PORTICO FUNDS, INC.
Statement of Additional Information
Short-Term Bond Market Fund Balanced Fund Growth Fund
Intermediate Bond Market Fund Growth and Income Fund Special Growth Fund
Tax-Exempt Intermediate Equity Index Fund International
Bond Fund Equity Fund
Bond IMMDEX/tm Fund
February 28, 1997 (as revised September 2, 1997)
TABLE OF CONTENTS
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Page
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Portico Funds............................................... 2
Investment Objectives and Policies.......................... 2
Net Asset Value............................................. 29
Additional Purchase and Redemption Information.............. 30
Description of Shares....................................... 34
Additional Information Concerning Taxes..................... 36
Management of the Company................................... 39
Custodian, Transfer Agent and Accounting Services Agent..... 49
Expenses.................................................... 50
Independent Accountants..................................... 50
Counsel..................................................... 51
Additional Information on Performance ...................... 51
Miscellaneous............................................... 56
Appendix A.................................................. A-1
Appendix B.................................................. B-1
This Statement of Additional Information is meant to be read in conjunction
with the Portico Funds' Prospectuses dated February 28, 1997, for the
Institutional and Retail Shares of the Short-Term Bond Market Fund, Intermediate
Bond Market Fund, Tax-Exempt Intermediate Bond Fund, Bond IMMDEX/tm Fund,
Balanced Fund, Growth and Income Fund, Equity Index Fund, Growth Fund, Special
Growth Fund, and International Equity Fund (collectively referred to as the
"Funds") and is incorporated by reference in its entirety into the Prospectuses.
Because this Statement of Additional Information is not itself a prospectus, no
investment in shares of these Funds should be made solely upon the information
contained herein. Copies of the Prospectus for the Funds may be obtained by
writing Portico Investor Services at 615 East Michigan Street, P.O. Box 3011,
Milwaukee, WI 53201-3011 or by calling 1-800-982-8909 or 414-287-3710
(Milwaukee area). Capitalized terms used but not defined herein have the same
meanings as in the Prospectus.
SHARES OF THE FUNDS ARE NOT BANK DEPOSITS, AND ARE NEITHER ENDORSED BY,
INSURED BY, GUARANTEED BY, OBLIGATIONS OF, NOR OTHERWISE SUPPORTED BY THE FDIC,
THE FEDERAL RESERVE BOARD, FIRSTAR INVESTMENT RESEARCH & MANAGEMENT COMPANY,
LLC, FIRSTAR TRUST COMPANY, FIRSTAR CORPORATION, ITS AFFILIATES OR ANY OTHER
BANK, OR OTHER GOVERNMENTAL AGENCY. AN INVESTMENT IN THE PORTICO FUNDS INVOLVES
RISKS INCLUDING POSSIBLE LOSS OF PRINCIPAL.
PORTICO FUNDS
Portico Funds, Inc. (the "Company") is a Wisconsin corporation which was
incorporated on February 15, 1988 as a management investment company. The
Company is authorized to issue separate classes of shares of Common Stock
representing interests in separate investment portfolios. Each class for the
Funds is currently divided into two series, a retail and institutional series.
This Statement of Additional Information pertains to Retail Series and
Institutional Series Shares of ten diversified portfolios, the Short-Term Bond
Market Fund, Intermediate Bond Market Fund, Tax-Exempt Intermediate Bond Fund,
Bond IMMDEX/tm Fund, Balanced Fund, Growth and Income Fund, Equity Index Fund,
Growth Fund, Special Growth Fund, and International Equity Fund (collectively
the "Funds"). The Short-Term Bond Market Fund changed its name from Short-
Intermediate Fixed Income Fund effective January 1, 1993. The Growth and Income
Fund changed its name from the Income and Growth Fund effective August 16, 1993.
The Growth Fund changed its name from the Growth Fund effective May 30, 1997.
The Balanced Fund commenced operations on March 30, 1992; the Growth and Income
Fund, Equity Index Fund, Short-Term Bond Market Fund and Bond IMMDEX/tm Fund
commenced operations on December 29, 1989; the Special Growth Fund commenced
operations on December 28, 1989; the Growth Fund commenced operations on
December 29, 1992; the Intermediate Bond Market Fund commenced operations on
January 5, 1993; the Tax-Exempt Intermediate Bond Fund commenced operations on
February 8, 1993; and the International Equity Fund commenced operations on
April 28, 1994. The Company also offers other investment portfolios which are
described in separate Prospectuses and Statements of Additional Information.
For information concerning these other portfolios contact the Portico Investor
Services at 1-800-982-8909 or write to 615 East Michigan Street, P.O. Box 3011,
Milwaukee, Wisconsin 53201-3011.
INVESTMENT OBJECTIVES AND POLICIES
The investment objective of the Short-Term Bond Market Fund is to seek to
provide an annual rate of total return, before Fund expenses, comparable to the
annual rate of total return on the Lehman Brothers 1-3 Year Government Corporate
Bond Index. The investment objective of the Intermediate Bond Market Fund is to
seek to provide an annual rate of total return, before Fund expenses, comparable
to the annual rate of total return on the Lehman Brothers Intermediate
Government/Corporate Bond Index. The investment objective of the Tax-Exempt
Intermediate Bond Fund is to seek to provide current income that is
substantially exempt from federal income tax and emphasize total return with
relatively low volatility of principal. The investment objective of the Bond
IMMDEX/tm Fund is to seek to provide an annual rate of total return, before Fund
expenses, comparable to the annual rate of total return on the Lehman Brothers
Government Corporate Bond Index. The investment objective of the Balanced Fund
is to seek capital appreciation and current income with low volatility of
capital. The investment objective of the Growth and Income Fund is to seek both
reasonable income and long-term capital appreciation. The investment objective
of the Equity Index Fund is to seek returns, before Fund expenses, comparable to
the price and yield performance of publicly-traded common stocks in the
aggregate, as represented by the S&P 500. The investment objective of the
Growth Fund is to seek capital appreciation through investment in securities of
medium- to large-sized companies. The investment objective of the Special
Growth Fund is to seek capital appreciation through investment in securities of
medium-sized companies. The investment objective of the International Equity
Fund is to seek capital appreciation through investment in foreign securities
of companies and governments which the Sub-Adviser believes are undervalued.
There is no assurance, however, that the Funds' investment objectives will in
fact be attained. The following policies supplement the Funds' respective
investment objectives and policies as set forth in the Prospectus.
Portfolio Transactions
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Subject to the general supervision of the Board of Directors, the Adviser
is responsible for, makes decisions with respect to, and places orders for all
purchases and sales of portfolio securities for each Fund except the
International Equity Fund. Subject to the general supervision of the Board of
Directors, the Adviser is responsible for the portfolio management of the
International Equity Fund. Pursuant to the terms of the Adviser's Advisory
Agreement with the Fund, the Adviser has delegated certain of its duties to
Hansberger Global Investors, Inc. (the "Sub-Adviser" or "Hansberger Global").
Within the framework of the investment objectives, policies and restrictions of
the Fund, and subject to the supervision of the Adviser, the Sub-Adviser is
responsible for, makes decisions with respect to, and places orders for all
purchases and sales of portfolio securities for the International Equity Fund.
The portfolio turnover rate for each Fund is calculated by dividing the
lesser of purchases or sales of portfolio securities for the reporting period by
the monthly average value of the portfolio securities owned during the reporting
period. The calculation excludes all securities, including options, whose
maturities or expiration dates at the time of acquisition are one year or less.
Portfolio turnover may vary greatly from year to year as well as within a
particular year, and may be affected by cash requirements for redemption of
shares and by requirements which enable the Funds to receive favorable tax
treatment. Portfolio turnover will not be a limiting factor in making portfolio
decisions, and each Fund may engage in short-term trading to achieve its
investment objective.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Unlike transactions on
U.S. stock exchanges which involve the payment of negotiated brokerage
commissions, transactions in foreign securities generally involve the payment of
fixed brokerage commissions which are generally higher than those in the United
States.
Transactions in the over-the-counter market are generally principal
transactions with dealers and the costs of such transactions involve dealer
spreads rather than brokerage commissions. With respect to over-the-counter
transactions, the Adviser and Sub-Adviser will normally deal directly with
dealers who make a market in the securities involved except in those
circumstances where better prices and execution are available elsewhere or as
described below.
Securities purchased and sold by the Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Tax-Exempt Intermediate Bond Fund and Bond
IMMDEX/tm Fund are generally traded in the over-the-counter market on a net
basis (i.e., without commission) through dealers, or otherwise involve
transactions directly with the issuer of an instrument. The cost of securities
purchased from underwriters includes an underwriting commission or concession,
and the prices at which securities are purchased from and sold to dealers
include a dealer's mark-up or mark-down.
The Funds may participate, if and when practicable, in bidding for the
purchase of portfolio securities directly from an issuer in order to take
advantage of the lower purchase price available to members of a bidding group.
The Funds will engage in this practice, however, only when the Adviser or Sub-
Adviser, in its sole discretion, believes such practice to be in the Funds'
interests.
For the fiscal years ended October 31, 1996, 1995, and 1994, the Company
paid brokerage commissions of $364,819, $226,925, and $202,429 with respect to
the Growth and Income Fund (including commissions of $16,262 on $8,134,565 in
brokerage transactions paid because of services provided in 1994); $1,128,115,
$714,710, and 556,029 with respect to the Special Growth Fund; and $109,625,
$41,610, and $55,904 with respect to the Equity Index Fund, respectively. For
the same periods, the Short-Term Bond Market and Bond IMMDEX/tm Funds paid no
brokerage commissions. For the fiscal years ended October 31, 1996, 1995 and
1994, the Company paid brokerage commissions of $161,362, $128,583, and
$117,641 with respect to the Balanced Fund (including commissions of $35,713 on
$14,573,796 in brokerage transactions paid because of services provided in
1994). For the fiscal years ended October 31, 1996, 1995 and 1994, the Company
paid brokerage commissions of $224,353, $190,681, and $135,711 with respect to
the Growth Fund (including commissions of $31,722 on $12,936,494 in brokerage
transactions paid because of services provided in 1994). The Intermediate Bond
Market and Tax-Exempt Intermediate Bond Funds paid no brokerage commissions for
the fiscal years ended October 31, 1996, 1995 and 1994. For the fiscal years
ended October 31, 1996, 1995, and 1994 the Company paid brokerage commissions of
$40,498, $23,067, and $21,346 with respect to the International Equity Fund.
None of the brokerage commissions were paid to affiliates of the Company, the
Adviser, Sub-Adviser or the Co-Administrator.
The Advisory Agreement between the Company and the Adviser and with respect
to the International Equity Fund, the Sub-Advisory Agreement among the Company,
the Adviser and Sub-Adviser, provides that, in executing portfolio transactions
and selecting brokers or dealers, the Adviser and Sub-Adviser will seek to
obtain the best overall terms available. In assessing the best overall terms
available for any transaction, the Adviser or Sub-Adviser shall consider factors
it deems relevant, including the breadth of the market in the security, the
price of the security, the financial condition and execution capability of the
broker or dealer, and the reasonableness of the commissions, if any, both for
the specific transaction and on a continuing basis. In addition, the Agreements
authorize the Adviser and Sub-Adviser to cause the Funds to pay a broker-dealer
which furnishes brokerage and research services a higher commission than that
which might be charged by another broker-dealer for effecting the same
transaction, provided that the Adviser or Sub-Adviser determines in good faith
that such commission is reasonable in relation to the value of the brokerage and
research services provided by such broker-dealer, viewed in terms of either the
particular transaction or the overall responsibilities of the Adviser and Sub-
Adviser to the Funds. Such brokerage and research services might consist of
reports and statistics relating to specific companies or industries, general
summaries of groups of stocks or bonds and their comparative earnings and
yields, or broad overviews of the stock, bond and government securities markets
and the economy.
Supplementary research information so received is in addition to, and not
in lieu of, services required to be performed by the Adviser or Sub-Adviser and
does not reduce the advisory fees payable to it by the Funds. The Directors
will periodically review the commissions paid by the Funds to consider whether
the commissions paid over representative periods of time appear to be reasonable
in relation to the benefits inuring to the Funds. It is possible that certain
of the supplementary research or other services received will primarily benefit
one or more other investment companies or other accounts for which investment
discretion is exercised. Conversely, a Fund may be the primary beneficiary of
the research or services received as a result of portfolio transactions effected
for such other account or investment company.
Portfolio securities will not be purchased from or sold to (and savings
deposits will not be made in and repurchase and reverse repurchase agreements
will not be entered into with) the Adviser, the Sub-Adviser, and the Distributor
or an affiliated person of any of them (as such term is defined in the 1940 Act)
acting as principal. In addition, the Funds will not purchase securities during
the existence of any underwriting or selling group relating thereto of which the
Distributor or its Adviser, or an affiliated person of any of them, is a member,
except to the extent permitted by the Securities and Exchange Commission
("SEC").
Investment decisions for the Funds are made independently from those for
other investment companies and accounts advised or managed by its Adviser or
Sub-Adviser. Such other investment companies and accounts may also invest in
the same securities as the Funds. When a purchase or sale of the same security
is made at substantially the same time on behalf of a Fund and another
investment company or account, the transaction will be averaged as to price and
available investments allocated as to amount, in a manner which the Adviser or
Sub-Adviser believes to be equitable to the Fund and such other investment
company or account. In some instances, this investment procedure may adversely
affect the price paid or received by a Fund or the size of the position obtained
or sold by the Fund. To the extent permitted by law, the Adviser or Sub-Adviser
may aggregate the securities to be sold or purchased for a Fund with those to be
sold or purchased for other investment companies or accounts in executing
transactions.
As of October 31, 1996, the Funds held securities of its regular brokers or
dealers (as defined under the 1940 Act) or their parents as follows: the Short-
Term Bond Market, Intermediate Bond Market, Bond IMMDEX/tm, and Balanced Funds
held securities of Lehman Brothers totaling $7,053, $7,375, $13,615, and $1,647,
respectively; the Intermediate Bond Market, Bond IMMDEX/tm, and Balanced Funds
held securities of Goldman Sachs totaling $9,649, $4,825, and $1,447,
respectively; the Institutional Money Market and Equity Index Funds held
securities of Morgan Stanley totaling $38,808 and $357, respectively; and the
Short-Term Bond Market, Intermediate Bond Market, Balanced, Growth and Income,
and Equity Index Funds held securities of Merrill Lynch totaling $1,088, $131,
$1,034, $6,827 and $555, respectively.
Additional Information On Portfolio Instruments
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RATINGS. The ratings of Standard & Poor's, Moody's and other nationally
recognized rating agencies represent their opinions as to the quality of debt
securities. It should be emphasized, however, that ratings are general and are
not absolute standards of quality, and debt securities with the same maturity,
interest rate and rating may have different yields while debt securities of the
same maturity and interest rate with different ratings may have the same yield.
The payment of principal and interest on most debt securities purchased by
a Fund will depend upon the ability of the issuers to meet their obligations.
An issuer's obligations under its debt securities are subject to the provisions
of bankruptcy, insolvency, and other laws affecting the rights and remedies of
creditors, such as the Federal Bankruptcy Code, and laws, if any, which may be
enacted by federal or state legislatures extending the time for payment of
principal or interest, or both, or imposing other constraints upon enforcement
of such obligations. The power or ability of an issuer to meet its obligations
for the payment of interest on, and principal of, its debt securities may be
materially adversely affected by litigation or other conditions.
Subsequent to its purchase by a Fund, a rated security may cease to be
rated or its rating may be reduced below the minimum rating required for
purchase by the Fund. The Adviser or Sub-Adviser will consider such an event in
determining whether the Fund involved should continue to hold the security.
SECURITIES LENDING. Although none of the Funds intend to during the
current fiscal year, each of the Funds may lend its portfolio securities to
unaffiliated domestic broker/dealers and other institutional investors pursuant
to agreements requiring that the loans be secured by collateral equal in value
to at least the market value of the securities loaned in order to increase
return on portfolio securities. Collateral for such loans may include cash,
securities of the U.S. Government, its agencies or instrumentalities, or an
irrevocable letter of credit issued by a bank which meets the investment
standards stated below under "Money Market Instruments," or any combination
thereof. Such loans will not be made during the current year. The Funds may at
any time call a loan and obtain the return of the securities loaned within five
business days. There may be risks of delay in receiving additional collateral
or in recovering the securities loaned or even a loss of rights in the
collateral should the borrower of the securities fail financially. However,
loans will be made only to borrowers deemed by the Adviser (and Sub-Adviser in
the case of the International Equity Fund) to be of good standing and when, in
the Adviser's (and Sub-Adviser's in the case of the International Equity Fund)
judgment, the income to be earned from the loan justifies the attendant risks.
When a Fund lends its securities, it continues to receive interest or dividends
on the securities loaned and may simultaneously earn interest on the investment
of the cash collateral which will be invested in readily marketable, high-
quality, short-term obligations. Although voting rights, or rights to consent,
attendant to securities on loan pass to the borrower, such loans may be called
at any time and will be called so that the securities may be voted by a Fund if
a material event affecting the investment is to occur.
Securities lending arrangements with broker/dealers require that the loans
be secured by collateral equal in value to at least the market value of the
securities loaned. During the term of such arrangements, a Fund will maintain
such value by the daily marking-to-market of the collateral.
MONEY MARKET INSTRUMENTS. As described in the Prospectuses, the Funds may
invest from time to time in "money market instruments," a term that includes,
among other things, bank obligations, commercial paper, variable amount master
demand notes and corporate bonds with remaining maturities of thirteen months or
less. The International Equity Fund may reduce its holdings in equity and
other securities and may invest up to 100% of its assets in certain short-term
(less than twelve months to maturity) and medium-term (not greater than five
years to maturity) debt securities and in cash (U.S. dollars, foreign
currencies, or multicurrency units) for temporary defensive purposes, during
periods in which the Adviser (or the Sub-Adviser) believes changes in economic,
financial or political conditions make it advisable.
Bank obligations include bankers' acceptances, negotiable certificates of
deposit and nonnegotiable time deposits, including U.S. dollar-denominated
instruments issued or supported by the credit of U.S. or foreign banks or
savings institutions. Although the Funds will invest in money market
obligations of foreign banks or foreign branches of U.S. banks only where the
Adviser (and Sub-Adviser in the case of the International Equity Fund)
determines the instrument to present minimal credit risks, such investments may
nevertheless entail risks that are different from those of investments in
domestic obligations of U.S. banks due to differences in political, regulatory
and economic systems and conditions. All investments in bank obligations are
limited to the obligations of financial institutions having more than $1 billion
in total assets at the time of purchase, and investments by each Fund in the
obligations of foreign banks and foreign branches of U.S. banks will not exceed
25% of such Fund's total assets at the time of purchase. The Funds may also
make interest-bearing savings deposits in commercial and savings banks in
amounts not in excess of 5% of its net assets.
Investments by a Fund in commercial paper will consist of issues rated at
the time A-1 and/or P-1 by Standard & Poor's, Moody's or similar rating by
another nationally recognized rating agency. In addition, the Funds may acquire
unrated commercial paper and corporate bonds that are determined by the Adviser
at the time of purchase to be of comparable quality to rated instruments that
may be acquired by such Fund as previously described.
The Funds may also purchase variable amount master demand notes which are
unsecured instruments that permit the indebtedness thereunder to vary and
provide for periodic adjustments in the interest rate. Although the notes are
not normally traded and there may be no secondary market in the notes, a Fund
may demand payment of the principal of the instrument at any time. The notes
are not typically rated by credit rating agencies, but issuers of variable
amount master demand notes must satisfy the same criteria as set forth above for
issuers of commercial paper. If an issuer of a variable amount master demand
note defaulted on its payment obligation, a Fund might be unable to dispose of
the note because of the absence of a secondary market and might, for this or
other reasons, suffer a loss to the extent of the default. The Funds invest in
variable amount master demand notes only when the Adviser (and Sub-Adviser in
the case of the International Equity Fund) deem the investment to involve
minimal credit risk.
REPURCHASE AGREEMENTS. Each Fund may agree to purchase securities from
financial institutions subject to the seller's agreement to repurchase them at
an agreed upon time and price ("repurchase agreements"). During the term of the
agreement, the Adviser (and Sub-Adviser in the case of the International Equity
Fund) will continue to monitor the creditworthiness of the seller and will
require the seller to maintain the value of the securities subject to the
agreement at not less than 102% of the repurchase price. Default or bankruptcy
of the seller would, however, expose the Fund to possible loss because of
adverse market action or delay in connection with the disposition of the
underlying securities. The securities held subject to a repurchase agreement
may have stated maturities exceeding one year, provided the repurchase agreement
itself matures in less than one year.
The repurchase price under the repurchase agreements described in the
Prospectuses generally equals the price paid by a Fund plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on the securities underlying the repurchase agreement). Securities subject
to repurchase agreements will be held by the Funds' custodian (or sub-custodian)
or in the Federal Reserve/Treasury book-entry system or other authorized
securities depository. Repurchase agreements are considered to be loans under
the 1940 Act.
INVESTMENT COMPANIES. Each Fund currently intends to limit its investments
in securities issued by other investment companies so that, as determined
immediately after a purchase of such securities is made: (i) not more than 5%
of the value of the Fund'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 the Fund or by the Company as a whole.
The Funds may invest from time to time in securities issued by other
investment companies which invest in high-quality, short-term debt securities.
Some emerging countries have laws and regulations that preclude direct foreign
investment in the securities of companies located there. Certain emerging
countries permit, however, indirect foreign investment in the securities of
companies listed and traded on the stock exchanges in these countries through
specifically authorized investment funds. The International Equity Fund may
invest in these investment funds, as well as other closed-end investment
companies. Securities of other investment companies will be acquired by the
Funds within the limits prescribed by the 1940 Act. As a shareowner of another
investment company, the Funds would bear, along with other shareowners, its pro
rata portion of the other investment company's expenses, including advisory fees
and such fees and other expenses will be borne indirectly by the Fund's
shareowners. These expenses would be in addition to the advisory and other
expenses that the Funds bear directly in connection with their own operations.
U.S. GOVERNMENT OBLIGATIONS. Examples of the types of U.S. Government
obligations that may be acquired by the Funds include U.S. Treasury bonds, notes
and bills and the obligations of Federal Home Loan Banks, Federal Farm Credit
Banks, Federal Land Banks, the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association, Federal National
Mortgage Association, General Services Administration, Student Loan Marketing
Association, Central Bank for Cooperatives, Federal Home Loan Mortgage
Corporation, Federal Intermediate Credit Banks, Maritime Administration, and
Resolution Trust Corp.
BANK OBLIGATIONS. For purposes of the Funds' investment policies with
respect to bank obligations, the assets of a bank or savings institution will be
deemed to include the assets of its domestic and foreign branches. A Fund's
investments in the obligations of foreign branches of U.S. banks and of foreign
banks may subject the Fund to investment risks (similar to those discussed below
under "American Depository Receipts") that are different in some respects from
those of investments in obligations of U.S. domestic issuers. Such risks
include future political and economic developments, the possible imposition of
withholding taxes on interest income, possible seizure or nationalization of
foreign deposits, the possible establishment of exchange controls or the
adoption of other foreign governmental restrictions which might adversely affect
the payment of principal and interest of such obligations. In addition, foreign
branches of U.S. banks and foreign banks may be subject to less stringent
reserve requirements and to different accounting, auditing, reporting and record
keeping standards than those applicable to domestic branches of U.S. banks.
Other Investment Considerations - Balanced Fund, Growth Fund, Special Growth
Fund, and International Equity Fund
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The Balanced Fund, Growth Fund, Special Growth Fund, and International
Equity Fund maintain a long-term investment horizon with respect to investments
in equity securities. However, when a company's growth in earnings and
valuation results in price appreciation that reaches a level which meets the
Fund's established return objective, the stock is normally sold. Holdings are
also sold if there has been significant deterioration in the underlying
fundamentals of the securities involved since their acquisition. Sale proceeds
are either re-invested in money market instruments or in other securities which
meet the respective Fund's investment criteria.
The increase or decrease of cash equivalents in a Fund is primarily the
residual effect of the research process. The portion of a Fund invested in cash
equivalents tends to rise when the pool of acceptable securities is limited and
tends to fall when the Fund's valuation screening process identifies a large
number of attractive securities. Short-term forecasts for the economy and
financial markets are not an important determinant of the level of cash
equivalents in a Fund. As stated in the Prospectuses, however, under normal
market conditions not more than 65% of the value of the Balanced Fund's and at
least 50% of the value of the Growth Fund's and Special Growth Fund's, and at
least 65% of the value of the International Equity Fund's total assets will be
invested in equity securities. The Funds do not attempt to "time" the
securities market.
Certain securities owned by the Special Growth Fund may be traded only in
the over-the-counter market or on a regional securities exchange, may be listed
only in the quotation service commonly known as the "pink sheets," and may not
be traded every day or in the volume typical of trading on a national securities
exchange. As a result, there may be a greater fluctuation in the value of
redemptions or for other reasons, to sell these securities at a discount from
market prices, to sell during periods when such disposition is not desirable, or
to make many small sales over a lengthy period of time.
WHEN-ISSUED PURCHASES, DELAYED DELIVERY AND FORWARD COMMITMENTS. When any
Fund agrees to purchase securities on a when-issued or delayed delivery basis or
enter into a forward commitment to purchase securities, its custodian will set
aside cash or liquid high grade debt securities equal to the amount of the
commitment in a segregated account. Normally, the custodian will set aside
portfolio securities to satisfy a purchase commitment, and in such a case the
Fund may be required subsequently to place additional assets in the segregated
account in order to ensure that the value of the account remains equal to the
amount of the Fund's commitments. It may be expected that the market value of a
Fund's net assets will fluctuate to a greater degree when it sets aside
portfolio securities to cover such purchase commitments than when it sets aside
cash. Because a Fund will set aside cash or liquid assets to satisfy its
purchase commitments in the manner described, the Fund's liquidity and ability
to manage its portfolio might be affected in the event its commitments ever
exceeded 25% of the value of its assets. In the case of a forward commitment to
sell portfolio securities, the Funds' custodian will hold the portfolio
securities themselves in a segregated account while the commitment is
outstanding. When-issued and forward commitment transactions involve the risk
that the price or yield obtained in a transaction (and therefore that value of a
security) may be less favorable then the price or yield (and therefore the value
of a security) available in the market when the securities delivery takes place.
The Funds will make commitments to purchase securities on a when-issued
basis or to purchase or sell securities on a forward commitment basis only with
the intention of completing the transaction and actually purchasing or selling
the securities. If deemed advisable as a matter of investment strategy, however,
a Fund may dispose of or renegotiate a commitment after it is entered into, and
may sell securities it has committed to purchase before those securities are
delivered to the Fund on the settlement date. In these cases the Fund may
realize a capital gain or loss.
When these Funds engage in when-issued, delayed delivery and forward
commitment transactions, they rely on the other party to consummate the trade.
Failure of such party to do so may result in a Fund's incurring a loss or
missing an opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a when-issued purchase or a
forward commitment to purchase securities, and any subsequent fluctuations in
their market value, are taken into account when determining the net asset value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date. When a Fund makes a
forward commitment to sell securities it owns, the proceeds to be received upon
settlement are included in the Fund's assets. Fluctuations in the market value
of the underlying securities are not reflected in the Fund's net asset value as
long as the commitment remains in effect.
OTHER INVESTMENT CONSIDERATIONS - INTERNATIONAL EQUITY FUND, FOREIGN
FUTURES AND OPTIONS ON FUTURES. The Adviser and Sub-Adviser may determine that
it would be in the interest of the International Equity Fund to purchase or sell
futures contracts, including interest rate, index, and currency futures for the
purpose of remaining fully invested and reducing transactions costs. A stock
index futures contract is a bilateral agreement pursuant to which parties agree
to take or make delivery of an amount of cash equal to a specified dollar amount
times the difference between the index value (which assigns relative values to
the securities included in the index) at the close of the last trading day of
the contract and the price at which the futures contract is originally struck.
No physical delivery of the underlying securities in the index is made.
The Fund may also purchase put and call options, and write covered put and
call options, on futures in which it is allowed to invest. The purchase of
futures or call options thereon can serve as a long hedge, and the sale of
futures or the purchase of put options thereon can serve as a short hedge.
Writing covered call options on futures contracts can serve as a limited short
hedge, and writing covered put options on futures contracts can serve as a
limited long hedge, using a strategy similar to that used for writing covered
options in securities. The Fund's hedging may include purchases of futures as
an offset against the effect of expected increases in securities prices or
currency exchange rates and sales of futures as an offset against the effect of
expected declines in securities prices or currency exchange rates. The Fund's
futures transactions may be entered into for hedging purposes or risk
management. The Fund may also write put options on futures contracts while at
the same time purchasing call options on the same futures contracts in order to
create synthetically a long futures contract position. Such options would have
the same strike prices and expiration dates. The Fund will engage in this
strategy only when the Adviser (or the Sub-Adviser) believes it is more
advantageous to the Fund than is purchasing the futures contract.
The International Equity Fund intends to limit its transactions in futures
contracts and related options so that not more than 25% of its net assets are at
risk. In connection with a futures transaction, unless the transaction is
covered in accordance with SEC positions, the Fund will maintain a segregated
account with its custodian or sub-custodian consisting of cash or liquid high
grade debt securities equal to the entire amount at risk (less margin deposits)
on a continuous basis.
Futures purchased or sold by the International Equity Fund (and related
options) will normally be traded in foreign securities. Participation in
foreign futures and foreign options transactions involves the execution and
clearing of trades on or subject to the rules of a foreign board of trade.
Neither the National Futures Association nor any domestic exchange regulates
activities of any foreign boards of trade, including the execution, delivery and
clearing of transactions, or has the power to compel enforcement of the rules of
a foreign board of trade or any applicable foreign law. This is true even if
the exchange is formally linked to a domestic market so that a position taken on
the market may be liquidated by a transaction on another market. Moreover, such
laws or regulations will vary depending on the foreign country in which the
foreign futures or foreign options transaction occurs. For these reasons,
customers who trade foreign futures of foreign options contracts may not be
afforded certain of the protective measures provided by the Commodity Exchange
Act, the Commodity Futures Trading Commission's ("CFTC") regulations and the
rules of the National Futures Association and any domestic exchange, including
the right to use reparations proceedings before the CFTC and arbitration
proceedings provided by the National Futures Association or any domestic futures
exchange. In particular, the International Equity Fund's investments in foreign
futures or foreign options transactions may not be provided the same protections
in respect of transactions on United States futures exchanges. In addition, the
price of any foreign futures or foreign options contract and, therefore the
potential profit and loss thereon may be affected by any variance in the foreign
exchange rate between the time an order is placed and the time it is
liquidated, offset or exercised. For a further description of futures contracts
and related options, including a discussion of the limitations imposed by
federal tax law, See Appendix B to the Statement of Additional Information.
OTHER INVESTMENT CONSIDERATIONS - INTERNATIONAL EQUITY FUND REVERSE
REPURCHASE AGREEMENTS. The Fund may engage in reverse repurchase agreements to
facilitate portfolio liquidity, a practice common in the mutual fund industry,
for temporary purposes only. In a reverse repurchase agreement, the Fund would
sell a security and enter into an agreement to repurchase the security at a
specified future date and price. The Fund generally retains the right to
interest and principal payments on the security. Since the Fund receives cash
upon entering into a reverse repurchase agreement, it may be considered a
borrowing. (See "Borrowing" above.) When required by guidelines of the SEC,
the Fund will set aside permissible liquid assets in a segregated account to
secure its obligations to repurchase the security.
Other Investment Considerations - International Equity Fund - Foreign Currency
Contracts and Foreign Currency Transactions
- -------------------------------------------------------------------------------
FORWARD CURRENCY CONTRACTS. The International Equity Fund may enter into
forward currency contracts; such transactions may serve as long hedges (for
example, if the Fund seeks to buy a security denominated in a foreign currency,
it may purchase a forward currency contract to lock in the $US price of the
security) or as short hedges (the Fund anticipates selling a security
denominated in a foreign currency may sell a forward currency contract to lock
in the $US equivalent of the anticipated sales proceeds).
The Fund may seek to hedge against changes in the value of a particular
currency by using forward contracts on another foreign currency or a basket of
currencies, the value of which the Adviser or Sub-Adviser believes will have a
positive correlation to the values of the currency being hedged. In addition,
the Fund may use forward currency contracts to shift exposure to foreign
currency fluctuations from one country to another. For example, if the Fund
owns securities denominated in a foreign currency and the Adviser or Sub-Adviser
believes that currency will decline relative to another currency, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in the second currency. Transactions that
use two foreign currencies are sometimes referred to as "cross hedges". Use
of different foreign currency magnifies the risk that movements in the price of
the instrument will not correlate or will correlate unfavorably with the foreign
currency being hedged.
The cost to the Fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and the
market conditions then prevailing. Because forward currency contracts are
usually entered into on a principal basis, no fees or commissions are involved.
When the Fund enters into a forward currency contract, it relies on the
counterpart to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterpart to do so would result in the loss
of any expected benefit of the transaction.
As is the case with future contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument held or written. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contacts only by
negotiating directly with the counterpart. Thus, there can be no assurance that
the Fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the counterpart, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in securities denominated in the
foreign currency or to maintain cash or securities in a segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the foreign
currency contract has been established. Thus, the Fund might need to purchase
or sell foreign currencies in the spot (cash) market to the extent such foreign
currency market movements is extremely difficult, and the successful execution
of a short-term hedging strategy is highly uncertain.
FOREIGN CURRENCY TRANSACTIONS. Although the International Equity Fund
values its assets daily in U.S. dollars, the Fund is not required to convert
their holdings of foreign currencies to U.S. dollars on a daily basis. The
Fund's foreign currencies generally will be held as "foreign currency call
accounts' at foreign branches of foreign or domestic banks. These accounts
bear interest at negotiated rates and are payable upon relatively short demand
periods. If a bank became insolvent, the Fund could suffer a loss of some or
all of the amounts deposited. The Fund may convert foreign currency to U.S.
dollars from time to time. Although foreign exchange dealers generally do not
charge a stated commission or fee for conversion, the prices posted generally
include a "spread", which is the difference between the prices at which the
dealers are buying and selling foreign currencies.
Other Investment Considerations - Balanced Fund, Short-Term Bond Market Fund,
Intermediate Bond Market Fund, and Bond IMMDEX/tm Fund
- -----------------------------------------------------------------------------
MORTGAGE-BACKED AND ASSET-BACKED SECURITIES. The Balanced Fund, Short-
Term Bond Market Fund, Intermediate Bond Market Fund and Bond IMMDEX/tm Fund may
purchase residential and commercial mortgage-backed as well as other asset-
backed securities (collectively called "asset-backed securities") that are
secured or backed by automobile loans, installment sale contracts, credit card
receivables or other assets and are issued by entities such as Government
National Mortgage Association ("GNMA"), Federal National Mortgage Association
("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), commercial banks,
trusts, financial companies, finance subsidiaries of industrial companies,
savings and loan associations, mortgage banks and investment banks. These
securities represent interests in pools of assets in which periodic payments of
interest and/or principal on the securities are made, thus, in effect passing
through periodic payments made by the individual borrowers on the assets that
underlie the securities, net of any fees paid to the issuer or guarantor of the
securities. The average life of these securities varies with the maturities and
the prepayment experience of the underlying instruments.
There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage-backed securities
and among the securities that they issue. Mortgage-backed securities guaranteed
by GNMA include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Mass") which are guaranteed as to the timely payment of principal and interest
by GNMA and such guarantee is backed by the full faith and credit of the United
States. GNMA is a wholly owned U.S. Government corporation within the
Department of Housing and Urban Development. GNMA certificates also are
supported by the authority of GNMA to borrow funds from the U.S. Treasury to
make payments under its guarantee. Mortgage-backed securities issued by FNMA
include FNMA Guaranteed Mortgage Pass-Through Certificates (also known as
"Fannie Mass") which are solely the obligations of 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 Mass are
guaranteed as to timely payment of the principal and interest by FNMA.
Mortgage-backed securities issued by the 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. Freddie Macs are not guaranteed by the United States or by any
Federal Home Loan Bank and do not constitute a debt or obligation of the United
States or of 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.
As stated in the Prospectuses for the Balanced Fund, Short-Term Bond
Market Fund, Intermediate Bond Market Fund and Bond IMMDEX/tm Fund, mortgage-
backed securities such as CMOs may be purchased. CMOs are issued in multiple
classes and their relative payment rights may be structured in many ways. In
many cases, however, payments of principal are applied to the CMO classes in
order of their respective maturities, so that no principal payments will be made
on a CMO class until all other classes having an earlier maturity date are paid
in full. The classes may include accrual certificates (also known as "Z-
Bonds"), which do not accrue interest at a specified rate until other specified
classes have been retired and are converted thereafter to interest-paying
securities. They may also include planned amortization classes ("PACs") which
generally require, within certain limits, that specified amounts of principal be
applied to each payment date, and generally exhibit less yield and market
volatility than other classes. Investments in CMO certificates can expose the
Fund to greater volatility and interest rate risk than other types of mortgage-
backed obligations. Prepayments on mortgage-backed securities generally
increase with falling interest rates and decrease with rising interest rates;
furthermore, prepayment rates are influenced by a variety of economic and social
factors.
The yield characteristics of asset-backed securities differ from
traditional debt securities. A major difference is that the principal amount of
the obligations may be prepaid at any time because the underlying assets (i.e.,
loans) generally may be prepaid at any time. As a result, if an asset-backed
security is purchased at a premium, a prepayment rate that is faster than
expected may reduce yield to maturity, while a prepayment rate that is slower
than expected may have the opposite effect of increasing yield to maturity.
Conversely, if an asset-backed security is purchased at a discount, faster than
expected prepayments may increase, while slower than expected prepayments may
decrease, yield to maturity.
In general, the collateral supporting non-mortgage asset-backed securities
is of shorter maturity than mortgage loans. Like other fixed-income securities,
when interest rates rise the value of an asset-backed security generally will
decline; however, when interest rates decline, the value of an asset-backed
security with prepayment features may not increase as much as that of other
fixed-income securities.
VARIABLE RATE MEDIUM TERM NOTES. The Funds may purchase variable rate
medium term notes which provide for periodic adjustments in the interest rates.
The adjustments in interest rates reflect changes in an index (which may be the
Lehman Brothers 1-3 Year Government/Corporate Bond Index, the Lehman Brothers
Intermediate Government/Corporate Bond Index or the Lehman Brothers
Government/Corporate Bond Index).
Other Investment Considerations - Tax-Exempt Intermediate Bond Fund
- -------------------------------------------------------------------
MUNICIPAL OBLIGATIONS. Municipal Obligations which may be acquired by the
Tax-Exempt Intermediate Bond Fund include debt obligations issued by
governmental entities to obtain funds for various public purposes, including the
construction of a wide range of public facilities, the refunding of outstanding
obligations, the payment of general operating expenses and the extension of
loans to public institutions and facilities.
Certain of the Municipal Obligations held by the Fund may be insured at the
time of issuance as to the timely payment of principal and interest. The
insurance policies will usually be obtained by the issuer of the Municipal
Obligation at the time of its original issuance. In the event that the issuer
defaults on interest or principal payment, the insurer will be notified and will
be required to make payment to the bondholders. There is, however, no guarantee
that the insurer will meet its obligations. In addition, such insurance will
not protect against market fluctuations caused by changes in interest rates and
other factors, including credit downgrades, supply and demand. The Fund may,
from time to time, invest more than 25% of its assets in Municipal Obligations
covered by insurance policies.
The payment of principal and interest on most securities purchased by the
Fund will depend upon the ability of the issuers to meet their obligations. An
issuer's obligations under its Municipal Obligations are subject to the
provisions of bankruptcy, insolvency, and other laws affecting the rights and
remedies of creditors, such as the Federal Bankruptcy Code, and laws, if any,
which may be enacted by federal or state legislatures extending the time for
payment of principal or interest, or both, or imposing other constraints upon
enforcement of such obligations or upon the ability of municipalities to levy
taxes. The power or ability of an issuer to meet its obligations for the
payment of interest on, and principal of, its Municipal Obligations may be
materially adversely affected by litigation or other conditions.
Certain types of Municipal Obligations (private activity bonds) have been
or are issued to obtain funds to provide privately operated housing facilities,
pollution control facilities, convention or trade show facilities, mass transit,
airport, port or parking facilities and certain local facilities for water
supply, gas, electricity or sewage or solid waste disposal. Private activity
bonds are also issued on behalf of privately held or publicly owned corporations
in the financing of commercial or industrial facilities. State and local
governments are authorized in most states to issue private activity bonds for
such purposes in order to encourage corporations to locate within their
communities. The principal and interest on these obligations may be payable
from the general revenues of the users of such facilities.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Obligations. For example, under the Tax Reform Act of
1986, interest on certain private activity bonds must be included in an
investor's alternative minimum taxable income, and corporate investors must
include all tax-exempt interest in their federal alternative minimum taxable
income. The Company cannot, of course, predict what legislation, if any, may be
proposed in the future as regards the income tax status of interest on Municipal
Obligations, or which proposals, if any, might be enacted. Such proposals,
while pending or if enacted, might materially and adversely affect the
availability of Municipal Obligations for investment by the Fund and the
liquidity and value of the Fund's portfolio. In such an event, the Company
would reevaluate the Fund's investment objective and policies and consider
possible changes in its structure or possible dissolution.
MUNICIPAL LEASE OBLIGATIONS. As stated in the Prospectus, the Fund may
acquire municipal lease obligations which are issued by a state or local
government authority to acquire land and a wide variety of equipment and
facilities. In making a determination that a municipal lease obligation is
liquid, the Adviser may consider, among other things (i) whether the lease can
be canceled; (ii) the likelihood that the assets represented by the lease can be
sold; (iii) the strength of the lessee's general credit; (iv) the likelihood
that the municipality will discontinue appropriating funds for the leased
property because the property is no longer deemed essential to the operations of
the municipality; and (v) availability of legal recourse in the event of failure
to appropriate.
STAND-BY COMMITMENTS. The Tax-Exempt Intermediate Bond Fund may acquire
"stand-by commitments" with respect to Municipal Obligations held in its
portfolio. Under a "stand-by commitment," a dealer agrees to buy from the Fund,
at the Fund's option, specified Municipal Obligations at a specified price.
"Stand-by commitments" acquired by the Fund may also be referred to in this
Statement of Additional Information as "put" options.
The amount payable to the Fund upon its exercise of a "stand-by commitment"
is normally (i) the Fund's acquisition cost of the Municipal Obligations
(excluding any accrued interest which the Fund paid on their acquisition), less
any amortized market premium or plus any amortized market or original issue
discount during the period the Fund owned the securities, plus (ii) all interest
accrued on the securities since the last interest payment date during that
period. A stand-by commitment may be sold, transferred or assigned by the Fund
only with the instrument involved.
The Fund expects that "stand-by commitments" will generally be available
without the payment of any direct or indirect consideration. However, if
necessary or advisable, the Fund may pay for a "stand-by commitment" either
separately in cash or by paying a higher price for the portfolio securities
which are acquired subject to the commitment (thus reducing the yield to
maturity otherwise available for the same securities). The total amount paid in
either manner for outstanding "stand-by commitments" held by the Fund will not
exceed 1/2 of 1% of the value of its total assets calculated immediately after
each "stand-by commitment" is acquired.
The Fund intends to enter into "stand-by commitments" only with dealers,
banks and broker/dealers which, in the investment adviser's opinion, present
minimal credit risks. The Fund's reliance upon the credit of these dealers,
banks and broker/dealers is secured by the value of the underlying Municipal
Obligations that are subject to a commitment.
The Fund would acquire "stand-by commitments" solely to facilitate
portfolio liquidity and does not intend to exercise its rights thereunder for
trading purposes. The acquisition of a "stand-by commitment" would not affect
the valuation or assumed maturity of the underlying Municipal Securities, which
would continue to be valued in accordance with the ordinary method of valuation
employed by the Fund. "Stand-by commitments" which would be acquired by the
Fund would be valued at zero in determining net asset value. Where the Fund
paid any consideration directly or indirectly for a "stand-by commitment," its
cost would be reflected as unrealized depreciation for the period during which
the commitment was held by the Fund.
VARIABLE AND FLOATING RATE INSTRUMENTS. With respect to the variable and
floating rate instruments that may be acquired by the Tax-Exempt Intermediate
Bond Fund as described in its Prospectus, the Adviser will consider the earning
power, cash flows and other liquidity ratios of the issuers and guarantors of
such instruments and, if the instrument is subject to a demand feature, will
monitor their financial status to meet payment on demand. In determining
average weighted portfolio maturity, an instrument will usually be deemed to
have a maturity equal to the longer of the period remaining to the next interest
rate adjustment or the time the Fund can recover payment of principal as
specified in the instrument. Variable U.S. Government obligations held by the
Fund, however, will be deemed to have maturities equal to the period remaining
until the next interest rate adjustment.
EQUITY INDEX FUND MANAGEMENT TECHNIQUES When purchasing securities for the
Equity Index Fund's portfolio, the Adviser will consider initially the relative
market capitalization weightings of the stocks included in the S&P 500 Index.
The weighted capitalization of an issuer is determined by dividing the issuer's
market capitalization by the total market capitalizations of all issuers
included in the S&P 500 Index.
The Adviser will then compare the industry sector diversification of the
stocks in the Fund, acquired solely on the basis of their weighted
capitalizations, with the industry sector diversification of all issuers
included in the S&P 500 Index. This comparison is made because the Adviser
believes, unless the Fund holds all stocks included in the S&P 500 Index, that
the selection of stocks for purchase by the Fund solely on the basis of their
weighted market capitalizations would tend to place heavier concentration (as
compared to the S&P 500 Index) in certain industry sectors that are dominated by
the larger corporations, such as communications, automobile, oil and energy. As
a result, events disproportionately affecting such industries could affect the
performance of the S&P 500 Index. Conversely, if smaller companies were not
purchased by the Fund, industries included in the S&P 500 Index that are
dominated by smaller market-capitalized companies would be underrepresented (as
compared to the S&P 500 Index).
For these reasons, the Adviser will identify the sectors which are (or,
except for sector balancing, would be) most underrepresented in the Fund's
portfolio and will purchase balancing securities in these sectors until the
portfolio's sector weightings closely match that of the S&P 500 Index. This
process continues until the portfolio is fully invested (except for cash
holdings).
THE IMMDEX/tm MODEL. The IMMDEX/tm model has been developed and is
maintained by Capital Management Sciences ("Capital Management") under the
"IMMDEX/tm" trademark. Capital Management is neither a sponsor of the Bond
IMMDEX/tm Fund nor affiliated in any way with the Bond IMMDEX/tm Fund or the
Adviser. Neither is Capital Management in any way affiliated with Lehman
Brothers which claims no interest in the model or its ability to effectively or
accurately replicate the Lehman Brothers Government/Corporate Bond Index.
Further, Capital Management is not responsible for the management or results of
the Bond IMMDEX/tm Fund's portfolio. Rather, the Adviser will use the IMMDEX/tm
model and the other investment techniques described in the Prospectus in
choosing portfolio securities and executing transactions in an effort to produce
an annual rate of total return for the Bond IMMDEX/tm Fund that is comparable,
before Fund expenses, to that of the Lehman Brothers Government/Corporate Bond
Index.
Other Portfolio Information
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OPTIONS TRADING. As stated in the Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Tax-Exempt Intermediate Bond Fund, Bond IMMDEX/tm
Fund, Growth and Income Fund, Equity Index Fund, and International Equity Fund
Prospectuses, the Funds may purchase put and (with the exception of the Tax-
Exempt Intermediate Bond Fund) call options. Option purchases by a Fund (except
the International Equity Fund will not exceed 5% of its net assets and the
International Equity Fund may purchase put and call options without limit. Such
options may relate to particular securities or to various indices. (In the case
of the Equity Index Fund, such options will relate only to stock indices.) This
is a highly specialized activity which entails greater than ordinary investment
risks. Regardless of how much the market price of the underlying security or
index increases or decreases, the option buyer's risk is limited to the amount
of the original investment for the purchase of the option. However, options may
be more volatile than the underlying securities or indices, and therefore, on a
percentage basis, an investment in options may be subject to greater fluctuation
than an investment in the underlying securities. In contrast to an option on a
particular security, an option on an index provides the holder with the right to
make or receive a cash settlement upon exercise of the option. The amount of
this settlement will be equal to the difference between the closing price of the
index at the time of exercise and the exercise price of the option expressed in
dollars, times a specified multiple. The Tax-Exempt Intermediate Bond Fund will
only purchase put options on Municipal Obligations, and will do so only to
enhance liquidity, shorten the maturity of the related municipal security or
permit the Fund to invest its assets at more favorable rates.
A call option gives the purchaser of the option the right to buy, and a
writer the obligation to sell, the underlying security or index at the stated
exercise price at any time prior to the expiration of the option, regardless of
the market price of the security. The premium paid to the writer is in
consideration for undertaking the obligations under the option contract. A put
option gives the purchaser the right to sell the underlying security or index at
the stated exercise price at any time prior to the expiration date of the
option, regardless of the market price of the security or index. Put and call
options purchased by a Fund will be valued at the last sale price or, in the
absence of such a price, at the mean between bid and asked prices.
These Funds (with the exception of the Tax-Exempt Intermediate Bond Fund)
may also sell covered call options listed on a national securities exchange.
Such options may relate to particular securities or to various indices. (In the
case of the Equity Index Fund, such options will relate only to stock indices.)
A call option on a security is covered if a Fund owns the security underlying
the call or has an absolute and immediate right to acquire that security without
additional cash consideration (or, if additional cash consideration is required,
cash or liquid assets in such amount as required are held in a segregated
account by its custodian) upon conversion or exchange of other securities held
by it. A call option on an index is covered if a Fund maintains with its
custodian cash or cash equivalents equal to the contract value. A call option
is also covered if a Fund holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less than
the exercise price of the call written, or (ii) greater than the exercise price
of the call written provided the difference is maintained by a Fund in cash or
liquid assets in a segregated account with its custodian.
A Fund's obligation under a covered call option written by it may be
terminated prior to the expiration date of the option by the Fund's executing a
closing purchase transaction, which is effected by purchasing on an exchange an
option of the same series (i.e., same underlying security or index, exercise
price and expiration date) as the option previously written. Such a purchase
does not result in the ownership of an option. A closing purchase transaction
will ordinarily be effected to realize a profit on an outstanding option, to
prevent an underlying security from being called, to permit the sale of the
underlying security or to permit the writing of a new option containing
different terms. The cost of such a liquidation purchase plus transactions
costs may be greater than the premium received upon the original option, in
which event a Fund will have incurred a loss in the transaction. An option
position may be closed out only on an exchange which provides a secondary market
for an option of the same series. There is no assurance that a liquid secondary
market on an exchange will exist for any particular option. A covered call
option writer, unable to effect a closing purchase transaction, will not be able
to sell an underlying security until the option expires or the underlying
security is delivered upon exercise with the result that the writer in such
circumstances will be subject to the risk of market decline during such period.
A Fund will write an option on a particular security only if the Adviser
believes that a liquid secondary market will exist on an exchange for options of
the same series which will permit the Fund to make a closing purchase
transaction in order to close out its position.
When a Fund writes a covered call option, an amount equal to the net
premium (the premium less the commission) received by the Fund is included in
the liability section of the Fund's statement of assets and liabilities. The
amount of the liability will be subsequently marked-to-market to reflect the
current value of the option written. The current value of the traded option is
the last sale price or, in the absence of a sale, the average of the closing bid
and asked prices. If an option expires on the stipulated expiration date or if
the Fund enters into a closing purchase transaction, it will realize a gain (or
loss if the cost of a closing purchase transaction exceeds the net premium
received when the option is sold) and the liability related to such option will
be eliminated. Any gain on a covered call option on a security may be offset by
a decline in the market price of the underlying security during the option
period. If a covered call option on a security is exercised, the Fund may
deliver the underlying security held by it or purchase the underlying security
in the open market. In either event, the proceeds of the sale will be increased
by the net premium originally received, and the Fund will realize a gain or
loss. Premiums from expired options written by a Fund and net gains from
closing purchase transactions are treated as short-term capital gains for
federal income tax purposes, and losses on closing purchase transactions are
short-term capital losses.
The International Equity Fund may also write (i.e., sell) covered put
options on securities and various securities indices. The writer of a put
incurs an obligation to buy the security underlying the option from the put's
purchaser at the exercise price at any time on or before the termination date, a
the purchaser's election(certain options the Fund writes will be exercisable by
the purchaser only on a specific date). Generally, a put is "covered" if the
Fund maintains cash, U.S. government securities or other liquid high grade debt
obligations equal to the exercise price o the option or if the Fund holds a put
on the same underlying security with a similar or higher exercise price. By
writing a covered put option on a security, the Fund receives a premium for
writing the option; however, the Fund assumes the risk that the value of the
security will decline before the exercise dates in which event, the Fund may
incur a loss in excess of the premium received when the put is exercised.
As noted previously, there are several risks associated with transactions
in options on securities and indices. For example, there are significant
differences between the securities and options markets that could result in an
imperfect correlation between these markets, causing a given transaction not to
achieve its objectives. A decision as to whether, when and how to use options
involves the exercise of skill and judgment, and a transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
FUTURES CONTRACTS AND RELATED OPTIONS The Adviser may determine that it
would be in the interest of the Short-Term Bond Market Fund, Intermediate Bond
Market Fund, Bond IMMDEX/tm Fund, Growth and Income Fund, and Equity Index Fund
to purchase or sell futures contracts, or options thereon, as a hedge against
changes resulting from market conditions in the value of the securities held by
a Fund, or of securities which it intends to purchase. The International Equity
Fund may engage in foreign futures and options (see "Other Investment
Considerations - International Equity Fund - Foreign Futures and Options on
Futures"). In addition, the Equity Index Fund will purchase and sell futures
and related options (based only on the S&P 500 Index) to maintain cash reserves
while simulating full investment in the stocks underlying the S&P 500 Index to
keep substantially all of its assets exposed to the market (as represented by
the S&P 500 Index) and to reduce transaction costs. For example, a Fund may
enter into transactions involving an index futures contract, which is a
bilateral agreement pursuant to which the parties agree to take or make delivery
of an amount of cash equal to a specified dollar amount times the difference
between the index value (which assigns relative values to the securities
included in the index) at the close of the last trading day of the contract and
the price at which the futures contract is originally struck. No physical
delivery of the underlying securities in the index is made.
During the current fiscal year the Short-Term Bond Market, Intermediate
Bond Market, Bond IMMDEX/tm, and Growth and Income Funds intend to limit their
transactions in futures contracts and related options so that not more than 5%
of their net assets are at risk and the Equity Index Fund will limit its
transactions in futures such that obligations under the transactions and
contracts represent not more than 10% of its assets. In connection with a
futures transaction, unless the transaction is covered in accordance with SEC
positions, the Fund will maintain a segregated account with its custodian or
sub-custodian consisting of cash or liquid high grade debt securities equal to
the entire amount at risk (less margin deposits) on a continuous basis. For a
more detailed description of futures contracts and related options, including a
discussion of the limitations imposed by federal tax law, see Appendix B to the
Statement of Additional Information.
AMERICAN DEPOSITORY RECEIPTS ("ADRS"). The Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Bond IMMDEX/tm Fund, Balanced Fund, Growth and
Income Fund, Growth Fund, Special Growth Fund, and International Equity Fund
may invest in sponsored ADRs. The International Equity Fund may also invest in
unsponsored ADRs. ADRs are receipts issued by an American bank or trust company
evidencing ownership of underlying securities issued by a foreign issuer. ADRs
may be listed on a national securities exchange or may trade in the over-the-
counter market. ADR prices are denominated in U.S. dollars; 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 securities also involve certain inherent risks,
such as political or economic instability of 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.
While "sponsored" and "unsponsored" ADR programs are similar, there are
differences regarding ADR holders' rights and obligations and the practices of
market participants. A depository may establish an unsponsored facility without
participation by (or acquiescence of) the underlying issuer; typically, however,
the depository requests a letter of non-objection from the underlying issuer
prior to establishing the facility. Holders of unsponsored ADRs generally bear
all the costs of the ADR facility. The depository usually charges fees upon the
deposit and withdrawal of the underlying securities, the conversion of dividends
into U.S. dollars, the disposition of non-cash distribution, and the performance
of other services. The depository of an unsponsored facility frequently is
under no obligation to distribute shareholder communications received from the
underlying issuer or to pass through voting rights to ADR holders in respect of
the underlying securities.
Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that sponsored ADRs are established jointly by a
depository and the underlying issuer through a deposit agreement. The deposit
agreement sets out the rights and responsibilities of the underlying issuer, the
depository and the ADR holders. With sponsored facilities, the underlying
issuer typically bears some of the costs of the ADR (such as dividend payment
fees of the depository), although ADR holders may bear costs such as deposit and
withdrawal fees. Depositories of most sponsored ADRs agree to distribute
notices of shareholder meetings, voting instructions, and other shareholder
communications and information to the ADR holders at the underlying issuer's
request.
ZERO COUPON BONDS. Zero coupon obligations have greater price volatility
than coupon obligations and will not result in the payment of interest until
maturity, provided that a Fund will purchase such zero coupon obligations only
if the likely relative greater price volatility of such zero coupon obligations
is not inconsistent with the Fund's investment objective. Although zero coupon
securities pay no interest to holders prior to maturity, interest on these
securities is reported as income to a Fund and distributed to its shareowners.
These distributions must be made from a Fund's cash assets or, if necessary,
from the proceeds of sales of portfolio securities. Additional income producing
securities may not be able to be purchased with cash used to make such
distributions and its current income ultimately may be reduced as a result.
CONVERTIBLE SECURITIES. The Balanced, Growth and Income, Growth, Special
Growth, and International Equity Funds may hold convertible securities.
Convertible securities entitle the holder to receive interest paid or accrued on
debt or the dividend paid on preferred stock until the securities mature or are
redeemed, converted or exchanged. Prior to conversion, convertible securities
have characteristics similar to ordinary debt securities in that they normally
provide a stable stream of income with generally higher yields than those of
common stock of the same or similar issuers. Convertible securities rank senior
to common stock in a corporation's capital structure and therefore generally
entail less risk than the corporation's common stock, although the extent to
which such risk is reduced depends in large measure upon the degree to which the
convertible security sells above its value as a fixed income security.
As described in the Prospectuses, the Funds may invest a portion of their
assets in convertible securities that are rated below investment grade.
WARRANTS. Warrants basically are options to purchase equity securities at
a specific price valid for a specific period of time. They do not represent
ownership of the securities, but only the right to buy them. They have no
voting rights, pay no dividends and have no rights with respect to the assets of
the company issuing them. Warrants differ from call options in that warrants
are issued by the issuer of the security which may be purchased on their
exercise, whereas call options may be written or issued by anyone. The prices
of warrants do not necessarily move parallel to the prices of the underlying
securities.
HIGH RISK DEBT SECURITIES ("JUNK BONDS"). As stated in the International
Equity Fund's Prospectus, the Fund may invest up to 5% of its net assets in non-
investment grade debt securities. Debt securities rated below Baa by Moody's or
BBB by S&P, or of comparable quality, are considered below investment grade.
Non-investment grade debt securities ("high risk debt securities") may include
(i) debt not in default but rated as low as C by Moody's, S&P, or Fitch
Investors Service, Inc. ("Fitch"), CC by Thomson BankWatch ("TBW") or ICBA, or
CCC by Duff & Phelps, Inc. ("D&P"); (ii) commercial paper rated as low as C (or
D if in default) by S&P, Not Prime by Moody's, F-S (or D if in default) by
Fitch, Duff 4 (or Duff 5 if in default) by Duff, TBW-4 by TBW, or D by ICBA; and
(iii) unrated debt securities of comparable quality. Each Fund may also buy
debt in default (rated D by S&P or TBW or Fitch, C by ICBA, DD by Duff, or of
comparable quality) and commercial paper in default (rated D by S&P or Fitch,
Not Prime by Moody's, Duff 5 by Duff, TBW-4 by TBW, D by ICBA, or of comparable
quality). Such securities, while generally offering higher yields than
investment grade securities with similar maturities, involve greater risks,
including the possibility of (or actual) default or bankruptcy. They are
regarded as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal.
The market for high risk debt securities is relatively new and its growth
has paralleled a long economic expansion. It is not clear how this market would
withstand a prolonged recession or economic downturn, which could severely
disrupt this market and adversely affect the value of such securities.
Market values of high risk debt securities tend to reflect individual
corporate developments to a greater extent, and tend to be more sensitive to
economic conditions, than do higher rated securities. As a result, high risk
debt securities generally involve more credit risks than higher rated debt.
During an economic downturn or a sustained period of rising interest rates,
highly leveraged issuers of high risk debt may experience financial stress and
may not have sufficient revenues to meet their payment obligations. An issuer's
ability to service its debt obligations may also be adversely affected by
specific corporate developments, its own inability to meet specific projected
business forecasts, or unavailability of additional financing. The risk of loss
due to default by an issuer is significantly greater for high risk debt than for
higher rated debt because the high risk debt is generally unsecured and often
subordinated.
If the issuer of high risk debt defaulted, the Fund might incur additional
expenses in seeking recovery. Periods of economic uncertainty and changes would
also generally result in increased volatility in the market prices of these
securities and thus in the Fund's net asset value.
If the Fund invested in high risk debt experiences unexpected net
redemptions in a rising interest rate market, it may be forced to liquidate a
portion of its portfolio without regard to their investment merits. Due to the
limited liquidity of high risk debt securities, the Fund may be forced to
liquidate these securities at a substantial discount. Any such liquidation
would reduce the Fund's asset base over which expenses could be allocated and
could result in a reduced rate of return for the Fund.
During periods of falling interest rates, issuers of high risk debt
securities that contain redemption, call or prepayment provisions are likely to
redeem or repay the securities and refinance with other debt at a lower interest
rate. If the Fund holds debt securities that are refinanced or otherwise
redeemed, it may have to replace the securities with a lower yielding security,
which would result in a lower return.
Credit ratings evaluate safety of principal and interest payments, but do
not evaluate the market value risk of high risk securities and, therefore, may
not fully reflect the true risks of an investment. In addition, rating agencies
may not make timely changes in a rating to reflect changes in the economy or in
the condition of the issuer that affect the market value of the security.
Consequently, credit ratings are used only as a preliminary indicator of
investment quality. Investments in high risk securities will depend more
heavily on the Sub-Adviser's credit analysis than investment-grade debt
securities. The Adviser (or the Sub-Adviser) will monitor the Fund's
investments and evaluate whether to dispose of or retain high risk securities
whose credit quality may have changed.
The Fund may have difficulty disposing of certain high risk securities with
a thin trading market. Not all dealers maintain markets in all these
securities, and for many such securities there is no established retail
secondary market. The Adviser (or the Sub-Adviser) anticipates that such
securities may be sold only to a limited number of dealers or institutional
investors. To the extent a secondary trading market does exist, it is generally
not as liquid as that for higher-rated securities; a lack of a liquid secondary
market may adversely affect the market price of a security, which may in turn
affect the Fund's net asset value and ability to dispose of particular
securities in order to meet liquidity needs or to respond to a specific economic
event, or may make it difficult for the Fund to obtain accurate market
quotations for valuation purposes. Market quotations on many high risk
securities may be available only from a limited number of dealers and may not
necessarily represent firm bids or prices for actual sales. During periods of
thin trading, the spread between bid and asked prices is likely to increase
significantly, and adverse publicity and investor perceptions (whether or not
based on fundamental analysis) may decrease the value and liquidity of a high
risk security.
Legislation has from time to time been or may be proposed that is designed
to limit the use of certain high risk debt. It is not possible to predict the
effect of such legislation on the market for high risk debt. However, any
legislation that may be proposed or enacted could have a material adverse effect
on the value of these securities, the existence of a secondary trading market
for the securities and, as a result, the Fund's net asset values.
SOVEREIGN DEBT. The International Equity Fund may invest up to 5% of its
net assets in obligations of foreign countries and political entities
("Sovereign Debt"), which may trade at a substantial discount from face value.
The Fund may hold and trade Sovereign Debt of emerging market countries in
appropriate circumstances and to participate in debt conversion programs.
Emerging country Sovereign Debt involves a high degree of risk, is generally
lower-quality debt, and is considered speculative in nature. The issuer or
governmental authorities that control Sovereign Debt repayment ("Sovereign
Debtors") may be unable or unwilling to repay principal or interest when due in
accordance with the terms of the debt. A Sovereign Debtor's willingness or
ability to repay principal and interest due in a timely manner may be affected
by, among other factors, its cash flow situation, the extent of its foreign
reserves, the availability of sufficient foreign exchange on the date a payment
is due, the relative size of the debt service burden to the economy as a whole,
the Sovereign Debtor's policy towards the International Monetary Fund (the
"IMF") and the political constraints to which the Sovereign Debtor may be
subject. Sovereign Debtors may also be dependent on expected disbursements from
foreign governments, multilateral agencies and others abroad to reduce principal
and interest arrearage on their debt. The commitment of these third parties to
make such disbursements may be conditioned on the Sovereign Debtor's
implementation of economic reforms or economic performance and the timely
service of the debtor's obligations. The Sovereign Debtor's failure to meet
these conditions may cause these third parties to cancel their commitments to
provide funds to the Sovereign Debtor, which may further impair the debtor's
ability or willingness to timely service its debts. In certain instances, a
Fund may invest in Sovereign Debt that is in default as to payments of principal
or interest. A Fund holding non-performing Sovereign Debt may incur additional
expenses in connection with any restructuring of the issuer's obligations or
in otherwise enforcing its rights thereunder.
BRADY BONDS. The International Equity Fund may invest up to 5% of its net
assets in Brady Bonds as part of its investment in Sovereign Debt of countries
that have restructured or are in the process of restructuring their Sovereign
Debt pursuant to the Brady Plan.
Brady Bonds are issued under the framework of the Brady Plan, an initiative
announced by former U.S. Treasury Secretary Nicholas F. Brady in 1989 as a
mechanism for debtor nations to restructure their outstanding external
indebtedness. The Brady Plan contemplates, among other things, the debtor
nation's adoption of certain economic reforms and the exchange of commercial
bank debt for newly issued bonds. In restructuring its external debt under the
Brady Plan framework, a debtor nation negotiates with its existing bank lenders
as well as the World Bank or IMF. The World Bank or IMF supports the
restructuring by providing funds pursuant to loan agreements or other
arrangements that enable the debtor nation to collateralize the new Brady Bonds
or to replenish reserves used to reduce outstanding bank debt. Under these loan
agreements or other arrangements with the World Bank or IMF, debtor nations have
been required to agree to implement certain domestic monetary and fiscal
reforms. The Brady Plan sets forth only general guiding principles for economic
reform and debt reduction, emphasizing that solutions must be negotiated on a
case-by-case basis between debtor nations and their creditors.
Brady Bonds are recent issues and do not have a long payment history.
Agreements implemented under the Brady Plan are designed to achieve debt and
debt-service reduction through specific options negotiated by a debtor nation
with its creditors. As a result, each country offers different financial
packages. Options have included the exchange of outstanding commercial bank debt
for bonds issued at 100% of face value of such debt, bonds issued at a discount
of face value of such debt, and bonds bearing an interest rate that increases
over time and the advancement of the new money for bonds. The principal of
certain Brady Bonds has been collateralized by U.S. Treasury zero coupon bonds
with a maturity equal to the final maturity of the Brady Bonds. Collateral
purchases are financed by the IMF, World Bank and the debtor nations' reserves.
Interest payments may also be collateralized in part in various ways.
Brady Bonds are often viewed as having three or four valuation components:
(i) the collateralized repayment of principal at final maturity; (ii) the
collateralized interest payments; (iii) the uncollateralized interest payments;
and (iv) any uncollateralized principal at maturity (these uncollateralized
amounts constitute the "residual risk"). In light of the residual risk of
Brady Bonds and, among other factors, the history of defaults with respect to
commercial bank loans by public and private entities of countries issuing Brady
Bonds, investments in Brady Bonds can be viewed as speculative.
Additional Investment Limitations
- ---------------------------------
Each Fund is subject to the investment limitations enumerated in this
subsection which may be changed with respect to a particular Fund only by a vote
of the holders of a majority of such Fund's outstanding shares (as defined under
"Miscellaneous" below).
No Fund may:
1. Make loans, except that a Fund may purchase and hold debt instruments
and enter into repurchase agreements in accordance with its investment objective
and policies and may lend portfolio securities in an amount not exceeding 30% of
its total assets.
2. Purchase securities of companies for the purpose of exercising
control.
3. Purchase or sell real estate or with respect to the International
Equity Fund, real estate limited partnerships, except that each Fund may
purchase securities of issuers which deal in real estate and may purchase
securities which are secured by interests in real estate.
4. Acquire any other investment company or investment company security
except in connection with a merger, consolidation, reorganization or acquisition
of assets or where otherwise permitted by the 1940 Act.
5. Act as an underwriter of securities within the meaning of the
Securities Act of 1933 except insofar as a Fund might be deemed to be an
underwriter upon the 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
the Fund's investment objective, policies and limitations may be deemed to be
underwriting.
6. Write or sell put options, call options, straddles, spreads, or any
combination thereof, except for transactions in options on securities, indices
of securities, futures contracts and options on futures contracts.
7. 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 Fund's transactions in futures contracts and related options, and (b)
a Fund may obtain short-term credit as may be necessary for the clearance of
purchases and sales of portfolio securities.
8. Purchase or sell commodity contracts, or invest in oil, gas or mineral
exploration or development programs, except that each Fund 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 enter into
futures contracts and related options.
In addition, as summarized in the Prospectuses, no Fund may:
9. Purchase securities of any one issuer (other than securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities) if,
immediately after such purchase, more than 5% of the value of the Fund'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 Fund or Portico
Funds, Inc. (the "Company"), except that up to 25% of the value of the Fund's
total assets may be invested without regard to these limitations. For purposes
of this limitation, a security is considered to be issued by the entity (or
entities) whose assets and revenues back the security. A guarantee of a
security shall not be deemed to be a security issued by the guarantor when the
value of all securities issued and guaranteed by the guarantor, and owned by the
Fund, does not exceed 10% of the value of the Fund's total assets.
10. Purchase any securities which would cause 25% or more of the value of
the Fund'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, (a) with regard to all Funds except the Tax-Exempt
Intermediate Bond Fund, there is no limitation with respect to instruments
issued or guaranteed by the United States, its agencies or instrumentalities and
repurchase agreements secured by such instruments; (b) with regard to the Tax-
Exempt Intermediate Bond Fund, there is no limitation with respect to
instruments issued or guaranteed by the United States, any state, territory or
possession of the United States, the District of Columbia or any of their
authorities, agencies, instrumentalities or political subdivisions and
repurchase agreements secured by such instruments; (c) 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 the parents; and
(d) 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.
11. Borrow money or issue senior securities, except that each Fund may
borrow from banks and enter into reverse repurchase agreements for temporary
purposes in amounts up to 10% of the value of the 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 value of the Fund's total assets at
the time of such borrowing. The Fund will not purchase securities while its
borrowings (including reverse repurchase agreements) in excess of 5% of its
total assets are outstanding. Securities held in escrow or separate accounts in
connection with the Fund's investment practices described in this Statement of
Additional Information or in the Prospectus are not deemed to be pledged for
purposes of this limitation.
12. With respect to the Tax-Exempt Intermediate Bond Fund, invest less
than 80% of its net assets in securities the interest on which is exempt from
federal income tax except during defensive periods or during unusual market
conditions. For purposes of this fundamental policy, Municipal Obligations that
are subject to federal alternative minimum tax are considered taxable.
If a percentage limitation is satisfied at the time of investment, a later
increase or decrease in such percentage resulting from a change in the value of
the Fund's portfolio securities will not constitute a violation of such
limitation.
If due to market fluctuations or other reasons, the amount of borrowings
and reverse repurchase agreements exceed the limit stated above, the Funds will
promptly reduce such amount. Except as otherwise provided in Investment
Restriction No. 10 above, for the purpose of such restriction, in determining
industry classification with respect to the International Equity Fund, the
Company intends to use the Morgan Stanley Capital International classification
titles.
With respect to investment limitation No. 3 under "Additional Investment
Limitations" as it relates to the Tax-Exempt Intermediate Bond Fund, real
estate shall include real estate mortgages. Although the foregoing investment
limitations would permit the Tax-Exempt Intermediate Bond Fund to invest in
options, futures contracts, options on futures contracts and engage in
securities lending, the Fund, during the current fiscal year, does not intend to
trade in such instruments (except that the Fund may purchase put options on
Municipal Obligations as described in the Prospectus) or lend portfolio
securities. Prior to engaging in any such transactions, the Fund will provide
its shareowners with notice and add any additional descriptions concerning the
instruments to the Prospectus and this Statement of Additional Information as
may be required. With respect to investment limitation No. 10 under
"Additional Investment Limitations," asset-backed securities will be divided
according to the type of assets underlying the security. For example,
automobile loans, credit card receivables and installment sales contracts will
each be considered a separate industry.
NET ASSET VALUE
The net asset value per share of each Fund is calculated separately for the
Institutional Series and Retail Series by adding the value of all portfolio
securities and other assets belonging to the particular Fund that are allocated
to a particular series, subtracting the liabilities charged to that series, and
dividing the result by the number of outstanding shares of that series. Assets
belonging to a Fund consist of the consideration received upon the issuance of
shares of the particular Fund together with all net investment income, realized
gains/losses and proceeds derived from the investment thereof, including any
proceeds from the sale of such investments, any funds or payments derived from
any reinvestment of such proceeds, and a portion of any general assets of the
Company not belonging to a particular investment portfolio. The liabilities that
are charged to a Fund are borne by each share of the Fund, except for certain
payments under the Funds' Distribution and Service Plan and Shareowner Servicing
Plan applicable only to Retail Series Shares of the non-money market funds.
Subject to the provisions of the Articles of Incorporation, determinations by
the Board of Directors as to the direct and allocable liabilities, and the
allocable portion of any general assets, with respect to a particular Fund are
conclusive.
The value of a Fund's portfolio securities that are traded on stock
exchanges outside the United States are based upon the price on the exchange as
of the close of business of the exchange immediately preceding the time of
valuation, except when an occurrence subsequent to the time a value was so
established is likely to have changed such value. Securities trading in over-
the-counter markets in European and Pacific Basin countries is normally
completed well before 3:00 P.M. Central Time. In addition, European and Pacific
Basin securities trading may not take place on all business days. Furthermore,
trading takes place in Japanese markets on certain Saturdays and in various
foreign markets on days which are not business days in New York and on which net
asset value of a Fund, including the International Equity Fund, is not
calculated. The calculation of the net asset value of a Fund, including the
International Equity Fund, may not take place contemporaneously with the
determination of the prices of portfolio securities used in such calculation.
Events affecting the values of portfolio securities that occur between the time
their prices are determined and 3:00 P.M. Central Time, and at other times, may
not be reflected in the calculation of net asset value of a Fund.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
COMPUTATION OF OFFERING PRICE OF THE FUNDS. An illustration of the
computation of the initial offering price per share of the Retail Shares of the
Short-Term Bond Market, Intermediate Bond Market, Tax-Exempt Intermediate Bond,
Bond IMMDEX/tm, Balanced, Growth and Income, Equity Index, Growth, Special
Growth, and International Equity Funds based on the value of each such Fund's
net assets and number of outstanding securities at October 31, 1996, follows:
Tax-
Short-Term Exempt
Bond Intermediate Intermediate Bond
Market Bond Market Bond IMMDEX/tm
Fund Fund Fund Fund
---- ---- ---- ----
Net Assets (000s) $58,843 $17,392 $10,690 $42,671
Number of Shares
Outstanding (000s) 5,738 1,707 1,047 1,549
Net Asset Value
Per Share $10.25 $10.19 $10.21 $27.54
Sales Charge, 2.00%
of offering price
(2.04% of net asset
value per share) 0.21 0.21 0.21 0.56
Public Offering Price $10.46 $10.40 $10.42 $28.10
Growth Inter-
and Equity Special national
Balanced Income Index Growth Growth Equity
Fund Fund Fund Fund Fund Fund
---- ---- ---- ---- ---- ----
Net Assets (000s) $29,034 $71,310 $39,656 $16,636 $111,159 $3,769
Number of Shares
Outstanding (000s) 1,038 2,156 803 549 2,686 186
Net Asset Value
Per Share $27.98 $33.07 $49.40 $30.32 $41.38 $20.21
Sales Charge, 4.00%
of offering price
(4.16% of net asset
value per share) 1.17 1.38 2.06 1.26 1.72 0.84
Public Offering Price $29.15 $34.45 $51.46 $31.58 $43.10 $21.05
Prior to January 9, 1995, the Funds offered only one class of shares to
both institutional and retail investors. On that date, the Funds began offering
Institutional Shares to institutional investors and Retail Shares to retail
investors.
Retail Shares of each of the non-money market funds are sold with a front-
end sales charge. A front-end sales charge will not be imposed on reinvested
dividends or distributions. Likewise, there is no front-end sales charge
(provided the status of the investment is explained at the time of investment)
on purchases of Retail Shares if (a) you were a Portico shareowner as of January
1, 1995 and have continuously maintained a shareowner account with the Company;
(b) you make any purchase within 60 days of a redemption of Portico
Institutional Shares; (c) you are an employee, director or retiree of Firstar
Corporation or its affiliates or of Portico; (d) you maintain a personal trust
account with an affiliate of Firstar Corporation at the time of purchase; (e)
you make any purchase within 60 days of a termination of a personal trust
account with an affiliate of Firstar Corporation; (f) you make any purchase for
your medical savings account for which an affiliate of Firstar Corporation
serves in a custodial capacity; (g) you make any purchase for your individual
retirement account; (h) you make any purchase within 60 days of a redemption of
a mutual fund on which you paid an initial sales charge or a contingent deferred
sales charge; (i) you are a registered investment adviser that has entered into
an agreement with the Distributor to purchase shares for your own account or for
discretionary client accounts; (j) you are a spouse, parent or child of an
individual who falls within the preceding categories (a) or (d) above; or (k)
you are a spouse, parent, sibling or child of an individual who falls within the
preceding category (c) above. These exemptions to the imposition of a front-end
sales charge are due to the nature of the investors and/or the reduced sales
efforts that will be needed in obtaining such investments.
Shareowner Organizations or Institutions may be paid by the Funds for
advertising, distribution or shareowner services. Depending on the terms of the
particular account, Shareowner Organizations or Institutions also may charge
their customers fees for automatic investment, redemption and other services
provided. Such fees may include, for example, account maintenance fees,
compensating balance requirements or fees based upon account transactions,
assets or income. Shareowner Organizations or Institutions are responsible for
providing information concerning these services and any charges to any customer
who must authorize the purchase of Fund shares prior to such purchase.
Shares of any Fund for which a redemption order is received in proper form
by the transfer agent or Elan before the close of the Exchange (currently 3:00
p.m. Central Time) on a business day will be redeemed as of the determination of
net asset value on that day. Orders for a redemption received after the close
of the Exchange on a business day or on a non-business day will be priced as of
the determination of net asset value on the next day on which shares of the
particular Fund are priced. If a shareowner requests that redemption proceeds
be paid by federal funds wire, the proceeds will be wired to a correspondent
member bank if the investor's designated bank is not a member of the Federal
Reserve System.
Under the 1940 Act, the Funds may suspend the right of redemption or
postpone the date of payment for shares during any period when (a) trading on
the Exchange is restricted by applicable rules and regulations of the SEC; (b)
the Exchange is closed for other than customary weekend and holiday closings;
(c) the SEC has by order permitted such suspension; or (d) an emergency exists
as determined by the SEC. (The Funds may also suspend or postpone the recording
of the transfer of their shares upon the occurrence of any of the foregoing
conditions.)
The Company's Articles of Incorporation permit a Fund to redeem an account
involuntarily, upon sixty days' notice, if redemptions cause the account's net
asset value to remain at less than $1,000.
In addition to the situations described in the Funds' Prospectuses under
"Redemption of Shares," the Funds may redeem shares involuntarily to reimburse
the Funds for any loss sustained by reason of the failure of a shareowner to
make full payment for shares purchased by the shareowner or to collect any
charge relating to a transaction effected for the benefit of a shareowner which
is applicable to Fund shares as provided in the Prospectus from time to time.
EXCHANGE PRIVILEGE. By use of the exchange privilege, shareowners authorize
the transfer agent to act on telephonic or written exchange instructions from
any person representing himself to be the shareowner or in some cases, the
shareowner's registered representative or account representative of record, and
believed by the transfer agent to be genuine. The transfer agent's records of
such instructions are binding. The exchange privilege may be modified or
terminated at any time upon notice to shareowners.
Exchange transactions described in paragraphs A, B, and C below will be
made on the basis of the relative net asset values per share of the Funds
involved in the transaction.
A. Retail Shares of any Fund purchased with a sales charge may be exchanged
without a sales charge for Retail Shares of any other Fund offered by the
Company with a sales charge.
B. Shares of any Fund offered by the Company acquired by a previous
exchange transaction involving Retail Shares on which a sales charge has
directly or indirectly been paid (e.g. shares purchased with a sales charge or
issued in connection with an exchange involving shares that had been purchased
with a sales charge) as well as additional Shares acquired through reinvestment
of dividends or distributions on such Shares may be exchanged without a sales
charge for Retail Shares of any other Fund offered by the Company with a sales
charge. To accomplish an exchange under the provisions of this paragraph,
investors must notify the transfer agent of their prior ownership of Retail
Shares and their account number.
C. Shares of any Fund offered by the Company may be exchanged without a
sales charge for Shares of any other Fund of the Company that is offered without
a sales charge.
Except as stated above, a sales charge will be imposed when Shares of a
Fund that were purchased or otherwise acquired without a sales charge are
redeemed and the proceeds are used to purchase Retail Shares of another Fund of
the Company with a sales charge.
Shares in a Fund from which the shareowner is withdrawing an investment
will be redeemed at the net asset value per share next determined on the date of
receipt. Shares of the new Fund into which the shareowner is investing will be
purchased at the net asset value per share next determined (plus any applicable
sales charge) after acceptance of the request by the Company in accordance with
the policies for accepting investments. Exchanges of Shares will be available
only in states where they may legally be made.
For federal income tax purposes, share exchanges are treated as sales on
which the shareowner may realize a gain or loss, depending upon whether the
value of the shares to be given up in exchange is more or less than the basis in
such shares at the time of the exchange. Investors exercising the exchange
privilege should request and review the Prospectus for the shares to be acquired
in the exchange prior to making an exchange.
Additional Information Regarding Shareowner Services for Retail Shares
- ----------------------------------------------------------------------
The Retail Shares of the Funds offer a Periodic Investment Plan whereby a
shareowner may automatically make purchases of shares of a Fund on a regular,
monthly basis ($100 minimum per transaction). Under the Periodic Investment
Plan, a shareowner's designated bank or other financial institution debits a
preauthorized amount on the shareowner's account each month and applies the
amount to the purchase of Retail Shares. The Periodic Investment Plan must be
implemented with a financial institution that is a member of the Automated
Clearing House. No service fee is currently charged by a Fund for participation
in the Periodic Investment Plan. A $20 fee will be imposed by the transfer agent
if sufficient funds are not available in the shareowner's account or the
shareowner's account has been closed at the time of the automatic transaction.
The Periodic Investment Plan permits an investor to use "Dollar Cost
Averaging" in making investments. Instead of trying to time market
performance, a fixed dollar amount is invested in Retail Shares at predetermined
intervals. This may help investors to reduce their average cost per share
because the agreed upon fixed investment amount allows more Retail Shares to be
purchased during periods of lower Retail Share prices and fewer Retail Shares to
be purchased during periods of higher Retail Share prices. In order to be
effective, Dollar Cost Averaging should usually be followed on a sustained,
consistent basis. Investors should be aware, however, that Retail Shares bought
using Dollar Cost Averaging are purchased without regard to their price on the
day of investment or to market trends. Dollar Cost Averaging does not assure a
profit and does not protect against losses in a declining market. In addition,
while investors may find Dollar Cost Averaging to be beneficial, it will not
prevent a loss if an investor ultimately redeems his Retail Shares at a price
which is lower than their purchase price. An investor may want to consider his
financial ability to continue purchases through periods of low price levels.
The Retail Shares of the Funds permit shareowners to effect ConvertiFund/R
transactions, an automated method by which a Retail shareowner may invest
proceeds from one account to another account of the Retail Shares of the Portico
family of funds. Such proceeds include dividend distribution, capital gain
distributions and systematic withdrawals. ConvertiFundR transactions may be used
to invest funds from a regular account to another regular account, from a
qualified plan account to another qualified plan account, or from a qualified
plan account to a regular account.
The Retail Shares of the Funds offer shareowners a Systematic Withdrawal
Plan, which allows a shareowner who owns shares of a Fund worth at least $15,000
at current net asset value at the time the shareowner initiates the Systematic
Withdrawal Plan to designate that a fixed sum ($50 minimum per transaction) be
distributed to the shareowner or as otherwise directed at regular intervals.
Special Procedures for In-Kind Payments
- ---------------------------------------
Payment for shares of a Fund may, in the discretion of the Fund, be made in
the form of securities that are permissible investments for the Fund as
described in its Prospectus. For further information about this form of
payment, contact Investor Services at 414-287-3710. In connection with an
in-kind securities payment, a Fund will require, among other things, that the
securities be valued on the day of purchase in accordance with the pricing
methods used by the Fund; that the Fund receive satisfactory assurances that it
will have good and marketable title to the securities received by it; that the
securities be in proper form for transfer to the Fund; that adequate information
be provided to the Fund concerning the basis and other tax matters relating to
the securities; and that the amount of the purchase be at least $1,000,000.
DESCRIPTION OF SHARES
---------------------
The Company's Articles of Incorporation authorize the Board of Directors to
issue up to 150,000,000,000 full and fractional shares of common stock, $.0001
par value per share, which is divided into thirty classes (each, a "Class" or
"Fund"). Each Class below is divided into two series designated as
Institutional Series and Series A/Retail Series (each, a "Series") and
consists of the number of shares set forth next to its Fund name in the table
below:
Class-Series of Fund in which Stock Number of Authorized
Common Stock Represents Interest Shares in Each Series
- --------------- ------------------- ---------------------
6-Institutional Special Growth 500 Million
6-A 500 Million
7-Institutional Bond IMMDEX/tm 500 Million
7-A 500 Million
8-Institutional Equity Index 500 Million
8-A 500 Million
9-Institutional Growth and Income 500 Million
9-A 500 Million
10-Institutional Short-Term Bond Market 500 Million
10-A 500 Million
11-Institutional Balanced Growth 500 Million
11-A 500 Million
12-Institutional Growth 500 Million
12-A 500 Million
13-Institutional Intermediate Bond Market 500 Million
13-A 500 Million
14-Institutional Tax-Exempt Intermediate Bond 500 Million
14-A 500 Million
15-Institutional International Equity 500 Million
15-A 500 Million
The Board of Directors has also authorized the issuance of Classes 1
through 5 and Classes 16 and 17 common stock representing interests in seven
other separate investment portfolios which are described in separate Statements
of Additional Information. The remaining authorized shares are classified into
thirteen additional classes representing interest in other potential future
investment portfolios of the Company. The Directors may similarly classify or
reclassify any particular class of shares into one or more additional series.
In the event of a liquidation or dissolution of the Company or an
individual Fund, shareowners of a particular Fund would be entitled to receive
the assets available for distribution belonging to such Fund, and a
proportionate distribution, based upon the relative assets of the Company's
respective investment portfolios, of any general assets not belonging to any
particular portfolio which are available for distribution. Subject to the
allocation of certain costs, expenses, charges and reserves attributed to the
operation of a particular series as described in the Funds' Prospectuses,
shareowners of a Fund are entitled to participate equally in the net
distributable assets of the particular Fund involved on liquidation, based on
the number of shares of the Fund that are held by each shareowner.
Shareowners of the Funds, as well as those of any other investment
portfolio offered by the Company, will vote together in the aggregate and not
separately on a Fund-by-Fund basis, except as otherwise required by law or when
the Board of Directors determines that the matter to be voted upon affects only
the interests of the shareowners of a particular class or a particular series
within a class. Rule 18f-2 under the 1940 Act provides that any matter required
to be submitted to the holders of the outstanding voting securities of an
investment company such as the Company shall not be deemed to have been
effectively acted upon unless approved by the shareowners of each portfolio
affected by the matter. A portfolio is affected by a matter unless it is clear
that the interests of each portfolio in the matter are substantially identical
or that the matter does not affect any interest of the portfolio. Under the
Rule, the approval of an investment advisory agreement or any change in a
fundamental investment policy would be effectively acted upon with respect to a
portfolio only if approved by a majority of the outstanding shares of such
portfolio. However, the Rule also provides that the ratification of the
appointment of independent accountants, the approval of principal underwriting
contracts and the election of Directors may be effectively acted upon by
shareowners of the Company voting together in the aggregate without regard to
particular portfolios. Similarly, on any matter submitted to the vote of
shareowners which only pertains to agreements, liabilities or expenses
applicable to one series of a Fund (such as the Distribution and Service Plan
and Shareowner Service Plan applicable to Retail Shares) but not the other
series of the same Fund, only the affected series will be entitled to vote.
When issued for payment as described in the Funds' Prospectus and this
Statement of Additional Information, shares of the Funds will be fully paid and
non-assessable by the Company, except as provided in Section 180.0622(2)(b) of
the Wisconsin Business Corporation Law, as amended, which in general provides
for personal liability on the part of a corporation's shareowners for unpaid
wages of employees. The Company does not intend to have any employees and, to
that extent, the foregoing statute will be inapplicable to holders of Fund
shares and will not have a material effect on the Company.
The Articles of Incorporation authorize the Board of Directors, without
shareowner approval (unless otherwise required by applicable law), to: (a) sell
and convey the assets belonging to a series of shares to another management
investment company for consideration which may include securities issued by the
purchaser and, in connection therewith, to cause all outstanding shares of such
series to be redeemed at a price which is equal to their net asset value and
which may be paid in cash or by distribution of the securities or other
consideration received from the sale and conveyance; (b) sell and convert the
assets belonging to a series of shares into money and, in connection therewith,
to cause all outstanding shares of such series to be redeemed at their net asset
value; or (c) combine the assets belonging to a series of shares with the assets
belonging to one or more other series of shares if the Board of Directors
reasonably determines that such combination will not have a material adverse
effect on the shareowners of any series participating in such combination and,
in connection therewith, to cause all outstanding shares of any such series to
be redeemed or converted into shares of another series of shares at their net
asset value.
ADDITIONAL INFORMATION CONCERNING TAXES
The following is only a summary of certain additional tax considerations
generally affecting the Funds and their shareowners that are not described in
the Funds' Prospectuses. No attempt is made to present a detailed explanation of
the tax treatment of the Funds or their shareowners, and the discussion here and
in the Prospectus is not intended as a substitute for careful tax planning.
Investors are advised to consult their tax advisers with specific reference to
their own tax situations.
A 4% non-deductible excise tax is imposed on regulated investment companies
that fail to currently distribute specified percentages of their ordinary
taxable income and capital gain net income (excess of capital gains over capital
losses). The Funds intend to make sufficient distributions or deemed
distributions of their ordinary taxable income and any capital gain net income
with respect to each calendar year to avoid liability for this excise tax.
Each Fund is treated as a separate tax entity under the Code. Although
each Fund expects to qualify as a "regulated investment company" and to be
relieved of all or substantially all federal income taxes, depending upon the
extent of the Company's activities in states and localities in which its offices
are maintained, in which its agents or independent contractors are located or in
which it is otherwise deemed to be conducting business, the Funds may be subject
to the tax laws of such states or localities. In addition, in those states and
localities which have income tax laws, the treatment of the Funds and their
shareowners under such laws may differ from their treatment under federal income
tax laws.
If for any taxable year a Fund does not qualify for the special federal
income tax treatment afforded regulated investment companies, all of its taxable
income will be subject to federal income tax at regular corporate rates (without
any deduction for distributions to its shareowners). In such event, dividend
distributions would be taxable as ordinary income to shareowners to the extent
of the Fund's current and accumulated earnings and profits and would be eligible
for the dividends received deduction in the case of corporate shareowners.
Investment company taxable income earned by the Fund will be distributed by
the Fund to its shareowners and will be taxable to shareowners as ordinary
income whether paid in cash or additional shares. In general, investment
company taxable income will be the Fund's taxable income, subject to certain
adjustments and excluding the excess of any net long-term capital gain for the
taxable year over the net short-term capital loss, if any, for such year.
A taxable gain or loss may be realized by a shareowner upon his redemption,
transfer or exchange of Fund shares depending upon the tax basis of such shares
and their price at the time of redemption, transfer or exchange.
Any distribution of the excess of net long-term capital gain over net
short-term capital loss is taxable to shareowners as long-term capital gain,
regardless of how long the shareowner has held the distributing Fund's shares
and whether such gains are received in cash or additional Fund shares. The Fund
will designate such a distribution as capital gain dividend in a written notice
mailed to shareowners within 60 days after the close of the Fund's taxable year.
It should be noted that, upon the sale or exchange of Fund shares, if the
shareowner has not held such shares for more than six months, any loss on the
sale or exchange of those shares will be treated as long-term capital loss to
the extent of the capital gain dividends received with respect to the shares.
Income received by a Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Tax
conventions between certain countries and the U.S. may reduce or eliminate such
taxes. If more than 50% of the value of the International Equity Fund's total
assets at the close of its taxable year consists of stock or securities of
foreign corporations, the Fund will be eligible to elect to "pass-through" to
its shareowners the amount of foreign income and similar taxes paid by the Fund.
If this election is made, a shareowner will be required to include in gross
income (in addition to taxable dividends actually received) his or her pro rata
share of foreign income and similar taxes paid by the Fund, and will be entitled
either to deduct (provided the shareowner itemizes deductions) his or her pro
rata share of foreign income and similar taxes in computing his taxable income
or to use it (subject to limitations) as a foreign tax credit against his or her
U.S. Federal income tax liability. Foreign taxes generally are not deductible in
computing alternative minimum taxable income. Each shareowner of the
International Equity Fund will be notified within 60 days after the close of the
Fund's taxable year if the foreign income and similar taxes paid by the Fund
will "pass-through" for that year.
Generally, a credit for foreign taxes is subject to the limitation that it
may not exceed the shareowner's U.S. tax attributable to his or her total
foreign source taxable income. For this purpose, if the pass-through election
is made, the source of the International Equity Fund's income will flow to
shareowners of the Fund. With respect to the Fund, gains from the sale of
securities will be treated as derived from U.S. sources and certain currency
fluctuation gains, including fluctuation gains from foreign currency denominated
debt securities, receivables and payables, will be treated as ordinary income
derived from U.S. sources. The limitation on the foreign tax credit is applied
separately to foreign source passive income, and to certain other types of
income. Shareowners may be unable to claim a credit for the full amount of
their proportionate share of foreign taxes paid by the International Equity
Fund. Certain additional limitations are imposed on the use of foreign tax
credits to offset liability for the alternative minimum tax.
If a Fund invests in certain "passive foreign investment companies"
("PFICs") which do not distribute their income on a regular basis, it
generally will be subject to federal income tax (and possibly additional
interest charges) on a portion of any "excess distribution" or gain from the
disposition of such investments even if it distributes the income to its
shareowners. If the Fund qualifies and elects to treat the PFIC as a
"qualified electing fund" ("QEF") and the PFIC furnishes certain financial
information in the required form, the Fund would instead be required to include
in income each year a portion of the ordinary earnings and net capital gains of
the QEF, whether or not received, and such amounts would be subject to the
various distribution requirements described above. In addition, another
election may be available that would involve marking to market the Fund's PFIC
holdings at the end of each taxable year (and on certain other dates prescribed
in the Code), with the result that unrealized gains are treated as though they
were realized. If this election were made, the tax described above at the fund
level under the PFIC rules generally would be eliminated.
The Tax-Exempt Intermediate Bond Fund is designed to provide investors with
current tax-exempt interest income. The Fund is not intended to constitute a
balanced investment program and is not designed for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations in
principal. Shares of the Fund may not be suitable for tax-exempt institutions,
or for retirement plans qualified under Section 401 of the Internal Revenue Code
of 1986 (the "Code"), H.R. 10 plans and individual retirement accounts because
such plans and accounts are generally tax-exempt and, therefore, not only would
not gain any additional benefit from the Fund's dividends being tax-exempt, but
such dividends ultimately would be taxable to the beneficiaries when distributed
to them. In addition, the Fund may not be an appropriate investment for
entities which are "substantial users" of facilities financed by private
activity bonds or "related persons" thereof. "Substantial user" is defined
under U.S. Treasury Regulations to include a non-exempt person who regularly
uses a part of such facilities in his trade or business and whose gross revenues
derived with respect to the facilities financed by the issuance of bonds are
more than 5% of the total revenues derived by all users of such facilities or
who occupies more than 5% of the usable area of such facilities or for whom such
facilities, part thereof where specifically constructed, reconstructed or
acquired. "Related persons" include certain related natural persons, affiliated
corporations, a partnership and its partners and an S Corporation and its
shareowners.
The percentage of total dividends paid by the Tax-Exempt Intermediate Bond
Fund with respect to any taxable year which qualifies as federal exempt-interest
dividends will be the same for all shareowners receiving dividends for such
year. In order for the Fund to pay exempt-interest dividends during any taxable
year, at the close of each taxable quarter at least 50% of the aggregate value
of the Fund's portfolio must consist of federal tax-exempt obligations. In
addition, the Fund must distribute an amount that is at least equal to the sum
of 90% of the net tax-exempt interest income and 90% of the investment company
taxable income earned by the Fund for the taxable year. Within 60 days of the
close of its taxable year, the Fund will notify shareowners of the portion of
the dividends paid by the Fund which constitutes an exempt-interest dividend
with respect to such taxable year. However, the aggregate amount of dividends
so designated cannot exceed the excess of the amount of interest exempt from tax
under Section 103 of the Code received by the Fund during the taxable year over
any amounts disallowed as deductions under Sections 265 and 171(a)(2) of the
Code.
Interest on indebtedness incurred by a shareowner to purchase or carry
shares of the Tax-Exempt Intermediate Bond Fund is generally not deductible for
federal income tax purposes if the Fund distributes exempt-interest dividends
during the shareowner's taxable year. If a shareowner holds shares of the Fund
for six months or less, any loss on the sale or exchange of those shares will be
disallowed to the extent of the amount of exempt-interest dividends received
with respect to the shares. The Treasury Department, however, is authorized to
issue regulations reducing the six-month holding requirement to a period of not
less than the greater of 31 days or the period between regular distributions for
investment companies that regularly distribute at least 90% of their net tax-
exempt interest. No such regulations had been issued as of the date of this
Statement of Additional Information.
The foregoing discussion is based on federal tax laws and regulations which
are in effect on the date of this Statement of Additional Information; such laws
and regulations may be changed by legislative or administrative action.
MANAGEMENT OF THE COMPANY
Directors and Officers
- ----------------------
The Directors and Officers of the Company, their addresses, age, principal
occupations during the past five years and other affiliations are as follows:
Principal
Position with Occupations During Past 5
Name, Address and Age the Company Years and Other Affiliations
- --------------------- ------------- ----------------------------
James M. Wade Chairman of Vice President and Chief
2802 Wind Bluff Circle the Board Financial Officer, Johnson
Wilmington, NC 28409 Controls, Inc. (a controls
Age: 53 manufacturing company)
January 1987 - May 1991.
Glen R. Bomberger Director Executive Vice President,
One Park Plaza Chief Financial Officer
11270 West Park Place and Director, A.O. Smith
Milwaukee, WI 53224-3690 Corporation (a diversified
Age: 59 manufacturing company) since
January 1987. Director
of companies affiliated with
A.O. Smith Corporation;
Chief Financial Officer,
Director and Vice President,
Smith Investment Company;
Officer and Director of
companies affiliated with Smith
Investment Company.
Jerry G. Remmel Director Vice President, Treasurer and
16650A Lake Circle Chief Financial Officer of
Brookfield WI 53005 Wisconsin Energy Corporation
Age: 65 1994-1996; Treasurer of
Wisconsin Electric Power
Company 1973-1996; Director
Wisconsin Electric Power Company
1989-1996; Senior Vice
President, Wisconsin Electric
Power Company 1988 - 1994; Chief
Financial Officer, Wisconsin
Electric Power Company 1983-
1996; Vice President and
Treasurer, Wisconsin Electric
Power Company 1983 - 1989.
Richard K. Riederer Director President, Chief Executive
400 Three Springs Drive Officer, and Chief Operating
Weirton, WV 26062-4989 Officer of Weirton Steel since
Age: 52 1995; Executive Vice
President and Chief Financial
Officer, Weirton Steel January
1994-1995; Vice President of
Finance and Chief Financial
Officer, Weirton Steel January
1989-1994; Member-Board of
Directors of American Iron and
Steel Institute since 1995;
Member-Board of Directors,
National Association of
Manufacturers since 1995.
Charles R. Roy* Director Vice President - Finance, Chief
14245 Heatherwood Court Financial Officer and
Elm Grove, WI 53122 Secretary, Rexnord Corporation
Age: 66 (an equipment manufacturing
company), 1988 - 1992; Vice
President - Finance and
Administration, Rexnord, Inc.,
1982 - 1992; Officer and
Director of several Rexnord
subsidiaries until 1992.
Steven R. Parish* President, Executive Vice President of
777 East Wisconsin Avenue Treasurer and Trust and Investments,
Suite 800 Director Firstar Corporation since 1996;
Milwaukee, WI 53202 Senior Vice President,
Age: 39 Firstar Bank Madison's Trust
Division, 1995; Vice President
and Portfolio Manager, FIRMCO,
1991-1994.
Mary Ellen Stanek Vice President President and Chief Operating
777 East Wisconsin Avenue Officer, FIRMCO since
Suite 800 1994, Director since 1992 and
Milwaukee, WI 53202 Director of Fixed Income
Age: 40 Securities since 1990.
W. Bruce McConnel, III Secretary Partner of the law firm of
Philadelphia National Drinker Biddle & Reath LLP.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107
Age: 53
* Messrs. Roy and Parish are considered by the Company to be "interested
directors" of the Company as defined in the 1940 Act.
The following chart provides certain information about the Director fees
for the year ended October 31, 1996 of the Company's Directors.
TOTAL
PENSION OR COMPENSATION
RETIREMENT ESTIMATED FROM COMPANY
AGGREGATE BENEFITS ANNUAL AND FUND
COMPENSATION ACCRUED AS BENEFITS COMPLEX *
NAME OF FROM THE PART OF FUND UPON PAID TO
PERSON/POSITION COMPANY EXPENSES RETIREMENT DIRECTORS
--------------- ----------- ------------ ---------- ------------
James M. Wade
President, Treasurer
and Chairman of the $15,000 $0 $0 $15,000
Board
Glen R. Bomberger
Director $12,000+ $0 $0 $12,000
Jerry G. Remmel
Director $12,000 $0 $0 $12,000
Richard K. Riederer
Director $12,000 $0 $0 $12,000
Charles R. Roy
Director $12,000 $0 $0 $12,000
Steven R. Parish
Director++ $0 $0 $0 $0
* The "Fund Complex" includes only the Company.
+ Includes $12,000 which Mr. Bomberger elected to defer under the Company's
deferred compensation plan.
++ As of October 31, 1996, Mr. Parish was not a director of the Company.
Each Director receives an annual fee of $7,000, a $1,000 per meeting
attendance fee and reimbursement of expenses incurred as a Director. The
Chairman of the Board is entitled to receive an additional $3,000 per annum for
services in such capacity. For the fiscal year ended October 31, 1996, the
Directors and Officers received aggregate fees of $63,000. Mr. Parish receives
no fees from the Company for his services as Director, President and Treasurer.
Ms. Stanek receives no fees from the Company for her services as Vice President,
although FIRMCO, of which she is President, receives fees from the Company for
advisory services. Drinker Biddle & Reath LLP, of which Mr. McConnel is a
partner, receives legal fees as counsel to the Company. As of the date of this
Statement of Additional Information, the Directors and Officers of the Company,
as a group, owned less than 1% of the outstanding shares of each Fund.
Advisory Services
- -----------------
FIRMCO became the investment adviser to the Short-Term Bond Market Fund,
Special Growth Fund, Bond IMMDEX/tm Fund and Equity Index Fund as of February 3,
1992 and became the Investment Adviser to the Growth and Income Fund effective
June 17, 1993. Prior thereto, investment advisory services were provided by
Firstar Trust Company, an affiliate of FIRMCO. Firstar Trust Company has
guaranteed all obligations incurred by FIRMCO in connection with its Investment
Advisory Agreement. FIRMCO is also the Investment Adviser to the Growth Fund,
Intermediate Bond Market Fund, Balanced Fund, Tax-Exempt Intermediate Bond Fund,
and International Equity Fund. In its Investment Advisory Agreement, the
Adviser has agreed to pay all expenses incurred by it in connection with its
advisory activities, other than the cost of securities and other investments,
including brokerage commissions and other transaction charges, if any, purchased
or sold for the Funds.
The Adviser is entitled to 4/10ths of the gross income earned by each Fund
on each loan of its securities, excluding capital gains or losses, if any.
Pursuant to current policy of the Securities and Exchange Commission, the Funds
do not intend to receive separate compensation for securities lending activity.
In addition, the Adviser may also voluntarily waive additional advisory fees
otherwise payable by the Funds
For the services provided and expenses assumed by the Adviser under its
investment advisory agreement in effect for the fiscal years ended October 31,
1996, 1995, and 1994, the Adviser earned and waived advisory fees as follows:
Advisory Fees Earned (Advisory Fees Waived)
-------------------------------------------
1996 1995 1994
Short-Term Bond Market Fund $552,764 $330,777 $339,126
(556,286) (436,239) (444,879)
Special Growth Fund 4,279,091 3,291,584 2,576,044
(250) (48,415) (119,214)
Bond IMMDEX/tm Fund 1,074,956 831,690 774,322
(1,673) (0) (0)
Equity Index Fund 555,115 319,929 197,707
(0) (0) (13,606)
Intermediate Bond 562,082 299,128 217,173
Market Fund (288,147) (238,251) (151,906)
Growth Fund 1,245,050 894,728 708,137
(8,639) (61,640) (61,181)
Balanced Fund 789,896 560,913 458,789
(309,983) (267,253) (213,732)
Growth and Income Fund 1,870,213 1,281,117 1,133,488
(18,262) (69,004) (83,990)
Tax-Exempt Intermediate 40,050 22,909 48,723
Bond Fund (159,121) (128,234) (90,055)
International Equity Fund 302,570 119,342 20,285
(332,273) (311,670) (111,361)<F1>
- --------------------
<F1> From inception (April 28, 1994) to October 31, 1994.
Under its Investment Advisory Agreement, the Adviser is not liable for any
error of judgment or mistake of law or for any loss suffered by the Funds in
connection with the performance of such Agreement, except a loss resulting from
a breach of fiduciary duty with respect to the receipt of compensation for
services or a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Adviser in the performance of its duties or from
its reckless disregard of its duties and obligations under the Agreement.
With regard to the International Equity Fund, under the Investment Advisory
Agreement, the Adviser is authorized to delegate its responsibilities to another
adviser. The Adviser has appointed Hansberger Global Investors, Inc. as Sub-
Adviser to the International Equity Fund. The Sub-Adviser determines the
securities to be purchased, retained or sold by the Fund. See "Sub-Adviser"
below.
SUB-ADVISER. The International Equity Fund receives sub-advisory services
from Hansberger Global Investors, Inc. (the "Sub-Adviser"). Under the terms
of the Sub-Advisory Agreement between the Adviser and Sub-Adviser, the Sub-
Adviser furnishes investment advisory and portfolio management services to the
International Equity Fund with respect to its investments. The Sub-Adviser is
responsible for decisions to buy and sell the International Equity Fund's
investments and all other transactions related to investment therein. The Sub-
Adviser negotiates brokerage commissions and places orders of purchases and
sales of the International Equity Fund's portfolio securities. During the term
of the Sub-Advisory Agreement, the Sub-Adviser will bear all expenses incurred
by it in connection with its services under such agreement.
Pursuant to the Sub-Advisory Agreement, in the absence of willful
misfeasance, bad faith or gross negligence on the part of the Sub-Adviser or
reckless disregard of its obligations and duties thereunder, or loss resulting
from a breach of fiduciary duty with respect to the receipt of compensation for
services, the Sub-Adviser will not be subject to any liability to the Adviser,
the International Equity Fund or the Company, or to any shareowner of the
International Equity Fund or the Company, for any act or omission in the course
of, or connected with, rendering services under the Sub-Advisory Agreement. See
"Banking Laws and Regulations" below for information regarding certain banking
laws and regulations and their applicability to the Sub-Adviser and its services
under the Sub-Advisory agreement.
For the services provided under its Sub-Advisory Agreement in effect for
the fiscal year ended October 31. 1996 and October 31, 1995 and the fiscal
period from the International Equity Fund's inception (April 28, 1994) to
October 31, 1994 the Sub-Adviser earned and waived advisory fees as follows:
Sub-Advisory Fees Earned (Sub-Advisory Fees Waived)
---------------------------------------------------
1996 1995 1994
International
Equity Fund 161,584 (0) 113,176 (0) 38,788 (0)
BANKING LAWS AND REGULATIONS. Banking laws and regulations, including the
Glass-Steagall Act as presently interpreted by the Board of Governors of the
Federal Reserve System, presently (a) prohibit a bank holding company registered
under the Federal Bank Holding Company Act of 1956 or any bank or non-bank
affiliate thereof from sponsoring, organizing, controlling or distributing the
shares of a registered, open-end investment company continuously engaged in the
issuance of its shares, and prohibit banks generally from underwriting
securities, but (b) do not prohibit such a bank holding company or affiliate or
banks generally from acting as investment adviser, transfer agent or custodian
to such an investment company or from purchasing shares of such a company as
agent and upon order of a customer. In 1971, the United States Supreme Court
held in INVESTMENT COMPANY INSTITUTE VS. CAMP that the Glass-Steagall Act
prohibits a national bank from operating a fund for the collective investment of
managing agency accounts. Subsequently, the Board of Governors of the Federal
Reserve System (the "Board") issued a regulation and interpretation to the
effect that the Glass-Steagall Act and such decision forbid a bank holding
company registered under the Federal Bank Holding Company Act of 1956 (the
"Holding Company Act"), or any non-bank affiliate thereof from sponsoring,
organizing or controlling a registered, open-end investment company continuously
engaged in the issuance of its shares, but did not prohibit such a holding
company or affiliate from acting as investment adviser, transfer agent and
custodian to such an investment company. In 1981, the United States Supreme
Court held in BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM V. INVESTMENT
COMPANY INSTITUTE that the Board did not exceed its authority under the Holding
Company Act when it adopted its regulation and interpretation authorizing bank
holding companies and their non-bank affiliates to act as investment advisers to
registered closed-end investment companies. FIRMCO, Firstar Trust Company and
SSBT are subject to such banking laws and regulations.
FIRMCO and Firstar Trust Company and the Sub-Adviser believe that they may
perform the services for the Funds contemplated by their respective agreements
with the Company without violation of the Glass-Steagall Act or other applicable
banking laws or regulations. These companies further believe that, if the
question were properly presented, a court should hold that these companies may
each perform such activities without violation of the Glass-Steagall Act or
other applicable banking laws and or regulations. It should be noted, however,
there have been no cases deciding whether banks and their affiliates may perform
services comparable to those performed by these companies, and future changes in
either federal or state statutes and regulations relating to permissible
activities of banks or trust companies and their subsidiaries or affiliates, as
well as further judicial or administrative decisions or interpretations of
present and future statutes and regulations, could prevent such companies from
continuing to perform such services for the Funds. If the companies were
prohibited from continuing to perform advisory, accounting, shareowner servicing
and custody services for the Funds, it is expected that the Board of Directors
would recommend that the Funds enter into new agreements or would consider the
possible termination of the Funds. Any new advisory or sub-advisory agreement
would be subject to shareowner approval.
Shares of the Funds are not bank deposits, are neither endorsed by, insured
by, or guaranteed by, obligations of, nor otherwise supported by the FDIC, the
Federal Reserve Board, Firstar Trust Company or FIRMCO, SSBT, their affiliates
or any other bank, or any other governmental agency. An investment in the Funds
involves risks including possible loss of principal.
Administration and Distribution Services
- ----------------------------------------
Firstar Trust Company ("Firstar Trust") became a Co-Administrator to the
Funds on September 1, 1994, and B. C. Ziegler and Company ("Ziegler") became a
Co-Administrator to the Funds on January 1, 1995. Under the Co-Administration
Agreement, the following administrative services will be provided jointly by the
Co-Administrators: assist in maintaining office facilities, furnish clerical
services, stationery and office supplies; monitor the company's arrangements
with respect to services provided by Shareowner Organizations; and generally
assist in the Funds' operations. The following administrative services will be
provided by Ziegler: review and comment upon the registration statement and
amendments thereto prepared by Firstar Trust or counsel to the Company, as
requested by Firstar Trust ; review and comment upon sales literature and
advertising relating to the Company, as requested by Firstar Trust; assist in
the administration of the marketing budget; periodically review blue sky
registration and sales reports for the Funds; attend meetings of the Board of
Directors, as requested by the Board of Directors of the Funds; and such other
services as may be requested in writing and expressly agreed to by Ziegler. The
following administrative services will be provided by Firstar Trust: compile
data for and prepare with respect to the Funds timely Notices to the SEC
required pursuant to Rule 24f-2 under the 1940 Act and Semi-Annual Reports on
Form N-SAR; coordinate execution and filing by the Company of all federal and
state tax returns and required tax filings other than those required to be made
by the Company's custodian and transfer agent; prepare compliance filings and
Blue Sky registrations pursuant to state securities laws with the advice of the
Company's counsel; assist to the extent requested by the Company with the
Company's preparation of annual and semi-annual reports to Fund shareowners and
registration statements for the Funds; monitor each Fund's expense accruals and
cause all appropriate expenses to be paid on proper authorization from each
Fund; monitor each Fund's status as a regulated investment company under
Subchapter M of the Code; maintain each Fund's fidelity bond as required by the
1940 Act; and monitor compliance with the policies and limitations of each Fund
as set forth in the prospectuses, statements of additional information, by-laws
and articles of incorporation.
Each of the Co-Administrators have agreed to pay all expenses incurred by
it in connection with its administrative activities. Under the Co-
Administration Agreement, the Co-Administrators are not liable for any error of
judgment or mistake of law or for any loss suffered by the Funds in connection
with the performance of the Co-Administration Agreement, except a loss resulting
from willful misfeasance, bad faith or gross negligence on the part of the Co-
Administrators in the performance of their respective duties or from their
reckless disregard of their duties and obligations under the Agreement.
The Distributor provides distribution services for each Fund as described
in the Funds' Prospectus pursuant to a Distribution Agreement with the Funds
under which the Distributor, as agent, sells shares of each Fund on a continuous
basis. The Distributor has agreed to use its best efforts to solicit orders for
the sale of shares, although it is not obliged to sell any particular amount of
shares. The Distributor causes expenses to be paid for the cost of printing and
distributing prospectuses to persons who are not shareowners of the Funds
(excluding preparation and printing expenses necessary for the continued
registration of the Funds' shares) and of printing and distributing all sales
literature. For the fiscal year ended October 31, 1994, Sunstone Financial
Group, Inc. ("Sunstone"), Portico Funds' former Distributor and Co-
Administrator, received no fees for its distribution services. For the fiscal
year ended October 31, 1996 and 1995, Ziegler received no fees for its
distribution services.
For its administrative services for the fiscal years ended October 31,
1996, 1995 and 1994, the Co-Administrators (and Sunstone for the fiscal year
ended October 31, 1994) earned and waived the following administrative fees:
Administration Fees Earned (Administration Fees Waived)
-------------------------------------------------------
1996 1995 1994
Short-Term Bond Market Fund $83,969 $59,323 $88,025
(127,339) (95,852) (72,075)
Special Growth Fund 257,995 194,656 249,168
(394,054) (345,563) (190,836)
Bond IMMDEX/tm Fund 159,028 151,431 227,105
(251,337) (174,586) (85,036)
Equity Index Fund 93,843 57,944 57,234
(160,223) (97,841) (46,232)
Intermediate Bond Market Fund 78,123 49,597 37,683
(116,341) (80,727) (52,610)
Growth Fund 75,054 64,612 71,418
(115,984) (90,089) (54,096)
Balanced Fund 65,092 51,415 56,667
(102,563) (82,629) (53,098)
Growth and Income Fund 113,216 82,730 110,256
(174,799) (134,204) (88,529)
Tax-Exempt Intermediate Bond Fund 20,315 14,551 20,580
(25,259) (22,137) (13,392)
International Equity Fund 20,015 14,701 5,560
(30,231) (20,395) (6,117)<F1>
<F1> From inception (April 28, 1994) to October 31, 1994.
Shareowner Organizations
- ------------------------
As stated in the Funds' Prospectus, for Retail Shares the Funds intend to
enter into agreements from time to time with Shareowner Organizations providing
for support and/or distribution services to customers of the Shareowner
Organizations who are the beneficial owners of Retail Shares of the Fund. Under
the agreements, the Funds may pay Shareowner Organizations up to 0.25% (on an
annualized basis) of the average daily net asset value of Retail Shares
beneficially owned by their customers. Services provided by Shareowner
Organizations under their agreements may include: (i) processing dividend and
distribution payments from a Fund; (ii) providing information periodically to
customers showing their share positions; (iii) arranging for bank wires; (iv)
responding to customer inquiries; (v) providing sub-accounting with respect to
shares beneficially owned by customers or the information necessary for sub-
accounting; (vi) forwarding shareowner communications; (vii) assisting in
processing share purchase, exchange and redemption requests from customers;
(viii) assisting customers in changing dividend options, account designations
and addresses; and (ix) other similar services requested by the Funds. In
addition, Shareowner Organizations, under the Distribution and Service Plan, may
provide assistance (such as the forwarding of sales literature and advertising
to their customers) in connection with the distribution of Fund shares. All
fees paid under these agreements are borne exclusively by the Fund's Retail
Shares.
The Funds' arrangements with Shareowner Organizations under the agreements
are governed by two Plans (a Service Plan and a Distribution and Service Plan),
which have been adopted by the Board of Directors. Because the Distribution and
Service Plan contemplates the provision of services related to the distribution
of Retail Shares (in addition to support services), that Plan has been adopted
in accordance with Rule 12b-1 under the 1940 Act and Rule 18f-3 of the 1940 Act.
In accordance with the Plans, the Board of Directors reviews, at least
quarterly, a written report of the amounts expended in connection with the
Funds' arrangements with Shareowner Organizations and the purposes for which the
expenditures were made. In addition, the Funds' arrangements with Shareowner
Organizations must be approved annually by a majority of the Directors,
including a majority of the Directors who are not "interested persons" of the
Funds as defined in the 1940 Act and have no direct or indirect financial
interest in such arrangements (the "Disinterested Directors").
The Funds believe that there is a reasonable likelihood that their
arrangements with Shareowner Organizations will benefit each Fund and the
holders of Retail Shares as a way of allowing Shareowner Organizations to
participate with the Funds in the provision of support and distribution services
to customers of the Shareowner Organization who own Retail Shares. Any material
amendment to the arrangements with Shareowner Organizations under the agreements
must be approved by a majority of the Board of Directors (including a majority
of the Disinterested Directors), and any amendment to increase materially the
costs under the Distribution and Service Plan with respect to a Fund must be
approved by the holders of a majority of the outstanding Retail Shares of the
Fund involved. So long as the Plans are in effect, the selection and nomination
of the members of the Board of Directors who are not "interested persons" (as
defined in the 1940 Act) of the Funds will be committed to the discretion of
such Disinterested Directors.
For the fiscal year ended 1994, the Company did not pay any fees to
Shareowner Organizations pursuant to Service Plans and Distribution and Service
Plans with respect to the Funds.
The Funds paid fees to Shareowner Organizations, none of which were
affiliated with the Adviser, pursuant to the Service Plan for the fiscal year
ended October 31, 1996 as follows:
Fees Earned by Non-Affiliated
Shareowner Organizations
-----------------------------
Short-Term Bond Market Fund $877
Special Growth Fund $1,427
Bond IMMDEX/tm Fund $0
Equity Index Fund $2,534
Intermediate Bond Market Fund $49
Growth Fund $0
Balanced Fund $0
Growth and Income Fund $437
Tax-Exempt Intermediate Bond Fund $3
International Equity Fund $0
The Funds paid fees to Shareowner Organizations, all of which were affiliated
with the Adviser, pursuant to the Service Plan for the fiscal year ended October
31, 1996 as follows:
Fees Earned by Affiliated
Shareowner Organizations
-------------------------
Short-Term Bond Market Fund $133,220
Special Growth Fund $250,839
Bond IMMDEX/tm Fund $81,916
Equity Index Fund $68,573
Intermediate Bond Market Fund $36,250
Growth Fund $33,578
Balanced Fund $64,413
Growth and Income Fund $137,847
Tax-Exempt Intermediate Bond Fund $23,012
International Equity Fund $6,964
CUSTODIAN, TRANSFER AGENT AND ACCOUNTING SERVICES AGENT
Firstar Trust serves as custodian of all the Funds' assets pursuant to a
Custody Agreement. Under the Custody Agreement, Firstar Trust has agreed to (i)
maintain a separate account in the name of each Fund, (ii) make receipts and
disbursements of money on behalf of each Fund, (iii) collect and receive all
income and other payments and distributions on account of each Fund's portfolio
investments, (iv) respond to correspondence from shareowners, security brokers
and others relating to its duties and (v) make periodic reports to the Company
concerning each Fund's operations. Firstar Trust may, at its own expense, open
and maintain a custody account or accounts on behalf of each Fund with other
banks or trust companies, provided that Firstar Trust shall remain liable for
the performance of all of its duties under the Custody Agreement notwithstanding
any delegation. For its services as custodian, Firstar Trust is entitled to
receive a fee, payable monthly, based on the annual rate of $0.20 per $1,000 of
the market value of Portico's first $2 billion of the aggregate market value of
assets, plus $0.15 per $1,000 of the market value of Portico's next $2 billion
of the aggregate market value of assets, and $0.10 per $1,000 of the aggregate
market value of Portico's assets in excess of $4 billion. In addition, Firstar
Trust, as custodian, is entitled to certain charges for securities transactions
and reimbursement for expenses.
Firstar Trust also serves as transfer agent and dividend disbursing agent
for each Fund under a Shareowner Servicing Agent Agreement. As transfer and
dividend disbursing agent, Firstar Trust has agreed to (i) issue and redeem
shares of the Funds, (ii) make dividend and other distributions to shareowners
of the Funds, (iii) respond to correspondence by Fund shareowners and others
relating to its duties, (iv) maintain shareowner accounts, and (v) make periodic
reports to the Funds. For its transfer agency and dividend disbursing services,
Firstar Trust is entitled to receive at the rate of $15.00 per shareowner
account with an annual minimum of $24,000 per portfolio, plus certain other
transaction charges and reimbursement for expenses.
In addition, all the Funds have entered into a Fund Accounting Servicing
Agreement with Firstar Trust pursuant to which Firstar Trust has agreed to
maintain the financial accounts and records of the Funds in compliance with the
1940 Act and to provide other accounting services to the Funds. For its
accounting services, Firstar Trust is entitled to receive fees, payable monthly,
at the following annual rates of the market value of each Fund's assets:
Balanced Fund, Growth and Income Fund, Equity Index Fund, Growth Fund, and
Special Growth Fund -- $27,500 on the first $40 million, 1.25/100th of 1% on the
next $200 million, and 6.25/1000ths of 1% on the balance, plus out-of-pocket
expenses, including pricing expenses; and Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Tax-Exempt Intermediate Bond Fund, Bond IMMDEX/tm
Fund and International Equity Fund -- $31,250 on the first $40 million,
2.5/100th of 1% on the next $200 million, and 1.25/100th of 1% on the next $200
million, and 6.25/1000th of 1% on the balance, plus out-of-pocket expenses,
including pricing expenses.
EXPENSES
Operating expenses of the Funds include taxes, interest, fees and expenses
of Directors and officers, Securities and Exchange Commission fees, state
securities and qualification fees, advisory fees, administrative fees,
Shareowner Organization fees (Retail Shares only), charges of the custodian and
transfer agent, dividend disbursing agent and accounting services agent, certain
insurance premiums, auditing and legal expenses, costs of preparing and printing
prospectuses for regulatory purposes and for distribution to shareowners, costs
of shareowner reports and meetings, membership fees in the Investment Company
Institute, and any extraordinary expenses. The Funds also pay any brokerage
fees, commissions and other transactions charges (if any) incurred in connection
with the purchase or sale of portfolio securities.
INDEPENDENT ACCOUNTANTS
Price Waterhouse LLP, independent accountants, 100 East Wisconsin Avenue,
Suite 1500, Milwaukee, Wisconsin, 53202, serve as auditors for the Company. The
financial statements and notes thereto contained in the Fund's Annual Report for
the fiscal year ended October 31, 1996 are incorporated herein by reference. No
other part of the Annual Report is incorporated herein by reference. Such
financial statements have been incorporated herein in reliance on the report of
Price Waterhouse LLP, independent accountants, given as authority of said firm
as experts in auditing and accounting.
COUNSEL
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of the
Company, is a partner), Philadelphia National Bank Building, 1345 Chestnut
Street, Philadelphia, Pennsylvania 19107, serve as counsel to the Company and
will pass upon the legality of the shares offered by each Fund's Prospectus.
ADDITIONAL INFORMATION ON PERFORMANCE
From time to time, the total return of the Retail Shares and Institutional
Shares of each Fund and the yields of such shares of the Short-Term Bond Market
Fund, Intermediate Bond Market Fund, Tax-Exempt Intermediate Bond Fund and Bond
IMMDEX/tm Fund may be quoted in advertisements, shareowner reports or other
communications to shareowners. Performance information is generally available
by calling the Portico Investor Services at 1-800-982-8909.
Yield Calculations.
- -------------------
The yield of a series of shares is calculated by dividing the net
investment income per share for that series (as described below) earned during a
30-day (or one-month) period by the net asset value per share for that series
(including the maximum front end sales charge of 2.00% for the Retail Shares of
the bond funds) on the last day of the period and annualizing the result on a
semiannual basis by adding one to the quotient, raising the sum to the power of
six, subtracting one from the result and then doubling the difference. Net
investment income per share earned during the period attributable to that series
is based on the average daily number of shares of the series outstanding during
the period entitled to receive dividends and includes dividends and interest
earned during the period attributable to that series minus expenses accrued for
the period, attributable to that series net of reimbursements.
This calculation can be expressed as follows:
a-b 6
Yield = 2 [(----- + 1) - 1]
c x d
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = Maximum offering price per share on the last day of the
period.
For the purpose of determining net investment income earned during the
period (variable "a" in the formula), dividend income on equity securities held
by a Fund is recognized by accruing 1/360 of the stated dividend rate of the
security each day that the security is in the portfolio. A Fund calculates
interest earned on any debt obligations held in its portfolio by computing the
yield to maturity of each obligation held by it based on the market value of the
obligation (including actual accrued interest) at the close of business on the
last business day of each month, or, with respect to obligations purchased
during the month, the purchase price (plus actual accrued interest) and dividing
the result by 360 and multiplying the quotient by the market value of the obli-
gation (including actual accrued interest) in order to determine the interest
income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. For purposes of this calculation, it is assumed
that each month contains 30 days. The maturity of an obligation with a call
provision is the next call date on which the obligation reasonably may be
expected to be called or, if none, the maturity date. With respect to debt
obligations purchased at a discount or premium, the formula generally calls for
amortization of the discount or premium. The amortization schedule will be
adjusted monthly to reflect changes in the market values of such debt
obligations.
Interest earned on tax-exempt obligations of the Tax-Exempt Intermediate
Bond Fund that are issued without original issue discount and have a current
market discount is calculated by using the coupon rate of interest instead of
the yield to maturity. In the case of tax-exempt obligations that are issued
with original issue discount but which have discounts based on current market
value that exceed the then-remaining portion of the original issue discount
(market discount), the yield to maturity is the imputed rate based on the
original issue discount calculation. On the other hand, in the case of tax-
exempt obligations that are issued with original issue discount but which have
the discounts based on current market value that are less than the then-
remaining portion of the original issue discount (market premium), the yield to
maturity is based on the market value.
With respect to mortgage or other receivables-backed obligations which are
expected to be subject to monthly payments of principal and interest ("pay
downs"), (a) gain or loss attributable to actual monthly pay downs are accounted
for as an increase or decrease to interest income during the period; and (b) a
Fund may elect either (i) to amortize the discount and premium on the remaining
security, based on the cost of the security, to the weighted average maturity
date, if such information is available, or to the remaining term of the
security, if any, if the weighted average maturity date is not available, or
(ii) not to amortize discount or premium on the remaining security.
Undeclared earned income may be subtracted from the net asset value per
share (variable "d" in the formula). Undeclared earned income is the net
investment income which, at the end of the 30-day base period, has not been
declared as a dividend, but is reasonably expected to be and is declared as a
dividend shortly thereafter.
In addition, the Tax-Exempt Intermediate Bond Fund may advertise a "tax-
equivalent yield" which is computed by: (a) dividing the portion of the Fund's
yield for a particular series (as calculated above) that is exempt from federal
income tax by one minus a stated federal income tax rate; and (b) adding the
figure resulting from (a) above to that portion, if any, of the Fund's yield
that is not exempt from federal income tax.
For the 30-day period ended October 31, 1996, the annualized yields for
Institutional Shares of the Short-Term Bond Market Fund, Intermediate Bond
Market Fund and Bond IMMDEX/tm Fund were 6.04%, 6.25%, and 6.50%, respectively.
Without fees waived by the Adviser and the Co-Administrators during such period,
the annualized yields would have been 5.63%, 6.01%, and 6.42%, respectively.
For the same period, the annualized taxable yield for the Tax-Exempt
Intermediate Bond Fund was 4.26%, and the tax-equivalent annualized yield was
6.17% (3.84% and 5.57%, respectively, without fees waived by the Adviser and Co-
Administrators during such period).
For the 30-day period ended October 31, 1996, the annualized yields,
assuming the maximum sales charge, for Retail Shares of the Short-Term Bond
Market Fund, Intermediate Bond Market Fund and Bond IMMDEX/tm Fund were 5.67%,
5.88%, and 6.12%, respectively. Without fees waived by the Adviser and the Co-
Administrators during such period, the annualized yields would have been 5.27%,
5.64%, and 6.05%, respectively. For the same period, the annualized taxable
yield for the Tax-Exempt Intermediate Bond Fund would have been 3.93% and the
tax-equivalent annualized yield would have been 5.70% (3.52% and 5.10%,
respectively, without fees waived by the Adviser and Co-Administrators during
such period).
For the 30-day period ended October 31, 1996 , the annualized yields for
Retail Shares of the Short-Term Bond Market Fund, Intermediate Bond Market Fund
and Bond IMMDEX/tm Fund purchased without a front end sales charge were 5.79%,
6.00%, and 6.25%, respectively. Without fees waived by the Adviser and the Co-
Administrators during such period, the annualized yields would have been 5.38%,
5.76% and 6.18%, respectively. For the same period, the annualized taxable
yield for the Tax-Exempt Intermediate Bond Fund purchased without a front end
sales charge would have been 4.01%, and the tax-equivalent annualized yield
would have been 5.81% (3.59%, and 5.20%, respectively, without fees waived by
the Adviser and Co-Administrators during such period).
Total Return Calculations.
- --------------------------
Each Fund computes "average annual total return" separately for its Retail
and Institutional Shares by determining the average annual compounded rates of
return during specified periods that equate the initial amount invested in a
particular series to the ending redeemable value of such investment in the
series. This is done by dividing the ending redeemable value of a hypothetical
$1,000 initial payment by $1,000 and raising the quotient to a power equal to
one divided by the number of years (or fractional portion thereof) covered by
the computation and subtracting one from the result. This calculation can be
expressed as follows:
ERV 1/n
T = [(-----) - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value at the end of the period
covered by the computation of a hypothetical $1,000
payment made at the beginning of the period.
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in terms
of years.
The Funds compute their aggregate total returns separately for the Retail
and Institutional Series, by determining the aggregate rates of return during
specified periods that likewise equate the initial amount invested in a
particular series to the ending redeemable value of such investment in the
series. The formula for calculating aggregate total return is as follows:
ERV
T = [(-----) - 1]
P
The calculations of average annual total return and aggregate total return
assume the reinvestment of all dividends and capital gain distributions on the
reinvestment dates during the period. The ending redeemable value (variable
"ERV" in each formula) is determined by assuming complete redemption of the
hypothetical investment and the deduction of all nonrecurring charges at the end
of the period covered by the computations. In addition, the Funds' average
annual total return and aggregate total return reflect the deduction of the 4%
maximum front-end sales charge for equity funds and 2% maximum front end sales
charge for fixed income funds in connection with the purchase of Retail Shares.
The Funds may also advertise total return data without reflecting sales charges
in accordance with the rules of the Securities and Exchange Commission.
Quotations that do not reflect the sales charge will, of course, be higher than
quotations that do reflect the sales charge.
PERFORMANCE HISTORY
AVERAGE ANNUAL TOTAL RETURN*
INSTITUTIONAL SHARES
----------------------------
Since inception
1 Year 5 Years 10 Years (inception date)
SHORT-TERM BOND
MARKET 5.80% 6.39% 7.17% N/A
INTERMEDIATE BOND
MARKET 5.77% --- --- 6.38% (Jan. 5, 1993)
TAX-EXEMPT
INTERMEDIATE BOND 4.02% --- --- 4.78% (Feb. 8, 1993)
BOND IMMDEX/tm 5.35% 8.05% 8.58% N/A
BALANCED 12.56% --- --- 10.36% (Mar. 30, 1992)
GROWTH AND INCOME 26.90% 13.43% --- 12.18% (Dec. 29, 1989)
EQUITY INDEX 23.68% 14.94% 14.14% N/A
GROWTH 18.82% --- --- 11.82% (Dec. 29, 1992)
SPECIAL GROWTH 12.58% 12.96% --- 15.23% (Dec. 28, 1989)
INTERNATIONAL EQUITY 8.21% --- --- 1.61% (Apr. 28, 1994)
AVERAGE ANNUAL TOTAL RETURN*
RETAIL SHARES
----------------------------
Since inception
1 Year 5 Years 10 Years (inception date)
SHORT-TERM BOND
MARKET 3.42% 5.89% 6.69% N/A
INTERMEDIATE BOND
MARKET 3.38% --- --- 5.71% (Jan. 5, 1993)
TAX-EXEMPT
INTERMEDIATE BOND 1.78% --- --- 4.10% (Feb. 8, 1993)
BOND IMMDEX/tm 2.95% 7.53% 8.09% N/A
BALANCED 7.80% --- --- 9.28% (Mar. 30, 1992)
GROWTH AND INCOME 21.56% 12.42% --- 11.44% (Dec. 29, 1989)
EQUITY INDEX 18.43% 13.92% 13.16% N/A
GROWTH 13.77% --- --- 10.51% (Dec. 29, 1992)
SPECIAL GROWTH 7.77% 11.95% --- 14.47% (Dec. 28, 1989)
INTERNATIONAL EQUITY 3.62% --- --- (0.20)% (Apr. 28, 1994)
* Average annual total return calculations are for periods ended
October 31, 1996.
The performance of the Short-Term Bond Market, Bond IMMDEX/tm and Equity
Index Funds for the period prior to December 29, 1989 is represented by the
performance of collective investment funds which operated prior to the
effectiveness of the registration statement of the Portico Short-Term Bond
Market, Bond IMMDEX/tm and Equity Index Funds. At the time of the Portico
Short-Term Bond Market, Bond IMMDEX/tm and Equity Index Funds' inception, each
collective investment fund was operated using substantially the same investment
objectives, policies and restrictions as its corresponding Portico fund. In
connection with the Portico Short-Term Bond Market, Bond IMMDEX/tm and Equity
Index Funds' commencement of operations, on December 29, 1989, each collective
investment fund transferred its assets to its Portico Fund equivalent. The
collective investment funds were not registered under the Investment Company Act
of 1940 (the "1940 Act") and were not subject to certain restrictions that are
imposed by the 1940 Act. If the collective investment funds had been registered
under the 1940 Act, performance may have been adversely affected. Performance
of the collective investment funds has been restated to reflect the Portico
Short-Term Bond Market, Bond IMMDEX/tm and Equity Index Funds' respective actual
expenses during such Fund's first fiscal year.
Prior to January 10, 1995, the Funds offered to retail and institutional
investors one series of shares with neither a sales charge nor a 0.25% service
organization fee. Retail Share performance reflects the deduction of the
current maximum sales charge of 4.00% for equity funds and 2.00% for fixed
income funds, but for periods prior to January 10, 1995, Retail Share
performance does not reflect service organization fees. If service organization
fees had been reflected, performance would be reduced.
Performance assumes the reinvestment of all net investment income and
capital gains and reflects fee waivers. In the absence of fee waivers,
performance would be reduced. Performance quotations represent past
performance, and should not be considered as representative of future results.
The Funds may also from time to time include discussions or illustrations
of the effects of compounding in advertisements. "Compounding" refers to the
fact that, if dividends or other distributions on a Fund investment are
reinvested by being paid in additional Fund shares, any future income or capital
appreciation of a Fund would increase the value, not only of the original Fund
investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase more
quickly than if dividends or other distribution had been paid in cash. The
Funds may also include discussions or illustrations of the potential investment
goals of a prospective investor, investment management techniques, policies or
investment suitability of a Fund, economic conditions, the effects of inflation
and historical performance of various asset classes, including but not limited
to, stocks, bonds and Treasury bills. From time to time advertisements or
communications to shareowners may summarize the substance of information
contained in shareowner reports (including the investment composition of a
Fund), as well as the views of the Adviser or Sub-Adviser as to market,
economic, trade and interest trends, legislative, regulatory and monetary
developments, investment strategies and related matters believed to be of
relevance to a Fund. The Funds may also include in advertisements, charts,
graphs or drawings which illustrate the potential risks and rewards of
investment in various investment vehicles, including but not limited to stocks,
bonds, treasury bills and shares of a Fund. In addition, advertisement or
shareowner communications may include a discussion of certain attributes or
benefits to be derived by an investment in a Fund. Such advertisements or
communications may include symbols, headlines or other materials which highlight
or summarize the information discussed in more detail therein.
MISCELLANEOUS
As used in this Statement of Additional Information and in the Funds'
Prospectus, with respect to the approval of an investment advisory agreement or
a charge in fundamental investment policy, a majority of the outstanding shares
of a Fund or portfolio means the lesser of (1) 67% of the shares of the
particular Fund or portfolio represented at a meeting at which the holders of
more than 50% of the outstanding shares of such Fund or portfolio are present in
person or by proxy, or (2) more than 50% of the outstanding shares of such Fund
or portfolio.
As of January 31, 1997, the Adviser and its affiliates held of record
substantially all of the outstanding shares of each of the Company's investment
portfolios as agent, custodian, trustee or investment adviser on behalf of their
customers. At such date, Firstar Trust Company, P.O. Box 2054, Milwaukee,
Wisconsin 53201, and its affiliated banks held as beneficial owner five percent
or more of the outstanding shares of the following investment portfolios of the
Company because they possessed sole voting or investment power with respect to
such shares: Money Market Fund 4%; Institutional Money Market Fund 86%; Tax-
Exempt Money Market Fund 45%; U.S. Treasury Money Market Fund 50%; U.S.
Government Money Market Fund 67%; Growth and Income Fund 65%; Short-Term Bond
Market Fund 69%; Special Growth Fund 72%; Bond IMMDEX/tm Fund 80%; Equity Index
Fund 79%; Balanced Fund 79%; Intermediate Bond Market Fund 78%; Growth Fund 86%;
Tax-Exempt Intermediate Bond Fund 67%; International Equity Fund 87%; and
MicroCap Fund 84%. At such date, no other person was known by the Company to
hold of record or beneficially 5% or more of the outstanding shares of any
investment portfolio of the Company.
APPENDIX A
----------
Commercial Paper Ratings
- ------------------------
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper.
"A-1" - Issue's degree of safety regarding timely payment is strong.
Those issues determined to possess extremely strong safety characteristics are
denoted "A-1+."
"A-2" - Issue's capacity for timely payment is satisfactory. However,
the relative degree of safety is not as high as for issues designated "A-1."
"A-3" - Issue has an adequate capacity for timely payment. It is
however, somewhat more vulnerable to the adverse effects of changes and
circumstances than an obligation carrying a higher designation.
"B"- Issue has only a speculative capacity for timely payment.
"C" - Issue has a doubtful capacity for payment.
"D" - Issue is in payment default.
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 9 months. The following summarizes the rating categories used by
Moody's for commercial paper:
"Prime-1" - Issuer or related supporting institutions are considered to
have a superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment capacity will normally be evidenced by the following
characteristics: leading market positions in well-established industries; high
rates of return on funds employed; conservative capitalization structures with
moderate reliance on debt and ample asset protection; broad margins in earning
coverage of fixed financial charges and high internal cash generation; and well-
established access to a range of financial markets and assured sources of
alternate liquidity.
"Prime-2" - Issuer or related supporting institutions are considered to
have a strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternative liquidity is
maintained.
"Prime-3" - Issuer or related supporting institutions have an acceptable
capacity for repayment of short-term promissory obligations. The effects of
industry characteristics and market composition may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and the requirement for relatively high financial
leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuer does 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 for 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 insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of variation.
"D-5" - Issuer 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
payment of principal or interest of unsubordinated instruments having a maturity
of one year or less which is 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 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 repayment 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,
the 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 which posses a particularly strong credit feature and
are supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely
repayment.
"A2" - Obligations are supported by a good capacity for timely repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligation for which there is an uncertainty as to the capacity to
ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which are
currently in default.
Corporate and Municipal Long-Term Debt Ratings
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay interest
and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay interest
and repay principal. Whereas such issues normally exhibit 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," and "C" - Debt 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 "C" 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.
"CI" - This rating is reserved for income bonds on which no interest is
being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S&P believes such payments will
be made during such grace period. Rating is also used upon the filing of a
bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." 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 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 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 considered 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," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing;
"Ca" represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may
be in default.
Con. (--) - Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes the probable credit stature upon
completion of construction or elimination of basis of condition.
(P) - When applied to forward delivery bonds, indicates that the rating is
provisional pending delivery of the bonds. The ratings may be revised prior to
delivery if changes occur in the legal documents or the underlying credit
quality of the bonds.
Moody's applies numerical modifiers 1, 2 and 3 in each generic
classification from "Aa" to "B" in its bond rating system. The modifier 1
indicates that the issuer 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 issuer ranks at the lower end of its generic rating category.
The following summarizes the long-term debt ratings used by Duff & Phelps
for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The risk
factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high quality. Protection factors are
strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but adequate.
However, risk factors are more variable and greater in periods of economic
stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+)
or minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds
rated in the "AAA" and "AA" categories are not significantly vulnerable to
foreseeable future developments, short-term debts of these issuers is generally
rated "F-1+."
"A" - Bonds considered to be investment grade and of high credit quality.
The obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
"BB," "B," "CCC," "CC," "C," "DDD," "DD," and "D" - bonds that
possess one of these ratings are considered by Fitch to be speculative
investments. The ratings "BB" to "C" represent Fitch's assessment of the
likelihood of timely payment of principal and interest in accordance with the
terms of obligation for bond issues not in default. For defaulted bonds, the
rating "DDD" to "D" is an assessment of the ultimate recovery value through
reorganization or liquidation.
To provide more detailed indications of credit quality, the Fitch ratings
from and including "AA" to "C" may be modified by the addition of a plus (+)
or minus (-) sign to show relative standing within these major rating
categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long-term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk versus
issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest investment
grade category and indicates an acceptable capacity to repay principal and
interest. Issues rated "BBB" are, however, more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BB," "B," "CCC," and "CC" - These designations are assigned by
Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of principal and interest. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation.
"D" - this designation indicates that the long-term debt is in default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may include
a plus or minus sign designation which indicates where within the respective
category the issue is placed.
IBCA assesses the investment quality of unsecured debt with an original
maturity of more 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 long-term ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial. Adverse changes in business, economic or financial conditions may
increase investment risk albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and interest is
adequate, although adverse changes in business, economic or financial conditions
are more likely to lead to increased investment risk than for obligations in
other categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree
of speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating to denote
relative status within major rating categories.
Municipal Note Ratings
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and market
access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Rating Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term loans
are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1" / "VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2" / "VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3" / "VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
"MIG-4" / "VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and lack
margins of protection.
Duff & Phelps and Fitch use the short-term ratings described under commercial
Paper Ratings for Municipal notes.
APPENDIX B
----------
ADDITIONAL INFORMATION CONCERNING FUTURES AND
RELATED OPTIONS
As stated in the Prospectus, certain of the Funds may enter into futures
contracts and options for hedging purposes. Such transactions are described in
this Appendix. In addition, the Equity Index Fund will purchase and sell
futures and related options (based only on the S&P 500 Index in the case of the
Equity Index Fund) to maintain cash reserves while-simulating full investment in
the stocks underlying the S&P 500 Index, to keep substantially all of its assets
exposed to the market (as represented by the S&P 500 Index), and to reduce
transaction costs. The International Equity Fund may also purchase and sell
futures contracts including interest rate, index, and currency futures for the
purpose of remaining fully invested and reducing transactions costs. During
the current fiscal year, the Short-Term Bond Market, Intermediate Bond Market,
Bond IMMDEX/tm and Growth and Income Funds intend to limit their transactions in
futures contracts and options so that not more than 5% of their net assets, if
any, are at risk and the Equity Index Fund and International Equity Fund will
limit its transactions in futures such that obligations under the transactions
and contracts represent not more than 10% and 25%, respectively, of its assets.
Furthermore, in no event would any Fund purchase or sell futures contracts, or
related options thereon if, immediately thereafter, the aggregate initial margin
that is required to be posted by the Fund under the rules of the exchange on
which the futures contract (or futures option) is traded, plus any premiums paid
by the Fund on its open futures options positions, exceeds 5% of the fund's
total assets, after taking into account any unrealized profits and unrealized
losses on the Fund's open contracts and excluding the amount that a futures
option is "in-the-money" at the time of purchase (an option to buy a futures
contract is "in-the-money" if the value of the contract that is subject to the
option exceeds the exercise price; and option to sell a futures contract is
"in-the-money" if the exercise price exceeds the value of the contract that is
subject of the option.) The International Equity Fund will only enter into
futures contracts and futures options which are standardized and traded on a
U.S. or foreign exchange, board of trade or similar entity, or in the case of
futures options, for which an established over-the-counter market exists.
I. Interest Rate Futures Contracts
-------------------------------
USE OF INTEREST RATE FUTURES CONTRACTS. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures markets have tended to move generally in the
aggregate in concert with the cash market prices and have maintained fairly
predictable relationships. Accordingly, the Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Bond IMMDEX/tm Fund and International Equity Fund
may use interest rate futures as a defense, or hedge, against anticipated
interest rate changes and not for speculation. As described below, this would
include the use of futures contract sales to protect against expected increases
in interest rates and futures contract purchases to offset the impact of
interest rate declines.
The Short-Term Bond Market Fund, Intermediate Bond Market Fund, Bond
IMMDEX/tm Fund and International Equity Fund presently could accomplish a
similar result to that which they hope to achieve through the use of futures
contracts by selling bonds with long maturities and investing in bonds with
short maturities when interest rates are expected to increase, or conversely,
selling short-term bonds and investing in long-term bonds when interest rates
are expected to decline. However, because of the liquidity that is often
available in the futures market the protection is more likely to be achieved,
perhaps at a lower cost and without changing the rate of interest being earned
by the Fund, through using futures contracts.
DESCRIPTION OF INTEREST RATE FUTURES CONTRACTS. An interest rate futures
contract sale would create an obligation by the Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Bond IMMDEX/tm Fund and International Equity
Fund, as seller, to deliver the specific type of financial instrument called for
in the contract at a specific future time for a specified price. A futures
contract purchase would create an obligation by the Fund, as purchaser, to take
delivery of the specific type of financial instrument at a specific future time
at a specific price. The specific securities delivered or taken, respectively,
at settlement date, would not be determined until at or near that date. The
determination would be in accordance with the rules of the exchange on which the
futures contract sale or purchase was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Fund's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly,
the closing out of a futures contract purchase is effected by the Fund's
entering into a futures contract sale. If the offsetting sale price exceeds the
purchase price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
Interest rate futures contracts are traded in an auction environment on the
floors of several exchanges - principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. The Funds would
deal only in standardized contracts on recognized exchanges. Each exchange
guarantees performance under contract provisions through a clearing corporation,
a nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various financial
instruments including long-term U.S. Treasury Bonds and Notes; Government
National Mortgage Association (GNMA) modified pass-through mortgage-backed
securities; three-month U.S. Treasury Bills; and ninety-day commercial paper.
The Short-Term Bond Market Fund, Intermediate Bond Market Fund, Bond IMMDEX/tm
Fund and International Equity Fund may trade in any futures contract for which
there exists a public market, including, without limitation, the foregoing
instruments.
EXAMPLES OF FUTURES CONTRACT SALE. The Short-Term Bond Market Fund,
Intermediate Bond Market Fund, Bond IMMDEX/tm Fund and International Equity Fund
would engage in an interest rate futures contract sale to maintain the income
advantage from continued holding of a long-term bond while endeavoring to avoid
part or all of the loss in market value that would otherwise accompany a decline
in long-term securities prices. Assume that the market value of a certain
security in a Fund tends to move in concert with the futures market prices of
long-term U.S. Treasury bonds ("Treasury bonds"). The Adviser wishes to fix
the current market value of this portfolio security until some point in the
future. Assume the portfolio security has a market value of 100, and the
Adviser believes that, because of an anticipated rise in interest rates, the
value will decline to 95. The Fund might enter into futures contract sales of
Treasury bonds for an equivalent of 98. If the market value of the portfolio
security does indeed decline from 100 to 95, the equivalent futures market price
for the Treasury bonds might also decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The Adviser could be wrong in its forecast of interest rates and the
equivalent futures market price could rise above 98. In this case, the market
value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Fund in the above example might
incur a loss of 2 points (which might be reduced by an offsetting transaction
prior to the settlement date). In each transaction, transaction expenses would
also be incurred.
EXAMPLES OF FUTURES CONTRACT PURCHASE. A Fund might engage in an interest
rate futures contract purchase when it is not fully invested in long-term bonds
but wishes to defer for a time the purchase of long-term bonds in light of the
availability of advantageous interim investments, e.g., shorter-term securities
whose yields are greater than those available on long-term bonds. A Fund's
basic motivation would be to maintain for a time the income advantage from
investment in the short-term securities; the Fund would be endeavoring at the
same time to eliminate the effect of all or part of an expected increase in
market price of the long-term bonds that the fund may purchase.
For example, assume that the market price of a long-term bond that the Fund
may purchase, currently yielding 10%, tends to move in concert with futures
market prices of Treasury bonds. The Adviser wishes to fix the current market
price (and thus 10% yield) of the long-term bond until the time (four months
away in this example) when it may purchase the bond. Assume the long-term bond
has a market price of 100, and the Adviser believes that, because of an
anticipated fall in interest rates, the price will have risen to 105 (and the
yield will have dropped to about 9 1/2%) in four months. A Fund might enter
into futures contracts purchases of Treasury bonds for an equivalent price of
98. At the same time, a Fund could, for example, assign a pool of investments
in short-term securities that are either maturing in four months or earmarked
for sale in four months, for purchase of the long-term bond at an assumed market
price of 100. Assume these short-term securities are yielding 15%. If the
market price of the long-term bond does indeed rise from 100 to 105, the
equivalent futures market price for Treasury bonds might also rise from 98 to
103. In that case, the 5-point increase in the price that the Fund pays for the
long-term bond would be offset by the 5-point gain realized by closing out the
futures contract purchase.
The Adviser could be wrong in its forecast of interest rates; long-term
interest rates might rise to above 10%; and the equivalent futures market price
could fall below 98. If short-term rates at the same time fall to 10% or below,
it is possible that the fund would continue with its purchase program for long-
term bonds. The market price of available long-term bonds would have decreased.
The benefit of this price decrease, and thus yield increase, will be reduced by
the loss realized on closing out the futures contract purchase.
If, however, short-term rates remained above available long-term rates, it
is possible that the Fund would discontinue its purchase program for long-term
bonds. The yield on short-term securities in the portfolio, including those
originally in the pool assigned to the particular long-term bond, would remain
higher than yields on long-term bonds. The benefit of this continued
incremental income will be reduced by the loss realized on closing out the
futures contract purchase.
In each transaction, expenses would also be incurred.
II. Index Futures Contracts.
------------------------
A stock or bond index assigns relative values to the stocks or bonds
included in the index and the index fluctuates with changes in the market values
of the stocks or bonds included. Some stock index futures contracts are based
on broad market indexes, such as the Standard & Poor's 500 or the New York Stock
Exchange Composite Index. In contrast, certain exchanges offer futures
contracts on narrower market indexes, such as the Standard & Poor's 100 or
indexes based on an industry or market segment, such as oil and gas stocks.
Futures contracts are traded on organized exchanges regulated by the Commodity
Futures Trading Commission. Transactions on such exchanges are cleared through
a clearing corporation, which guarantees the performance of the parties to each
contract. With regard to the International Equity Fund, the Sub-Adviser
anticipates engaging in transactions, from time to time, in foreign stock index
futures such as the ALL-ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the
FTSE-100 (United Kingdom).
The Growth and Income Fund, the Equity Index and International Equity Funds
may sell index futures contracts in order to offset a decrease in market value
of its portfolio securities that might otherwise result from a market decline.
The Funds may do so either to hedge the value of its portfolio as a whole, or to
protect against declines, occurring prior to sales of securities, in the value
of the securities to be sold. Conversely, these Funds may purchase index
futures contracts in anticipation of purchases of securities, with respect to
the Equity Index Fund and International Equity Fund, to maintain cash reserves
while simulating full investment in stocks underlying the S&P 500 Index (in the
case of the Equity Index Fund) and in foreign stock indices (in the case of the
International Equity Fund) and to keep substantially all of its assets exposed
to the market. In a substantial majority of these transactions, the Funds will
purchase such securities upon termination of the long futures position, but a
long futures position may be terminated without a corresponding purchase of
securities.
In addition, the Funds may utilize index futures contracts in anticipation
of changes in the composition of its portfolio holdings. For example, in the
event that a Fund expects to narrow the range of industry groups represented in
its holdings it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. The Funds may
also sell futures contracts in connection with this strategy, in order to
protect against the possibility that the value of the securities to be sold as
part of the restructuring of the portfolio will decline prior to the time of
sale.
The following are examples of transactions in stock index futures (net of
commissions and premiums, if any).
ANTICIPATORY PURCHASE HEDGE: Buy the Future Hedge
Objective: Protect Against Increasing Price
Portfolio Futures
--------- -------
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/Contract
Increase in Purchase Price = $2,500 Gain on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors:
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index = 1.0
Portfolio Futures
--------- -------
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio - Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Portfolio Value = $40,000 Gain on Futures = $40,000
If however, the market moved in the opposite direction, that is, market value
decreased and the Fund had entered into an anticipatory purchase hedge, or
market value increased and the fund had hedged its stock portfolio, the results
of the Fund's transactions in stock index futures would be as set forth below.
Portfolio Futures
--------- -------
-Day Hedge is Placed-
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/Contract
Portfolio Futures
--------- -------
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 120
Actual Cost - $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Price = $2,500 Loss on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors:
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index = 1.0
Portfolio Futures
--------- -------
-Day Hedge is Placed-
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio - Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Loss in Portfolio Value = $40,000 Gain on Futures = $40,000
III. Futures Contracts on Foreign Currencies.
----------------------------------------
A futures contract on foreign currency creates a binding obligation on one
party to deliver, and a corresponding obligation on another party to accept
delivery of, a stated quantity of foreign currency, for an amount fixed in U.S.
dollars. Foreign currency futures may be used by the International Equity Fund
to hedge against exposure to fluctuations in exchange rates between the U.S.
dollar and other currencies arising from multinational transactions.
IV. Margin Payments.
----------------
Unlike when a Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract.
Initially, in accordance with the terms of the exchange on which such futures
contract is traded, the Fund may be required to deposit with the broker or in a
segregated account with the Fund's custodian an amount of cash or cash
equivalents, the value of which may vary but is generally equal to 10% or less
of the value of the contract. This amount is known as initial margin. The
nature of initial margin in futures transactions is different from that of
margin in security transactions in that futures contract margin does not involve
the borrowing of funds by the customer to finance the transactions. Rather, the
initial margin is in the nature of a performance bond or good faith deposit on
the contract which is returned to the Fund upon termination of the futures
contract assuming all contractual obligations have been satisfied. Subsequent
payments, called variation margin, to and from the broker, will be made on a
daily basis as the price of the underlying security or index fluctuates making
the long and short positions in the futures contract more or less valuable, a
process known as marking to the market. For example, when a Fund has purchased
a futures contract and the price of the contract has risen in response to a rise
in the underlying instruments, that position will have increased in value and
the Fund will be entitled to receive from the broker a variation margin payment
equal to that increase in value. Conversely, where a Fund has purchased a
futures contract and the price of the future contract has declined in response
to a decrease in the underlying instruments, the position would be less valuable
and the Fund would be required to make a variation margin payment to the broker.
At any time prior to expiration of the futures contract, the Adviser and the
Sub-Adviser may elect to close the position by taking an opposite position,
subject to the availability of a secondary market, which will operate to
terminate the Fund's position in the futures contract. A final determination of
variation margin is then made, additional cash is required to be paid by or
released to the Fund, and the Fund realizes a loss or gain.
V. Risks of Transactions in Futures Contracts.
-------------------------------------------
There are several risks in connection with the use of futures by a Fund as
a hedging device. One risk arises because of the imperfect correlation between
movements in the price of the future and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price
of the future moves less than the price of the securities which are the subject
of the hedge, the hedge will not be fully effective but, if the price of the
securities being hedged has moved in an unfavorable direction, the Fund would be
in a better position than if it had not hedged at all. If the price of the
securities being hedged has moved in an unfavorable direction, the Fund would be
in a better position than if it had not hedged at all. If the price of the
securities being hedged has moved in a favorable direction, this advantage will
be partially offset by the loss on the future. If the price of the future moves
more than the price of the hedged securities, the Fund involved will experience
either a loss or gain on the future which will not be completely offset by
movements in the price of the securities which are the subject of the hedge. To
compensate for the imperfect correlation of movements in the price of securities
being hedged and movements in the price of futures contracts, a Fund may buy or
sell futures contracts in a greater dollar amount than the dollar amount of
securities being hedged if the volatility over a particular time period of the
prices of such securities has been greater than the volatility over such time
period of the future, or if otherwise deemed to be appropriate by the Adviser.
Conversely, a Fund may buy or sell fewer futures contracts if the volatility
over a particular time period of the prices of the securities being hedged is
less than the volatility over such time period of the futures contract being
used, or if otherwise deemed to be appropriate by the Adviser. It is also
possible that, where a Fund has sold futures to hedge its portfolio against a
decline in the market, the market may advance and the value of securities held
by the Fund may decline. If this occurred, the Fund would lose money on the
future and also experience a decline in value in its portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, the Fund will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's custodian
and/or in a margin account with a broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the securities
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. Rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced thus producing distortions. Third, from the point of
view of speculators, the deposit requirements in the futures market are less
onerous than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market, and because of the imperfect correlation between the movements in the
cash market and movements in the price of futures, a correct forecast of general
market trends or interest rate movements by the Adviser and Sub-Adviser may
still not result in a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Fund
intends to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to
close a futures investment position, and in the event of adverse price
movements, a Fund would continue to be required to make daily cash payments of
variation margin. However, in the event futures contracts have been used to
hedge portfolio securities, such securities will not be sold until the futures
contract can be terminated. In such circumstances, an increase in the price of
the securities, if any, may partially or completely offset losses on the futures
contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions. The
trading of futures contracts is also subject to the risk of trading halts,
suspensions, exchange or clearing house equipment failures, government
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal activity, which could at times make it difficult or
impossible to liquidate existing positions or to recover excess variation margin
payments.
Successful use of futures by a Fund is also subject to the Adviser's or the
Sub-Adviser's (in the case of the International Equity Fund) ability to predict
correctly movements in the direction of the market. For example, if a Fund has
hedged against the possibility of a decline in the market adversely affecting
securities held in its portfolio and securities prices increase instead, the
Fund will lose part or all of the benefit to the increased value of its
securities which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Fund has
insufficient cash, it may have to sell securities to meet daily variation margin
requirements. Such sales of securities may be, but will not necessarily be, at
increased prices which reflect the rising market. A Fund may have to sell
securities at a time when it may be disadvantageous to do so.
VI. Options on Futures Contracts.
-----------------------------
A Fund may purchase options on the futures contracts described above. The
International Equity Fund may also sell options on futures contracts. A futures
option gives the holder, in return for the premium paid, the right to buy (call)
from or sell (put) to the writer of the option a futures contract at a specified
price at any time during the period of the option. Upon exercise, the writer of
the option is obligated to pay the difference between the cash value of the
futures contract and the exercise price. Like the buyer or seller of a futures
contract, the holder, or writer, of an option has the right to terminate its
position prior to the scheduled expiration of the option by selling, or
purchasing, an option of the same series, at which time the person entering into
the closing transaction will realize a gain or loss. A Fund will be required to
deposit initial margin and variation margin with respect to put and call options
on futures contracts written by it pursuant to brokers' requirements similar to
those described above. Net option premiums received will be included as initial
margin deposits. As an example, in anticipation of a decline in interest rates,
a Fund may purchase call options on futures contracts as a substitute for the
purchase of futures contracts to hedge against a possible increase in the price
of securities which the Fund intends to purchase. Similarly, if the value of
the securities held by a Fund is expected to decline as a result of an increase
in interest rates, the Fund might purchase put options or sell call options on
futures contracts rather than sell futures contracts.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). In addition, the purchase or sale
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the
futures contract upon which it is based, or upon the price of the securities
being hedged, an option may or may not be less risky than ownership of the
futures contract or such securities. In general, the market prices of options
can be expected to be more volatile than the market prices on the underlying
futures contract. Compared to the purchase or sale of futures contracts,
however, the purchase of call or put options on futures contracts may frequently
involve less potential risk to a Fund because the maximum amount at risk is the
premium paid for the options (plus transaction costs). Although permitted by
their fundamental investment policies, the Funds do not currently intend to
write futures options, and will not do so in the future absent any necessary
regulatory approvals.
VII. Accounting and Tax Treatment.
-----------------------------
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles.
Generally, futures contracts held by a Fund at the close of the Fund's
taxable year will be treated for federal income tax purposes as sold for their
fair market value on the last business day of such year, a process known as
"mark-to-market." Forty percent of any gain or loss resulting from such
constructive sale will be treated as short-term capital gain or loss and 60% of
such gain or loss will be treated as long-term capital gain or loss without
regard to the length of time the Fund holds the futures contract ("the 40%-60%
rule"). The amount of any capital gain or loss actually realized by a Fund in
a subsequent sale or other disposition of those futures contracts will be
adjusted to reflect any capital gain or loss taken into account by the Fund in a
prior year as a result of the constructive sale of the contracts. With respect
to futures contracts to sell, which will be regarded as parts of a "mixed
straddle" because their values fluctuate inversely to the values of specific
securities held by the Fund, losses as to such contracts to sell will be subject
to certain loss deferral rules which limit the amount of loss currently
deductible on either part of the straddle to the amount thereof which exceeds
the unrecognized gain (if any) with respect to the other part of the straddle,
and to certain wash sales regulations. Under short sales rules, which will also
be applicable, the holding period of the securities forming part of the straddle
will (if they have not been held for the long-term holding period) be deemed not
to begin prior to termination of the straddle. With respect to certain futures
contracts, deductions for interest and carrying charges will not be allowed.
Notwithstanding the rules described above, with respect to futures contracts to
sell which are properly identified as such, a Fund may make an election which
will exempt (in whole or in part) those identified futures contracts from being
treated for federal income tax purposes as sold on the last business day of the
Fund's taxable year, but gains and losses will be subject to such short sales,
wash sales, loss deferral rules and the requirement to capitalize interest and
carrying charges. Under temporary regulations, a Fund would be allowed (in lieu
of the foregoing) to elect to either (1) to offset gains or losses from portions
which are part of a mixed straddle by separately identifying each mixed straddle
to which such treatment applies, or (2) to establish a mixed straddle account
for which gains and losses would be recognized and offset on a periodic basis
during the taxable year. Under either election, the 40%-60% rule will apply to
the net gain or loss attributable to the futures contracts, but in the case of a
mixed straddle account election, not more than 50% of any net gain may be
treated as long-term and no more than 40% of any net loss may be treated as
short-term. Options on futures contracts generally receive federal tax
treatment similar to that described above.
Certain foreign currency contracts entered into by the International Equity
Fund may be subject to the "marking to market" process and the 40%-60% rule in
a manner similar to that described in the preceding paragraph for futures
contracts. To receive such federal income tax treatment, a foreign currency
contract must meet the following conditions: (1) the contract must require
delivery of a foreign currency of a type in which regulated futures contracts
are traded or upon which the settlement value of the contract depends; (2) the
contract must be entered into at arm's length at a price determined by reference
to the price in the interbank market; and (3) the contract must be traded in the
interbank market. The Treasury Department has broad authority to issue
regulations under the provisions respecting foreign currency contracts. As of
the date of this Additional Statement, the Treasury Department has not issued
any such regulations. Other foreign currency contracts entered into by the
International Equity Fund may result in the creation of one or more straddles
for federal income tax purposes, in which case certain loss deferral, short
sales, and wash sales rules and the requirement to capitalize interest and
carrying charges may apply.
Special rules govern the federal income tax treatment of certain
transactions denominated in terms of a currency other than the U.S. dollar or
determined by reference to the value of one or more currencies other than the
U.S. dollar. The types of transactions covered by the special rules include the
following: (i) the acquisition of, or becoming the obligor under, a bond or
other debt instrument (including, to the extent provided in Treasury
regulations, preferred stock); (ii) the accruing of certain trade receivables
and payables; and (iii) the entering into or acquisition of any forward
contract, futures contract, option or similar financial instrument. The
disposition of a currency other than the U.S. dollar by a U.S. taxpayer is also
treated as a transaction subject to the special currency rules. However,
foreign currency-related regulated futures contracts and nonequity options are
generally not subject to the special currency rules if they are or would be
treated as sold for their fair market value at year-end under the mark-to-market
rules unless an election is made to have such currency rules apply. With
respect to transactions covered by the special rules, foreign currency gain or
loss is calculated separately from any gain or loss on the underlying
transaction and is normally taxable as ordinary gain or loss. The Fund may
elect to treat as capital gain or loss foreign currency gain or loss arising
from certain identified forward contracts, futures contracts and options that
are capital assets in the hands of the Fund and which are not part of a
straddle. In accordance with Treasury regulations, certain transactions subject
to the special currency rules that are part of a "Section 988 hedging
transactions" (as defined in the Code and the Treasury regulations) will be
integrated and treated as a single transaction or otherwise treated consistently
for purposes of the Code. "Section 988 hedging transactions" are not subject
to the mark-to-market or loss deferral rules under the Code. It is possible
that some of the non-U.S. dollar denominated investments that Growth and Income
Fund and International Equity Fund may make will be subject to the special
currency rules described above. Gain or loss attributable to the foreign
currency component of transactions engaged in by a Fund which are not subject to
the special currency rules (such as foreign equity investment other than certain
preferred stocks) will be treated as capital gain or loss and will not be
segregated from the gain or loss on the underlying transaction.
Qualification as a regulated investment company under the Code requires
that each Fund satisfy certain requirements with respect to the source of its
income during a taxable year. At least 90% of the gross income of each Fund
must be derived from dividends, interest, certain payments with respect to
securities loans, gains from the sale or other disposition of stock, securities
or foreign currencies, and other income (including but not limited to gains from
options, futures or forward contracts) derived with respect to the Fund's
business of investing in such stock, securities or currencies. The Treasury
Department may by regulation exclude from qualifying income foreign currency
gains which are not directly related to a Fund's principal business of
investment in stock or securities, or options and futures with respect to stock
or securities. Any income derived by a Fund from a partnership or trust is
treated for this purpose as derived with respect to the Fund's business of
investment in stock, securities or currencies only to the extent that such
income is attributable to items of income which would have been qualifying
income if realized by the Fund in the same manner as by the partnership or
trust.
An additional requirement for qualification as a regulated investment
company under the Code is that less than 30% of a Fund's gross income must be
derived from gains realized on the sale or other disposition of the following
investments held for less than three months: (1) stock and securities (as
defined in section 2(a)(36) of the 1940 Act); (2) options, futures and forward
contracts other than those on foreign currencies; and (3) foreign currencies
(and options, futures and forward contracts on foreign currencies) that are not
directly related to a Fund's principal business of investment in stock and
securities (and options and futures with respect to stock and securities). With
respect to futures contracts and other financial instruments subject to the
marking-to-market rules, the Internal Revenue Service has ruled in private
letter rulings that a gain realized from such a futures contract or financial
instrument will be treated as being derived from a security held for three
months or more (regardless of the actual period for which the contract or
instrument is held) if the gain arises as a result of a constructive sale under
the marking-to-market rules, and will be treated as being derived from a
security held for less than three months only if the contract or instrument is
terminated (or transferred) during the taxable year (other than by reason of
mark-to-market) and less than three months have elapsed between the date the
contract or instrument is acquired and the termination date. In determining
whether the 30% test is met for a taxable year, increases and decreases in the
value of each Fund's futures contracts and other investments that qualify as
part of a "designated hedge," as defined in the Code, may be netted.
