<PAGE>
As filed with the Securities and Exchange Commission on November 25, 1998
Registration No. 33-26305
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
PRE-EFFECTIVE AMENDMENT NO. ___ [ ]
POST-EFFECTIVE AMENDMENT NO. 39 [X]
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [X]
AMENDMENT NO. 41 [X]
_____________________________________________
BLACKROCK FUNDS(SM)
(Exact Name of Registrant as Specified in Charter)
<TABLE>
<CAPTION>
<S> <C> <C>
Bellevue Corporate Center Brian Kindelan, Esq. copy to:
400 Bellevue Parkway BlackRock Advisors, Inc. Gary S. Schpero, Esq.
Suite 100 1600 Market Street, 28th Floor Simpson Thacher & Bartlett
Wilmington, Delaware 19809 Philadelphia, PA 19103 425 Lexington Avenue
(Address of Principal (Name and Address of New York, New York 10017
Executive Offices) Agent for Service)
Registrant's Telephone Number
(302) 792-2555
</TABLE>
_____________________________________________
It is proposed that this filing will become effective (check appropriate box)
[X] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(i)
[ ] on (date) pursuant to paragraph (a)(i)
[ ] 75 days after filing pursuant to paragraph (a)(ii)
[ ] on (date) pursuant to paragraph (a)(ii) of rule 485.
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
<PAGE>
EXPLANATORY NOTE
----------------
The prospectuses for the Service, Investor A, Investor B, Investor C and
Institutional Shares of the Low Duration Bond, Intermediate Government Bond,
Intermediate Bond, Core Bond, Government Income, Managed Income, International
Bond, Tax-Free Income, Pennsylvania Tax-Free Income, New Jersey Tax-Free Income,
Ohio Tax-Free Income, Money Market, Municipal Money Market, U.S. Treasury Money
Market, Ohio Municipal Money Market, Pennsylvania Municipal Money Market, North
Carolina Municipal Money Market, Virginia Municipal Money Market, New Jersey
Municipal Money Market, Large Cap Value Equity, Large Cap Growth Equity, Index
Equity, Small Cap Value Equity, Mid-Cap Value Equity, International Equity,
International Emerging Markets, International Small Cap Equity, Balanced, Small
Cap Growth Equity, Mid-Cap Growth Equity and Select Equity Portfolios, each
dated January 28, 1998, are incorporated by reference to the Registrant's filing
of Post-Effective Amendment No. 33 to its Registration Statement on Form N-1A on
January 27, 1998.
The prospectus for Service Shares of the Money Market Portfolio, dated January
28, 1998, is incorporated by reference to the Registrant's filing of a
definitive copy under Rule 497 under the Securities Act on February 11, 1998.
The prospectus for Investor A Shares of the Ohio Municipal Money Market,
Pennsylvania Municipal Money Market, North Carolina Municipal Money Market,
Virginia Municipal Money Market and New Jersey Municipal Money Market
Portfolios, dated January 28, 1998, is incorporated by reference to the
Registrant's filing of a definitive copy under Rule 497 under the Securities Act
on February 11, 1998.
The prospectuses for the Service, Investor A, Investor B, Investor C and
Institutional Shares of the Micro-Cap Equity Portfolio, each dated January 28,
1998, as revised April 15, 1998, are incorporated by reference to the
Registrant's filing of definitive copies under Rule 497 under the Securities Act
on April 15, 1998.
The prospectus for the BlackRock Shares of the Low Duration Bond, Core Bond and
Intermediate Bond Portfolios, dated January 28, 1998, is incorporated by
reference to the Registrant's filing of Post-Effective Amendment No. 33 to its
Registration Statement on Form N-1A on January 27, 1998.
The prospectuses for the Service, Investor A, Investor B, Investor C and
Institutional Shares of the Kentucky Tax-Free Income, Delaware Tax-Free Income
and GNMA Portfolios, each dated April 29, 1998, are incorporated by reference to
the Registrant's filing of definitive copies under Rule 497 under the Securities
Act on May 14, 1998.
The prospectuses for the Service, Investor A, Investor B, Investor C,
Institutional and BlackRock Shares of the High Yield Bond Portfolio, each dated
October 21, 1998, are
<PAGE>
incorporated by reference to the Registrant's filing of Post-Effective Amendment
No. 38 to its Registration Statement on Form N-1A on October 20, 1998.
The statement of additional information for the Service, Investor A, Investor B,
Investor C, Institutional and, as applicable, BlackRock Shares of the Low
Duration Bond, Intermediate Government Bond, Intermediate Bond, Core Bond,
Government Income, Managed Income, International Bond, Tax-Free Income,
Pennsylvania Tax-Free Income, New Jersey Tax-Free Income, Ohio Tax-Free Income,
Kentucky Tax-Free Income, Delaware Tax-Free Income, GNMA, Money Market,
Municipal Money Market, U.S. Treasury Money Market, Ohio Municipal Money Market,
Pennsylvania Municipal Money Market, North Carolina Municipal Money Market,
Virginia Municipal Money Market, New Jersey Municipal Money Market, Large Cap
Value Equity, Large Cap Growth Equity, Index Equity, Small Cap Value Equity,
Mid-Cap Value Equity, International Equity, International Emerging Markets,
International Small Cap Equity, Balanced, Small Cap Growth Equity, Mid-Cap
Growth Equity, Select Equity and Micro-Cap Equity Portfolios, and the BlackRock
Shares of the Low Duration Bond, Core Bond and Intermediate Bond Portfolios,
dated April 29, 1998, is incorporated by reference to the Registrant's filing of
Post-Effective Amendment No. 36 to its Registration Statement on Form N-1A on
April 29, 1998.
The statement of additional information for the Service, Investor A, Investor B,
Investor C, Institutional and BlackRock Shares of the High Yield Bond Portfolio,
dated October 21, 1998, is incorporated by reference to the Registrant's filing
of Post-Effective Amendment No. 38 to its Registration Statement on Form N-1A on
October 20, 1998.
<PAGE>
BLACKROCK FUNDS(SM)
(INSTITUTIONAL SHARES OF
BLACKROCK STRATEGIC PORTFOLIO I
AND
BLACKROCK STRATEGIC PORTFOLIO II)
CROSS REFERENCE SHEET
FORM N-1A ITEM PROSPECTUS CAPTION
- -------------- ------------------
PART A
1. Cover page....................................... Cover Page
2. Synopsis......................................... Summary of Expenses
3. Condensed Financial Information.................. Financial Highlights
4. General Description of Registrant................ Cover Page; Investment
Objective and Policies;
Eligible Investments;
Portfolio Techniques,
Instruments and Risks;
Organization
5. Management of the Fund........................... Management of the Fund
5A. Management's Discussion of Fund Performance...... Not Applicable
6. Capital Stock and Other Securities............... Cover Page; Dividends
and Distributions;
Taxes; Organization
7. Purchase of Securities Being Offered............. Purchases and
Redemptions; Dividends
and Distributions; Net
Asset Value
8. Redemption or Repurchase......................... Purchases and
Redemptions
9. Pending Legal Proceedings....................... Not Applicable
<PAGE>
Item Number
Form N-1A, Statement of Additional
Part B Information Caption
- ------ -------------------
10 Cover Page
11 Table of Contents
12 Miscellaneous
13(a),(b),(c) Investment Objective and
Policies; Investment
Restrictions
13(d) Portfolio Transactions
14(a) Trustees And Officers
14(b) Trustees and Officers
14(c) Trustees And Officers
15(a) Miscellaneous
15(b) Miscellaneous
15(c) Trustees And Officers
16 Investment Advisory,
Administration, Distribution
and Servicing Arrangements
17(a) Portfolio Transactions
17(b) Not Applicable
17(c) Portfolio Transactions
17(d) Not Applicable
17(e) Not Applicable
18(a) Additional Information
Concerning Shares
18(b) Not Applicable
19(a) Purchase And Redemption
Information
<PAGE>
Item Number
Form N-1A, Statement of Additional
Part B Information Caption
- ------ -------------------
19(b) Valuation Of Portfolio
Securities
19(c) Purchase And Redemption
Information
20 Taxes
21(a) Investment Advisory,
Administration, Distribution
And Servicing Arrangements
21(b) Not Applicable
21(c) Not Applicable
22(a) Not Applicable
22(b) Performance Information
23 Financial Statements
Part C
- ------
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
BLACKROCK STRATEGIC PORTFOLIO I
BLACKROCK STRATEGIC PORTFOLIO II
INSTITUTIONAL INVESTMENT PORTFOLIOS OFFERED
BY BLACKROCK FUNDS(SM)
PROSPECTUS
NOVEMBER 25, 1998
<PAGE>
BLACKROCK STRATEGIC PORTFOLIO I
BLACKROCK STRATEGIC PORTFOLIO II
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Page
----
Summary of Expenses................................................. 2
Financial Highlights................................................ 4
The Portfolios...................................................... 7
Investment Objective and Policies................................... 7
Eligible Investments................................................ 8
Portfolio Techniques, Instruments and Risks......................... 9
Management of the Fund.............................................. 21
Purchases and Redemptions........................................... 24
Net Asset Value..................................................... 25
Dividends and Distributions......................................... 26
Taxes............................................................... 26
Organization........................................................ 27
Performance......................................................... 28
Shareholder Inquiries............................................... 28
</TABLE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS, OR IN THE STATEMENT OF
ADDITIONAL INFORMATION INCORPORATED HEREIN BY REFERENCE, IN CONNECTION WITH THE
OFFERING MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY THE FUND OR BY
THE DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE
MADE.
Prospectus
November 25, 1998
<PAGE>
BLACKROCK STRATEGIC PORTFOLIO I
BLACKROCK STRATEGIC PORTFOLIO II
This Prospectus relates to BlackRock Strategic Portfolio I ("Portfolio I")
and BlackRock Strategic Portfolio II ("Portfolio II") (collectively, the
"Portfolios"), two separate investment portfolios offered by BlackRock Funds(SM)
(the "Fund") to the separate account clients of BlackRock Financial Management,
Inc. ("BlackRock"). Each Portfolio seeks to maximize total return through
investment in a portfolio of investment grade fixed income securities of foreign
and U.S. issuers denominated in foreign currencies, baskets of foreign
currencies and the U.S. dollar.
This Prospectus describes concisely the information about the Portfolios
that you should consider before investing. Please read and keep it for future
reference. More information about the Portfolios is contained in a Statement of
Additional Information dated November 25, 1998 that has been filed with the
Securities and Exchange Commission (the "SEC"). The Statement of Additional
Information, as supplemented from time to time, can be obtained free upon
request by calling 1-800-422-6538, and is incorporated by reference into this
Prospectus. The SEC maintains a Web site at http://www.sec.gov that contains
the Statement of Additional Information, material incorporated by reference, and
other information regarding the Fund.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
SHARES OF THE PORTFOLIOS ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION, OR ANY OTHER BANK AND SHARES ARE
NOT INSURED BY, GUARANTEED BY, OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S.
GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD, OR ANY OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN SHARES OF THE
PORTFOLIOS INVOLVE INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL
AMOUNT INVESTED.
November 25, 1998
-1-
<PAGE>
SUMMARY OF EXPENSES
Below is a summary of the annual operating expenses (i) incurred by Portfolio I
after fee waivers for the fiscal period ended September 30, 1998 and (ii)
expected to be incurred by Portfolio II after fee waivers for the current fiscal
year, as a percentage of average daily net assets. An example based on the
summary is also shown.
<TABLE>
<CAPTION>
BLACKROCK STRATEGIC BLACKROCK STRATEGIC
PORTFOLIO I PORTFOLIO II
-------------------- --------------------
<S> <C> <C>
ANNUAL PORTFOLIO OPERATING
EXPENSES (AS A PERCENTAGE
OF AVERAGE NET ASSETS)
Advisory fees
(after fee waivers)(1) .00% .00%
Other operating expenses
(after fee waivers)(1) .26% .26%
--- ---
Administrative fees .10% .10%
Other expenses .16% .16%
--- ---
Total Portfolio operating
expenses (after fee
waivers)(1) .26% .26%
=== ===
</TABLE>
(1) Without waivers, advisory fees would be .20% and administration fees would
be .23% for each Portfolio. The Portfolios' investment adviser and
administrators are under no obligation to waive fees or reimburse expenses,
but have informed the Fund that they expect to do so during the current
fiscal year. "Other operating expenses" in the Table for Portfolio II are
based on estimated amounts for the current fiscal year. Without waivers,
"Other operating expenses" would be .40% and .40%, respectively, and "Total
Portfolio operating expenses" would be .60% and .60%, respectively.
-2-
<PAGE>
EXAMPLE
Based on the foregoing Table, an investor in the Portfolios would pay the
following expenses on a $1,000 investment assuming (1) 5% annual return, and (2)
redemption at the end of each time period:
<TABLE>
<CAPTION>
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
<S> <C> <C> <C> <C>
BlackRock Strategic Portfolio I $3 $8 $15 $33
BlackRock Strategic Portfolio II 3 8 N/A N/A
</TABLE>
The foregoing Table and Example are intended to assist investors in
understanding the costs and expenses that an investor in the Portfolios will
bear either directly or indirectly. They do not reflect any charges that may be
imposed by BlackRock directly on its customer accounts in connection with
investments in the Portfolios.
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE INVESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND
OPERATING EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN. INFORMATION ABOUT THE
ACTUAL PERFORMANCE OF THE PORTFOLIOS WILL BE CONTAINED IN THE PORTFOLIOS' FUTURE
ANNUAL REPORTS TO SHAREHOLDERS, WHICH MAY BE OBTAINED WITHOUT CHARGE WHEN THEY
BECOME AVAILABLE.
-3-
<PAGE>
FINANCIAL HIGHLIGHTS
The following financial information has been derived from the
financial statements incorporated by reference into the Statement of Additional
Information and has been audited by the Fund's independent accountants,
PricewaterhouseCoopers LLP. Additional information about the performance of
Portfolio I is contained in that Portfolio's annual report. Both the Statement
of Additional Information and the Portfolio's annual report may be obtained from
the Fund free of charge by calling the number on the front cover of this
Prospectus. During the period shown, Portfolio I offered one class of shares to
institutional investors.
-4-
<PAGE>
BLACKROCK STRATEGIC PORTFOLIO I
<TABLE>
<CAPTION>
10/6/97 (a)
Through
Sept. 30, 1998
--------------
PER SHARE OPERATING PERFORMANCE:
<S> <C>
Net asset value, beginning of period................................ $ 10.00
Net investment income (b)....................................... 0.51
Net realized and unrealized gain
(loss) on investments................................................ 0.53
Net increase from investment operations.............................. 1.04
Distributions from net investment income............................. (0.58)
Distributions from net realized capital gains........................ -
Total dividends and distributions.................................... (0.58)
Net asset value, end of period....................................... $ 10.46
TOTAL RETURN (c)..................................................... 10.84%
RATIOS TO AVERAGE NET ASSETS:
Expenses (b)(d)...................................................... 0.26%
Net investment income (b)(d)......................................... 5.39%
SUPPLEMENTAL DATA:
Average net assets (in thousands).................................... $28,461
Portfolio turnover................................................... 164%
Net assets, end of period (in thousands)............................. $31,654
===============================================================================================
</TABLE>
(a) Commencement of investment operations.
(b) The Adviser waived fees amounting to $56,922 for the period ended September
30, 1998. Net investment income would have been $0.48 on a per share basis
for the period ended September 30, 1998 in the absence of fee waivers. The
ratio of net operating expenses to average net assets would have been 0.60%
for the period ended September 30, 1998 in the
-5-
<PAGE>
absence of fee waivers. The net investment income ratio would have
been 5.05% for the period ended September 30, 1998 in the absence of fee
waivers.
(c) Total investment return is calculated assuming a purchase of common stock
at net asset value per share on the first day and a sale at net asset value
per share on the last day of the period reported. Dividends are assumed,
for purposes of this calculation, to be reinvested at the net asset value
per share on the payment date.
(d) Annualized.
The information above represents audited operating performance based on an
average share of common stock outstanding, total investment return, ratios
to average net assets and other supplemental data, for each of the periods
indicated. This information has been determined based upon financial
information provided in the financial statements.
-6-
<PAGE>
THE PORTFOLIOS
BlackRock Strategic Portfolio I and BlackRock Strategic Portfolio II are non-
diversified portfolios within the BlackRock Fund group designed for the separate
account clients of BlackRock Financial Management, Inc. ("BlackRock"), the
Portfolios' investment adviser (the "Adviser").
INVESTMENT OBJECTIVE AND POLICIES
Each Portfolio seeks to maximize total return through investment in a portfolio
of investment grade fixed income securities of foreign and U.S. issuers
denominated in foreign currencies, baskets of foreign currencies and the U.S.
dollar. Under normal market conditions, each Portfolio expects to invest a
significant portion of its assets in securities denominated in foreign
currencies or baskets of foreign currencies. U.S. dollar investments will be
utilized primarily for hedging purposes, to conform to U.S. tax diversification
regulations, or for temporary defensive purposes.
BlackRock Strategic Portfolio I will generally maintain a U.S. dollar-weighted
average duration between 0 and 8 years and will invest in securities across the
entire maturity spectrum. BlackRock Strategic Portfolio II will generally
maintain a U.S. dollar-weighted average duration between 0 and 6 years and may
invest in securities across the entire maturity spectrum, though it will tend to
emphasize securities that on average have shorter durations than those utilized
in BlackRock Strategic Portfolio I.
Under normal conditions, each Portfolio intends to hedge its exposure to foreign
currencies such that no more than 25% of the Portfolio's net assets are exposed
to all currencies other than the U.S. dollar.
No assurance can be provided that a Portfolio will achieve its investment
objective. A Portfolio's investment objective and the policies stated in this
Prospectus may be changed by the Fund's Board of Trustees without shareholder
approval. The Portfolios have, however, also adopted certain fundamental
investment limitations that are set forth in the Statement of Additional
Information and may be changed only with the approval of "a majority of the
outstanding shares of a Portfolio" (as defined in the Statement of Additional
Information).
-7-
<PAGE>
ELIGIBLE INVESTMENTS
The Portfolios may invest in the following types of securities, which may be
issued by domestic or foreign entities and denominated in U.S. dollars or
foreign currencies: securities issued or guaranteed by the U.S. Government and
its agencies or instrumentalities ("U.S. Government Obligations"); obligations
issued or guaranteed by a foreign government, or any of its political
subdivisions, authorities, agencies or instrumentalities; obligations of
international agencies or supranational organizations; Brady bonds; bank
obligations, including certificates of deposit, fixed time deposits, notes and
bankers' acceptances; corporate debt securities, including convertible
securities and corporate commercial paper; preferred stock; structured notes and
loan participations; repurchase agreements; mortgage-backed and asset-backed
securities; and obligations issued or guaranteed by a state or local government.
These securities may be publicly or privately offered and may have fixed,
variable or floating rates of interest.
The Portfolios may buy or sell interest rate futures contracts, options on
interest rate futures contracts, interest rate caps and floors, and options on
fixed income securities, and may enter into interest rate swap transactions.
The Portfolios may also engage in foreign currency exchange transactions by
means of buying or selling foreign currencies on a spot basis, entering into
foreign currency forward contracts and swaps, and buying or selling foreign
currency options, foreign currency futures, and options on foreign currency
futures.
The debt securities and counterparties of each of the Portfolios will, at the
time of investment, be rated investment grade by at least one nationally
recognized statistical rating organization ("NRSRO") or, if unrated by those
rating organizations, will be determined by the Adviser to be of comparable
credit quality at the time of investment or will be U.S. Government Obligations.
In the case of short-term investments, the Portfolios' assets will be rated in
the highest rating category by at least one NRSRO or, if unrated by any NRSRO,
will be determined by the Adviser to be of comparable credit quality at the time
of investment or will be U.S. Government Obligations. Securities rated BBB or
Baa are generally considered to be investment grade although they have
speculative characteristics. If a security's ratings are reduced by all rating
services below the minimum rating that is permitted for a Portfolio, the Adviser
will consider whether the Portfolio should continue to hold the security. See
Appendix A to the Statement of Additional Information for a description of the
securities ratings mentioned above.
-8-
<PAGE>
PORTFOLIO TECHNIQUES, INSTRUMENTS AND RISKS
A brief description of the portfolio techniques, instruments and risks
applicable to the Portfolios is provided below. Further information is set
forth in the Statement of Additional Information.
PORTFOLIO SECURITIES GENERALLY. Investment by the Portfolios in securities of
foreign issuers involves considerations not typically associated with investing
in securities of companies organized and operated in the United States. Because
foreign securities generally are denominated and pay interest in foreign
currencies, the value of a Portfolio will be affected favorably or unfavorably
by changes in currency exchange rates.
A Portfolio's investments in foreign securities may also be adversely affected
by changes in foreign political or social conditions, diplomatic relations,
confiscatory taxation, expropriation, limitations on the removal of funds or
assets, or imposition of (or change in) exchange control regulations. In
addition, changes in government administrations or economic or monetary policies
in the U.S. or abroad could result in appreciation or depreciation of portfolio
securities and could favorably or adversely affect a Portfolio's operations. In
general, less information is publicly available with respect to foreign issuers
than is available with respect to U.S. companies. Most foreign companies are
also not subject to the uniform accounting and financial reporting requirements
applicable to issuers in the United States. While the volume of transactions in
foreign securities markets has increased in recent years, it remains appreciably
below that of the U.S. securities markets. Accordingly, a Portfolio's foreign
investments may be less liquid and their prices may be more volatile than
comparable investments in U.S. securities. In addition, there is generally less
government supervision and regulation of securities exchanges, brokers and
issuers in foreign countries than in the United States.
The Portfolios intend to invest primarily in obligations of issuers based in
developed countries. Each Portfolio may, however, invest up to a maximum of 20%
of its total assets in obligations of issuers based in emerging market countries
subject to the same credit quality restrictions as other investments.
Foreign investments may include: (a) debt obligations issued or guaranteed by
foreign sovereign governments or their agencies, authorities, instrumentalities
or political subdivisions, including a foreign state, province or municipality;
(b) debt obligations of supranational organizations such as the World Bank,
Asian Development Bank, European Investment Bank and European Economic
Community; (c) debt obligations of foreign banks and bank holding companies; (d)
debt obligations of
-9-
<PAGE>
domestic banks and corporations issued in foreign currencies; (e) debt
obligations denominated in baskets of foreign currencies, such as the European
Currency Unit (ECU); and (f) foreign corporate debt securities and commercial
paper. Such securities may include loan participations and assignments,
convertible securities, preferred stock, Brady bonds and zero-coupon securities.
On January 1, 1999, the European Monetary Union (EMU) plans to implement a new
currency unit, the Euro, which is expected to reshape financial markets, banking
systems and monetary policies in Europe and other parts of the world. The
countries initially expected to convert or tie their currencies to the Euro
include Austria, Belgium, France, Germany, Luxembourg, the Netherlands, Ireland,
Finland, Italy, Portugal and Spain. Implementation of this plan will mean that
financial transactions and market information, including share quotations and
company accounts, in participating countries will be denominated in Euros.
Participating governments will issue their bonds in Euros, and monetary policy
for participating countries will be uniformly managed by a new central bank, the
European Central Bank.
Although it is not possible to predict the impact of the Euro implementation
plan on the Portfolios, the transition to the Euro may change the economic
environment and behavior of investors, particularly in European markets. For
example, investors may begin to view those countries participating in the EMU as
a single entity, and the Adviser may need to adapt its investment strategy
accordingly. The process of implementing the Euro also may adversely affect
financial markets world-wide and may result in changes in the relative strength
and value of the U.S. dollar or other major currencies, as well as possible
adverse tax consequences. The transition to the Euro is likely to have a
significant impact on fiscal and monetary policy in the participating countries
and may produce unpredictable effects on trade and commerce generally. These
resulting uncertainties could create increased volatility in financial markets
world-wide.
Subject to the limitation stated above regarding investments in emerging market
countries, each Portfolio may invest more than 25% of its total assets in the
securities of issuers located in a single country. Investments of 25% or more
of a Portfolio's total assets in a particular country will make the Portfolio's
performance more dependent upon the political and economic circumstances of a
particular country than a mutual fund that is more widely diversified among
issuers in different countries.
The value of fixed income securities held by the Portfolios can generally be
expected to vary inversely with changes in prevailing interest rates. Fixed
income securities with longer maturities, which tend to produce higher yields,
are subject to
-10-
<PAGE>
potentially greater capital appreciation and depreciation than securities with
shorter maturities. The Portfolios are not restricted to any maximum or minimum
time to maturity in purchasing individual portfolio securities, and the average
maturity of a Portfolio's assets will vary based upon the Adviser's assessments
of economic and market conditions. As stated above, the Portfolios will seek to
maintain a duration within broad, though specified, limits. A Portfolio's
duration is a measure of its price sensitivity, including expected cash flows
and prepayments on its securities holdings under a wide range of interest rate
scenarios. In computing the duration of a Portfolio, the Adviser will estimate
the duration of obligations that are subject to prepayment or redemption by the
issuer taking into account the influence of interest rates on prepayments and
coupon flows. The Adviser may use various techniques to lengthen or shorten the
duration of a Portfolio, including the acquisition of debt obligations at a
premium or discount, interest rate swaps and interest rate futures and related
options. There can be no assurance that the Adviser's estimation of a
Portfolio's duration will be accurate or that the duration of a Portfolio will
always be within the limits designated above.
Emerging market countries in which the Portfolios may invest are located in the
Asia-Pacific region, Eastern Europe, Latin and South America and Africa.
Political and economic structures in many of such countries may be undergoing
significant evolution and rapid development, and such countries may lack the
social, political and economic stability characteristic of more developed
countries. Some of these countries may have in the past failed to recognize
private property rights and have at times nationalized or expropriated the
assets of private companies. As a result, the risks described above, including
the risks of nationalization or expropriation of assets, may be heightened. In
addition, unanticipated political or social developments may affect the value of
investments in these countries and the availability to the Portfolios of
additional investments in emerging market countries. The small size and
inexperience of the securities markets in certain of these countries and the
limited volume of trading in securities in these countries may make investments
in the countries illiquid and more volatile than investments in Japan or most
Western European countries. There may be little financial or accounting
information available with respect to issuers located in certain emerging
markets countries, and it may be difficult to assess the value or prospects of
an investment in such issuers.
NON-DIVERSIFIED STATUS. Each Portfolio is classified as a non-diversified
portfolio under the Investment Company Act of 1940 (the "1940 Act"). Investment
returns on a non-diversified portfolio typically are dependent upon the
performance of a smaller number of securities relative to the number held in a
diversified portfolio. Consequently, the change in value of any
-11-
<PAGE>
one security may affect the overall value of a non-diversified portfolio more
than it would a diversified portfolio. In conformance with applicable tax
requirements each Portfolio will not invest in securities (except U.S.
Government securities within the meaning of the Internal Revenue Code of 1986)
that would cause, at the end of any tax quarter (plus any additional grace
period), more than 5% of its total assets to be invested in securities of any
one issuer, except that up to 50% of a Portfolio's total assets may be invested
without regard to this limitation so long as no more than 25% of the Portfolio's
total assets are invested in the securities of any one issuer (except U.S.
Government securities as so defined).
CURRENCY HEDGING TRANSACTIONS. Under normal conditions, each Portfolio intends
to hedge its exposure to foreign currencies such that no more than 25% of the
Portfolio's net assets are exposed to all currencies other than the U.S. dollar.
For this purpose, assets that are subject to proxy hedging transactions as
described below are considered to be assets that are not exposed to foreign
currencies.
Each Portfolio may enter into spot and forward foreign currency exchange
contracts and currency swaps, and may purchase and sell foreign currency futures
contracts, options on foreign currency futures contracts and exchange traded and
over-the-counter ("OTC") options on currencies to hedge the currency exchange
risk associated with its assets or obligations denominated in foreign currencies
or baskets of foreign currencies. A Portfolio may also engage in proxy hedging
transactions. Proxy hedging entails entering into a forward contract to sell a
currency whose changes in value are generally considered to be linked to a
currency or currencies in which some or all of the Portfolio's securities are,
or are expected to be, denominated, and to buy U.S. dollars. There is the risk
that the perceived linkage between various currencies may not be present or may
not be present during the particular time that a Portfolio is engaging in proxy
hedging. Each Portfolio may also cross-hedge currencies by entering into
forward contracts to sell one or more currencies that are expected to decline in
value relative to other currencies to which the Portfolio has or in which the
Portfolio expects to have portfolio exposure.
In addition, subject to the limitation on foreign currency exposure stated
above, each Portfolio may enter into currency transactions to seek to increase
total return when the Advisor believes the transactions are in furtherance of a
Portfolio's investment objective. In connection with their currency
transactions, the Portfolios will segregate cash, U.S. Government securities or
other liquid assets, or will otherwise cover their position in accordance with
the applicable requirements of the SEC.
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In general, currency transactions are subject to risks different from those of
other portfolio transactions, and can result in greater losses to a Portfolio
than would otherwise be incurred, even when the currency transactions are used
for hedging purposes.
U.S. GOVERNMENT OBLIGATIONS. Treasury obligations differ only in their interest
rates, maturities and times of issuance. Obligations of certain agencies and
instrumentalities of the U.S. Government such as the Government National
Mortgage Association ("GNMA") are supported by the United States' full faith and
credit; others such as those of the Federal National Mortgage Association
("FNMA") and the Student Loan Marketing Association are supported by the right
of the issuer to borrow from the Treasury; others such as those of the Federal
Farm Credit Banks or the Federal Home Loan Mortgage Corporation ("FHLMC") are
supported only by the credit of the instrumentality. No assurance can be given
that the U.S. Government will provide financial support to U.S. Government-
sponsored agencies or instrumentalities if it is not obligated to do so by law.
CORPORATE AND BANK OBLIGATIONS. The Portfolios may invest in debt obligations
of domestic or foreign corporations and banks. Bank obligations may include
certificates of deposit, notes, bankers' acceptances and fixed time deposits.
These obligations may be general obligations of the parent bank or may be
limited to the issuing branch or subsidiary by the terms of a specific
obligation or by government regulation. The Portfolios may also make interest-
bearing savings deposits in commercial and savings banks in amounts not in
excess of 5% of their respective total assets.
MUNICIPAL OBLIGATIONS. When deemed advisable by the Adviser, the Portfolios may
invest in obligations issued by a state or local government ("Municipal
Obligations"). Municipal Obligations include general obligation securities that
are secured by the issuer's pledge of its full faith, credit and taxing power
for the payment of principal and interest, and revenue securities that are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise tax or other
specific revenue source. Municipal Obligations also include "moral obligation"
bonds, which are normally issued by special purpose public authorities, and
participation certificates in a lease, an installment purchase contract or a
conditional sales contract ("lease obligations") entered into by a state or
political subdivision to finance the acquisition or construction of equipment,
land or facilities. Dividends paid by the Portfolios that are derived from
income earned on Municipal Obligations will not be tax-exempt.
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MORTGAGE-RELATED AND ASSET-BACKED SECURITIES. The Portfolios may purchase
securities that are secured or backed by residential or commercial mortgages as
well as other assets (e.g., automobile loans and credit card receivables).
Issuers of these mortgage-related and asset-backed securities include both
governmental and private issuers. Mortgage-related securities include, but are
not limited to, guaranteed mortgage pass-through certificates, which provide the
holder with a pro rata interest in the underlying mortgages, and collateralized
mortgage obligations ("CMOs"), which provide the holder with a specified
interest in the cash flow of a pool of underlying mortgages or other mortgage-
related securities. Issuers of CMOs ordinarily elect to be taxed as pass-
through entities known as real estate mortgage investment conduits ("REMICs").
CMOs are issued in multiple classes with different relative payment rights, and
each with a specified fixed or floating interest rate and a final distribution
date.
Non-mortgage asset-backed securities may present certain risks that are not
presented by mortgage-related securities. Primarily, these securities do not
have the benefit of the same security interest in the underlying collateral.
For example, credit card receivables are generally unsecured and the debtors are
entitled to the protection of a number of state and Federal consumer credit
laws. In addition, the trustee for the holders of the automobile receivables
may not have an effective security interest in all of the obligations backing
such receivables.
The yield and maturity characteristics of mortgage-related and other asset-
backed securities differ from traditional debt securities. A major difference
is that the principal amount of the obligations normally may be prepaid by the
issuer at any time because the underlying assets (i.e., loans) generally may be
prepaid by the borrowers at any time. In periods of falling interest rates, the
rate of prepayments tends to increase, and in periods of rising interest rates,
prepayments tend to slow. Because of these and other reasons, an asset-backed
security's total return and maturity may be difficult to predict precisely, and
a change in the rate of expected prepayments may result in a loss to a Portfolio
on its investment.
The Portfolios may from time to time purchase in the secondary market certain
mortgage pass-through securities packaged and master serviced by PNC Mortgage
Securities Corp ("PNC Mortgage") or Midland Loan Services, Inc. ("Midland")(or
Sears Mortgage if PNC Mortgage succeeded to the rights and duties of Sears
Mortgage) or mortgage-related securities containing loans or mortgages
originated by PNC Bank, National Association ("PNC Bank") or its affiliates. It
is possible that under some circumstances, PNC Mortgage, Midland or their
affiliates could have interests that are in conflict with the holders of these
mortgage-backed securities, and such holders could have rights against PNC
Mortgage, Midland or their affiliates.
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LOAN PARTICIPATIONS AND OTHER STRUCTURED SECURITIES. The Portfolios may
purchase participation interests in debt securities from foreign and domestic
financial institutions. A participation interest gives a Portfolio an undivided
interest in the security in the proportion that the participation interest bears
to the total principal amount of the security. Participation interests may have
fixed, floating or variable rates of interest. The Portfolios intend only to
purchase participations from an entity or syndicate, and do not intend to serve
as co-lenders in any participations. It is possible that a participation
interest might be deemed to be an extension of credit by a Portfolio to the
issuing financial institution that is not a direct interest in the credit of the
obligor of the underlying security and is not directly entitled to the
protection of any collateral security provided by such obligor. In that event,
the ability of the Portfolio to obtain repayment might depend on the issuing
financial institution.
The Portfolios also may purchase other types of structured securities, including
zero coupon bonds, which are normally issued at a significant discount from face
value and do not provide for periodic interest payments, as well as instruments
that have interest rates that reset inversely to changing short-term rates
and/or have imbedded interest rate floors and caps that require the issuer to
pay an adjusted interest rate if market rates fall below or rise above a
specified rate.
In addition, the Portfolios may purchase Treasury receipts and other "stripped"
securities that evidence ownership in either the future interest payments or the
future principal payments on U.S. Government and other obligations. These
securities, which may be issued by the U.S. Government (or a U.S. Government
agency or instrumentality) or by private issuers such as banks and other
institutions, are issued at a discount to their "face value," and may include
stripped mortgage-backed securities ("SMBS"). The Portfolios also may purchase
"stripped" securities that evidence ownership in the future interest payments or
principal payments on obligations of foreign governments.
Many of the instruments described above represent relatively recent innovations,
and the trading market for these instruments is less developed than the markets
for traditional types of securities. It is uncertain how these instruments will
perform under different economic and interest-rate scenarios. Because certain
of these instruments are leveraged, their market values may be more volatile
than other types of instruments and may present greater potential for capital
gain or loss. On the other hand, the imbedded option features of certain
instruments could limit the amount of appreciation a Portfolio can realize on
its investment, could cause a Portfolio to hold a security it might otherwise
sell or could force the sale of a security at inopportune times or for prices
that do not reflect current
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market value. The possibility of default by the issuer or the issuer's credit
provider may be greater for these instruments than for other types of
instruments. In some cases it may be difficult to determine the fair value of a
derivative instrument because of a lack of reliable objective information.
INTEREST RATE SWAPS, FLOORS AND CAPS AND CURRENCY SWAPS. The Portfolios may
enter into interest rate swaps and may purchase or sell interest rate caps and
floors. The Portfolios expect to enter into these transactions primarily to
preserve a return or spread on a particular investment or portion of their
holdings, as a duration management technique or to protect against an increase
in the price of securities a Portfolio anticipates purchasing at a later date.
The Portfolios intend to use these transactions as a hedge and not as a
speculative investment.
Interest rate swaps involve the exchange by a Portfolio with another party of
their respective commitments to pay or receive interest, e.g., an exchange of
floating rate payments for fixed rate payments. The purchase of an interest
rate cap entities the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate cap. The purchase of
an interest rate floor entitles the purchaser, to the extent that a specified
index falls below a predetermined interest rate, to receive payments of interest
on a notional principal amount from the party selling such interest rate floor.
In order to protect against currency rate fluctuations, the Portfolios also may
enter into currency swaps. Currency swaps involve the exchange of the rights of
a Portfolio and another party to make or receive payments in specified
currencies.
OPTIONS AND FUTURES CONTRACTS. Each Portfolio may write (i.e. sell) covered
call options, buy put options, buy call options and write secured put options
for the purpose of hedging or cross-hedging, or for the purpose of earning
additional income which may be deemed speculative. For the payment of a
premium, the purchaser of an option obtains the right to buy (in the case of a
call option) or to sell (in the case of a put option) the item which is the
subject of the option at a stated exercise price for a specific period of time.
These options may relate to particular securities, financial instruments,
foreign currencies, securities indices or the yield differential between two
securities, and may or may not be listed on a securities exchange and may or may
not be issued by the Options Clearing Corporation. Options trading is a highly
specialized activity that entails greater than ordinary investment risks. In
addition, unlisted options are not subject to the protections afforded
purchasers of listed options issued by the Options Clearing Corporation, which
performs the obligations of its members if they default.
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To the extent consistent with its investment objective, each Portfolio may also
invest in futures contracts and options on futures contracts. Futures contracts
obligate a Portfolio, at maturity, to take or make delivery of certain
securities, the cash value of a securities index or a stated quantity of a
foreign currency. A Portfolio may sell a futures contract in order to offset an
expected decrease in the value of its portfolio positions that might otherwise
result from a market decline or currency exchange fluctuation. A Portfolio may
do so either to hedge the value of its securities portfolio as a whole, or to
protect against declines occurring prior to sales of securities in the value of
the securities to be sold. In addition, a Portfolio may utilize futures
contracts in anticipation of changes in the composition of its holdings or in
currency exchange rates.
A Portfolio may purchase and sell call and put options on futures contracts
traded on an exchange or board of trade. When a Portfolio purchases an option
on a futures contract, it has the right to assume a position as a purchaser or a
seller of a futures contract at a specified exercise price during the option
period. When a Portfolio sells an option on a futures contract, it becomes
obligated to sell or buy a futures contract if the option is exercised. In
connection with a Portfolio's position in a futures contract or related option,
the Portfolio will segregate liquid assets or will otherwise cover its position
in accordance with applicable SEC requirements.
The primary risks associated with the use of futures contracts and options are
(a) the imperfect correlation between the change in market value of the
instruments held by a Portfolio and the price of the futures contract or option;
(b) possible lack of a liquid secondary market for a futures contract and the
resulting inability to close a futures contract when desired; (c) losses caused
by unanticipated market movements, which are potentially unlimited; (d) the
Adviser's inability to predict correctly the direction of securities prices,
interest rates, currency exchange rates and other economic factors; and (e) the
possibility that the counterparty will default in the performance of its
obligations. For further discussion of risks involved with domestic and foreign
futures and options, see Appendix B in the Statement of Additional Information.
The Portfolios intend to comply with the regulations of the Commodity Futures
Trading Commission ("CFTC") exempting the Portfolios from registration as a
"commodity pool operator." Consistent with those regulations, the value of a
Portfolio's contracts may equal or exceed 100% of its total assets; however, a
Portfolio will not purchase or sell a futures contract unless immediately
afterwards the aggregate amount of margin deposits on its existing futures
positions plus the amount of premiums paid
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for related futures options entered into for other than bona fide hedging
purposes is 5% or less of its net assets.
CONVERTIBLE SECURITIES AND PREFERRED STOCK. The Portfolios may, from time to
time, invest in convertible securities. Convertible securities acquired by the
Portfolios may include convertible bonds and convertible preferred stock, and
will be subject to the same rating requirements as a Portfolio's investments in
other fixed income securities. The Portfolios ordinarily will sell units of
common stock received upon conversion. The Portfolios may also purchase non-
convertible preferred stock when deemed to be in furtherance of a Portfolio's
investment objective.
SECURITIES LENDING. A Portfolio may seek additional income by lending
securities on a short-term basis. The securities lending agreements will
require that the loans be secured by collateral in cash, U.S. Government
securities or irrevocable bank letters of credit maintained on a current basis
equal in value to at least the market value of the loaned securities. A
Portfolio may not make such loans in excess of 33 1/3% of the value of its total
assets. Securities loans involve risks of delay in receiving additional
collateral or in recovering the loaned securities, or possibly loss of rights in
the collateral if the borrower of the securities becomes insolvent.
REPURCHASE AGREEMENTS. Each Portfolio may agree to purchase debt securities
from financial institutions subject to the seller's agreement to repurchase such
securities at an agreed upon time and price ("repurchase agreements").
Repurchase agreements are, in substance, loans. Default by or bankruptcy of a
seller would expose a Portfolio to possible loss because of adverse market
action, expenses and/or delays in connection with the disposition of the
underlying obligations.
REVERSE REPURCHASE AGREEMENTS AND OTHER BORROWINGS. Each Portfolio is
authorized to borrow money. If the securities held by a Portfolio should decline
in value while borrowings are outstanding, the net asset value of the
Portfolio's outstanding shares will decline in value by proportionately more
than the decline in value suffered by the Portfolio's securities. Borrowings
may be made through reverse repurchase agreements under which a Portfolio sells
portfolio securities to financial institutions such as banks and broker-dealers
and agrees to repurchase them at a particular date and price. The Portfolios
may use proceeds of reverse repurchase agreements to purchase other securities
either maturing, or under an agreement to resell, on a date simultaneous with or
prior to the expiration of the reverse repurchase agreement. The Portfolios may
use reverse repurchase agreements when it is anticipated that the interest
income to be earned from the investment of the proceeds of the transaction is
greater than the interest expense of the transaction. This use of reverse
repurchase agreements may be
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regarded as leveraging and, therefore, speculative. Reverse repurchase
agreements involve the risks that the interest income earned in the investment
of the proceeds will be less than the interest expense, that the market value of
the securities sold by a Portfolio may decline below the price of the securities
the Portfolio is obligated to repurchase and that the securities may not be
returned to the Portfolio. During the time a reverse repurchase agreement is
outstanding, a Portfolio will segregate cash, U.S. Government or other
appropriate liquid assets having a value at least equal to the repurchase price.
A Portfolio's reverse repurchase agreements, together with any other borrowings,
will not exceed, in the aggregate, 33 1/3% of the value of its total assets. In
addition, a Portfolio may borrow up to an additional 5% of its total assets for
temporary purposes.
DOLLAR ROLL TRANSACTIONS. To take advantage of attractive opportunities in the
mortgage market and to enhance current income, each Portfolio may enter into
dollar roll transactions. A dollar roll transaction involves a sale by the
Portfolio of a mortgage-backed or other security concurrently with an agreement
by the Portfolio to repurchase a similar security at a later date at an agreed-
upon price. The securities that are repurchased will bear the same interest
rate and stated maturity as those sold, but pools of mortgages collateralizing
those securities may have different prepayment histories than those sold.
During the period between the sale and repurchase, a Portfolio will not be
entitled to receive interest and principal payments on the securities sold.
Proceeds of the sale will be invested in additional instruments for the
Portfolio, and the income from these investments will generate income for the
Portfolio. This use of dollar rolls may be regarded as leveraging and,
therefore, speculative. If the income earned from the investment of the
proceeds of the transaction does not exceed the income, capital appreciation and
gain or loss that would have been realized on the securities sold as part of the
dollar roll, the use of this technique will diminish the investment performance
of a Portfolio compared with what the performance would have been without the
use of dollar rolls. At the time a Portfolio enters into a dollar roll
transaction, it will segregate with its custodian cash, U.S. Government
securities or other liquid assets having a value equal to the repurchase price
(including accrued interest) and will subsequently monitor the account to ensure
that its value is maintained. A Portfolio's dollar rolls, together with its
reverse repurchase agreements and other borrowings, will not exceed, in the
aggregate, 33 1/3% of the value of its total assets.
Dollar roll transactions involve the risk that the market value of the
securities a Portfolio is required to purchase may decline below the agreed upon
repurchase price of those securities. If the broker/dealer to whom a Portfolio
sells securities becomes
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insolvent, the Portfolio's right to purchase or repurchase securities may be
restricted. Successful use of mortgage dollar rolls may depend upon the
Adviser's ability to correctly predict interest rates and prepayments. There is
no assurance that dollar rolls can be successfully employed.
INVESTMENT COMPANIES. Each Portfolio may invest in securities issued by other
investment companies within the limits prescribed by the 1940 Act. As a
shareholder of another investment company, a Portfolio would bear, along with
other shareholders, its pro rata portion of the other investment company's
expenses, including advisory fees. These expenses would be in addition to the
advisory and other expenses that each Portfolio bears directly in connection
with its own operations.
ILLIQUID SECURITIES. No Portfolio will invest more than 15% of the value of its
net assets in securities that are illiquid. Instruments that cannot be disposed
of within seven days, and repurchase agreements and time deposits that do not
provide for payment within seven days after notice, without taking a reduced
price, are subject to this 15% limit. Each Portfolio may purchase securities
which are not registered under the Securities Act of 1933 (the "1933 Act") but
which can be sold to "qualified institutional buyers" in accordance with Rule
144A under the 1933 Act. These securities will not be considered illiquid so
long as it is determined by the Adviser that an adequate trading market exists
for the securities. This investment practice could have the effect of
increasing the level of illiquidity in a Portfolio during any period that
qualified institutional buyers become uninterested in purchasing these
restricted securities.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. Each Portfolio may purchase
securities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" basis. These transactions involve a commitment by a
Portfolio to purchase or sell particular securities with payment and delivery
taking place at a future date (perhaps one or two months later), and permit a
Portfolio to lock in a price or yield on a security that it owns or intends to
purchase, regardless of future changes in interest rates or market action.
When-issued and forward commitment transactions involve the risk, however, that
the price or yield obtained in a transaction may be less favorable than the
price or yield available in the market when the securities delivery takes place.
Each Portfolio's when-issued purchases and forward commitments may exceed 25% of
the value of its total assets.
SHORT SALES. The Portfolios may make short sales of securities. A short sale is
a transaction in which a Portfolio sells a security it does not own in
anticipation that the market price of that security will decline. The
Portfolios may make short sales both as a form of hedging to offset potential
declines in long positions in similar securities and in order to maintain
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portfolio flexibility. During the period of a short sale, a Portfolio will
segregate on a daily basis cash, U.S. Government securities or other permissible
liquid assets at such a level that (a) the segregated amount will equal the
current value of the security sold short and (b) the segregated amount will not
be less than the market value of the security at the time it was sold short.
PORTFOLIO TURNOVER RATES. A Portfolio's annual portfolio turnover rate will not
be a factor preventing a sale or purchase when the Adviser believes investment
considerations warrant such sale or purchase. Portfolio turnover may vary
greatly from year to year as well as within a particular year. The Adviser
expects to allocate a portion of its separate account clients' portfolios to the
Portfolios when it believes that the securities in which the Portfolios invest
present favorable risk-reward characteristics. During other periods,
investments by the separate accounts in the Portfolios may be redeemed. This
activity may produce higher than normal portfolio turnover which may result in
increased transaction costs to the Portfolios. As of the date of this
Prospectus, under normal market conditions the annual portfolio turnover rate of
each Portfolio is not expected to exceed 400%.
MANAGEMENT OF THE FUND
BOARD OF TRUSTEES. The business and affairs of the Fund are managed under the
direction of its Board of Trustees. The following individuals serve as trustees
of the Fund:
William O. Albertini--Executive Vice President and Chief Financial
Officer of Bell Atlantic Global Wireless.
Raymond J. Clark--Treasurer of Princeton University.
Robert M. Hernandez--Vice Chairman and Chief Financial Officer of USX
Corporation.
Anthony M. Santomero--Professor of Finance and Director of the
Financial Institutions Center at The Wharton School, University of
Pennsylvania.
David R. Wilmerding, Jr.--Chairman of Gee, Wilmerding & Associates,
Inc.
ADVISER. The Portfolios' investment adviser is BlackRock Financial Management,
Inc. The Adviser's principal business address is 345 Park Avenue, New York, New
York 10154. Since 1995, BlackRock has been a majority-owned indirect
subsidiary
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of PNC Bank Corp., one of the largest diversified financial services
companies in the United States. BlackRock provides asset management services
with respect to U.S. and foreign fixed income instruments. As adviser,
BlackRock is responsible for the day-to-day management of the Portfolios, and
generally makes all purchase and sale decisions regarding the investments made
by the Portfolios. BlackRock also provides research and credit analysis as well
as certain other services. Investment decisions are made by BlackRock's
Investment Strategy Committee and no one person is primarily responsible for
making recommendations to that committee. BlackRock currently serves as
investment adviser to institutional and individual investors in the United
States and overseas through several funds and separately managed accounts. For
its investment advisory services to the Portfolios, the Adviser is entitled to a
fee, computed daily for each Portfolio and payable monthly, at the annual rate
of .20% of each Portfolio's average daily net assets. From time to time, the
Adviser may waive some or all of its advisory fee from a Portfolio.
Like other mutual funds and financial and business organizations worldwide, the
Portfolios could be adversely affected if computer systems on which the Fund
relies are unable to distinguish between the year 1900 and the year 2000
(typically, this is called the "Year 2000 Problem"). The Year 2000 Problem
could have a negative impact on handling securities trades, pricing and account
services and could otherwise have a material adverse effect on the Portfolios'
business, operations and/or investments. BlackRock has commenced review of the
Year 2000 Problem as it may affect the Portfolios, both directly and through the
systems of the Fund's other service providers, and is taking steps reasonably
designed to address any Year 2000 Problems. In light of these remedial steps,
BlackRock expects that its systems and the systems of the Fund's other service
providers will be adapted to deal with the Year 2000 Problem before the
beginning of the year 2000. There can be no assurance, however, that the
systems of BlackRock or the Fund's other service providers will be successfully
adapted to deal with the Year 2000 Problem, or that interaction with other
third-party computer systems which are not prepared for the Year 2000 Problem
will not impair their services at that time, or that the Year 2000 Problem will
not have an adverse effect on companies whose securities are held by the
Portfolios or on global markets or economies generally.
ADMINISTRATORS. BlackRock Advisors, Inc. ("BAI") and PFPC Inc. ("PFPC")(the
"Administrators") serve as the Portfolios' co-administrators. BAI is an
indirect majority-owned, and PFPC is an indirect wholly-owned, subsidiary of PNC
Bank Corp.
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The Administrators generally assist the Portfolios in all aspects of their
administration and operation, including matters relating to the maintenance of
financial records, fund accounting and the servicing of investors in the
Portfolios. As compensation for these services, BAI and PFPC are entitled to
receive a combined administration fee, computed daily and payable monthly, at
the annual rate of .23% of the first $500 million of each Portfolio's average
daily net assets, .21% of the next $500 million of each Portfolio's average
daily net assets and .19% of the average daily net assets of each Portfolio in
excess of $1 billion. From time to time the Administrators may waive some or
all of their administration fees from a Portfolio.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND CUSTODIAN. PNC Bank, whose
principal offices are located at 1600 Market Street, Philadelphia, Pennsylvania
19103, serves as the Portfolios' custodian and PFPC, whose principal offices are
located at 400 Bellevue Parkway, Wilmington, Delaware 19809, serves as their
transfer agent and dividend disbursing agent.
EXPENSES. Expenses are deducted from the total income of each Portfolio before
dividends and distributions are paid. Expenses include, but are not limited to,
fees paid to BlackRock and the Administrators, transfer agency and custodian
fees, trustee fees, taxes, interest, professional fees, fees and expenses in
registering the Portfolios and their shares for distribution under Federal and
state securities laws, expenses of preparing prospectuses and statements of
additional information and of printing and distributing prospectuses and
statements of additional information to existing shareholders, expenses relating
to shareholder reports, shareholder meetings and proxy solicitations, insurance
premiums, the expense of independent pricing services, and other expenses which
are not expressly assumed by the Adviser or the Portfolios' service providers
under their agreements for the Portfolios. Any general expenses of the Fund
that do not belong to a particular investment portfolio will be allocated among
all investment portfolios by or under the direction of the Board of Trustees in
a manner the Board determines to be fair and equitable.
The expense ratios of the Portfolios can be expected to be higher than those of
portfolios investing primarily in domestic securities. The costs attributable
to investing abroad are usually higher for several reasons, including higher
investment research costs, higher foreign custody costs, higher commission costs
and additional costs arising from delays in settlements of transactions
involving foreign securities.
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PURCHASES AND REDEMPTIONS
DISTRIBUTOR. BlackRock Distributors, Inc. ("BDI") serves as distributor of the
Portfolios' shares (the "Distributor"). BDI maintains its principal offices at
Four Falls Corporate Center, 6th Floor, West Conshohocken, Pennsylvania 19428-
2961. BDI is a wholly-owned subsidiary of Provident Distributors, Inc. ("PDI").
A majority of the outstanding stock of PDI is owned by its officers.
PURCHASE OF SHARES. Shares of the Portfolios are offered to the separate
account clients of the Adviser.
Shares are sold at their net asset value per share next computed after an order
is received by PFPC. Orders received by PFPC by 3:00 p.m. (Eastern Time) on a
Business Day are priced the same day. A "Business Day" is any weekday that the
New York Stock Exchange (the "NYSE")is open for business.
Purchase orders may be placed by telephoning PFPC at (800) 441-7450. Orders
received by PFPC after 3:00 p.m. (Eastern Time) are priced on the following
Business Day.
There is no minimum initial or subsequent investment requirement. Payment for
shares must normally be made in Federal funds or other funds immediately
available to the Portfolios' custodian. Payment may also, in the discretion of
the Portfolios, be made in the form of securities that are permissible
investments for the respective Portfolios. For further information, see the
Statement of Additional Information.
The Portfolios may in their discretion reject any order for shares.
REDEMPTION OF SHARES. Redemption orders for shares may be placed by telephoning
PFPC at (800) 441-7450. Shares are redeemed at their net asset value per share
next determined after PFPC's receipt of the redemption order. The Portfolios,
the Administrators and the Distributor will employ reasonable procedures to
confirm that instructions communicated by telephone are genuine. The Portfolios
and their service providers will not be liable for any loss, liability, cost or
expense for acting upon telephone instructions that are reasonably believed to
be genuine in accordance with such procedures.
Payment for redeemed shares for which a redemption order is received by PFPC
before 3:00 p.m. (Eastern Time) on a Business Day is normally made in Federal
funds wired to the redeeming shareholder on the next Business Day, provided that
the Portfolios' custodian is also open for business. Payment for redemption
orders received after 3:00 p.m. (Eastern Time) or on a
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<PAGE>
day when the Portfolios' custodian is closed is normally wired in Federal funds
on the next Business Day following redemption on which the Portfolios' custodian
is open for business. The Portfolios reserve the right to wire redemption
proceeds within seven days after receiving a redemption order if, in the
judgment of the Adviser, an earlier payment could adversely affect a Portfolio.
No charge for wiring redemption payments is imposed by the Portfolios.
During periods of substantial economic or market change, telephone redemptions
may be difficult to complete. Redemption requests may also be mailed to PFPC at
P.O. Box 8907, Wilmington, Delaware 19899-8907.
The Portfolios may also suspend the right of redemption or postpone the date of
payment upon redemption for such periods as are permitted under the 1940 Act,
and may redeem shares involuntarily or make payment for redemption in securities
or other property when determined appropriate in light of the Portfolios'
responsibilities under the 1940 Act. See "Purchase and Redemption Information"
in the Statement of Additional Information for examples of when such redemption
might be appropriate. The Fund reserves the express right to redeem shares of
each Portfolio involuntarily at any time if the Fund's Board of Trustees
determines, in its sole discretion, that failure to do so may have adverse
consequences to the holders of shares in the Portfolio. Upon such redemption
the holders of shares so redeemed shall have no further right with respect
thereto other than to receive payment of the redemption price.
NET ASSET VALUE
The net asset value for each Portfolio is determined as of 4:00 p.m. (Eastern
Time) by dividing the total value of the Portfolio's investments and other
assets, less any liabilities, by the number of total outstanding shares of that
Portfolio.
Each Portfolio will compute its net asset value once daily on days that the New
York Stock Exchange is open for trading, except on days on which no orders to
purchase or redeem have been received. Notwithstanding whether any orders to
purchase or redeem have been received or whether the New York Stock Exchange is
open for business, the net asset value will be calculated on the last day of
each month.
Most securities held by a Portfolio are priced based on their market value as
determined by reported sales prices or the mean between their bid and asked
prices. Portfolio securities which are traded primarily on foreign securities
exchanges are normally valued at the preceding closing values of such securities
on their respective exchanges. Securities for which market
-25-
<PAGE>
quotations are not readily available are valued at fair market value as
determined in good faith by or under the direction of the Board of Trustees. The
amortized cost method of valuation will also be used with respect to debt
obligations with sixty days or less remaining to maturity unless the Adviser
under the supervision of the Board of Trustees determines such method does not
represent fair value.
DIVIDENDS AND DISTRIBUTIONS
Dividends for each Portfolio will be declared daily on shares held of record at
3:00 p.m. (Eastern Time). Over the course of a year, substantially all of a
Portfolio's net investment income will be declared as dividends. The amount of
the daily dividend for each Portfolio will be based on periodic projections of
its net investment income. All dividends are paid not later than ten days after
the end of each month. Net realized capital gains, if any, will be distributed
by each Portfolio at least annually. All dividends and distributions will be
reinvested automatically at net asset value in additional shares of the same
Portfolio, unless cash payment is requested.
TAXES
The following discussion is only a brief summary of some of the important tax
considerations generally affecting the Portfolios and their shareholders and is
not intended as a substitute for careful tax planning. Accordingly, investors
in the Portfolios should consult their tax advisers with specific reference to
their own tax situation.
Distributions paid out of a Portfolio's "net capital gain" (i.e., the excess of
----
its net long-term capital gain over net short-term capital loss), if any, will
be taxed to shareholders as long-term capital gain, regardless of the length of
time a shareholder holds the shares. All other distributions, to the extent
taxable, are taxed to shareholders as ordinary income.
The Fund will send written notices to shareholders annually regarding the tax
status of distributions made by each Portfolio. Dividends declared in October,
November or December of any year payable to shareholders of record on a
specified date in those months will be deemed to have been received by the
shareholders on December 31 of such year, if the dividends are paid during the
following January.
An investor considering buying shares on or just before the record date for a
distribution should be aware that the amount of the forthcoming distribution
payment, although in effect a return of capital, will be taxable.
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<PAGE>
A taxable gain or loss may be realized by a shareholder upon the redemption or
transfer of shares depending upon their tax basis and their price at the time of
redemption or transfer.
This is not an exhaustive discussion of applicable tax consequences, and
investors may wish to contact their tax advisers concerning investments in the
Portfolios. Dividends paid by each Portfolio may be taxable to investors under
state or local law as dividend income even though all or a portion of the
dividends may be derived from interest on obligations which, if realized
directly, would be exempt from such income taxes. In addition, future
legislative or administrative changes or court decisions may materially affect
the tax consequences of investing in a Portfolio. Shareholders who are non-
resident alien individuals, foreign trusts or estates, foreign corporations or
foreign partnerships may be subject to different U.S. Federal income tax
treatment.
ORGANIZATION
The Fund was organized as a Massachusetts business trust on December 22, 1988
and is registered under the 1940 Act as an open-end management investment
company. Effective January 31, 1998, the Fund changed its name from Compass
Capital Funds(SM) to BlackRock Funds(SM). The Declaration of Trust authorizes
the Board of Trustees to classify and reclassify any unissued shares into one or
more classes of shares. Pursuant to this authority, the Trustees have authorized
the issuance of an unlimited number of shares in 40 investment portfolios, some
of which offer multiple classes of shares to investors. This prospectus relates
only to the two Portfolios described herein, each of which offers a single class
of shares -- Institutional Shares.
Each share of a Portfolio has a par value of $.001, represents a pro rata
interest in that Portfolio with each other share of the same class and is
entitled to the dividends and distributions earned on that Portfolio's assets as
are declared in the discretion of the Board of Trustees. The Fund's
shareholders are entitled to one vote for each full share held and proportionate
fractional votes for fractional shares held, and will vote in the aggregate and
not by investment portfolio or class, except where otherwise required by law or
as determined by the Board of Trustees. The Fund does not currently intend to
hold annual meetings of shareholders for the election of trustees (except as
required under the 1940 Act). For a further discussion of the voting rights of
shareholders, see "Additional Information Concerning Shares" in the Statement of
Additional Information.
On November 13, 1998, PNC Bank held of record approximately 72% of the Fund's
outstanding shares, as trustee on behalf of individual and institutional
investors, and may be deemed a
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<PAGE>
controlling person of the Fund under the 1940 Act. PNC Bank is a subsidiary of
PNC Bank Corp., a multi-bank holding company.
PERFORMANCE
Performance information for shares of the Portfolios may be quoted in
advertisements and communications to shareholders. Total return will be
calculated on an average annual total return basis for various periods. Average
annual total return reflects the average annual percentage change in value of an
investment in shares of a Portfolio over the measuring period. Total return may
also be calculated on an aggregate total return basis. Aggregate total return
reflects the total percentage change in value over the measuring period. Both
methods of calculating total return assume that dividend and capital gain
distributions made by a Portfolio with respect to its shares are reinvested in
shares.
A Portfolio's yield is computed by dividing the Portfolio's net income per share
during a 30-day (or one month) period by the net asset value per share on the
last day of the period and analyzing the result on a semi-annual basis.
Performance quotations represent past performance and should not be considered
representative of future results. The investment return and principal value of
an investment in a Portfolio will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost. Any fees charged
directly to the customer accounts of the Adviser in connection with investments
in a Portfolio will not be included in the Portfolio's performance calculations.
SHAREHOLDER INQUIRIES
Shareholder inquiries may be directed to BlackRock at 212-754-5560.
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<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
BLACKROCK STRATEGIC PORTFOLIO I
BLACKROCK STRATEGIC PORTFOLIO II
This Statement of Additional Information provides supplementary information
pertaining to shares representing interests in BlackRock Strategic Portfolio I
and BlackRock Strategic Portfolio II (the "Portfolios") of BlackRock FundsSM
(the "Fund"). This Statement of Additional Information is not a prospectus, and
should be read only in conjunction with the Prospectus of the Fund relating to
the Portfolios dated November 25, 1998, as amended from time to time (the
"Prospectus"). The Prospectus may be obtained from the Fund's distributor by
calling toll-free (800) 441-7379. This Statement of Additional Information is
dated November 25, 1998. Capitalized terms used herein and not otherwise
defined have the same meanings as are given to them in the Prospectus.
CONTENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
THE FUND.................................................................... 2
INVESTMENT OBJECTIVE AND POLICIES........................................... 2
INVESTMENT RESTRICTIONS..................................................... 15
TRUSTEES AND OFFICERS....................................................... 17
INVESTMENT ADVISORY, ADMINISTRATION, DISTRIBUTION AND SERVICE ARRANGEMENTS.. 22
PORTFOLIO TRANSACTIONS...................................................... 26
PURCHASE AND REDEMPTION INFORMATION......................................... 28
VALUATION OF PORTFOLIO SECURITIES........................................... 29
PERFORMANCE INFORMATION..................................................... 30
TAXES....................................................................... 34
ADDITIONAL INFORMATION CONCERNING SHARES.................................... 38
MISCELLANEOUS............................................................... 40
FINANCIAL STATEMENTS........................................................ 41
APPENDIX A.................................................................. A-1
APPENDIX B.................................................................. B-1
</TABLE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS STATEMENT OF ADDITIONAL INFORMATION OR THE
PROSPECTUS IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE FUND OR ITS DISTRIBUTOR. THE PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING BY THE FUND OR BY THE FUND'S DISTRIBUTOR IN ANY
JURISDICTION IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
<PAGE>
2
THE FUND
The Fund was organized on December 22, 1988 as a Massachusetts business
trust.
The Fund also offers other investment portfolios which are described in
separate Prospectuses and separate Statements of Additional Information. For
information concerning these other portfolios, contact the Distributor at the
telephone number stated on the cover page of this Statement of Additional
Information.
INVESTMENT OBJECTIVE AND POLICIES
For a description of the objective and policies of the Portfolios, see
"Investment Objective and Policies" in the Prospectus. The following
information is provided for those investors desiring information in addition to
that contained in the Prospectus.
CURRENCY TRANSACTIONS. As discussed in the Prospectus, the Portfolios may
engage in currency transactions with counterparties in order to hedge the value
of portfolio holdings denominated in particular currencies against fluctuations
in relative value or to enhance potential gain. Currency transactions include
spot and forward currency contracts, exchange listed currency futures, exchange
listed and OTC options on currencies, and currency swaps. A forward currency
contract involves a privately negotiated obligation to purchase or sell (with
delivery generally required) a specific currency at a future date, which may be
any fixed number of days from the date of the contract agreed upon by the
parties, at a price set at the time of the contract. Currency swaps usually
involve the delivery of the entire principal value of one designated currency in
exchange for the other designated currency. Because currency swaps usually
involve the delivery of the entire principal value of one designated currency in
exchange for the other designated currency, the entire principal value of a
currency swap is subject to the risk that the other party to the swap will
default on its contractual delivery obligations. A Portfolio may enter into
over-the-counter currency transactions with counterparties which have received,
combined with any credit enhancements, a long-term debt rating of "A" by S&P or
Moody's, respectively, or that have an equivalent rating from a nationally
recognized statistical rating organization ("NRSRO") or (except for OTC currency
options) whose obligations are determined to be of equivalent credit quality by
BlackRock Financial Management, Inc. ("BlackRock" or the "Adviser").
A Portfolio may also cross-hedge currencies by entering into transactions
to purchase or sell one or more currencies that are expected to decline in value
in relation to other currencies to
<PAGE>
3
which the Portfolio has or in which the Portfolio expects to have exposure.
For example, a Portfolio may hold both French government bonds and German
government bonds, and the Adviser may believe that French francs will
deteriorate against German marks. The Portfolio would sell French francs to
reduce its exposure to that currency and buy German marks. This strategy would
be a hedge against a decline in the value of French francs, although it would
expose the Portfolio to declines in the value of the German mark relative to the
U.S. dollar.
To reduce the effect of currency fluctuations on the value of existing or
anticipated holdings of portfolio securities, the Portfolios may also engage in
proxy hedging. Proxy hedging is often used when the currency to which the
Portfolio is exposed is difficult to hedge or to hedge against the dollar.
Proxy hedging entails entering into a forward contract to sell a currency whose
changes in value are generally considered to be linked to a currency or
currencies in which certain of the Portfolio's securities are or are expected to
be denominated, and to buy U.S. dollars. Proxy hedging involves some of the
same risks and considerations as other transactions with similar instruments.
Currency transactions can result in losses to the Portfolio if the currency
being hedged fluctuates in value to a degree or in a direction that is not
anticipated. Further, there is the risk that the perceived linkage between
various currencies may not be present or may not be present during the
particular time that the Portfolio is engaging in proxy hedging. Whenever a
Portfolio enters into a currency hedging transaction, the Portfolio will comply
with the asset segregation requirements of the SEC.
Currency transactions are subject to risks different from those of other
portfolio transactions. Because currency control is of great importance to the
issuing governments and influences economic planning and policy, purchases and
sales of currency and related instruments can be negatively affected by
government exchange controls, blockages, and manipulations or exchange
restrictions imposed by governments. These can result in losses to a Portfolio
if it is unable to deliver or receive currency or funds in settlement of
obligations, and could also cause hedges it has entered into to be rendered
useless, resulting in full currency exposure as well as incurring transaction
costs. Buyers and sellers of currency futures are subject to the same risks
that apply to the use of futures generally. Further, settlement of a currency
futures contract for the purchase of most currencies must occur at an
institution based in the issuing nation. Trading options on currency futures is
relatively new, and the ability to establish and close out positions on such
options is subject to the maintenance of a liquid market which may not always be
available. Currency exchange rates may fluctuate based on factors extrinsic to
that country's economy.
REVERSE REPURCHASE AGREEMENTS. Each Portfolio may invest in reverse
repurchase agreements. Reverse repurchase agreements involve the sale of
securities held by a Portfolio pursuant to a
<PAGE>
4
Portfolio's agreement to repurchase the securities at an agreed upon price, date
and interest rate. Such agreements are considered to be borrowings under the
Investment Company Act of 1940 (the "1940 Act"). While reverse repurchase
transactions are outstanding, a Portfolio will segregate cash, U.S. Government
securities or other liquid assets in an amount at least equal to the repurchase
price.
VARIABLE AND FLOATING RATE INSTRUMENTS. With respect to purchasable
variable and floating rate instruments, the Adviser will consider the earning
power, cash flows and liquidity ratios of the issuers and guarantors of such
instruments and, if the instruments are subject to a demand feature, will
monitor their financial status to meet payment on demand. Such instruments may
include variable amount master demand notes that permit the indebtedness
thereunder to vary in addition to providing for periodic adjustments in the
interest rate. The absence of an active secondary market with respect to
particular variable and floating rate instruments could make it difficult for a
Portfolio to dispose of a variable or floating rate note if the issuer defaulted
on its payment obligation or during periods that the Portfolio is not entitled
to exercise its demand rights, and the Portfolio could, for these or other
reasons, suffer a loss with respect to such instruments.
MONEY MARKET OBLIGATIONS OF DOMESTIC BANKS, FOREIGN BANKS AND FOREIGN
BRANCHES OF U.S. BANKS. Each Portfolio may purchase bank obligations, such as
certificates of deposit, bankers' acceptances and time deposits, including
instruments issued or supported by the credit of U.S. or foreign banks or
savings institutions having total assets at the time of purchase in excess of $1
billion. The assets of a bank or savings institution will be deemed to include
the assets of its domestic and foreign branches for purposes of each Portfolio's
investment policies. Investments in short-term bank obligations may include
obligations of foreign banks and domestic branches of foreign banks, and also
foreign branches of domestic banks.
MORTGAGE-RELATED SECURITIES. There are a number of important differences
among the agencies and instrumentalities of the U.S. Government that issue
mortgage-related securities and among the securities that they issue. Mortgage-
related securities guaranteed by the Government National Mortgage Association
("GNMA") include GNMA Mortgage Pass-Through Certificates (also known as "Ginnie
Maes") 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-related securities issued by the
Federal National Mortgage Association ("FNMA") include FNMA guaranteed Mortgage
Pass-Through Certificates (also known as
<PAGE>
5
"Fannie Maes") which are solely the obligations of the FNMA, are not backed by
or entitled to the full faith and credit of the United States and are supported
by the right of the issuer to borrow from the Treasury. FNMA is a government-
sponsored organization owned entirely by private stockholders. Fannie Maes are
guaranteed as to timely payment of principal and interest by FNMA. Mortgage-
related securities issued by the Federal Home Loan Mortgage Corporation
("FHLMC") include FHLMC Mortgage Participation Certificates (also known as
"Freddie Macs" or "Pcs"). FHLMC is a corporate instrumentality of the United
States, created pursuant to an Act of Congress, which is owned entirely by
Federal Home Loan Banks. Freddie Macs are not guaranteed by the United States or
by any Federal Home Loan Banks 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.
The Portfolios may invest in multiple class pass-through securities,
including collateralized mortgage obligations ("CMOs") and real estate mortgage
investment conduit ("REMIC") pass-through or participation certificates ("REMIC
Certificates"). These multiple class securities may be issued by U.S.
Government agencies or instrumentalities, including FNMA and FHLMC, or by trusts
formed by private originators of, or investors in, mortgage loans. In general,
CMOs and REMICs are debt obligations of a legal entity that are collateralized
by, and multiple class pass-through securities represent direct ownership
interests in, a pool of residential or commercial mortgage loans or mortgage
pass-through securities (the "Mortgage Assets"), the payments on which are used
to make payments on the CMOs or multiple pass-through securities. Investors may
purchase beneficial interests in CMOs and REMICs, which are known as "regular"
interests or "residual" interests. The Portfolios do not intend to purchase
residual interests. The markets for CMOs and REMICs may be more illiquid than
those of other securities.
Each class of CMOs or REMIC Certificates, often referred to as a "tranche,"
is issued at a specific adjustable or fixed interest rate and must be fully
retired no later than its final distribution date. Principal prepayments on the
Mortgage Assets underlying the CMOs or REMIC Certificates may cause some or all
of the classes of CMOs or REMIC Certificates to be retired substantially earlier
than their final distribution dates. Generally, interest is paid or accrues on
all classes of CMOs or REMIC Certificates on a monthly basis.
The principal of and interest on the Mortgage Assets may be
<PAGE>
6
allocated among the several classes of CMOs or REMIC Certificates in various
ways. In certain structures (known as "sequential pay" CMOs or REMIC
Certificates), payments of principal, including any principal prepayments, on
the Mortgage Assets generally are applied to the classes of CMOs or REMIC
Certificates in the order of their respective final distribution dates. Thus no
payment of principal will be made on any class of sequential pay CMOs or REMIC
Certificates until all other classes having an earlier final distribution date
have been paid in full.
Additional structures of CMOs or REMIC Certificates include, among others,
"parallel pay" CMOs and REMIC Certificates. Parallel pay CMOs or REMIC
Certificates are those which are structured to apply principal payments and
prepayments of the Mortgage Assets to two or more classes concurrently on a
proportionate or disproportionate basis. These simultaneous payments are taken
into account in calculating the final distribution date of each class.
A wide variety of REMIC Certificates may be issued in the parallel pay or
sequential pay structures. These securities include accrual certificates (also
known as "Z-Bonds"), which only accrue interest at a specified rate until all
other certificates having an earlier final distribution date have been retired
and are converted thereafter to an interest-paying security, and planned
amortization class ("PAC") certificates, which are parallel pay REMIC
Certificates which generally require that specified amounts of principal be
applied on each payment date to one or more classes of REMIC Certificates (the
"PAC Certificates"), even though all other principal payments and prepayments of
the Mortgage Assets are then required to be applied to one or more other classes
of the Certificates. The scheduled principal payments for the PAC Certificates
generally have the highest priority on each payment date after interest due has
been paid to all classes entitled to receive interest currently. Shortfalls, if
any, are added to the amount payable on the next payment date. The PAC
Certificate payment schedule is taken into account in calculating the final
distribution date of each class of PAC. In order to create PAC tranches, one or
more tranches generally must be created that absorb most of the volatility in
the underlying Mortgage Assets. These tranches tend to have market prices and
yields that are much more volatile than the PAC classes.
FNMA REMIC Certificates are issued and guaranteed as to timely distribution
of principal and interest by FNMA. In addition, FNMA will be obligated to
distribute on a timely basis to holders of FNMA REMIC Certificates required
installments of principal and interest and to distribute the principal balance
of each class of REMIC Certificates in full, whether or not sufficient funds are
otherwise available.
For FHLMC REMIC Certificates, FHLMC guarantees the timely payment of
interest, and also guarantees the ultimate payment of
<PAGE>
7
principal as payments are required to be made on the underlying Pcs. Pcs
represent undivided interests in specified level payment, residential mortgages
or participation therein purchased by FHLMC and placed in a Pc pool. With
respect to principal payments on Pcs, FHLMC generally guarantees ultimate
collection of all principal of the related mortgage loans without offset or
deduction. FHLMC also guarantees timely payment of principal on certain Pcs,
referred to as "Gold Pcs."
The average life of a mortgage-related instrument, in particular, is likely
to be substantially less than the original maturity of the mortgage pools
underlying the securities as the result of scheduled principal payments and
mortgage prepayments.
ASSET-BACKED SECURITIES. Asset-backed securities are generally issued as
pass-through certificates, which represent undivided fractional ownership
interests in an underlying pool of assets, or as debt instruments, which are
also known as collateralized obligations, and are generally issued as the debt
of a special purpose entity organized solely for the purpose of owning such
assets and issuing such debt. Asset-backed securities are often backed by a
pool of assets representing the obligations of a number of different parties.
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. The relationship between prepayments and interest
rates may give some high-yielding asset-backed securities less potential for
growth in value than conventional bonds with comparable maturities.
In general, the collateral supporting non-mortgage asset-backed securities
is of shorter maturity than mortgage-related securities. 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.
U.S. GOVERNMENT OBLIGATIONS. Examples of the types of U.S. Government
obligations which the Portfolios may hold include U.S. Treasury bills, Treasury
instruments and Treasury bonds and the obligations of Federal Home Loan Banks,
Federal Farm Credit Banks, Federal Land Banks, the Federal Housing
Administration, the Farmers Home Administration, the Export-Import Bank of the
<PAGE>
8
United States, the Small Business Administration, FNMA, GNMA, the General
Services Administration, the Student Loan Marketing Association, the Central
Bank for Cooperatives, FHLMC, the Federal Intermediate Credit Banks, the
Maritime Administration, the International Bank for Reconstruction and
Development (the "World Bank"), the Asian-American Development Bank and the
Inter-American Development Bank.
SUPRANATIONAL ORGANIZATION OBLIGATIONS. The Portfolios may purchase debt
securities of supranational organizations such as the European Coal and Steel
Community, the European Economic Community and the World Bank, which are charted
to promote economic development.
MUNICIPAL OBLIGATIONS. When deemed advisable by the Adviser, the
Portfolios may invest in obligations issued by a state or local government
("Municipal Obligations"). The two principal classifications of Municipal
Obligations are "general obligation" securities and "revenue" securities.
General obligation securities are secured by the issuer's pledge of its full
faith, credit and taxing power for the payment of principal and interest.
Revenue securities are payable only from the revenues derived from a particular
facility or class of facilities or, in some cases, from the proceeds of a
special excise tax or other specific revenue source such as the user of the
facility being financed. Revenue securities include private activity bonds
which are not payable from the unrestricted revenues of the issuer.
Consequently, the credit quality of private activity bonds is usually
directly related to the credit standing of the corporate user of the facility
involved. Municipal Obligations may also include "moral obligation" bonds,
which are normally issued by special purpose public authorities. If the issuer
of moral obligation bonds is unable to meet its debt service obligations from
current revenues, it may draw on a reserve fund the restoration of which is a
moral commitment but not a legal obligation of the state or municipality which
created the issuer.
The Portfolios may hold participation certificates in a lease, an
installment purchase contract, or a conditional sales contract ("lease
obligations"). In determining whether a lease obligation is liquid, the Adviser
will consider, among other factors, the following: (i) whether the lease can be
cancelled; (ii) the degree of assurance that assets represented by the lease
could be sold; (iii) the strength of the lessee's general credit (e.g., its
debt, administrative, economic, and financial characteristics); (iv) the
likelihood that the municipality would discontinue appropriating funding for the
leased property because the property is no longer deemed essential to the
operations of the municipality (e.g., the potential for an "event of
nonappropriation"); (v) legal recourse in the event of failure to appropriate;
(vi) whether the security is backed by a credit enhancement such as insurance;
and (vii) any limitations which
<PAGE>
9
are imposed on the lease obligor's ability to utilize substitute property or
services other than those covered by the lease obligation.
Municipal leases, like other municipal debt obligations, are subject to the
risk of non-payment. The ability of issuers of municipal leases to make timely
lease payments may be adversely impacted in general economic downturns and as
relative governmental cost burdens are allocated and reallocated among federal,
state and local governmental units. Such non-payment would result in a
reduction of income to a Portfolio, and could result in a reduction in the value
of the municipal lease experiencing non-payment and a potential decrease in the
net asset value of the Portfolio. Issuers of municipal securities might seek
protection under the bankruptcy laws. In the event of bankruptcy of such an
issuer, a Portfolio could experience delays and limitations with respect to the
collection of principal and interest on such municipal leases and a Portfolio
may not, in all circumstances, be able to collect all principal and interest to
which it is entitled. To enforce its rights in the event of a default in lease
payments, a Portfolio may take possession of and manage the assets securing the
issuer's obligations on such securities, which may increase a Portfolio's
operating expenses and adversely affect the net asset value of the Portfolio.
When the lease contains a non-appropriation clause, however, the failure to pay
would not be a default and the Portfolio would not have the right to take
possession of the assets. In addition, a Portfolio's intention to qualify as a
"regulated investment company" under the Internal Revenue Code of 1986, as
amended, may limit the extent to which a Portfolio may exercise its rights by
taking possession of such assets, because as a regulated investment company a
Portfolio is subject to certain limitations on its investments and on the nature
of its income.
COMMERCIAL PAPER. The Portfolios may purchase commercial paper rated in
one of the highest rating categories of an NRSRO. These ratings symbols are
described in Appendix A.
Commercial paper purchasable by each Portfolio includes "Section 4(2)
paper," a term that includes debt obligations issued in reliance on the "private
placement" exemption from registration afforded by Section 4(2) of the
Securities Act of 1933. Section 4(2) paper is restricted as to disposition
under the Federal securities laws, and is frequently sold (and resold) to
institutional investors such as the Portfolios through or with the assistance of
investment dealers who make a market in the Section 4(2) paper, thereby
providing liquidity. Certain transactions in Section 4(2) paper may qualify for
the registration exemption provided in Rule 144A under the Securities Act of
1933.
REPURCHASE AGREEMENTS. Each Portfolio may invest in repurchase agreements.
The repurchase price under the repurchase agreements described in the Prospectus
generally equals the price
<PAGE>
10
paid by a Portfolio involved plus interest negotiated on the basis of current
short-term rates (which may be more or less than the rate on securities
underlying the repurchase agreement). The financial institutions with which a
Portfolio may enter into repurchase agreements will be banks and non-bank
dealers of U.S. Government securities that are listed on the Federal Reserve
Bank of New York's list of reporting dealers, if such banks and non-bank dealers
are deemed creditworthy by the Adviser. The Adviser will continue to monitor
creditworthiness of the seller under a repurchase agreement, and will require
the seller to maintain during the term of the agreement the value of the
securities subject to the agreement at not less than the repurchase price
(including accrued interest). In addition, the Adviser will require that the
value of this collateral, after transaction costs (including loss of interest)
reasonably expected to be incurred on a default, be equal to or greater than the
repurchase price (including accrued premium provided in the repurchase
agreement). The accrued premium is the amount specified in the repurchase
agreement or the daily amortization of the difference between the purchase price
and the repurchase price specified in the repurchase agreement. The Adviser will
mark-to-market daily the value of the securities. Securities subject to
repurchase agreements will be held by the Portfolios' custodian (or sub-
custodian) in the Federal Reserve/Treasury book-entry system or by another
authorized securities depository. Repurchase agreements are considered to be
loans by the Portfolios under the 1940 Act.
The use of repurchase agreements involves certain risks. For example, if
the seller of securities under a repurchase agreement defaults on its obligation
to repurchase the underlying securities, as a result of its bankruptcy or
otherwise, the Portfolio will seek to dispose of such securities, which action
could involve costs or delays. If the seller becomes insolvent and subject to
liquidation or reorganization under applicable bankruptcy or other laws, a
Portfolio's ability to dispose of the underlying securities may be restricted.
Finally, it is possible that a Portfolio may not be able to substantiate its
interest in the underlying securities. To minimize this risk, the securities
underlying the repurchase agreement will be held by the custodian at all times
in an amount at least equal to the repurchase price, including accrued interest.
If the seller fails to repurchase the securities, a Portfolio may suffer a loss
to the extent proceeds from the sale of the underlying securities are less than
the repurchase price.
INVESTMENT GRADE DEBT OBLIGATIONS. The Portfolios invest in "investment
grade securities," which are securities rated in the four highest rating
categories of an NRSRO. It should be noted that debt obligations rated in the
lowest of the top four ratings (i.e., "Baa" by Moody's or "BBB" by S&P) are
considered to have some speculative characteristics and are more sensitive to
economic change than higher rated securities. See Appendix A to this Statement
of Additional Information for a description of
<PAGE>
11
applicable securities ratings.
BRADY BONDS. Each of the Portfolios may invest in Brady Bonds. Brady
Bonds are securities created through the exchange of existing commercial bank
loans to sovereign entities for new obligations in connection with debt
restructuring under a debt restructuring plan introduced by former U.S.
Secretary of the Treasury, Nicholas F. Brady. Brady Bonds may be collateralized
or uncollateralized, are issued in various currencies (but primarily the U.S.
dollar), and are actively traded in the over-the-counter secondary market.
Brady Bonds are not considered to be U.S. Government obligations. There can be
no assurance that Brady Bonds acquired by a Portfolio will not be subject to
restructuring arrangements or to requests for new credit, which may cause the
Portfolio to suffer a loss of interest or principal on any of its holdings.
WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS. The Portfolios may enter
into "when-issued" and "forward" commitments, including "TBA" (to be announced)
purchase commitments, to purchase or sell securities at a fixed price at a
future date. When a Portfolio agrees to purchase securities on a when-issued or
forward commitment basis, the custodian will set aside liquid assets equal to
the amount of the commitment in a separate account. Normally, the custodian
will set aside portfolio securities to satisfy a purchase commitment, and in
such a case the Portfolio may be required subsequently to place additional
assets in the separate account in order to ensure that the value of the account
remains equal to the amount of the Portfolio commitments. It may be expected
that the market value of the Portfolios' 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. A Portfolio's liquidity and ability
to manage its portfolio might be affected when it sets aside cash or portfolio
securities to cover such purchase commitments.
If deemed advisable as a matter of investment strategy, a Portfolio may
dispose of or renegotiate a commitment after it has been entered into, and may
sell securities it has committed to purchase before those securities are
delivered to the Portfolio on the settlement date. In these cases the Portfolio
may realize a taxable capital gain or loss.
When a Portfolio engages in when-issued, TBA and forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such party to do so may result in the Portfolio's incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a commitment to purchase
securities, and any subsequent fluctuations in their market value, is taken into
account when determining the market value of a Portfolio starting on the day the
Portfolio agrees to
<PAGE>
12
purchase the securities. The Portfolio does not earn interest on the securities
it has committed to purchase until they are paid for and delivered on the
settlement date.
OPTIONS. Options trading is a highly specialized activity which entails
greater than ordinary investment risks. Options on particular securities may be
more volatile than the underlying securities, and therefore, on a percentage
basis, an investment in the underlying securities themselves. A Portfolio will
write call options only if they are "covered." In the case of a call option on
a security, the option is "covered" if a Portfolio 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,
liquid assets in such amount are segregated by its custodian) upon conversion or
exchange of other securities held by it. For a call option on an index, the
option is covered if a Portfolio maintains with its custodian liquid assets
equal to the contract value. A call option is also covered if a Portfolio 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 Portfolio segregates liquid assets in the amount of the difference.
When a Portfolio purchases a put option, the premium paid by it is recorded
as an asset of the Portfolio. When a Portfolio writes an option, an amount
equal to the net premium (the premium less the commission) received by the
Portfolio is included in the liability section of the Portfolio's statement of
assets and liabilities as a deferred credit. The amount of this asset or
deferred credit will be subsequently marked-to-market to reflect the current
value of the option purchased or written. The current value of the traded
option is the last sale price or, in the absence of a sale, the mean between the
last bid and asked prices. If an option purchased by a Portfolio expires
unexercised the Portfolio realizes a loss equal to the premium paid. If the
Portfolio enters into a closing sale transaction on an option purchased by it,
the Portfolio will realize a gain if the premium received by the Portfolio on
the closing transaction is more than the premium paid to purchase the option, or
a loss if it is less. If an option written by a Portfolio expires on the
stipulated expiration date or if the Portfolio 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
deferred credit related to such option will be eliminated. If an option written
by a Portfolio is exercised, the proceeds of the sale will be increased by the
net premium originally received and the Portfolio will realize a gain or loss.
There are several risks associated with transactions in options on
securities and indexes. For example, there are significant differences between
the securities (or currencies)
<PAGE>
13
and options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. In addition,
a liquid secondary market for particular options, whether traded over-the-
counter or on a national securities exchange ("Exchange"), may be absent for
reasons which include the following: there may be insufficient trading interest
in certain options; restrictions may be imposed by an Exchange on opening
transactions or closing transactions or both; trading halts, suspensions or
other restrictions may be imposed with respect to particular classes or series
of options or underlying securities; unusual or unforeseen circumstances may
interrupt normal operations on an Exchange; the facilities of an Exchange or the
Options Clearing Corporation may not at all times be adequate to handle current
trading volume; or one or more Exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of options
(or a particular class or series of options), in which event the secondary
market on that Exchange (or in that class or series of options) would cease to
exist, although outstanding options that had been issued by the Options Clearing
Corporation as a result of trades on that Exchange would continue to be
exercisable in accordance with their terms.
FUTURES CONTRACTS AND RELATED OPTIONS. Each Portfolio may invest in
futures contracts and options thereon. These instruments are described in
Appendix B to this Statement of Additional Information.
SECURITIES LENDING. A Portfolio would continue to accrue interest on
loaned securities and would also earn income on investment collateral for such
loans. Any cash collateral received by a Portfolio in connection with such
loans may be invested in a broad range of high quality, U.S. dollar-denominated
money market instruments that meet Rule 2a-7 restrictions for money market
funds. Specifically, cash collateral may be invested in any of the following
instruments: (a) securities issued or guaranteed as to principal and interest by
the U.S. Government or by its agencies or instrumentalities and related
custodial receipts; (b) "first tier" quality commercial paper and other
obligations issued or guaranteed by U.S. and foreign corporations and other
issuers rated (at the time of purchase) in the highest rating category by at
least two NRSRO's, or one if only rated by one NRSRO; (c) U.S. dollar-
denominated obligations issued or supported by the credit of U.S. or foreign
banks or savings institutions with total assets in excess of $1 billion
(including obligations of foreign branches of such banks) (i.e. CD's, BA's and
time deposits); (d) repurchase agreements relating to the above instruments, as
well as corporate debt; and (e) unaffiliated money market funds. Any such
investments must be rated "first tier" and must have a maturity of 397 days or
less from the date of purchase.
YIELDS AND RATINGS. The yields on certain obligations are dependent on a
variety of factors, including general market
<PAGE>
14
conditions, conditions in the particular market for the obligation, the
financial condition of the issuer, the size of the offering, the maturity of the
obligation and the ratings of the issue. The ratings of Moody's, Duff & Phelps
Credit Co. ("Duff & Phelps"), Fitch Investor Services, Inc. ("Fitch") and S&P
represent their respective opinions as to the quality of the obligations they
undertake to rate. Ratings, however, are general and are not absolute standards
of quality. Consequently, obligations with the same rating, maturity and
interest rate may have different market prices. Subsequent to its purchase by a
Portfolio, a rated security may cease to be rated. The Adviser will consider
such an event in determining whether the Portfolio should continue to hold the
security.
INTEREST RATE TRANSACTIONS. The Portfolios may enter into interest rate
swaps, caps and floors on either an asset-based or liability-based basis,
depending on whether a Portfolio is hedging its assets or its liabilities.
Interest rate swaps involve the exchange by a Portfolio with another party of
their respective commitments to pay or receive interest (e.g., an exchange of
floating rate payments for fixed rate payments). The purchase of an interest
rate floor entitles the purchaser, to the extent that a specified index falls
below a predetermined interest rate, to receive payments of interest on a
notional principal amount from the party selling such interest rate floor. The
purchase of an interest rate cap entitles the purchaser, to the extent that a
specified index exceeds a predetermined interest rate, to receive payments of
interest on a notional principal amount from the party selling such interest
rate cap.
A Portfolio will usually enter into interest rate swaps on a net basis,
i.e., the two payments streams are netted out, with the Portfolio receiving or
paying, as the case may be, only the net amount of the two payments.
A Portfolio will accrue the net amount of the excess, if any, of its
obligations over its entitlements with respect to each interest rate swap on a
daily basis and will deliver an amount of liquid assets having an aggregate net
asset value at least equal to the accrued excess to a custodian that satisfies
the requirements of the 1940 Act. If the other party to an interest rate swap
defaults, a Portfolio's risk of loss consists of the net amount of interest
payments that the Portfolio is contractually entitled to receive. A Portfolio
may enter into transactions with counterparties which have received, combined
with any credit enhancements, a long-term debt rating of "A" by S&P or Moody's,
respectively, or that have an equivalent rating from an NRSRO or whose
obligations are determined to be of equivalent credit quality by the Adviser.
A Portfolio will enter into interest rate swap, cap and floor transactions
only with institutions deemed the creditworthy by the Adviser. If there is a
default by the other party to such a transaction, a Portfolio will have
contractual remedies
<PAGE>
15
pursuant to the agreements related to the transaction. The swap market has grown
substantially in recent years with a large number of banks and investment
banking firms acting both as principals and as agents utilizing standardized
swap documentation. As a result, the swap market has become relatively liquid.
Caps and floors are more recent innovations and, accordingly, they are less
liquid than swaps.
INVESTMENT COMPANIES. Each Portfolio currently intends to limit its
investments so that, as determined immediately after a securities purchase is
made: (i) not more than 5% of the value of its 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 Portfolio or by
the Fund as a whole.
INVESTMENT RESTRICTIONS
Each Portfolio is subject to the investment limitations enumerated in this
subsection which may be changed only by a vote of the holders of a majority of
the Portfolio's outstanding shares (as defined below under "Miscellaneous").
Each Portfolio may not:
(1) Purchase any securities which would cause 25% or more of the
value of the Portfolio's total assets at the time of purchase to
be invested in the securities of one or more issuers conducting
their principal business activities in the same industry,
provided that (a) there is no limitation with respect to (i)
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 (ii) repurchase agreements secured
by the instruments described in clause (i); (b) 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; (c) 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; and (d) securities issued or
guaranteed by foreign governments are not considered to belong to
a particular industry.
(2) Issue senior securities (including borrowed money, including on
margin if margin securities are
<PAGE>
16
owned) in excess of 33 1/3% of its total assets (including the
amount of senior securities issued but excluding any liabilities
and indebtedness not constituting senior securities) except that
the Portfolio may borrow up to an additional 5% of its total
assets for temporary purposes; or pledge its assets other than to
secure such issuances or in connection with hedging transactions,
short sales, when-issued and forward commitment transactions,
dollar rolls, option and futures transactions, currency
transactions and similar investment strategies. A Portfolio's
obligations under interest rate and currency swaps are not
treated as senior securities.
(3) Makes loans, except that each Portfolio may purchase and hold
debt instruments and enter into repurchase agreements in
accordance with its investment objective and policies and may
lend portfolio securities.
(4) Act as an underwriter of securities within the meaning of the
Securities Act of 1933 except to the extent that the purchase of
obligations directly from the issuer thereof, or the disposition
of securities, in accordance with the Portfolio's investment
objective, policies and limitations may be deemed to be
underwriting.
(5) Purchase or sell real estate, except that each Portfolio may
purchase securities of issuers which deal in real estate and may
purchase securities which are secured by interests in real
estate.
(6) Purchase or sell commodities except that each Portfolio may, to
the extent appropriate to its investment policies, purchase
securities of companies engaging in whole or in part in such
activities, may engage in currency transactions and may enter
into futures contracts and related options.
<PAGE>
17
TRUSTEES AND OFFICERS
THE FUND
The trustees and executive officers of the Fund, and their business
addresses and principal occupations during the past five years, are:
<TABLE>
<CAPTION>
Position Principal Occupation
Name and Address with Fund During Past Five Years
- ---------------- --------- ----------------------
<S> <C> <C>
William O. Albertini
Bell Atlantic Global Trustee Executive Vice President and Chief
Wireless Financial Officer since August
1717 Arch street 1997, Bell Atlantic Global
29th Floor East Wireless (global wireless
Philadelphia, PA 19103 communications); Executive Vice
Age: 55 President, Chief Financial Officer
and Director from February 1995 -
August 1997, Vice President and
Chief Financial Officer from
January 1991 - February 1995, Bell
Atlantic Corporation (a
diversified telecommunications
company); Director, Groupo
Iusacell, S.A. de C.V. (cellular
communications company) since June
1994; Director, American
Waterworks, Inc. (water utility)
since May 1990; Trustee, The Carl
E. & Emily I. Weller Foundation
since October 1991.
Raymond J. Clark/1/ Trustee, President Treasurer of Princeton University
Office of the Treasurer and Treasurer since 1987; Trustee, The Compass
Princeton University Capital Group of Funds from 1987
3 New South Building to 1996; Trustee, United-Way
P.O. Box 35 Princeton Area Communities from
Princeton, NJ 08540 1992-1994; Trustee, Chemical Bank,
New Jersey Advisory Board from
Age: 63 1994 until 1995; Trustee, Medical
Center of Princeton; Trustee,
American Red Cross - Mercer County
Chapter since 1995; and Trustee,
United Way-Greater Mercer County
from 1996-1997.
</TABLE>
- -------------------------------
/1/ This trustee may be deemed an "interested person" of the Fund as defined in
the 1940 Act.
<PAGE>
18
<TABLE>
<CAPTION>
Position Principal Occupation
Name and Address with Fund During Past Five Years
- ---------------- --------- ----------------------
<S> <C> <C>
Robert M. Hernandez
USX Corporation Trustee Director since 1991, Vice Chairman
600 Grant Street and Chief Financial Officer since
6105 USX Tower 1994, Executive Vice President -
Pittsburgh, PA 15219 Accounting & Finance and Chief
Age: 54 Financial Officer from 1991 to
1994, USX Corporation (a
diversified company principally
engaged in energy and steel
businesses); Director and Chairman
of the Executive Committee, ACE
Limited (insurance company);
Trustee, Allegheny University
Hospitals, Allegheny General; and
Allegheny Health, Education and
Research Foundation; Director,
Marinette Marine Corporation;
Director, Pittsburgh Baseball,
Inc. from 1994-1996; Director,
Transtar, Inc. (transportation
company) since 1996; and Director
and Chairman of the Board, RMI
Titanium Company.
Anthony M. Santomero Vice Chairman of the Deputy Dean from 1990 to 1994,
The Wharton School Board Richard K. Mellon Professor of
University of Pennsylvania Finance since April 1984,
Room 2344 Director, Wharton Financial
Steinberg Hall-Dietrich Hall Institutions Center, since July
Philadelphia, PA 19104-6367 1995, and Dean=s Advisory Council
Age: 52 Member since July 1984, The
Wharton School, University of
Pennsylvania; Associate Editor,
Journal of Banking and Finance
since June 1978; Associate Editor,
Journal of Economics and Business
since October 1979; Associate
Editor, Journal of Money, Credit
and Banking since January 1980;
Editorial Advisory Board, Open
Economics Review since November
1990; Director, the Zweig Total
Return Fund; Director of Municipal
Fund for California Investors,
Inc. and Municipal Fund for New
York Investors, Inc.
</TABLE>
<PAGE>
19
<TABLE>
<CAPTION>
Position Principal Occupation
Name and Address with Fund During Past Five Years
- ---------------- --------- ----------------------
<S> <C> <C>
David R. Wilmerding, Jr. Chairman of the Chairman, Gee, Wilmerding &
One Aldwyn Center Board Associates, Inc. (investment
Villanova, PA 19085 advisers) since February 1989;
Age: 63 Director, Beaver Management
Corporation (land management
company); Managing General
Partner, Chestnut Street Exchange
Fund; Director, Independence
Square Income Securities, Inc.;
Director, The Mutual Fire, Marine
and Inland Insurance Company;
Director, U.S. Retirement
Communities, Inc.; Director,
Trustee or Managing General
Partner of a number of investment
companies advised by PIMC and its
affiliates.
Karen H. Sabath Assistant Managing Director, BlackRock
BlackRock Advisors, Inc. Secretary Advisors, Inc. since February
345 Park Avenue 1998; President, Compass Capital
New York, NY 10154 Group, Inc. from 1995 to March
Age: 33 1998; Managing Director of
BlackRock Financial Management,
Inc. since 1993.
Ellen L. Corson Assistant Vice President and Director of
PFPC Inc. Treasurer Mutual Fund Accounting and
103 Bellevue Parkway Administration, PFPC Inc. since
Wilmington, DE 19809 November 1997; Assistant Vice
Age: 34 President, PFPC Inc. from March
1997 to November 1997; Senior
Accounting Officer, PFPC Inc. from
March 1993 to March 1997.
Brian P. Kindelan Secretary Vice President and Senior Counsel,
BlackRock Financial BlackRock Financial Management,
Management, Inc. Inc. since April 1998; Senior
1600 Market Street Counsel, PNC Bank Corp. from 1995
28th Floor to April 1998; Associate,
Philadelphia, PA 19103 Stradley, Ronon, Stevens & Young,
Age: 39 LLP from March 1990 to May 1995.
</TABLE>
The Fund pays trustees who are not affiliated with BlackRock, BlackRock
Advisors, Inc. ("BAI")or BlackRock Distributors, Inc. ("BDI" or "Distributor")
$20,000 annually ($30,000 annually in the event that the Fund's assets exceed
$40 billion) and $350 per investment portfolio of the Fund for each
<PAGE>
20
full in-person meeting of the Board that they attend. The Fund pays the Chairman
and Vice Chairman an additional $10,000 and $5,000, respectively, for their
services in such capacities. Trustees who are not affiliated with BlackRock or
the Distributor are reimbursed for any expenses incurred in attending meetings
of the Board of Trustees or any committee thereof. The term of office of each
trustee will automatically terminate when such trustee reaches 72 years of age.
No officer, director or employee of BlackRock, any of the Fund's other advisers
or sub-advisers, PFPC Inc. ("PFPC"), or PNC Bank, National Association ("PNC
Bank" or the "Custodian") currently receives any compensation from the Fund. As
of the date of this Statement of Additional Information, the trustees and
officers of the Fund, as a group, owned less than 1% of the outstanding shares
of each class of each investment portfolio of the Fund.
The table below sets forth the compensation actually received from the Fund
Complex of which the Fund is a part by the trustees for the fiscal year ended
September 30, 1998:
<TABLE>
<CAPTION>
Pension or Total
Retirement Compensation from
Benefits Estimated and Fund
Aggregate Accrued as Annual Complex/1/
Name of Person, Compensation Part of Fund Benefits upon Paid to
Position from Registrant Expenses Retirement Trustees
- -------- --------------- -------- ---------- --------
<S> <C> <C> <C> <C>
Anthony M. Santomero, $57,675 N/A N/A (3)/2/
Trustee ------- $70,175
David R. Wilmerding, $62,675 N/A N/A (3)/2/
Jr., Trustee ------- $76,675
William O. Albertini, $52,675 N/A N/A (1)/2/
Trustee ------- $52,675
Raymond J. Clark, $52,675 N/A N/A (1)/2/
Trustee ------- $52,675
Robert M. Hernandez, $52,675 N/A N/A (1)/2/
Trustee ------- $52,675
</TABLE>
- -------------------------
1. A Fund Complex means two or more investment companies that hold themselves
out to investors as related companies for purposes of investment and
investor services, or have a common investment adviser or have an
investment adviser that is an affiliated person of the investment adviser
of any of the other investment companies.
2. Total number of investment company boards trustees served on within the
Fund Complex.
<PAGE>
21
SHAREHOLDER AND TRUSTEE LIABILITY. Under Massachusetts law, shareholders
of a business trust may, under certain circumstances, be held personally liable
as partners for the obligations of the trust. However, the Fund's Declaration
of Trust provides that shareholders shall not be subject to any personal
liability in connection with the assets of the Fund for the acts or obligations
of the Fund, and that every note, bond, contract, order or other undertaking
made by the Fund shall contain a provision to the effect that the shareholders
are not personally liable thereunder. The Declaration of Trust provides for
indemnification out of the trust property of any shareholder held personally
liable solely by reason of his being or having been a shareholder and not
because of his acts or omissions or some other reason. The Declaration of Trust
also provides that the Fund shall, upon request, assume the defense of any claim
made against any shareholder for any act or obligation of the Fund, and shall
satisfy any judgment thereon.
The Declaration of Trust further provides that all persons having any claim
against the trustees or Fund shall look solely to the trust property for
payment; that no trustee of the Fund shall be personally liable for or on
account of any contract, debt, tort, claim, damage, judgment or decree arising
out of or connected with the administration or preservation of the trust
property or the conduct of any business of the Fund; and that no trustee shall
be personally liable to any person for any action or failure to act except by
reason of his own bad faith, willful misfeasance, gross negligence or reckless
disregard of his duties as a trustee. With the exception stated, the
Declaration of Trust provides that a trustee is entitled to be indemnified
against all liabilities and expenses reasonably incurred by him in connection
with the defense or disposition of any proceeding in which he may be involved or
with which he may be threatened by reason of his being or having been a trustee,
and that the Fund will indemnify officers, representatives and employees of the
Fund to the same extent that trustees are entitled to indemnification.
INVESTMENT ADVISORY, ADMINISTRATION,
DISTRIBUTION AND SERVICE ARRANGEMENTS
ADVISORY AGREEMENT. The advisory services provided by BlackRock, an
indirect majority-owned subsidiary of PNC Bank Corp., and the fees received by
it for such services are described in the Prospectus. As stated in the
Prospectus, BlackRock may from time to time voluntarily waive its advisory fees
with respect to the Portfolio and may voluntarily reimburse the Portfolio for
expenses.
BlackRock renders advisory services to the Portfolios pursuant to an
Investment Advisory Agreement (the "Advisory Contract"). Under the Advisory
Contract, BlackRock is not liable for any error of judgment or mistake of law or
for any loss suffered by the Fund or the Portfolios in connection with the
<PAGE>
22
performance of the Advisory Contract, except a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of BlackRock in the
performance of its duties or from reckless disregard of its duties and
obligations thereunder. The Advisory Contract is terminable as to a Portfolio
by vote of the Board of Trustees or by the holders of a majority of the
outstanding voting securities of the Portfolio involved, at any time without
penalty, on 60 days' written notice to BlackRock. BlackRock may also terminate
its advisory relationship with respect to either Portfolio on 60 days' written
notice to the Fund. The Advisory Contract terminates automatically in the event
of its assignment.
For the period from October 6, 1997 through September 30, 1998 BlackRock
Strategic Portfolio I paid no advisory fees to BlackRock, and BlackRock waived
$56,922 in expenses.
ADMINISTRATION AGREEMENT. The Fund has entered into an Administration
Agreement with BAI, whose principal business offices are located at 345 Park
Avenue, New York, New York 10154, and PFPC (the "Administration Agreement").
PFPC, whose principal business offices are located at 400 Bellevue Parkway,
Wilmington, DE 19809, has agreed to maintain office facilities for the Fund;
furnish the Fund with statistical and research data, clerical, accounting, and
bookkeeping services; provide and supervise the operation of an automated data
processing system to process purchase and redemption orders; provide information
and distribute written communications to shareholders; handle shareholder
problems and calls; research issues raised by financial intermediaries relating
to investments in a Portfolio's shares; review and provide advice with respect
to communications for a Portfolio's shares; monitor the investor programs that
are offered in connection with a Portfolio's shares; provide oversight and
related support services that are intended to ensure the delivery of quality
service to the holders of a Portfolio's shares; and provide certain other
services required by the Fund.
BAI is responsible for: the supervision and coordination of the performance
of the Fund's service providers; the negotiation of service contracts and
arrangements between the Fund and its service providers; acting as liaison
between the trustees of the Fund and the Fund's service providers; and providing
ongoing business management and support services in connection with the Fund's
operations. Pursuant to the terms of the Administration Agreement, BAI has
delegated certain of its duties thereunder to BDI.
As compensation for these services, BAI and PFPC (collectively, the
"Administrators") are entitled to receive a combined fee, computed daily and
payable monthly, at the maximum annual aggregate rate of .23% of the first $500
million of each Portfolio's average daily net assets, .21% of the next $500
million of each Portfolio's average daily net assets, and .19% of each
Portfolio's average daily net assets
<PAGE>
23
in excess of $1 billion. From time to time the Administrators may waive some or
all of their administration fees from a Portfolio and may voluntarily reimburse
a Portfolio for expenses.
The Administration Agreement provides that the Administrators will not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Fund or the Portfolios in connection with the performance of the
Administration Agreement, except a loss resulting from willful misfeasance, bad
faith or gross negligence in the performance of their respective duties or from
reckless disregard of their respective duties and obligations thereunder. In
addition, the Fund will indemnify each of BAI and PFPC and their affiliates
against any loss arising in connection with their provision of services under
the Administration Agreement, except that neither BAI nor PFPC nor their
affiliates shall be indemnified against any loss arising out of willful
misfeasance, bad faith, gross negligence or reckless disregard of their duties
under the Administration Agreement.
For the period from October 6, 1997 to September 30, 1998, BlackRock
Strategic Portfolio I paid $19,851 in administrative fees to the Administrators,
and the Administrators waived $41,136 in fees.
CUSTODIAN AND TRANSFER AGENCY AGREEMENTS. PNC Bank, whose principal
business address is 1600 Market Street, Philadelphia, Pennsylvania 19103, is
custodian of the Fund's assets pursuant to a custodian agreement (the "Custodian
Agreement"). Under the Custodian Agreement, PNC Bank or a sub-custodian (i)
maintains a separate account or accounts in the name of each Portfolio, (ii)
holds and transfers portfolio securities on account of each Portfolio, (iii)
accepts receipts and makes disbursements of money on behalf of each Portfolio,
(iv) collects and receives all income and other payments and distributions on
account of each Portfolio's securities and (v) makes periodic reports to the
Board of Trustees concerning each Portfolio's operations. PNC Bank is
authorized to select one or more banks or trust companies to serve as sub-
custodian on behalf of the Fund, provided that, with respect to sub-custodians
other than sub-custodians for foreign securities, PNC Bank remains responsible
for the performance of all its duties under the Custodian Agreement and holds
the Fund harmless from the acts and omissions of any sub-custodian. Citibank,
N.A. serves as the international sub-custodian for each of the Portfolios.
For its services to the Fund under the Custodian Agreement, PNC Bank is
entitled to receive a fee which is calculated based upon each Portfolio's
average gross assets, with a minimum monthly fee of $1,000 per investment
portfolio. PNC Bank is also entitled to out-of-pocket expenses and certain
transaction charges.
PFPC, an affiliate of PNC Bank, serves as the transfer and dividend
disbursing agent for the Fund pursuant to a Transfer
<PAGE>
24
Agency Agreement (the "Transfer Agency Agreement"), under which PFPC (i) issues
and redeems shares in each Portfolio, (ii) addresses and mails all
communications by each Portfolio to record owners of its shares, including
reports to shareholders, dividend and distribution notices and proxy materials
for its meetings of shareholders, (iii) maintains shareholder accounts and, if
requested, sub-accounts and (iv) makes periodic reports to the Board of Trustees
concerning the operations of each Portfolio. PFPC may, on 30 days' notice to the
Fund, assign its duties as transfer and dividend disbursing agent to any other
affiliate of PNC Bank Corp. For its services with respect to the Portfolios
under the Transfer Agency Agreement, PFPC is entitled to receive fees at the
annual rate of .03% of the average net asset value of outstanding shares in each
Portfolio, plus per account fees and disbursements.
DISTRIBUTOR. The Fund has entered into a distribution agreement with the
Distributor under which the Distributor, as agent, offers shares of the
Portfolios on a continuous basis. The Distributor has agreed to use appropriate
efforts to effect sales of the shares, but it is not obligated to sell any
particular amount of shares.
The Fund has adopted an Amended and Restated Distribution and Service Plan
(the "Plan") pursuant to Rule 12b-1 under the 1940 Act on behalf of its
Institutional Shares. The Plan was approved by a majority of (i) the trustees
of the Fund and (ii) the trustees of the Fund who are not interested persons of
the Fund and who have no direct or indirect financial interest in the operation
of the Plan or in any agreement related to the Plan (the "Rule 12b-1 Trustees").
The Fund is not required or permitted under the Plan to make distribution
payments with respect to its Institutional Shares. However, the Plan permits
BDI, BlackRock, the Administrators and other companies that receive fees from
the Fund to make payments relating to distribution and sales support activities
out of their past profits or other sources available to them. The Distributor,
BlackRock, and their affiliates may pay financial institutions, broker/dealers
and/or their salespersons certain compensation for the sale and distribution of
shares of the Fund or for services to the Fund. These payments ("Additional
Payments") may take the form of "due diligence" payments for a dealer's
examination of a Portfolio and payments for providing extra employee training
and information relating to a Portfolio; "listing" fees for the placement of a
Portfolio on a dealer's list of mutual funds available for purchase by its
customers; "finders" or "referral" fees for directing investors to the Fund;
"marketing support" fees for providing assistance in promoting the sale of the
Funds' shares; and payments for the sale of shares and/or the maintenance of
share balances. In addition, the Distributor, BAI and their affiliates may make
Additional Payments for subaccounting, administrative and/or shareholder
processing services. The Additional Payments made by the Distributor, BAI and
their affiliates may be a fixed
<PAGE>
25
dollar amount, may be based on the number of customer accounts maintained by a
financial institution or broker/dealer, or may be based on a percentage of the
value of shares sold to, or held by, customers of the financial institutions or
dealers involved, and may be different for different institutions and dealers.
Furthermore, the Distributor, BAI and their affiliates may contribute to various
non-cash and cash incentive arrangements to promote the sale of shares, and may
sponsor various contests and promotions subject to applicable NASD regulations
in which participants may receive prizes such as travel awards, merchandise and
cash. The Distributor, BAI and their affiliates may also pay for the travel
expenses, meals, lodging and entertainment of broker/dealers, financial
institutions and their salespersons in connection with educational and sales
promotional programs subject to applicable NASD regulations.
The Plan will continue from year to year, provided that each such
continuance is approved at least annually by a vote of the Board of Trustees,
including a majority vote of the Rule 12b-1 Trustees, cast in person at a
meeting called for the purpose of voting on such continuance. The Plan may be
terminated with respect to a Portfolio at any time, without penalty, by the vote
of a majority of the Rule 12b-1 Trustees or by a vote of the holders of a
majority of the outstanding shares of a Portfolio. The Plan may not be amended
materially without the approval of the Board of Trustees, including a majority
of the Rule 12b-1 Trustees, cast in person at a meeting called for that purpose.
Any modification to the Plan which would materially increase the costs borne by
a Portfolio for distribution purposes pursuant to the Plan must also be
submitted to the stockholders of a Portfolio for approval. In addition, while
the Plan remains in effect, the selection and nomination of the Fund's trustees
who are not "interested persons" of the Fund shall be committed to the
discretion of the Fund's non-interested trustees.
PORTFOLIO TRANSACTIONS
The Adviser is responsible for decisions to buy and sell securities for the
Portfolios, the selection of brokers and dealers to effect the transactions and
the negotiation of prices and any brokerage commissions. The securities in
which the Portfolios invest are traded principally in the over-the-counter
market. In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a mark-up
to the dealer. Securities purchased in underwritten offerings generally
include, in the price, a fixed amount of compensation for the manager(s),
underwriter(s) and dealer(s). The Portfolios may also purchase certain money
market instruments directly from an issuer, in which case no commissions or
discounts are paid. Purchases and sales of debt securities on a stock exchange
are effected through brokers who charge a commission for their services.
<PAGE>
26
The Adviser's primary considerations in selecting the manner of executing
securities transactions for the Portfolios will be prompt execution of orders,
the size and breadth of the market for the security, the reliability, integrity
and financial condition and execution capability of the firm, the size of and
difficulty in executing the order, and the best net price. There are many
instances when, in the judgment of the Adviser, more than one firm can offer
comparable execution services. In selecting among such firms, consideration is
given to those firms which supply research and other services in addition to
execution services. However, it is not the policy of the Adviser, absent
special circumstances, to pay higher commissions to a firm because it has
supplied such services.
The Adviser is able to fulfill its obligations to furnish a continuous
investment program to the Portfolios without receiving such information from
brokers; however, it considers access to such information to be an important
element of financial management. Although such information is considered
useful, its value is not determinable, as it must be reviewed and assimilated by
the Adviser, and does not reduce the Adviser's normal research activities in
rendering investment advice under the Advisory Contract. It is possible that
the Adviser's expenses could be materially increased if it attempted to purchase
this type of information or generate it through its own staff.
One or more of the other accounts which the Adviser manages may own from
time to time the same investments as the Portfolios. Investment decisions for
the Portfolios are made independently from those of such other accounts;
however, from time to time, the same investment decision may be made for more
than one company or account. When two or more companies or accounts seek to
purchase or sell the same securities, the securities actually purchased or sold
will be allocated among the companies and accounts on a good faith equitable
basis by the Adviser in its discretion in accordance with the accounts' various
investment objectives. In some cases, this system may adversely affect the
price or size of the position obtainable for the Portfolios. In other cases,
however, the ability of the Portfolios to participate in volume transactions may
produce better execution for the Portfolios.
It is expected that under normal market conditions the annual portfolio
turnover rate of the Portfolios will not exceed 400%, excluding securities
having a maturity of one year or less. Because it is difficult to predict
accurately portfolio turnover rate, actual turnover may be higher or lower.
Higher portfolio turnover results in increased Portfolio expenses, including
brokerage commissions, dealer mark-ups and other transaction costs on the sale
of securities and on reinvestment in other securities. The Adviser will monitor
the tax status of the Portfolios under the Internal Revenue Code during periods
in which the annual turnover rate of a Portfolio exceeds 100%.
A Portfolio will not purchase securities during the
<PAGE>
27
existence of any underwriting or selling group relating to such securities of
which BlackRock, the Administrators, the Distributor or any affiliated person
(as defined in the 1940 Act) thereof is a member except pursuant to procedures
adopted by the Board of Trustees in accordance with Rule 10f-3 under the 1940
Act. In no instance will portfolio securities be purchased from or sold to
BlackRock, the Administrators, the Distributor or any affiliated person of the
foregoing entities except as permitted by SEC exemptive order or by applicable
law.
The portfolio turnover rate of a Portfolio is calculated by dividing the
lesser of a Portfolio's annual sales or purchases of portfolio securities
(exclusive of purchases or sales of securities whose maturities at the time of
acquisition were one year or less) by the monthly average value of the
securities held by the Portfolio during the year.
For the period from October 6, 1997 to September 30, 1998, BlackRock
Strategic Portfolio I paid no brokerage commissions. For that period, BlackRock
Strategic Portfolio I had a portfolio turnover rate of 164%.
PURCHASE AND REDEMPTION INFORMATION
Shares of the Portfolios are sold at the net asset value per share next
determined after a purchase order is received. The Fund reserves the right, if
conditions exist which make cash payments undesirable, to honor any request for
redemption or repurchase of the Portfolios' shares by making payment in whole or
in part in securities chosen by the Fund and valued in the same way as they
would be valued for purposes of computing the Portfolios' net asset values. If
payment is made in securities, a shareholder may incur transaction costs in
converting these securities into cash. The Fund has elected, however, to be
governed by Rule 18f-1 under the 1940 Act so that each Portfolio is obligated to
redeem its shares solely in cash up to the lesser of $250,000 or 1% of its net
asset value during any 90-day period for any one shareholder of the Portfolios.
Under the 1940 Act, the Portfolios may suspend the right to redemption or
postpone the date of payment upon redemption for any period during which the New
York Stock Exchange (the "NYSE") is closed (other than customary weekend and
holiday closings), or during which trading on the NYSE is restricted, or during
which (as determined by the SEC by rule or regulation) an emergency exists as a
result of which disposal or valuation of portfolio securities is not reasonably
practicable, or for such other periods as the SEC may permit. (A Portfolio may
also suspend or postpone the recordation of the transfer of its shares upon the
occurrence of any of the foregoing conditions.)
In addition to the situations described in the Prospectus, the Fund may
redeem shares involuntarily to reimburse the
<PAGE>
28
Portfolios for any loss sustained by reason of the failure of a shareholder to
make full payment for shares purchased by the shareholder or to collect any
charge relating to a transaction effected for the benefit of a shareholder as
provided in the Prospectus from time to time. The Fund reserves the express
right to redeem shares of each Portfolio involuntarily at any time if the Fund's
Board of Trustees determines, in its sole discretion, that failure to do so may
have adverse consequences to the holders of shares in the Portfolio. Upon such
redemption the holders of shares so redeemed shall have no further right with
respect thereto other than to receive payment of the redemption price.
VALUATION OF PORTFOLIO SECURITIES
Valuation of securities held by each Portfolio is as follows: domestic
securities traded on a national securities exchange or on the NASDAQ National
Market System are valued at the last reported sale price that day; domestic
securities traded on a national securities exchange or on the NASDAQ National
Market System for which there were no sales on that day are valued at the mean
of the bid and asked prices; foreign securities traded on a recognized stock
exchange, whether U.S. or foreign, are valued at the latest sale price on that
exchange prior to the time when assets are valued or prior to the close of
regular trading hours on the NYSE (if a security is traded on more than one
exchange, the latest sale price on the exchange where the stock is primarily
traded is used); foreign securities traded on a recognized stock exchange for
which there were no sales on that day are valued at the mean of the bid and
asked prices; other securities are valued on the basis of valuations provided by
a pricing service approved by the Board of Trustees, provided that if the
Adviser concludes that the price provided by a pricing service does not
represent the fair value of a security, such security will be valued at fair
value determined by the Adviser based on quotations or the equivalent thereof
received from dealers; an option or futures contract is valued at the last sales
price prior to 4:00 p.m. (Eastern Time), as quoted on the principal exchange or
board of trade on which such option or futures contract is traded, or in the
absence of a sale, the mean between the last bid and asked prices prior to 4:00
p.m. (Eastern Time); the amortized cost method of valuation is used with respect
to debt obligations with sixty days or less remaining to maturity; and
securities for which market quotations are not readily available are valued at
fair market value as determined in good faith by or under the direction of the
Fund's Board of Trustees. Any securities which are denominated in a foreign
currency are translated into U.S. dollars at the prevailing market rates.
Certain of the securities acquired by the Portfolios may be traded on
foreign exchanges or over-the-counter markets on days on which the Portfolios'
net asset values are not calculated. In such cases, the net asset value of a
Portfolio's shares may be
<PAGE>
29
significantly affected on days when investors can neither purchase nor redeem
shares of the Portfolios.
In determining the approximate market value of portfolio investments,
pricing services used by the Fund may use, without limitation, a matrix or
formula method that takes into consideration market indexes, matrices, yield
curves and other specific adjustments. This may result in the securities being
valued at a price different from the price that would have been determined had
the matrix or formula method not been used. All cash, receivables and current
payables are carried on the Fund's books at their face value.
PERFORMANCE INFORMATION
TOTAL RETURN. For purposes of quoting and comparing the performance of
shares of the Portfolios to the performance of other mutual funds and to stock
or other relevant indexes in advertisements, sales literature, communications to
shareholders and other materials, performance may be stated in terms of total
return. Under the rules of the SEC, funds advertising performance must include
total return quotes calculated according to the following formula:
ERV
T = [(-----) to the first power divided by n - 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.
Total return, or "T" in the formula above, is computed by finding the
average annual compounded rates of return over the specified periods that would
equate the initial amount invested to the ending redeemable value.
<PAGE>
30
Based on the foregoing, the total return for BlackRock Strategic Portfolio I was
as follows:
--------------------------------
--------------------------------
AVERAGE ANNUAL TOTAL
--------------------
Return
------
FROM COMMENCEMENT
-----------------
OF OPERATIONS TO
----------------
9/30/98/1)/
----------
--------------------------------
10.84%
------
--------------------------------
(1) BlackRock Strategic Portfolio I commenced operations on October 6,
1997.
A Portfolio may also from time to time include in advertisements, sales
literature and communications to shareholders, and other materials a total
return figure that is not calculated according to the formula set forth above in
order to compare more accurately the performance of the Portfolio's shares with
other performance measures. For example, in comparing the total return of a
Portfolio's shares with data published by Lipper Analytical Services, Inc., CDA
Investment Technologies, Inc. or Weisenberger Investment Company Service, or
with the performance of the Salomon Broad Investment Grade Index, as
appropriate, a Portfolio may calculate the aggregate total return for its shares
for the period of time specified in the advertisement or communication by
assuming the investment of $10,000 in the Portfolio's shares and assuming the
reinvestment of each dividend or other distribution at net asset value on the
reinvestment date. Percentage increases are determined by subtracting the
initial value of the investment from the ending value and by dividing the
remainder by the beginning value.
In addition to average annual total returns, a Portfolio may quote
unaveraged or cumulative total returns reflecting the simple change in value of
an investment over a stated period. Average annual and cumulative total returns
may be quoted as a percentage or as a dollar amount, and may be calculated for a
single investment, a series of investments, or a series of redemptions, over any
time period. Total returns may be broken down into their components of income
and capital (including capital gains and changes in share price) in order to
illustrate the relationship of these factors and their contributions to total
return. Total returns may be quoted on a before-tax or after-tax basis. Total
returns, yields, and other performance information may be quoted numerically or
in a table, graph or similar illustration.
YIELD. Each Portfolio may advertise the yield on its shares. Under the
rules of the SEC, a Portfolio must calculate yield using the following formula:
<PAGE>
31
a-b
YIELD = 2[(----- +1) to the sixth power - 1]
cd
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 = the 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 each Portfolio is recognized by accruing 1/360th of the stated dividend rate
of the security each day that the security is in the Portfolio. Except as noted
below, interest earned on any debt obligations held by a Portfolio is calculated
by computing the yield to maturity of each obligation held by the Portfolio
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 obligation (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 held by 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.
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
Portfolio 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
<PAGE>
32
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. The amortization schedule will be adjusted monthly to reflect changes
in the market values of debt obligations.
Undeclared earned income will be subtracted from the maximum offering price
per share (variable "d" in the formula). Undeclared earned income is the net
investment income which, at the end of the base period, has not been declared as
a dividend, but is reasonably expected to be and is declared and paid as a
dividend shortly thereafter.
The yield of BlackRock Strategic Portfolio I for the 30-day period ended
September 30, 1998 was 4.76%
OTHER INFORMATION REGARDING INVESTMENT RETURNS. In addition to providing
performance information that demonstrates the total return or yield of shares of
a Portfolio over a specified period of time, the Fund may provide certain other
information demonstrating hypothetical investment returns. Such information may
include, but is not limited to, illustrating the compounding effects of a
dividend in a dividend reinvestment plan.
MISCELLANEOUS. Performance information for the Portfolios assumes the
reinvestment of dividends and distributions. Performance information may
reflect fee waivers that subsidize and reduce the total operating expenses of a
Portfolio. In these cases, the Portfolios' returns would be lower if there were
not such waivers.
Yield on shares of a Portfolio will fluctuate daily and does not provide a
basis for determining future yield. Because yield will fluctuate, it cannot be
compared with yields on savings accounts or other investment alternatives that
provide an agreed to or guaranteed fixed yield for a stated period of time. In
comparing the yield of one fund to another, consideration should be given to
each fund's investment policies, including the types of investments made,
lengths of maturities of the portfolio securities, and whether there are any
special account charges which may reduce the effective yield. The fees which
may be imposed by the Adviser on its customer accounts are not reflected in the
calculations of total returns or yields for the Portfolios.
As stated above, the Fund 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 an investment in
a Portfolio are reinvested by being paid in additional Portfolio shares, any
future income or capital appreciation of the Portfolio would increase the value,
not only of the original investment in the Portfolio, but also of the
<PAGE>
33
additional Portfolio shares received through reinvestment. The Fund may also
include discussions or illustrations of the potential investment goals of a
prospective investor, investment management techniques, policies or investment
suitability of a Portfolio, 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 shareholders may summarize the substance of information
contained in shareholder reports (including the investment composition of a
Portfolio), as well as the views of BlackRock as to current market, economy,
trade and interest rate trends, legislative, regulatory and monetary
developments, investment strategies and related matters believed to be of
relevance to a Portfolio. The Fund 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 Portfolio. In addition, advertisements or
shareholder communications may include a discussion of certain attributes or
benefits to be derived by an investment in a Portfolio. Such advertisements or
communications may include symbols, headlines or other material which highlight
or summarize the information discussed in more detail therein.
TAXES
The following is only a summary of certain additional tax considerations
generally affecting the Portfolios and their shareholders that are not described
in the Prospectus. No attempt is made to present a detailed explanation of the
tax treatment of the Portfolios or their shareholders, and the discussion here
and in the Prospectuses is not intended as a substitute for careful tax
planning. Investors may wish to consult their tax advisers with specific
reference to their own tax situation.
The Portfolios will each elect to be taxed as a regulated investment
company under Part I of Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code"). As a regulated investment company, each Portfolio
generally is exempt from Federal income tax on its net investment income (i.e.,
----
its investment company taxable income as that term is defined in the Code
without regard to the deduction for dividends paid) and net capital gain (i.e.,
----
the excess of its long-term capital gains over short-term capital losses) that
it distributes to shareholders, provided that it distributes at least 90% of its
net investment income (the "Distribution Requirement") and satisfies certain
other requirements of the Code that are described below. Distributions of net
investment income made during the taxable year or, under specified
circumstances, within twelve months after the close of the taxable year will
satisfy the
<PAGE>
34
Distribution Requirement.
In addition to satisfaction of the Distribution Requirement, each Portfolio
must derive at least 90% of its gross income from dividends, interest, certain
payments with respect to securities loans and gains from the sale or other
disposition of stock or securities or foreign currencies (including, but not
limited to, gains from forward foreign currency exchange contacts), or from
other income derived with respect to its business of investment in such stock,
securities, or currencies (the "Income Requirement").
In addition to the foregoing requirements, at the close of each quarter of
its taxable year, at least 50% of the value of each Portfolio's assets must
consist of cash and cash items, U.S. government securities, securities of other
regulated investment companies, and securities of other issuers (as to which the
Portfolio has not invested more than 5% of the value of its total assets in
securities of such issuer and as to which the Portfolio does not hold more than
10% of the outstanding voting securities of such issuer), and no more than 25%
of the value of the Portfolio's total assets may be invested in the securities
of any one issuer (other than U.S. Government securities and securities of other
regulated investment companies), or in two or more issuers which such Portfolio
controls and which are engaged in the same or similar trades or businesses.
Distributions of net investment income will be taxable to shareholders as
ordinary income, regardless of whether such distributions are paid in cash or
are reinvested in shares. Shareholders receiving any taxable distribution from
the Portfolio in the form of additional shares will be treated as receiving a
taxable distribution in an amount equal to the fair market value of the shares
received, determined as of the reinvestment date.
Each Portfolio intends to distribute to shareholders all of its net capital
gain for each taxable year. Such gain is distributed as a capital gain dividend
and is taxable to shareholders as long-term capital gain, regardless of the
length of time the shareholder has held his or her shares, whether such gain was
recognized by the Portfolio prior to the date on which a shareholder acquired
shares of the Portfolio and whether the distribution was paid in cash or
reinvested in shares.
It is expected that distributions from each of the Portfolios will
generally not qualify for the "dividends received" deduction for corporate
shareholders. In addition, it is expected that dividends and certain interest
income earned by the Portfolios from foreign securities will be subject to
foreign withholding taxes or other taxes. If more than 50% of the value of a
Portfolio's total assets at the close of the taxable year in question consists
of stock or
<PAGE>
35
securities of foreign corporations, the Portfolio may elect, for U.S. Federal
income tax purposes, to treat certain foreign taxes paid by it, including
generally any withholding taxes and other foreign income taxes, as paid by its
shareholders. If this election were made, the amount of such foreign taxes paid
by a Portfolio would be included in its shareholders' income pro rata (in
addition to taxable distributions actually received by them), and subject to
applicable limitations each shareholder generally would be entitled either (a)
to credit a proportionate amount of such taxes against U.S. Federal income tax
liabilities, or (b) if a shareholder itemizes deductions, to deduct such
proportionate amounts from U.S. income. It is uncertain whether either Portfolio
will meet the test stated above necessary to make this tax election. In certain
circumstances, a shareholder that (i) has held shares of a Portfolio for less
than a specified minimum period during which it is not protected from risk of
loss or (ii) is obligated to make payments related to the dividends, will not be
allowed a foreign tax credit for foreign taxes deemed imposed on dividends paid
on such shares. A Portfolio must also meet this holding period requirement with
respect to its foreign securities in order to flow through "creditable" taxes.
If a Portfolio purchases shares in a "passive foreign investment company"
(a "PFIC"), such Portfolio may be subject to U.S. federal income tax on a
portion of any "excess distribution" or gain from the disposition of such shares
even if such income is distributed as a taxable dividend by the Portfolio to its
shareholders. Additional charges in the nature of interest may be imposed on a
Portfolio in respect of deferred taxes arising from such distributions or gains.
If a Portfolio were to invest in a PFIC and elected to treat the PFIC as a
"qualified electing fund" under the Code (a "QEF"), in lieu of the foregoing
requirements, the Portfolio would be required to include in income each year a
portion of the ordinary earnings and net capital gain of the qualified electing
fund, even if not distributed to the Portfolio. Alternatively, a Portfolio can
elect to mark-to-market at the end of each taxable year its shares in a PFIC; in
this case, the Portfolio would recognize as ordinary income any increase in the
value of such shares, and as ordinary loss any decrease in such value to the
extent it did not exceed prior increases included in income. Under either
election, a Portfolio might be required to recognize in a year income in excess
of its distributions from PFICs and its proceeds from dispositions of PFIC stock
during that year, and such income would nevertheless be subject to the
Distribution Requirement and would be taken into account for purposes of the 4%
excise tax (described below).
Ordinary income of individuals will be taxable at a maximum marginal rate
of 39.6%, but because of limitations on itemized deductions otherwise allowable
and the phase-out of personal exemptions, the maximum effective marginal rate of
tax for some
<PAGE>
36
taxpayers may be higher. Long-term capital gains of individuals are taxed at a
maximum rate of 28%. Capital gains and ordinary income of corporate taxpayers
are both taxed at a maximum nominal rate of 35%. Investors should be aware that
any loss realized upon the sale, exchange or redemption of shares held for six
months or less will be treated as a long-term capital loss to the extent any
capital gain dividends have been paid with respect to such shares.
Each Portfolio may engage in hedging or derivatives transactions involving
foreign currencies, forward contracts, options and futures contracts (including
options, futures and forward contracts on foreign currencies) and short sales.
Such transactions will be subject to special provisions of the Code that, among
other things, may affect the character of gains and losses realized by the
Portfolio (that is, may affect whether gains or losses are ordinary or capital),
accelerate recognition of income of the Portfolio and defer recognition of
certain of the Portfolio's losses. These rules could therefore affect the
character, amount and timing of distributions to shareholders. In addition,
these provisions (1) will require a Portfolio to "mark-to-market" certain types
of positions in its portfolio (that is, treat them as if they were closed out)
and (2) may cause a Portfolio to recognize income without receiving cash with
which to pay dividends or make distributions in amounts necessary to satisfy the
Distribution Requirement and avoid the 4% excise tax (described below). Each
Portfolio intends to monitor its transactions, will make the appropriate tax
elections and will make the appropriate entries in its books and records when it
acquires any option, futures contract, forward contract or hedged investment in
order to mitigate the effect of these rules.
If for any taxable year a Portfolio does not qualify as a regulated
investment company, all of its taxable income will be subject to tax at regular
corporate rates without any deduction for distributions to shareholders, and all
distributions will be taxable as ordinary dividends to the extent of a
Portfolio's current and accumulated earnings and profits. Such distributions
will be eligible for the dividends received deduction in the case of corporate
shareholders.
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 Portfolios intend to make sufficient distributions or deemed
distributions of their ordinary taxable income and any capital gain net income
prior to the end of the each calendar year to avoid liability for this excise
tax.
A Portfolio will be required in certain cases to withhold and remit to the
United States Treasury 31% of dividends and gross sale
<PAGE>
37
proceeds paid to any shareholder (i) who has provided either an incorrect tax
identification number or no number at all, (ii) who is subject to backup
withholding by the Internal Revenue Service for failure to report the receipt of
interest or dividend income properly, or (iii) who has failed to certify to the
Fund that he is not subject to backup withholding or that he is an "exempt
recipient."
Shareholders will be advised annually as to the federal income tax
consequences of distributions made by a Portfolio each year.
The foregoing general discussion of federal income tax consequences is
based on the Code and the regulations issued thereunder as in effect on the date
of this Statement of Additional Information. Future legislative or
administrative changes or court decisions may significantly change the
conclusions expressed herein, and any such changes or decisions may have a
retroactive effect with respect to the transactions contemplated herein.
Although each Portfolio 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 its 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, a
Portfolio may be subject to the tax laws of such states or localities.
Shareholders should consult their tax advisors about state and local tax
consequences, which may differ from the federal income tax consequences
described above.
ADDITIONAL INFORMATION CONCERNING SHARES
Shares of the Fund have noncumulative voting rights and, accordingly, the
holders of more than 50% of the Fund's outstanding shares (irrespective of
Portfolio or class) may elect all of the trustees. Shares have no preemptive
rights and only such conversion and exchange rights as the Board may grant in
its discretion. When issued for payment as described in the Prospectus, shares
will be fully paid and non-assessable by the Fund.
There will normally be no meetings of shareholders for the purpose of
electing trustees unless and until such time as required by law. At that time,
the trustees then in office will call a shareholders meeting to elect trustees.
Except as set forth above, the trustees will continue to hold office and may
appoint successor trustees. The Fund's Declaration of Trust provides that
meetings of the shareholders of the Fund will be called by the trustees upon the
written request of shareholders owning at least 10% of the outstanding shares
entitled to vote.
<PAGE>
38
Rule 18f-2 under the 1940 Act provides that any matter required by the
provisions of the 1940 Act or applicable state law, or otherwise, to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Fund shall not be deemed to have been effectively acted upon
unless approved by the holders of a majority of the outstanding shares of each
investment portfolio affected by such matter. Rule 18f-2 further provides that
an investment portfolio shall be deemed to be affected by a matter unless the
interests of each investment portfolio in the matter are substantially identical
or the matter does not affect any interest of the investment portfolio. Under
the Rule, the approval of an investment advisory agreement, a distribution plan
subject to Rule 12b-1 under the 1940 Act or any change in a fundamental
investment policy would be effectively acted upon with respect to an investment
portfolio only if approved by a majority of the outstanding shares of such
investment 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 Trustees may be effectively acted
upon by shareholders of the Fund voting together in the aggregate without regard
to a particular investment portfolio.
The proceeds received by the Portfolios for each issue or sale of its
shares, and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to and constitute the underlying assets of that Portfolio. The underlying
assets of the Portfolios will be segregated on the books of account, and will be
charged with the liabilities in respect to that Portfolio and with a share of
the general liabilities of the Fund.
The Fund's Declaration of Trust authorizes the Board of Trustees, without
shareholder approval (unless otherwise required by applicable law), to: (i)
sell and convey the assets belonging to a class 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
class 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; (ii) sell and convert the
assets belonging to one or more classes of shares into money and, in connection
therewith, to cause all outstanding shares of such class to be redeemed at their
net asset value; or (iii) combine the assets belonging to a class of shares with
the assets belonging to one or more other classes of shares if the Board of
Trustees reasonably determines that such combination will not have a material
adverse effect on the shareholders of any class participating in such
combination and, in connection therewith, to cause all outstanding shares of any
such class to be redeemed or converted into shares of
<PAGE>
39
another class of shares at their net asset value. The Board of Trustees may
authorize the termination of any class of shares after the assets belonging to
such class have been distributed to its shareholders.
MISCELLANEOUS
Effective January 31, 1998, the Fund changed its name from Compass Capital
Funds(SM) to BlackRock Funds(SM).
COUNSEL. The law firm of Simpson Thacher & Bartlett, 425 Lexington Avenue,
New York, New York 10017, serves as the Fund's counsel.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, 2400 Eleven Penn
Center, Philadelphia, Pennsylvania 19103, serves as the Fund's independent
accountants.
SHAREHOLDER OWNERSHIP. The name, address and percentage ownership of each
person that on October 30, 1998 owned of record or beneficially 5% or more of
BlackRock Strategic Portfolio I is as follows: ARMCO Inc., C/O BlackRock
Financial Mgmt, 345 Park Avenue, 29th Floor, New York, NY, 10154, 7.97%;
Federated Dept. Stores, C/O BlackRock Financial Mgmt, 345 Park Avenue, 29th
Floor, New York, NY, 10154, 18.99%; Salaried Pension Plan, Ball Corporation, C/O
BlackRock Financial Mgmt, 345 Park Avenue, 29th Floor, New York, NY, 10154,
5.69%; Deere & Company, C/O BlackRock Financial Mgmt, 345 Park Avenue, 29th
Floor, New York, NY, 10154, 11.62%; Defined Contribution Union Camp, C/O
BlackRock Financial Mgmt, 345 Park Avenue, 29th Floor, New York, NY, 10154,
7.13%; Defined Benefit Union Camp, C/O BlackRock Financial Mgmt, 345 Park
Avenue, 29th Floor, New York, NY, 10154, 16.18%; McCune Charitable Foundation,
C/O BlackRock Financial Mgmt, 345 Park Avenue, 29th Floor, New York, NY, 10154,
5.37%; Alltel Fixed Income Portfolio (ATC), C/O BlackRock Financial Mgmt, 345
Park Avenue, 29th Floor, New York, NY, 10154, 8.63%.
On November 13, 1998, PNC Bank held of record approximately 72% of the
Fund's outstanding shares, and may be deemed a controlling person of the Fund
under the 1940 Act. PNC Bank is a national bank organized under the laws of the
United States. All of the capital stock of PNC Bank is owned by PNC Bancorp,
Inc. All of the capital stock of PNC Bancorp, Inc. is owned by PNC Bank Corp.,
a publicly-held bank holding company.
BANKING LAWS. Banking laws and regulations currently 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,
<PAGE>
40
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 such banking laws and
regulations do not prohibit such a holding company or affiliate or banks
generally from acting as investment adviser, administrator, transfer agent or
custodian to such an investment company, or from purchasing shares of such a
company as agent for and upon the order of customers. BlackRock, BAI, PFPC and
PNC Bank are subject to such banking laws and regulations.
BlackRock, BAI, PFPC and PNC Bank believe they may perform the services for
the Fund contemplated by their respective agreements with the Fund without
violation of applicable banking laws or regulations. It should be noted,
however, that there have been no cases deciding whether bank and non-bank
subsidiaries of a registered bank holding company may perform services
comparable to those that are to be performed by these companies, and future
changes in either Federal or state statutes and regulations relating to
permissible activities of banks and their subsidiaries or affiliates, as well as
further judicial or administrative decisions or interpretations of present and
future statutes and regulations, could prevent these companies from continuing
to perform such services for the Fund. If such were to occur, it is expected
that the Board of Trustees would recommend that the Fund enter into new
agreements or would consider the possible termination of the Fund. Any new
advisory agreement would be subject to shareholder approval.
SHAREHOLDER APPROVALS. As used in this Statement of Additional Information
and in the Prospectus, a "majority of the outstanding shares" means, with
respect to the approval of a Portfolio's investment advisory agreement or a
change in a fundamental investment limitation, the lesser of (1) 67% of the
shares of that Portfolio represented at a meeting at which the holders of more
than 50% of the outstanding shares of the Portfolio are present in person or by
proxy, or (2) more than 50% of the outstanding shares of that Portfolio.
FINANCIAL STATEMENTS
The audited financial statements for BlackRock Strategic Portfolio I
contained in its Annual Report to Shareholders for the period ended September
30, 1998 (the "1998 Annual Report") are incorporated by reference in this
Statement of Additional Information. No other parts of the 1998 Annual Report
are incorporated by reference herein. The financial statements included in the
1998 Annual Report have been audited by the Fund's independent accountants,
PricewaterhouseCoopers LLP. The report of PricewaterhouseCoopers LLP is
incorporated herein by reference. Such financial statements have been
incorporated herein in reliance upon such report given upon their
<PAGE>
41
authority as experts in accounting and auditing. Additional copies of the Annual
Report may be obtained at no charge by telephoning the Distributor at the
telephone number appearing on the front page of this Statement of Additional
Information.
<PAGE>
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 highest rating category 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+."
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 highest rating
category 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.
The highest rating category of Duff & Phelps for commercial paper and
short-term debt is "D-1". Duff & Phelps employs three designations, "D-1+," "D-
1" and "D-1-," within the highest rating category. The following summarizes the
highest 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.
A-1
<PAGE>
"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.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years. The
following summarizes the highest rating category 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+."
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one year or less which are issued by United
States commercial banks, thrifts and non-bank banks; non-United States banks;
and broker-dealers. The following summarizes the highest rating used by Thomson
BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
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
highest rating category used by IBCA for short-term debt ratings:
"A1+" - Obligations possess 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.
A-2
<PAGE>
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the "investment grade" 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.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "BBB" 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 absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the "investment grade" 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
A-3
<PAGE>
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.
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 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 rating may be revised
prior to delivery if changes occur in the legal documents or the underlying
credit quality of the bonds.
Note: Those bonds in the Aa, A and Baa groups which Moody's believes
possess the strongest investment attributes are designated by the symbols, Aa1,
A1 and Baa1.
The following summarizes the "investment grade" long-term debt ratings
used by Duff & Phelps for corporate and municipal long-term debt:
A-4
<PAGE>
"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 credit 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.
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 debt 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
A-5
<PAGE>
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.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "BBB" may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major rating
categories.
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
"investment grade" rating categories used by IBCA for long-term debt 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, such that 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.
IBCA may append a rating of plus (+) or minus (-) to a rating to
denote relative status within 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 "investment grade"
A-6
<PAGE>
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 extremely high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk compared
to 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.
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.
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 highest rating used by Standard & Poor's Ratings 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.
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 highest rating by Moody's Investors Service,
Inc. for short-term notes:
A-7
<PAGE>
"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.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
A-8
<PAGE>
APPENDIX B
As stated in the Prospectus, the Portfolios may enter into certain
futures transactions. Such transactions are described in this Appendix.
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, as an example, a Portfolio may use
interest rate futures contracts as a defense, or hedge, against anticipated
interest rate changes. 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.
A Portfolio could accomplish a similar result to that which it hopes
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 Portfolio, by using futures contracts.
Description of Interest Rate Futures Contracts. An interest rate
----------------------------------------------
futures contract sale would create an obligation by a Portfolio, 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 a Portfolio, 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
B-1
<PAGE>
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 a Portfolio
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
of the sale exceeds the price of the offsetting purchase, the Portfolio is
immediately paid the difference and thus realizes a gain. If the offsetting
purchase price exceeds the sale price, the Portfolio pays the difference and
realizes a loss. Similarly, the closing out of a futures contract purchase is
effected by the Portfolio entering into a futures contract sale. If the
offsetting sale price exceeds the purchase price, the Portfolio realizes a gain,
and if the purchase price exceeds the offsetting sale price, the Portfolio
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. 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 Portfolios may trade in any interest rate futures contracts for
which there exists a public market, including, without limitation, the foregoing
instruments.
With regard to each Portfolio, the Adviser also anticipates engaging
in transactions, from time to time, in foreign index futures such as the ALL-
ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the FTSE-100 (United
Kingdom).
II. Index Futures Contracts
-----------------------
A securities index assigns relative values to the securities included
in the index, which fluctuates with changes in the market values of the
securities included. Some index futures contracts are based on broad market
indexes, while other futures contracts are based on narrower market indexes
segment. As an example, a Portfolio might sell index futures contracts in order
to offset a decrease in market
B-2
<PAGE>
value of its portfolio securities that might otherwise result from a market
decline. A Portfolio might 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, a Portfolio might
purchase index futures contracts in anticipation of purchases of securities. A
long futures position may be terminated without a corresponding purchase of
securities.
In addition, a Portfolio might utilize index futures contracts in
anticipation of changes in the composition of its portfolio holdings.
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 (or another currency). Foreign currency futures may be used by a
Portfolio to hedge against exposure to fluctuations in exchange rates between
different currencies arising from multinational transactions, as well as for
other purposes as described in the Prospectus.
IV. Margin Payments
---------------
Unlike purchase or sales of portfolio securities, no price is paid or
received by a Portfolio upon the purchase or sale of a futures contract.
Initially, a Portfolio will be required to deposit with the broker or segregate
with a custodian an amount of liquid assets known as initial margin, based on
the value of the contract. 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
Portfolio 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 instruments 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 particular Portfolio 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
Portfolio will be entitled to receive from the broker a variation margin payment
equal to that increase in value. Conversely, where the Portfolio has purchased a
futures contract and the price of the future
B-3
<PAGE>
contract has declined in response to a decrease in the underlying instruments,
the position would be less valuable and the Portfolio would be required to make
a variation margin payment to the broker. Prior to expiration of the futures
contract, the 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 Portfolio'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 Portfolio, and the Portfolio 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
Portfolio. One risk arises because of the imperfect correlation between
movements in the price of the futures and movements in the price of any
instruments which are the subject of a hedge. The price of the futures may move
more than or less than the price of the instruments being hedged. If the price
of the futures moves less than the price of the instruments which are the
subject of the hedge, the hedge will not be fully effective but, if the price of
the instruments being hedged has moved in an unfavorable direction, the
Portfolio would be in a better position than if it had not hedged at all. If
the price of the instruments being hedged has moved in a favorable direction,
this advantage will be partially offset by the loss on the futures. If the
price of the futures moves more than the price of the hedged instruments, the
Portfolio involved will experience either a loss or gain on the futures which
will not be completely offset by movements in the price of the instruments which
are the subject of the hedge. To compensate for the imperfect correlation of
movements in the price of instruments being hedged and movements in the price of
futures contracts, a Portfolio may buy or sell futures contracts in a greater
dollar amount than the dollar amount of instruments being hedged if the
volatility over a particular time period of the prices of such instruments 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 Portfolio may
buy or sell fewer futures contracts if the volatility over a particular time
period of the prices of the instruments 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 Portfolio
has sold futures to hedge its portfolio against a decline in the market, the
market may advance and the value of instruments held in the Portfolio may
decline. If this occurred, the Portfolio would lose money on the futures and
also experience a decline in value in its portfolio securities.
B-4
<PAGE>
When futures are purchased to hedge against a possible increase in the
price of securities or a currency before a Portfolio is able to invest its cash
(or cash equivalents) in an orderly fashion, it is possible that the market may
decline instead; if the Portfolio then concludes not to invest its cash at that
time because of concern as to possible further market decline or for other
reasons, the Portfolio will realize a loss on the futures contract that is not
offset by a reduction in the price of the instruments that were to be purchased.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and any
instruments 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 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
Portfolios intend 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 Portfolio 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
B-5
<PAGE>
futures contract. However, as described above, there is no guarantee that
the price of the securities will in fact correlate with the price movements in
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 Portfolio is also subject to the
Adviser's ability to predict correctly movements in the direction of the market.
For example, if a particular Portfolio has hedged against the possibility of a
decline in the market adversely affecting securities held by it and securities
prices increase instead, the Portfolio 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 Portfolio 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
Portfolio may have to sell securities at a time when it may be disadvantageous
to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may result in losses in excess of the amount invested in the
B-6
<PAGE>
contract.
VI. Options on Futures Contracts
----------------------------
A Portfolio may purchase and write options on the futures contracts
described above. 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 Portfolio 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.
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 correspond to changes 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 underlying
securities or currencies, an option may or may not be less risky than ownership
of the futures contract or such securities or currencies. 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 Portfolio because the
maximum amount at risk is the premium paid for the options (plus transaction
costs). The writing of an option on a futures contract involves risks similar
to those risks relating to the sale of futures contracts.
VII. Other Matters
-------------
Accounting for futures contracts will be in accordance with generally
accepted accounting principles.
B-7
<PAGE>
BLACKROCK FUNDS(SM)
(INSTITUTIONAL SHARES OF THE
MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III)
CROSS REFERENCE SHEET
FORM N-1A ITEM PROSPECTUS
- -------------- Caption
----------
PART A
1. Cover page....................................... Cover Page
2. Synopsis......................................... Expense Table
3. Condensed Financial Information.................. Financial Highlights
4. General Description of Registrant................ Cover Page;
Investment Policies;
Description of Shares
5. Management of the Fund........................... Management
5A. Management's Discussion of Fund Performance...... Not Applicable
6. Capital Stock and Other Securities............... Cover Page; Dividends
and Distributions;
Description of Shares
7. Purchase of Securities Being Offered............. Purchase and Redemption
of Shares; Dividends and
Distributions Net Asset
Value
8. Redemption or Repurchase......................... Purchase and Redemption
of Shares - Redemption
of Shares
9. Pending Legal Proceedings........................ Not Applicable
<PAGE>
Item Number
Form N-1A, Statement of Additional
Part B Information Caption
- ------ -------------------
10 Cover Page
11 Table of Contents
12 Miscellaneous
13(a),(b),(c) Investment Objective and
Policies; Investment
Restrictions
13(d) Portfolio Transactions
14(a) Trustees And Officers
14(b) Trustees And Officers
14(c) Trustees And Officers
15(a) Miscellaneous
15(b) Miscellaneous
15(c) Trustees And Officers
16 Investment Advisory,
Administration,
Distribution and
Servicing Arrangements
17(a) Portfolio Transactions
17(b) Not Applicable
17(c) Portfolio Transactions
17(d) Not Applicable
17(e) Not Applicable
18(a) Additional Information
Concerning Shares
18(b) Not Applicable
19(a) Purchase And Redemption
Information
<PAGE>
Item Number
Form N-1A, Statement of Additional
Part B Information Caption
- ------ -------------------
19(b) Valuation Of Portfolio
Securities
19(c) Purchase And Redemption
Information
20 Taxes
21(a) Investment Advisory,
Administration,
Distribution And
Servicing Arrangements
21(b) Not Applicable
21(c) Not Applicable
22(a) Not Applicable
22(b) Performance Information
23 Financial Statements
Part C
- ------
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
THE MULTI-SECTOR MORTGAGE
SECURITIES PORTFOLIO III
BlackRock Funds(SM) (the "Fund") consists of 40 investment portfolios. This
Prospectus relates to shares ("Institutional Shares" or "Shares") representing
interests in the Multi-Sector Mortgage Securities Portfolio III (the
"Portfolio"). The Portfolio seeks to provide a total rate of return before fees
and expenses over rolling twelve-month periods that exceeds the total rate of
return of the Salomon Broad Investment Grade Index over the same periods by at
least 1.60% on an annualized basis. The securities in which the Portfolio may
invest include, but are not limited to, Commercial and Residential Mortgage-
Backed Securities, collateralized mortgage obligations, real estate mortgage
investment conduits, adjustable rate mortgages and U.S. Treasury and agency
securities. The Portfolio will maintain a dollar-weighted average credit quality
of at least BBB/Baa2, with U.S. Government securities being assigned a AAA
rating.
INVESTMENTS IN THE PORTFOLIO MAY INCLUDE SECURITIES HAVING A CREDIT QUALITY
BELOW INVESTMENT GRADE. SUCH SECURITIES, ALSO CALLED "JUNK BONDS," ARE
CONSIDERED TO BE SPECULATIVE AND MAY BE SUBJECT TO SPECIAL RISKS, INCLUDING A
GREATER RISK OF LOSS OF PRINCIPAL AND NON-PAYMENT OF INTEREST. SEE "DESCRIPTION
OF SECURITIES -- LOWER RATED SECURITIES" AND "RISK FACTORS".
Institutional Shares of the Portfolio are sold at net asset value to
institutional investors ("Institutions").
This Prospectus sets forth concisely information that a prospective
investor needs to know before investing. Please keep it for future reference.
A Statement of Additional Information ("SAI") currently dated November 25, 1998,
as revised from time to time, has been filed with the Securities and Exchange
Commission (the "SEC"). The current Statement of Additional Information may be
obtained free of charge from the Fund by calling (800) 422-6538. The Statement
of Additional Information, as it may be supplemented from time to time, is
incorporated by reference in this Prospectus. The SEC maintains a Web site
(http://www.sec.gov) that contains the Statement of Additional Information,
material incorporated by reference and other information regarding the Fund that
has been filed with the SEC.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY
<PAGE>
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
SHARES OF THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR
ENDORSED BY, PNC BANK, NATIONAL ASSOCIATION OR ANY OTHER BANK AND SHARES ARE NOT
INSURED BY, GUARANTEED BY, OBLIGATIONS OF OR OTHERWISE SUPPORTED BY THE U.S.
GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE
BOARD, OR ANY OTHER GOVERNMENTAL AGENCY. INVESTMENTS IN SHARES OF THE FUND
INVOLVE INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL AMOUNT
INVESTED.
PROSPECTUS November 25, 1998
2
<PAGE>
INTRODUCTION
- --------------------------------------------------------------------------------
The Fund is an open-end management investment company which currently
consists of 40 investment portfolios, of which only the Portfolio is described
in this Prospectus.
PORTFOLIO MANAGEMENT
BlackRock Financial Management, Inc. ("BlackRock" or the "Adviser") serves
as investment adviser to the Portfolio. The investment adviser is an indirect
majority-owned subsidiary of PNC Bank Corp.
THE ADMINISTRATORS
BlackRock Advisors, Inc. ("BAI") and PFPC Inc. ("PFPC") serve as the Fund's
administrators (collectively, the "Administrators").
THE DISTRIBUTOR
BlackRock Distributors, Inc. ("BDI" or the "Distributor") serves as the
Fund's distributor.
CERTAIN RISK FACTORS TO CONSIDER
An investment in the Portfolio is subject to certain investment
considerations, as set forth in detail under "Investment Policies." As with
other mutual funds, there can be no assurance that the Portfolio will achieve
its investment objective. The following are some of these considerations. The
Portfolio may invest in both Commercial Mortgage-Backed Securities and
Residential Mortgage-Backed Securities. The Portfolio may invest in lower
credit quality securities, which are commonly referred to as "junk bonds." The
Portfolio is classified as non-diversified under the Investment Company Act of
1940 (the "1940 Act"). The Portfolio (subject to limitations described herein)
may use various other investment management techniques that also involve special
considerations including purchasing illiquid securities, engaging in hedging
transactions, selling listed and over-the-counter covered call options, making
forward commitments, entering into repurchase agreements, purchasing securities
on a when-issued basis, entering into interest rate swaps and purchasing or
selling interest rate caps and floors. For further discussion of these
practices and the associated risks and special considerations, see "Description
of Securities," "Other Investment Practices" and "Risk Factors."
3
<PAGE>
EXPENSE TABLE
ANNUAL PORTFOLIO OPERATING EXPENSES (AS A PERCENTAGE OF AVERAGE NET ASSETS)
Advisory fees(a).....................................25%
Other expenses (after expense reimbursements)(b).....12%
----
Total Portfolio operating expenses(b) ...............37%
====
_______________
(a) BlackRock reserves the right in its sole discretion to reduce the
advisory fee charged to the Portfolio.
(b) BlackRock has agreed to cap the "Other expenses" for the Portfolio at
this level for the current fiscal year. Without fee waivers and
expense reimbursements, "Other expenses" would be .36% and "Total
Portfolio Operating expenses" would be .61%.
EXAMPLE
An investor in Institutional Shares would pay the following expenses on a
$1,000 investment in Shares of the Portfolio, assuming (1) 5% annual return, and
(2) redemption at the end of each time period:
ONE THREE FIVE TEN
YEAR YEARS YEARS YEARS
---- ----- ----- -----
Multi-Sector Mortgage Securities
Portfolio III................. $4 $12 $21 $47
The foregoing Expense Table and Example are intended to assist investors in
understanding the Portfolio's estimated annual operating expenses with respect
to Institutional Shares based on the level of such expenses during its most
recent fiscal year ended September 30, 1998. Investors bear these expenses
either directly or indirectly. See "Financial Highlights--Background,"
"Management," "Purchase and Redemption of Shares" and "Description of Shares"
for a more complete description of shareholder transaction expenses and
operating expenses. The Expense Table and Example do not reflect any charges
that may be imposed by Institutions directly on their customer accounts in
connection with investments in the Portfolio. In addition to the compensation
itemized above, certain broker-dealers and/or their salespersons may receive
certain compensation for the sale and distribution of shares or for services to
the Portfolio. For additional information regarding such compensation, see
"Investment Advisory, Administration, Distribution and Servicing Arrangements"
in the Statement of Additional Information.
THE EXAMPLE SHOWN ABOVE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR
FUTURE INVESTMENT RETURN OR OPERATING EXPENSES. ACTUAL INVESTMENT RETURN AND
OPERATING EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
4
<PAGE>
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
BACKGROUND
The Portfolio commenced investment operations on October 6, 1994 as a
separate investment portfolio (the "Predecessor Portfolio") of The BFM
Institutional Trust Inc., which was organized as a Maryland corporation. On
April 26, 1996, the assets and liabilities of the Predecessor Portfolio were
transferred to the Portfolio, which had no prior operating history. The
Predecessor Portfolio also received investment advisory services from BlackRock.
The following financial information has been derived from the financial
statements incorporated by reference into the Statement of Additional
Information and has been audited by the Portfolio's independent accountants,
PricewaterhouseCoopers LLP. Additional information about the performance of the
Portfolio is contained in the Portfolio's annual report. Both the Statement of
Additional Information and the Portfolio's annual report may be obtained from
the Fund free of charge by calling the number on the front cover of this
Prospectus. During the period shown, the Portfolio offered one class of shares
to institutional investors.
5
<PAGE>
<TABLE>
<CAPTION>
The Multi-Sector
Mortgage Securities
Portfolio III
------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
October 6,
Six Months Nine Months 1994(a)
Year Ended Year Ended Ended Ended Through
Sept. 30, Sept. 30, Sept 30, Mar 31, June 30,
1998 1997 1996 1996 1995
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period............................... $1,056.37 $ 1,016.08 $1,019.41 $ 1,068.11 $1,000.00
--------- ---------- --------- ---------- ---------
Net investment income (b)............ 74.41 73.74 38.33 61.37 55.81
----- ----- ----- ----- -----
Net realized and unrealized gain (loss) on
investments..................................... 15.26 49.82 (3.33) (9.06) 68.11
--------- ---------- --------- ---------- ---------
Net increase from investment operations......... 89.67 123.56 35.00 52.31 123.92
--------- ---------- --------- ---------- ---------
Dividends from net investment income............ (74.41) (73.74) (38.33) (61.37) (55.81)
--------- ---------- --------- ---------- ---------
Distributions from net realized
capital gains........................ (15.26) (9.53) --- (39.64) ---
--------- ---------- --------- ---------- ---------
Total dividends and distributions............... (89.67) (83.27) (38.33) (101.01) (55.81)
--------- ---------- --------- ---------- ---------
Net asset value, end of period ................. $1,056.37 $ 1,056.37 $1,016.08 $ 1,019.41 $1,068.11
--------- ---------- --------- ---------- ---------
TOTAL INVESTMENT RETURN (c)
RATIOS TO AVERAGE NET ASSETS:................... 9.06% 12.67% 3.53% 5.02% 12.78%
----- ------ ----- ----- ------
Expenses (b)(d)................................. 0.37% 0.37% 0.37% 0.37% 0.37%
----- ------ ----- ----- ------
Net investment income (b)(d).................... 7.28% 7.13% 7.60% 7.77% 7.54%
----- ------ ----- ----- ------
SUPPLEMENTAL DATA:
Average net assets (in thousands)............... $78,512 $129,382 $119,550 $115,362 $103,332
--------- ---------- --------- ---------- ---------
Portfolio turnover.............................. 11% 52% 24% 119% 215%
--- --- --- ---- ----
Net assets, end of period (in thousands)........ $46,600.00 $121,251.00 $121,738.00 $117,569.00 $112,810.00
---------- ----------- ----------- ----------- -----------
</TABLE>
(a) Commencement of investment operations.
(b) The Adviser waived fees amounting to $21,516, $45,000, $85,659,
$3,652 and $56,269 for the periods ended September 30, 1998,
September 30, 1997, September 30, 1996, March 31, 1996 and June 30,
1995, respectively. Net investment income would have been $72.00,
$70.58, $37.38, $61.37 and $55.28 on a per share basis for the
periods ended September 30, 1998, September 30, 1997, September 30,
1996, March 31, 1996 and June 30, 1995, respectively, in the absence
of fee waivers. The ratio of net operating expenses to average net
assets would have been .61%, .62%, 0.51%, 0.37% and 0.45% for the
periods ended September 30, 1998, September 30, 1997,
6
<PAGE>
September 30, 1996, March 31, 1996 and June 30, 1995, respectively, in the
absence of fee waivers. The net investment income ratios would have been
7.04%, 6.88%, 7.45%, 7.76% and 7.46%, for the periods ended September 30,
1998, September 30, 1997, September 30, 1996, March 31, 1996 and June 30,
1995, respectively, in the absence of fee waivers.
(c) Total investment return is calculated assuming a purchase of common stock
at net asset value per share on the first day and a sale at net asset value
per share on the last day of the period reported. Dividends are assumed,
for purposes of this calculation, to be reinvested at the net asset value
per share on the payment date.
(d) Annualized.
The information above represents audited operating performance based on an
average share of common stock outstanding, total investment return, ratios
to average net assets and other supplemental data, for each of the periods
indicated. This information has been determined based upon financial
information provided in the financial statements.
7
<PAGE>
INVESTMENT POLICIES
- --------------------------------------------------------------------------------
The following describes briefly the investment objective and policies of
the Portfolio. Certain instruments and techniques discussed in this section are
described in greater detail later in this Prospectus and in the Statement of
Additional Information ("SAI").
INVESTMENT OBJECTIVE
The Portfolio's investment objective is to seek to provide a total rate of
return before fees and expenses over rolling twelve-month periods that exceeds
the total return of the Salomon Broad Investment Grade Index over the same
periods by at least 1.60% on an annualized basis. The Portfolio will not invest
in Asset-Backed Securities, bank or corporate debt securities other than money
market instruments, or non-rated securities (other than U.S. Government
securities), and will maintain a dollar-weighted average credit quality of at
least BBB by Standard & Poor's Ratings Group, Division of McGraw Hill ("S&P"),
Duff & Phelps Inc. ("D&P") or Fitch Investors Service ("Fitch") or Baa2 by
Moody's Investors Service, Inc. ("Moody's"), with U.S. Government securities
being assigned a AAA rating. The Portfolio will maintain a targeted duration
within 20% shorter or longer than the then current duration of the Salomon Broad
Investment Grade Index. Duration is a measure of the expected life of a fixed
income security on a present value basis and is indicative of a security's price
"volatility" or "risk" associated with changes in interest rates. The Portfolio
seeks to meet its objective by investing in a range of agency and non-agency
Mortgage-Backed Securities, including primarily senior and subordinated tranches
of residential, commercial, multi-family and agricultural mortgage securities.
The securities in which the Portfolio may invest include, but are not limited
to, collateralized mortgage obligations, real estate mortgage investment
conduits, adjustable rate mortgages and U.S. Treasury and agency securities.
The Portfolio will limit to 20% of net assets its investments in U.S. Government
securities that are not also Mortgage-Backed Securities. The Portfolio may
invest in lower rated securities. Such securities are commonly referred to as
"junk bonds" and have a higher risk of default of principal and interest.
During temporary defensive periods and in order to keep cash on hand fully
invested, the Portfolio may invest in money market instruments.
In determining which Mortgage-Backed Securities the Portfolio will
purchase, the Adviser will consider, among other
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factors, the following: characteristics of the underlying mortgage loan,
including LTV and debt service coverage ratio, loan seasoning, and refinancing
risk; characteristics of the underlying property, including diversity of the
loan pool, occupancy and leasing, and competitiveness in the pertinent market;
economic, environmental and local considerations; deal structure, including
historical performance of the originator, subordination percentages and reserve
fund balances; and structural participants such as administrators and servicers.
In addition to examining the relative value of the investments, the
Adviser's disciplined approach to investments for the Portfolio will include
considerable interaction with rating agencies, extensive review of due diligence
by underwriters and rating agencies, confirmation of debt service coverage
ratios and stress testing of security cash flows. The Adviser also will select
investments which will vary the Portfolio by underlying property types,
geographic regions and industry exposure. In this regard, the Portfolio will
not purchase any Commercial Mortgage-Backed Security ("CMBS") if, giving effect
thereto, (i) the net assets of the Portfolio constituting CMBS that are directly
or indirectly secured by or payable out of cash flow from the same pool of
collateral would increase and would account for more than 10% of the Portfolio's
net assets, or (ii) the net assets of the Portfolio attributable to CMBS backed
by the same pool of collateral would increase and the Portfolio would own more
than 25% of the currently outstanding principal amount of CMBS that are directly
or indirectly secured by or payable out of cash flow from the same pool of
collateral. In addition, the Portfolio will not, except during any three-month
period after any month in which its net assets have increased by more than 30%,
purchase any CMBS if, giving effect thereto, (i) the net assets of the Portfolio
constituting CMBS that are directly or indirectly secured by or payable out of
cash flow from properties located within a single state of the U.S. would
increase and would account for more than 25% of the Portfolio's net assets or
(ii) the net assets of the Portfolio constituting CMBS that are directly or
indirectly secured by or payable out of cash flow from office properties would
increase and would account for more than 33%, or from hotel and motel properties
would increase and would account for more than 20%, or from any one of multi-
family, cooperative, industrial and warehouse, retail and shopping mall, mobile
home park, nursing home and senior living center or hospital properties would
increase and would account for more than 75% of the Portfolio's net assets, or
(iii) the net assets of the Portfolio constituting particular issuances of CMBS
that are directly or indirectly secured by or payable out of cash flow from
single properties would increase and would account for more than 50% of the
Portfolio's net assets. For the foregoing purpose, a CMBS will be considered to
be secured by or payable
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out of the cash flow from a property only in the proportion that the outstanding
principal amount of the mortgage loan relating to such property and backing such
security bears to the sum of the outstanding principal amount of all mortgage
loans backing such security. If the Portfolio's asset composition in any of the
foregoing categories subsequently exceeds 110% of the related percentage
limitation for any reason, the Portfolio will take such action as may be
necessary so that within 60 days after the occurrence of such excess the
relevant percentage limitation is again satisfied. The Portfolio will not invest
in any issuance of Mortgage-Backed Securities more than 5% of the principal
amount of the collateral of which at the time of issuance is single-family
residential and agricultural properties in the aggregate.
INVESTMENT RESTRICTIONS
The Portfolio has also adopted a number of fundamental investment
restrictions which may not be changed without the approval of the Portfolio's
outstanding voting securities. The SAI sets forth these restrictions in full.
In addition, the Portfolio's investment objective is fundamental and may not be
changed without such shareholder approval.
The Portfolio has also adopted several non-fundamental portfolio investment
limitations. The Portfolio will not modify any of its non-fundamental portfolio
investment limitations without providing at least 60 days prior written notice
of such modification to its shareholders.
DESCRIPTION OF SECURITIES
The following describes certain types of securities in which the Portfolio
may invest:
COMMERCIAL MORTGAGE-BACKED SECURITIES
Commercial Mortgage-Backed Securities are generally multi-class debt or
pass-through securities backed by a mortgage loan or pool of mortgage loans
secured by commercial property, such as industrial and warehouse properties,
office buildings, retail space and shopping malls, multi-family properties and
cooperative apartments, hotels and motels, nursing homes, hospitals, senior
living centers and agricultural property. The commercial mortgage loans that
underlie Commercial Mortgage-Backed Securities have certain distinct
characteristics. Commercial mortgage loans are generally not amortizing or not
fully amortizing. At their maturity date, repayment of the remaining principal
balance or "balloon" is due and is repaid through the attainment of an
additional loan or sale of the property. Unlike most single family residential
mortgages,
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commercial real property loans often contain provisions which substantially
reduce the likelihood that such securities will be prepaid. The provisions
generally impose significant prepayment penalties on loans and, in some cases,
there may be prohibitions on principal prepayments for several years following
origination. This difference in prepayment exposure is significant due to
extraordinarily high levels of refinancing of traditional residential mortgages
experienced over the past years as mortgage rates reached 25 year lows. Assets
underlying Commercial Mortgage-Backed Securities may relate to only a few
properties or to a single property. See "Risk Factors."
Commercial Mortgage-Backed Securities have been issued in public and
private transactions by a variety of public and private issuers. Non-
governmental entities that have issued or sponsored Commercial Mortgage-Backed
Securities offerings include owners of commercial properties, originators of and
investors in mortgage loans, savings and loan associations, mortgage banks,
commercial banks, insurance companies, investment banks and special purpose
subsidiaries of the foregoing. The Portfolio may from time to time purchase
Commercial Mortgage-Backed Securities directly from issuers in negotiated
transactions or from a holder of such Commercial Mortgage-Backed Securities in
the secondary market.
Commercial Mortgage-Backed Securities generally are structured to protect
the senior class investors against potential losses on the underlying mortgage
loans. This is generally provided by the subordinated class investors, which
may be included in the Portfolio, by taking the first loss if there are defaults
on the underlying commercial mortgage loans. Other protection, which may
benefit all of the classes, including the subordinated classes in which the
Portfolio intends to invest, may include issuer guarantees, reserve funds,
additional subordinated securities, cross-collateralization, over-
collateralization and the equity investors in the underlying properties.
By adjusting the priority of interest and principal payments on each class
of a given Commercial Mortgage-Backed Security, issuers are able to issue senior
investment grade securities and lower rated or non-rated subordinated securities
tailored to meet the needs of sophisticated institutional investors. In
general, subordinated classes of Commercial Mortgage-Backed Securities are
entitled to receive repayment of principal only after all required principal
payments have been made to more senior classes and have subordinate rights as to
receipt of interest distributions. Such subordinated classes are subject to a
substantially greater risk of nonpayment than are senior classes of Commercial
Mortgage-Backed Securities. Even within a class of subordinate securities, most
Commercial Mortgage-Backed
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Securities are structured with a hierarchy of levels (or "loss positions"). Loss
positions are the order in which non-recoverable losses of principal are applied
to the securities within a given structure. For instance, a first loss
subordinate security will absorb any principal losses before any higher loss
position subordinate security. This type of structure allows a number of classes
of securities to be created with varying degrees of credit exposure, prepayment
exposure and potential total return.
Subordinated classes of Commercial Mortgage-Backed Securities have more
recently been structured to meet specific investor preferences and issuer
constraints and have different priorities for cash flow and loss absorption. As
previously discussed, from a credit perspective, they are structured to absorb
any credit-related losses prior to the senior class. The principal cash flow
characteristics of subordinated classes are designed to be among the most stable
in the Mortgage-Backed Securities market, the probability of prepayment being
much lower than with traditional Residential Mortgage-Backed Securities. This
characteristic is primarily due to the structural feature that directs the
application of principal payments first to the senior classes until they are
retired before the subordinated classes receive any prepayments. While this
serves to enhance the credit protection of the senior classes, it produces
subordinated classes with more stable average lives. Subject to the applicable
provisions of the 1940 Act, there are no limitations on the classes of
Commercial Mortgage-Backed Securities in which the Portfolio may invest.
Accordingly, in certain circumstances, the Portfolio may recover proportionally
less of its investment in a Commercial Mortgage-Backed Security than the holders
of more senior classes of the same Commercial Mortgage-Backed Security.
The rating assigned to a given issue and class of Commercial Mortgage-
Backed Securities is a product of many factors, including the structure of the
security, the level of subordination, the quality and adequacy of the
collateral, and the past performance of the originators and servicing companies.
The rating of any Commercial Mortgage-Backed Security is determined to a
substantial degree by the debt service coverage ratio (i.e., the ratio of
current net operating income from the commercial properties, in the aggregate,
to the current debt service obligations on the properties) and the LTV ratio of
the pooled properties. The amount of the securities issued in any one rating
category is determined by the rating agencies after a rigorous credit rating
process which includes analysis of the issuer, servicer and property manager, as
well as verification of the LTV and debt service coverage ratios. LTV ratios
may be particularly important in the case of commercial mortgages because most
commercial mortgage loans provide that the lender's
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sole remedy in the event of a default is against the mortgaged property, and the
lender is not permitted to pursue remedies with respect to other assets of the
borrower. Accordingly, loan-to-value ratios may, in certain circumstances,
determine the amount realized by the holder of the Commercial Mortgaged-Backed
Security.
RESIDENTIAL MORTGAGE-BACKED SECURITIES
The Portfolio also expects to invest in Residential Mortgage-Backed
Securities that are Mortgage-Backed Securities representing participation
interests in pools of single-family residential mortgage loans originated by
private mortgage originators. Traditionally, Residential Mortgage-Backed
Securities were issued by governmental agencies such as Fannie Mae, Freddie Mac
and Ginnie Mae. The Portfolio intends to invest in those securities issued by
nongovernmental agencies as well as governmental agencies. Nongovernmental
entities that have issued or sponsored Residential Mortgage-Backed Securities
offerings include savings and loan associations, mortgage banks, insurance
companies, investment banks and special purpose subsidiaries of the foregoing.
Residential Mortgage-Backed Securities, similar to Commercial Mortgage-Backed
Securities, have been issued using a variety of structures, including multi-
class structures featuring senior and subordinated classes.
While single-family residential loans do not typically have prepayment
penalties or restrictions, as commercial mortgage loans often do, Residential
Mortgage-Backed Securities are often structured so that subordinated classes may
be locked out of prepayments for a period of time. However, in a period of
extremely rapid prepayments, during which senior classes may be retired faster
than expected, the subordinated classes may receive unscheduled payments of
principal and would have average lives that, while longer than the average lives
of the senior classes, would be shorter than originally expected.
The types of agency and non-agency Commercial and Residential Mortgage-
Backed Securities in which the Portfolio may invest shall include, but not be
limited to, the following securities:
MORTGAGE-RELATED SECURITIES ISSUED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES. The Portfolio may invest in Mortgage-Backed Securities
issued by agencies or instrumentalities of the U.S. Government including GNMA,
FNMA and FHLMC. The U.S. Government or the issuing agency guarantees the
payment of interest and principal on these securities. However, the guarantees
do not extend to the securities' yield or value, nor do the guarantees extend to
the yield or value of the Portfolio's shares. These securities are in most
cases
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"pass-through" instruments, through which the holder receives a share of
all interest and principal payments from the mortgages underlying the security,
net of certain fees. See "Mortgage-Backed Securities" in the SAI.
PRIVATE MORTGAGE PASS-THROUGH SECURITIES. Private mortgage pass-through
securities are structured similarly to GNMA, FNMA and FHLMC mortgage pass-
through securities and are issued by originators of and investors in mortgage
loans, including depository institutions, mortgage banks, investment banks and
special purpose subsidiaries of the foregoing. These securities usually are
backed either by GNMA, FNMA or FHLMC certificates or by a pool of fixed rate or
adjustable rate mortgage loans. Securities which are backed by a pool of fixed
rate or adjustable rate mortgage loans generally are structured with one or more
types of credit enhancement. See "Types of Credit Enhancement" in the SAI.
ADJUSTABLE RATE MORTGAGE SECURITIES. Adjustable rate mortgage securities
are pass-through mortgage securities collateralized by mortgages with adjustable
rather than fixed rates ("ARMs"). ARMs eligible for inclusion in a mortgage
pool generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index. See "Adjustable Rate Mortgage
Securities" in the SAI.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS PASS-THROUGH
SECURITIES. Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities.
Typically, CMOs are collateralized by GNMA, FNMA or FHLMC certificates, but also
may be collateralized by whole loans or private mortgage pass-through securities
(collectively, "Mortgage Assets"). Multi-class pass-through securities are
equity interests in a trust composed of Mortgage Assets. Unless the context
indicates otherwise, all references herein to CMOs include multi-class pass-
through certificates. Payments of principal of and interest on the Mortgage
Assets, and any reinvestment income thereon, provide the funds to pay debt
service on the CMOs or make scheduled distributions on the multi-class pass-
through securities. CMOs may be issued by agencies or instrumentalities of the
U.S. Government, or by private originators of, or investors in, mortgage loans,
including depository institutions, mortgage banks, investment banks and special
purpose subsidiaries of the foregoing. The issuer of CMOs or multi-class pass-
through securities may elect to be treated as a Real Estate Mortgage Investment
Conduit ("REMIC"). See "Collateralized Mortgage Obligations and Multi-Class
Pass-Through Securities" in the SAI.
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MISCELLANEOUS. The Portfolio may from time to time purchase in the
secondary market certain mortgage pass-through securities packaged and master
serviced by PNC Mortgage Securities Corp. ("PNC Mortgage"), or Midland Loan
Services, Inc. ("Midland") (or Sears Mortgage if PNC Mortgage succeeded to
rights and duties of Sears Mortgage) or mortgage-related securities containing
loans or mortgages originated by PNC Bank, National Association ("PNC Bank") or
its affiliates. It is possible that under some circumstances, PNC Mortgage,
Midland or their affiliates could have interests that are in conflict with the
holders of these mortgage-backed securities, and such holders could have rights
against PNC Mortgage; Midland or their affiliates.
LOWER RATED SECURITIES. The Mortgage-Backed Securities in which the
Portfolio may invest may be lower rated (i.e., have a credit quality below
investment grade) subordinated classes. Investments in such lower rated
securities are subject to special risks, including a greater risk of loss of
principal and non-payment of interest. An investor should carefully consider
the following factors before purchasing shares of the Portfolio. The Portfolio
(i) will not invest in securities (other than U.S. Government securities) that
are not rated at least B by S&P, D&P or Fitch or B2 by Moody's at the time of
investment; (ii) will not invest in securities (other than U.S. Government
securities) not rated by at least one of the foregoing organizations at the time
of investment; (iii) will not invest more than 12.5% of its assets in securities
that are rated below BB-/Ba3 by any of the foregoing organizations; and (iv)
will not invest more than 25% of its assets in securities that are rated below
BBB-/Baa3 by any of the foregoing organizations. In the case of short-term
money market instruments and short-term commingled funds the applicable rating
requirement will be A2/P2. Split rated securities will be accounted for at the
lower rating. If any security held in its portfolio is downgraded such that the
Portfolio would not be able at that time to make an investment in such security,
the Portfolio will sell such security within 30 days after such downgrade. The
Portfolio will maintain a dollar-weighted average credit quality of at least
BBB/Baa2, with U.S. Government securities assigned a AAA rating. In order to
calculate the average credit quality of the Portfolio, the Portfolio will assign
sequential numbers to each of the 20 rating categories from AAA to D, multiply
the value of each instrument by the rating equivalent number assigned to its
lowest rating, sum all of such products, divide the aggregate by the net asset
value of the Portfolio and convert the number back to its equivalent rating
symbol.
Generally, lower rated securities offer a higher return potential than
higher rated securities but involve greater volatility of price and greater risk
of loss of income and principal, including the possibility of default or
bankruptcy of the issuers of such securities. Lower rated securities will
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likely have large uncertainties or major risk exposure to adverse conditions and
are predominately speculative. The occurrence of adverse conditions and
uncertainties would likely reduce the value of securities held by the Portfolio,
with a commensurate effect on the value of the Portfolio's shares. While the
market values of lower rated securities tend to react less to fluctuations in
interest rate levels than do those of higher rated securities, the market values
of certain of these securities also tend to be more sensitive to changes in
economic conditions than higher rated securities. In addition, lower rated
securities generally present a higher degree of credit risk. The Portfolio may
incur additional expenses to the extent that it is required to seek recovery
upon a default in the payment of principal or interest on its portfolio
holdings.
Securities which are rated BB by S&P, D&P and Fitch and Ba by Moody's have
speculative characteristics with respect to capacity to pay interest and repay
principal. Securities which are rated B generally lack characteristics of a
desirable investment and assurance of interest and principal payments over any
long period of time may be small. A general description of the bond ratings of
Moody's, S&P, D&P and Fitch is set forth in Appendix A to the Prospectus.
The rating assigned by a rating agency evaluates the safety of a non-
investment grade security's principal and interest payments, but does not
address market value risk. Ratings may from time to time change, positively or
negatively, to reflect developments regarding the issuer's financial condition.
Because such ratings of the ratings agencies may not always reflect current
conditions and events, in addition to using recognized rating agencies and other
sources, the Adviser performs its own analysis of the issuers whose non-
investment grade securities the Portfolio holds. Because of this, the
Portfolio's performance may depend more on the Adviser's own credit analysis
than in the case of mutual funds investing in higher-rated securities.
U.S. GOVERNMENT SECURITIES
U.S. TREASURY SECURITIES. The Portfolio will invest in U.S. Treasury
securities, including bills, notes, bonds and other debt securities issued by
the U.S. Treasury. These instruments are direct obligations of the U.S.
Government and, as such, are backed by the "full faith and credit" of the United
States. They differ primarily in their interest rates, the lengths of their
maturities and the dates of their issuances.
SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES. The Portfolio may invest in securities issued by agencies of
the U.S. Government or instrumentalities of the U.S. Government, including, but
not limited to, GNMA, FNMA
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and FHLMC securities. Obligations of GNMA, the Farmers Home Administration and
the Export-Import Bank are backed by the "full faith and credit" of the United
States. In the case of securities not backed by the "full faith and credit" of
the United States, the Portfolio must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment. Such securities include
obligations issued by FNMA and FHLMC, each of which may borrow from the U.S.
Treasury to meet its obligations, although the U.S. Treasury is under no
obligation to lend to FNMA or FHLMC. GNMA, FNMA and FHLMC investments by the
Portfolio may also include pass-through securities, CMOs and certain other
Mortgage-Backed Securities.
BANK AND CORPORATE DEBT SECURITIES
The Portfolio may not invest in bank or corporate debt securities except
that it may invest in money market instruments for temporary defensive purposes
and in order to keep cash on hand fully invested. Such instruments include but
are not limited to notes, certificates of deposit, bankers' acceptances and
commercial paper.
FLOATING RATE AND INDEX OBLIGATIONS
The Portfolio may invest in debt securities with interest payments or
maturity values that are not fixed, but float in conjunction with an underlying
index or price. These securities may be backed by U.S. Government or corporate
issuers, or by collateral such as mortgages. In certain cases, a change in the
underlying index or price may have a leveraging effect on the periodic coupon
payments, creating larger possible swings in the prices of such securities than
would be expected when taking into account their maturities alone. The indices
and prices upon which such securities can be based include interest rates,
currency rates and commodities prices. However, the Portfolio will not invest
in any instrument whose value is computed based on a multiple of the change in
price or value of an asset or an index of or relating to assets in which the
Portfolio could not invest.
Floating rate securities pay interest according to a coupon which is reset
periodically. This reset mechanism may be formula based, or reflect the passing
through of floating interest payments on an underlying collateral pool. The
coupon is usually reset daily, weekly, monthly, quarterly or semi-annually, but
other schedules are possible. Floating rate obligations generally exhibit a low
price volatility for a given stated maturity or average life because their
coupons adjust with changes in interest rates. If their underlying index is not
an interest rate, or the reset mechanism lags the movement of rates
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in the current market, greater price volatility may be experienced.
Index securities pay a fixed rate of interest, but have a maturity value
that varies by formula, so that when the obligation matures a gain or loss is
realized. The risk of index obligations depends on the volatility of the
underlying index, the coupon payment and the maturity of the obligation.
ILLIQUID SECURITIES
Illiquid securities are subject to legal or contractual restrictions on
disposition or lack an established secondary trading market. The sale of
restricted and illiquid securities often requires more time and results in
higher brokerage charges or dealer discounts and other selling expenses than
does the sale of securities eligible for trading on national securities
exchanges or in the over-the-counter markets. Restricted securities may sell at
a price lower than similar securities that are not subject to restrictions on
resale. The Portfolio may purchase certain restricted securities up to 15% of
its net assets eligible for sale to qualified institutional buyers as
contemplated by Rule 144A under the Securities Act of 1933 and may treat such
securities as being liquid if the Adviser determines, pursuant to procedures
adopted by the Trust's Board of Trustees, that a sufficient secondary market
does exist for such securities. See the SAI for a further discussion of
illiquid securities.
OTHER INVESTMENT PRACTICES.
DURATION MANAGEMENT AND OTHER MANAGEMENT TECHNIQUES
As a basic element of its overall investment strategy the Portfolio intends
to use a variety of other investment management techniques and instruments. A
more complete description of such techniques is contained in the SAI. The
Portfolio may purchase and sell futures contracts, enter into various interest
rate transactions such as swaps, caps and floors and may purchase and sell
exchange-listed and over-the-counter put and call options on securities,
financial indices and futures contracts (collectively, "Additional Investment
Management Techniques"). These Additional Investment Management Techniques may
be used for duration management and other risk management to attempt to protect
against possible changes in the market value of the Portfolio resulting from
trends in the debt securities markets and changes in interest rates, to protect
the Portfolio's unrealized gains in the value of its securities holdings, to
facilitate the sale of such securities for investment purposes and to establish
a position in the securities markets as a temporary substitute for purchasing
particular securities. There
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is no particular strategy that requires use of one technique rather than another
as the decision to use any particular strategy or instrument is a function of
market conditions and the composition of the portfolio. See Appendix B "General
Characteristics and Risks of Additional Investment Management Techniques."
Additional Investment Management Techniques present certain risks. With
respect to hedging and risk management, the variable degree of correlation
between price movements of hedging instruments and price movements in the
position being hedged creates the possibility that losses on the hedge may be
greater than gains in the value of the Portfolio's position. In addition,
certain instruments and markets may not be liquid in all circumstances. As a
result, in volatile markets, the Portfolio may not be able to close out a
transaction without incurring losses substantially greater than the initial
deposit. Although the contemplated use of these instruments predominantly for
hedging should tend to minimize the risk of loss due to a decline in the value
of the position, at the same time they tend to limit any potential gain which
might result from an increase in the value of such position. The ability of the
Portfolio to successfully utilize Additional Investment Management Techniques
will depend on the Adviser's ability to predict pertinent market movements and
sufficient correlations, which cannot be assured. Finally, the daily deposit
requirements in futures contracts that the Portfolio has sold create an ongoing
greater potential financial risk than do options transactions, where the
exposure is limited to the cost of the initial premium. Losses due to the use
of Additional Investment Management Techniques will reduce net asset value.
In selecting counterparties for OTC hedging and risk management
transactions, the Portfolio will adhere to the following minimum ratings: (i)
with respect to an OTC derivative instrument with a remaining nominal maturity
of six months or less, a Moody's Derivative Counterparty Rating of A3; (ii) with
respect to an OTC derivative instrument with a remaining maturity of more than
six months, a Moody's Derivative Counterparty Rating of AA3. If the
counterparty does not have a Moody's counterparty rating, then either the
Moody's or S&P long-term securities rating of A3/A- (with respect to category
(i) above) or Aa3/AA- (with respect to category (ii) above) may be used as a
substitute. In addition, all such counterparties must have a minimum short-term
rating of A-1 by Moody's and P-1 by S&P. If a counterparty drops below the
minimum ratings, then the Portfolio will seek to unwind existing agreements with
such counterparty in a cost-effective manner and will be prohibited from
entering into new agreements with the counterparty so long as the counterparty's
rating is below the relevant minimum.
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The principal risks relating to the use of futures contracts and other
Additional Investment Management Techniques are: (a) less than perfect
correlation between the prices of the instrument and the market value of the
securities in the Portfolio's holdings; (b) possible lack of a liquid secondary
market for closing out a position in such instruments; (c) losses resulting from
interest rate or other market movements not anticipated by the Adviser; and (d)
the obligation to meet additional variation margin or other payment
requirements, all of which could result in the Portfolio being in a worse
position than if such techniques had not been used. See Appendix B "General
Characteristics and Risks of Additional Investment Management Techniques" and
the Statement of Additional Information for further information.
The Portfolio may also purchase securities on a "when-issued" basis and may
purchase or sell securities on a "forward commitment" basis. When such
transactions are negotiated, the price, which is generally expressed in yield
terms, is fixed at the time the commitment is made, but delivery and payment for
the securities take place at a later date outside the normal course of
settlement for securities of that type. When-issued securities and forward
commitments may be sold prior to the settlement date, but the Portfolio will
enter into when-issued and forward commitments only with the intention of
actually receiving or delivering the securities, as the case may be. If the
Portfolio disposes of the right to acquire a when-issued security prior to its
acquisition or disposes of its right to deliver or receive against a forward
commitment, it can incur a gain or loss. At the time the Portfolio enters into
a transaction on a when-issued or forward commitment basis, it will segregate
with its custodian cash or other liquid debt securities with a value not less
than the value of the when-issued or forward commitment securities. The value
of these assets will be monitored daily to ensure that their marked to market
value will at all times equal or exceed the corresponding obligations of the
Portfolio. There is always a risk that the securities may not be delivered and
that the Portfolio may incur a loss. Settlements in the ordinary course, which
typically occur monthly for mortgage-related securities, are not treated by the
Portfolio as when-issued or forward commitment transactions and accordingly are
not subject to the foregoing restrictions.
REPURCHASE AGREEMENTS
The Portfolio may invest temporarily, without limitation, in repurchase
agreements, which are agreements pursuant to which securities are acquired by
the Portfolio from a third party with the understanding that they will be
repurchased by the seller at a fixed price on an agreed upon date. These
agreements may be made with respect to any of the securities in which the
Portfolio
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is authorized to invest. Repurchase agreements may be characterized as loans
secured by the underlying securities and will be entered into in accordance with
the requirements of the SEC. The Portfolio will not enter into any repurchase
agreement with respect to securities other than U.S. Government securities and
mortgage-backed securities. The value of the collateral for such repurchase
agreement marked-to-market at the end of each business day will be at least
equal to the amount of the repurchase agreement. The Portfolio will not enter
into any repurchase agreement the term of which exceeds 90 days.
RISK FACTORS
COMMERCIAL MORTGAGE-BACKED SECURITIES AND RESIDENTIAL MORTGAGE-BACKED
SECURITIES. Investments in Commercial Mortgage-Backed Securities involve the
credit risks of delinquency and default. Delinquency refers to interruptions in
the payment of interest and principal. Default refers to the potential for
unrecoverable principal loss from the sale of foreclosed property. These risks
include the risks inherent in the commercial mortgage loans which support such
Commercial Mortgage-Backed Securities and the risks associated with direct
ownership of real estate. This may be especially true in the case of Commercial
Mortgage-Backed Securities secured by, or evidencing an interest in, a
relatively small or less diverse pool of commercial mortgage loans. The factors
contributing to these risks include the effects of general and local economic
conditions on real estate values, the conditions of specific industry segments,
the ability of tenants to make lease payments and the ability of a property to
attract and retain tenants, which in turn may be affected by local conditions
such as oversupply of space or a reduction of available space, the ability of
the owner to provide adequate maintenance and insurance, energy costs,
government regulations with respect to environmental, zoning, rent control and
other matters, and real estate and other taxes.
While the credit quality of the Commercial Mortgage-Backed Securities in
which the Portfolio may invest will reflect the perceived likelihood of future
cash flows to meet operating expenses and cash flow requirements, the underlying
commercial properties may not be able to continue to generate income to meet
their operating expenses and cash flow requirements (mainly debt service, lease
payments, capital expenditures, taxes, maintenance, insurance and tenant
improvements) as a result of any of the factors mentioned above. Consequently,
the obligors under commercial mortgages may be unable to make payments of
interest in a timely fashion, increasing the risk of default on a related
Commercial Mortgage-Backed Security. In addition, the repayment of the
commercial mortgage loans underlying Commercial Mortgage-Backed Securities will
typically depend upon the future
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availability of financing and the stability of real estate property values.
The commercial mortgage loans that underlie Commercial Mortgage-Backed
Securities have certain distinct characteristics. Commercial mortgage loans are
generally not amortizing or not fully amortizing. At their maturity date,
repayment of the remaining principal balance or "balloon" is due and is repaid
through the attainment of an additional loan or sale of the property. Most
commercial mortgage loans are nonrecourse obligations of the borrower, meaning
that the sole remedy of the lender in the event of a default is to foreclose
upon the collateral. As a result, in the event of default by a borrower,
recourse may be had only against the specified property pledged to secure the
loan and not against the borrower's other assets. If borrowers are not able or
willing to refinance or dispose of the property to pay the principal balance due
at maturity, payments on the subordinated classes of the related Commercial
Mortgage-Backed Security are likely to be adversely affected. The ultimate
extent of the loss, if any, to the subordinated classes may only be determined
after the foreclosure of the mortgage encumbering the property and, if the
mortgagee takes title to the property, upon liquidation of the property.
Factors such as the title of the property, its physical condition and financial
performance, as well as governmental disclosure requirements with respect to the
condition of the property, may make a third party unwilling to purchase the
property at a foreclosure sale or for a price sufficient to satisfy the
obligations with respect to the related Commercial Mortgage-Backed Securities.
The condition of a property may deteriorate during foreclosure proceedings.
Certain obligors on underlying mortgages may become subject to bankruptcy
proceedings, in which case the amount and timing of amounts due under the
related Commercial Mortgage-Backed Securities may be materially adversely
affected.
In general, any losses on a given Commercial Mortgage-Backed Security will
be absorbed first by the equity holder, then by a cash reserve fund or letter of
credit, if any, and then by the "first loss" subordinated security to the extent
of its principal balance. Because the Portfolio intends to invest in
subordinated classes of Commercial Mortgage-Backed Securities, there can be no
assurances that in the event of default and the exhaustion of equity support,
the reserve fund and any debt classes junior to those in which the Portfolio
invests, the Portfolio will be able to recover all of its investment in the
securities it purchases. In addition, if the underlying mortgage portfolio has
been overvalued by the originator, or if mortgage values subsequently decline,
the Portfolio may hold the "first loss" position in certain Commercial Mortgage-
Backed Securities ahead of the more senior debt holders, which may result in
significant losses.
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Many of the lower-rated Commercial Mortgage-Backed Securities are subject to
less prepayment risk than in the case of Residential Mortgage-Backed Securities
because of structural features of the underlying mortgage loans and the fact
that they are entitled to repayment only after more senior classes are paid.
Investments in Residential Mortgage-Backed Securities involve the credit
risks that affect interest and principal cash flows similar to the credit risks
of Commercial Mortgage-Backed Securities discussed above, as well as the
prepayment risks associated with the possibility that prepayments of principal
generally may be made at any time without penalty. Prepayment rates are
influenced by changes in current interest rates and a variety of economic,
geographic, social and other factors. Changes in the rate of prepayments on a
Residential Mortgage-Backed Security may change the yield to maturity of the
security and amounts available for reinvestment from such securities by the
Portfolio are likely to be greater during periods of relatively low or declining
interest rates and therefore are likely to be reinvested at lower interest rates
than during a period of relatively high interest rates. This prepayment effect
has been particularly pronounced in recent years as borrowers have refinanced
higher interest rate mortgages into lower interest rate mortgages available in
the marketplace. Because the Portfolio expects to invest in subordinated
Residential Mortgage-Backed Securities, the prioritization of cash flows from
mortgages under the Residential Mortgage-Backed Securities in favor of the
senior classes generally reduces this prepayment risk.
INVESTING IN LOWER CREDIT QUALITY SECURITIES. An investor should recognize
that the lower-rated Commercial and Residential Mortgage-Backed Securities in
which the Portfolio may invest have speculative characteristics. The prices of
lower credit quality securities, which are commonly referred to as "junk bonds,"
have been found to be less sensitive to interest rate changes than more highly
rated investments, but more sensitive to adverse economic downturns or
individual issuer developments. Securities rated lower than B by S&P and
Moody's, including bonds rated as low as D by S&P or C by Moody's, can be
regarded as having extremely poor prospects of ever attaining any real
investment standing and may be in default with payment of interest and/or
repayment of principal in arrears. A projection of an economic downturn or the
advent of a recession, for example, could cause a decline in the price of lower
credit quality securities because the advent of a recession could lessen the
ability of obligors of mortgages underlying Commercial Mortgage-Backed
Securities and Residential Mortgage-Backed Securities to make principal and
interest payments. In such event, existing credit supports and any first loss
positions may be insufficient to protect against loss of principal.
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Issuers of lower rated securities are often in the growth stage of their
development and/or involved in a reorganization or takeover. The companies are
often highly leveraged (have a significant amount of debt relative to
shareholders' equity) and may not have available to them more traditional
financing methods, thereby increasing the risk associated with acquiring these
types of securities. In some cases, obligations with respect to lower rated
securities are subordinated to the prior repayment of senior indebtedness, which
will potentially limit a Portfolio's ability to fully recover principal or to
receive interest payments when senior securities are in default.
The secondary markets for lower rated securities are not as liquid as the
secondary markets for higher rated securities. The secondary markets for lower
rated securities are concentrated in relatively few market makers and
participants in the markets are mostly institutional investors, including
insurance companies, banks, other financial institutions and mutual funds. In
addition, the trading volume for these securities is generally lower than that
for higher rated securities and the secondary markets could contract under
adverse market or economic conditions independent of any specific adverse
changes in the condition of a particular issuer. Under certain economic and/or
market conditions, the Portfolio may have difficulty disposing of certain lower
rated securities due to the limited number of investors in that sector of the
market. An illiquid secondary market may adversely affect the market price of
the security, which may result in increased difficulty selling the particular
issue and obtaining accurate market quotations on the issue when valuing a
Portfolio's assets. Market quotations on lower rated securities are available
only from a limited number of dealers, and such quotations may not be the actual
prices available for a purchase or sale.
The markets for lower rated securities may react strongly to adverse news
about an issuer or the economy, or to the perception or expectation of adverse
news, whether or not it is based on fundamental analysis. Additionally, prices
for these securities may be affected by legislative and regulatory developments.
These developments could adversely affect the Portfolio's net asset value and
investment practices, the secondary market, the financial condition of issuers
of these securities and the value and liquidity of outstanding securities,
especially in a thinly traded market. For example, federal legislation
requiring the divestiture by federally insured savings and loan associations of
their investments in lower rated bonds and limiting the deductibility of
interest by certain corporate issuers of these bonds adversely affected the
market in recent years.
When the secondary market for lower rated securities becomes more illiquid,
or in the absence of readily available market
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<PAGE>
quotations for such securities, the relative lack of reliable objective data
makes it more difficult to value the Portfolio's securities, and judgment plays
a more important role in determining such valuations. Increased illiquidity, in
combination with the relative youth and growth of the market for such
securities, also may affect the ability of the Portfolio to dispose of such
securities at a desirable price. Additionally, if the secondary markets for
lower rated securities contract due to adverse economic conditions or for other
reasons, certain of the Portfolio's liquid securities may become illiquid and
the proportion of the Portfolio's assets invested in illiquid securities may
significantly increase.
The costs attributable to investing in lower rated securities are usually
higher for several reasons, such as higher investment research costs and higher
commission costs.
NON-DIVERSIFIED STATUS. The Portfolio has registered as a "non-
diversified" investment company which enables it to invest more than 5% of its
assets in the obligations of any single issuer, subject only to the
diversification requirements of Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). As a result of its ability to concentrate its
investments in the obligations of a smaller number of issuers, the Portfolio may
be more susceptible than a more widely diversified fund to any single economic,
political or regulatory occurrence.
ILLIQUID SECURITIES. Liquidity of a security relates to the ability to
easily dispose of securities and the price to be obtained, and does not
necessarily relate to the credit risk or likelihood of receipt of cash at
maturity. Illiquid securities may trade at a discount from comparable, more
liquid investments. The Commercial Mortgage-Backed Securities which the
Portfolio intends to acquire may be less marketable and in some instances will
be considered illiquid by the Portfolio under applicable standards because of
the absence of registration under the federal securities laws, contractual
restrictions on transfer or the small size of the issue (relative to the issues
of comparable interests).
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PORTFOLIO TURNOVER
The Portfolio has no fixed policy with respect to portfolio turnover. The
Portfolio does not expect to trade in securities for short-term gain. The
portfolio turnover rate is calculated by dividing the lesser of sales or
purchases of portfolio securities by the average monthly value of the
Portfolio's securities, excluding securities having a maturity at the date of
purchase of one year or less. While the Portfolio will pay commissions in
connection with its options and futures transactions, the other securities in
which the Portfolio invests are generally traded on a "net" basis with dealers
acting as principals for their own account without a stated commission.
Nevertheless, high portfolio turnover may involve correspondingly greater
brokerage commissions and other transaction costs which will be borne directly
by the Portfolio. It is expected that the annual portfolio turnover rate for
the Portfolio will not exceed 400%, excluding securities having a maturity of
one year or less. Higher portfolio turnover results in increased Portfolio
expenses, including brokerage commissions, dealer mark-ups and other transaction
commissions, costs on the sale of securities and on reinvestment in other
securities. BlackRock will monitor the tax status of the Portfolio under the
Code during any period in which the annual turnover rate of the Portfolio
exceeds 100%.
MANAGEMENT
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BOARD OF TRUSTEES
The business and affairs of the Fund are managed under the direction of the
Fund's Board of Trustees. The Statement of Additional Information contains the
name of each trustee and certain background information.
ADVISER
BlackRock (formerly BlackRock Financial Management L.P.) was organized in
1988. On February 28, 1995, BlackRock Financial Management L.P. sold its
business to PNC Bank, National Association ("PNC Bank"). The principal business
address of BlackRock is 345 Park Avenue, New York, NY 10154. BlackRock, now a
majority-owned indirect subsidiary of PNC Bank Corp., provides asset management
services with respect to U.S. and foreign fixed income instruments. As adviser,
BlackRock is responsible for the day-to-day management of the Portfolio, and
generally makes all purchase and sale decisions regarding the investments made
by the Portfolio. BlackRock also provides research and credit analysis as well
as certain other services. BlackRock currently serves as investment adviser to
institutional
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and individual investors in the United States and overseas through several funds
and separately managed accounts.
Keith Anderson and Mark S. Warner are the persons primarily responsible for
the day-to-day management of the Portfolio's investments.
Keith Anderson is a Managing Director at BlackRock and co-head of the
Portfolio Management Group. In addition, Mr. Anderson co-chairs the Investment
Strategy Committee and he is a member of the firm's Management Committee. Mr.
Anderson has primary responsibility for managing client portfolios and for
acting as a specialist in the government and mortgage sectors. His areas of
expertise include Treasuries, agencies, futures, options, swaps and a wide range
of traditional and non-traditional mortgage securities. Mr. Anderson has been a
co-manager of the Portfolio since its inception.
Prior to founding BlackRock in 1988, Mr. Anderson was a Vice President in
Fixed Income Research at The First Boston Corporation. Mr. Anderson joined
First Boston in 1987 as a mortgage securities and derivative products strategist
working with institutional money managers. From 1983 to 1987, Mr. Anderson was
a Vice President and Portfolio Manager at Criterion Investment Management
Company where he had primary responsibility for a $2.8 billion fixed income
portfolio and was an integral part of the firm's portfolio management team.
Mr. Anderson has published numerous articles on fixed income strategies,
including two articles in The Handbook of Fixed Income Options: "Scenario
------------------------------------
Analysis and the Use of Options in Total Return Portfolio Management" and
"Measuring, Interpreting, and Applying Volatility within the Fixed Income
Market." Mr. Anderson received a Bachelor of Science in Economics and Finance
from Nichols College in 1981 and an M.B.A. from Rice University in 1983.
Mark S. Warner, CFA, is a Director of BlackRock with primary responsibility
for managing client portfolios. Mr. Warner specializes in investing in the
commercial mortgage and non-agency residential mortgage sectors. Mr. Warner has
been a co-manager of the Portfolio since July 1996.
Prior to joining BlackRock in 1993, Mr. Warner was a director in the
Capital Markets Unit of the Prudential Insurance Company of America. Mr. Warner
joined the Prudential Insurance Company of America in 1987, and was initially
responsible for asset/liability strategies for the $7 billion participating
annuity segment. Mr. Warner joined Prudential's Commercial Real Estate Division
in 1989, where he was responsible for the sale of commercial whole loans,
purchases of private
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placement mortgage-backed securities and securitization opportunities within the
Prudential's $25 billion non-residential portfolio. Between 1989 and 1993, Mr.
Warner successfully structured and executed securitization of approximately $2
billion of non-residential mortgages. Mr. Warner previously worked in the fixed
income department at PaineWebber.
Mr. Warner earned a B.A. degree in political science from Columbia
University in 1983 and an M.B.A. degree in finance and marketing from Columbia
Business School in 1987. Mr. Warner received his Chartered Financial Analyst
designation in 1993.
For the services provided and expenses assumed by it, BlackRock is entitled
to receive from the Portfolio a fee computed daily and payable monthly at an
annualized rate of .25% of the Portfolio's average daily net assets. From time
to time BlackRock may waive all or any portion of its advisory fee for and may
reimburse expenses of the Portfolio. The Adviser has advised the Fund that it
will cap the Portfolio's expenses (other than advisory fees) at no more than
.12% of average net assets for the current fiscal year. See "Introduction--
Expense Table."
Since its commencement of operations, the Portfolio has paid investment
advisory fees at the annual rate of .25% of the Portfolio's average daily net
assets.
Like other mutual funds and financial and business organizations worldwide,
the Portfolio could be adversely affected if computer systems on which the Fund
relies are unable to distinguish between the year 1900 and the year 2000
(typically, this is called the "Year 2000 Problem"). The Year 2000 Problem
could have a negative impact on handling securities trades, pricing and account
services and could otherwise have a material adverse effect on the Portfolio's
business, operations and/or investments. BlackRock has commenced review of the
Year 2000 Problem as it may affect the Portfolio, both directly and through the
systems of the Fund's other service providers, and is taking steps reasonably
designed to address any Year 2000 Problems. In light of these remedial steps,
BlackRock expects that its systems and the systems of the Fund's other service
providers will be adapted to deal with the Year 2000 Problem before the
beginning of the year 2000. There can be no assurance, however, that the
systems of BlackRock or the Fund's other service providers will be successfully
adapted to deal with the Year 2000 Problem, or that interaction with other
third-party computer systems which are not prepared for the Year 2000 Problem
will not impair their services at that time, or that the Year 2000 Problem will
not have an adverse effect on companies whose securities are held by the
Portfolio or on global markets or economies generally.
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ADMINISTRATORS
BAI, whose principal business address is 345 Park Avenue, New York, New
York 10154 and PFPC, whose principal business address is 400 Bellevue Parkway,
Wilmington, Delaware 19809 serve as the Fund=s co-administrators. BAI is an
indirect majority-owned, and PFPC is an indirect wholly-owned, subsidiary of PNC
Bank Corp.
The Administrators generally assist the Fund in all aspects of its
administration and operation, including matters relating to the maintenance of
financial records and fund accounting. As compensation for these services, BAI
and PFPC are entitled to receive a combined fee, computed daily and payable
monthly, at an annual rate of .23% of the first $500 million of the Portfolio's
average daily net assets, .21% of the next $500 million of the Portfolio's
average daily net assets, and .19% of the Portfolio's average daily net assets
in excess of $1 billion. From time to time the Administrators may waive all or
any portion of the administration fees for the Portfolio.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND CUSTODIAN
PNC Bank, whose principal business address is 1600 Market Street,
Philadelphia, PA 19103, serves as the Fund's custodian and PFPC serves as the
Fund's transfer agent and dividend disbursing agent.
EXPENSES
Expenses are deducted from the total income of the Portfolio before
dividends and distributions are paid. These expenses include, but are not
limited to, fees paid to BlackRock and the Administrators, transfer agency fees,
fees and expenses of officers and trustees who are not affiliated with BlackRock
or the Distributor or any of their affiliates, taxes, interest, legal fees,
custodian fees, auditing fees, certain fees and expenses in registering and
qualifying the Portfolio and its Shares for distribution under Federal and state
securities laws, expenses of preparing prospectuses and statements of additional
information and of printing and distributing prospectuses and statements of
additional information to existing shareholders, the expense of reports to
shareholders, shareholders' meetings and proxy solicitations, fidelity bond and
trustees and officers liability insurance premiums, the expense of using
independent pricing services and other expenses which are not expressly assumed
by BlackRock or the Administrators under their respective agreements with the
Fund. Any general expenses of the Fund that are not readily identifiable as
belonging to a particular investment
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portfolio will be allocated among all investment portfolios by or under the
direction of the Board of Trustees in a manner the Board determines to be fair
and equitable.
PORTFOLIO TRANSACTIONS
The Portfolio's adviser may consider a number of factors in determining
which brokers to use in purchasing or selling portfolio securities. These
factors, which are more fully discussed in the Statement of Additional
Information, include, but are not limited to, research services, sales of shares
of the Fund, the reasonableness of commissions and quality of services and
execution. Brokerage transactions for the Portfolio may be directed through
registered broker/dealers ("Authorized Dealers") who have entered into dealer
agreements with the Distributor, subject to the requirements of best execution.
BANKING LAWS
Banking laws and regulations currently 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 such banking laws and regulations do not prohibit
such a holding company or affiliate or banks generally from acting as investment
adviser, administrator, transfer agent or custodian to such an investment
company, or from purchasing shares of such company as agent for and upon the
order of customers. PNC Bank, BlackRock, BAI, PFPC and Institutions that are
banks or bank affiliates are subject to such banking laws and regulations. In
addition, state securities laws on this issue may differ from the
interpretations of Federal law expressed herein and banks and financial
institutions may be required to register as dealers pursuant to state law.
Should future legislative, judicial or administrative action prohibit or
restrict the activities of such companies in connection with the provision of
services on behalf of the Fund and the holders of its Shares, the Fund might be
required to alter materially or discontinue its arrangements with such companies
and change its method of operations with respect to its Shares. It is not
anticipated, however, that any change in the Fund's method of operations would
affect its net asset value per share or result in a financial loss to any
investor.
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PURCHASE AND REDEMPTION OF SHARES
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DISTRIBUTOR
Shares of the Portfolio are offered on a continuous basis for the Fund by
the distributor, BlackRock Distributors, Inc. The Distributor is a registered
broker/dealer with principal offices at Four Falls Corporate Center, 6th Floor,
West Conshohocken, PA 19428-2961. The Distributor is a wholly-owned subsidiary
of Provident Distributors, Inc. ("APDI"). A majority of the outstanding stock of
PDI is owned by its officers.
The Fund has adopted a distribution plan pursuant to Rule 12b-1 (the
"Plan") under the 1940 Act. The Fund is not required or permitted under the
Plan to make distribution payments with respect to the Portfolio's Shares.
However, the Plan permits BDI, BlackRock, the Administrators and other companies
that receive fees from the Fund to make payments relating to distribution and
sales support activities out of their past profits or other sources available to
them which, subject to applicable NASD regulations, may include contributions to
various non-cash and cash incentive arrangements to promote the sale of shares,
as well as sponsorship of various educational programs, sales contests and
promotions in which participants may receive reimbursement of expenses,
entertainment and prizes such as travel awards, merchandise and cash. For
further information, see "Investment Advisory, Administration, Distribution, and
Servicing Arrangements" in the Statement of Additional Information.
PURCHASE OF SHARES
Shares of the Portfolio are offered without a sales load on a continuous
basis to Institutions at the net asset value per share of the Portfolio next
computed after an order and payment are received in proper form by PFPC.
Dividends will commence accruing on that day. Shares may be purchased on any
Business Day. A "Business Day" is any weekday that the New York Stock Exchange
(the "NYSE") is open for business. Purchase orders may be transmitted by
telephoning PFPC at (800) 441-7379. The Fund may in its discretion reject any
order for Shares.
Payment for Shares may be made only in Federal funds or other funds
immediately available to the Fund's custodian. Normally, payments for Shares
should be received by PFPC no later than 12:00 Noon (Eastern Time). The minimum
initial investment by an Institution is $50 million. There is no minimum
subsequent investment.
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REDEMPTION OF SHARES
Redemption orders may be transmitted to PFPC by telephone at (800) 441-
7379. Shares are redeemed at the net asset value per share of the Portfolio
next determined after PFPC's receipt of the redemption request in proper order,
and dividends will not accrue after the day on which the redemption is
effectuated. THE FUND, THE ADMINISTRATORS AND THE DISTRIBUTOR WILL EMPLOY
REASONABLE PROCEDURES TO CONFIRM THAT INSTRUCTIONS COMMUNICATED BY TELEPHONE ARE
GENUINE. THE FUND AND ITS SERVICE PROVIDERS WILL NOT BE LIABLE FOR ANY LOSS,
LIABILITY, COST OR EXPENSE FOR ACTING UPON TELEPHONE INSTRUCTIONS THAT ARE
REASONABLY BELIEVED TO BE GENUINE IN ACCORDANCE WITH SUCH PROCEDURES.
The date on which a redemption request is received will be the redemption
date unless the redemption request specifies a particular date in the future for
its effectiveness. The Fund expects to pay all redemption requests made with at
least thirty (30) days' advance notice in cash. Redemption requests in excess
of $250,000 by any single shareholder made within any three-month period may be
paid in kind unless the Fund has received at least thirty (30) days' advance
notice and will be paid in kind if the redeeming shareholder so requests and
such payment will not adversely affect other shareholders. Shareholders who
receive redemptions in kind will incur additional expense and delay in disposing
of such securities and the value of such securities may decline during the
disposition period.
If a proper redemption request is received prior to 12:00 noon (Eastern
time) on any Business Day payment of the redemption price will ordinarily be
wired to the shareholder's bank on the first Business Day subsequent to the 30-
day advance notice period. If the request is received after 12:00 noon (Eastern
time) payment will ordinarily be wired to the shareholder's bank within two
Business Days subsequent to the 30-day advance notice period. Redemption
proceeds will be sent by wire only to the bank named on the shareholder's
application form. A shareholder may change the wire instructions on the
application form by writing to PFPC with an appropriate signature
guarantee.
During periods of substantial economic or market change, telephone
redemptions may be difficult to complete. If an Institution is unable to
contact PFPC by telephone, the Institution may also deliver the redemption
request to PFPC by mail at 400 Bellevue Parkway, Wilmington, DE 19809.
The Fund may suspend the right of redemption or postpone the date of
payment upon redemption (as well as suspend the recordation of the transfer of
Shares) for such periods as are permitted under the 1940 Act. The Fund may also
redeem Shares
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involuntarily or make payment for redemption in securities or other property if
it appears appropriate to do so in light of the Fund's responsibilities under
the 1940 Act. See "Purchase and Redemption Information" in the Statement of
Additional Information for examples of when such redemption might be
appropriate.
NET ASSET VALUE
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The net asset value for the Portfolio is calculated as of the close of
trading on the NYSE (currently 4:00 p.m. Eastern Time) on each Business Day by
adding the value of all its securities, cash and other assets, subtracting the
liabilities and dividing by the total number of Shares outstanding. The net
asset value per Share of the Portfolio is determined independently of the Fund's
other portfolios.
The value of securities held by the Portfolio is based upon market
quotations or, if market quotations are not readily available, the securities
are valued at fair value as determined in good faith by or under the direction
of the Fund's Board of Trustees.
The Portfolio may use a pricing service, bank or broker/dealer experienced
in such matters to value the Portfolio's securities. A more detailed discussion
of net asset value and security valuation is contained in the Statement of
Additional Information.
DIVIDENDS AND DISTRIBUTIONS
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The Portfolio will distribute substantially all of its net investment
income and net capital gain, if any, to shareholders. For dividend purposes,
the Portfolio's investment income available for distribution to holders of
Institutional Shares is reduced by accrued expenses directly attributable to the
Portfolio and the general expenses of the Fund prorated to the Portfolio on the
basis of its relative net assets. All distributions are reinvested at net asset
value in the form of additional full and fractional Shares of the Portfolio
unless an Institution elects otherwise. Such election, or any revocation
thereof, must be made in writing to PFPC, and will become effective with respect
to dividends paid after its receipt by PFPC. The net investment income of the
Portfolio is declared daily. All such dividends are paid not later than ten
days after the end of each month and within seven days after redemption of all
of a shareholder's Shares in the Portfolio. Net capital
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gain, if any, will be distributed by the Portfolio at least annually.
TAXES
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The following discussion is only a brief summary of some of the important
tax considerations generally affecting the Portfolio and its shareholders and is
not intended as a substitute for careful tax planning. Accordingly, investors
in the Portfolio should consult their tax advisers with specific reference to
their own tax situation.
The Portfolio will elect to be taxed as a regulated investment company
under Subchapter M of the Internal Revenue Code of 1986, as amended. So long as
the Portfolio qualifies for this tax treatment, it generally will be relieved of
Federal income tax on amounts distributed to shareholders, but shareholders,
unless otherwise exempt, will pay income or capital gains taxes on amounts so
distributed (except distributions that are treated as a return of capital),
regardless of whether such distributions are paid in cash or reinvested in
additional Shares.
Distributions paid out of the "net capital gain" (the excess of its net
long-term capital gain over net short-term capital loss), if any, of the
Portfolio will be taxed to shareholders as long-term capital gain, regardless of
the length of time a shareholder has held his Shares and whether such gain was
reflected in the price paid for the Shares. All other distributions, to the
extent they are taxable, are taxed to shareholders as ordinary income.
The Fund will send written notices to shareholders annually regarding the
tax status of distributions made by the Portfolio. Dividends declared in
October, November or December of any year payable to shareholders of record on a
specified date in those months will be deemed to have been received by the
shareholders on December 31 of such year, provided the dividends are paid during
January of the following year.
A taxable gain or loss may be realized by a shareholder upon the
redemption, transfer or exchange of Portfolio Shares depending upon the tax
basis of such Shares and their price at the time of redemption, transfer or
exchange.
Future legislative or administrative changes or court decisions may
materially affect the tax consequences of investing in the Portfolio.
Shareholders are urged to consult their tax advisers concerning the application
of state and local income taxes to investments in the Fund which may differ from
the Federal income
34
<PAGE>
tax consequences described above. Shareholders who are nonresident alien
individuals, foreign trusts or estates, foreign corporations or foreign
partnerships may be subject to different U.S. Federal income tax treatment and
should consult their tax advisers.
DESCRIPTION OF SHARES
- --------------------------------------------------------------------------------
The Fund was organized as a Massachusetts business trust on December 22,
1988 and is registered under the 1940 Act as an open-end management investment
company. Effective January 31, 1998, the Fund changed its name from Compass
Capital FundsSM to BlackRock FundsSM. The Declaration of Trust authorizes the
Board of Trustees to classify and reclassify any unissued shares into one or
more classes of shares. Pursuant to such authority, the Board of Trustees has
authorized the issuance of an unlimited number of shares in 40 investment
portfolios. This Prospectus describes the Institutional Shares of the Multi-
Sector Mortgage Securities Portfolio III, which is classified as a non-
diversified company under the 1940 Act. For information regarding other
portfolios of the Fund, contact the Distributor by phone at (800) 998-7633 or at
the address listed in "Purchase and Redemption of Shares--Distributor."
Each share of the Portfolio has a par value of $.001, represents an equal
proportionate interest in the Portfolio and is entitled to such dividends and
distributions earned on the Portfolio's assets as are declared in the discretion
of the Board of Trustees. The Fund's shareholders are entitled to one vote for
each full share held and proportionate fractional votes for fractional shares
held, and will vote in the aggregate and not by class, except where otherwise
required by law or as determined by the Board of Trustees. The Fund does not
currently intend to hold annual meetings of shareholders for the election of
trustees (except as required under the 1940 Act). For a further discussion of
the voting rights of shareholders, see "Additional Information Concerning
Shares" in the Statement of Additional Information.
On November 13, 1998, PNC Bank held of record approximately 72% of the
Fund's outstanding shares, as trustee on behalf of individual and institutional
investors, and may be deemed a controlling person of the Fund under the 1940
Act. PNC Bank is a subsidiary of PNC Bank Corp., a multi-bank holding company.
35
<PAGE>
OTHER INFORMATION
- --------------------------------------------------------------------------------
REPORTS AND INQUIRIES
Shareholders will receive unaudited semi-annual financial statements and
annual financial statements audited by independent accountants. Shareholder
inquiries should be addressed to the Fund c/o PFPC, P.O. Box 8950, Wilmington,
Delaware 19885-9628, toll-free (800) 441-7764 (in Delaware call collect (302)
791-1104).
PERFORMANCE INFORMATION
From time to time, total return and yield data for Shares of the Portfolio
may be quoted in advertisements or in communications to Institutions. Total
return will be calculated on an average annual total return basis for various
periods. Average annual total return reflects the average annual percentage
change in value of an investment in Shares of the Portfolio over the measuring
period. Total return may also be calculated on an aggregate total return basis.
Aggregate total return reflects the total percentage change in value over the
measuring period. Both methods of calculating total return assume that
dividends and capital gain distributions made by the Portfolio during the period
relating to Shares are reinvested in Shares.
The yield of Shares of the Portfolio is computed based on the net income of
the Portfolio allocated to such Shares during a 30-day (or one month) period,
which period will be identified in connection with the particular yield
quotation. More specifically, the yield of Shares of the Portfolio is computed
by dividing the Portfolio's net income per share allocated to such Shares during
a 30-day (or one month) period by the net asset value per share on the last day
of the period and annualizing the result on a semi-annual basis.
Performance data of Shares of the Portfolio may be compared to those of
other mutual funds with similar investment objectives and to other relevant
indexes or to ratings or rankings prepared by independent services or other
financial or industry publications that monitor the performance of mutual funds.
In addition, certain indexes may be used to illustrate historic performance of
select asset classes. For example, the total return and/or yield of Shares of
the Portfolio may be compared to data prepared by Lipper Analytical Services,
Inc., CDA Investment Technologies, Inc. and Weisenberger Investment Company
Service, and with the performance of the Salomon Broad Investment Grade Index,
the T-Bill Index and the "stocks, bonds and inflation index" published annually
by Ibbotson Associates. Performance
36
<PAGE>
information may also include evaluations of the Portfolio and their Shares
published by nationally recognized ranking services and information as reported
by financial publications such as Business Week, Fortune, Institutional
Investor, Money Magazine, Forbes, Barron's, The Wall Street Journal and The New
York Times, or in publications of a local or regional nature.
In addition to providing performance information that demonstrates the
actual yield or returns of Shares of the Portfolio over a particular period of
time, the Portfolio may provide certain other information demonstrating
hypothetical investment returns. Such information may include, but is not
limited to, illustrating the compounding effects of a dividend in a dividend
reinvestment plan.
Performance quotations of Shares of the Portfolio represent past
performance and should not be considered as representative of future results.
The investment return and principal value of an investment in Shares of the
Portfolio will fluctuate so that a shareholder's Shares, when redeemed, may be
worth more or less than their original cost. Since performance will fluctuate,
performance data for Shares of the Portfolio cannot necessarily be used to
compare an investment in such Shares with bank deposits, savings accounts and
similar investment alternatives which often provide an agreed or guaranteed
fixed yield for a stated period of time. Shareholders should remember that
performance is generally a function of the kind and quality of the instruments
held in the portfolio, portfolio maturity, operating expenses and market
conditions. Any fees charged by brokers or other institutions directly to their
customer accounts in connection with investments in Shares will not be included
in the Portfolio's calculations of yield and total return.
37
<PAGE>
APPENDIX A
The following summarizes the ratings used for debt securities:
DESCRIPTION OF MOODY'S BOND RATINGS:
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 "Aa" 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 "Aa" 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
A-1
<PAGE>
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 rating may be revised prior
to delivery if changes occur in the legal documents or the underlying credit
quality of the bonds.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols, Aa1, A1, Ba1 and B1.
DESCRIPTION OF S&P BOND RATINGS:
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 AA 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.
BB - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
B - Debt has a greater vulnerability to default but currently has the
capacity to meet interest payments and
A-2
<PAGE>
principal repayments. Adverse business, financial, or economic conditions will
likely impair capacity or willingness to pay interest and repay principal. The
"B" rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BB" or "BB-" rating.
CCC - Debt has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
CC - The rating "CC" typically is applied to debt subordinated to
senior debt that is assigned an actual or implied "CCC" rating.
C - The rating "C" typically is applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
CI - The rating "CI" is reserved for income bonds on which no interest
is being paid.
D - Debt rated "D" is in payment default. The "D" rating category 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 that
such payments will be made during such grace period. The "D" rating also will
be used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
Standard & Poor's letter ratings may be modified by the addition of a
plus or minus sign, which is used to show relative standing within the major
rating categories, except in the AA, CC, C, CI and D categories.
DESCRIPTION OF DUFF & PHELPS' BOND RATINGS:
AAA - Bonds rated AA are of the highest credit quality. The risk
factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
AA - Bonds rated AA have high credit quality with strong protection
factors. Risk is modest.
A - Bonds rated A have average but adequate protection factors. Risk
factors are greater and more variable in times of economic stress than AA or AA.
A-3
<PAGE>
BBB - Bonds rated BBB exhibit below average protection factors, but
still considered sufficient for prudent investment. Considerable variability in
risk is present during economic cycles.
BB - Bonds rated BB are below investment grade, but deemed likely to
meet obligations when due.
B - Bonds rated B are below investment grade and possessing risk that
obligations will not be met when due.
CCC - Bonds rated CCC are well below investment grade. They may be in
default or have considerable uncertainty as to timely payment of principal,
interest or preferred dividends.
DD - Bonds rated DD are defaulted debt obligations.
Duff & Phelps' letter ratings may be modified by the addition of a
plus or minus sign, which is used to show relative standing within the major
rating categories, except in the AA, CCC and DD categories.
DESCRIPTION OF FITCH BOND RATINGS:
AAA - Bonds rated AA are considered investment grade and of the
highest quality. The ability to pay interest and principal is exceptionally
strong and unlikely to be affected by reasonably foreseeable events.
AA - Bonds rated AA are considered investment grade and very high
credit quality.
A - Bonds rated A are considered investment grade and of high credit
quality. The ability to pay interest and principal is strong, but may be
vulnerable to adverse changes in economic conditions and circumstances than
bonds with higher ratings.
BBB - Bonds rated BBB are considered investment grade and satisfactory
credit quality. The likelihood that these bonds will fall below investment
grade, however, is higher than for bonds with higher ratings.
BB - Bonds rated BB are considered speculative. The ability to pay
interest and principal may be affected over time by adverse economic
changes.
B - Bonds rated B are considered highly speculative. While bonds in
this class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the issuer's limited
margin of safety and the need for reasonable business and economic activity
throughout the life of the issue.
A-4
<PAGE>
CCC - Bonds rated CCC have certain identifiable characteristics which,
if not remedied, may lead to default.
CC - Bonds rated CC are minimally protected. Default seems probable
over time.
C - Bonds rated C are in imminent default in payments of interest or
principal.
DDD, DD and D - Bonds rated in any of these categories are in default
on interest and/or principal payments.
Fitch's letter ratings may be modified by the addition of a plus or
minus sign, which is used to show relative standing within the major rating
categories, except in the AAA category.
A-5
<PAGE>
APPENDIX B
GENERAL CHARACTERISTICS AND RISKS OF
ADDITIONAL INVESTMENT MANAGEMENT TECHNIQUES
In order to manage the risk of its securities portfolio, including
duration management, or to enhance income or gain as described above, the
Portfolio will engage in Additional Investment Management Techniques. The
Portfolio will engage in such activities in the Adviser's discretion, and may
not necessarily be engaging in such activities when movements in interest rates
that could affect the value of the assets of the Portfolio occur. The
Portfolio's ability to pursue certain of these strategies may be limited by
applicable regulations of the CFTC and the federal income tax requirements
applicable to regulated investment companies.
PUT AND CALL OPTIONS ON SECURITIES AND INDICES
The Portfolio may purchase and sell put and call options on securities
and indices. A put option gives the purchaser of the option the right to sell
and the writer the obligation to buy the underlying security at the exercise
price during the option period. The Portfolio may also purchase and sell
options on stock indices ("index options"). Index options are similar to
options on securities except that, rather than taking or making delivery of
securities underlying the option at a specified price upon exercise, an index
option gives the holder the right to receive cash upon exercise of the option if
the level of the stock index upon which the option is based is greater, in the
case of a call, or less, in the case of a put, than the exercise price of the
option. The purchase of a put option on a debt security could protect the
Portfolio's holdings in a security or a number of securities against a
substantial decline in the market value. A call option gives the purchaser of
the option the right to buy and the seller the obligation to sell the underlying
security or index at the exercise price during the option period or for a
specified period prior to a fixed date. The purchase of a call option on a
security could protect the Portfolio against an increase in the price of a
security that it intended to purchase in the future. In the case of either put
or call options that it has purchased, if the option expires without being sold
or exercised, the Portfolio will experience a loss in the amount of the option
premium plus any related commissions. When the Portfolio sells put and call
options, it receives a premium as the seller of the option. The premium that
the Portfolio receives for selling the option will serve as a partial hedge, in
the amount of the option premium, against changes in the value of the securities
in its portfolio. During the term of the option, however, a covered call seller
has, in return for the premium on the option, given up the opportunity for
capital appreciation above the exercise price of the option if the value of the
underlying security increases, but has retained the risk of loss should the
price of the underlying security decline. Conversely, a secured put seller
retains the risk of loss should the market value of the underlying security
B-1
<PAGE>
decline below the exercise price of the option, less the premium received on the
sale of the option. The Portfolio is authorized to purchase and sell exchange
listed options and over-the-counter options ("OTC Options") which are privately
negotiated with the counterparty. Listed options are issued by the Options
Clearing Corporation ("OCC") which guarantees the performance of the obligations
of the parties to such options.
The Portfolio's ability to close out its position as a purchaser or
seller of an exchange-listed put or call option is dependent upon the existence
of a liquid secondary market on option exchanges. Among the possible reasons
for the absence of a liquid secondary market on an exchange are: (i)
insufficient trading interest in certain options; (ii) restrictions on
transactions imposed by an exchange; (iii) trading halts, suspensions or other
restrictions imposed with respect to particular classes or series of options or
underlying securities; (iv) interruption of the normal operations on an
exchange; (v) inadequacy of the facilities of an exchange or OCC to handle
current trading volume; or (vi) a decision by one or more exchanges to
discontinue the trading of options (or a particular class or series of options),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options on that exchange
that had been listed by the OCC as a result of trades on that exchange would
generally continue to be exercisable in accordance with their terms. OTC
Options are purchased from or sold to dealers, financial institutions or other
counterparties which have entered into direct agreements with the Portfolio.
With OTC Options, such variables as expiration date, exercise price and premium
will be agreed upon between the Portfolio and the counterparty, without the
intermediation of a third party such as the OCC. If the counterparty fails to
make or take delivery of the securities underlying an option it has written, or
otherwise settle the transaction in accordance with the terms of that option as
written, the Portfolio would lose the premium paid for the option as well as any
anticipated benefit of the transaction. As the Portfolio must rely on the
credit quality of the counterparty rather than the guarantee of the OCC, it will
only enter into OTC Options with counterparties with the highest long-term
credit ratings, and with primary United States government securities dealers
recognized by the Federal Reserve Bank of New York.
The hours of trading for options on debt securities may not conform to
the hours during which the underlying securities are traded. To the extent that
the option markets close before the markets for the underlying securities,
significant price and rate movements can take place in the underlying markets
that cannot be reflected in the option markets.
FUTURES CONTRACTS AND RELATED OPTIONS
CHARACTERISTICS. The Portfolio may sell financial futures contracts
or purchase put and call options on such futures as a hedge against anticipated
interest rate changes or
B-2
<PAGE>
other market movements. The sale of a futures contract creates an obligation by
the Portfolio, as seller, to deliver the specific type of financial instrument
called for in the contract at a specified future time for a specified price.
Options on futures contracts are similar to options on securities except that an
option on a futures contract gives the purchaser the right in return for the
premium paid to assume a position in a futures contract (a long position if the
option is a call and a short position if the option is a put).
MARGIN REQUIREMENTS. At the time a futures contract is purchased or
sold, the Portfolio must allocate cash or securities as a deposit payment
("initial margin"). It is expected that the initial margin that the Portfolio
will pay may range from approximately 1% to approximately 5% of the value of the
securities or commodities underlying the contract. In certain circumstances,
however, such as periods of high volatility, the Portfolio may be required by an
exchange to increase the level of its initial margin payment. Additionally,
initial margin requirements may be increased generally in the future by
regulatory action. An outstanding futures contract is valued daily and the
payment in cash of "variation margin" may be required, a process known as
"marking to the market." Transactions in listed options and futures are usually
settled by entering into an offsetting transaction, and are subject to the risk
that the position may not be able to be closed if no offsetting transaction can
be arranged.
LIMITATIONS ON USE OF FUTURES AND OPTIONS ON FUTURES. The Portfolio's
use of futures and options on futures will in all cases be consistent with
applicable regulatory requirements and in particular the rules and regulations
of the CFTC. Under such regulations the Portfolio currently may enter into such
transactions without limit for bona fide hedging purposes, including risk
management and duration management and other portfolio strategies.
The Portfolio will not enter into a futures contract or related option
if, immediately thereafter, the sum of the amount of its initial deposits and
premiums on open contracts and options would exceed 5% of the Portfolio's
liquidation value, i.e. net assets (taken at current value); provided, however,
that in the case of an option that is in-the-money at the time of the purchase,
the in-the-money amount may be excluded in calculating the 5% limitation. Also,
when required, a segregated account of cash or cash equivalents will be
maintained and marked to market in an amount equal to the market value of the
contract. The Portfolio reserves the right to comply with such different
standard as may be established from time to time by CFTC rules and regulations
with respect to the purchase or sale of futures contracts or options thereon.
SEGREGATION AND COVER REQUIREMENTS. Futures contracts, interest rate
swaps, caps, floors and collars and listed options on securities, indices and
futures contracts sold by the Portfolio are subject to segregation and coverage
requirements of
B-3
<PAGE>
either the CFTC or the SEC, with the result that, if the Portfolio does not hold
the security or futures contract underlying the instrument, the Portfolio will
be required to segregate on an ongoing basis with its custodian, cash, U.S.
government securities, or other liquid debt obligations in an amount at least
equal to the Portfolio's obligations with respect to such instruments. Such
amounts fluctuate as the obligations increase or decrease. The segregation
requirement can result in the Portfolio maintaining securities positions it
would otherwise liquidate, segregating assets at a time when it might be
disadvantageous to do so or otherwise restrict portfolio management.
B-4
<PAGE>
No person has been authorized to give any information or make any
representations not contained in this Prospectus, or in the Statement of
Additional Information incorporated herein by reference, in connection with the
offering made by this Prospectus and, if given or made, such representations
must not be relied upon as having been authorized by the Fund or its
Distributor. This Prospectus does not constitute an offering by the Fund or by
the Distributor in any jurisdiction in which such offering may not lawfully be
made.
___________________
TABLE OF CONTENTS
Page
----
Introduction . . . . . . . . . . . 3
Financial Highlights . . . . . . . 5
Investment Policies. . . . . . . . 8
Management . . . . . . . . . . . . 26
Purchase and Redemption of Shares. 31
Net Asset Value. . . . . . . . . . 33
Dividends and Distributions. . . . 33
Taxes. . . . . . . . . . . . . . . 34
Description of Shares. . . . . . . 35
Other Information. . . . . . . . . 36
Appendix A . . . . . . . . . . . . A-1
Appendix B . . . . . . . . . . . . B-1
The Multi-Sector
Mortgage
Securities
Portfolio III
Institutional
Class
Prospectus
Investment Adviser November 25, 1998
BlackRock Financial Management, Inc.
New York, New York
Co-Administrator
BlackRock Advisors, Inc.
New York, New York
Co-Administrator and Transfer Agent
PFPC Inc.
Wilmington, Delaware
Distributor
BlackRock Distributors, Inc.
West Conshohocken, Pennsylvania
Counsel
Simpson Thacher & Bartlett
New York, New York
Independent Accountants
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
<PAGE>
BLACKROCK FUNDS(SM)
STATEMENT OF ADDITIONAL INFORMATION
MULTI-SECTOR MORTGAGE SECURITIES PORTFOLIO III
This Statement of Additional Information provides supplementary information
pertaining to Institutional Shares ("Shares") representing interests in the
Multi-Sector Mortgage Securities Portfolio III (the "Portfolio") of BlackRock
Funds(SM) (the "Fund"). This Statement of Additional Information is not a
prospectus, and should be read only in conjunction with the Prospectus of the
Fund relating to the Portfolio dated November 25, 1998, as amended from time to
time (the "Prospectus"). The Prospectus may be obtained from the Fund's
distributor by calling toll-free (800) 441-7379. This Statement of Additional
Information is dated November 25, 1998. Capitalized terms used herein and not
otherwise defined have the same meanings as are given to them in the
Prospectus.
CONTENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
THE FUND.................................. 2
INVESTMENT OBJECTIVE AND POLICIES......... 2
INVESTMENT RESTRICTIONS................... 13
TRUSTEES AND OFFICERS..................... 15
INVESTMENT ADVISORY, ADMINISTRATION,
DISTRIBUTION AND SERVICING ARRANGEMENTS... 22
PORTFOLIO TRANSACTIONS.................... 27
PURCHASE AND REDEMPTION INFORMATION....... 30
VALUATION OF PORTFOLIO SECURITIES......... 30
PERFORMANCE INFORMATION................... 31
TAXES..................................... 35
ADDITIONAL INFORMATION CONCERNING SHARES.. 39
MISCELLANEOUS............................. 40
FINANCIAL STATEMENTS...................... 42
</TABLE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS STATEMENT OF ADDITIONAL INFORMATION OR THE
PROSPECTUS IN CONNECTION WITH THE OFFERING MADE BY THE PROSPECTUS AND, IF GIVEN
OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED BY THE FUND OR ITS DISTRIBUTOR. THE PROSPECTUS DOES NOT
CONSTITUTE AN OFFERING BY THE FUND OR BY THE FUND'S DISTRIBUTOR IN ANY
JURISDICTION IN WHICH SUCH OFFERING MAY NOT LAWFULLY BE MADE.
<PAGE>
THE FUND
The Fund was organized on December 22, 1988 as a Massachusetts business
trust. The Portfolio originally commenced operations on October 6, 1994 as a
separate investment portfolio (the "Predecessor Portfolio") of The BFM
Institutional Trust Inc., which was organized as a Maryland corporation. On
April 26, 1996 the assets and liabilities of the Predecessor Portfolio were
transferred to the Portfolio, which had no prior operating history.
The Fund also offers other investment portfolios which are described in
separate Prospectuses and separate Statements of Additional Information. For
information concerning these other portfolios contact the distributor at the
telephone number stated on the cover page of this Statement of Additional
Information.
INVESTMENT OBJECTIVE AND POLICIES
For a description of the objective and policies of the Portfolio, see
"Investment Policies" in the Prospectus. In accordance with the applicable
provisions of the Investment Company Act of 1940 (the "1940 Act"), the Portfolio
will maintain with its custodian a segregated account of liquid assets to the
extent the Portfolio's obligations require segregation from the use of
investment practices listed below. The following information is provided for
those investors desiring information in addition to that contained in the
Prospectus.
OTHER INVESTMENT PRACTICES
INTEREST RATE TRANSACTIONS. The Portfolio may enter into interest rate
swaps and the purchase or sale of interest rate caps and floors. The Portfolio
expects to enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of its portfolio as a duration
management technique or to protect against any increase in the price of
securities that the Portfolio anticipates purchasing at a later date. The
Portfolio will use these transactions as a hedge or for duration or risk
management. The Portfolio will not sell interest rate caps or floors that it
does not own. Interest rate swaps involve the exchange by the Portfolio with
another party of their respective commitments to pay or receive interest e.g.,
----
an exchange of floating rate payments for fixed rate payments with respect to a
notional amount of principal. The purchase of an interest rate cap entitles the
purchaser, to the extent that a specified index exceeds a predetermined interest
rate, to receive payments of interest on a notional principal
-2-
<PAGE>
amount from the party selling such interest rate cap. The purchase of an
interest rate floor entitles the purchaser, to the extent that a specified index
falls below a predetermined interest rate, to receive payments of interest on a
notional principal amount from the party selling such interest rate floor.
The Portfolio may enter into interest rate swaps, caps and floors on either
an asset-based or liability-based basis, and will usually enter into interest
rate swaps on a net basis, i.e., the two payment streams are netted out, with
----
the Portfolio receiving or paying, as the case may be, only the net amount of
the two payments on the payment dates. The Portfolio will accrue the net amount
of the excess, if any, of the Portfolio's obligations over its entitlements with
respect to each interest rate swap on a daily basis and will segregate with a
custodian an amount of cash or liquid securities having an aggregate net asset
value at all times at least equal to the accrued excess. If there is a default
by the other party to such a transaction, the Portfolio will have contractual
remedies pursuant to the agreements related to the transaction.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Portfolio may also
enter into contracts for the purchase or sale for future delivery ("futures
contracts") of debt securities, aggregates of debt securities or indices or
prices thereof, other financial indices and U.S. government debt securities or
options on the above. The Portfolio will ordinarily engage in such transactions
only for bona fide hedging, risk management (including duration management) and
other portfolio management purposes.
CALLS ON SECURITIES, INDICES AND FUTURES CONTRACTS. The Portfolio may sell
or purchase call options ("calls") on U.S. Treasury securities, mortgage-backed
securities, other debt securities, indices, and Eurodollar instruments that are
traded on U.S. and foreign securities exchanges and in the over-the-counter
markets, and future contracts. A call gives the purchaser of the option the
right to buy, and obligates the seller to sell, the underlying security, futures
contract or index at the exercise price at any time or at a specified time
during the option period. All such calls sold by the Portfolio must be
"covered" as long as the call is outstanding (i.e., the Portfolio must own the
----
securities or futures contract subject to the call or other securities
acceptable for applicable segregation requirements). A call sold by the
Portfolio exposes the Portfolio during the term of the option to possible loss
of opportunity to realize appreciation in the market price of the underlying
security, index or futures contract and may require the Portfolio to hold a
security or futures contract which it might otherwise have sold. The purchase
of a call gives the
-3-
<PAGE>
Portfolio the right to buy a security, futures contract or index at a fixed
price. Calls on futures on U.S. Treasury securities, Mortgage-Backed Securities,
other debt securities and Eurodollar instruments must also be covered by
deliverable securities or the futures contract or by liquid debt securities
segregated to satisfy the Portfolio's obligations pursuant to such instruments.
PUTS ON SECURITIES, INDICES AND FUTURES CONTRACTS. The Portfolio may
purchase put options ("puts") that relate to U.S. Treasury securities, Mortgage-
Backed Securities, other debt securities and Eurodollar instruments (whether or
not it holds such securities in its portfolio), indices or futures contracts.
The Portfolio may also sell puts on U.S. Treasury securities, Mortgage-Backed
Securities, other debt securities, Eurodollar instruments, indices or futures
contracts on such securities if the Portfolio's contingent obligations on such
puts are secured by segregated assets consisting of cash or liquid debt
securities having a value not less than the exercise price. The Portfolio will
not sell puts if, as a result, more than 50% of the Portfolio's assets would be
required to cover its potential obligations under its hedging and other
investment transactions. In selling puts, there is a risk that the Portfolio
may be required to buy the underlying instrument at a price higher than the
current market price.
WHEN-ISSUED AND FORWARD COMMITMENT SECURITIES. The Portfolio may also
purchase securities on a "when-issued" basis and may purchase or sell securities
on a "forward commitment" basis. When such transactions are negotiated, the
price, which is generally expressed in yield terms, is fixed at the time the
commitment is made, but delivery and payment for the securities take place at a
later date. When-issued securities and forward commitments may be sold prior to
the settlement date, but the Portfolio will enter into when-issued and forward
commitments only with the intention of actually receiving or delivering the
securities, as the case may be. If the Portfolio disposes of the right to
acquire a when-issued security prior to its acquisition or disposes of its right
to deliver or receive against a forward commitment, it can incur a gain or loss.
At the time the Portfolio enters into a transaction on a when-issued or forward
commitment basis, it will segregate with its custodian liquid assets with a
value not less than the value of the when-issued or forward commitment
securities. The value of these assets will be monitored daily to ensure that
their marked to market value will at all times equal or exceed the corresponding
obligations of the Portfolio. There is always a risk that the securities may
not be delivered and that the Portfolio may incur a loss. Settlements in the
ordinary course, which typically occur monthly for mortgage-related securities,
are not treated by the Portfolio as
-4-
<PAGE>
when-issued or forward commitment transactions and accordingly are not subject
to the foregoing restrictions.
REPURCHASE AGREEMENTS. The Portfolio may invest temporarily, without
limitation, in repurchase agreements, which are agreements pursuant to which
securities are acquired by the Portfolio from a third party with the
understanding that they will be repurchased by the seller at a fixed price on an
agreed date. These agreements may be made with respect to any of the portfolio
securities in which the Portfolio is authorized to invest. Repurchase
agreements may be characterized as loans secured by the underlying securities
and will be entered into in accordance with the requirements of the SEC.
The repurchase price under the repurchase agreements generally equals the
price paid by the Portfolio plus interest negotiated on the basis of current
short-term rates (which may be more or less than the rate on securities
underlying the repurchase agreement). The financial institutions with which the
Portfolio may enter into repurchase agreements will be banks and non-bank
dealers of U.S. Government securities that are listed on the Federal Reserve
Bank of New York's list of reporting dealers, if such banks and non-bank dealers
are deemed creditworthy by the Adviser. The Adviser will continue to monitor
creditworthiness of the seller under a repurchase agreement, and will require
the seller to maintain during the term of the agreement the value of the
securities subject to the agreement to equal at least the repurchase price
(including accrued interest). In addition, the Adviser will require that the
value of this collateral, after transaction costs (including loss of interest)
reasonably expected to be incurred on a default, be equal to or greater than the
repurchase price (including accrued premium) provided in the repurchase
agreement. The accrued premium is the amount specified in the repurchase
agreement or the daily amortization of the difference between the purchase price
and the repurchase price specified in the repurchase agreement. The Portfolio's
Adviser will mark-to-market daily the value of the securities. Securities
subject to repurchase agreements will be held by the Fund's custodian (or sub-
custodian) in the Federal Reserve/Treasury book-entry system or by another
authorized securities depository. Repurchase agreements are considered to be
loans by the Portfolio under the 1940 Act.
The use of repurchase agreements involves certain risks. For example, if
the seller of securities under a repurchase agreement defaults on its obligation
to repurchase the underlying securities, as a result of its bankruptcy or
otherwise, the Portfolio will seek to dispose of such securities, which action
could involve costs or delays. If the seller becomes insolvent and subject to
liquidation or reorganization under applicable
-5-
<PAGE>
bankruptcy or other laws, the Portfolio's ability to dispose of the underlying
securities may be restricted. Finally, it is possible that the Portfolio may not
be able to substantiate its interest in the underlying securities. To minimize
this risk, the securities underlying the repurchase agreement will be held by
the custodian at all times in an amount at least equal to the repurchase price,
including accrued interest. If the seller fails to repurchase the securities,
the Portfolio may suffer a loss to the extent proceeds from the sale of the
underlying securities are less than the repurchase price.
RESTRICTED AND ILLIQUID SECURITIES. The Portfolio may purchase certain
restricted securities ("Rule 144A securities") eligible for sale to qualified
institutional buyers as contemplated by Rule 144A under the Securities Act of
1933. Rule 144A provides an exemption from the registration requirements of the
Securities Act of 1933 for the resale of certain restricted securities to
qualified institutional buyers. One effect of Rule 144A is that certain
restricted securities may now be liquid, though no assurance can be given that a
liquid market for Rule 144A securities will develop or be maintained. The
Portfolio's holdings of Rule 144A securities which are liquid securities will
not be subject to its limitation on investment in illiquid securities. The
Fund's Board of Trustees has adopted policies and procedures for the purpose of
determining whether securities that are eligible for resale under Rule 144A are
liquid or illiquid. The Board of Trustees will periodically review the
Portfolio's purchases and sales of Rule 144A securities.
OTHER INVESTMENTS
U.S. GOVERNMENT SECURITIES
U.S. Government securities include:
1. U.S. Treasury bills (maturities of one year or less), U.S.
Treasury notes (maturities of one to ten years) and U.S. Treasury
bonds (generally maturities of greater than ten years), all of which
are direct obligations of the U.S. Government and, as such, are backed
by the "full faith and credit" of the United States.
2. Securities issued by agencies and instrumentalities of the
U.S. Government which are backed by the full faith and credit of the
United States. Among the agencies and instrumentalities issuing such
obligations are the Federal Housing Administration, the Government
National Mortgage Association ("GNMA"), the Department of Housing and
-6-
<PAGE>
Urban Development, the Export-Import Bank, the Farmers Home
Administration ("FHA"), the General Services Administration, the
Maritime Administration and the Small Business Administration. The
maturities of such obligations range from three months to 30 years.
3. Securities issued by agencies and instrumentalities which are
not backed by the full faith and credit of the United States, but
whose issuing agency or instrumentalities may borrow, to meet its
obligations, from the U.S. Treasury. Among the agencies and
instrumentalities issuing such obligations are the Tennessee Valley
Authority, the Federal National Mortgage Association ("FNMA"), the
Federal Home Loan Mortgage Corporation ("FHLMC") and the U.S. Postal
Service.
4. Securities issued by agencies and instrumentalities which are
not backed by the full faith and credit of the United States, but
which are backed by the credit of the issuing agency or
instrumentality. Among the agencies and instrumentalities issuing
such obligations are the Federal Farm Credit System and the Federal
Home Loan Bank.
Neither the value nor the yield of the Portfolio's shares or of the U.S.
Government securities which may be invested in by the Portfolio are guaranteed
by the U.S. Government. Such values and yield will fluctuate with changes in
prevailing interest rates and other factors. Generally, as prevailing interest
rates rise, the value of any U.S. Government securities held by the Portfolio
will fall. Such securities with longer maturities generally tend to produce
higher yields and are subject to greater market fluctuation, as a result of
changes in interest rates, than debt securities with shorter maturities.
MORTGAGE-BACKED SECURITIES
As discussed in the Prospectus, the Mortgage-Backed Securities purchased by
the Portfolio evidence an interest in a specific pool of mortgages. Such
securities are issued by GNMA, FNMA and FHLMC and by private issuers, such as
depository institutions, mortgage banks, investment banks and special purpose
subsidiaries of the foregoing.
GNMA CERTIFICATES. GNMA is a wholly-owned corporate instrumentality of the
United States within the Department of Housing and Urban Development. The
National Housing Act of 1934, as amended (the "Housing Act"), authorized GNMA to
guarantee the
-7-
<PAGE>
timely payment of the principal of and interest on certificates that are based
on and backed by a pool of mortgage loans insured by the Federal Housing
Administration under the Housing Act, or Title V of the Housing Act of 1949
("FHA Loans"), or guaranteed by the Veterans' Administration under the
Servicemen's Readjustment Act of 1944, as amended ("VA Loans"), or by pools of
other eligible mortgage loans. The Housing Act provides that the full faith and
credit of the U.S. Government is pledged to the payment of all amounts that may
be required to be paid under the guarantee. In order to meet its obligations
under such guarantee, GNMA is authorized to borrow from the U.S. Treasury with
no limitations as to amount.
The GNMA certificates will represent a pro-rata interest in one or more
pools of the following types of mortgage loans: (i) fixed rate level payment
mortgage loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed
rate growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multi-family residential
properties under construction; (vi) mortgage loans on completed multi-family
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used to
reduce the borrower's monthly payments during the early years of the mortgage
loans ("buydown" mortgage loans); (viii) mortgage loans that provide for
adjustments in payments based on periodic changes in interest rates or in other
payment terms of the mortgage loans; and (ix) mortgage-backed serial notes. All
of these mortgage loans will be FHA Loans or VA Loans and, except as otherwise
specified above, will be fully-amortizing loans secured by first liens on one-to
four-family housing units.
FNMA CERTIFICATES. FNMA is a federally chartered and privately owned
corporation organized and existing under the Federal National Mortgage
Association Charter Act. FNMA was originally established in 1938 as a U.S.
Government agency to provide supplemental liquidity to the mortgage market and
was transformed into a stockholder owned and privately managed corporation by
legislation enacted in 1968. FNMA provides funds to the mortgage market
primarily by purchasing home mortgage loans from local lenders, thereby
replenishing their funds for additional lending. FNMA acquires funds to
purchase home mortgage loans from many capital market investors that may not
ordinarily invest in mortgage loans directly, thereby expanding the total amount
of funds available for housing.
Each FNMA certificate will entitle the registered holder thereof to receive
amounts representing such holder's pro-rata interest in scheduled principal
payments and interest payments (at such FNMA certificate's pass-through rate,
which is net of any servicing and guarantee fees on the underlying mortgage
-8-
<PAGE>
loans), and any principal prepayments on the mortgage loans in the pool
represented by such FNMA certificate and such holder's proportionate interest in
the full principal amount of any foreclosed or otherwise finally liquidated
mortgage loan. The full and timely payment of principal of and interest on each
FNMA certificate will be guaranteed by FNMA, which guarantee is not backed by
the full faith and credit of the U.S. Government.
Each FNMA certificate will represent a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency) of the
following types: (i) fixed rate level payment mortgage loans; (ii) fixed rate
graduated payment mortgage loans; and (iii) adjustable rate mortgage loans.
FHLMC CERTIFICATES. FHLMC is a corporate instrumentality of the United
States created pursuant to the Emergency Home Finance Act of 1970, as amended
(the "FHLMC Act"). FHLMC was established primarily for the purpose of
increasing the availability of mortgage credit for the financing of needed
housing. The principal activity of FHLMC currently consists of the purchase of
first lien, conventional, residential mortgage loans and participation interests
in such mortgage loans and the resale of the mortgage loans so purchased in the
form of mortgage securities, primarily FHLMC certificates.
FHLMC guarantees to each registered holder of a FHLMC certificate the
timely payment of interest at the rate provided for by such FHLMC certificate,
whether or not received. FHLMC also guarantees to each registered holder of a
FHLMC certificate ultimate collection of all principal of the related mortgage
loans, without any offset or deduction, but does not, generally, guarantee the
timely payment of scheduled principal. FHLMC may remit the amount due on
account of its guarantee of collection of principal at any time after default on
an underlying mortgage loan, but not later than 30 days following (i)
foreclosure sale, (ii) payment of a claim by any mortgage insurer or (iii) the
expiration of any right of redemption, whichever occurs later, but in any event
no later than one year after demand has been made upon the mortgagor for
accelerated payment of principal. The obligations of FHLMC under its guarantee
are obligations solely of FHLMC and are not backed by the full faith and credit
of the U.S. Government.
FHLMC certificates represent a pro rata interest in a group of mortgage
loans (a "FHLMC certificate group") purchased by FHLMC. The mortgage loans
underlying the FHLMC certificates will consist of fixed rate or adjustable rate
mortgage loans with original terms to maturity of between ten and thirty years,
substantially all of which are secured by first liens on one- to
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<PAGE>
four-family residential properties or multifamily projects. Each mortgage loan
must meet the applicable standards set forth in the FHLMC Act. A FHLMC
certificate group may include whole loans, participation interests in whole
loans and undivided interests in whole loans and participations comprising
another FHLMC certificate group.
ADJUSTABLE RATE MORTGAGE SECURITIES. Adjustable rate mortgage securities
are pass-through mortgage securities collateralized by mortgages with adjustable
rather than fixed rates ("ARMs"). ARMs eligible for inclusion in a mortgage
pool generally provide for a fixed initial mortgage interest rate for either the
first three, six, twelve, thirteen, thirty-six or sixty scheduled monthly
payments. Thereafter, the interest rates are subject to periodic adjustment
based on changes to a designated benchmark index.
ARMs contain maximum and minimum rates beyond which the mortgage interest
rate may not vary over the lifetime of the mortgage. In addition, certain ARMs
provide for additional limitations on the maximum amount by which the mortgage
interest rate may adjust for any single adjustment period. Alternatively,
certain ARMs contain limitations on changes in the required monthly payment. In
the event that a monthly payment is not sufficient to pay the interest accruing
on an ARM, any such excess interest is added to the principal balance of the
mortgage loan, which is repaid through future monthly payments. If the monthly
payment for such an instrument exceeds the sum of the interest accrued at the
applicable mortgage interest rate and the principal payment required at such
point to amortize the outstanding principal balance over the remaining term of
the loan, the excess is utilized to reduce the then outstanding principal
balance of the ARM.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS PASS-THROUGH
SECURITIES. Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities.
Typically, CMOs are collateralized by GNMA, FNMA or FHLMC certificates, but also
may be collateralized by whole loans or private mortgage pass-through securities
(collectively, "Mortgage Assets"). Multi-class pass-through securities are
equity interests in a trust composed of Mortgage Assets. Unless the context
indicates otherwise, all references herein to CMOs include multi-class pass-
through certificates. Payments of principal of and interest on the Mortgage
Assets, and any reinvestment income thereon, provide the funds to pay debt
service on the CMOs or make scheduled distributions on the multi-class pass-
through securities. CMOs may be issued by agencies or instrumentalities of the
U.S. Government, or by private originators of, or investors in,
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<PAGE>
mortgage loans, including depository institutions, mortgage banks, investment
banks and special purpose subsidiaries of the foregoing. The issuer of CMOs or
multi-class pass-through securities may elect to be treated as a Real Estate
Mortgage Investment Conduit ("REMIC").
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause the CMOs to be
retired substantially earlier than their stated maturities or final distribution
dates. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semi-annual basis. The principal of and interest on the Mortgage
Assets may be allocated among the several classes of a CMO series in a number of
different ways. Generally, the purpose of the allocation of the cash flow of a
CMO to the various classes is to obtain a more predictable cash flow to the
individual tranches than exists with the underlying collateral of the CMO. As a
general rule, the more predictable the cash flow is on a CMO tranche, the lower
the anticipated yield will be on that tranche at the time of issuance relative
to prevailing market yields on Mortgage-Backed securities.
The Portfolio also may invest in, among other things, parallel-pay CMOs and
Planned Amortization Class CMOs ("PAC Bonds"). Parallel-pay CMOs are structured
to provide payments of principal on each payment date to more than one class.
These simultaneous payments are taken into account in calculating the stated
maturity date or final distribution date of each class, which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC Bonds generally require payments of a
specified amount of principal on each payment date. PAC Bonds are parallel-pay
CMOs with the required principal payment on such securities having the highest
priority after interest has been paid to all classes.
The Portfolio may invest in CMO residuals. The residual in a CMO structure
generally represents the interest in any excess cash flow remaining after making
required payments of principal of and interest on the CMOs and related
administrative expenses of the issuer.
TYPES OF CREDIT ENHANCEMENT
Mortgage-Backed Securities are often backed by a pool of assets
representing the obligations of a number of different parties. To lessen the
effect of failures by obligors on
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underlying assets to make payments, those securities may contain elements of
credit support, which fall into two categories: (i) liquidity protection and
(ii) protection against losses resulting from ultimate default by an obligor on
the underlying assets. Liquidity protection refers to the provision of advances,
generally by the entity administering the pool of assets, to ensure that the
receipt of payments on the underlying pool occurs in a timely fashion.
Protection against losses resulting from default ensures ultimate payment of the
obligations on at least a portion of the assets in the pool. This protection may
be provided through guarantees, insurance policies or letters of credit obtained
by the issuer or sponsor from third parties, through various means of
structuring the transaction or through a combination of such approaches. The
Portfolio will not pay any additional fees for credit support, although the
existence of credit support may increase the price of a security.
Examples of credit support arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of "reserve
funds" (where cash or investments, sometimes funded from a portion of the
payments on the underlying assets, are held in reserve against future losses)
and "overcollateralization" (where the scheduled payments on, or the principal
amount of, the underlying assets exceeds that required to make payment of the
securities and pay any servicing or other fees). The degree of credit support
provided for each issue is generally based on historical information respecting
the level of credit risk associated with the underlying assets. Delinquencies
or losses in excess of those anticipated could adversely affect the return on an
investment in such issue.
RISK FACTORS RELATING TO MORTGAGE-BACKED SECURITIES
The yield characteristics of Mortgage-Backed Securities differ from
traditional debt securities. Among the major differences are that interest and
principal payments are made more frequently, usually monthly, and that principal
may be prepaid at any time because the underlying mortgage loans or other assets
generally may be prepaid at any time. As a result, if the Portfolio purchases
such a security at a premium, a prepayment rate that is faster than expected
will reduce yield to maturity, while a prepayment rate that is slower than
expected will have the opposite effect of increasing yield to maturity.
Alternatively, if the Portfolio purchases these securities at a discount, faster
than expected prepayments will increase, while slower than expected prepayments
will reduce, yield to maturity.
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<PAGE>
Although the extent of prepayments on a pool of mortgage loans depends on
various economic and other factors, as a general rule prepayments on fixed rate
mortgage loans will increase during a period of falling interest rates and
decrease during a period of rising interest rates. Accordingly, amounts
available for reinvestment by the Portfolio are likely to be greater during a
period of declining interest rates and, as a result, likely to be reinvested at
lower interest rates than during a period of rising interest rates. Mortgage-
Backed Securities may decrease in value as a result of increases in interest
rates and may benefit less than other fixed income securities from declining
interest rates because of the risk of prepayment. The markets for Mortgage-
Backed Securities may be more illiquid than those of other securities.
INVESTMENT RESTRICTIONS
The Portfolio is subject to the investment limitations enumerated in this
subsection which may be changed only by a vote of the holders of a majority of
the Portfolio's outstanding shares (as defined below under "Miscellaneous").
The Portfolio may not:
(1) invest 25% or more of the value of its total assets in any one
industry (Mortgage-Backed Securities and other securities issued
or guaranteed by the U.S. government or any agency or
instrumentality thereof are not treated as industries); provided,
however, that the Portfolio will, except for temporary defensive
purposes, invest at least 25% of the value of its total assets
in securities which represent interests in mortgages or liens on
real property;
(2) issue senior securities (including borrowing money, including on
margin if margin securities are owned) in excess of 33 1/3% of
its total assets (including the amount of senior securities
issued but excluding any liabilities and indebtedness not
constituting senior securities) except that the Portfolio may
borrow up to an additional 5% of its total assets for temporary
purposes; or pledge its assets other than to secure such
issuances or in connection with hedging transactions, short
sales, when-issued and forward commitment transactions and
similar investment strategies. The Portfolio's obligations under
interest rate swaps are not treated as senior securities;
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<PAGE>
(3) make loans of money or property to any person, except through
loans of portfolio securities, the purchase of fixed income
securities consistent with the Portfolio's investment objective
and policies or the acquisition of securities subject to
repurchase agreements;
(4) underwrite the securities of other issuers, except to the extent
that in connection with the disposition of portfolio securities
or the sale of its own shares the Portfolio may be deemed to be
an underwriter;
(5) invest for the purpose of exercising control over management of
any company other than issuers of collateralized mortgage
obligations;
(6) purchase real estate or interests therein other than Commercial
and Residential Mortgage-Backed Securities and similar
instruments;
(7) purchase or sell commodities or commodity contracts for any
purposes except as, and to the extent, permitted by applicable
law without the Portfolio becoming subject to registration with
the Commodity Futures Trading Commission as a commodity pool; or
(8) make any short sale of securities except in conformity with
applicable laws, rules and regulations and unless, giving effect
to such sale, the market value of all securities sold short does
not exceed 25% of the value of the Portfolio's total assets and
the Portfolio's aggregate short sales of a particular class of
securities does not exceed 25% of the then outstanding securities
of that class.
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<PAGE>
TRUSTEES AND OFFICERS
The trustees and executive officers of the Fund, and their business
addresses and principal occupations during the past five years, are:
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- --------------------- ----------------------
<S> <C> <C>
William O. Albertini
Bell Atlantic Global Wireless Trustee Executive Vice President and
1717 Arch Street Chief Financial Officer since
29th Floor East August 1997, Bell Atlantic
Philadelphia, PA 19103 Global Wireless (Global
Age: 55 Wireless Communications);
Director, Executive Vice
President and Chief Financial
Officer from February 1995 -
August 1997, Vice President
and Chief Financial Officer
from January 1991 - February
1995, Bell Atlantic
Corporation (a diversified
telecommunications company);
Director, Groupo Iusacell,
S.A. de C.V.(Cellular
Communications Company) since
June 1994; Director, American
Waterworks, Inc. since May
1990; Trustee, The Carl E. &
Emily I. Weller Foundation
since October 1991.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- --------------------- ----------------------
<S> <C> <C>
Raymond J. Clark/1/
Office of the Treasurer Trustee, President and Treasurer of Princeton
Princeton University Treasurer University since 1987;
3 New South Building Trustee, The Compass Capital
P.O. Box 35 Group of Funds from 1987 to
Princeton, New Jersey 08540 1996; Trustee, United Way
Age: 63 Princeton Area Communities
from 1992- 94; Trustee,
Chemical Bank, New Jersey
Advisory Board from 1994 until
1995; Trustee, American Red
Cross - Mercer County Chapter
since 1995; and Trustee,
United Way-Greater Mercer
County from 1996-1997.
Robert M. Hernandez
USX Corporation Trustee Director since 1991, Vice
600 Grant Street Chairman and Chief Financial
6105 USX Tower Officer since 1994, Executive
Pittsburgh, PA 15219 Vice President - Accounting &
Age: 54 Finance and Chief Financial
Officer from 1991 to 1994, USX
Corporation (a diversified
company principally engaged in
energy and steel businesses);
Director, ACE Limited;
Trustee, Allegheny University
Hospitals, Allegheny General;
and Allegheny Health,
Education and Research
Foundation; Director,
Marinette Marine Corporation;
Director, Pittsburgh Baseball,
Inc.; and Director and
Chairman of the Board, RMI
Titanium Company.
</TABLE>
- ----------
/1/ This trustee may be deemed an "interested person" of the Fund as defined in
the 1940 Act.
-16-
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- --------------------- ----------------------
<S> <C> <C>
Anthony M. Santomero
The Wharton School Vice Chairman of the Deputy Dean from 1990 to 1994,
University of Pennsylvania Board Richard K. Mellon Professor of
Room 2344 Finance since April 1984,
Steinberg Hall-Dietrich Hall Director, Wharton Financial
Philadelphia, PA 19104-6367 Institutions Center, since
Age: 52 July 1995, and Dean's Advisory
Council Member since July
1984, The Wharton School,
University of Pennsylvania;
Associate Editor, Journal of
Banking and Finance since June
1978; Associate Editor,
Journal of Economics and
Business since October 1979;
Associate Editor, Journal of
Money, Credit and Banking
since January 1980; Research
Associate, New York University
Center for Japan-U.S. Business
and Economic Studies since
July 1989; Editorial Advisory
Board, Open Economics Review
since November 1990; Director,
The Zweig Fund and the Zweig
Total Return Fund; Director of
Municipal Fund for California
Investors, Inc., and Municipal
Fund for New York Investors,
Inc.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- --------------------- ----------------------
<S> <C> <C>
David R. Wilmerding, Jr.
One Aldwyn Center Chairman of the Board Chairman, Gee, Wilmerding &
Villanova, PA 19085 Associates, Inc. (investment
Age: 63 advisers) since February 1989;
Director, Beaver Management
Corporation; Managing General
Partner, Chestnut Street
Exchange Fund; Director,
Independence Square Income
Securities, Inc.; Director,
The Mutual Fire, Marine and
Inland Insurance Company;
Director U.S. Retirement
Communities, Inc.; Director,
Trustee or Managing General
Partner of a number of
investment companies advised
by PIMC and its affiliates.
Karen H. Sabath
BlackRock Advisors, Inc. Assistant Secretary Managing Director, BlackRock
345 Park Avenue Advisors, Inc. since February
New York, NY 10154 1998; President, Compass
Age: 33 Capital Group, Inc. from 1995
to March 1998; Managing
Director of BlackRock
Financial Management, Inc.
since 1993.
Ellen L. Corson
PFPC Inc. Assistant Treasurer Vice President and Director of
103 Bellevue Parkway Mutual Fund Accounting and
Wilmington, DE 19809 Administration, PFPC Inc.
Age: 34 since November 1997; Assistant
Vice President, PFPC Inc. from
March 1997 to November 1997;
Senior Accounting Officer,
PFPC Inc. from March 1993 to
March 1997.
</TABLE>
-18-
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION
NAME AND ADDRESS POSITION WITH FUND DURING PAST FIVE YEARS
- ---------------- --------------------- ----------------------
<S> <C> <C>
Brian P. Kindelan
BlackRock Financial Management, Inc. Secretary Vice President and Senior
1600 Market Street Counsel, BlackRock Financial
28th Floor Management, Inc. since April
Philadelphia, PA 19103 1998; Senior Counsel, PNC Bank
Age: 39 Corp. from May 1995 to April
1998; Associate, Stradley,
Ronon, Stevens & Young from
March 1990 to May 1995.
</TABLE>
The Fund pays trustees who are not affiliated with Blackrock, BlackRock
Advisors, Inc. ("ABAI") or BlackRock Distributors, Inc. ("BDI" or the
"Distributor") $20,000 annually ($30,000 annually in the event that the Fund's
assets exceed $40 billion) and $350 per investment portfolio of the Fund for
each full in-person meeting of the Board that they attend. The Fund pays the
Chairman and Vice Chairman an additional $10,000 and $5,000, respectively, for
their services in such capacities. Trustees who are not affiliated with BAI or
the Distributor are reimbursed for any expenses incurred in attending meetings
of the Board of Trustees or any committee thereof. The term of office of each
trustee will automatically terminate when such trustee reaches 72 years of age.
No officer, director or employee of BAI, BlackRock, BlackRock Institutional
Management Corporation ("ABIMC"), BlackRock International, Ltd. ("ABIL"), PFPC
Inc. ("APFPC"), or PNC Bank, National Association ("APNC Bank" or the
"Custodian") currently receives any compensation from the Fund. As of the date
of this Statement of Additional Information, the trustees and officers of the
Fund, as a group, owned less than 1% of the outstanding shares of each class of
each investment portfolio of the Fund.
The table below sets forth the compensation actually received from the Fund
Complex of which the Fund is a part by the trustees for the fiscal year ended
September 30, 1998:
-19-
<PAGE>
<TABLE>
<CAPTION>
========================================================================================================================
Total Compensation
PENSION OR from Registrant
RETIREMENT BENEFITS and Fund
AGGREGATE ACCRUED AS ESTIMATED ANNUAL Complex/1/
NAME OF PERSON, COMPENSATION FROM PART OF FUND BENEFITS UPON PAID TO
POSITION REGISTRANT EXPENSES RETIREMENT TRUSTEES
- -------------- ---------- ------- ---------- ---------------
<S> <C> <C> <C> <C>
Anthony M.
Santomero, Vice $57,675 N/A N/A (3)(2)$70,175
Chairman of the
Board
- -------------------------------------------------------------------------------------------------------------------------
David R.
Wilmerding, Jr., $62,675 N/A N/A (3)(2)$76,675
Chairman of the
Board
- -------------------------------------------------------------------------------------------------------------------------
William O.
Albertini, Trustee $52,675 N/A N/A (1)2$52,675
- -------------------------------------------------------------------------------------------------------------------------
Raymond J. Clark,
Trustee, President $52,675 N/A N/A (1)(2)$52,675
and Treasurer
- -------------------------------------------------------------------------------------------------------------------------
Robert M.
Hernandez, Trustee $52,675 N/A N/A (1)(2)$52,675
=========================================================================================================================
</TABLE>
SHAREHOLDER AND TRUSTEE LIABILITY. Under Massachusetts law, shareholders
of a business trust may, under certain circumstances, be held personally liable
as partners for the
- -------------------
/1/ A Fund Complex means two or more investment companies that hold themselves
out to investors as related companies for purposes of investment and
investor services, or have a common investment adviser or have an
investment adviser that is an affiliated person of the investment adviser
of any of the other investment companies.
/2/ Total number of investment company boards trustees served on within the
Fund Complex.
-20-
<PAGE>
obligations of the trust. However, the Fund's Declaration of Trust provides that
shareholders shall not be subject to any personal liability in connection with
the assets of the Fund for the acts or obligations of the Fund, and that every
note, bond, contract, order or other undertaking made by the Fund shall contain
a provision to the effect that the shareholders are not personally liable
thereunder. The Declaration of Trust provides for indemnification out of the
trust property of any shareholder held personally liable solely by reason of his
being or having been a shareholder and not because of his acts or omissions or
some other reason. The Declaration of Trust also provides that the Fund shall,
upon request, assume the defense of any claim made against any shareholder for
any act or obligation of the Fund, and shall satisfy any judgment thereon.
The Declaration of Trust further provides that all persons having any claim
against the trustees or Fund shall look solely to the trust property for
payment; that no trustee of the Fund shall be personally liable for or on
account of any contract, debt, tort, claim, damage, judgment or decree arising
out of or connected with the administration or preservation of the trust
property or the conduct of any business of the Fund; and that no trustee shall
be personally liable to any person for any action or failure to act except by
reason of his own bad faith, willful misfeasance, gross negligence or reckless
disregard of his duties as a trustee. With the exception stated, the
Declaration of Trust provides that a trustee is entitled to be indemnified
against all liabilities and expenses reasonably incurred by him in connection
with the defense or disposition of any proceeding in which he may be involved or
with which he may be threatened by reason of his being or having been a trustee,
and that the Fund will indemnify officers, representatives and employees of the
Fund to the same extent that trustees are entitled to indemnification.
INVESTMENT ADVISORY, ADMINISTRATION,
DISTRIBUTION AND SERVICING ARRANGEMENTS
Advisory AGREEMENT. The advisory services provided by BlackRock, an
indirect majority-owned subsidiary of PNC Bank Corp., and the fees received by
it for such services are described in the Prospectus. As stated in the
Prospectus, BlackRock may from time to time voluntarily waive its advisory fees
with respect to the Portfolio and may voluntarily reimburse the Portfolio for
expenses.
BlackRock renders advisory services to the Portfolio pursuant to an
Investment Advisory Agreement (the "Advisory Contract"). Under the Advisory
Contract, BlackRock is not liable
-21-
<PAGE>
for any error of judgment or mistake of law or for any loss suffered by the Fund
or the Portfolio in connection with the performance of the Advisory Contract,
except a loss resulting from willful misfeasance, bad faith or gross negligence
on the part of BlackRock in the performance of its duties or from reckless
disregard of its duties and obligations thereunder. The Advisory Contract is
terminable as to the Portfolio by vote of the Board of Trustees or by the
holders of a majority of the outstanding voting securities of the Portfolio, at
any time without penalty, on 60 days' written notice to BlackRock. BlackRock may
also terminate its advisory relationship with respect to the Portfolio, on 60
days' written notice to the Fund. The Advisory Contract terminates automatically
in the event of its assignment.
For the period from October 1, 1997 through September 30, 1998, the
Portfolio paid $172,973 in advisory fees to BlackRock, and BlackRock waived
$23,306 in expenses. For the period from October 1, 1996 through September 30,
1997, the Portfolio paid $323,455 in advisory fees to BlackRock and BlackRock
waived $45,000 in expenses. For the period from April 26, 1996 through
September 30, 1996, the Portfolio paid $150,034 in advisory fees to BlackRock,
and BlackRock waived $31,063 in expenses.
The Predecessor Portfolio was also advised by BlackRock. For the period
from April 1, 1996 through April 25, 1996, the Portfolio paid $24,092 in
advisory fees to BlackRock, and BlackRock waived $344 in expenses. For the
fiscal period from July 1, 1995 to March 31, 1996 and the fiscal period from
October 6, 1994 (commencement of investment operations) through June 30, 1995,
the Predecessor Portfolio paid $213,047 and $189,677, respectively, in
investment advisory fees to BlackRock pursuant to the prior advisory agreement.
In addition, during the same periods, BlackRock waived $3,652 and $56,269,
respectively, in expenses.
ADMINISTRATION AGREEMENT. The Fund has entered into an Administration
Agreement with BAI, whose principal business address is 345 Park Avenue, New
York, New York 10154, and PFPC, whose principal business address is 400 Bellevue
Parkway, Wilmington, DE 19809 (the "Administration Agreement"). PFPC has
agreed to maintain office facilities for the Fund; furnish the Fund with
statistical and research data, clerical, accounting, and bookkeeping services;
provide and supervise the operation of an automated data processing system to
process purchase and redemption orders; provide information and distribute
written communications to shareholders; handle shareholder problems and calls;
research issues raised by financial intermediaries relating to investments in a
Portfolio's shares; review and provide advice with respect to communications
-22-
<PAGE>
for a Portfolio's shares; monitor the investor programs that are offered in
connection with a Portfolio's shares; provide oversight and related support
services that are intended to ensure the delivery of quality service to the
holders of the Portfolio's shares; and provide certain other services required
by the Fund.
BAI is responsible for: the supervision and coordination of the performance
of the Fund's service providers; the negotiation of service contracts and
arrangements between the Fund and its service providers; acting as liaison
between the trustees of the Fund and the Fund's service providers; and providing
ongoing business management and support services in connection with the Fund's
operations. Pursuant to the terms of the Administration Agreement, BAI has
delegated certain of its duties thereunder to BDI.
As compensation for these services, BAI and PFPC (collectively, the
"Administrators") are entitled to receive a combined fee, computed daily and
payable monthly, at the maximum annual aggregate rate of .23% of the first $500
million of each Portfolio's average daily net assets, .21% of the next $500
million of each Portfolio's average daily net assets, and .19% of each
Portfolio's average daily net assets in excess of $1 billion. From time to time
the Administrators may waive some or all of their administration fees from a
Portfolio.
The Administration Agreement provides that the Administrators will not be
liable for any error of judgment or mistake of law or for any loss suffered by
the Fund or the Portfolio in connection with the performance of the
Administration Agreement, except a loss resulting from willful misfeasance, bad
faith or gross negligence in the performance of their respective duties or from
reckless disregard of their respective duties and obligations thereunder. In
addition, the Fund will indemnify each of BAI and PFPC and their affiliates
against any loss arising in connection with their provision of services under
the Administration Agreement, except that neither BAI nor PFPC nor their
affiliates shall be indemnified against any loss arising out of willful
misfeasance, bad faith, gross negligence or reckless disregard of their duties
under the Administration Agreement.
For the period from October 1, 1997 through September 30, 1998, the
Portfolio paid $24,794 in administrative fees, and the Administrators waived
fees totaling $137,776.
For the period from October 1, 1996 through September 30, 1997, the
Portfolio paid $297,578 in administrative fees to
-23-
<PAGE>
Compass Capital Group, Inc. ("CCG", which served as Co-Administrator to the Fund
from December 1, 1995 until September 30, 1997), PFPC and BDI (which served as
Co-Administrator to the Fund from January 16, 1996 until September 30, 1997),
and CCG, PFPC and BDI waived fees totalling $276,079. For the period from April
26, 1996 through September 30, 1996, the Portfolio paid $86,204 in
administrative fees to CCG, PFPC and BDI, and CCG, PFPC and BDI waived fees
totalling $54,252.
During the periods from April 1, 1996 through April 25, 1996 and January
13, 1996 through March 31, 1996, the Predecessor Portfolio paid $8,673 and
$8,620, respectively, in administrative fees to CCG, PFPC and BDI.
During the period from July 1, 1995 through January 12, 1996, the
Predecessor Portfolio received administrative services from PFPC. During that
period, the Predecessor Portfolio paid PFPC $55,878 in administrative fees
pursuant to a prior administrative agreement. Prior to July 1, 1995, the
Predecessor Portfolio received administrative services from State Street Bank
and Trust Company ("State Street").
CUSTODIAN AND TRANSFER AGENCY AGREEMENTS. PNC Bank, National Association
("PNC Bank"), whose principal business address is 1600 Market Street,
Philadelphia, Pennsylvania 19103, is custodian of the Fund's assets pursuant to
a custodian agreement (the "Custodian Agreement"). Under the Custodian
Agreement, PNC Bank or a sub-custodian (i) maintains a separate account or
accounts in the name of the Portfolio, (ii) holds and transfers portfolio
securities on account of the Portfolio, (iii) accepts receipts and makes
disbursements of money on behalf of the Portfolio, (iv) collects and receives
all income and other payments and distributions on account of the Portfolio's
securities and (v) makes periodic reports to the Board of Trustees concerning
the Portfolio's operations. PNC Bank is authorized to select one or more banks
or trust companies to serve as sub-custodian on behalf of the Fund, provided
that, with respect to sub-custodians other than sub-custodians for foreign
securities, PNC Bank remains responsible for the performance of all its duties
under the Custodian Agreement and holds the Fund harmless from the acts and
omissions of any sub-custodian. Citibank, N.A. serve as the international sub-
custodians for various portfolios of the Fund.
For its services to the Fund under the Custodian Agreement, PNC Bank
receives a fee which is calculated based upon the Portfolio's average gross
assets, with a minimum monthly fee of $1,000 per investment portfolio. PNC Bank
is also entitled to out-of-pocket expenses and certain transaction charges.
-24-
<PAGE>
PFPC, an affiliate of PNC Bank, serves as the transfer and dividend
disbursing agent for the Fund pursuant to a Transfer Agency Agreement (the
"Transfer Agency Agreement"), under which PFPC (i) issues and redeems shares in
the Portfolio, (ii) addresses and mails all communications by the Portfolio to
record owners of its shares, including reports to shareholders, dividend and
distribution notices and proxy materials for its meetings of shareholders, (iii)
maintains shareholder accounts and, if requested, sub-accounts and (iv) makes
periodic reports to the Board of Trustees concerning the operations of the
Portfolio. PFPC may, on 30 days' notice to the Fund, assign its duties as
transfer and dividend disbursing agent to any other affiliate of PNC Bank Corp.
For its services with respect to the Fund's Institutional Shares under the
Transfer Agency Agreement, PFPC is entitled to receive fees at the annual rate
of .03% of the average net asset value of outstanding Institutional Shares in
the Portfolio, plus per account fees and disbursements.
DISTRIBUTOR AND DISTRIBUTION PLAN. The Fund has entered into a
distribution agreement with the Distributor under which the Distributor, as
agent, offers shares of the Portfolio on a continuous basis. The Distributor
has agreed to use appropriate efforts to effect sales of the shares, but it is
not obligated to sell any particular amount of shares. The Distributor=s
principal business address is Four Falls Corporate Center, West Conshohocken,
Pennsylvania 19428.
The Fund has adopted an Amended and Restated Distribution and Service Plan
(the "Plan") pursuant to Rule 12b-1 under the 1940 Act on behalf of its
Institutional Shares. The Plan was approved by a majority of (i) the trustees
of the Fund and (ii) the trustees of the Fund who are not interested persons of
the Fund and who have no direct or indirect financial interest in the operation
of the Plan or in any agreement related to the Plan (the "Rule 12b-1 Trustees").
The Fund is not required or permitted under the Plan to make distribution
payments with respect to its Institutional Shares. However, the Plan permits
BDI, BlackRock, the Administrators and other companies that receive fees from
the Fund to make payments relating to distribution and sales support activities
out of their past profits or other sources available to them. The Distributor,
BAI and their affiliates may pay financial institutions, broker/dealers and/or
their salespersons certain compensation for the sale and distribution of shares
of the Fund or for services to the Fund. These payments ("Additional Payments")
may take the form of "due diligence" payments for a dealer's examination of the
Portfolio and payments for providing extra employee training and information
relating to the Portfolio; "listing" fees for the placement of the Portfolio
on a
-25-
<PAGE>
dealer's list of mutual funds available for purchase by its customers;
"finders" or "referral" fees for directing investors to the Fund; "marketing
support" fees for providing assistance in promoting the sale of the Funds'
shares; and payments for the sale of shares and/or the maintenance of share
balances. In addition, the Distributor, BAI and their affiliates may make
Additional Payments for subaccounting, administrative and/or shareholder
processing services. The Additional Payments made by the Distributor, BAI and
their affiliates may be a fixed dollar amount, may be based on the number of
customer accounts maintained by a financial institution or broker/dealer, or may
be based on a percentage of the value of shares sold to, or held by, customers
of the financial institutions or dealers involved, and may be different for
different institutions and dealers. Furthermore, the Distributor, BAI and their
affiliates may contribute to various non-cash and cash incentive arrangements to
promote the sale of shares, and may sponsor various contests and promotions
subject to applicable NASD regulations in which participants may receive prizes
such as travel awards, merchandise and cash. The Distributor, BAI and their
affiliates may also pay for the travel expenses, meals, lodging and
entertainment of broker/dealers, financial institutions and their salespersons
in connection with educational and sales promotional programs subject to
applicable NASD regulations.
The Plan will continue from year to year, provided that each such
continuance is approved at least annually by a vote of the Board of Trustees,
including a majority vote of the Rule 12b-1 Trustees, cast in person at a
meeting called for the purpose of voting on such continuance. The Plan may be
terminated with respect to the Portfolio at any time, without penalty, by the
vote of a majority of the Rule 12b-1 Trustees or by a vote of the holders of a
majority of the outstanding shares of the Portfolio. The Plan may not be
amended materially without the approval of the Board of Trustees, including a
majority of the Rule 12b-1 Trustees, cast in person at a meeting called for that
purpose. Any modification to the Plan which would materially increase the costs
borne by the Portfolio for distribution purposes pursuant to the Plan must also
be submitted to the stockholders of the Portfolio for approval. In addition,
while the Plan remains in effect, the selection and nomination of the Fund's
trustees who are not "interested persons" of the Fund shall be committed to the
discretion of the Fund's non-interested trustees.
PORTFOLIO TRANSACTIONS
The Adviser is responsible for decisions to buy and sell securities for the
Portfolio, the selection of brokers and dealers to effect the transactions and
the negotiation of prices and any brokerage commissions. The securities in
which the
-26-
<PAGE>
Portfolio invests are traded principally in the over-the-counter market. In the
over-the-counter market, securities are generally traded on a "net" basis with
dealers acting as principal for their own accounts without a stated commission,
although the price of the security usually includes a mark-up to the dealer.
Securities purchased in underwritten offerings generally include, in the price,
a fixed amount of compensation for the manager(s), underwriter(s) and dealer(s).
The Portfolio may also purchase certain money market instruments directly from
an issuer, in which case no commissions or discounts are paid. Purchases and
sales of debt securities on a stock exchange are effected through brokers who
charge a commission for their services.
The Adviser's primary considerations in selecting the manner of executing
securities transactions for the Portfolio will be prompt execution of orders,
the size and breadth of the market for the security, the reliability, integrity
and financial condition and execution capability of the firm, the size of and
difficulty in executing the order, and the best net price. There are many
instances when, in the judgment of the Adviser, more than one firm can offer
comparable execution services. In selecting among such firms, consideration is
given to those firms which supply research and other services in addition to
execution services. However, it is not the policy of the Adviser, absent
special circumstances, to pay higher commissions to a firm because it has
supplied such services.
The Adviser is able to fulfill its obligations to furnish a continuous
investment program to the Portfolio without receiving such information from
brokers; however, it considers access to such information to be an important
element of financial management. Although such information is considered
useful, its value is not determinable, as it must be reviewed and assimilated by
the Adviser, and does not reduce the Adviser's normal research activities in
rendering investment advice under the Advisory Contract. It is possible that
the Adviser's expenses could be materially increased if it attempted to purchase
this type of information or generate it through its own staff.
One or more of the other accounts which the Adviser manages may own from
time to time the same investments as the Portfolio. Investment decisions for
the Portfolio are made independently from those of such other accounts; however,
from time to time, the same investment decision may be made for more than one
company or account. When two or more companies or accounts seek to purchase or
sell the same securities, the securities actually purchased or sold will be
allocated among the companies and accounts on a good faith equitable basis by
the Adviser in its discretion in accordance with the accounts' various
investment objectives. In some cases, this system may adversely affect the
-27-
<PAGE>
price or size of the position obtainable for the Portfolio. In other cases,
however, the ability of the Portfolio to participate in volume transactions may
produce better execution for the Portfolio.
Although the Advisory Agreement contains no restrictions on portfolio
turnover, it is not the policy of the Portfolio to engage in transactions with
the objective of seeking profits from short-term trading. It is expected that
the annual portfolio turnover rate of the Portfolio will not exceed 400%,
excluding securities having a maturity of one year or less. Because it is
difficult to predict accurately portfolio turnover rate, actual turnover may be
higher or lower. Higher portfolio turnover results in increased Portfolio
expenses, including brokerage commissions, dealer mark-ups and other transaction
costs on the sale of securities and on reinvestment in other securities. The
Adviser will monitor the tax status of the Portfolio under the Internal Revenue
Code during periods in which the annual turnover rate of the Portfolio exceeds
100%. The portfolio turnover rate of the Portfolio is calculated by dividing
the lesser of the Portfolio's annual sales or purchases of portfolio securities
(exclusive of purchases or sales of securities whose maturities at the time of
acquisition were one year or less) by the monthly average value of the
securities held by the Portfolio during the year.
The Portfolio will not purchase securities during the existence of any
underwriting or selling group relating to such securities of which BAI, BIMC,
BlackRock, BIL, PNC Bank, PFPC, the Distributor or any affiliated person (as
defined in the 1940 Act) thereof is a member except pursuant to procedures
adopted by the Board of Trustees in accordance with Rule 10f-3 under the 1940
Act. In no instance will portfolio securities be purchased from or sold to BAI,
BIMC, BlackRock, BIL, PNC Bank, PFPC, the Distributor or any affiliated person
of the foregoing entities except as permitted by SEC exemptive order or by
applicable law.
For the periods from October 1, 1997 through September 30, 1998, October 1,
1996 through September 30, 1997, and April 26, 1996 through September 30, 1996,
the Portfolio paid no brokerage commissions. In addition, for the same periods,
the portfolio turnover rate for the Portfolio was 11%, 52% and 19%,
respectively. For the period from April 1, 1996 through April 25, 1996, the
period from July 1, 1995 through March 31, 1996 and the period from October 6,
1994 (commencement of operations) through June 30, 1995, the Predecessor
Portfolio paid no brokerage commissions. In addition, for the same periods, the
portfolio turnover rate for the Predecessor Portfolio was 4%, 119% and 215%,
respectively.
-28-
<PAGE>
PURCHASE AND REDEMPTION INFORMATION
Institutional Shares of the Portfolio are sold at the net asset value per
share next determined after a purchase order is received.
The Fund reserves the right, if conditions exist which make cash payments
undesirable, to honor any request for redemption or repurchase of the
Portfolio's shares by making payment in whole or in part in securities chosen by
the Fund and valued in the same way as they would be valued for purposes of
computing the Portfolio's net asset value. If payment is made in securities, a
shareholder may incur transaction costs in converting these securities into
cash. The Fund has elected, however, to be governed by Rule 18f-1 under the
1940 Act so that the Portfolio is obligated to redeem its shares solely in cash
up to the lesser of $250,000 or 1% of its net asset value during any 90-day
period for any one shareholder of the Portfolio.
Under the 1940 Act, the Portfolio may suspend the right to redemption or
postpone the date of payment upon redemption for any period during which the New
York Stock Exchange (the "NYSE") is closed (other than customary weekend and
holiday closings), or during which trading on the NYSE is restricted, or during
which (as determined by the SEC by rule or regulation) an emergency exists as a
result of which disposal or valuation of portfolio securities is not reasonably
practicable, or for such other periods as the SEC may permit. (The Portfolio
may also suspend or postpone the recordation of the transfer of its shares upon
the occurrence of any of the foregoing conditions.)
In addition to the situations described in the Prospectus, the Fund may
redeem shares involuntarily to reimburse the Portfolio for any loss sustained by
reason of the failure of a shareholder to make full payment for shares purchased
by the shareholder or to collect any charge relating to a transaction effected
for the benefit of a shareholder as provided in the Prospectus from time to
time.
VALUATION OF PORTFOLIO SECURITIES
In determining the approximate market value of portfolio investments, the
Fund may employ outside organizations, which may use, without limitation, a
matrix or formula method that takes into consideration market indexes, matrices,
yield curves and other specific adjustments. This may result in the securities
-29-
<PAGE>
being valued at a price different from the price that would have been determined
had the matrix or formula method not been used. All cash, receivables and
current payables are carried on the Fund's books at their face value. Other
assets, if any, are valued at fair value as determined in good faith under the
supervision of the Board of Trustees.
PERFORMANCE INFORMATION
Total Return. For purposes of quoting and comparing the performance of
shares of the Portfolio to the performance of other mutual funds and to stock or
other relevant indexes in advertisements, sales literature, communications to
shareholders and other materials, performance may be stated in terms of total
return. Under the rules of the SEC, funds advertising performance must include
total return quotes calculated according to the following formula:
ERV
T = [(-----) to the first power divided by n - 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.
Total return, or "T" in the formula above, is computed by finding the
average annual compounded rates of return over the specified periods that would
equate the initial amount invested to the ending redeemable value.
The total returns for the Portfolio include performance information for the
Predecessor Portfolio for periods prior to April 26, 1996, the date on which the
assets and liabilities of the Predecessor Portfolio were transferred to the
Portfolio. Based on the foregoing, the total returns for the Portfolio were as
follows:
-30-
<PAGE>
<TABLE>
<CAPTION>
==============================================================================
Average Annual Average Annual
Total Return Total Return
- ------------------------------------------------------------------------------
<S> <C> <C>
FOR THE
TWELVE MONTHS FROM COMMENCEMENT
ENDED OF OPERATIONS TO
9/30/98 9/30/98(1)
- -------------------------------------------------------------------------------
9.06% 10.81%
----- ------
===============================================================================
</TABLE>
- -------------------------------
(1) Predecessor Portfolio commenced investment operations on October 6,
1994.
The Portfolio may also from time to time include in advertisements, sales
literature, communications to shareholders and other materials a total return
figure that is not calculated according to the formula set forth above in order
to compare more accurately the performance of the Portfolio's shares with other
performance measures. For example, in comparing the total return of the
Portfolio's shares with data published by Lipper Analytical Services, Inc., CDA
Investment Technologies, Inc. or Weisenberger Investment Company Service, or
with the performance of the Salomon Broad Investment Grade Index, as
appropriate, the Portfolio may calculate the aggregate total return for its
shares for the period of time specified in the advertisement or communication by
assuming the investment of $10,000 in the Portfolio's shares and assuming the
reinvestment of each dividend or other distribution at net asset value on the
reinvestment date. Percentage increases are determined by subtracting the
initial value of the investment from the ending value and by dividing the
remainder by the beginning value.
In addition to average annual total returns, the Portfolio may quote
unaveraged or cumulative total returns reflecting the simple change in value of
an investment over a stated period. Average annual and cumulative total returns
may be quoted as a percentage or as a dollar amount, and may be calculated for a
single investment, a series of investments, or a series of redemptions, over any
time period. Total returns may be broken down into their components of income
and capital (including capital gains and changes in share price) in order to
illustrate the relationship of these factors and their contributions to total
return. Total returns may be quoted on a before-tax or after-tax basis. Total
returns, yields, and other performance information may be quoted numerically or
in a table, graph or similar illustration.
-31-
<PAGE>
YIELD. The Portfolio may advertise its yield on its Institutional Shares.
Under the rules of the SEC, the Portfolio must calculate yield using the
following formula:
a-b
YIELD = 2[(----- +1) to the sixth power - 1]
cd
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 = the 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 the Portfolio is recognized by accruing 1/360th of the stated dividend rate
of the security each day that the security is in the Portfolio. Except as noted
below, interest earned on any debt obligations held by the Portfolio is
calculated by computing the yield to maturity of each obligation held by the
Portfolio 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 obligation (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 held by 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.
With respect to mortgage or other receivables-backed obligations which are
expected to be subject to monthly payments
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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) the Portfolio 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. The amortization schedule will be adjusted
monthly to reflect changes in the market values of debt obligations.
Undeclared earned income will be subtracted from the maximum offering price
per share (variable "d" in the formula). Undeclared earned income is the net
investment income which, at the end of the base period, has not been declared as
a dividend, but is reasonably expected to be and is declared and paid as a
dividend shortly thereafter.
The yield for the 30-day period ended September 30, 1998 for the Portfolio
was 6.24%.
OTHER INFORMATION REGARDING INVESTMENT RETURNS. In addition to providing
performance information that demonstrates the total return or yield of
Institutional Shares of the Portfolio over a specified period of time, the Fund
may provide certain other information demonstrating hypothetical investment
returns. Such information may include, but is not limited to, illustrating the
compounding effects of a dividend in a dividend reinvestment plan.
MISCELLANEOUS. Performance information for the Portfolio assumes the
reinvestment of dividends and distributions. Performance information may
reflect fee waivers that subsidize and reduce the total operating expenses of
the Portfolio. In these cases, the Portfolio's return would be lower if there
were not such waivers.
Yield on shares of the Portfolio will fluctuate daily and does not provide
a basis for determining future yield. Because yield will fluctuate, it cannot
be compared with yields on savings account or other investment alternatives that
provide an agreed to or guaranteed fixed yield for a stated period of time. In
comparing the yield of one fund to another, consideration should be given to
each fund's investment policies, including the types of investments made,
lengths of maturities of the portfolio securities, and whether there are any
special account charges which may reduce the effective yield. The fees which
may be imposed by authorized dealers and other institutions on their
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<PAGE>
customers are not reflected in the calculations of total returns or yields for
the Portfolio.
As stated above, the Fund 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 an investment in
the Portfolio are reinvested by being paid in additional Portfolio shares, any
future income or capital appreciation of the Portfolio would increase the value,
not only of the original investment in the Portfolio, but also of the additional
Portfolio shares received through reinvestment. The Fund may also include
discussions or illustrations of the potential investment goals of a prospective
investor, investment management techniques, policies or investment suitability
of the Portfolio, 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
shareholders may summarize the substance of information contained in shareholder
reports (including the investment composition of the Portfolio), as well as the
views of BlackRock as to current market, economy, trade and interest rate
trends, legislative, regulatory and monetary developments, investment strategies
and related matters believed to be of relevance to the Portfolio. The Fund 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 the
Portfolio. In addition, advertisements or shareholder communications may
include a discussion of certain attributes or benefits to be derived by an
investment in the Portfolio. Such advertisements or communications may include
symbols, headlines or other material which highlight or summarize the
information discussed in more detail therein.
TAXES
The following is only a summary of certain additional tax considerations
generally affecting the Portfolio and its shareholders that are not described in
the Prospectus. No attempt is made to present a detailed explanation of the tax
treatment of the Portfolio or its shareholders, and the discussion here and in
the Prospectuses is not intended as a substitute for careful tax planning.
Investors are urged to consult their tax advisers with specific reference to
their own tax situation.
The Portfolio will elect to be taxed as a regulated investment company
under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"). As a regulated investment
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<PAGE>
company, the Portfolio generally is exempt from federal income tax on its net
investment income (i.e., its investment company taxable income as that term is
defined in the Code without regard to the deduction for dividends paid) and net
capital gain (i.e., the excess of its net long-term capital gain over net short-
term capital loss) that it distributes to shareholders, provided that it
distributes an amount equal to at least 90% of its net investment income (the
"Distribution Requirement") and satisfies certain other requirements of the Code
that are described below. Distributions of net investment income made during the
taxable year or, under specified circumstances, within twelve months after the
close of the taxable year will satisfy the Distribution Requirement.
In addition to satisfaction of the Distribution Requirement, the Portfolio
must derive at least 90% of its gross income from dividends, interest, certain
payments with respect to securities loans and gains from the sale or other
disposition of stock or securities or foreign currencies (including, but not
limited to, gains from forward foreign currency exchange contacts), or from
other income derived with respect to its business of investment in such stock,
securities, or currencies (the "Income Requirement").
In addition to the foregoing requirements, at the close of each quarter of
its taxable year, at least 50% of the value of the Portfolio's assets must
consist of cash and cash items, U.S. government securities, securities of other
regulated investment companies, and securities of other issuers (as to which the
Portfolio has not invested more than 5% of the value of its total assets in
securities of such issuer and as to which the Portfolio does not hold more than
10% of the outstanding voting securities of such issuer), and no more than 25%
of the value of the Portfolio's total assets may be invested in the securities
of any one issuer (other than U.S. Government securities and securities of other
regulated investment companies), or in two or more issuers which such Portfolio
controls and which are engaged in the same or similar trades or businesses.
Distributions of net investment income will be taxable to shareholders as
ordinary income, regardless of whether such distributions are paid in cash or
are reinvested in shares. Shareholders receiving any taxable distribution from
the Portfolio in the form of additional shares will be treated as receiving a
taxable distribution in an amount equal to the fair market value of the shares
received, determined as of the reinvestment date.
The Portfolio intends to distribute to shareholders any of its net capital
gain for each taxable year. Net capital gain is distributed as a capital gain
dividend and is taxable to
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<PAGE>
shareholders as long-term capital gain, regardless of the length of time the
shareholder has held his shares, whether net capital gain was recognized by the
Portfolio prior to the date on which a shareholder acquired shares of the
Portfolio and whether the distribution was paid in cash or reinvested in shares.
It is expected that distributions from the Portfolio will generally not
qualify for the "dividends received" deduction for corporate shareholders.
Ordinary income of individuals will be taxable at a maximum marginal rate
of 39.6%, but because of limitations on itemized deductions otherwise allowable
and the phase-out of personal exemptions, the maximum effective marginal rate of
tax for some taxpayers may be higher. Long-term capital gains of individuals
are taxed at a maximum rate of 28%. Capital gains and ordinary income of
corporate taxpayers are both taxed at a maximum rate of 35%. Investors should
be aware that any loss realized upon the sale, exchange or redemption of shares
held for six months or less will be treated as a long-term capital loss to the
extent any capital gain dividends have been paid with respect to such
shares.
The Portfolio may engage in hedging or derivatives transactions involving
forward contracts, options and futures contracts and short sales. Such
transactions will be subject to special provisions of the Code that, among other
things, may affect the character of gains and losses realized by the Portfolio
(that is, may affect whether gains or losses are ordinary or capital),
accelerate recognition of income of the Portfolio and defer recognition of
certain of the Portfolio's losses. These rules could therefore affect the
character, amount and timing of distributions to shareholders. In addition,
these provisions (1) will require the Portfolio to "mark-to-market" certain
types of positions in its portfolio (that is, treat them as if they were closed
out) and (2) may cause the Portfolio to recognize income without receiving cash
with which to pay dividends or make distributions in amounts necessary to
satisfy the Distribution Requirement and avoid the 4% excise tax (described
below). The Portfolio intends to monitor its transactions, will make the
appropriate tax elections and will make the appropriate entries in its books and
records when it acquires any option, futures contract, forward contract or
hedged investment in order to mitigate the effect of these rules.
If for any taxable year the Portfolio does not qualify as a regulated
investment company, all of its taxable income will be subject to tax at regular
corporate rates without any deduction for distributions to shareholders, and all
distributions will be taxable as ordinary dividends to the extent of the
Portfolio's current and accumulated earnings and profits. Such distributions
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<PAGE>
will be eligible for the dividends received deduction in the case of corporate
shareholders.
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 Portfolio intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and any capital gain net income
prior to the end of the calendar year to avoid liability for this excise
tax.
The Fund will be required in certain cases to withhold and remit to the
United States Treasury 31% of dividends and gross sale proceeds paid to any
shareholder (i) who has provided either an incorrect tax identification number
or no number at all, (ii) who is subject to backup withholding by the Internal
Revenue Service for failure to report the receipt of interest or dividend income
properly, or (iii) who has failed to certify to the Fund that he is not subject
to backup withholding or that he is an "exempt recipient."
Shareholders will be advised annually as to the federal income tax
consequences of distributions made by the Portfolio each year.
The foregoing general discussion of federal income tax consequences is
based on the Code and the regulations issued thereunder as in effect on the date
of this Statement of Additional Information. Future legislative or
administrative changes or court decisions may significantly change the
conclusions expressed herein, and any such changes or decisions may have a
retroactive effect with respect to the transactions contemplated herein.
Although the Portfolio 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 its 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 Portfolio may be
subject to the tax laws of such states or localities. Shareholders should
consult their tax advisors about state and local tax consequences, which may
differ from the federal income tax consequences described above.
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<PAGE>
ADDITIONAL INFORMATION CONCERNING SHARES
Shares of the Fund have noncumulative voting rights and, accordingly, the
holders of more than 50% of the Fund's outstanding shares (irrespective of
Portfolio or class) may elect all of the trustees. Shares have no preemptive
rights and only such conversion and exchange rights as the Board may grant in
its discretion. When issued for payment as described in the Prospectus, shares
will be fully paid and non-assessable by the Fund.
There will normally be no meetings of shareholders for the purpose of
electing trustees unless and until such time as required by law. At that time,
the trustees then in office will call a shareholders meeting to elect trustees.
Except as set forth above, the trustees will continue to hold office and may
appoint successor trustees. The Fund's Declaration of Trust provides that
meetings of the shareholders of the Fund will be called by the trustees upon the
written request of shareholders owning at least 10% of the outstanding shares
entitled to vote.
Rule 18f-2 under the 1940 Act provides that any matter required by the
provisions of the 1940 Act or applicable state law, or otherwise, to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Fund shall not be deemed to have been effectively acted upon
unless approved by the holders of a majority of the outstanding shares of each
investment portfolio affected by such matter. Rule 18f-2 further provides that
an investment portfolio shall be deemed to be affected by a matter unless the
interests of each investment portfolio in the matter are substantially identical
or the matter does not affect any interest of the investment portfolio. Under
the Rule, the approval of an investment advisory agreement, a distribution plan
subject to Rule 12b-1 under the 1940 Act or any change in a fundamental
investment policy would be effectively acted upon with respect to an investment
portfolio only if approved by a majority of the outstanding shares of such
investment 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 Trustees may be effectively acted
upon by shareholders of the Fund voting together in the aggregate without regard
to a particular investment portfolio.
The proceeds received by the Portfolio for each issue or sale of its
shares, and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to and constitute the underlying assets of the Portfolio. The underlying assets
of the Portfolio will be segregated on the books of account,
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<PAGE>
and will be charged with the liabilities in respect to the Portfolio and with a
share of the general liabilities of the Fund.
The Funds' Declaration of Trust authorizes the Board of Trustees, without
shareholder approval (unless otherwise required by applicable law), to: (i)
sell and convey the assets belonging to a class 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
class 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; (ii) sell and convert the
assets belonging to one or more classes of shares into money and, in connection
therewith, to cause all outstanding shares of such class to be redeemed at their
net asset value; or (iii) combine the assets belonging to a class of shares with
the assets belonging to one or more other classes of shares if the Board of
Trustees reasonably determines that such combination will not have a material
adverse effect on the shareholders of any class participating in such
combination and, in connection therewith, to cause all outstanding shares of any
such class to be redeemed or converted into shares of another class of shares at
their net asset value. The Board of Trustees may authorize the termination of
any class of shares after the assets belonging to such class have been
distributed to its shareholders.
MISCELLANEOUS
Effective January 31, 1998, the Fund changed its name from Compass Capital
Funds(SM) to BlackRock Funds(SM).
COUNSEL. The law firm of Simpson Thacher & Bartlett, 425 Lexington Avenue,
New York, New York 10017 serves as the Fund's counsel.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, 2400 Eleven Penn
Center, Philadelphia, Pennsylvania 19103, serves as the Fund's independent
accountants.
FIVE PERCENT OWNERS. The name, address and percentage ownership of each
person that on October 30, 1998 owned of record or beneficially 5% or more of
the outstanding shares of the Portfolio was as follows: Ameritech Pension
Trust, c/o Harris Trust & Savings Bank, 111 West Monroe 5W, Chicago, IL 60603,
99.92%.
On November 13, 1998, PNC Bank held of record approximately 72% of the
Fund's outstanding shares, and may be deemed a controlling person of the Fund
under the 1940 Act.
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<PAGE>
PNC Bank is a national bank organized under the laws of the United States. All
of the capital stock of PNC Bank is owned by PNC Bancorp, Inc. All of the
capital stock of PNC Bancorp, Inc. is owned by PNC Bank Corp., a publicly-held
bank holding company.
BANKING LAWS. Banking laws and regulations currently 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 such banking laws and regulations do not
prohibit such a holding company or affiliate or banks generally from acting as
investment adviser, administrator, transfer agent or custodian to such an
investment company, or from purchasing shares of such a company as agent for and
upon the order of customers. BlackRock, BAI, PFPC and PNC Bank are subject to
such banking laws and regulations.
BlackRock, BAI, PFPC and PNC Bank believe they may perform the services for
the Fund contemplated by their respective agreements with the Fund without
violation of applicable banking laws or regulations. It should be noted,
however, that there have been no cases deciding whether bank and non-bank
subsidiaries of a registered bank holding company may perform services
comparable to those that are to be performed by these companies, and future
changes in either Federal or state statutes and regulations relating to
permissible activities of banks and their subsidiaries or affiliates, as well as
further judicial or administrative decisions or interpretations of present and
future statutes and regulations, could prevent these companies from continuing
to perform such services for the Fund. If such were to occur, it is expected
that the Board of Trustees would recommend that the Fund enter into new
agreements or would consider the possible termination of the Fund. Any new
advisory or sub-advisory agreement would be subject to shareholder
approval.
SHAREHOLDER APPROVALS. As used in this Statement of Additional Information
and in the Prospectus, a "majority of the outstanding shares" means, with
respect to the approval of the Portfolio's investment advisory agreement, a
distribution plan or a change in a fundamental investment policy, the lesser of
(1) 67% of the shares of the Portfolio represented at a meeting at which the
holders of more than 50% of the outstanding shares of the Portfolio are present
in person or by proxy, or (2) more than 50% of the outstanding shares of the
Portfolio.
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<PAGE>
FINANCIAL STATEMENTS
The audited financial statements for the Portfolio contained in its Annual
Report to Shareholders for the period ended September 30, 1998 (the "1998 Annual
Report") are incorporated by reference in this Statement of Additional
Information. No other parts of the 1998 Annual Report are incorporated by
reference herein. The financial statements included in the 1998 Annual Report
have been audited by the Fund's independent accountant, PricewaterhouseCoopers
LLP, except for the financial statements and financial highlights covering the
periods ended March 31, 1996 and June 30, 1995 which have been audited by other
auditors. The report of PricewaterhouseCoopers LLP is incorporated herein by
reference. Such financial statements have been incorporated herein in reliance
upon such report given upon their authority as experts in accounting and
auditing. Additional copies of the Annual Report may be obtained at no charge
by telephoning the Distributor at the telephone number appearing on the front
page of this Statement of Additional Information.
The financial statements included in the 1998 Annual Report for the period
from October 6, 1994 through June 30, 1995 and for the nine month period ended
March 31, 1996 have been audited by the former independent accountants of the
Predecessor Portfolio, Deloitte & Touche, L.L.P., whose report thereon is also
incorporated herein by reference. Such financial statements have been
incorporated herein by reference in reliance on the reports of
PricewaterhouseCoopers LLP, and Deloitte & Touche, L.L.P. given upon their
authority as experts in accounting and auditing.
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<PAGE>
BLACKROCK FUNDS(SM)
PART C
OTHER INFORMATION
Item 24. Financial Statements and Exhibits
(a) Financial Statements:
(1) Incorporated by reference into Part A of the Registration
Statement are the following tables:
(i) Audited Financial Highlights for the Money Market,
U.S. Treasury Money Market, Municipal Money Market,
Ohio Municipal Money Market, Pennsylvania Municipal
Money Market, North Carolina Municipal Money Market,
Virginia Municipal Money Market, Large Cap Value
Equity, Large Cap Growth Equity, Mid-Cap Value Equity,
Mid-Cap Growth Equity, Small Cap Value Equity, Small
Cap Growth Equity, International Equity,
International Small Cap Equity, International Emerging
Markets, Select Equity, Index Equity, Balanced,
Intermediate Government Bond, Intermediate Bond,
Managed Income, Tax-Free Income, Pennsylvania Tax-Free
Income, Government Income and Ohio Tax-Free Income
Portfolios for the fiscal years or periods ended
September 30, 1997, September 30, 1996, September 30,
1995, September 30, 1994, September 30, 1993,
September 30, 1992, September 30, 1991 and September
30, 1990.
(ii) Audited Financial Highlights for the International
Bond, New Jersey Tax-Free Income and New Jersey
Municipal Money Market Portfolios for the fiscal years
or periods ended September 30, 1997, September 30,
1996 and January 31, 1996, and for the fiscal years
ended February 28, 1995, February 28, 1994, February
28, 1993 and February 29, 1992.
(iii) Audited Financial Highlights for the Low Duration
Bond (formerly the Short Government Bond) and Core
Bond Portfolios for the fiscal years or periods ended
September 30, 1997, September 30, 1996 and March 31,
1996, and for the fiscal years ended June 30, 1995,
June 30, 1994 and June 30, 1993.
<PAGE>
(iv) Audited Financial Highlights for the Multi-Sector
Mortgage Securities Portfolio III for the fiscal years
or periods ended September 30, 1998, September 30,
1997, September 30, 1996, March 31, 1996 and June 30,
1995.
(v) Audited Financial Highlights for the BlackRock
Strategic Portfolio I for the fiscal period ended
September 30, 1998.
(2) Incorporated by reference into Part B of the Registration
Statement are the following audited financial statements:
(i) With respect to the Money Market, U.S. Treasury Money
Market, Municipal Money Market, Ohio Municipal Money
Market, Pennsylvania Municipal Money Market, North
Carolina Municipal Money Market, New Jersey Municipal
Money Market and Virginia Municipal Money Market
Portfolios:
Report of Independent Accountants
(PricewaterhouseCoopers LLP) for the year ended
September 30, 1997;
Statements of Net Assets - September 30, 1997;
Statements of Operations for the year ended
September 30, 1997;
Statements of Changes in Net Assets for the years
ended September 30, 1997 and 1996;
Financial Highlights for all periods
presented;
Notes to Financial Statements.
(ii) With respect to the Large Cap Value Equity, Large Cap
Growth Equity, Mid-Cap Value Equity, Mid-Cap Growth
Equity, Small Cap Growth Equity, Select Equity, Index
Equity, Small Cap Value Equity, International Equity,
International Small Cap Equity, International Emerging
Markets and Balanced Portfolios:
Report of Independent Accountants
(PricewaterhouseCoopers LLP) for the year or
period ended September 30, 1997;
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Statements of Net Assets - September 30, 1997;
Statements of Operations for the year or period
ended September 30, 1997;
Statements of Changes in Net Assets for the years
or periods ended September 30, 1997 and 1996;
Financial Highlights for all periods
presented;
Notes to Financial Statements.
(iii) With respect to the Managed Income, Tax-Free Income,
Intermediate Government Bond, Ohio Tax-Free Income,
Pennsylvania Tax-Free Income, Intermediate Bond,
Government Income, Low Duration Bond (formerly the
Short Government Bond), Core Bond, New Jersey Tax-Free
Income and International Bond Portfolios:
Report of Independent Accountants
(PricewaterhouseCoopers LLP) for the year ended
September 30, 1997;
Schedules of Investments and Statements of Assets
and Liabilities with respect to the International
Bond and Tax-Free Income Portfolios - September
30, 1997;
Statements of Net Assets (all Portfolios except
International Bond and Tax-Free Income Portfolios)
- September 30, 1997;
Statements of Operations for the year ended
September 30, 1997;
Statement of Cash Flows with respect to the
Government Income Portfolio for the year ended
September 30, 1997;
Statements of Changes in Net Assets for the years
or periods ended September 30, 1997 and 1996 and
for the periods ended March 31, 1996 for the Low
Duration Bond (formerly the Short Government Bond)
Portfolio and the Core Bond Portfolio and
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January 31, 1996 for the International Bond and
New Jersey Tax-Free Income Portfolios;
Financial highlights for all periods presented
except for the periods ended June 30, 1995 and
prior periods for the Low Duration Bond (formerly
the Short Government Bond) and Core Bond
Portfolios;
Notes to Financial Statements.
(iv) With respect to the Low Duration Bond Portfolio
(formerly the Short Government Bond Portfolio) and
Core Bond Portfolio:
Report of Independent Accountants (Deloitte &
Touche L.L.P.) for the fiscal year ended June 30,
1995 as it relates to the Statement of Changes in
Net Assets for the year ended June 30, 1995 and
the Financial Highlights for the years or periods
ended June 30, 1995, 1994 and 1993.
(v) With respect to The Multi-Sector Mortgage Securities
Portfolio III:
Report of Independent Accountants
(PricewaterhouseCoopers LLP) for the year ended
September 30, 1998;
Schedule of Investments - September 30, 1998;
Statement of Assets and Liabilities - September
30, 1998;
Statement of Operations for the year ended
September 30, 1998;
Statement of Changes in Net Assets for the years
ended September 30, 1998 and September 30,
1997;
Financial highlights for all periods presented;
Notes to Financial Statements.
(vi) With respect to the BlackRock Strategic Portfolio
I:
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Report of Independent Accountants
(PricewaterhouseCoopers LLP) for the period ended
September 30, 1998;
Schedule of Investments - September 30, 1998;
Statement of Net Assets - September 30, 1998;
Statement of Operations for the period ended
September 30, 1998;
Statement of Changes in Net Assets for the period
ended September 30, 1998;
Financial highlights for all periods
presented;
Notes to Financial Statements.
(vii) With respect to The U.S. Large Company Series of The
DFA Investment Trust Company:
Report of Independent Accountants
(PricewaterhouseCoopers LLP) for the fiscal year
ended November 30, 1997;
Statement of Net Assets - November 30, 1997;
Statement of Operations for the year ended
November 30, 1997;
Statement of Changes in Net Assets for the years
ended November 30, 1997 and November 30,
1996;
Financial Highlights for all periods
presented;
Notes to Financial Statements.
(3) Included in Part B of the Registration Statement are the
following unaudited financial statements with respect to the
International Small Cap Equity Portfolio:
Schedule of Investments - February 28, 1998
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Statement of Assets and Liabilities - February 28,
1998;
Statement of Operations for the period ended
February 28, 1998;
Statement of Changes in Net Assets for the period
ended February 28, 1998;
Statement of Realized Gains and Losses for the
period ended February 28, 1998;
Financial Highlights;
Notes to Financial Statements.
(b) Exhibits:
(1) (a) Declaration of Trust of the Registrant dated December
22, 1988 is incorporated herein by reference to
Exhibit (1)(a) of Post-Effective Amendment No. 33 to
Registrant's Registration Statement on Form N-1A filed
on January 27, 1998.
(b) Amendment No. 1 to Declaration of Trust dated May 4,
1989 is incorporated herein by reference to Exhibit
(1)(b) of Post-Effective Amendment No. 33 to
Registrant's Registration Statement on Form N-1A filed
on January 27, 1998.
(c) Amendment No. 2 to the Declaration of Trust dated
December 23, 1993 is incorporated herein by reference
to Exhibit (1)(c) of Post-Effective Amendment No. 33
to Registrant's Registration Statement on Form N-1A
filed on January 27, 1998.
(d) Amendment No. 3 to the Declaration of Trust dated
January 5, 1996 is incorporated by reference to
Exhibit 1(d) of Post-Effective Amendment No. 23 to
Registrant's Registration Statement on Form N-1A (No.
33-26305) filed on October 18, 1996 ("Post-Effective
Amendment No. 23").
(e) Amendment No. 4 to the Declaration of Trust dated
December 23, 1997 is incorporated herein by reference
to
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<PAGE>
Exhibit (1)(e) of Post-Effective Amendment No. 33 to
Registrant's Registration Statement on Form N-1A filed
on January 27, 1998.
(2) Registrant's Code of Regulations is incorporated
herein by reference to Exhibit (2) of Post-Effective
Amendment No. 33 to Registrant's Registration
Statement on Form N-1A filed on January 27, 1998.
(3) None.
(4) Sections V, VIII and IX of Registrant's Declaration of
Trust dated December 22, 1988 are incorporated herein
by reference to Exhibit (1)(a) of Post-Effective
Amendment No. 33 to Registrant's Registration
Statement on Form N-1A filed on January 27, 1998;
Article II of Registrant's Code of Regulations is
incorporated herein by reference to Exhibit (2) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(5) (a) Investment Advisory Agreement between Registrant and
PNC Asset Management Group, Inc. relating to all
Portfolios except the Multi-Sector Mortgage Securities
Portfolio III and Index Equity Portfolio is
incorporated herein by reference to Exhibit (5)(a) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(b) Investment Advisory Agreement between Registrant and
BlackRock Financial Management, Inc. with respect to
the Multi-Sector Mortgage Securities Portfolio III is
incorporated herein by reference to Exhibit (5)(b) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(c) Addendum No. 1 to Investment Advisory Agreement
between Registrant and PNC Asset Management Group,
Inc. with respect to the Mid-Cap Value Equity and Mid-
Cap Growth Equity Portfolios is incorporated herein by
reference to Exhibit 5(c) of Post-Effective Amendment
No. 27 to Registrant's Registration Statement on Form
N-1A filed on January 28, 1997.
C-7
<PAGE>
(d) Form of Amendment No. 1 to Investment Advisory
Agreement between Registrant and BlackRock Financial
Management, Inc. with respect to BlackRock Strategic
Portfolio I and BlackRock Strategic Portfolio II is
incorporated herein by reference to Exhibit 5(d) of
Post-Effective Amendment No. 26 to Registrant's
Registration Statement on Form N-1A filed on December
18, 1996.
(e) Form of Addendum No. 2 to Investment Advisory
Agreement between Registrant and PNC Asset Management
Group, Inc. with respect to the International Small
Cap Equity Portfolio is incorporated herein by
reference to Exhibit 5(e) of Post-Effective Amendment
No. 30 to Registrant's Registration Statement on Form
N-1A filed on August 19, 1997.
(f) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and BlackRock Financial Management, Inc.
with respect to the Managed Income, Tax-Free Income,
Intermediate Government Bond, Ohio Tax-Free Income,
Pennsylvania Tax-Free Income, Low Duration Bond,
Intermediate Bond, Government Income, New Jersey Tax-
Free Income and Core Bond Portfolios is incorporated
herein by reference to Exhibit (5)(c) of Post-
Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(g) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and Provident Capital Management, Inc.
with respect to the Large Cap Value Equity, Small Cap
Value Equity and Select Equity Portfolios is
incorporated herein by reference to Exhibit (5)(c) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(h) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and PNC Equity Advisors Company with
respect to the Large Cap Growth Equity and Small Cap
Growth Equity Portfolios is incorporated herein by
reference to Exhibit (5)(c) of Post-Effective
Amendment No. 21 to Registrant's Registration
Statement on Form N-1A filed on May 30, 1996.
C-8
<PAGE>
(i) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and PNC Institutional Management
Corporation with respect to the Money Market, U.S.
Treasury Money Market, Municipal Money Market,
Pennsylvania Municipal Money Market, Ohio Municipal
Money Market, North Carolina Municipal Money Market,
Virginia Municipal Money Market and New Jersey
Municipal Money Market Portfolios is incorporated
herein by reference to Exhibit (5)(c) of Post-
Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(j) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and CastleInternational Asset Management
Limited with respect to the International Equity and
International Emerging Markets Portfolios is
incorporated herein by reference to Exhibit (5)(c) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(k) Sub-Advisory Agreement among PNC Asset Management
Group, Inc., Provident Capital Management, Inc. and
BlackRock Financial Management, Inc. with respect to
the Balanced Portfolio is incorporated herein by
reference to Exhibit (5)(c) of Post-Effective
Amendment No. 21 to Registrant's Registration
Statement on Form N-1A filed on May 30, 1996.
(l) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and Provident Capital Management, Inc.
with respect to the Mid-Cap Value Equity Portfolio is
incorporated herein by reference to Exhibit 5(k) of
Post-Effective Amendment No. 27 to Registrant's
Registration Statement on Form N-1A filed on January
28, 1997.
(m) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and PNC Equity Advisors Company with
respect to the Mid-Cap Growth Equity Portfolio is
incorporated herein by reference to Exhibit 5(l) of
Post-Effective Amendment No. 27 to Registrant's
Registration Statement on Form N-1A filed on January
28, 1997.
C-9
<PAGE>
(n) Sub-Advisory Agreement between PNC Asset Management
Group, Inc. and BlackRock Financial Management, Inc.
with respect to the International Bond Portfolio is
incorporated herein by reference to Exhibit 5(m) of
Post-Effective Amendment No. 27 to Registrant's
Registration Statement on Form N-1A filed on January
28, 1997.
(o) Form of Sub-Advisory Agreement between PNC Asset
Management Group, Inc. and CastleInternational Asset
Management Limited with respect to the International
Small Cap Equity Portfolio is incorporated herein by
reference to Exhibit 5(o) of Post-Effective Amendment
No. 30 to Registrant's Registration Statement on Form
N-1A filed on August 19, 1997.
(p) Form of Addendum No. 3 to Investment Advisory
Agreement between Registrant and PNC Asset Management
Group, Inc. with respect to the Micro-Cap Equity
Portfolio, GNMA Portfolio, Delaware Tax-Free Income
Portfolio and Kentucky Tax-Free Income Portfolio is
incorporated herein by reference to Exhibit (5)(p) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(q) Form of Sub-Advisory Agreement between PNC Asset
Management Group, Inc. and PNC Equity Advisors Company
with respect to the Micro-Cap Equity Portfolio is
incorporated herein by reference to Exhibit (5)(q) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(r) Form of Sub-Advisory Agreement between BlackRock, Inc.
and BlackRock Financial Management, Inc. with respect
to the GNMA, Delaware Tax-Free Income and Kentucky
Tax-Free Income Portfolios is incorporated herein by
reference to Exhibit (5)(r) of Post-Effective
Amendment No. 34 to Registrant's Registration
Statement on Form N-1A filed on February 13, 1998.
(s) Form of Addendum No. 4 to Investment Advisory
Agreement between Registrant and BlackRock Advisors,
Inc. with respect to the High Yield Bond Portfolio is
C-10
<PAGE>
incorporated herein by reference to Exhibit 5(s) of
Post-Effective Amendment No. 37 to Registrant's
Registration Statement on Form N-1A filed on August 7,
1998.
(t) Form of Sub-Advisory Agreement between BlackRock
Advisors, Inc. and BlackRock Financial Management,
Inc. with respect to the High Yield Bond Portfolio is
incorporated herein by reference to Exhibit 5(t) of
Post-Effective Amendment No. 37 to Registrant's
Registration Statement on Form N-1A filed on August 7,
1998.
(6) (a) Distribution Agreement between Registrant and
Provident Distributors, Inc. dated January 31, 1994 is
incorporated herein by reference to Exhibit (6)(a) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(b) Form of Appendix A to Distribution Agreement between
Registrant and BlackRock Distributors, Inc. is
incorporated herein by reference to Exhibit 6(b) of
Post-Effective Amendment No. 37 to Registrant's
Registration Statement on Form N-1A filed on August 7,
1998.
(c) Amendment No. 2 to the Distribution Agreement between
Registrant and Provident Distributors, Inc. dated
October 18, 1994 is incorporated herein by reference
to Exhibit (6)(c) of Post-Effective Amendment No. 33
to Registrant's Registration Statement on Form N-1A
filed on January 27, 1998.
(d) Amendment No. 3 to the Distribution Agreement between
Registrant and Provident Distributors, Inc. is
incorporated herein by reference to Exhibit (6)(d) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(7) None.
(8) (a) Custodian Agreement dated October 4, 1989 between
Registrant and PNC Bank, National Association is
incorporated herein by reference to Exhibit (8)(a) of
Post-Effective Amendment No. 33 to Registrant's
C-11
<PAGE>
Registration Statement on Form N-1A filed on January
27, 1998.
(b) Amendment No. 1 to Custodian Agreement between
Registrant and PNC Bank, National Association is
incorporated herein by reference to Exhibit (8)(b) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(c) Amendment No. 2 dated March 1, 1993 to Custodian
Agreement between Registrant and PNC Bank, National
Association with respect to the Short-Term Bond,
Intermediate-Term Bond, Core Equity, Small Cap Growth
Equity and North Carolina Municipal Money Market
Portfolios is incorporated herein by reference to
Exhibit (8)(c) of Post-Effective Amendment No. 33 to
Registrant's Registration Statement on Form N-1A filed
on January 27, 1998.
(d) Form of Appendix B to Custodian Agreement between
Registrant and PNC Bank, National Association is
incorporated herein by reference to Exhibit 8(d) of
Post-Effective Amendment No. 37 to Registrant's
Registration Statement on Form N-1A filed on August 7,
1998.
(e) Sub-Custodian Agreement dated April 27, 1992 among the
Registrant, PNC Bank, National Association and The
Chase Manhattan Bank is incorporated herein by
reference to Exhibit (8)(e) of Post-Effective
Amendment No. 34 to Registrant's Registration
Statement on Form N-1A filed on February 13, 1998.
(f) Global Custody Agreement between Barclays Bank PLC and
PNC Bank, National Association dated October 28, 1992
is incorporated herein by reference to Exhibit (8)(f)
of Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(g) Custodian Agreement between State Street Bank and
Trust Company and PNC Bank, National Association dated
June 13, 1983 is incorporated herein by reference to
Exhibit (8)(g) of Post-Effective Amendment No. 34 to
C-12
<PAGE>
Registrant's Registration Statement on Form N-1A filed
on February 13, 1998.
(h) Amendment No. 1 to Custodian Agreement between State
Street Bank and Trust Company and PNC Bank, National
Association dated November 21, 1989 is incorporated
herein by reference to Exhibit (8)(h) of Post-
Effective Amendment No. 34 to Registrant's
Registration Statement on Form N-1A filed on February
13, 1998.
(i) Subcustodial Services Agreement dated January 10, 1996
between PNC Bank, National Association and Citibank,
N.A. is incorporated herein by reference to Exhibit
8(j) of Post-Effective Amendment No. 27 to
Registrant's Registration Statement on Form N-1A filed
on January 28, 1997.
(9) (a) Form of Administration Agreement among Registrant,
BlackRock Advisors, Inc. and PFPC Inc. is incorporated
herein by reference to Exhibit 9(a) of Post-Effective
Amendment No. 37 to Registrant's Registration
Statement on Form N-1A filed on August 7, 1998.
(b) Forms of Appendix A and Appendix B to Administration
Agreement among Registrant, BlackRock Advisors, Inc.
and PFPC Inc. is incorporated herein by reference to
Exhibit 9(b) of Post-Effective Amendment No. 37 to
Registrant's Registration Statement on Form N-1A filed
on August 7, 1998.
(c) Transfer Agency Agreement dated October 4, 1989
between Registrant and PFPC Inc. is incorporated
herein by reference to Exhibit (9)(e) of Post-
Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(d) Amendment No. 1 to Transfer Agency Agreement dated
October 4, 1989 between Registrant and PFPC Inc.
relating to the Tax-Free Income Portfolio is
incorporated herein by reference to Exhibit (9)(f) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(e) Amendment No. 2 to Transfer Agency Agreement dated
October 4, 1989 between Registrant and PFPC Inc.
C-13
<PAGE>
relating to the Pennsylvania Municipal Money Market,
Ohio Municipal Money Market, Intermediate Government,
Ohio Tax-Free Income, Pennsylvania Tax-Free Income,
Large Cap Value Equity, Index Equity and Small Cap
Value Equity Portfolios is incorporated herein by
reference to Exhibit (9)(g) of Post-Effective
Amendment No. 33 to Registrant's Registration
Statement on Form N-1A filed on January 27, 1998.
(f) Amendment No. 3 to Transfer Agency Agreement dated
October 4, 1989 between Registrant and PFPC Inc.
relating to the Short-Term Bond, Intermediate-Term
Bond, Core Equity, Small Cap Growth Equity and North
Carolina Municipal Money Market Portfolios is
incorporated herein by reference to Exhibit (9)(h) of
Post-Effective Amendment No. 33 to Registrant's
Registration Statement on Form N-1A filed on January
27, 1998.
(g) Amendment No. 4 to Transfer Agency Agreement dated
October 4, 1989 between Registrant and PFPC Inc.
relating to Series B Investor Shares of the Money
Market, Managed Income, Tax-Free Income, Intermediate
Government, Ohio Tax-Free Income, Pennsylvania Tax-
Free Income, Large Cap Value Equity, Large Cap Growth
Equity, Index Equity, Small Cap Value Equity,
Intermediate-Term Bond, Small Cap Growth Equity, Core
Equity, International Fixed Income, Government Income,
International Emerging Markets, International Equity
and Balanced Portfolios is incorporated herein by
reference to Exhibit (9)(i) of Post-Effective
Amendment No. 33 to Registrant's Registration
Statement on Form N-1A filed on January 27, 1998.
(h) Form of Appendix C to Transfer Agency Agreement
between Registrant and PFPC Inc. is incorporated
herein by reference to Exhibit 9(h) of Post-Effective
Amendment No. 37 to Registrant's Registration
Statement on Form N-1A filed on August 7, 1998.
(i) License Agreement dated as of December 1, 1995 between
the Registrant and Compass Capital Group, Inc. is
incorporated herein by reference to Exhibit 9(q) of
Post-Effective Amendment No. 27 to Registrant's
C-14
<PAGE>
Registration Statement on Form N-1A filed on January
28, 1997.
(j) Share Acquisition Agreement dated April 29, 1998 by
and among Registrant and PNC Bank, National
Association and PNC Bank, Delaware, respectively, each
as trustee for certain of the common trust funds
listed therein.
(10) None.
(11) Consent of PricewaterhouseCoopers LLP.
(12) None.
(13) (a) Form of Purchase Agreement between Registrant and
Registrant's distributor relating to Classes A-1, B-1,
C-1, D-2, E-2, F-2, G-2, H-2, I-1, I-2, J-1, J-2, K-2,
L-2, M-2, N-2, O-2, P-2, D-1, E-1, F-1, G-1, H-1, K-1,
L-1, M-1, N-1, O-1, P-1, A-2, B-2, C-2, I-2, J-2, A-3,
B-3, C-3, D-3, E-3, F-3, G-3, H-3, I-3, J-3, K-3, L-3,
M-3, N-3, O-3, P-3, Q-1, Q-2, Q-3, R-1, R-2, R-3, S-1,
S-2, S-3, T-1, T-2, T-3, U-1, U-2, U-3, A-4, D-4, E-4,
F-4, G-4, H-4, K-4, L-4, M-4, N-4, O-4, P-4, R-4, S-4,
T-4, U-4, W-4, X-4, Y-4, V-1, V-2, V-3, W-1, W-2, W-3,
X-1, X-2, X-3, Y-1, Y-2, Y-3, Z-1, Z-2, Z-3, AA-1, AA-
2, AA-3, AA-4, AA-5, BB-1, BB-2, BB-3, BB-4, BB-5, CC-
3, A-5, B-4, B-5, C-4, C-5, I-4, I-5, J-4, J-5, Q-4,
Q-5, V-4, V-5, Z-4, Z-5, X-1, X-3, D-5, E-5, F-5, G-5,
H-5, K-5, L-5, M-5, N-5, O-5, P-5, R-5, S-5, T-5, U-5,
W-5, X-5, Y-5, DD-1, DD-2, DD-3, DD-4, DD-5, EE-1, EE-
2, EE-3, EE-4, EE-5, R-6, BB-6, FF-3, GG-3, HH-1, HH-
2, HH-3, HH-4, HH-5, II-1, II-2, II-3, II-4, II-5, S-
6, JJ-1, JJ-2, JJ-3, JJ-4, JJ-5, KK-1, KK-2, KK-3, KK-
4, KK-5, LL-1, LL-2, LL-3, LL-4 and LL-5 is
incorporated herein by reference to Exhibit (13)(a) of
Post-Effective Amendment No. 34 to Registrant's
Registration Statement on Form N-1A filed on February
13, 1998.
(b) Form of Purchase Agreement between Registrant and
Registrant's distributor relating to Classes MM-1, MM-
2, MM-3, MM-4, MM-5 and MM-6 is incorporated herein by
reference to Exhibit 13(b) of Post-Effective Amendment
No. 37 to Registrant's Registration Statement on Form
N-1A filed on August 7, 1998.
C-15
<PAGE>
(14) None.
(15) (a) Amended and Restated Distribution and Service Plan for
Service, Series A Investor, Series B Investor, Series
C Investor, Institutional and BlackRock Shares is
incorporated herein by reference to Exhibit (15) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(b) Form of Appendix A to Amended and Restated
Distribution and Service Plan is incorporated herein
by reference to Exhibit 15(b) of Post-Effective
Amendment No. 37 to Registrant's Registration
Statement on Form N-1A filed on August 7, 1998.
(16) Schedules for computation of performance quotations
are incorporated herein by reference to Exhibit (16)
of Post-Effective Amendment No. 34 to Registrant's
Registration Statement on Form N-1A filed on February
13, 1998.
(17) Financial Data Schedules are filed herewith.
(18) Amended and Restated Plan Pursuant to Rule 18f-3 for
Operation of a Multi-Class Distribution System is
incorporated herein by reference to Exhibit (18) of
Post-Effective Amendment No. 21 to Registrant's
Registration Statement on Form N-1A filed on May 30,
1996.
(24) (a) Registrant's Annual Reports for the Money Market,
Equity and Bond Portfolios, each dated September 30,
1997, are incorporated herein by reference to
Registrant's filings including such Annual Reports
filed on December 5, 1997 with respect to the Money
Market Portfolios (Accession No. 0000935069-97-
000209), and December 9, 1997 with respect to the
Equity and Bond Portfolios (Accession Nos. 0000935069-
97-000210 and 0000935069-97-000211).
(b) Registrant's Annual Report for the Multi-Sector
Mortgage Securities Portfolio III, dated September 30,
1998, is incorporated herein by reference to
Registrant's filing
C-16
<PAGE>
including such Annual Report filed on November 20,
1998 (Accession No. 0000930413-98-000993).
(c) Registrant's Annual Report for the BlackRock Strategic
Portfolio I, dated September 30, 1998, is incorporated
herein by reference to Registrant's filing including
such Annual Report filed on November 20, 1998
(Accession No. 0000935069-98-000212).
(d) Annual Report for The DFA Investment Trust Company
("DFA") (File No. 811-7436) dated November 30, 1997
with respect to the U.S. Large Company Series is
incorporated herein by reference to DFA's filing
including such Annual Report and filed on February 5,
1998 (Accession No. 0001047469-98-003623).
(99) (a) Power of Attorney of David R. Wilmerding dated March
5, 1996 appointing David R. Wilmerding, Raymond J.
Clark and Karen H. Sabath as attorneys and agents is
incorporated herein by reference to such Power of
Attorney filed in Post-Effective Amendment No. 28 to
Registrant's Registration Statement on form N-1A filed
on February 18, 1997.
(b) Power of Attorney of William O. Albertini dated March
5, 1996 appointing David R. Wilmerding, Raymond J.
Clark and Karen H. Sabath as attorneys and agents is
incorporated herein by reference to such Power of
Attorney filed in Post-Effective Amendment No. 28 to
Registrant's Registration Statement on form N-1A filed
on February 18, 1997.
(c) Power of Attorney of Raymond J. Clark dated March 5,
1996 appointing David R. Wilmerding, Raymond J. Clark
and Karen H. Sabath as attorneys and agents is
incorporated herein by reference to such Power of
Attorney filed in Post-Effective Amendment No. 28 to
Registrant's Registration Statement on form N-1A filed
on February 18, 1997.
(d) Power of Attorney of Robert M. Hernandez dated March
5, 1996 appointing David R. Wilmerding, Raymond J.
Clark and Karen H. Sabath as attorneys and agents is
incorporated herein by reference to such Power of
Attorney filed in Post-Effective Amendment No. 28 to
C-17
<PAGE>
Registrant's Registration Statement on form N-1A filed
on February 18, 1997.
(e) Power of Attorney of Anthony M. Santomero dated March
5, 1996 appointing David R. Wilmerding, Raymond J.
Clark and Karen H. Sabath as attorneys and agents is
incorporated herein by reference to such Power of
Attorney filed in Post-Effective Amendment No. 28 to
Registrant's Registration Statement on form N-1A filed
on February 18, 1997.
Item 25. Persons Controlled by or under Common Control with Registrant
Registrant is controlled by its Board of Trustees.
Item 26. Number of Holders of Securities
With regard to the classes of shares of the Registrant, the following
information is as of September 30, 1998:
<TABLE>
<CAPTION>
Portfolio Institutional Service Investor A Investor B Investor C
- --------- ------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Money Market 24 388 897 94 5
US Treasury Money Market 4 134 80 N/A N/A
Municipal Money Market 2 42 7 N/A 6
Ohio Municipal Money Market 9 3 4 N/A N/A
Pennsylvania Municipal Money Market 28 31 39 N/A N/A
North Carolina Municipal 14 4 8 N/A N/A
Money Market
New Jersey Municipal Money Market 10 57 19 2 N/A
Virginia Municipal Money Market 12 2 3 N/A N/A
Managed Income 33 11 898 271 N/A
Tax-Free Income 14 68 228 78 6
Ohio Tax-Free Income 4 2 113 35 2
Pennsylvania Tax-Free Income 5 59 1,235 541 1
New Jersey Tax-Free Income 1 869 44 31 N/A
Low Duration Bond 21 446 85 4 3
Low Duration Bond/BlackRock Class 10 N/A N/A N/A N/A
Intermediate Bond 14 1,486 113 21 N/A
Intermediate Bond/BlackRock Class 2 N/A N/A N/A N/A
</TABLE>
C-18
<PAGE>
<TABLE>
<CAPTION>
Portfolio Institutional Service Investor A Investor B Investor C
- --------- ------------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Core Bond 26 512 260 759 17
Core Bond/BlackRock Class 7 N/A N/A N/A N/A
Intermediate Government 18 3 340 6 2
Government Income N/A N/A 321 1,233 28
International Bond 7 80 117 115 55
GNMA 4 1 10 7 1
Kentucky Tax-Free Income 5 1 3 1 1
Delaware Tax-Free Income 4 1 38 42 3
International Emerging Markets 16 15 884 384 2
Large Cap Growth Equity 30 420 2,449 1,688 52
Index Equity 24 548 2,658 5,418 2,125
Small Cap Value Equity 72 254 4,135 3,326 187
International Equity 30 346 2,903 1,439 16
International Small Cap Equity 4 2 169 168 8
Balanced 16 87 6,803 3,876 15
Large Cap Value Equity 61 4,165 3,985 3,606 70
Small Cap Growth Equity 193 515 6,078 5,190 455
Select Equity 36 12 3,340 4,518 72
Mid-Cap Value Equity 24 7 935 1,556 43
Mid-Cap Growth Equity 19 9 759 940 29
Micro-Cap Equity 4 5 886 923 124
Multi-Sector Mortgage 2 N/A N/A N/A N/A
Securities III
BlackRock Strategic I 13 N/A N/A N/A N/A
BlackRock Strategic II 0 N/A N/A N/A N/A
</TABLE>
Item 27. Indemnification
Indemnification of Registrant's principal underwriter against certain
losses is provided for in Section 7 of the Distribution Agreement incorporated
by reference herein as Exhibit (6)(a). Indemnification of Registrant's
Custodian and Transfer Agent is provided for, respectively, in Section 22 of the
Custodian Agreement incorporated by reference herein as Exhibit 8(a) and Section
17 of the Transfer Agency Agreement incorporated by reference herein as Exhibit
9(c). Registrant intends to obtain from a major insurance carrier a trustees'
and officers' liability policy covering certain types of errors and omissions.
In addition, Section 9.3
C-19
<PAGE>
of the Registrant's Declaration of Trust incorporated by reference herein as
Exhibit 1(a) provides as follows:
Indemnification of Trustees, Officers, Representatives and Employees.
--------------------------------------------------------------------
The Trust shall indemnify each of its Trustees against all liabilities and
expenses (including amounts paid in satisfaction of judgments, in
compromise, as fines and penalties, and as counsel fees) reasonably incurred
by him in connection with the defense or disposition of any action, suit or
other proceeding, whether civil or criminal, in which he may be involved or
with which he may be threatened, while as a Trustee or thereafter, by reason
of his being or having been such a Trustee except with respect to any matter
------
as to which he shall have been adjudicated to have acted in bad faith,
willful misfeasance, gross negligence or reckless disregard of his duties,
provided that as to any matter disposed of by a compromise payment by such
--------
person, pursuant to a consent decree or otherwise, no indemnification either
for said payment or for any other expenses shall be provided unless the
Trust shall have received a written opinion from independent legal counsel
approved by the Trustees to the effect that if either the matter of willful
misfeasance, gross negligence or reckless disregard of duty, or the matter
of bad faith had been adjudicated, it would in the opinion of such counsel
have been adjudicated in favor of such person. The rights accruing to any
person under these provisions shall not exclude any other right to which he
may be lawfully entitled, provided that no person may satisfy any right of
--------
indemnity or reimbursement hereunder except out of the property of the
Trust. The Trustees may make advance payments in connection with the
indemnification under this Section 9.3, provided that the indemnified person
--------
shall have given a written undertaking to reimburse the Trust in the event
it is subsequently determined that he is not entitled to such
indemnification.
The Trustee shall indemnify officers, representatives and employees of
the Trust to the same extent that Trustees are entitled to indemnification
pursuant to this Section 9.3.
Insofar as indemnification for liability arising under the Securities
Act of 1933 may be permitted to trustees, officers and controlling persons of
Registrant pursuant to the foregoing provisions, or otherwise, Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by Registrant of expenses incurred or
paid by a trustee, officer or controlling person of Registrant in the successful
defense of any action, suit or proceeding) is asserted by such trustee, officer
or controlling person in connection with the securities being registered,
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
C-20
<PAGE>
Section 9.6 of the Registrant's Declaration of Trust, filed herein as
Exhibit 1(a), also provides for the indemnification of shareholders of the
Registrant. Section 9.6 states as follows:
Indemnification of Shareholders. In case any Shareholder or former
-------------------------------
Shareholder shall be held to be personally liable solely by reason of his
being or having been a Shareholder and not because of his acts or omissions
or for some other reason, the Shareholder or former Shareholder (or his
heirs, executors, administrators or other legal representatives or, in the
case of a corporation or other entity, its corporate or other general
successor) shall be entitled out of the assets belonging to the classes of
Shares with the same alphabetical designation as that of the Shares owned by
such Shareholder to be held harmless from and indemnified against all loss
and expense arising from such liability. The Trust shall, upon request by
the Shareholder, assume the defense of any claim made against any
Shareholder for any act or obligations of the Trust and satisfy any judgment
thereon from such assets.
Item 28. Business and Other Connections of Investment Advisers
(a) BlackRock Advisors, Inc. (formerly BlackRock, Inc.) is an indirect
wholly-owned subsidiary of PNC Bank Corp. BlackRock Advisors, Inc. was
organized in 1994 for the purpose of providing advisory services to investment
companies. The list required by this Item 28 of officers and directors of
BlackRock Advisors, Inc., together with information as to any other business,
profession, vocation or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated by reference
to Schedules A and D of Form ADV, filed by BlackRock Advisors, Inc. pursuant to
the Investment Advisers Act of 1940 (SEC File No. 801-47710).
(b) BlackRock Institutional Management Corporation (formerly PNC
Institutional Management Corporation) ("BIMC") is an indirect wholly-owned
subsidiary of PNC Bank Corp. The list required by this Item 28 of officers and
directors of BIMC, together with information as to any other business,
profession, vocation or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated by reference
to Schedules A and D of Form ADV, filed by BIMC pursuant to the Investment
Advisers Act of 1940 (SEC File No. 801-13304).
(c) BlackRock Financial Management, Inc. ("BlackRock") is an indirect
wholly-owned subsidiary of PNC Bank Corp. BlackRock currently offers investment
advisory services to institutional investors such as pension and profit-sharing
plans or trusts, insurance companies and banks. The list required by this Item
28 of officers and directors of BlackRock, together with information as to any
other business, profession, vocation or employment of a substantial nature
engaged in by such officers and directors during the past two years, is
incorporated by reference to Schedules A and D of Form ADV, filed by BlackRock
pursuant to the Investment Advisers Act of 1940 (SEC File No. 801-48433).
C-21
<PAGE>
(d) BlackRock International, Ltd. (formerly CastleInternational Asset
Management Limited) ("BIL") is an indirect wholly-owned subsidiary of PNC Bank
Corp. The list required by this Item 28 of officers and directors of BIL,
together with information as to any other business, profession, vocation or
employment of a substantial nature engaged in by such officers and directors
during the past two years, is incorporated by reference to Schedules A and D of
Form ADV, filed by BIL pursuant to the Investment Advisers Act of 1940 (SEC File
No. 801-51087).
Item 29. Principal Underwriter
(a) Not applicable.
(b) The information required by this Item 29 with respect to each
director, officer or partner of BlackRock Distributors, Inc. (formerly Compass
Distributors, Inc.) is incorporated by reference to Schedule A of FORM BD filed
by BlackRock Distributors, Inc. with the Securities and Exchange Commission
pursuant to the Securities Exchange Act of 1934 (File No. 8-48775).
(c) Not applicable.
Item 30. Location of Accounts and Records
(1) PNC Bank, National Association, Broad and Chestnut Streets,
Philadelphia, Pennsylvania 19102 (records relating to its
functions as custodian).
(2) BlackRock Distributors, Inc., Four Falls Corporate Center,
6th Floor, West Conshohocken, PA 19428-2961 (records
relating to its functions as distributor).
(3) BlackRock Advisors, Inc. (formerly BlackRock, Inc.), 345
Park Avenue, New York, New York 10154 (records relating to
its functions as investment adviser and co-administrator).
(4) BlackRock Institutional Management Corporation (formerly PNC
Institutional Management Corporation), Bellevue Corporate
Center, 103 Bellevue Parkway, Wilmington, Delaware 19809
(records relating to its functions as investment sub-
adviser).
(5) BlackRock Financial Management, Inc., 345 Park Avenue, New
York, New York 10154; 30 South 17th Street, Philadelphia,
Pennsylvania 19103; and 1600 Market Street, 29th Floor,
C-22
<PAGE>
Philadelphia, Pennsylvania 19103 (records relating to its
functions as investment adviser and sub-adviser).
(6) PFPC Inc., Bellevue Corporate Center, 400 Bellevue Parkway,
Wilmington, Delaware 19809 (records relating to its
functions as co-administrator, transfer agent and dividend
disbursing agent).
(7) The Chase Manhattan Bank, N.A., 1285 Avenue of the Americas,
New York, New York 10019 (records relating to its function
as sub-custodian).
(8) State Street Bank and Trust Company, P.O. Box 1631, Boston,
Massachusetts (records relating to its function as sub-
custodian).
(9) Barclays Bank PLC, 75 Wall Street, New York, New York 10265
(records relating to its function as sub-custodian).
(10) BlackRock International, Ltd. (formerly CastleInternational
Asset Management Limited), 7 Castle Street, Edinburgh,
Scotland, EH2 3AH (records relating to its functions as
investment sub-adviser).
(11) Citibank, N.A., 111 Wall Street, 23rd Floor, Zone 6, New
York, NY 10043 (records relating to its functions as sub-
custodian).
(12) PNC Bank Corp., 1600 Market Street, 28th Floor,
Philadelphia, PA 19103 (Registrant's declaration of trust,
code of regulations and minute books).
Item 31. Management Services
None.
Item 32. Undertakings
(a) Registrant undertakes to furnish each person to whom a prospectus is
delivered with a copy of Registrant's latest annual report to
shareholders upon request and without charge.
C-23
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Post-Effective Amendment to its
Registration Statement pursuant to Rule 485(b) under the Securities Act of 1933
and has duly caused this Post-Effective Amendment to its Registration Statement
to be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York and the State of New York on the 25th day of November,
1998.
BLACKROCK FUNDS(SM)
Registrant
By /S/ Raymond J. Clark
---------------------------------
Raymond J. Clark,
President and Treasurer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Act of 1933, this Post-
Effective Amendment to the Registration Statement has been signed by the
following persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/S/ Raymond J. Clark Trustee, President and
- ------------------------- Treasurer November 25, 1998
(Raymond J. Clark)
*David R. Wilmerding, Jr. Chairman of the Board November 25, 1998
- -------------------------
(David R. Wilmerding, Jr.)
*Anthony M. Santomero Vice-Chairman of the
- ------------------------- Board November 25, 1998
(Anthony M. Santomero)
*William O. Albertini Trustee November 25, 1998
- -------------------------
(William O. Albertini)
*Robert M. Hernandez Trustee November 25, 1998
- -------------------------
(Robert M. Hernandez)
</TABLE>
*By: /S/ Karen H. Sabath
--------------------------------------
Karen H. Sabath, Attorney-in-fact
C-24
<PAGE>
EXHIBIT INDEX
-------------
Exhibit No. Description
- ----------- -----------
11 Consent of PricewaterhouseCoopers LLP.
17 Financial Data Schedules.
<PAGE>
EXHIBIT 99.11
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference of the following reports in this
Post-Effective Amendment No. 39 under the Securities Act of 1933, as amended, to
this Registration Statement on Form N-1A (No. 33-26305) of BlackRock Funds:
* Our report dated November 13, 1998 for the Multi-Sector Mortgage
Securities Portfolio III.
* Our report dated November 13, 1998 for the BlackRock Strategic
Portfolio I.
We consent to the reference to our Firm under the headings "Miscellaneous -
Independent Accountants" and "Financial Statements" in the Statement of
Additional Information.
/s/ PricewaterhouseCoopers LLP
- ------------------------------
PricewaterhouseCoopers LLP
2400 Eleven Penn Center
Philadelphia, Pennsylvania
November 20, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 001
<NAME> STRATEGIC PORTFOLIO I
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-06-1997
<PERIOD-END> SEP-30-1998
<INVESTMENTS-AT-COST> 29,685,846
<INVESTMENTS-AT-VALUE> 31,033,351
<RECEIVABLES> 785,346
<ASSETS-OTHER> (4,113)
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 31,814,584
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 160,674
<TOTAL-LIABILITIES> 160,674
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 30,281,802
<SHARES-COMMON-STOCK> 3,025,180
<SHARES-COMMON-PRIOR> 0
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 31,753
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 1,340,355
<NET-ASSETS> 31,653,910
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 1,608,792
<OTHER-INCOME> 0
<EXPENSES-NET> 74,946
<NET-INVESTMENT-INCOME> 1,533,846
<REALIZED-GAINS-CURRENT> 166,753
<APPREC-INCREASE-CURRENT> 1,340,355
<NET-CHANGE-FROM-OPS> 3,040,954
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 1,668,846
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 2,870,975
<NUMBER-OF-SHARES-REDEEMED> 0
<SHARES-REINVESTED> 154,205
<NET-CHANGE-IN-ASSETS> 31,653,910
<ACCUMULATED-NII-PRIOR> 0
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 56,922
<INTEREST-EXPENSE> 954
<GROSS-EXPENSE> 171,300
<AVERAGE-NET-ASSETS> 28,461,072
<PER-SHARE-NAV-BEGIN> 10.00
<PER-SHARE-NII> 0.51
<PER-SHARE-GAIN-APPREC> 0.50
<PER-SHARE-DIVIDEND> (0.55)
<PER-SHARE-DISTRIBUTIONS> 0.00
<RETURNS-OF-CAPITAL> 0.00
<PER-SHARE-NAV-END> 10.46
<EXPENSE-RATIO> 0.26
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 6
<SERIES>
<NUMBER> 002
<NAME> MULTI SECTOR MORTGAGE SECURITIES III
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> SEP-30-1998
<INVESTMENTS-AT-COST> 45,648,867
<INVESTMENTS-AT-VALUE> 46,578,321
<RECEIVABLES> 318,430
<ASSETS-OTHER> 22,344
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 46,919,095
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> 318,643
<TOTAL-LIABILITIES> 318,643
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 41,197,662
<SHARES-COMMON-STOCK> 44,114
<SHARES-COMMON-PRIOR> 114,781
<ACCUMULATED-NII-CURRENT> 0
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 3,952,128
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 1,450,661
<NET-ASSETS> 46,600,452
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 6,005,315
<OTHER-INCOME> 0
<EXPENSES-NET> 290,493
<NET-INVESTMENT-INCOME> 5,714,822
<REALIZED-GAINS-CURRENT> 4,322,510
<APPREC-INCREASE-CURRENT> (3,353,003)
<NET-CHANGE-FROM-OPS> 6,684,330
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (5,714,822)
<DISTRIBUTIONS-OF-GAINS> (1,765,966)
<DISTRIBUTIONS-OTHER> 0
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 78,300
<SHARES-REINVESTED> 7,633
<NET-CHANGE-IN-ASSETS> (74,650,486)
<ACCUMULATED-NII-PRIOR> 0,633
<ACCUMULATED-GAINS-PRIOR> 1,395,583
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 4,803,664
<GROSS-ADVISORY-FEES> 196,279
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 475,279
<AVERAGE-NET-ASSETS> 78,511,570
<PER-SHARE-NAV-BEGIN> 1,056.37
<PER-SHARE-NII> 74.41
<PER-SHARE-GAIN-APPREC> 15.26
<PER-SHARE-DIVIDEND> (74.41)
<PER-SHARE-DISTRIBUTIONS> (15.26)
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 1,056.37
<EXPENSE-RATIO> 0.61
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
