STATEMENT OF ADDITIONAL INFORMATION
COVA SERIES TRUST
ONE TOWER LANE, SUITE 3000
OAKBROOK TERRACE, ILLINOIS 60181-4644
The date of this Statement of Additional Information is May 1, 2000
This Statement of Additional Information is not a prospectus. It contains
information that supplements the information in the prospectus dated May 1,
2000, for the Trust and its Portfolios. It also contains additional information
that may be of interest to you. The prospectus incorporates this Statement of
Additional Information by reference. You may obtain a free copy of the
prospectus from your registered representative who offered or sold you your
variable annuity contract or variable life insurance policy that uses the
Portfolios for investment. You may also obtain copies by calling Cova Financial
Services Life Insurance Company at 1-800-831-LIFE or by writing to: Cova
Financial Services Life Insurance Company, One Tower Lane, Suite 3000, Oakbrook
Terrace, Illinois 60181-4644.
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TABLE OF CONTENTS
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THE TRUST.........................................................................................................3
INVESTMENT STRATEGIES AND RISKS...................................................................................3
INVESTMENT LIMITATIONS...........................................................................................38
DESCRIPTION OF SECURITIES RATINGS................................................................................56
MANAGEMENT OF THE TRUST..........................................................................................56
OFFICERS AND TRUSTEES............................................................................................56
SUBSTANTIAL SHAREHOLDERS.........................................................................................60
OWNERSHIP BY CERTAIN BENEFICIAL OWNERS...........................................................................60
CUSTODIAN........................................................................................................60
DIVIDENDS........................................................................................................60
TAX STATUS.......................................................................................................60
NET ASSET VALUES.................................................................................................61
PERFORMANCE DATA.................................................................................................62
LEGAL COUNSEL AND INDEPENDENT AUDITORS...........................................................................63
INVESTMENT ADVISORY AGREEMENT....................................................................................63
PORTFOLIO TRANSACTIONS...........................................................................................68
FINANCIAL STATEMENTS.............................................................................................70
APPENDIX ........................................................................................................71
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THE TRUST
HISTORY
The Trust was established as a Massachusetts business trust under the laws of
Massachusetts by a Declaration of Trust dated July 9, 1987 (the "Declaration of
Trust"). The Trust changed its name from "Van Kampen Merritt Series Trust" to
its current name on May 1, 1996.
CLASSIFICATION
The Trust is an open-end, management investment company. It is divided into
different series, each of which has its own assets, investment objectives and
policies. Each is managed separately, using distinct strategies appropriate to
its objectives and policies. The Trust currently has seventeen Portfolios. The
Trust may authorize additional Portfolios in the future. The Trust cannot change
its classification as an open-end, management investment company without the
consent of a majority of its shareholders. A Portfolio that is currently
diversified cannot change to nondiversified without the approval of a majority
of the shareholders of that Portfolio.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders of a trust may be held personally liable
as partners for the obligations of the trust under certain circumstances. The
Declaration of Trust contains an express disclaimer of shareholder liability in
connection with Trust property or the acts, obligations, or affairs of the
Trust. The Declaration of Trust also provides for indemnification out of a
Portfolio's property of any shareholder of that Portfolio held personally liable
for the claims and liabilities to which a shareholder may become subject by
reason of being or having been a shareholder. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Portfolio itself would be unable to meet its
obligations. A copy of the Declaration of Trust is on file with the Secretary of
State of The Commonwealth of Massachusetts.
INVESTMENT STRATEGIES AND RISKS
SUMMARY
The prospectus for the Trust describes the principal strategies of each of the
Portfolios and the risks of those strategies. This Section describes the
strategies that are not principal strategies for the Portfolios, but which the
Sub-Advisers may use in managing a Portfolio and the risks of those strategies.
Some of these strategies could affect the return of the Portfolio. Additional
information on certain Portfolios is also provided.
ADDITIONAL INFORMATION - PORTFOLIOS MANAGED BY J.P. MORGAN INVESTMENT MANAGEMENT
INC.
QUALITY BOND PORTFOLIO. The Quality Bond Portfolio is designed to be an
economical and convenient means of making substantial investments in a domestic
and foreign issuer, subject to certain quality and other restrictions. See
"Quality and Diversification Requirements. The Portfolio's investment objective
is to provide a high total return consistent with moderate risk of capital and
maintenance of liquidity. Although the net asset value of the Portfolio will
fluctuate, the Portfolio attempts to conserve the value of its investments to
the extent consistent with its objective.
The Portfolio attempts to achieve its investment objective by investing in
high grade corporate and government debt obligations and related securities of
domestic and foreign issuers described in the Prospectus and this Statement of
Additional Information.
INVESTMENT PROCESS
Duration/yield curve management: The Sub-Adviser's duration decision begins
with an analysis of real yields, which its research indicates are generally a
reliable indicator of longer term interest rate trends. Other factors the
Sub-Adviser studies in regard to interest rates include economic growth and
inflation, capital flows and monetary policy. Based on this analysis, the
Sub-Adviser forms a view of the most likely changes in the level and shape of
the yield curve -- as well as the timing of those changes -- and sets the
Portfolio's duration and maturity structure accordingly. The Sub-Adviser
typically limits the overall duration of the Portfolio to a range between one
year shorter and one year longer than that of the Salomon Brothers Broad
Investment Grade Bond Index, the benchmark index.
Sector allocations: Sector allocations are driven by the Sub-Adviser's
fundamental and quantitative analysis of the relative valuation of a broad array
of fixed income sectors. Specifically, the Sub-Adviser utilizes market and
credit analysis to assess whether the current risk-adjusted yield spreads of
various sectors are likely to widen or narrow. The Sub-Adviser then overweights
(underweights) those sectors its analysis indicates offer the most (least)
relative value, basing the speed and magnitude of these shifts on valuation
considerations.
Security selection: Securities are selected by the portfolio manager, with
substantial input from the Sub-Adviser's fixed income analysts and traders.
Using quantitative analysis as well as traditional valuation methods, the
Sub-Adviser's applied research analysts aim to optimize security selection
within the bounds of the Portfolio's investment objective. In addition, credit
analysts -- supported by the Sub-Adviser's equity analysts -- assess the
creditworthiness of issuers and counterparties. A dedicated trading desk
contributes to security selection by tracking new issuance, monitoring dealer
inventories, and identifying attractively priced bonds. The traders also handle
all transactions for the Portfolio.
SELECT EQUITY PORTFOLIO AND LARGE CAP STOCK PORTFOLIO. The investment
objective of each Portfolio is long-term growth of capital and income.
In normal circumstances, at least 65% of each Portfolio's net assets will
be invested in equity securities consisting of common stocks and other
securities with equity characteristics comprised of preferred stock, warrants,
rights, convertible securities, trust certificates, limited partnership
interests and equity participations (collectively, "Equity Securities"). Each
Portfolio's primary equity investments are the common stock of large and medium
sized U.S. corporations and, to a limited extent, similar securities of foreign
corporations.
INVESTMENT PROCESS
Research: The Sub-Adviser's domestic equity analysts, each an industry
specialist, follow 700 predominantly large- and medium-sized U.S. companies --
500 of which form the universe for each Portfolio's investments. Their research
goal is to forecast normalized, longer term earnings and dividends for the most
attractive companies among those they cover. In doing this, they may work in
concert with the Sub-Adviser's international equity analysts in order to gain a
broader perspective for evaluating industries and companies in today's global
economy.
Valuation: The analysts' forecasts are converted into comparable expected
returns by a dividend discount model, which calculates those expected returns by
comparing a company's current stock price with the "fair value" price forecasted
by its estimated long term earnings power. Within each sector, companies are
ranked by their expected return and grouped into quintiles: those with the
highest expected returns (Quintile 1) are deemed the most undervalued relative
to their long-term earnings power, while those with the lowest expected returns
(Quintile 5) are deemed the most overvalued.
Stock Selection: A diversified portfolio is constructed using disciplined
buy and sell rules. The specific names selected reflect the portfolio manager's
judgment concerning the soundness of the underlying forecasts, the likelihood
that the perceived misevaluation will be corrected within a reasonable time
frame and the magnitude of the risks versus the rewards. Portfolio sector
weightings are held close to those of the S&P 500 Index, reflecting the
Sub-Adviser's belief that its research has the potential to add value at the
individual stock level, but not at the sector level. Sector neutrality is also
seen as a way to help protect the portfolio from macroeconomic risks, and -
together with diversification -- represents an important element of the
Sub-Adviser's risk control strategy. A dedicated trading desk handles all
transactions for the Portfolio.
SMALL CAP STOCK PORTFOLIO. This Portfolio is designed for investors who are
willing to assume the somewhat higher risk of investing in small companies in
order to seek a higher return over time than might be expected from a portfolio
of stocks of large companies. The Portfolio's investment objective is to provide
a high total return from a portfolio of Equity Securities of small companies.
The Portfolio attempts to achieve its investment objective by investing
primarily in the common stock of small U.S. companies included in the Russell
2000 Index, which is composed of 2000 common stocks of U.S. companies with
market capitalizations ranging between $100 million and $2 billion.
INVESTMENT PROCESS
Research: The Sub-Adviser's domestic equity analysts -- each an industry
specialist -- continuously monitor the small cap stocks in their respective
sectors with the aim of identifying companies that exhibit superior financial
strength and operating returns. Meetings with management and on-site visits play
a key role in shaping their assessments. Their research goal is to forecast
normalized, long-term earnings and dividends for the most attractive small cap
companies among those they monitor -- a universe that generally contains a total
of approximately 600 names. Because the Sub- Adviser's analysts follow both the
larger and smaller companies in their industries -- in essence, covering their
industries from top to bottom -- they are able to bring broad perspective to the
research they do on both.
Valuation: The analysts' forecasts are converted into comparable expected
returns by the Sub-Adviser's dividend discount model, which calculates those
returns by comparing a company's current stock price with the "fair value" price
forecasted by its estimated long-term earnings power. Within each industry,
companies are ranked by their expected returns and grouped into quintiles: those
with the highest expected returns (Quintile 1) are deemed the most undervalued
relative to their long-term earnings power, while those with the lowest expected
returns (Quintile 5) are deemed the most overvalued.
Stock Selection: A diversified portfolio is constructed using disciplined
buy and sell rules. Purchases are concentrated among the stocks in the top two
quintiles of the rankings: the specific names selected reflect the portfolio
manager's judgment concerning the soundness of the underlying forecasts, the
likelihood that the perceived misevaluation will soon be corrected and the
magnitude of the risks versus the rewards. Once a stock falls into the third
quintile because its price has risen or its fundamentals have deteriorated -- it
generally becomes a sale candidate. The portfolio manager seeks to hold sector
weightings close to those of the Russell 2000 Index, the Portfolio's benchmark,
reflecting the Sub-Adviser's belief that its research has the potential to add
value at the individual stock level, but not at the sector level. Sector
neutrality is also seen as a way to help to protect the portfolio from
macroeconomic risks, and -- together with diversification -- represents an
important element of the Sub-Adviser's investment strategy.
INTERNATIONAL EQUITY PORTFOLIO. This Portfolio is designed for investors
with a long-term investment horizon who want to diversify their portfolios by
investing in an actively managed portfolio of non-U.S. securities that seeks to
outperform the Morgan Stanley Capital International Europe, Australia and Far
East Index (the "EAFE Index"). The Portfolio's investment objective is to
provide a high total return from a portfolio of Equity Securities of foreign
corporations.
The Portfolio seeks to achieve its investment objective by investing
primarily in the Equity Securities of foreign corporations. Under normal
circumstances, the Portfolio expects to invest at least 65% of its total assets
in such securities. The Portfolio does not intend to invest in U.S. securities
(other than money market instruments), except temporarily, when extraordinary
circumstances prevailing at the same time in a significant number of developed
foreign countries render investments in such countries inadvisable.
INVESTMENT PROCESS
Country allocation: The Sub-Adviser's country allocation decision begins
with a forecast of equity risk premiums, which provide a valuation signal by
measuring the relative attractiveness of stocks versus bonds. Using a
proprietary approach, the Sub-Adviser calculates this risk premium for each of
the nations in the Portfolio's universe, determines the extent of its deviation
- -- if any -- from its historical norm, and then ranks countries according to
the size of those deviations. Countries with high (low) rankings are
overweighted (underweighted) in comparisons to the EAFE Index to reflect the
above-average (below-average) attractiveness of their stock markets. In
determining weightings, the Sub-Adviser analyzes a variety of qualitative
factors as well -- including the liquidity, earnings momentum and interest rate
climate of the market at hand. These qualitative assessments can change the
magnitude but not the direction of the country allocations called for by the
risk premium forecast. The Sub-Adviser places limits on the total size of the
Portfolio's country over- and under-weightings relative to the EAFE Index.
Stock selection: The Sub-Adviser's international equity analysts, each an
industry and country specialist, forecast normalized earnings and dividend
payouts for roughly 1,000 non-U.S. companies -- taking a long-term perspective
rather than the short time frame common to consensus estimates. These forecasts
are converted into comparable expected returns by a dividend discount model, and
then companies are ranked from most to least attractive by industry and country.
A diversified portfolio is constructed using disciplined buy and sell rules. The
portfolio manager's objective is to concentrate the purchases in the top third
of the rankings, and to keep sector weightings close to those of the EAFE Index,
the Portfolio's benchmark. Once a stock falls into the bottom third of the
rankings, it generally becomes a sales candidate. Where available, warrants and
convertibles may be purchased instead of common stock if they are deemed a more
attractive means of investing in an undervalued company.
Currency management: Currency is actively managed, in conjunction with
country and stock allocation, with the goal of protecting and possibly enhancing
the Portfolio's return. The Sub-Adviser's currency decisions are supported by a
proprietary tactical mode which forecasts currency movements based on an
analysis of four fundamental factors -- trade balance trends, purchasing power
parity, real short-term interest differentials and real bond yields -- plus a
technical factor designed to improve the timing of transactions. Combining the
output of this model with a subjective assessment of economic, political and
market factors, the Sub-Adviser's currency group recommends currency strategies
that are implemented in conjunction with the Portfolio's investment strategy.
EMERGING MARKETS EQUITY PORTFOLIO. This Portfolio is designed for investors
with a long term investment horizon who want exposure to the rapidly growing
emerging markets. The Portfolio's investment objective is to provide a high
total return from a portfolio of equity securities of companies in emerging
markets.
The Portfolio seeks to achieve its investment objective by investing
primarily in equity securities of emerging markets issuers. Under normal
circumstances, the Portfolio expects to invest at least 65% of its total assets
in such securities. The Portfolio does not intend to invest in U.S. securities
(other than money market instruments), except temporarily, when extraordinary
circumstances prevailing at the same time in a significant number of emerging
markets countries render investments in such countries inadvisable.
INVESTMENT PROCESS
Country allocation: The Sub-Adviser's country allocation decision begins
with a forecast of the expected return of each market in the Portfolio's
universe. These expected returns are calculated using a proprietary valuation
method that is forward looking in nature rather than based on historical data.
The Sub-Adviser then evaluates these expected returns from two different
perspectives: first, it identifies those countries that have high real expected
returns relative to their own history and other nations in their universe.
Second, it identifies those countries that it expects will provide high returns
relative to their currency risk. Countries that rank highly on one or both of
these scores are overweighted relative to the Portfolio's benchmark, the MSCI
Emerging Markets Free Index, while those that rank poorly are underweighted. To
help contain risk, the Sub-Adviser places limits on the total size of the
Portfolio's country over- and under-weightings.
Stock selection: The Sub-Adviser's 12 emerging market equity analysts--each
an industry specialist--monitor a universe of approximately 900 companies in
these countries, developing forecasts of earnings and cash flows for the most
attractive among them. Companies are ranked from most to least attractive based
on this research, and then a diversified portfolio is constructed using
disciplined buy and sell rules. The portfolio manager's objective is to
concentrate the Portfolio's holdings in the stocks deemed most undervalued, and
to keep sector weightings relatively close to those of the index. Stocks are
generally held until they fall into the bottom half of the Sub-Adviser's
rankings.
MONEY MARKET INSTRUMENTS
As discussed in the Prospectus, each Portfolio may invest in money market
instruments to the extent consistent with its investment objective and policies.
A description of the various types of money market instruments that may be
purchased by the Portfolios appears below. See "Quality and Diversification
Requirements."
U.S. TREASURY SECURITIES. Each of the Portfolios may invest in direct
obligations of the U.S. Treasury, including Treasury bills, notes and bonds, all
of which are backed as to principal and interest payments by the full faith and
credit of the United States.
ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. Each of the Portfolios may invest
in obligations issued or guaranteed by U.S. Government agencies or
instrumentalities. These obligations may or may not be backed by the "full faith
and credit" of the United States. In the case of securities not backed by the
full faith and credit of the United States, each Portfolio must look principally
to the federal agency issuing or guaranteeing the obligations for ultimate
repayment, and may not be able to assert a claim against the United States
itself in the event the agency or instrumentality does not meet its commitments.
Securities in which each Portfolio may invest that are not backed by the full
faith and credit of the United States include, but are not limited to,
obligations of the Tennessee Valley Authority, the Federal Home Loan Mortgage
Corporation and the U.S. Postal Service, each of which has the right to borrow
from the U.S. Treasury to meet its obligations, and obligations of the Federal
Farm Credit System and the Federal Home Loan Banks, both of whose obligations
may be satisfied only by the individual credits of each issuing agency.
Securities which are backed by the full faith and credit of the United States
include obligations of the Government National Mortgage Association, the Farmers
Home Administration, and the Export-Import Bank.
FOREIGN GOVERNMENT OBLIGATIONS. Each of the Portfolios, subject to its
applicable investment policies, may also invest in short-term obligations of
foreign sovereign governments or of their agencies, instrumentalities,
authorities or political subdivisions. These securities may be denominated in
the U.S. dollar or in another currency. See "Foreign Investments."
STRIPPED U.S. GOVERNMENT OBLIGATIONS. As described in the Prospectus and
subject to their respective investment policies, certain Portfolios may hold
stripped U.S. Treasury securities, including (1) coupons that have been stripped
from U.S. Treasury bonds, which are held through the Federal Reserve Bank's
book-entry system called "Separate Trading of Registered Interest and Principal
of Securities" ("STRIPS") or (2) through a program entitled "Coupon Under
Book-Entry Safekeeping" ("CUBES"). Certain Portfolios may also acquire U.S.
Government obligations and their unmatured interest coupons that have been
stripped by a custodian bank or investment brokerage firm. Having separated the
interest coupons from the underlying principal of the U.S. Government
obligations, the holder will resell the stripped securities in custodial receipt
programs with a number of different names, including "Treasury Income Growth
Receipts" ("TIGRS") and "Certificates of Accrual on Treasury Securities"
("CATS"). Such securities may not be as liquid as STRIPS and CUBES and are not
viewed by the staff of the SEC as U.S.
Government securities for purposes of the 1940 Act.
The stripped coupons are sold separately from the underlying principal,
which is sold at a deep discount because the buyer receives only the right to
receive a future fixed payment on the security and does not receive any rights
to periodic interest (cash) payments. Purchasers of stripped principal-only
securities acquire, in effect, discount obligations that are economically
identical to the zero coupon securities that the Treasury Department sells
itself. In the case of bearer securities (i.e., unregistered securities which
are owned ostensibly by the bearer or holder), the underlying U.S. Treasury
bonds and notes themselves are held in trust on behalf of the owners.
The U.S. Government does not issue stripped Treasury securities directly.
The STRIPS program, which is ongoing, is designed to facilitate the secondary
market in the stripping of selected U.S. Treasury notes and bonds into separate
interest and principal components. Under the program, the U.S. Treasury
continues to sell its notes and bonds through its customary auction process. A
purchaser of those specified notes and bonds who has access to a book-entry
account at a Federal Reserve bank, however, may separate the Treasury notes and
bonds into interest and principal components. The selected Treasury securities
thereafter may be maintained in the book-entry system operated by the Federal
Reserve in a manner that permits the separate trading and ownership of the
interest and principal payments.
For custodial receipts, the underlying debt obligations are held separate
from the general assets of the custodian and nominal holder of such securities,
and are not subject to any right, charge, security interest, lien or claim of
any kind in favor of or against the custodian or any person claiming through the
custodian. The custodian is also responsible for applying all payments received
on those underlying debt obligations to the related receipts or certificates
without making any deductions other than applicable tax withholding. The
custodian is required to maintain insurance for the protection of holders of
receipts or certificates in customary amounts against losses resulting from the
custody arrangement due to dishonest or fraudulent action by the custodian's
employees. The holders of receipts or certificates, as the real parties in
interest, are entitled to the rights and privileges of the underlying debt
obligations, including the right, in the event of default in payment of
principal or interest, to proceed individually against the issuer without acting
in concert with other holders of those receipts or certificates or the
custodian.
VARIABLE AND FLOATING RATE INSTRUMENTS. Subject to their respective
investment limitations, certain Portfolios may purchase variable and floating
rate obligations. The Sub-Advisers will consider the earning power, cash flows
and other liquidity ratios of the issuers and guarantors of such obligations
and, for obligations subject to a demand feature, will monitor their financial
status to meet payment on demand. In determining average weighted portfolio
maturity, a variable or floating rate instrument issued or guaranteed by the
U.S. Government, its agencies and instrumentalities, or a variable or floating
rate instrument scheduled on its face to be paid in 397 days or less, will be
deemed to have a maturity equal to the period remaining until the obligation's
next interest rate adjustment. Other variable or floating rate notes will be
deemed to have a maturity equal to the longer of the period remaining to the
next interest rate adjustment or the time the Portfolio can recover payment of
principal as specified in the instrument.
BANK OBLIGATIONS. Each of the Portfolios, unless otherwise noted in the
Prospectus or below, may invest in negotiable certificates of deposit, time
deposits and bankers' acceptances of (i) banks, savings and loan associations
and savings banks which (for those Portfolios managed by J.P. Morgan Investment
Management Inc. except the International Equity Portfolio) have more than $2
billion in total assets and are organized under the laws of the United States or
any state, (ii) foreign branches of these banks or of foreign banks of
equivalent size (Euros) and (iii) U.S. branches of foreign banks of equivalent
size (Yankees) with respect to the Portfolios managed by J.P. Morgan Investment
Management Inc. See "Foreign Investments." Bank instruments may include
Eurodollar Certificates of Deposit ("ECDs"), Yankee Certificates of Deposit
("Yankee CDs"), Eurodollar Time Deposits ("ETDs") and Canadian Time Deposits.
ECDs are issued by foreign branches of U.S. or foreign banks. Yankee CDs are
U.S. dollar-denominated certificates of deposit issued by U.S. branches of
foreign banks and held in the United States. ETDs are U.S. dollar- denominated
deposits in foreign branches of U.S. or foreign banks. Canadian Time Deposits
are U.S. dollar-denominated deposits issued by branches of major Canadian banks
located in the United States. The Portfolios will not invest in obligations for
which J.P. Morgan Investment Management Inc., or any of its affiliated persons,
is the ultimate obligor or accepting bank. Each of the Portfolios may also
invest in obligations of international banking institutions designated or
supported by national governments to promote economic reconstruction,
development or trade between nations (e.g., the European Investment Bank, the
Inter-American Development Bank, or the World Bank).
COMMERCIAL PAPER. Each of the Portfolios may invest in commercial paper,
including master demand obligations. Master demand obligations are obligations
that provide for a periodic adjustment in the interest rate paid and permit
daily changes in the amount borrowed. The monies loaned to the borrower come
from accounts managed by a Sub-Adviser or its affiliates, pursuant to
arrangements with such accounts. Interest and principal payments are credited to
such accounts. The Sub- Adviser, or its affiliates, acting as a fiduciary on
behalf of its clients, has the right to increase or decrease the amount provided
to the borrower under an obligation. The borrower has the right to pay without
penalty all or any part of the principal amount then outstanding on an
obligation together with interest to the date of payment. Since these
obligations typically provide that the interest rate is tied to the Federal
Reserve commercial paper composite rate, the rate on master demand obligations
is subject to change. Repayment of a master demand obligation to participating
accounts depends on the ability of the borrower to pay the accrued interest and
principal of the obligations on demand which is continuously monitored by the
Sub- Adviser. Since master demand obligations typically are not rated by credit
rating agencies, the Portfolios may invest in such unrated obligations only if
at the time of an investment the obligation is determined by the Sub-Adviser to
have a credit quality which satisfies the Portfolio's quality restrictions. See
"Quality and Diversification Requirements." Although there is no secondary
market for master demand obligations, such obligations are considered by the
Portfolios to be liquid because they are payable upon demand. The Portfolios do
not have any specific percentage limitation on investments in master demand
obligations.
REPURCHASE AGREEMENTS. Each of the Portfolios may enter into repurchase
agreements with brokers, dealers or banks that meet the credit guidelines
approved by the Trustees of the Trust. In a repurchase agreement, a Portfolio
buys a security from a seller that has agreed to repurchase the same security at
a mutually agreed upon date and price. The resale price normally is in excess of
the purchase price, reflecting an agreed upon interest rate. This interest rate
is effective for the period of time the Portfolio is invested in the agreement
and is not related to the coupon rate on the underlying security. A repurchase
agreement may also be viewed as a fully collateralized loan of money by a
Portfolio to the seller. The period of these repurchase agreements will usually
be short, from overnight to one week, and at no time will the Portfolios invest
in repurchase agreements for more than thirteen months. The securities which are
subject to repurchase agreements, however, may have maturity dates in excess of
thirteen months from the effective date of the repurchase agreement. The
Portfolios will always receive securities as collateral whose market value is,
and during the entire term of the agreement remains, at least equal to 100% of
the dollar amount invested by the Portfolios in each agreement plus accrued
interest, and the Portfolios will make payment for such securities only upon
physical delivery or upon evidence of book entry transfer to the account of the
Custodian. If the seller defaults, a Portfolio might incur a loss if the value
of the collateral securing the repurchase agreement declines and might incur
disposition costs in connection with liquidating the collateral. In addition, if
bankruptcy proceedings are commenced with respect to the seller of the security,
realization upon disposal of the collateral by a Portfolio may be delayed or
limited.
Each of the Portfolios may make investments in other debt securities with
remaining effective maturities of not more than thirteen months, including
without limitation corporate and foreign bonds, asset-backed securities and
other obligations described in the prospectus or this Statement of Additional
Information.
CORPORATE BONDS AND OTHER DEBT SECURITIES
As discussed in the Prospectus, certain of the Portfolios may invest in
bonds and other debt securities of domestic and foreign issuers to the extent
consistent with their investment objectives and policies. A description of these
investments appears in the prospectus and below. See "Quality and
Diversification Requirements." For information on short-term investments in
these securities, see "Money Market Instruments."
ASSET-BACKED SECURITIES. Asset-backed securities directly or indirectly
represent a participation interest in, or are secured by and payable from, a
stream of payments generated by particular assets such as motor vehicle or
credit card receivables. Payments of principal and interest may be guaranteed up
to certain amounts and for a certain time period by a letter of credit issued by
a financial institution unaffiliated with the entities issuing the securities.
The asset-backed securities in which a Portfolio may invest are subject to the
Portfolio's overall credit requirements. However, asset-backed securities, in
general, are subject to certain risks. Most of these risks are related to
limited interests in applicable collateral. For example, credit card debt
receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
give such debtors the right to set off certain amounts on credit card debt
thereby reducing the balance due. Additionally, if the letter of credit is
exhausted, holders of asset-backed securities may also experience delays in
payments or losses if the full amounts due on underlying sales contracts are not
realized. Because asset- backed securities are relatively new, the market
experience in these securities is limited and the market's ability to sustain
liquidity through all phases of the market cycle has not been tested.
COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS).
Certain Portfolios may invest in CMOs. Privately issued CMOs generally represent
an ownership interest in a pool of federal agency mortgage pass-through
securities, such as those issued by the Government National Mortgage
Association. The terms and characteristics of the mortgage instruments may vary
among pass- through mortgage loan pools. The market for such CMOs has expanded
considerably since its inception. The size of the primary issuance market and
the active participation in the secondary market by securities dealers and other
investors make government-related pools highly liquid.
Generally speaking, the mortgages underlying mortgage-backed securities often
may be prepaid without penalty or premium. Therefore, mortgage-backed securities
are generally subject to higher prepayment risks than most other types of debt
instruments. Prepayment risks on mortgage securities tend to increase during
periods of declining mortgage interest rates, because many borrowers refinance
their mortgages to take advantage of the more favorable rates. Depending upon
market conditions, the yield that a Portfolio receives from the reinvestment of
such prepayments, or any scheduled principal payments, may be lower than the
yield on the original mortgage security. As a consequence, mortgage securities
may be a less effective means of "locking in" interest rates than other types of
debt securities having the same stated maturity and may also have less potential
for capital appreciation. For certain types of asset pools, such as
collateralized mortgage obligations, prepayments may be allocated to one tranche
of securities ahead of other tranches, in order to reduce the risk of
prepayments for the other tranches. Prepayments may result in a capital loss to
a Portfolio to the extent that the prepaid mortgage securities were purchased at
a market premium over their stated principal amount. Conversely, the prepayment
of mortgage securities purchased at a market discount from their stated
principal amount will accelerate the recognition of interest income by a
Portfolio, which would be taxed as ordinary income when distributed to the
shareholders.
EQUITY INVESTMENTS
As discussed in the prospectus, certain of the Portfolios invest primarily
in Equity Securities. The Equity Securities in which these Portfolios invest
include those listed on any domestic or foreign securities exchange or traded in
the over-the-counter market as well as certain restricted or unlisted
securities. A discussion of the various types of equity investments which may be
purchased by these Portfolios appears in the prospectus and below. See "Quality
and Diversification Requirements."
The Equity Securities in which these Portfolios may invest may or may not
pay dividends and may or may not carry voting rights. Common stock occupies the
most junior position in a company's capital structure.
The convertible securities in which these Portfolios may invest include any
debt securities or preferred stock which may be converted into common stock or
which carry the right to purchase common stock. Convertible securities entitle
the holder to exchange the securities for a specified number of shares of common
stock, usually of the same company, at specified prices within a certain period
of time.
The terms of any convertible security determine its ranking in a company's
capital structure. In the case of subordinated convertible debentures, the
holders' claims on assets and earnings are subordinated to the claims of other
creditors, and are senior to the claims of preferred and common shareholders. In
the case of convertible preferred stock, the holders' claims on assets and
earnings are subordinated to the claims of all creditors and are senior to the
claims of common shareholders.
RIGHTS AND WARRANTS
Certain of the Portfolios may participate in rights offerings and purchase
warrants, which are privileges issued by corporations enabling the owners to
subscribe to and purchase a specified number of shares of the corporation at a
specified price during a specified period of time. Subscription rights normally
have a short life span to expiration. Warrants may have a life ranging from less
than a year to twenty years or may be perpetual. However, most warrants have
expiration dates after which they are worthless. The purchase of rights or
warrants involves the risk that the Portfolio could lose the purchase value of a
right or warrant if the right to subscribe to additional shares is not exercised
prior to the rights' or warrants' expiration. Also, the purchase of rights or
warrants involves the risk that the effective price paid for the right or
warrant added to the subscription price of the related security may exceed the
value of the subscribed security's market price such as when there is no
movement in the level of the underlying security.
FOREIGN INVESTMENTS
Each of the Portfolios may invest in foreign securities. The International
Equity Portfolio and the Emerging Markets Equity Portfolio make substantial
investments in foreign countries. The Quality Bond, Select Equity, Large Cap
Stock and Small Cap Stock Portfolios may invest in certain foreign securities.
The Quality Bond Portfolio may invest in U.S. and non-U.S. dollar-denominated
fixed income securities of foreign issuers including in countries with emerging
economies or securities markets. The Select Equity and Large Cap Stock
Portfolios may invest in equity securities of foreign corporations listed on a
U.S. securities exchange. The Small Cap Stock Portfolio may invest in equity
securities of foreign issuers that are listed on a national securities exchange
or denominated or principally traded in the U.S. dollar. The Quality Bond
Portfolio, Select Equity Portfolio, Large Cap Stock Portfolio and the Small Cap
Stock Portfolio do not expect to invest more than 25%, 5%, 5%, and 5%,
respectively, of their total assets at the time of purchase in securities of
foreign issuers. In the case of the Quality Bond Portfolio, any foreign
commercial paper must not be subject to foreign withholding tax at the time of
purchase. Foreign investments may be made directly in securities of foreign
issuers or in the form of American Depositary Receipts ("ADRs") and European
Depositary Receipts ("EDRs"). (See "ADRs and EDRs", below.) Foreign investments
may also include ECDs, ETDs, Yankee CDs, Canadian Commercial Paper and
Europaper.
Since investments in foreign securities may involve foreign currencies, the
value of a Portfolio's assets as measured in U.S. dollars may be affected
favorably or unfavorably by changes in currency rates and in exchange control
regulations, including currency blockage. Certain of the Portfolios may enter
into forward commitments for the purchase or sale of foreign currencies in
connection with the settlement of foreign securities transactions or to manage
the Portfolios' currency exposure related to foreign investments.
Different risks may exist for ECDs, ETDs and Yankee CDs because the banks
issuing these instruments, or their domestic or foreign branches, are not
necessarily subject to the same regulatory requirements that apply to domestic
banks, such as reserve requirements, loan limitations, examinations, accounting,
auditing, and recordkeeping, and the public availability of information.
BRADY BONDS
Certain Portfolios may invest in Brady bonds, which are securities created
through the exchange of existing commercial bank loans to public and private
entities in certain emerging markets for new bonds in connection with debt
restructurings. Brady bonds have been issued since 1989 and do not have a long
payment history. In light of the history of defaults of countries issuing Brady
bonds on their commercial bank loans, investments in Brady bonds may be viewed
as speculative. Brady bonds may be fully or partially collateralized or
uncollateralized, are issued in various currencies (but primarily the dollar)
and are actively traded in over-the-counter secondary markets. Incomplete
collateralization of interest or principal payment obligations results in
increased credit risk. Dollar-denominated collateralized Brady bonds, which may
be fixed-rate bonds or floating-rate bonds, are generally collateralized by U.S.
Treasury zero coupon bonds having the same maturity as the Brady bonds.
INVESTING IN EMERGING MARKETS
Certain Portfolios may invest in countries with emerging economies or securities
markets. Political and economic structures in many of such countries may be
undergoing significant evolution and rapid development, and such countries may
lack the social, political and economic stability characteristic of more
developed countries. Certain of such countries may have in the past failed to
recognize private property rights and have at times nationalized or expropriated
the assets of private companies. As a result, the risks described above,
including the risks of nationalization or expropriation of assets, may be
heightened. In addition, unanticipated political or social developments may
affect the values of a Portfolio's investments in those countries and the
availability to a Portfolio of additional investments in those countries. The
small size and inexperience of the securities markets in certain of such
countries and the limited volume of trading in securities in those countries may
make a Portfolio's investments in such countries illiquid and more volatile than
investments in more developed countries, and a Portfolio may be required to
establish special custodial or other arrangements before making certain
investments in those countries. There may be little financial or accounting
information available with respect to issuers located in certain of such
countries, and it may be difficult as a result to assess the value or prospects
of an investment in such issuers.
Transaction costs in emerging markets may be higher than in the United States
and other developed securities markets. As legal systems in emerging markets
develop, foreign investors may be adversely affected by new or amended laws and
regulations or may not be able to obtain swift and equitable enforcement of
existing law.
Certain Portfolios may make investments denominated in emerging markets
currencies. Some countries in emerging markets also may have managed currencies,
which are not free floating against the U.S. dollar. In addition, emerging
markets are subject to the risk of restrictions upon the free conversion of
their currencies into other currencies. Any devaluations relative to the U.S.
dollar in the currencies in which the Portfolio's securities are quoted would
reduce the Portfolio's net asset value.
RESTRICTIONS ON INVESTMENT AND REPATRIATION
Certain emerging markets limit, or require governmental approval prior to,
investments by foreign persons. Repatriation of investment income and capital
from certain emerging markets is subject to certain governmental consents. Even
where there is no outright restriction on repatriation of capital, the mechanics
of repatriation may affect the operation of a Portfolio.
CONVERSION TO THE EURO
Like other mutual funds, the Trust could be affected by problems relating to the
conversion of European currencies into the Euro, which extends from 1/1/99 to
7/1/02.
The Trust is taking steps to ensure that the systems used by the Trust's major
service providers are compliant with Euro issues.
At the same time, it is impossible to know whether the ongoing conversion, which
could disrupt Trust operations and investments if problems arise, has been
adequately addressed until the conversion is complete.
ADRS AND EDRS
Certain Portfolios may invest their assets in securities such as ADRs and
EDRs, which are receipts issued by a U.S. bank or trust company evidencing
ownership of underlying securities issued by a foreign issuer. ADRs and EDRs may
be listed on a national securities exchange or may trade in the over-the-counter
market. ADR and EDR prices are denominated in U.S. dollars, even though the
underlying security may be denominated in a foreign currency. The underlying
security may be subject to foreign government taxes which would reduce the yield
on such securities. Investments in such instruments involve risks similar to
those of investing directly in foreign securities. Such risks include political
or economic instability of the issuer or the country of issue, the difficulty of
predicting international trade patterns and the possibility of imposition of
exchange controls. Such securities may also be subject to greater fluctuations
in price than securities of domestic corporations. In addition, there may be
less publicly available information about a foreign company than about a
domestic company. Foreign companies generally are not subject to uniform
accounting, auditing and financial reporting standards comparable to those
applicable to domestic companies. With respect to certain foreign countries,
there is a possibility of expropriation or confiscatory taxation, or diplomatic
developments which could affect investment in those countries.
ADDITIONAL INVESTMENTS
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each of the Portfolios may
purchase securities on a when-issued or delayed delivery basis. For example,
delivery of and payment for these securities can take place a month or more
after the date of the purchase commitment. The purchase price and the interest
rate payable, if any, on the securities are fixed on the purchase commitment
date or at the time the settlement date is fixed. The value of such securities
is subject to market fluctuation and no interest accrues to a Portfolio until
settlement takes place. At the time a Portfolio makes the commitment to purchase
securities on a when-issued or delayed delivery basis, it will record the
transaction, reflect the value each day of such securities in determining its
net asset value and, if applicable, calculate the maturity for the purposes of
average maturity from that date. At the time of settlement a when-issued
security may be valued at less than the purchase price. To facilitate such
acquisitions, each Portfolio will maintain on the Trust's records a segregated
account with liquid assets, consisting of cash, U.S. Government securities or
other appropriate securities, in an amount at least equal to such commitments.
On delivery dates for such transactions, each Portfolio will meet its
obligations from maturities or sales of the securities held in the segregated
account and/or from cash flow. If a Portfolio chooses to dispose of the right to
acquire a when-issued security prior to its acquisition, it could, as with the
disposition of any other portfolio obligation, incur a gain or loss due to
market fluctuation. It is the current policy of each Portfolio not to enter into
when-issued commitments exceeding in the aggregate 15% (except for the Quality
Bond Portfolio) of the market value of the Portfolio's total assets, less
liabilities other than the obligations created by when-issued commitments. There
is no current policy limiting the percentage of assets of the Quality Bond
Portfolio which may be invested in when-issued commitments.
SECURITIES OF OTHER INVESTMENT COMPANIES. Securities of other investment
companies may be acquired by each of the Portfolios to the extent permitted
under the Investment Company Act of 1940, as amended ("1940 Act"). These limits
require that, as determined immediately after a purchase is made, (i) not more
than 5% of the value of a Portfolio's total assets will be invested in the
securities of any one investment company, (ii) not more than 10% of the value of
its total assets will be invested in the aggregate in securities of investment
companies as a group, and (iii) not more than 3% of the outstanding voting stock
of any one investment company will be owned by a Portfolio.
REVERSE REPURCHASE AGREEMENTS. Each of the Portfolios may enter into
reverse repurchase agreements. In a reverse repurchase agreement, a Portfolio
sells a security and agrees to repurchase the same security at a mutually agreed
upon date and price. For purposes of the 1940 Act it is also considered as a
borrowing of money by the Portfolio and, therefore, a form of leverage. The
Portfolios will invest the proceeds of borrowings under reverse repurchase
agreements. In addition, a Portfolio will enter into a reverse repurchase
agreement only when the interest income to be earned from the investment of the
proceeds is greater than the interest expense of the transaction. A Portfolio
will not invest the proceeds of a reverse repurchase agreement for a period
which exceeds the duration of the reverse repurchase agreement. A Portfolio may
not enter into reverse repurchase agreements exceeding in the aggregate
one-third of the market value of its total assets, less liabilities other than
the obligations created by reverse repurchase agreements. Each Portfolio will
establish and maintain on the Trust's records a separate account with a
segregated portfolio of securities in an amount at least equal to its purchase
obligations under its reverse repurchase agreements.
MORTGAGE DOLLAR ROLL TRANSACTIONS. Certain of the Portfolios of the Trust
may engage in mortgage dollar roll transactions with respect to mortgage
securities issued by the Government National Mortgage Association, the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation. In
a mortgage dollar roll transaction, the Portfolio sells a mortgage backed
security and simultaneously agrees to repurchase a similar security on a
specified future date at an agreed upon price. During the roll period, the
Portfolio will not be entitled to receive any interest or principal paid on the
securities sold. The Portfolio is compensated for the lost interest on the
securities sold by the difference between the sales price and the lower price
for the future repurchase as well as by the interest earned on the reinvestment
of the sales proceeds. The Portfolio may also be compensated by receipt of a
commitment fee. When the Portfolio enters into a mortgage dollar roll
transaction, liquid assets in an amount sufficient to pay for the future
repurchase are segregated with the Custodian. Mortgage dollar roll transactions
are considered reverse repurchase agreements for purposes of the Portfolio's
investment restrictions.
LOANS OF PORTFOLIO SECURITIES. Each of the Portfolios may lend its
securities if such loans are secured continuously by cash or equivalent
collateral or by a letter of credit in favor of the Portfolio at least equal at
all times to 100% of the market value of the securities loaned, plus accrued
interest. While such securities are on loan, the borrower will pay the Portfolio
any income accruing thereon. Loans will be subject to termination by the
Portfolios in the normal settlement time, generally five business days after
notice, or by the borrower on one day's notice. Borrowed securities must be
returned when the loan is terminated. Any gain or loss in the market price of
the borrowed securities which occurs during the term of the loan inures to a
Portfolio and its respective investors. The Portfolios may pay reasonable
finders' and custodial fees in connection with a loan. In addition, a Portfolio
will consider all facts and circumstances including the creditworthiness of the
borrowing financial institution, and no Portfolio will make any loans in excess
of one year.
PRIVATELY PLACED AND CERTAIN UNREGISTERED SECURITIES. The Portfolios may
invest in privately placed, restricted, Rule 144A or other unregistered
securities as described in the Prospectus.
As to illiquid investments, a Portfolio is subject to a risk that should
the Portfolio decide to sell them when a ready buyer is not available at a price
the Portfolio deems representative of their value, the value of the Portfolio's
net assets could be adversely affected. Where an illiquid security must be
registered under the Securities Act of 1933, as amended (the "1933 Act") before
it may be sold, a Portfolio may be obligated to pay all or part of the
registration expenses, and a considerable period may elapse between the time of
the decision to sell and the time the Portfolio may be permitted to sell a
security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, a Portfolio might obtain a less
favorable price than prevailed when it decided to sell.
REAL ESTATE INVESTMENT TRUSTS
Certain Portfolios may purchase interests in real estate investment trusts.
Risks associated with real estate investments include the fact that equity and
mortgage real estate investment trusts are dependent upon management skill and
are not diversified, and are, therefore, subject to the risk of financing single
projects or unlimited number of projects. They are also subject to heavy cash
flow dependency, defaults by borrowers, and self-liquidation. Additionally,
equity real estate investment trusts may be affected by any changes in the value
of the underlying property owned by the trusts, and mortgage real estate
investment trusts may be affected by the quality of any credit extended. These
risks may be mitigated by selecting real estate investment trusts diversified by
sector (shopping malls, apartment building complexes, and health care
facilities) and geographic location.
QUALITY AND DIVERSIFICATION REQUIREMENTS
Each of the Portfolios intends to meet the diversification requirements of
the 1940 Act. To meet these requirements, 75% of the assets of these Portfolios
is subject to the following fundamental limitations: (1) the Portfolio may not
invest more than 5% of its total assets in the securities of any one issuer,
except obligations of the U.S. Government, its agencies and instrumentalities,
and (2) the Portfolio may not own more than 10% of the outstanding voting
securities of any one issuer. As for the other 25% of the Portfolio's assets not
subject to the limitation described above, there is no limitation on investment
of these assets under the 1940 Act, so that all of such assets may be invested
in securities of any one issuer, subject to the limitation of any applicable
state securities laws. Investments not subject to the limitations described
above could involve an increased risk to a Portfolio should an issuer, or a
state or its related entities, be unable to make interest or principal payments
or should the market value of such securities decline.
QUALITY BOND PORTFOLIO. The Quality Bond Portfolio invests principally in a
diversified portfolio of "high grade" and "investment grade" securities.
Investment grade debt is rated, on the date of investment, within the four
highest ratings of Moody's, currently Aaa, Aa, A and Baa, or of Standard &
Poor's, currently AAA, AA, A and BBB, while high grade debt is rated, on the
date of the investment, within the two highest of such ratings. The Quality Bond
Portfolio may also invest up to 5% of its total assets in securities which are
"below investment grade." Such securities must be rated, on the date of
investment, Ba by Moody's or BB by Standard & Poor's. The Portfolio may invest
in debt securities which are not rated or other debt securities to which these
ratings are not applicable, if in the opinion of the Sub-Adviser, such
securities are of comparable quality to the rated securities discussed above. In
addition, at the time the Portfolio invests in any commercial paper, bank
obligation or repurchase agreement, the issuer must have outstanding debt rated
A or higher by Moody's or Standard & Poor's, the issuer's parent corporation, if
any, must have outstanding commercial paper rated Prime-1 by Moody's or A-1 by
Standard & Poor's, or if no such ratings are available, the investment must be
of comparable quality in the Sub-Adviser's opinion.
CONVERTIBLE AND OTHER DEBT SECURITIES. Certain of the Portfolios may invest
in convertible debt securities, for which there are no specific quality
requirements. In addition, at the time a Portfolio invests in any commercial
paper, bank obligation or repurchase agreement, the issuer must have outstanding
debt rated A or higher by Moody's or Standard & Poor's, the issuer's parent
corporation, if any, must have outstanding commercial paper rated Prime-1 by
Moody's or A-1 by Standard & Poor's, or if no such ratings are available, the
investment must be of comparable quality in the Sub-Adviser's opinion. At the
time the Portfolio invests in any other short-term debt securities, they must
berated A or higher by Moody's or Standard & Poor's, or if unrated, the
investment must be of comparable quality in the Sub-Adviser's opinion.
In determining suitability of investment in a particular unrated security,
the Sub- Adviser takes into consideration asset and debt service coverage, the
purpose of the financing, history of the issuer, existence of other rated
securities of the issuer, and other relevant conditions, such as comparability
to other issuers.
GNMA CERTIFICATES
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION. The Government National Mortgage
Association is a wholly-owned corporate instrumentality of the United States
within the U.S. Department of Housing and Urban Development. GNMA's principal
programs involve its guarantees of privately issued securities backed by pools
of mortgages.
NATURE OF GNMA CERTIFICATES. GNMA Certificates are mortgage-backed
securities. The Certificates evidence part ownership of a pool of mortgage
loans. The Certificates which a Portfolio purchases are of the modified
pass-through type. Modified pass-through Certificates entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
fees paid to the GNMA Certificate issuer and GNMA, regardless of whether or not
the mortgagor actually makes the payment.
GNMA Certificates are backed by mortgages and, unlike most bonds, their
principal amount is paid back by the borrower over the length of the loan rather
than in a lump sum at maturity. Principal payments received by the Portfolio
will be reinvested in additional GNMA Certificates or in other permissible
investments.
GNMA GUARANTEE. The National Housing Act authorizes GNMA to guarantee the
timely payment of principal of and interest on securities backed by a pool of
mortgages insured by the Federal Housing Administration or the Farmers Home
Administration or guaranteed by the Veterans Administration. The GNMA guarantee
is backed by the full faith and credit of the United States. GNMA is also
empowered to borrow without limitation from the U.S. Treasury if necessary to
make any payments required under its guarantee. The net asset value and return
of the Portfolio will, however, fluctuate depending on market conditions and
other factors.
LIFE OF GNMA CERTIFICATES. The average life of a GNMA Certificate is likely
to be substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by mortgagors and mortgage
foreclosures will result in the return of a portion of principal invested before
the maturity of the mortgages in the pool.
As prepayment rates of individual mortgage pools will vary widely, it is
not possible to predict accurately the average life of a particular issue of
GNMA Certificates. However, statistics published by the Federal Housing
Administration are normally used as an indicator of the expected average life of
GNMA Certificates.
YIELD CHARACTERISTICS OF GNMA CERTIFICATES. The coupon rate of interest of
GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or
FHA- insured mortgages underlying the Certificates, but only by the amount of
the fees paid to GNMA and the GNMA Certificate issuer.
The coupon rate by itself, however, does not indicate the yield which will
be earned on the Certificates for the following reasons:
1. Certificates are usually issued at a premium or discount, rather than
at par.
2. After issuance, Certificates usually trade in the secondary market at
a premium or discount.
3. Interest is paid monthly rather than semi-annually as is the case for
traditional bonds. Monthly compounding has the effect of raising the
effective yield earned on GNMA Certificates.
4. The actual yield of each GNMA Certificate is influenced by the
prepayment experience of the mortgage pool underlying the Certificate.
If mortgagors prepay their mortgages, the principal returned to
Certificate holders may be reinvested at higher or lower rates.
MARKET FOR GNMA CERTIFICATES. Since the inception of the GNMA mortgage-
backed securities program in 1970, the amount of GNMA Certificates outstanding
has grown rapidly. The size of the market and the active participation in the
secondary market by securities dealers and many types of investors make GNMA
Certificates highly liquid instruments. Quotes for GNMA Certificates are readily
available from securities dealers and depend on, among other things, the level
of market rates, the Certificate's coupon rate and the prepayment experience of
the pool of mortgages backing each Certificate.
FNMA AND FHLMC CERTIFICATES. Mortgage-backed securities issued by the
Federal National Mortgage Association ("FNMA") include FNMA Guaranteed Mortgage
Pass-through Certificates (also known as "Fannie Maes") which are solely the
obligations of the FNMA and are not backed by or entitled to the full faith and
credit of the United States, but are supported by the right of the issuer to
borrow from the Treasury. FNMA is a government-sponsored organization owned
entirely by private stockholders. Fannie Maes are guaranteed as to timely
payment of the principal and interest by FNMA. Mortgage-backed securities issued
by the Federal Home Loan Mortgage Corporation ("FHLMC") include FHLMC Mortgage
Participation Certificates (also known as "Freddie Macs" or "PCs"). FHLMC is a
corporate instrumentality of the United States, created pursuant to an Act of
Congress, which is owned entirely by Federal Home Loan Banks. Freddie Macs are
not guaranteed by the United States or by any Federal Home Loan Bank. Freddie
Macs entitle the holder to timely payment of interest, which is guaranteed by
the FHLMC. FHLMC guarantees either ultimate collection or timely payment of all
principal payments on the underlying mortgage loans. When FHLMC does not
guarantee timely payment of principal, FHLMC may remit the amount due on account
of its guarantee of ultimate payment of principal at any time after default on
an underlying mortgage, but in no event later than one year after it becomes
payable.
LOWER GRADE SECURITIES
Certain of the Portfolios may invest in lower-grade income securities. (The
Bond Debenture Portfolio may invest a substantial portion of its assets in
medium and lower grade corporate debt securities entailing certain risks.) Such
lower grade securities are rated BB or B by S&P or Ba or B by Moody's and are
commonly referred to as "junk bonds." Investment in such securities involves
special risks, as described herein. Liquidity relates to the ability of the
Portfolio to sell a security in a timely manner at a price which reflects the
value of that security. As discussed below, the market for lower grade
securities is considered generally to be less liquid than the market for
investment grade securities. The relative illiquidity of some of the Portfolio's
portfolio securities may adversely affect the ability of the Portfolio to
dispose of such securities in a timely manner and at a price which reflects the
value of such security in the Sub-Adviser's judgment. The market for less liquid
securities tends to be more volatile than the market for more liquid securities
and market values of relatively illiquid securities may be more susceptible to
change as a result of adverse publicity and investor perceptions than are the
market values of higher grade, more liquid securities.
The Portfolio's net asset value will change with changes in the value of
its portfolio securities. Because the Portfolio will invest in fixed income
securities, the Portfolio's net asset value can be expected to change as general
levels of interest rates fluctuate. When interest rates decline, the value of a
portfolio invested in fixed income securities can be expected to rise.
Conversely, when interest rates rise, the value of a portfolio invested in fixed
income securities can be expected to decline. Net asset value and market value
may be volatile due to the Portfolio's investment in lower grade and less liquid
securities. Volatility may be greater during periods of general economic
uncertainty.
The Portfolio's investments are valued pursuant to guidelines adopted and
periodically reviewed by the Board of Trustees. To the extent that there is no
established retail market for some of the securities in which the Portfolio may
invest, during periods of reduced market liquidity and in the absence of readily
available market quotations for securities held in the Portfolio's portfolio,
the valuation of such securities becomes more difficult and judgment may play a
greater role in the valuation of the Portfolio's securities due to the reduced
availability of reliable objective data. To the extent that the Portfolio
invests in illiquid securities and securities which are restricted as to resale,
the Portfolio may incur additional risks and costs. Illiquid and certain
restricted securities are particularly difficult to dispose of.
Lower grade securities generally involve greater credit risk than higher
grade securities. A general economic downturn or a significant increase in
interest rates could severely disrupt the market for lower grade securities and
adversely affect the market value of such securities. In addition, in such
circumstances, the ability of issuers of lower grade securities to repay
principal and to pay interest, to meet projected financial goals and to obtain
additional financing may be adversely affected. Such consequences could lead to
an increased incidence of default for such securities and adversely affect the
value of the lower grade securities in the Portfolio's portfolio and thus the
Portfolio's net asset value. The secondary market prices of lower grade
securities are less sensitive to changes in interest rates than are those for
higher rated securities, but are more sensitive to adverse economic changes or
individual issuer developments. Adverse publicity and investor perceptions,
whether or not based on rational analysis, may also affect the value and
liquidity of lower grade securities.
Yields on the Portfolio's portfolio securities can be expected to fluctuate
over time. In addition, periods of economic uncertainty and changes in interest
rates can be expected to result in increased volatility of the market prices of
the lower grade securities in the Portfolio's portfolio and thus in the net
asset value of the Portfolio. Net asset value and market value may be volatile
due to the Portfolio's investment in lower grade and less liquid securities.
Volatility may be greater during periods of general economic uncertainty. The
Portfolio may incur additional expenses to the extent it is required to seek
recovery upon a default in the payment of interest or a repayment of principal
on its portfolio holdings, and the Portfolio may be unable to obtain full
recovery thereof. In the event that an issuer of securities held by the
Portfolio experiences difficulties in the timely payment of principal or
interest and such issuer seeks to restructure the terms of its borrowings, the
Portfolio may incur additional expenses and may determine to invest additional
capital with respect to such issuer or the project or projects to which the
Portfolio's portfolio securities relate.
A Portfolio will rely on the Sub-Adviser's judgment, analysis and
experience in evaluating the creditworthiness of an issue. In this evaluation,
the Sub-Adviser will take into consideration, among other things, the issuer's
financial resources, its sensitivity to economic conditions and trends, its
operating history, the quality of the issuer's management and regulatory
matters. The Sub-Adviser also may consider, although it does not rely primarily
on, the credit ratings of S&P and Moody's in evaluating fixed-income securities.
Such ratings evaluate only the safety of principal and interest payments, not
market value risk. Additionally, because the creditworthiness of an issuer may
change more rapidly than is able to be timely reflected in changes in credit
ratings, the Sub-Adviser continuously monitors the issuers of such securities
held in the Portfolio's portfolio. The Portfolio may, if deemed appropriate by
the Sub-Adviser, retain a security whose rating has been downgraded below B by
S&P or below B by Moody's, or whose rating has been withdrawn.
With respect to Portfolios which may invest in these unrated income
securities, achievement by the Portfolio of its investment objective may be more
dependent upon the Sub-Adviser's investment analysis than would be the case if
the Portfolio were investing exclusively in rated securities.
STRATEGIC TRANSACTIONS
As described in the Prospectus, certain Portfolios of the Trust may, but
are not required to, utilize various other investment strategies as described
below to hedge various market risks (such as interest rates, currency exchange
rates and broad or specific market movements) or to manage the effective
maturity or duration of a Portfolio's income securities. Such strategies are
generally accepted by modern portfolio managers and are regularly utilized by
many mutual funds and other institutional investors. Techniques and instruments
may change over time as new instruments and strategies are developed or
regulatory changes occur.
In the course of pursuing these investment strategies, a Portfolio may
purchase and sell exchange-listed and over-the-counter put and call options on
securities, equity and income indices and other financial instruments, purchase
and sell financial futures contracts and options thereon, enter into various
interest rate transactions such as swaps, caps, floors or collars and enter into
various currency transactions such as currency forward contracts, currency
futures contracts, currency swaps or options on currencies or currency futures
(collectively, all the above are called "Strategic Transactions" or
"Derivatives"). Strategic Transactions are hedging transactions which may be
used to attempt to protect against possible changes in the market value of
securities held in or to be purchased for a Portfolio's portfolio resulting from
securities markets or exchange rate fluctuations, to protect a Portfolio's
unrealized gains in the value of its portfolio securities, to facilitate the
sale of such securities for investment purposes, to manage the effective
maturity or duration of a Portfolio's portfolio, or to establish a position in
the derivatives markets as a temporary substitute for purchasing or selling
particular securities.
Any or all of these investment techniques may be used at any time and there
is no particular strategy that dictates the use of one technique rather than
another, as use of any Strategic Transaction is a function of numerous variables
including market conditions. The ability of a Portfolio to utilize these
Strategic Transactions successfully will depend on the Sub-Adviser's ability to
predict pertinent market movements, which cannot be assured. A Portfolio will
comply with applicable regulatory requirements when implementing these
strategies, techniques and instruments.
Strategic Transactions have risks associated with them including possible
default by the other party to the transaction, illiquidity and, to the extent
the Sub- Adviser's view as to certain market movements is incorrect, the risk
that the use of such Strategic Transactions could result in losses greater than
if they had not been used. Use of put and call options may result in losses to a
Portfolio, force the sale or purchase of portfolio securities at inopportune
times or for prices other than current market values, limit the amount of
appreciation a Portfolio can realize on its investments or cause a Portfolio to
hold a security it might otherwise sell. The use of currency transactions can
result in a Portfolio incurring losses as a result of a number of factors
including the imposition of exchange controls, suspension of settlements or the
inability to deliver or receive a specified currency. The use of options and
futures transactions entails certain other risks. In particular, the variable
degree of correlation between price movements of futures contracts and price
movements in the related portfolio position of a Portfolio creates the
possibility that losses on the hedging instrument may be greater than gains in
the value of a Portfolio's position. In addition, futures and options markets
may not be liquid in all circumstances and certain over-the-counter options may
have no markets. As a result, in certain markets, a Portfolio might not be able
to close out a transaction without incurring substantial losses, if at all.
Although the use of futures and options transactions for hedging should
tend to minimize the risk of loss due to a decline in the value of the hedged
position, at the same time they tend to limit any potential gain which might
result from an increase in value of such position. Finally, the daily variation
margin requirements for futures contracts would create a greater ongoing
potential financial risk than would purchases of options, where the exposure is
limited to the cost of the initial premium. Losses resulting from the use of
Strategic Transactions would reduce net asset value, and possibly income, and
such losses can be greater than if the Strategic Transactions had not been
utilized. Income earned or deemed to be earned, if any, by a Portfolio from its
Strategic Transactions will generally be taxable income of the Trust. See "Tax
Status" in the Prospectus.
GENERAL CHARACTERISTICS OF OPTIONS. Put options and call options typically
have similar structural characteristics and operational mechanics regardless of
the underlying instrument on which they are purchased or sold. Thus, the
following general discussion relates to each of the particular types of options
discussed in greater detail below. In addition, many Strategic Transactions
involving options require segregation of Portfolio assets in special accounts,
as described below under
"Use of Segregated and Other Special Accounts."
A put option gives the purchaser of the option, upon payment of a premium,
the right to sell, and the writer the obligation to buy, the underlying
security, commodity, index, currency or other instrument at the exercise price.
For instance, a Portfolio's purchase of a put option on a security might be
designed to protect its holdings in the underlying instrument (or, in some
cases, a similar instrument) against a substantial decline in the market value
by giving the Portfolio the right to sell such instrument at the option exercise
price. A call option, upon payment of a premium, gives the purchaser of the
option the right to buy, and the seller the obligation to sell, the underlying
instrument at the exercise price. A Portfolio's purchase of a call option on a
security, financial future, index, currency or other instrument might be
intended to protect the Portfolio against an increase in the price of the
underlying instrument that it intends to purchase in the future by fixing the
price at which it may purchase such instrument. An American style put or call
option may be exercised at any time during the option period while a European
style put or call option may be exercised only upon expiration or during a fixed
period prior thereto. As described in the Prospectus, certain Portfolios of the
Trust are authorized to purchase and sell exchange listed options and
over-the-counter options ("OTC options"). Exchange listed options are issued by
a regulated intermediary such as the Options Clearing Corporation ("OCC"), which
guarantees the performance of the obligations of the parties to such options.
The discussion below uses the OCC as a paradigm, but is also applicable to other
financial intermediaries.
With certain exceptions, OCC issued and exchange listed options generally
settle by physical delivery of the underlying security or currency, although in
the future cash settlement may become available. Index options and Eurodollar
instruments are cash settled for the net amount, if any, by which the option is
"in-the-money" (i.e., where the value of the underlying instrument exceeds, in
the case of a call option, or is less than, in the case of a put option, the
exercise price of the option) at the time the option is exercised. Frequently,
rather than taking or making delivery of the underlying instrument through the
process of exercising the option, listed options are closed by entering into
offsetting purchase or sale transactions that do not result in ownership of the
new option.
A Portfolio's ability to close out its position as a purchaser or seller of
an OCC or exchange listed put or call option is dependent, in part, upon the
liquidity of the option market. Among the possible reasons for the absence of a
liquid option market on an exchange are: (i) insufficient trading interest in
certain options; (ii) restrictions on transactions imposed by an exchange; (iii)
trading halts, suspensions or other restrictions imposed with respect to
particular classes or series of options or underlying securities including
reaching daily price limits; (iv) interruption of the normal operations of the
OCC or an exchange; (v) inadequacy of the facilities of an exchange or OCC to
handle current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the relevant market for that option on that exchange would cease
to exist, although outstanding options on that exchange would generally continue
to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours
during which the underlying financial instruments are traded. To the extent that
the option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of an
OTC option, including such terms as method of settlement, term, exercise price,
premium, guarantees and security, are set by negotiation of the parties. A
Portfolio will only sell OTC options (other than OTC currency options) that are
subject to a buy-back provision permitting the Portfolio to require the
Counterparty to sell the option back to the Portfolio at a formula price within
seven days. The Portfolios expect generally to enter into OTC options that have
cash settlement provisions, although they are not required to do so.
Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC option. As a result, if the Counterparty fails to make or
take delivery of the security, currency or other instrument underlying an OTC
option it has entered into with a Portfolio or fails to make a cash settlement
payment due in accordance with the terms of that option, the Portfolio will lose
any premium it paid for the option as well as any anticipated benefit of the
transaction. Accordingly, the Sub-Adviser must assess the creditworthiness of
each such Counterparty or any guarantor or credit enhancement of the
Counterparty's credit to determine the likelihood that the terms of the OTC
option will be satisfied. A Portfolio will engage in OTC option transactions
only with United States government securities dealers recognized by the Federal
Reserve Bank of New York as "primary dealers", or broker dealers, domestic or
foreign banks or other financial institutions which have received (or the
guarantors of the obligation of which have received) a short-term credit rating
of "A-1" from Standard & Poor's Corporation or "P-1" from Moody's Investors
Service, Inc. or an equivalent rating from any other nationally recognized
statistical rating organization ("NRSRO").
If a Portfolio sells a call option, the premium that it receives may serve
as a partial hedge, to the extent of the option premium, against a decrease in
the value of the underlying securities or instruments in its portfolio or will
increase a Portfolio's income. The sale of put options can also provide income.
A Portfolio may purchase and sell call options on securities, including
U.S. Treasury and agency securities, municipal obligations, mortgage-backed
securities, corporate debt securities, equity securities (including convertible
securities) and Eurodollar instruments that are traded on U.S. and foreign
securities exchanges and in the over-the-counter markets and or securities
indices, currencies and futures contracts. All calls sold by a Portfolio must be
"covered" (i.e., the Portfolio must own the securities or futures contract
subject to the call) or must meet the asset segregation requirements described
below as long as the call is outstanding. Even though a Portfolio will receive
the option premium to help protect it against loss, a call sold by a Portfolio
exposes the Portfolio during the term of the option to possible loss of
opportunity to realize appreciation in the market price of the underlying
security or instrument and may require the Portfolio to hold a security or
instrument which it might otherwise have sold. In selling calls on securities
not owned by the Portfolio, the Portfolio may be required to acquire the
underlying security at a disadvantageous price in order to satisfy its
obligations with respect to the call.
A Portfolio may purchase and sell put options on securities including U.S.
Treasury and agency securities, mortgage-backed securities, municipal
obligations, corporate debt securities, equity securities (including convertible
securities) and Eurodollar instruments (whether or not it holds the above
securities in its portfolio) and on securities indices, currencies and futures
contracts other than futures on individual corporate debt and individual equity
securities. A Portfolio will not sell put options if, as a result, more than 50%
of the Portfolio's assets would be required to be segregated to cover its
potential obligations under such put options other than those with respect to
futures and options thereon. In selling put options, there is a risk that a
Portfolio may be required to buy the underlying security at a disadvantageous
price above the market price.
GENERAL CHARACTERISTICS OF FUTURES. Certain Portfolios of the Trust may
enter into financial futures contracts or purchase or sell put and call options
on such futures as a hedge against anticipated interest rate, currency, equity
or income market changes, for duration management and for risk management
purposes. Futures are generally bought and sold on the commodities exchanges
where they are listed with payment of initial and variation margin as described
below. The purchase of a futures contract creates a firm obligation by a
Portfolio, as purchaser, to take delivery from the seller of the specific type
of financial instrument called for in the contract at a specific future time for
a specified price (or, with respect to index futures and Eurodollar instruments,
the net cash amount). The sale of a futures contract creates a firm obligation
by the Portfolio, as seller, to deliver to the buyer the specific type of
financial instrument called for in the contract at a specific future time for a
specified price (or, with respect to index futures and Eurodollar instruments,
the net cash amount). Options on futures contracts are similar to options on
securities except that an option on a futures contract gives the purchaser the
right in return for the premium paid to assume a position in a futures contract
and obligates the seller to deliver such option.
The Portfolio's use of financial futures and options thereon will in all
cases be consistent with applicable regulatory requirements and, in particular,
with the rules and regulations of the Commodity Futures Trading Commission.
Typically, maintaining a futures contract or selling an option thereon requires
the Portfolio to deposit with a financial intermediary, as security for its
obligations, an amount of cash or other specified assets (initial margin) which
initially is typically 1% to 10% of the face amount of the contract (but may be
higher in some circumstances). Additional cash or assets (variation margin) may
be required to be deposited thereafter on a daily basis as the mark to market
value of the contract fluctuates. The purchase of options on financial futures
involves payment of a premium for the option without any further obligation on
the part of the Portfolio. If the Portfolio exercises an option on a futures
contract it will be obligated to post initial margin (and potential subsequent
variation margin) for the resulting futures position just as it would for any
position. Futures contracts and options thereon are generally settled by
entering into an offsetting transaction but there can be no assurance that the
position can be offset prior to settlement at an advantageous price nor that
delivery will occur.
A Portfolio will not enter into a futures contract or related option
(except for closing transactions) for other than bona fide hedging purposes if,
immediately thereafter, the sum of the amount of its initial margin and premiums
on open futures contracts and options thereon would exceed 5% of the Portfolio's
total assets (taken at current value); however, in the case of an option that is
in-the-money at the time of the purchase, the in-the-money amount may be
excluded in calculating the 5% limitation. The segregation requirements with
respect to futures contracts and options thereon are described below.
OPTIONS ON SECURITIES INDICES AND OTHER FINANCIAL INDICES. A Portfolio also
may purchase and sell call and put options on securities indices and other
financial indices and in so doing can achieve many of the same objectives it
would achieve through the sale or purchase of options on individual securities
or other instruments. Options on securities indices and other financial indices
are similar to options on a security or other instrument except that, rather
than settling by physical delivery of the underlying instrument, they settle by
cash settlement, i.e., an option on an index gives the holder the right to
receive, upon exercise of the option, an amount of cash if the closing level of
the index upon which the option is based exceeds, in the case of a call, or is
less than, in the case of a put, the exercise price of the option (except if, in
the case of an OTC option, physical delivery is specified). This amount of cash
is equal to the excess of the closing price of the index over the exercise price
of the option, which also may be multiplied by a formula value. The seller of
the option is obligated, in return for the premium received, to make delivery of
this amount. The gain or loss on an option on an index depends on price
movements in the instruments making up the market, market segment, industry or
other composite on which the underlying index is based, rather than price
movements in individual securities, as is the case with respect to options on
securities.
CURRENCY TRANSACTIONS. Certain Portfolios of the Trust may engage in
currency transactions with Counterparties in order to hedge the value of
portfolio holdings denominated in particular currencies against fluctuations in
relative value. Currency transactions include forward currency contracts,
exchange listed currency futures, exchange listed and OTC options on currencies,
and currency swaps. A forward currency contract involves a privately negotiated
obligation to purchase or sell (with delivery generally required) a specific
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. A currency swap is an agreement to exchange cash flows based on the
notional difference among two or more currencies and operates similarly to an
interest rate swap, which is described below. A Portfolio may enter into
currency transactions with Counterparties which have received (or the guarantors
of the obligations of such Counterparties have received) a credit rating of A- 1
or P-1 by S&P or Moody's, respectively, or that have an equivalent rating from
an NRSRO or (except for OTC currency options) are determined to be of equivalent
credit quality by the Sub-Adviser.
Dealings by the Portfolios in forward currency contracts and other currency
transactions such as futures, options, options on futures and swaps will be
limited to hedging involving either specific transactions or portfolio
positions. Transaction hedging is entering into a currency transaction with
respect to specific assets or liabilities of the Portfolio, which will generally
arise in connection with the purchase or sale of its portfolio securities or the
receipt of income therefrom. Position hedging is entering into a currency
transaction with respect to portfolio security positions denominated or
generally quoted in that currency.
A Portfolio will not enter into a transaction to hedge currency exposure to
an extent greater, after netting all transactions intended to wholly or
partially offset other transactions, than the aggregate market value (at the
time of entering into the transaction) of the securities held in its portfolio
that are denominated or generally quoted in or currently convertible into such
currency other than with respect to cross hedging and proxy hedging as described
below.
A Portfolio may cross-hedge currencies by entering into transactions to
purchase or sell one or more currencies that are expected to decline in value
relative to other currencies to which the Portfolio has or in which the
Portfolio expects to have portfolio exposure.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, a Portfolio may also engage in
proxy hedging. Proxy hedging is often used when the currency to which the
Portfolio's portfolio is exposed is difficult to hedge or to hedge against the
dollar. Proxy hedging entails entering into a forward contract to sell a
currency whose changes in value are generally considered to be linked to a
currency or currencies in which some or all of the Portfolio's portfolio
securities are or are expected to be denominated, and to buy U.S. dollars. For
example, if the Sub-Adviser considers the Austrian schilling as being linked to
the German deutsche mark (the "D-mark") and the Trust holds securities
denominated in schillings and the Sub-Adviser believes that the value of
schillings will decline against the U.S. dollar, the Sub-Adviser may enter into
a contract to sell D- marks and buy dollars. Currency hedging involves some of
the same risks and considerations as other transactions with similar
instruments. Currency transactions can result in losses to a Portfolio if the
currency being hedged fluctuates in value to a degree or in a direction that is
not anticipated. Further, there is the risk that the perceived linkage between
various currencies may not be present or may not be present during the
particular time that the Portfolio is engaging in proxy hedging. If a Portfolio
enters into a currency hedging transaction, the Portfolio will comply with the
asset segregation requirements described below.
RISKS OF CURRENCY TRANSACTIONS. Currency transactions are subject to risks
different from those of other portfolio transactions. Because currency control
is of great importance to the issuing governments and influences economic
planning and policy, purchases and sales of currency and related instruments can
be negatively affected by government exchange controls, blockages, and
manipulations or exchange restrictions imposed by governments. These can result
in losses to a Portfolio if it is unable to deliver or receive currency or funds
in settlement of obligations and could also cause hedges it has entered into to
be rendered useless, resulting in full currency exposure as well as incurring
transaction costs. Buyers and sellers of currency futures are subject to the
same risks that apply to the use of futures generally. Further, settlement of a
currency futures contract for the purchase of most currencies must occur at a
bank based in the issuing nation. Trading options on currency futures is
relatively new, and the ability to establish and close out positions on such
options is subject to the maintenance of a liquid market which may not always be
available. Currency exchange rates may fluctuate based on factors extrinsic to
that country's economy.
COMBINED TRANSACTIONS. Certain Portfolios of the Trust may enter into
multiple transactions, including multiple options transactions, multiple futures
transactions, multiple currency transactions (including forward currency
contracts), multiple interest rate transactions and any combination of futures,
options, currency and interest rate transactions ("component" transactions),
instead of a single Strategic Transaction, as part of a single or combined
strategy when, in the opinion of the Sub-Adviser, it is in the best interest of
the Portfolio to do so. A combined transaction will usually contain elements of
risk that are present in each of its component transactions. Although combined
transactions are normally entered into based on the Sub-Adviser's judgment that
the combined strategies will reduce risk or otherwise more effectively achieve
the desired portfolio management goal, it is possible that the combination will
instead increase such risks or hinder achievement of the portfolio management
objective.
SWAPS, CAPS, FLOORS AND COLLARS. Among the Strategic Transactions into
which certain Portfolios may enter are interest rate, currency and index swaps
and the purchase or sale of related caps, floors and collars. The Portfolios
expect to enter into these transactions primarily to preserve a return or spread
on a particular investment or portion of their portfolios, to protect against
currency fluctuations, as a duration management technique or to protect against
any increase in the price of securities the Portfolio anticipates purchasing at
a later date. The Portfolios intend to use these transactions as hedges and not
as speculative investments and will not sell interest rate caps or floors where
they do not own securities or other instruments providing the income stream the
Portfolios may be obligated to pay. Interest rate swaps involve the exchange by
the Portfolio with another party of their respective commitments to pay or
receive interest, e.g., an exchange of floating rate payments for fixed rate
payments with respect to a notional amount of principal. A currency swap is an
agreement to exchange cashflows on a notional amount of two or more currencies
based on the relative value differential among them. An index swap is an
agreement to swap cash flows on a notional amount based on changes in the values
of the reference indices. The purchase of a cap entitles the purchaser to
receive payments on a notional principal amount from the party selling such cap
to the extent that a specified index exceeds a predetermined interest rate or
amount. The purchase of a floor entitles the purchaser to receive payments on a
notional principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount. A collar is
a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates or values.
A Portfolio will usually enter into swaps on a net basis, i.e., the two
payment streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Portfolio receiving or paying, as the case
may be, only the net amount of the two payments. Inasmuch as these swaps, caps,
floors and collars are entered into for good faith hedging purposes, the
Sub-Adviser and the Portfolio believe such obligations do not constitute senior
securities under the 1940 Act and, accordingly, will not treat them as being
subject to its borrowing restrictions. A Portfolio will not enter into any swap,
cap, floor or collar transaction unless, at the time of entering into such
transaction, the unsecured long-term debt of the Counterparty, combined with any
credit enhancements, is rated at least "A" by S&P or Moody's or has an
equivalent equity rating from an NRSRO or is determined to be of equivalent
credit quality by the Sub-Adviser. If there is a default by the Counterparty,
the Portfolio may have contractual remedies pursuant to the agreements related
to the transaction. The swap market has grown substantially in recent years with
a large number of banks and investment banking firms acting both as principals
and agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps, floors and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
EURODOLLAR INSTRUMENTS. Certain Portfolios of the Trust may make
investments in Eurodollar instruments. Eurodollar instruments are U.S.
dollar-denominated futures contracts or options thereon which are linked to the
London Interbank Offered Rate ("LIBOR"), although foreign currency-denominated
instruments are available from time to time. Eurodollar futures contracts enable
purchasers to obtain a fixed rate for the lending of funds and sellers to obtain
a fixed rate for borrowings. A Portfolio might use Eurodollar futures contracts
and options thereon to hedge against changes in LIBOR, to which many interest
rate swaps and income instruments are linked.
RISKS OF STRATEGIC TRANSACTIONS OUTSIDE THE UNITED STATES. When conducted
outside the United States, Strategic Transactions may not be regulated as
rigorously as in the United States, may not involve a clearing mechanism and
related guarantee, and are subject to the risk of governmental actions affecting
trading in, or the prices of, foreign securities, currencies and other
instruments. The value of such positions also could be adversely affected by:
(i) other complex foreign political, legal and economic factors, (ii) lesser
availability than in the United States of data on which to make trading
decisions, (iii) delays in a Portfolio's ability to act upon economic events
occurring in foreign markets during non-business hours in the United States,
(iv) the imposition of different exercise and settlement terms and procedures
and margin requirements than in the United States, and (v) lower trading volume
and liquidity.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS. Many Strategic Transactions,
in addition to other requirements, require that the Portfolio segregate liquid
high-grade assets with its custodian to the extent Portfolio obligations are not
otherwise "covered" through ownership of the underlying security, financial
instrument or currency. In general, either the full amount of any obligation by
the Portfolio to pay or deliver securities or assets must be covered at all
times by the securities, instruments or currency required to be delivered, or,
subject to any regulatory restrictions, an amount of cash or liquid high-grade
debt securities at least equal to the current amount of the obligation must be
segregated with the custodian. The segregated assets cannot be sold or
transferred unless equivalent assets are substituted in their place or it is no
longer necessary to segregate them. For example, a call option written by a
Portfolio will require the Portfolio to hold the securities subject to the call
(or securities convertible into the needed securities without additional
consideration) or to segregate liquid high-grade debt securities sufficient to
purchase and deliver the securities if the call is exercised. A call option sold
by a Portfolio on an index will require the Portfolio to own portfolio
securities which correlate with the index or to segregate liquid high-grade
assets equal to the excess of the index value over the exercise price on a
current basis. A put option written by a Portfolio requires the Portfolio to
segregate liquid, high-grade assets equal to the exercise price.
Except when a Portfolio enters into a forward contract for the purchase or
sale of a security denominated in a particular currency, which requires no
segregation, a currency contract which obligates the Portfolio to buy or sell
currency will generally require the Portfolio to hold an amount of that currency
or liquid securities denominated in that currency equal to the Portfolio's
obligations or to segregate liquid high-grade assets equal to the amount of the
Portfolio's obligation.
OTC options entered into by a Portfolio, including those on securities,
currencies, financial instruments or indices and OCC issued and exchange listed
index options, will generally provide for cash settlement. As a result, when a
Portfolio sells these instruments it will only segregate an amount of assets
equal to its accrued net obligations, as there is no requirement for payment or
delivery of amounts in excess of the net amount. These amounts will equal 100%
of the exercise price in the case of a non cash-settled put, the same as an OCC
guaranteed listed option sold by the Portfolio, or the in-the-money amount plus
any sell-back formula amount in the case of a cash-settled put or call. In
addition, when the Portfolio sells a call option on an index at a time when the
in-the-money amount exceeds the exercise price, the Portfolio will segregate,
until the option expires or is closed out, cash or cash equivalents equal in
value to such excess. OCC issued and exchange listed options sold by the
Portfolio other than those above generally settle with physical delivery or with
an election of either physical delivery or cash settlement, and the Portfolio
will segregate an amount of assets equal to the full value of the option. OTC
options settling with physical delivery, or with an election of either physical
delivery or cash settlement, will be treated the same as other options settling
with physical delivery.
In the case of a futures contract or an option thereon, the Portfolio must
deposit initial margin and possible daily variation margin in addition to
segregating assets sufficient to meet its obligation to purchase or provide
securities or currencies, or to pay the amount owed at the expiration of an
index-based futures contract. Such assets may consist of cash, cash equivalents,
liquid debt securities or other acceptable assets.
With respect to swaps, a Portfolio will accrue the net amount of the
excess, if any, of its obligations over its entitlements with respect to each
swap on a daily basis and will segregate an amount of cash or liquid high-grade
securities having a value equal to the accrued excess. Caps, floors and collars
require segregation of assets with a value equal to a Portfolio's net
obligation, if any.
Strategic Transactions may be covered by other means when consistent with
applicable regulatory policies. A Portfolio may also enter into offsetting
transactions so that its combined position, coupled with any segregated assets,
equals its net outstanding obligation in related options and Strategic
Transactions. For example, a Portfolio could purchase a put option if the strike
price of that option is the same or higher than the strike price of a put option
sold by the Portfolio. Moreover, instead of segregating assets if the Portfolio
held a futures or forward contract, it could purchase a put option on the same
futures or forward contract with a strike price as high or higher than the price
of the contract held. Other Strategic Transactions may also be offset in
combinations. If the offsetting transaction terminates at the time of or after
the primary transaction, no segregation is required. However, if it terminates
prior to such time, assets equal to any remaining obligation would need to be
segregated.
The Trust's activities involving Strategic Transactions may be limited by
the requirements of Subchapter M of the Internal Revenue Code for qualification
as a regulated investment company. See "Tax Status" in the Prospectus.
INVESTMENT LIMITATIONS
The Trust has adopted the following restrictions and policies relating to
the investment of assets of the Portfolios and their activities. These are
fundamental policies and may not be changed without the approval of the holders
of a majority of the outstanding voting shares of each Portfolio affected (which
for this purpose and under the Investment Company Act of 1940 means the lesser
of (i) 67% of the shares represented at a meeting at which more than 50% of the
outstanding shares are present or represented by proxy and (ii) more than 50% of
the outstanding shares). A change in policy affecting only one Portfolio may be
effected with the approval of a majority of the outstanding shares of such
Portfolio. Where an investment restriction or policy restricts it to a specified
percentage of its total assets in any type of instrument, that percentage is
measured at the time of purchase. Except as noted hereunder, there will be no
violation of any investment policy or restriction if that restriction is
complied with at the time the relevant action is taken notwithstanding a later
change in the market value of an investment, in net or total assets, in the
securities rating of the investment or any other change.
QUALITY BOND PORTFOLIO
The Quality Bond Portfolio of the Trust may not:
1. Borrow money, except from banks for extraordinary or emergency purposes
and then only in amounts up to 30% of the value of the Portfolio's total assets,
taken at cost at the time of such borrowing and except in connection with
reverse repurchase agreements permitted by Investment Restriction No. 8.
Mortgage, pledge, or hypothecate any assets except in connection with any such
borrowing in amounts up to 30% of the value of the Portfolio's net assets at the
time of such borrowing. The Portfolio will not purchase securities while
borrowings (including reverse repurchase agreements) exceed 5% of the
Portfolio's total assets. This borrowing provision facilitates the orderly sale
of portfolio securities, for example, in the event of abnormally heavy
redemption requests. This provision is not for investment purposes. Collateral
arrangements for premium and margin payments in connection with the
Portfolio's's hedging activities are not deemed to be a pledge of assets;
2. Purchase the securities or other obligations of any one issuer if,
immediately after such purchase, more than 5% of the value of the Portfolio's
total assets would be invested in securities or other obligations of any one
such issuer. This limitation shall not apply to securities issued or guaranteed
by the U.S. Government, its agencies or instrumentalities or to permitted
investments of up to 25% of the Portfolio's total assets;
3. Purchase the securities of an issuer if, immediately after such
purchase, the Portfolio owns more than 10% of the outstanding voting securities
of such issuer. This limitation shall not apply to permitted investments of up
to 25% of the Portfolio's total assets;
4. Purchase securities or other obligations of issuers conducting their
principal business activity in the same industry if, immediately after such
purchase the value of its investments in such industry would exceed 25% of the
value of the Portfolio's total assets. For purposes of industry concentration,
there is no percentage limitation with respect to investments in U.S. Government
securities;
5. Make loans, except through the purchase or holding of debt obligations
including privately placed securities) or the entering into of repurchase
agreements, or loans of portfolio securities in accordance with the Portfolio's
investment objective and policies;
6. Purchase or sell puts, calls, straddles, spreads, or any combination
thereof, real estate, commodities, commodity contracts, except for the
Portfolio's interest in hedging activities as described under "Investment
Objectives and Policies"; or interests in oil, gas, or mineral exploration or
development programs. However, the Portfolio may purchase debt obligations
secured by interests in real estate or issued by companies which invest in real
estate or interests therein including real estate investment trusts;
7. Purchase securities on margin, make short sales of securities, or
maintain a short position in securities, except in the course of the Portfolio's
hedging activities, unless at all times when a short position is open the
Portfolio owns an equal amount of such securities, provided that this
restriction shall not be deemed to be applicable to the purchase or sale of
when-issued securities or delayed delivery securities;
8. Issue any senior security, except as appropriate to evidence
indebtedness which constitutes a senior security and which the Portfolio is
permitted to incur pursuant to Investment Restriction No. 1 and except that the
Portfolio may enter into reverse repurchase agreements, provided that the
aggregate of senior securities, including reverse repurchase agreement, shall
not exceed one-third of the market value of the Portfolio's total assets, less
liabilities other than obligations created by reverse repurchase agreements. The
Portfolio's arrangements in connection with its hedging activities as described
in "Investment Objectives and Policies" shall not be considered senior
securities for purposes hereof;
9. Acquire securities of other investment companies, except as permitted by
the 1940 Act; or
10. Act as an underwriter of securities.
SELECT EQUITY, LARGE CAP STOCK AND SMALL CAP STOCK PORTFOLIOS
Each of the Select Equity, Large Cap Stock and Small Cap Stock Portfolios
may not:
1. Purchase the securities or other obligations of issuers conducting their
principal business activity in the same industry if, immediately after such
purchase the value of its investments in such industry would exceed 25% of the
value of the Portfolio's total assets. For purposes of industry concentration,
there is no percentage limitation with respect to investments in U.S. Government
securities;
2. Borrow money, except from banks for extraordinary or emergency purposes
and then only in amounts not to exceed 10% of the value of the Portfolio's total
assets, taken at cost, at the time of such borrowing. Mortgage, pledge, or
hypothecate any assets except in connection with any such borrowing and in
amounts not to exceed 10% of the value of the Portfolio's net assets at the time
of such borrowing. The Portfolio will not purchase securities while borrowings
exceed 5% of the Portfolio's total assets. This borrowing provision is included
to facilitate the orderly sale of portfolio securities, for example, in the
event of abnormally heavy redemption requests, and is not for investment
purposes. Collateral arrangements for premium and margin payments in connection
with the Portfolio's hedging activities are not deemed to be a pledge of assets;
3. Purchase the securities or other obligations of any one issuer if,
immediately after such purchase, more than 5% of the value of the Portfolio's
total assets would be invested in securities or other obligations of any one
such issuer. This limitation shall not apply to issues of the U.S. Government,
its agencies or instrumentalities and to permitted investments of up to 25% of
the Portfolio's total assets;
4. Purchase the securities of an issuer if, immediately after such
purchase, the Portfolio owns more than 10% of the outstanding voting securities
of such issuer;
5. Make loans, except through the purchase or holding of debt obligations
(including privately placed securities), or the entering into of repurchase
agreements, or loans of portfolio securities in accordance with the Portfolio's
investment objective and policies (see "Investment Objectives and Policies");
6. Purchase or sell puts, calls, straddles, spreads, or any combination
thereof, real estate, commodities, or commodity contracts, except for the
Portfolio's interest in hedging activities as described under "Investment
Objectives and Policies"; or interests in oil, gas, or mineral exploration or
development programs. However, the Portfolio may purchase securities or
commercial paper issued by companies which invest in real estate or interests
therein, including real estate investment trusts;
7. Purchase securities on margin, make short sales of securities, or
maintain a short position, except in the course of the Portfolio's hedging
activities, provided that this restriction shall not be deemed to be applicable
to the purchase or sale of when-issued securities or delayed delivery
securities;
8. Acquire securities of other investment companies, except as permitted by
the 1940 Act;
9. Act as an underwriter of securities;
10. Issue any senior security, except as appropriate to evidence
indebtedness which the Portfolio is permitted to incur pursuant to Investment
Restriction No. 2. The Portfolio's arrangements in connection with its hedging
activities as described in "Investment Objectives and Policies" shall not be
considered senior securities for purposes hereof; or
11. Purchase any equity security if, as a result, the Portfolio would then
have more than 5% of its total assets invested in securities of companies
(including predecessors) that have been in continuous operation for fewer than
three years.
INTERNATIONAL EQUITY PORTFOLIO
The International Equity Portfolio may not:
1. Borrow money, except from banks for extraordinary or emergency purposes
and then only in amounts up to 30% of the value of the Portfolio's net assets at
the time of borrowing, and except in connection with reverse repurchase
agreements and then only in amounts up to 33 1/3% of the value of the
Portfolio's net assets; or purchase securities while borrowings, including
reverse repurchase agreements, exceed 5% of the Portfolio's total assets. The
Portfolio will not mortgage, pledge, or hypothecate any assets except in
connection with any such borrowing and in amounts not to exceed 30% of the value
of the Portfolio's net assets at the time of such borrowing;
2. Purchase the securities or other obligations of any one issuer if,
immediately after such purchase, more than 5% of the value of the Portfolio's
total assets would be invested in securities or other obligations of any one
such issuer. This limitation shall not apply to securities issued or guaranteed
by the U.S. Government, its agencies or instrumentalities or to permitted
investments of up to 25% of the Portfolio's total assets;
3. Purchase the securities of an issuer if, immediately after such
purchase, the Portfolio owns more than 10% of the outstanding voting securities
of such issuer. This limitation shall not apply to permitted investments of up
to 25% of the Portfolio's total assets;
4. Purchase the securities or other obligations of issuers conducting their
principal business activity in the same industry if, immediately after such
purchase, the value of its investments in such industry would exceed 25% of the
value of the Portfolio's total assets. For purposes of industry concentration,
there is no percentage limitation with respect to investments in U.S. Government
securities;
5. Make loans, except through the purchase or holding of debt obligations
(including restricted securities), or the entering into of repurchase
agreements, or loans of portfolio securities in accordance with the Portfolio's
investment objective and policies, see "Investment Practices" in the Prospectus
and "Investment Objectives and Policies" in this Statement of Additional
Information;
6. Purchase or sell puts, calls, straddles, spreads, or any combination
thereof, real property, including limited partnership interests, commodities, or
commodity contracts, except for the Portfolio's interests in hedging and foreign
exchange activities as described under "Investment Practices" in the Prospectus;
or interests in oil, gas, mineral or other exploration or development programs
or leases. However, the Portfolio may purchase securities or commercial paper
issued by companies that invest in real estate or interests therein including
real estate investment trusts;
7. Purchase securities on margin, make short sales of securities, or
maintain a short position in securities, except to obtain such short-term credit
as necessary for the clearance of purchases and sales of securities, provided
that this restriction shall not be deemed to apply to the purchase or sale of
when-issued securities or delayed delivery securities;
8. Acquire securities of other investment companies, except as permitted by
the 1940 Act;
9. Act as an underwriter of securities, except insofar as the Portfolio may
be deemed to be an underwriter under the 1933 Act by virtue of disposing of
portfolio securities; or
10. Issue any senior security, except as appropriate to evidence
indebtedness which the Portfolio is permitted to incur pursuant to Investment
Restriction No. 1. The Portfolio's arrangements in connection with its hedging
activities as described in "Investment Practices" in the Prospectus shall not be
considered senior securities for purposes hereof.
EMERGING MARKETS EQUITY PORTFOLIO
The Emerging Markets Equity Portfolio may not:
1. Purchase any security if, as a result, more than 25% of the value of the
Portfolio's total assets would be invested in securities of issuers having their
principal business activities in the same industry. This limitation shall not
apply to obligations issued or guaranteed by the U.S. Government, its agencies
or instrumentalities;
2. Borrow money, except that the Portfolio may (i) borrow money from banks
for temporary or emergency purposes (not for leveraging purposes) and (ii) enter
into reverse repurchase agreements for any purpose; provided that (i) and (ii)
in total do not exceed 33 1/3% of the value of the Portfolio's total assets
(including the amount borrowed)less liabilities (other than borrowings). If at
any time any borrowings come to exceed 33 1/3% of the value of the Portfolio's
total assets, the Portfolio will reduce its borrowings within three business
days to the extent necessary to comply with the 33 1/3% limitation;
3. With respect to 75% of its total assets, purchase any security if, as a
result, (a) more than 5% of the value of the Portfolio's total assets would be
invested in securities or other obligations of any one issuer; or (b) the
Portfolio would hold more than 10% of the outstanding voting securities of that
issuer. This limitation shall not apply to Government securities (as defined in
the 1940 Act);
4. Make loans to other persons, except through the purchase of debt
obligations, loans of portfolio securities, and participation in repurchase
agreements;
5. Purchase or sell physical commodities or contracts thereon, unless
acquired as a result of the ownership of securities or instruments, but the
Portfolio may purchase or sell futures contracts or options (including options
on futures contracts, but excluding options or futures contracts on physical
commodities) and may enter into foreign currency forward contracts;
6. Purchase or sell real estate, but the Portfolio may purchase or sell
securities that are secured by real estate or issued by companies (including
real estate investment trusts) that invest or deal in real estate;
7. Underwrite securities of other issuers, except to the extent the
Portfolio, in disposing of portfolio securities, may be deemed an underwriter
within the meaning of the 1933 Act; and
8. Issue senior securities, except as permitted under the 1940 Act or any
rule, order or interpretation thereunder.
BOND DEBENTURE PORTFOLIO
The Bond Debenture Portfolio of the Trust may not:
1. Sell short or buy on margin, although it may obtain short-term credit as
needed to clear purchases of securities;
2. Buy or sell put or call options, although it may buy, hold or sell
warrants acquired with debt securities;
3. Borrow in excess of 5% of the Portfolio's gross assets taken at cost or
market value whichever is lower at the time of borrowing, and then only as a
temporary measure for extraordinary or emergency purposes;
4. Act as an underwriter of securities issued by others, except where it
may be deemed to be an underwriter by selling a portfolio security requiring
registration under the Securities Act of 1933;
5. Invest knowingly more than 15% of its gross assets in illiquid
securities;
6. Make loans, except for (a) time or demand deposits with banks, (b)
purchasing commercial paper or publicly-offered debt securities at original
issue or otherwise, (c) short-term repurchase agreements with sellers of
securities the Portfolio has bought and (d) loans of portfolio securities to
registered broker-dealers if 100% secured by cash or cash equivalents, made in
full compliance with applicable regulations and which, in management's opinion,
do not expose the Portfolio to significant risks or impair its qualification for
pass-through tax treatment under the Internal Revenue Code;
7. Pledge, mortgage, or hypothecate its assets;
8. Buy or sell real estate (including limited partnership interests but
excluding securities of companies, such as real estate investment trusts, which
deal in real estate or interests therein) or oil, gas or other mineral leases,
or commodities, or commodity contracts although it may buy securities of
companies that deal in such interests (however, the Portfolio may hold and sell
any of the aforementioned or any other property acquired through ownership of
other securities, although the Portfolio may not purchase securities for the
purpose of acquiring those interests);
9. Buy securities issued by any other open-end investment company (except
pursuant to a plan of merger, consolidation or acquisition of assets), although
it may invest up to 5% of its gross assets, taken at market value at the time of
investment, in closed-end investment companies, provided such purchase is made
in the open market and does not involve the payment of a fee or commission
greater than the customary broker's commission;
10. Invest more than 5% of its gross assets, taken at market value at the
time of investment in securities of companies with less than three years'
continuous operation, including predecessor companies;
11. With respect to 75% of its gross assets, buy the securities of any
issuer if the purchase causes it (a) to have more than 5% of its gross assets
invested in the securities of such issuer (except obligations of the United
States, its agencies or instrumentalities) or (b) to own more than 10% of the
outstanding voting securities of such issuer;
12. Hold securities of any issuer, any of whose officers, directors or
security holders is an officer, director or partner of the Adviser or
Sub-Adviser or an officer or director of the Portfolio, if after the purchase of
the securities of such issuer, one or more of such persons owns beneficially
more than 1/2 of 1% of the securities of such issuer and such persons together
own beneficially more than 5% of such securities;
13. Concentrate its investments in a particular industry, though, if it is
deemed appropriate to its investment objective, up to 25% of the market value of
its gross assets at the time of investment may be invested in any one industry
classification used for investment purposes;
14. Buy from or sell to any of the Trust's directors, employees, or the
Investment Adviser or Sub-Adviser or any of its officers, directors, partners or
employees, any securities other than shares of the Portfolio's common stock; or
15. Invest more than 10% of the market value of its gross assets at the
time of investment in debt securities which are in default as to interest or
principal.
With respect to investment restriction 5. above, securities subject to
legal or contractual restrictions on resale, which are determined by the Board
of Trustees, or by the Sub-Adviser pursuant to delegated authority, to be liquid
are considered liquid securities.
GROWTH & INCOME EQUITY, BALANCED AND EQUITY INCOME PORTFOLIOS
The Growth & Income Equity, Balanced and Equity Income Portfolios of the
Trust may not:
1. Purchase securities of any one issuer (other than obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities), if,
immediately after and as a result of such investments, more than 5% of the
Portfolio's total assets would be invested in the securities of such issuer, or
more than 10% of the issuer's outstanding voting securities would be owned by
the Portfolio or the Trust, except that up to 25% of the Portfolio's total
assets may be invested without regard to such limitations.
2. Purchase any securities which would cause 25% or more of the Portfolio's
total assets at the time of purchase to be invested in the securities of one or
more issuers conducting their principal business activities in the same
industry, provided that, however, (a) with respect to each Portfolio, (i) there
is no limitation with respect to obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, and repurchase agreements secured
by obligations of the U.S. Government or its agencies or instrumentalities, and
with respect to the Equity Income Portfolio only, securities issued by domestic
banks, thrifts or savings institutions; (ii) wholly-owned finance companies will
be considered to be in the industries of their parents if their activities are
primarily related to financing the activities of their parents; and (iii)
utilities will be divided according to their services (for example, gas, gas
transmission, electric and gas, electric, and telephone will each be considered
a separate industry).
3. Borrow money or issue senior securities, except that the Portfolio may
borrow from banks and enter into reverse repurchase agreements for temporary
defensive purposes in amounts not in excess of 10% of the Portfolio's total
assets at the time of such borrowing; or mortgage, pledge, or hypothecate any
assets, except in connection with any such borrowing and in amounts not in
excess of the lesser of the dollar amounts borrowed or 10% of the Portfolio's
total assets at the time of such borrowing; or purchase securities while its
borrowings exceed 5% of its total assets. A Portfolio's transactions in futures
and related options (including the margin posted by a Portfolio in connection
with such transactions), and securities held in escrow or separate accounts in
connection with a Portfolio's investment practices described in this Statement
of Additional Information are not subject to this limitation.
4. Make loans, except that each Portfolio may purchase or hold debt
instruments, lend portfolio securities, enter into repurchase agreements and
make other investments in accordance with its investment objective and policies.
5. Purchase securities on margin, make short sales of securities or
maintain a short position, except that (a) this investment limitation shall not
apply to a Portfolio's transactions in options, and futures contracts and
related options, and (b) a Portfolio may obtain short-term credits as may be
necessary for the clearance of purchases and sales of portfolio securities.
6. Make investments for the purpose of exercising control or management.
7. Purchase or sell real estate, provided that each Portfolio may invest in
securities secured by real estate or interests therein or issued by companies or
investment trusts which invest in real estate or interests therein.
8. Act as an underwriter of securities within the meaning of the Securities
Act of 1933 except insofar as a Portfolio might be deemed to be an underwriter
upon disposition of portfolio securities acquired within the limitation on
purchases of restricted securities and except to the extent that the purchase of
obligations directly from the issuer thereof in accordance with a Portfolio's
investment objective, policies and limitations may be deemed to be underwriting.
9. Purchase or sell commodity contracts, or invest in oil, gas or mineral
exploration or development programs, except that each of the Balanced Portfolio
and the Equity Income Portfolio may, to the extent appropriate to its investment
objective, purchase publicly traded securities of companies engaging in whole or
in part in such activities and may invest in futures contracts and related
options in accordance with their respective investment activities and policies.
10. Act as an underwriter of securities within the meaning of the
Securities Act of 1933 except insofar as a Portfolio might be deemed to be an
underwriter upon disposition of portfolio securities acquired within the
limitation on purchases of restricted securities and except to the extent that
the purchase of obligations directly from the issuer thereof in accordance with
a Portfolio's investment objective, policies and limitations may be deemed to be
underwriting.
LORD ABBETT GROWTH AND INCOME PORTFOLIO
The Lord Abbett Growth and Income Portfolio may not:
1. sell short securities or buy securities or evidences of interests
therein on margin, although it may obtain short-term credit necessary for the
clearance of purchases of securities;
2. buy or sell put or call options, although it may buy, hold or sell
rights or warrants, write covered call options and enter into closing purchase
transactions as discussed below;
3. borrow money which is in excess of one-third of the value of its total
assets taken at market value (including the amount borrowed) and then only from
banks as a temporary measure for extraordinary or emergency purposes (borrowings
beyond 5% of such total assets may not be used for investment leverage to
purchase securities but solely to meet redemption requests where the liquidation
of the Portfolio's investment is deemed to be inconvenient or disadvantageous);
4. lend money or securities to any person except that it may enter into
short- term repurchase agreements with sellers of securities it has purchased,
and it may lend its portfolio securities to registered broker-dealers where the
loan is 100% secured by cash or its equivalent as long as it complies with
regulatory requirements and the Portfolio deems such loans not to expose the
Portfolio to significant risk (investment in repurchase agreements exceeding 7
days and in other illiquid investments is limited to a maximum of 5% of a
Portfolio's assets);
5. pledge, mortgage or hypothecate its assets; however, this provision does
not apply to permitted borrowing mentioned above or to the grant of escrow
receipts or the entry into other similar escrow arrangements arising out of the
writing of covered call options;
6. buy or sell real estate including limited partnership interests therein
(except securities of companies, such as real estate investment trusts, that
deal in real estate or interests therein), or oil, gas or other mineral leases,
commodities or commodity contracts in the ordinary course of its business,
except such interests and other property acquired as a result of owning other
securities, though securities will not be purchased in order to acquire any of
these interests;
7. invest more than 5% of its gross assets, taken at market value at the
time of investment, in companies (including their predecessors) with less than
three years' continuous operation;
8. buy securities if the purchase would then cause a Portfolio to have more
than (i) 5% of its gross assets, at market value at the time of purchase,
invested in securities of any one issuer, except securities issued or guaranteed
by the U.S. Government, its agencies or instrumentalities, or (ii) 25% of its
gross assets, at market value at the time of purchase, invested in securities
issued or guaranteed by a foreign government, its agencies or instrumentalities;
9. buy voting securities if the purchase would then cause a Portfolio to
own more than 10% of the outstanding voting stock of any one issuer;
10. own securities in a company when any of its officers, directors or
security holders is an officer or Trustee of the Trust or an officer, director
or partner of the investment adviser or sub-adviser, if after the purchase any
of such persons owns beneficially more than 1/2 of 1% of such securities and
such persons together own more than 5% of such securities;
11. concentrate its investments in any particular industry, but if deemed
appropriate for attainment of its investment objective, up to 25% of its gross
assets (at market value at the time of investment) may be invested in any one
industry classification used for investment purposes; or
12. buy securities from or sell them to the Trust's officers, directors, or
employees, or to the investment adviser or sub-adviser or to their partners,
directors and employees.
LARGE CAP RESEARCH, DEVELOPING GROWTH AND MID-CAP VALUE PORTFOLIOS
The Large Cap Research, Developing Growth and Mid-Cap Value Portfolios may
not:
1. borrow money, except that (i) the Portfolio may borrow from banks (as
defined in the Investment Company Act of 1940, as amended (the "1940 Act")) in
amounts up to 33 1/3% of its total assets (including the amount borrowed), (ii)
the Portfolio may borrow up to an additional 5% of its total assets for
temporary purposes, (iii) the Portfolio may obtain such short-term credit as may
be necessary for the clearance of purchases and sales of portfolio securities
and (iv) the Portfolio may purchase securities on margin to the extent permitted
by applicable law;
2. pledge its assets (other than to secure borrowings, or to the extent
permitted by the Portfolio's investment policies as permitted by applicable
law);
3. engage in the underwriting of securities, except pursuant to a merger or
acquisition or to the extent that, in connection with the disposition of its
portfolio securities, it may be deemed to be an underwriter under federal
securities laws;
4. make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar instruments
shall not be subject to this limitation, and except further that the Portfolio
may lend its portfolio securities, provided that the lending of portfolio
securities may be made only in accordance with applicable law;
5. buy or sell real estate (except that the Portfolio may invest in
securities directly or indirectly secured by real estate or interests therein or
issued by companies which invest in real estate or interests therein) or
commodities or commodity contracts (except to the extent the Portfolio may do so
in accordance with applicable law and without registering as a commodity pool
operator under the Commodity Exchange Act, as, for example, with futures
contracts);
6. with respect to 75% of the gross assets of the Portfolio, buy securities
of one issuer representing more than (i) 5% of the Portfolio's gross assets,
except securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities or (ii) 10% of the voting securities of such issuer;
7. invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding securities of the
U.S. Government, its agencies and instrumentalities); or
8. issue senior securities to the extent such issuance would violate
applicable laws.
RIGGS STOCK, RIGGS SMALL COMPANY STOCK AND RIGGS U.S. GOVERNMENT SECURITIES
PORTFOLIOS
1. The Portfolios will not issue senior securities except that a Portfolio
may borrow money directly or through reverse repurchase agreements in amounts up
to one-third of the value of its total assets, including the amount borrowed;
and except to the extent that a Portfolio may enter into futures contracts. The
Portfolios will not borrow money or engage in reverse repurchase agreements for
investment leverage, but rather as a temporary, extraordinary, or emergency
measure or to facilitate management of the Portfolio by enabling a Portfolio to
meet redemption requests when the liquidation of portfolio securities is deemed
to be inconvenient or disadvantageous. A Portfolio will not purchase any
securities while any borrowings in excess of 5% of its total assets are
outstanding. During the period any reverse repurchase agreements are
outstanding, a Portfolio will restrict the purchase of portfolio securities to
money market instruments maturing on or before the expiration date of the
reverse repurchase agreements, but only to the extent necessary to assure
completion of the reverse repurchase agreements.
2. The Portfolios will not sell any securities short or purchase any
securities on margin, but may obtain such short-term credits as are necessary
for clearance of purchases and sales of securities. The deposit or payment by a
Portfolio of initial or variation margin in connection with futures contracts or
related options transactions is not considered the purchase of a security on
margin.
3. The Portfolios will not mortgage, pledge, or hypothecate any assets,
except to secure permitted borrowings. In these cases the Portfolios may pledge
assets having a value of 15% of assets taken at cost. For purposes of this
restriction, (a) the deposit of assets in escrow in connection with the writing
of covered put or call options and the purchase of securities on a when-issued
basis; and (b) collateral arrangements with respect to (i) the purchase and sale
of stock options and (ii) initial or variation margin for futures contracts will
not be deemed to be pledges of a Portfolio's assets. Margin deposits for the
purchase and sale of futures contracts and related options are not deemed to be
a pledge.
4. The Portfolios will not lend any of their respective assets except
portfolio securities up to one-third of the value of total assets. This shall
not prevent a Portfolio from purchasing or holding U.S. government obligations,
money market instruments, variable amount demand master notes, bonds,
debentures, notes, certificates of indebtedness, or other debt securities,
entering into repurchase agreements, or engaging in other transactions where
permitted by a Portfolio's investment objective, policies, and limitations or
the Trust's Declaration of Trust.
5. The Portfolios will not invest more than 10% of their respective net
assets in securities subject to restrictions on resale under the Securities Act
of 1933, except for commercial paper issued under Section 4(2) of the Securities
Act of 1933 and certain other restricted securities which meet the criteria for
liquidity as established by the Board of Trustees.
6. The Portfolios will not invest in commodities, except to the extent that
they may engage in transactions involving futures contracts or options on
futures contracts.
7. The Portfolios will not purchase or sell real estate, including limited
partnership interests, although they may invest in securities of issuers whose
business involves the purchase or sale of real estate or in securities which are
secured by real estate or interests in real estate.
8. With respect to 75% of the value of its respective total assets, each
Portfolio will not purchase securities issued by any one issuer (other than
cash, cash items or securities issued or guaranteed by the government of the
United States or its agencies or instrumentalities and repurchase agreements
collateralized by such securities), if as a result more than 5% of the value of
its total assets would be invested in the securities of that issuer. No
Portfolio will acquire more than 10% of the outstanding voting securities of any
one issuer.
9. A Portfolio will not invest 25% or more of the value of its respective
total assets in any one industry (other than securities issued by the U.S.
government, its agencies, or instrumentalities or repurchase agreements
collateralized by these securities).
10. A Portfolio will not underwrite any issue of securities, except as a
Portfolio may be deemed to be an underwriter under the Securities Act of 1933 in
connection with the sale of securities in accordance with its investment
objective, policies, and limitations.
Except with respect to the Portfolios' policy of borrowing money, if a
percentage limitation is adhered to at the time of investment, a later increase
or decrease in percentage resulting from any change in value or net assets will
not result in a violation of such restriction.
For purposes of their policies and limitations, the Portfolios consider
certificates of deposit and demand and time deposits issued by a U.S. branch of
a domestic bank or savings association having capital, surplus, and undivided
profits in excess of $100,000,000 at the time of investment to be "cash items."
NON-FUNDAMENTAL INVESTMENT LIMITATIONS
The investment limitations described below are not fundamental policies of the
Portfolios described and may be changed by the Trustees without shareholder
approval.
NON-FUNDAMENTAL INVESTMENT LIMITATIONS - QUALITY BOND PORTFOLIO, SELECT EQUITY
PORTFOLIO, LARGE CAP STOCK PORTFOLIO, SMALL CAP STOCK PORTFOLIO AND
INTERNATIONAL EQUITY PORTFOLIO
These non-fundamental investment policies require that each such Portfolio may
not:
(i) Acquire any illiquid securities, such as repurchase agreements with
more than seven days to maturity or fixed time deposits with a duration of over
seven calendar days, if as a result thereof, more than 15% of the market value
of the Portfolio's total assets would be in investments that are illiquid;
(ii) Purchase any security if, as a result, the Portfolio would then have
more than 5% of its total assets invested in securities of companies (including
predecessors) that have been in continuous operation for fewer than three years;
(iii) Invest in warrants (other than warrants acquired by the Portfolio as
part of a unit or attached to securities at the time of purchase) if, as a
result, the investments (valued at the lower of cost or market) would exceed 5%
of the value of the Portfolio's net assets or if, as a result, more than 2% of
the Portfolio's net assets would be invested in warrants not listed on a
recognized U.S. or foreign stock exchange, to the extent permitted by applicable
state securities laws; or
(iv) Purchase or retain securities of any issuer if, to the knowledge of
the Portfolio, any of the Portfolio's officers or Trustees or any officer of the
Advisor individually owns more than 1/2 of 1% of the issuer's outstanding
securities and such persons owning more than 1/2 of 1% of such securities
together beneficially own more than 5% of such securities, all taken at market.
NON-FUNDAMENTAL INVESTMENT LIMITATIONS - EMERGING MARKETS EQUITY PORTFOLIO
The Portfolio may not:
(i) Acquire securities of other investment companies, except as permitted
by the 1940 Act or any rule, order or interpretation thereunder, or in
connection with a merger, consolidation, reorganization, acquisition of assets
or an offer of exchange;
(ii) Acquire any illiquid securities, such as repurchase agreements with
more than seven days to maturity or fixed time deposits with a duration of over
seven calendar days, if as a result thereof, more than 15% of the market value
of the Portfolio's net assets would be in investments that are illiquid;
(iii) Sell any security short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold or unless it
covers such short sales as required by the current rules or positions of the SEC
or its staff. Transactions in futures contracts and options shall not constitute
selling securities short; or
(iv) Purchase securities on margin, but the Portfolio may obtain such short
term credits as may be necessary for the clearance of transactions.
NON-FUNDAMENTAL INVESTMENT LIMITATIONS - LARGE CAP RESEARCH, DEVELOPING GROWTH
AND MID-CAP VALUE PORTFOLIOS
Each Portfolio may not:
1. borrow in excess of 5% of its gross assets taken at cost or market
value, whichever is lower at the time of borrowing, and then only as a temporary
measure for extraordinary or emergency purposes;
2. make short sales of securities or maintain a short position except to
the extent permitted by applicable law;
3. invest knowingly more than 15% of its net assets (at the time of
investment) in illiquid securities, except for securities qualifying for resale
under Rule 144A of the Securities Act of 1933, deemed to be liquid by the Board
of Trustees;
4. invest in the securities of other investment companies as defined in the
1940 Act except as permitted by applicable law;
5. invest in securities of issuers which, with their predecessors, have a
record of less than three years' continuous operations, if more than 5% of the
Portfolio's total assets would be invested in such securities (this restriction
shall not apply to mortgaged-backed securities, asset-backed securities or
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities);
6. hold securities of any issuer if more than 1/2 of 1% of the securities
of such issuer are owned beneficially by one or more officers or Trustees of the
Trust or by one or more partners or members of the Trust's underwriter or
investment adviser if these owners in the aggregate own beneficially more than
5% of the securities of such issuer;
7. invest in warrants if, at the time of the acquisition, its investment in
warrants, value at the lower of cost or market, would exceed 5% of the
Portfolio's total assets (included within such limitation, but not to exceed 2%
of the Portfolio's total assets, are warrants which are not listed on the New
York or American Stock Exchange or a major foreign exchange);
8. invest in real estate limited partnership interests or interests in oil,
gas or other mineral leases, or exploration or other development programs,
except that the Portfolio may invest in securities issued by companies that
engage in oil, gas or other mineral exploration or other development activities;
9. write, purchase or sell puts, calls, straddles, spreads or combinations
thereof, except to the extent permitted in the Portfolio's prospectus and
statement of additional information, as they may be amended from time to time;
or
10. buy from or sell to any of its officers, Trustees, employees, or its
investment adviser or any of its officers, directors, partners or employees, any
securities other than shares of the Portfolio's common stock.
NON-FUNDAMENTAL INVESTMENT LIMITATIONS - RIGGS STOCK, RIGGS SMALL COMPANY STOCK
AND RIGGS U.S. GOVERNMENT SECURITIES PORTFOLIOS
1. The Portfolios will not invest more than 15% of the value of their
respective net assets in illiquid securities, including repurchase agreements
providing for settlement more than seven days after notice, over-the-counter
options and certain restricted securities not determined by the Trustees to be
liquid.
2. Unless permitted by order of the Securities and Exchange Commission, the
Portfolios will limit their respective investment in other investment companies
to no more than 3% of the total outstanding voting stock of any investment
company, and will not invest more than 5% of their respective total assets in
any one investment company, or invest more than 10% of their respective total
assets in investment companies in general. The Portfolios will purchase
securities of closed-end investment companies only in open market transactions
involving only customary broker's commissions. However, these limitations are
not applicable if the securities are acquired in a merger, consolidation,
reorganization, or acquisition of assets.
3. A Portfolio will not enter into transactions for the purpose of engaging
in arbitrage.
4. A Portfolio will not purchase securities of a company for the purpose of
exercising control or management.
5. The Riggs U.S. Government Securities Portfolio will not invest in
warrants. The Riggs Stock and Riggs Small Company Stock Portfolios may not
invest more than 5% of their respective net assets in warrants, including those
acquired in units or attached to other securities. For purposes of this
investment restriction, warrants will be valued at the lower of cost or market,
except that warrants acquired by the Portfolios in units with or attached to
securities may be deemed to be without value.
DESCRIPTION OF SECURITIES RATINGS
A description of the securities ratings is contained in the Appendix to the
Statement of Additional Information.
MANAGEMENT OF THE TRUST
RESPONSIBILITIES OF TRUSTEES
The Board of Trustees of the Trust provides broad supervision over the affairs
of the Trust and the Portfolios. In carrying out their duties, the Trustees
follow the provisions of the Investment Company Act of 1940, the General Laws of
the Commonwealth of Massachusetts governing business trusts, the Declaration of
Trust of the Trust and its Bylaws. The Trustees approve contracts with the
investment adviser, custodians and other service providers on behalf of the
Portfolios. The Trustees also set broad policies for the management of the
assets of each Portfolio, including the pricing of securities owned by the
Portfolios and the policies governing investments by the Portfolios.
<TABLE>
<CAPTION>
OFFICERS AND TRUSTEES
MANAGEMENT OF THE TRUST
Principal Occupation During Past Five
Position(s) Held Years (and Positions held with Affiliated
Name, Address and Age with Registrant Persons or Principal Underwriters of the
--------------------- --------------- Registrant)
--------------------------------------------------------
<S> <C> <C>
Lorry J. Stensrud* President and Chief President of Cova Financial Services Life
One Tower Lane, Suite 3000 Executive Officer Insurance Company ("Cova
Oakbrook Terrace, IL 60181- Life") since June, 1995;
4644 prior thereto, Executive Vice
Age: 50 President of Cova
William C. Mair* Vice President, Vice President and Controller of Cova Life;
One Tower Lane, Suite 3000 Treasurer, Controller, Vice President, Treasurer and Controller of
Oakbrook, Terrace IL 60181- Chief Financial Officer, Cova Investment Advisory Corporation
4644 Chief Accounting Officer
Age: 58 and Trustee
Stephen M. Alderman Trustee Partner in the law firm of Garfield & Merel
211 West Wacker Drive
Chicago, IL 60606
Age: 40
Theodore A. Myers Trustee Senior Financial Advisor; formerly Chief
550 Washington Avenue Financial Officer of Qualitech Steel
Glencoe, IL 60022 Corporation, 1990-1994; Director of 34 Van
Age: 69 Kampen American Capital Mutual Funds;
member of Arthur Andersen C.F.O.
Advisory Committee.
Deborah A. Vohasek Trustee Principal, Vohasek Oetjen Marketing
7752 W. Lake Street
Morton Grove, IL 60053
Age: 36
R. Kevin Williams Trustee Partner in the law firm of O'Donnell, Byrne &
20 North Wacker Drive Williams from June 1993 through the
Chicago, IL 60606 present
Age: 46
William H. Wilton Vice President Vice President & Actuary of Cova Life; prior
One Tower Lane, Suite 3000 to October, 1992, Associate Actuary,
Oakbrook Terrace, IL 60181- Allstate Life Insurance Co., Northbrook, IL
4644
Age: 39
Bernard J. Spaulding Secretary Senior Vice President and General Counsel of
One Tower Lane, Suite 3000 Cova since March, 1999; Secretary of Cova
Oakbrook Terrace, IL 60181- since July 1, 1999; prior thereto, President of
4644 Delta Holdings
Age: 56
</TABLE>
* Interested person of the Trust within the meaning of the 1940 Act.
COMMITTEES
The Board has established two committees. The committees, their members and the
responsibilities of the committees are as follows:
Pricing Committee. The Pricing Committee has the responsibility of overseeing
the determination of the net asset value of the Portfolios and the calculation
of the value of any debt instrument, share of stock, or other Portfolio security
or asset. The members are as follows:
Drew Ahrens
William Flory
Terri Tanaka
Audit Committee. The Audit Committee makes recommendations to the Board
concerning the selection of the Trust's independent auditors and reviews with
such auditors the scope and results of the Trust's annual audit. The members are
as follows:
Stephen M. Alderman
Theodore A. Myers
Deborah A. Vohasek
R. Kevin Williams
COMPENSATION OF MANAGEMENT
Each Trustee of the Trust who is not an interested person of the Trust or
Adviser or Sub-Adviser receives an annual fee of $10,000 and an additional fee
of $1,000 for each Trustees' meeting attended. In addition, disinterested
Trustees who are members of any Board committees will receive a separate $1,000
fee for attendance of any committee meeting that is held on a day on which no
Board meeting is held.
The table below describes the compensation paid by the Trust during the
past fiscal year to each of the Trustees who is a not an interested person of
the Trust. None of the officers and no Trustee who is an interested person of
the Trust received compensation from the Trust during the past fiscal year.
<TABLE>
<CAPTION>
COMPENSATION TABLE
(1) (2) (3) (4) (5)
Total
Pension or Compensation
Retirement Estimated From Registrant
Aggregate Benefits Accrued Annual and Fund
Compensation As Part of Fund Benefits Upon Complex Paid to
Name of Person, From Registrant Expenses Retirement Trustees
Position
--------------------- --------------- ----------------- -------------- --------------------
<S> <C> <C> <C> <C>
William C. Mair, N/A N/A N/A N/A
Vice President, Treasurer,
Controller, Chief Financial
Officer, Chief Accounting
Officer and Trustee
Stephen M. Alderman, $15,000 N/A N/A $15,000
Trustee
Theodore A. Myers, $15,000 N/A N/A $15,000
Trustee
Deborah A. Vohasek, $15,000 N/A N/A $15,000
Trustee
R. Kevin Williams, $15,000 N/A N/A $15,000
Trustee
</TABLE>
SUBSTANTIAL SHAREHOLDERS
Shares of the Trust are issued and redeemed in connection with investments
in and payments under certain variable annuity contracts and variable life
insurance policies ("Variable Contracts") issued by Cova Financial Services Life
Insurance Company and/or its affiliated insurance companies. On March 31, 2000,
Cova Variable Annuity Account One, Cova Variable Life Account One and Cova
Variable Life Account Eight, separate accounts of Cova Financial Services Life
Insurance Company; Cova Variable Annuity Account Five and Cova Variable Life
Account Five, separate accounts of Cova Financial Life Insurance Company; and
First Cova Variable Annuity Account One, a separate account of First Cova Life
Insurance Company, together were known to the Board of Trustees and the
management of the Trust to own of record 99.71% of the Trust's shares.
OWNERSHIP BY CERTAIN BENEFICIAL OWNERS
Cova Life has advised the Trust that as of March 31, 2000, there were no
persons owning Variable Contracts which would entitle them to instruct Cova Life
with respect to more than 5% of the voting securities of the Trust.
CUSTODIAN
Investors Bank & Trust Company ("IBT"), 200 Clarendon Street, Boston,
Massachusetts 02116, is the custodian of the Trust and has custody of all
securities and cash of the Trust. The custodian, among other things, attends to
the collection of principal and income, and payment for and collection of
proceeds of securities bought and sold by the Trust. IBT also provides fund
administration and accounting services to the Trust and is the Trust's transfer
agent.
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.
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.
PERFORMANCE DATA
As required by regulations of the Securities and Exchange Commission, the
annualized total return of the Portfolios for a period is computed by assuming a
hypothetical initial payment of $1,000. It is then assumed that all of the
dividends and distributions by the Portfolio over the period are reinvested. It
is then assumed that at the end of the period, the entire amount is redeemed.
The annualized total return is then calculated by determining the annual rate
required for the initial payment to grow to the amount which would have been
received upon redemption.
Quotations of average annual total return for a Portfolio will be expressed
in terms of the average annual compounded rate of return of a hypothetical
investment in a Portfolio over a period of one, five and ten years (or, if less,
up to the life of a Portfolio, calculated pursuant to the formula:
n
P (1 + T) = ERV
Where:
P = a hypothetical initial payment of $1,000
T = an average annual total return
n = the number of years
ERV = the ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1, 5, or 10 year period at the end
of the 1, 5, or 10 year period (or fractional portion thereof)
From time to time, the investment adviser may reduce its compensation or assume
expenses in respect of the operations of a Portfolio in order to reduce the
Portfolio's expenses. Any such waiver or assumption would increase a Portfolio's
yield and total return during the period of the waiver or assumption.
Advertisements and other sales literature for the Portfolios may quote total
returns which are calculated for periods other than the 1-, 5- and 10-year
periods required by the Rules of the Securities and Exchange Commission or may
quote returns that do not reflect the deduction of all expenses incurred by a
Portfolio. The investment adviser may use these returns in advertising if the
investment adviser believes the nonstandard returns are useful. Nonstandard
returns are always accompanied by total returns calculated as required by Rules
of the Securities and Exchange Commission, which require performance to be
calculated for 1-, 5- and 10-year periods with the deduction of all expenses and
the assumption that all dividends and distributions are reinvested.
In addition, Portfolio performance may be advertised relative to certain indices
and benchmark investments. The composition of the investment in such indices are
the characteristics of such benchmark investments are not identical to, and in
some cases are very different from, those of a Portfolio. These indices and
averages are generally unmanaged and the items included in the calculations of
such indices and averages may be different from those of the equations used by
the Trust to calculate a Portfolio's performance figures.
A Portfolio's investment results will vary from time to time depending upon
market conditions, the composition of its investment portfolio and its operating
expenses. The effective yield and total return for a Portfolio should be
distinguished from the rate of return of a corresponding division of Cova Life's
separate account, which rate will reflect the deduction of additional charges,
including mortality and expense risk charges, and will therefore be lower.
Accordingly, performance figures for a Portfolio will only be advertised if
comparable performance figures for the corresponding division of the separate
account are included in the advertisements. Contract owners should consult the
Contract prospectus for further information. Each Portfolio's results also
should be considered relative to the risks associated with its investment
objectives and policies.
LEGAL COUNSEL AND INDEPENDENT AUDITORS
Blazzard, Grodd & Hasenauer, P.C., Westport, Connecticut is counsel to the
Trust and passes upon the legality of the Trust's shares.
The independent auditors for the Trust are KPMG LLP, 99 High Street,
Boston, Massachusetts 02110.
INVESTMENT ADVISORY AGREEMENT
Cova Investment Advisory Corporation (the "Investment Adviser"), One Tower
Lane, Suite 3000, Oakbrook Terrace, Illinois 60181-4644 is an Illinois
corporation which was incorporated on August 31, 1993 under the name Oakbrook
Investment Advisory Corporation and which is registered with the Securities and
Exchange Commission as an investment adviser under the Investment Advisers Act
of 1940.
The Investment Adviser commenced providing investment advisory services to
all Portfolios of the Trust as of May 1, 1996 pursuant to an Investment Advisory
Agreement dated April 1, 1996, as amended ("Investment Advisory Agreement").
Prior to this date, Van Kampen American Capital Investment Advisory Corp. had
acted as the investment adviser to all Portfolios of the Trust. The Investment
Advisory Agreement was most recently approved by the Board of Trustees on
November 12, 1999. The Investment Advisory Agreement was most recently approved
by the shareholders of each of the Portfolios of the Trust at a Special Meeting
of Shareholders held on January 6, 2000.
As described in the Prospectus, the Investment Adviser has retained Sub-
Advisers to assist it in managing the Portfolios. The Sub-Advisory Agreements
between the Investment Adviser and each of the Sub-Advisers were approved most
recently by the Board of Trustees on November 12, 1999 and by the shareholders
of each of the Portfolios of the Trust at a Special Meeting of Shareholders held
on January 6, 2000.
Under the terms of the Investment Advisory Agreement, the Investment
Adviser is obligated to (i) manage the investment and reinvestment of the assets
of each Portfolio of the Trust in accordance with each Portfolio's investment
objective and policies and limitations, or (ii) in the event that the Investment
Adviser shall retain a sub-adviser or sub-advisers, to supervise and implement
the investment activities of any Portfolio for which any such sub-adviser has
been retained, including responsibility for overall management and
administrative support including managing, providing for and compensating any
sub-advisers; and to administer the Trust's affairs. The Investment Advisory
Agreement further provides that the Investment Adviser agrees, among other
things, to administer the business affairs of each Portfolio, to furnish offices
and necessary facilities and equipment to each Portfolio, to provide
administrative services for each Portfolio, to render periodic reports to the
Board of Trustees of the Trust with respect to each Portfolio, and to permit any
of its officers or employees, or those of any sub-adviser to serve without
compensation as trustees or officers of the Portfolio if elected to such
positions.
The Investment Advisory Agreement provides that the Investment Adviser will
not be liable for any error in judgment or of law, or for any loss suffered by
the Trust in connection with the matters to which the agreement relates, except
a loss resulting from willful misfeasance, bad faith, or gross negligence on the
part of the Investment Adviser in the performance of its obligations and duties,
or by reason of its reckless disregard of its obligations and duties under the
Agreement.
The Investment Adviser's activities are subject to the review and
supervision of the Trust's Trustees to whom the Investment Adviser renders
periodic reports of the Trust's investment activities.
The Investment Advisory Agreement may be terminated without penalty upon 60
days written notice by either party and will automatically terminate in the
event of assignment.
Compensation. The Investment Adviser receives a fee from the Trust for its
services as investment adviser as described in the Prospectus.
The Investment Adviser calculates the fee each day that the New York Stock
Exchange is open for business based on the net asset value determined for that
day.
The fee accrues daily and is paid monthly. The Investment Adviser received the
following fees from each Portfolio during the past three fiscal years.
<TABLE>
<CAPTION>
Name of
Portfolio Fiscal Year Ended
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Quality Bond Portfolio $ 505,285 $ 165,294 $ 56,257
Small Cap Stock Portfolio $ 687,540 $ 596,903 $ 292,360
Large Cap Stock Portfolio $ 1,479,955 $ 402,802 $ 130,631
Select Equity Portfolio $ 1,507,688 $1,023,054 $450,572
International Equity Portfolio $ 905,709 $ 717,933 $ 349,944
Bond Debenture Portfolio $ 1,210,327 $ 647,086 $ 196,145
Mid-Cap Value Portfolio $ 247,340 $ 92,358 $ 2,150
Large Cap Research Portfolio $ 241,534 $ 61,036 $ 1,521
Developing Growth Portfolio $ 203,145 $ 67,992 $ 1,753
Balanced Portfolio $ 73,532 $ 27,149 $ 6,200
Equity Income Portfolio $ 62,362 $ 30,163 $ 6,707
Growth & Income Equity Portfolio $ 131,419 $ 53,799 $ 8,283
Lord Abbett Growth & Income
Portfolio $ 5,289,797 N/A N/A
Riggs Stock Portfolio $ 231 N/A N/A
Riggs U.S. Government Securities
Portfolio $ 368 N/A N/A
</TABLE>
The Investment Adviser received no advisory fee with respect to the Emerging
Markets Equity Portfolio or the Riggs Small Company Stock Portfolio through
December 31, 1999 in that these Portfolios had not yet commenced investment
operations as of that date.
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, 1999, the expenses, taking into account the
waivers and expense assumptions, borne by the Bond Debenture Portfolio amounted
to $1,371,690 or .85% of its average net assets on an annualized basis; the net
expenses borne by the Quality Bond Portfolio amounted to $600,321 or .64% of its
average net assets on an annualized basis; the net expenses borne by the
International Equity Portfolio amounted to $1,253,973 or 1.10% of its average
net assets on an annualized basis; the net expenses borne by the Select Equity
Portfolio amounted to $1,737,044 or .77% of its average net assets on an
annualized basis; the net expenses borne by the Large Cap Stock Portfolio
amounted to $1,704,505 or .75% of its average net assets on an annualized basis;
the net expenses borne by the Small Cap Stock Portfolio amounted to $847,429 or
1.05% of its average net assets on an annualized basis; the net expenses borne
by the Balanced Portfolio amounted to $80,904 or 1.10% of its average net assets
on an annualized basis; the net expenses borne by the Equity Income Portfolio
amounted to $68,615 or 1.10% of its average net assets on an annualized basis;
the net expenses borne by the Growth & Income Equity Portfolio amounted to
$144,592 or 1.10% of its average net assets on an annualized basis; the net
expenses borne by the Mid-Cap Value Portfolio amounted to $308,331 or 1.25% of
its average net assets on an annualized basis; the net expenses borne by the
Large Cap Research Portfolio amounted to $301,679 or 1.25% of its average net
assets on an annualized basis; the net expenses borne by the Developing Growth
Portfolio amounted to $259,188 or 1.15% of its average net assets on an
annualized basis;; the net expenses borne by the Lord Abbett Growth and Income
Portfolio amounted to $5,736,259 or .70% of its average net assets on an
annualized basis; the net expenses borne by the Riggs Stock Portfolio amounted
to $255 or 1.05% of its average net assets on an annualized basis; and the net
expenses borne by the Riggs U.S. Government Securities Portfolio amounted to
$417 or .85% of its average net assets on an annualized basis.
Cova Life and/or the Adviser and/or the Sub-Adviser(s) may at their discretion,
but are not obligated to, assume all or any portion of Trust expenses. For the
year ended December 31, 1999, Cova Life and the Adviser together assumed
expenses of $59,975, with respect to the Quality Bond Portfolio; $55,853, with
respect to the International Equity Portfolio; $21,437 with respect to the Bond
Debenture Portfolio; $412, with respect to the Select Equity Portfolio; $21,826,
with respect to the Large Cap Stock Portfolio; $32,598, with respect to the
Small Cap Stock Portfolio; $70,427 with respect to the Balanced Portfolio;
$70,417 with respect to the Equity Income Portfolio; $64,401 with respect to the
Growth & Income Equity Portfolio;
$39,659 with respect to the Mid-Cap Value Portfolio; $31,960 with respect to the
Large Cap Research Portfolio; $42,877 with respect to the Developing Growth
Portfolio; $23,044 with respect to the Riggs Stock Portfolio; and $24,025 with
respect to the Riggs U.S. Government Securities Portfolio.
CODE OF ETHICS
To mitigate the possibility that a Portfolio will be adversely affected by
personal trading of employees, the Trust, the Adviser and the Sub-Advisers have
adopted Codes of Ethics under Rule 17j-1 of the 1940 Act. These Codes contain
policies restricting securities trading in personal accounts of the portfolio
managers and others who normally come into possession of information on
portfolio transactions. These Codes comply, in all material respects, with the
recommendations of the Investment Company Institute. Employees subject to the
Codes of Ethics may invest in securities for their own investment accounts,
including securities that may be purchased or held by the Trust.
SUB-ADVISERS
Appointment. The Investment Adviser has entered into agreements with registered
investment advisers to carry out the management of the assets of the Portfolios
based on the investment objectives and policies of the Portfolios. The
Sub-Advisers are responsible for deciding which securities to purchase and sell
for the Portfolios and for placing trades for those securities. The prospectus
provides more information about the Sub-Advisers.
Compensation. The Investment Adviser pays the Sub-Advisers fees for their
services, as described in the Prospectus, out of the compensation the Investment
Adviser receives from each Portfolio.
INVESTMENT DECISIONS
Investment decisions for the Trust and for the other investment advisory
clients of the Sub-Advisers are made with a view to achieving their respective
investment objectives and after consideration of such factors as their current
holdings, availability of cash for investment, and the size of their investments
generally. Frequently, a particular security may be bought or sold for only one
client or in different amounts and at different times for more than one but less
than all clients. Likewise, a particular security may be bought for one or more
clients when one or more other clients are selling the security. In addition,
purchases or sales of the same security may be made for two or more clients of a
Sub-Adviser on the same day. In such event, such transactions will be allocated
among the clients in a manner believed by the Sub- Adviser to be equitable to
each. In some cases, this procedure could have an adverse effect on the price or
amount of the securities purchased or sold by the Trust. Purchase and sale
orders for the Trust may be combined with those of other clients of a
Sub-Adviser in the interest of achieving the most favorable net results for
the Trust.
PORTFOLIO TRANSACTIONS
Transactions on U.S. stock exchanges and other agency transactions involve
the payment by the Trust of negotiated brokerage commissions. Such commissions
vary among different brokers. Also, a particular broker may charge different
commissions according to such factors as the difficulty and size of the
transaction. Transactions in foreign securities often involve the payment of
fixed brokerage commissions, which are generally higher than those in the United
States. There is generally no stated commission in the case of securities traded
in the over-the-counter markets, but the price paid by the Trust usually
includes an undisclosed dealer commission or mark-up. In underwritten offerings,
the price paid by the Trust includes a disclosed, fixed commission or discount
retained by the underwriter or dealer. It is currently intended that the
Sub-Advisers will place all orders for the purchase and sale of portfolio
securities for the Trust and buy and sell securities for the Trust through a
substantial number of brokers and dealers. In so doing, the Sub-Advisers will
use their best efforts to obtain for the Trust the best price and execution
available. In seeking the best price and execution, the Sub-Advisers, having in
mind the Trust's best interests, will consider all factors they deem relevant,
including, by way of illustration, price, the size of the transaction, the
nature of the market for the security, the amount of the commission, the timing
of the transaction taking into account market prices and trends, the reputation,
experience, and financial stability of the broker-dealer involved, and the
quality of service rendered by the broker-dealer in other transactions.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive research, statistical, and quotation services from broker-dealers who
execute portfolio transactions for the clients of such advisers. Consistent with
this practice, the Sub-Advisers may receive research, statistical, and quotation
services from any broker-dealers with whom they place the Trust's portfolio
transactions. These services, which in some cases may also be purchased for
cash, include such matters as general economic and security market reviews,
industry and company reviews, evaluations of securities, and recommendations as
to the purchase and sale of securities. Some of these services may be of value
to the Sub-Advisers and/or their affiliates in advising various other clients
(including the Trust), although not all of these services are necessarily useful
and of value in managing the Trust. The management fees paid by the Trust are
not reduced because the Sub-Advisers and/or their affiliates may receive such
services. As permitted by Section 28(e) of the Securities Exchange Act of 1934,
a Sub-Adviser may cause a Portfolio to pay a broker-dealer who provides
brokerage and research services to the Sub-Adviser an amount of disclosed
commission for effecting a securities transaction for the Portfolio in excess of
the commission which another broker-dealer would have charged for effecting that
transaction provided that the Sub-Adviser determines in good faith that such
commission was reasonable in relation to the value of the brokerage and research
services provided by such broker-dealer viewed in terms of that particular
transaction or in terms of all of the accounts over which investment discretion
is so exercised. A Sub-Adviser's authority to cause a Portfolio to pay any such
greater commissions is also subject to such policies as the Adviser or the
Trustees may adopt from time to time.
Commissions Paid by the Portfolios. The following are the aggregate amounts of
commissions paid by each of the Portfolios for brokerage during the past three
fiscal years:
<TABLE>
<CAPTION>
Name of Fiscal Year Ended
Portfolio
1999 1998 1997
---- ---- ----
<S> <C>
Quality Bond Portfolio $ 10,634 N/A N/A
Small Cap Stock Portfolio $ 128,288 $ 91,650 $ 69,720
Large Cap Stock Portfolio $ 174,716 $ 59,636 $ 18,544
Select Equity Portfolio $ 564,579 $437,251 $ 174,538
International Equity Portfolio $ 267,666 $255,634 $ 280,279
Bond Debenture Portfolio $ 5,341 $ 3,461 N/A
Mid-Cap Value Portfolio $ 109,084 $ 53,000 $ 3,986
Large Cap Research Portfolio $ 54,923 $ 23,532 $ 1,399
Developing Growth Portfolio $ 25,992 $ 15,664 $ 1,204
Balanced Portfolio $ 6,617 $ 3,945 $ 1,215
Equity Income Portfolio $ 12,897 $ 10,665 $ 2,451
Growth & Income Equity
Portfolio $ 16,692 $ 13,871 $ 3,580
Lord Abbett Growth and Income
Portfolio $1,325,443 N/A N/A
Riggs Stock Portfolio $ 320 N/A N/A
Riggs U.S. Government Securities
Portfolio N/A N/A N/A
</TABLE>
FINANCIAL STATEMENTS
The Financial Statements and notes thereto for the year ended December 31, 1999
and the independent auditors' report thereon appear in the Trust's Annual Report
for the year ended December 31, 1999, which is incorporated by reference into
this Statement of Additional Information. The Trust delivers a copy of the
Annual Report to investors. In addition, the Trust will furnish, without charge,
additional copies of such Annual Report and copies of the Statement of
Additional Information to investors which may be obtained without charge by
calling the Life Company at (800) 831-LIFE.
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 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, B, CCC, CC - Debt rated 'BB', 'B', 'CCC', or 'CC' is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. 'BB'
indicates the lowest degree of speculation and 'CC' the highest degree of
speculation. While such 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.
COMMERCIAL PAPER RATINGS
COMMERCIAL PAPER
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. The four categories are as
follows:
A Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated
with the numbers 1, 2 and 3 to indicate the relative degree of safety.
Those issues determined to possess overwhelming safety characteristics
are denoted with a plus (+) sign designation.
A-1 This designation indicates that the degree of safety regarding timely
payment is very strong.
A-2 Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for
issues designated "A- 1."
A-3 Issues carrying this designation have a satisfactory capacity for
timely of payment. They are, however, somewhat more vulnerable to the
adverse effects changes in circumstances than obligations carrying the
higher designations.
B Issues rated "B" are regarded as having only an adequate capacity for
timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.
C&D These ratings indicate that the issue is either in default or is
expected to be in default upon maturity.
Moody's commercial paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs the following three designations, all
judged to be investment grade, to indicate the relative repayment capacity of
rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations.
Issuers rated Prime-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations.
Issuers rated Not Prime do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+." "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment. Liquidity
factors are excellent and supported by good fundamental protection factors. Risk
factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity factors
are strong and supported by good fundamental protection factors. Risk factors
are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity factors
and company fundamentals are sound. Although ongoing funding needs may enlarge
total financing requirements, access to capital markets is good. Risk factors
are small.
"D-3" - Debt possesses satisfactory liquidity, and other protection factors
qualify issue as investment grade. Risk factors are larger and subject to more
variation. Nevertheless, timely payment is expected.
"D-4" - Debt possesses speculative investment characteristics. Liquidity is
not sufficient to ensure against disruption in debt service. Operating factors
and market access may be subject to a high degree of variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years. The following
summarizes the rating categories used by Fitch for short-term obligations:
"F-1+" - Securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
"F-1" - Securities possess very strong credit quality. Issues assigned this
rating reflect an assurance of timely payment only slightly less in degree than
issues rated "F- 1+."
"F-2" - Securities possess good credit quality. Issues assigned this rating
have a satisfactory degree of assurance for timely payment, but the margin of
safety is not as great as the "F-1+" and "F-1" categories.
"F-3" - Securities possess fair credit quality. Issues assigned this rating
have characteristics suggesting that the degree of assurance for timely payment
is adequate; however, near-term adverse changes could cause these securities to
be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this rating
have characteristics suggesting a minimal degree of assurance for timely payment
and are vulnerable to near-term adverse changes in financial and economic
conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to indicate
that the rating is based upon a letter of credit issued by a commercial bank.
Thomson BankWatch short-term ratings assess the likelihood of an untimely
or incomplete payment of principal or interest of unsubordinated instruments
having a maturity of one year or less which are issued by United States
commercial banks, thrifts and non-bank banks; non-United States banks; and
broker-dealers. The following summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest rating
category and indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade category
and indicates that while the debt is more susceptible to adverse developments
(both internal and external) than obligations with higher ratings, capacity to
service principal and interest in a timely fashion is considered adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an original
maturity of less than one year which is issued by bank holding companies and
their principal bank subsidiaries. The following summarizes the rating
categories used by IBCA for short-term debt ratings:
"A1+" - Obligations supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by a strong capacity for timely repayment.
"A2" - Obligations are supported by a satisfactory capacity for timely
repayment, although such capacity may be susceptible to adverse changes in
business, economic or financial conditions.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
Such capacity is more susceptible to adverse changes in business, economic or
financial conditions than for obligations in higher categories.
"B" - Obligations for which the capacity for timely repayment is
susceptible to adverse changes in business, economic or financial conditions.
"C" - Obligations for which there is an inadequate capacity to ensure
timely repayment.
"D" - Obligations which have a high risk of default or which are currently
in default.
VARIABLE RATE DEMAND BOND RATINGS
Standard & Poor's assigns "dual" ratings to all long-term debt issues that
have as part of their provisions a variable rate demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, 'AAA/A-1') or if the nominal maturity is short, a rating of
'SP-1+/AAA' is assigned.
NOTES
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive a
note rating. Notes maturing beyond 3 years will most likely receive a long-term
debt rating. The following criteria will be used in making that assignment:
- - Amortization schedule (the longer the final maturity relative to other
maturities the more likely it will be treated as a note).
- - Source of payment (the more dependent the issue is on the market for
its refinancing, the more likely it will be treated as a note). Note rating
symbols are as follows:
SP-1 Very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be given a
plus (+) designation.
SP-2 Satisfactory capacity to pay principal and interest.
SP-3 Speculative capacity to pay principal and interest.
PREFERRED STOCK RATINGS (STANDARD & POOR'S)
AAA This is the highest rating that may be assigned by Standard & Poor's to
a preferred stock issue and indicates an extremely strong capacity to pay the
preferred stock obligations.
AA A preferred stock issue rated 'AA' also qualifies as a high-quality
fixed income security. The capacity to pay preferred stock obligations is very
strong, although not as overwhelming as for issues rated 'AAA'.
A An issue rated 'A' is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions.
BBB An issue rated 'BBB' is regarded as backed by an adequate capacity to
pay the preferred stock obligations. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to make payments for a preferred
stock in this category than for issues in the 'A' category.
BB Preferred stock rated 'BB', 'B' and 'CCC' is regarded, on balance, as
B Predominantly speculative with respect to the issuer's capacity to pay
CCC preferred stock obligations. 'BB' indicates the lowest degree of
speculation and 'CCC' the highest degree of speculation. While such issues will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
CC The rating 'CC' is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments, but that is currently paying.
C A preferred stock rated 'C' is a non-paying issue.
D A preferred stock rated 'D' is a non-paying issue with the issuer in
default on debt instruments.
PLUS (+) OR MINUS (-): To provide more detailed indications of preferred
stock quality, the ratings from 'AA' to 'B' may be modified by the addition of a
plus or minus sign to show relative standing within the major rating categories.
NR This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
A preferred stock rating is not a recommendation to purchase, sell, or hold
a security inasmuch as it does not comment as to market price or suitability for
a particular investor. The ratings are based on current information furnished to
S&P by the issuer or obtained by S&P from other sources it considers reliable.
S&P does not perform an audit in connection with any rating and may, on
occasion, rely on unaudited financial information. The ratings may be changed,
suspended, or withdrawn as a result of changes in, or unavailability of, such
information, or based on other circumstances.
MOODY'S INVESTORS SERVICE, INC. - A brief description of the applicable
Moody's Investors Service, Inc. rating symbols with respect to preferred stock
and their meanings (as published by Moody's Investors Service, Inc.) follows:
PREFERRED STOCK RATINGS (MOODY'S)
Preferred stock rating symbols and their definitions are as follows:
aaa: An issue which is rated 'aaa' is considered to be a top-quality
preferred stock. This rating indicates good asset protection and the least risk
of dividend impairment within the universe of preferred stocks.
aa: An issue which is rated 'aa' is considered a high-grade preferred
stock. This rating indicates that there is a reasonable assurance the earnings
and asset protection will remain relatively well maintained in the foreseeable
future.
a: An issue which is rated 'a' is considered to be an upper-medium
preferred stock. While risks are judged to be somewhat greater than in the 'aaa'
and 'aa' classifications, earnings and asset protection are, nevertheless,
expected to be maintained at adequate levels.
baa: An issue which is rated 'baa' is considered to be a medium grade
preferred stock, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time.
ba: An issue which is rated 'ba' is considered to have speculative elements
and its future cannot be considered well assured. Earnings and asset protection
may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class.
b: An issue which is rated 'b' generally lacks the characteristics of a
desirable investment. Assurance of dividend payments and maintenance of other
terms of the issue over any long period of time may be small.
caa: An issue which is rated 'caa' is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future status
of payments.
ca: An issue which is rated 'ca' is speculative in a high degree and is
likely to be in arrears on dividends with little likelihood of eventual payment.
c: This is the lowest rated class of preferred or preference stock. Issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
NOTE: Beginning May 3, 1982, Moody's began applying numerical modifiers 1,
2 and 3 in each rating classification from "aa" through "b" in its preferred
stock rating system. The modifier 1 indicates that the security ranks in the
higher end of its generic rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates that the issue ranks in the lower end of
its generic rating category.
