terms to assure continuity and a forum
for different judgments as to what securities represent the greatest investment
value, regardless of industry sector, market capitalization or Wall Street
sponsorship.
Stephen J. McGruder serves as portfolio manager for the Developing Growth
Portfolio. Prior to joining Lord Abbett, Mr. McGruder had served as Vice
President of Wafra Investments Advisory Group, a private investment company,
since October 1988. Mr. McGruder has over 25 years of experience in the
investment business.
Van Kampen American Capital Investment Advisory Corp. ("VKAC"), One Parkview
Plaza, Oakbrook Terrace, Illinois 60181. VKAC, formerly known as Van Kampen
Merritt Investment Advisory Corp., served as the investment adviser to the Trust
from its commencement of operations until May 1, 1996. VKAC is the Sub-Adviser
for the Quality Income, High Yield, Stock Index, Money Market and VKAC Growth
and Income Portfolios of the Trust. VKAC is an indirect subsidiary of VK/AC
Holding, Inc. which, in turn, is a wholly-owned subsidiary of MSAM Holdings II,
Inc., which, in turn, is a wholly-owned subsidiary of Morgan Stanley Group Inc.
As of September 30, 1996, Morgan Stanley Asset Management Inc., together with
its affiliated investment advisory companies, had approximately $103.5 billion
of assets under management and fiduciary advice. On February 5, 1997, Morgan
Stanley Group, Inc. and Dean Witter, Discover & Co. announced that they had
entered into an Agreement and Plan of Merger to form Morgan Stanley, Dean
Witter, Discover & Co. Subject to certain conditions being met, it is currently
anticipated that the transaction will close in mid-1997. Thereafter, VKAC will
be an indirect subsidiary of Morgan Stanley, Dean Witter, Discover & Co.
Van Kampen American Capital, Inc. is a diversified asset management company with
more than two million retail investor accounts and nearly $50 billion under
management or supervision. Van Kampen American Capital, Inc.'s over 40 open-end
and 38 closed-end funds and more than 2,700 unit investment trusts are
distributed by financial advisers nationwide. In connection with advising the
Trust, VKAC utilizes at its own expense credit analysis and research services
provided by its affiliate, McCarthy, Crisanti & Maffei, Inc.
Pete Papageorgakis has been a member of VKAC since 1992 and is currently the
Portfolio Manager for the Stock Index Portfolio of the Trust. Additionally, he
serves as a Portfolio Analyst for Institutional Accounts and is responsible for
both equity and corporate bond securities. Prior to his current duties, he
assisted in the management of the Van Kampen Merritt Growth & Income Fund, the
VKAC Growth and Income Portfolio of the Trust, the Van Kampen Merritt Utility
Fund and the Van Kampen Merritt Balanced Fund. Mr. Papageorgakis received his
B.S. degree, Summa Cum Laude, in Finance from the University of Illinois at
Urbana-Champaign. He is currently working towards receiving his Chartered
Financial Analyst (CFA) designation, having successfully completed the CFA Level
II Exam.
Reid J. Hill is the Portfolio Manager for the Money Market Portfolio of the
Trust. Mr. Hill is also the Portfolio Manager for the Van Kampen American
Capital Tax Free Money Fund and the Van Kampen Series Trust Money Market Fund.
Mr. Hill has three years of experience in the taxable and tax free fixed income
sector. Mr. Hill is also responsible for the management of the short term cash
for the entire complex of Van Kampen funds. Mr. Hill received his B.S. degree in
Finance and Marketing from Bradley University.
Robert J. Hickey is the Portfolio Manager for the Quality Income Portfolio of
the Trust. Mr. Hickey is Vice President of VKAC. He has been a member of VKAC
since 1989. He has nine years of experience in the taxable and tax free fixed
income sector. Currently, he is the Portfolio Manager for the Van Kampen
American Capital Strategic Income Fund and the Van Kampen Series Trust Quality
Income Fund. In addition, Mr. Hickey manages the assets of the OakRe Life
Insurance portfolio, formerly known as Xerox Financial Services Life Insurance.
Previous experience includes managing the Van Kampen Adjustable Rate U.S.
Government Fund, the Van Kampen Money Market Fund, and the Van Kampen Tax Free
Money Fund. Mr. Hickey received his B.A. in Economics and International Affairs
from the University of Wisconsin at Madison, and his M.B.A. with a
specialization in Finance from the Kellogg Graduate School of Management at
Northwestern University.
Sub-Advisory Fees
Under the terms of the Sub-Advisory Agreements, the Adviser shall pay to the
Sub-Advisers, as full compensation for services rendered under the respective
Agreements with respect to the various Portfolios, monthly fees at the following
annual rates shown in the table below based on the average daily net assets of
each Portfolio.
Average Daily Sub-Advisory
Portfolio Net Assets Fee
- --------- ---------- ---
Money Market First $500 million .25%
Over $500 million .15%
Quality Income First $500 million .25%
Over $500 million .20%
Stock Index _______________ .25%
Bond Debenture _______________ .50%
Quality Bond First $75 million .30%
Over $75 million .25%
International First $50 million .60%
Equity Over $50 million .50%
Select Equity First $50 million .50%
Over $50 million .40%
Small Cap _______________ .60%
Stock
Large Cap _______________ .40%
Stock
Mid-Cap Value _______________ .75%
Large Cap _______________ .75%
Research
Developing _______________ .65%
Growth
DESCRIPTION OF THE TRUST
Shareholder Rights
The Trust is an unincorporated business trust established under the laws of the
Commonwealth of Massachusetts by a Declaration of Trust dated July 9, 1987. The
Declaration of Trust permits the Trustees to issue an unlimited number of full
and fractional shares.
Each Portfolio issues its own class of shares. Each share represents an equal
proportionate interest in the assets of the Portfolio with each other share in
the Portfolio. On any matter submitted to a vote of shareholders, all shares of
the Trust then issued and outstanding and entitled to vote will be voted in the
aggregate and not by class except for matters concerning only one class. The
holders of each share of stock of the Trust will be entitled to one vote for
each full share and a fractional vote for each fractional share of stock. Shares
of one class may not bear the same economic relationship to the Trust as another
class.
In accordance with its view of present applicable law, the separate account(s)
of Cova Life, as shareholder(s) of the Trust, have the right to vote Trust
shares at any meeting of shareholders and will provide pass-through voting
privileges to all contract owners. Cova Life will vote shares of the Trust held
in the separate account(s) for which no timely voting instructions from contract
owners are received, as well as shares it owns, in the same proportion as those
shares for which voting instructions are received. Additional information
concerning voting rights is described in the Variable Account Prospectus
attached hereto under the caption, "Investment Options - Voting Rights".
The Trust is not required to hold annual meetings of shareholders and does not
plan to do so. The Trustees may call special meetings of shareholders for action
by shareholder vote as may be required by the 1940 Act, or the Declaration of
Trust. The Trust will hold a shareholder meeting to fill existing vacancies on
the Board in the event that less than a majority of Trustees were elected by the
shareholders. The Trustees shall also call a meeting of shareholders for the
purpose of voting upon the question of removal of any Trustee when requested in
writing to do so by the record holders of not less than 10 percent of the
outstanding shares.
The Trust has an obligation to assist shareholder communications.
The Declaration of Trust provides that shareholders are not liable for any
liabilities of the Trust, requires inclusion of a clause to that effect in every
agreement entered into by the Trust and indemnifies shareholders against any
liability. Although shareholders of an unincorporated business trust established
under Massachusetts law may, under certain limited circumstances, be held
personally liable for the obligations of the Trust as though they were general
partners in a partnership, the provisions of the Declaration of Trust described
in the foregoing sentence make the likelihood of personal liability remote.
The Trustees may amend the Declaration of Trust in any manner without
shareholder approval, except that the Trustees may not adopt any amendment
adversely affecting the rights of shareholders without approval by a majority of
the shares present at a meeting of shareholders (or higher vote as may be
required by the 1940 Act, or other applicable law) and except that the Trustees
cannot amend the Declaration of Trust to impose any liability on shareholders,
make any assessment on shares, or impose liabilities on the Trustees without
approval from each affected shareholder or Trustee, as the case may be.
Inquiries
Any inquiries should be directed to Cova Life, One Tower Lane, Suite 3000,
Oakbrook Terrace, Illinois 60181-4644. The telephone number is (800) 831-LIFE.
Distribution and Redemption of Shares
Shares of the Trust are currently issued and redeemed only in connection with
investment in and payments under the Variable Contracts issued by Cova Life. The
shares of the Trust are purchased and redeemed at net asset value (see below).
Redemptions will be effected by the separate accounts to meet obligations under
the Variable Contracts. Variable Contract owners do not deal directly with the
Trust with respect to acquisition or redemption of shares.
Dividends
All dividends are distributed to the separate accounts and will be automatically
reinvested in Trust shares. Dividends and distributions made by the Portfolios
are taxable, if at all, to Cova Life; they are not taxable to Variable Contract
owners.
Tax Status
It is the intention of the Trust to qualify as a "regulated investment company"
under Sub-chapter M of the Internal Revenue Code. If the Trust so qualifies and
distributes each year to its shareholders at least 90% of its net investment
income in each year, it will not be required to pay federal income taxes on any
income distributed to shareholders. Each Portfolio of the Trust distributes all
of its net income and gains to its shareholders (the separate accounts). Each
Portfolio is treated as a separate entity for Federal income tax purposes and,
therefore, the investments and results of the Portfolio are determined
separately for purposes of determining whether the Trust qualifies as a
"regulated investment company" and for purposes of determining net ordinary
income (or loss) and net realized capital gains (or losses).
Some of the Trust's investment practices are subject to special provisions of
the Code that, among other things, may defer the use of certain losses of the
Trust and affect the holding period of the securities held by the Trust and the
character of the gains or losses realized by the Trust. These provisions may
also require the Trust to mark-to-market some of the positions in its portfolio
(i.e., treat them as if they were closed out), which may cause the Trust to
recognize income without receiving cash with which to make distributions in
amounts necessary to satisfy the 90% distribution requirement and the
distribution requirements for avoiding income and excise taxes. The Trust will
monitor its transactions and may make certain tax elections in order to mitigate
the effect of these rules and prevent disqualification of the Trust as a
regulated investment company.
Investments of the Trust in securities issued at a discount or providing for
deferred interest or payment of interest in kind are subject to special tax
rules that will affect the amount, timing and character of distributions to
shareholders. For example, with respect to securities issued at a discount, the
Trust will be required to accrue as income each year a portion of the discount
and to distribute such income each year in order to maintain its qualification
as a regulated investment company and to avoid income and excise taxes. In order
to generate sufficient cash to make distributions necessary to satisfy the 90%
distribution requirement and to avoid income and excise taxes, the Trust may
have to dispose of securities that it would otherwise have continued to hold.
The Trust's ability to dispose of portfolio securities may be limited by the
requirement for qualification as a regulated investment company that less than
30% of the Trust's annual gross income be derived from the disposition of
securities held for less than three months.
Net Asset Values
Portfolio shares are sold and redeemed at a price equal to the share's net asset
value. The net asset value of a Portfolio is determined by calculating the total
value of the Portfolio's assets, deducting its total liabilities, and dividing
the result by the number of shares outstanding. The net asset value for each
Portfolio is computed once daily as of the close of the New York Stock Exchange,
Monday through Friday, except on customary business holidays, or except on any
day on which no purchase or redemption orders are received, or there is not a
sufficient degree of trading in the Portfolio's investments so that the
Portfolio's net asset value per share might be materially affected. The Trust
reserves the right to calculate the net asset value and to adjust the public
offering price based thereon more frequently than once a day if deemed
desirable.
Securities that are listed on a securities exchange are valued at their closing
sales price on the day of the valuation. Price valuations for listed securities
are based on market quotations where the security is primarily traded or, if not
available, are valued at the mean of the bid and asked prices on any valuation
date. Unlisted securities in a Portfolio are primarily valued based on their
latest quoted bid price or, if not available, are valued by a method determined
by the Trustees to accurately reflect fair value. Money market instruments
maturing in 60 days or less are valued on the basis of amortized cost, which
means that securities are valued at their acquisition cost to reflect a constant
amortization rate to maturity of any premium or discount, rather than at current
market value. Other assets are valued at fair value as determined in good faith
by the Trustees.
The Money Market Portfolio values its securities on the basis of amortized cost,
which means that securities are valued at their acquisition cost to reflect a
constant amortized rate to maturity of any premium or discount, rather than at
current market value. Calculations are made to compare the amortized cost
valuation of the securities with current market values. Money market valuations
are obtained by using market quotations provided by market makers, estimates of
market values, or values obtained from published yield data of money market
instruments. If a deviation of 1/2 of 1% or more were to occur between the net
asset value calculated by reference to market values and the Portfolio's $1.00
per share net asset value, or if there were any other deviation which the
Trustees believe would result in a material dilution to shareholders, the
Trustees would promptly consider what action, if any, should be initiated.
FUND PERFORMANCE
From time to time advertisements and other sales materials for the Trust may
include information concerning the historical performance of the Trust. Such
advertisements will also describe the performance of the relevant insurance
company separate accounts. Any such information will include the average annual
total return of the Trust calculated on a compounded basis for specified periods
of time. Total return information will be calculated pursuant to rules
established by the Securities and Exchange Commission. In lieu of or in addition
to total return calculations, such information may include performance rankings
and similar information from independent organizations such as Lipper Analytical
Services, Inc., Morningstar, Business Week, Forbes or other industry
publications.
The Trust calculates average annual total return by determining the redemption
value at the end of specified periods (assuming reinvestment of all dividends
and distributions) of a $1,000 investment in the Trust at the beginning of the
period, deducting the initial $1,000 investment, annualizing the increase or
decrease over the specified period and expressing the result as a percentage.
Total return figures utilized by the Trust are based on historical performance
and are not intended to indicate future performance. Total return and net asset
value per share can be expected to fluctuate over time, and accordingly, upon
redemption, shares may be worth more or less than their original cost. See
"Performance Data" in the Statement of Additional Information.
Inception dates for the Portfolios depicted below are: December 11, 1989 for the
Quality Income Portfolio; July 1, 1991 for the Money Market Portfolio; and
November 1, 1991 for the Stock Index 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 inception date for the Quality Bond, Small Cap Stock, Large Cap Stock,
Select Equity, International Equity and Bond Debenture Portfolios is May 1,
1996, which is the date from which the average annual total return computations
are calculated for these Portfolios.
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 12/31/96
Portfolio Performance
Since
Portfolio 1 year 5 years Inception
- --------------------------------------------------------------------------------
Money Market 5.42% 4.55% 4.64%
Quality Income 2.82% 6.76% 8.04%
Stock Index 22.48% 14.13% 16.10%
Quality Bond -- -- 5.68%*
Small Cap Stock -- -- 8.65%*
Large Cap Stock -- -- 14.35%*
Select Equity -- -- 8.52%*
International Equity -- -- 8.44%*
Bond Debenture -- -- 12.89%*
*Not annualized
Public Fund Performance
The Bond Debenture Portfolio, which is managed by Lord, Abbett & Co., commenced
public sale of its shares on May 1, 1996. It does not yet have a meaningful
performance record. The Mid-Cap Value, Large Cap Research and Developing Growth
Portfolios, also managed by Lord Abbett, are commencing operations as of the
date of this Prospectus and therefore do not yet have their own performance
records. However, each of these Portfolios has the same investment objective and
follows substantially the same investment strategies as a mutual fund ("public
fund") whose shares are sold to the public and managed by the same portfolio
managers of Lord, Abbett & Co., as a corresponding public fund.
Set forth below is the historical performance of the public funds. Investors
should not consider the performance data of the public funds as an indication of
the future performance of the Portfolios. The performance figures shown below
reflect the deduction of the historical fees and expenses paid by the public
funds, and not those to be paid by the Portfolios. The figures also do not
reflect the deduction of any insurance fees or charges which are imposed by Cova
Life in connection with its sale of Variable Contracts. Investors should refer
to the separate account prospectus describing the Variable Contracts for
information pertaining to these insurance fees and charges. The insurance
separate account fees will have a detrimental effect on the performance of the
Portfolios. Additionally, although it is anticipated that each Portfolio and its
corresponding public fund series will hold similar securities, their investment
results are expected to differ. In particular, differences in asset size and in
cash flow resulting from purchases and redemptions of Portfolio shares may
result in different security selections, differences in the relative weightings
of securities or differences in the price paid for particular portfolio
holdings. The results shown reflect the reinvestment of dividends and
distributions, and were calculated in the same manner that will be used by the
Portfolios to calculate their own performance.
The following tables show average annualized total returns for the time periods
shown for the public funds. The inception date for the Lord Abbett Research Fund
(Large Cap Series) was June 3, 1992.
Bond Debenture Portfolio
Corresponding 1 5 10
Public Fund Year Year Year
- --------------------------------------------------------------------------------
Lord Abbett Bond -
Debenture Fund, Inc. 5.90% 9.98% 9.62%
Mid-Cap Value Portfolio
Corresponding 1 5 10
Public Fund Year Year Year
- --------------------------------------------------------------------------------
Lord Abbett -
Mid-Cap Value Fund 21.20% 13.80% 11.90%
Large Cap Research Portfolio
Corresponding 1 Since
Public Fund Year Inception
- --------------------------------------------------------------------------------
Lord Abbett Research Fund
(Large Cap Series) 20.20% 19.20%
Developing Growth Portfolio
Corresponding 1 5 10
Public Fund Year Year Year
- --------------------------------------------------------------------------------
Lord Abbett Developing
Growth Fund 22.20% 15.60% 13.60%
Private Account Performance
The Select Equity, Large Cap Stock, Small Cap Stock and Quality Bond Portfolios,
each of which is managed by J.P. Morgan Investment Management Inc., commenced
public sale of their shares on May 1, 1996, and therefore do not yet have any
meaningful performance records. However, each of these Portfolios has investment
objectives, policies and strategies which are substantially similar to those
employed by J.P. Morgan Investment Management Inc. with respect to certain
Private Accounts.
Thus, the performance information derived from these Private Accounts may be
deemed relevant to the investor. The performance of the Portfolios will vary
from the Private Account composite information because each Portfolio will be
actively managed and its investments will vary from time to time and will not be
identical to the past portfolio investments of the Private Accounts. Moreover,
the Private Accounts are not subject to certain investment limitations,
diversification requirements and other restrictions imposed by the 1940 Act and
the Internal Revenue Code of 1986, as amended, which, if applicable, may have
adversely affected the performance results of the Private Account Composites.
The chart below shows performance information derived from historical composite
performance of the Private Accounts. The performance figures for the Portfolios
represent the actual performance results of the composites of comparable Private
Accounts, adjusted to reflect the deduction of the fees and expenses paid by the
Portfolios. The Private Account composite performance figures are time-weighted
rates of return which include all income and accrued income and realized and
unrealized gains or losses, but do not reflect the deduction of investment
advisory fees actually charged to the Private Accounts. Inception was June 1,
1987 for the Public Bond Composite and November 1, 1989 for the Structured Stock
Selection Composite.
Investors should not consider the performance data of these Private Accounts as
an indication of the future performance of the respective Portfolios. The
figures also do not reflect the deduction of any insurance fees or charges which
are imposed by Cova Life in connection with its sale of Variable Contracts.
Investors should refer to the separate account prospectus describing the
Variable Contracts for information pertaining to these insurance fees and
charges. The insurance fees and charges will have a detrimental effect on the
performance of a Portfolio.
Private Account Composite Performance
Reduced by Portfolio Fees and Expenses
For the periods ended 12/31/96
Average Annual Total Return
10 Years
or Since
Portfolio 1 year 5 years Inception
- --------------------------------------------------------------------------------
Active Equity
Composite 21.22% 16.33% 16.13%
(Select Equity
Portfolio)
Structured Stock
Selection
Composite 23.03% 16.19% 15.35%
(Large Cap Stock
Portfolio)
Small Cap
Directly Invested
Composite 22.69% 17.33% 13.71%
(Small Cap
Stock Portfolio)
Public Bond
Composite 2.85% 6.84% 8.86%
(Quality Bond
Portfolio)
Additional Performance Information
Further information about the Trust's performance is contained in the Annual
Report to shareholders which may be obtained, without charge, by calling (800)
831-LIFE, or writing Cova Life at One Tower Lane, Suite 3000, Oakbrook Terrace,
Illinois 60181-4644.
APPENDIX -- DESCRIPTION OF
CORPORATE BOND RATINGS
Standard & Poor's Corporation. A brief description of the applicable Standard &
Poor's Corporation ("S&P") rating symbols and their meanings (as published by
S&P) follows:
An S&P corporate or municipal debt rating is a current assessment of the
creditworthiness of an obligor with respect to a specific obligation. This
assessment may take into consideration obligors such as guarantors, insurers, or
lessees.
The debt rating is not a recommendation to purchase, sell, or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or obtained
by S&P from other sources it considers reliable. S&P does not perform an audit
in connection with any rating and may, on occasion, rely on unaudited financial
information. The ratings may be changed, suspended, or withdrawn as a result of
changes in, or unavailability of, such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
1. Likelihood of default - capacity and willingness of the obligor as to the
timely payment of interest and repayment of principal in accordance with
the terms of the obligation;
2. Nature of and provisions of the obligation;
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization, or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
Long-term corporate bonds.
AAA Debt rated 'AAA' has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small
degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher rated categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than in higher
rated categories.
BB Debt rated 'BB', 'B', 'CCC', or 'CC' is regarded,
B on balance, as predominantly speculative with
CCC respect to capacity to pay interest and repay
CC principal in accordance with the terms of the obligation. 'BB'
indicates the lowest degree of speculation and 'CC' the highest degree
of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties
or major risk exposures to adverse conditions.
C This rating is reserved for income bonds on which no interest is being
paid.
D Debt rated 'D' is in default, and payment of interest and/or repayment
of principal is in arrears.
Plus (+) or Minus (-): The ratings from 'A' to 'B' may be modified by
the addition of a plus or minus sign to show relative standing within
the major rating categories.
Provisional Ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of
the project being financed by the debt being rated and indicates that
payment of debt service requirements is largely or entirely dependent
upon the successful and timely completion of the project. This rating,
however, while addressing credit quality subsequent to completion of
the project, makes no comment on the likelihood of, or the risk of
default upon failure of, such completion. The investor should exercise
judgment with respect to such likelihood and risk.
L The letter 'L' indicates that the rating pertains to the principal
amount of those bonds where the underlying deposit collateral is fully
insured by the Federal Deposit Insurance Corp.
[dagger] Continuance of the rating is contingent upon S&P's receipt
of closing documentation confirming investments and cash flow.
* Continuance of the rating is contingent upon S&P's receipt of an
executed copy of the escrow agreement.
NR Indicates no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
Moody's Investors Service, Inc. A brief description of the applicable Moody's
Investors Service, Inc. rating symbols and their meanings (as published by
Moody's Investors Service, Inc.) follows:
Long-term corporate bonds.
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge". Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long term risks appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations, i.e.
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba - Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca - Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa 1,
A 1, Baa 1, Ba 1 and B 1.
<TABLE>
<CAPTION>
PERFORMANCE RECAP
As of December 31, 1996
Performance
10 Yrs or
Portfolio Type 1 Yr 5 Yrs Since Inception
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Managed by J. P. Morgan
Investment Management Inc.
Select Equity Private Account 21.22% 16.33% 16.13%
Composite
Existing Portfolio - - - - 8.52%*
Small Cap Stock Private Account 22.69% 17.33% 13.71%
Composite
Existing Portfolio - - - - 8.65%*
Quality Bond Private Account 2.85% 6.84% 8.86%
Composite
Existing Portfolio - - - - 5.68%*
Large Cap Stock Private Account 23.03% 16.19% 15.35%
Composite
Existing Portfolio - - - - 14.35%*
International Equity Existing Portfolio - - - - 8.44%*
- ------------------------------------------------------------------------------------------------------------------------------------
Managed by
Lord, Abbett & Co.
Bond Debenture Public Fund 5.90% 9.98% 9.62%
Existing Portfolio - - - - 12.89%*
Mid-Cap Value Public Fund 21.20% 13.80% 11.90%
Large Cap Research Public Fund 20.20% - - 19.20%
Developing Growth Public Fund 22.20% 15.60% 13.60%
- ------------------------------------------------------------------------------------------------------------------------------------
Managed by Van Kampen
American Capital Investment
Advisory Corp.
Money Market Existing Portfolio 5.42% 4.55% 4.64%
Quality Income Existing Portfolio 2.82% 6.76% 8.04%
Stock Index Existing Portfolio 22.48% 14.13% 16.10%
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
* The inception date for the Quality Bond, Small Cap Stock, Large Cap Stock,
Select Equity, International Equity and Bond Debenture Portfolios is May 1,
1996, which is the date from which the average annual total return
computations are calculated for these Portfolios. The Mid-Cap Value, Large
Cap Research and Developing Growth Portfolios are commencing regular
investment operations as of the date of this Prospectus. Inception dates for
the following Existing Portfolios depicted above are: December 11, 1989 for
the Quality Income Portfolio; July 1, 1991 for the Money Market Portfolio;
and November 1, 1991 for the Stock Index 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.
</FN>
</TABLE>
Investors should not consider the performance data of these Private Accounts and
Public Funds as an indication of the future performance of the respective
Portfolios. The figures also do not reflect the deduction of any insurance fees
or charges which are imposed by Cova Life in connection with its sale of
Variable Contracts. Investors should refer to the separate account prospectus
describing the Variable Contracts for information pertaining to these insurance
fees and charges. The insurance fees and charges will have a detrimental effect
on the performance of a Portfolio.